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Chapter - v
DISSOLUTION OF PARTNERSHIP FIRM
Insolvency
of partnership if any partner becomes and his account shows a debit balance, then the solvent
partners have to share such loss.
But the problem arises as to the ratio of sharing such loss due to the insolvency of partner by
the solvent partners. The solvent partners may share such deficiency in the following ways:


In their profit sharing ratio (like any other business losses)
In the ratio of their last agreed capitals (as decided by Garner Vs Murray)
Garner Vs Murray decision (1904)
As per Garner Vs Murray decision, in the absence of any agreement to the contrary, the loss
due to the insolvency of a partner should be borne by the solvent partner’s in the ratio of their
capitals. The capital for the purpose means the agreed capital or capital standing just prior to
the time of dissolution.
The agreed capital or capital standing just prior to the time of dissolution should be
interpreted as under:
Case
a. In case of fluctuating capitals
b. In case of fixed capitals
Meaning of last agreed capitals
Agreed capitals means the capital after
adjustments for past accumulated reserves,
profit & losses , drawings, interest on
capitals, interest on drawings, remuneration
to a partner etc. To the date of dissolution but
before making adjustment for profit & loss
on realisation
Agreed capital means the fixed capital
without any adjustment (given in the balance
sheet)
Practical guidelines in case of insolvency of a partner according to the decision in Garner Vs
Murray.
a. Realisation account should be prepared in the usual manner and its profit or loss
should be transferred to the capital accounts of all partners in the profit sharing ratio.
b. Solvent partners should bring in cash equal to their respective shares of the loss (if
any) on realisation.
c. The ratio of the last agreed capitals of the solvent partners should be calculated.
d. If any amount is received from the private estate of an insolvent partner, it should be
credited to his capital account.
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e. The unrecovered debit balance after making all adjustments (including the share of
any profit or loss on realisation be transferred to the capital accounts of the solvent
partners ), in the ratio of their Last Agreed Capitals (step c).
When all partners are insolvent
The realisation account is prepared in usual manner, but the external liabilities such as
creditors, bills payable etc, will not be transferred to this account as they cannot be paid in
full. Any available cash balance is utilised for the payment of liabilities and unpaid
portion is transferred to the ‘deficiency account.’ Any deficiency in the capital accounts
also be transferred to the deficiency account, to get it closed.
Gradual realisation of assets and piecemeal distribution
In the actual practice the sale of assets and realisation of liabilities immediately after
dissolution is unrealistic. In process of assets are sold one after another to get maximum
amount. But creditors & partners could not wait until last realisation. Interim payments are
made to them whenever assets realised.
But one problem arise is the profit or loss on realisation can be determined only after the
completing the realisation process. And no partners have to be overpaid or underpaid. i.e., if a
partner is paid more than his balance due and he becomes insolvent then excess amount
cannot be recovered from him.
Therefore, a method called piecemeal is followed to make payments to the partners in a
proper manner. I.e., no partner is paid more than actual amount due to him and unpaid
amount will be in their profit sharing ratio.
 Distribute the amount available on realisation on the basis of priority
a.
b.
c.
d.
e.
Priority for distribution
Realisation expenses
Preferential creditors
Creditors/liabilities to third parties
Partner’s loans
Partner’s capital
Methods of piecemeal distribution
i.
ii.
Proportionate capital method
Maximum loss or notional loss method
Proportionate capital method

Calculate the balances of partners capital accounts( after making adjustments for reserves ,
accumulated profit , profit and loss balance etc ) distribute it to partners in profit sharing ratio.

After distribution of realisation amount to third party next comes the partners capital
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
If the partners capital are their profit sharing ratio, then the realisation amount is to be paid
in that ratio

If the partners capital is not in the ratio ,then following steps are considered
 Take
smallest capital as base capital and calculate the proportionate capital by
multiplying the base capital and profit sharing ratio.
For eg: suppose A, B, C is partners with profit sharing ratio 2:2:1 and their capital
balances is as follows: A – 16,000
B – 12,000
C-5,000
Here smallest amt of capital is C’s capital i.e. 5000 take this as base capital and
multiply the remaining partners ratio with this base.(2:2:1)
A -5000 X 2 = 10,000 B – 5000 X 2 = 10,000
C- 5000 X 1 = 5000
Proportionate capitals = 10,000 : 10,000: 5,000
 Calculate the surplus amount by deducting proportionate capital from actual capital
A – 16000 – 10000 = 6000
B – 12000 – 10000 = 2000
C – 5000 – 5000 = 0
 If one partner has the surplus capital, make payment to him first. If there are 2 or
more partners and their surplus is:
In profit sharing ratio – distribute the cash in their profit sharing ratio till such
surplus is paid off
Not in profit sharing ratio – make it in profit sharing ratio first for that divide the
surplus capital by profit sharing ratio and treat smallest as revised base capital and
then divide the amount.
In the above given example A’s surplus 6000 is more than B’s -2000 so first make
them in ratio. Hence they are equal partners make their capitals equal i.e. first pay
4000 to A so balance of A & B will become equal.
 Once the partners balance due reaches at the proportionate capital then distribute
the amount in their profit sharing ratio and the balance remaining at the end of all
realisation is realisation loss.
Maximum loss or notional loss method
Steps
1. Calculate the partners capital ratio just before the date of dissolution
2. Calculate the balances of partners capital accounts( after making adjustments for reserves ,
accumulated profit , profit and loss balance etc ) distribute it to partners in profit sharing
ratio.
3. After distribution of realisation amount to third party next comes the partners capital
4. Calculate the maximum loss in the assumption that it is a last realisation and remaining
assets will realise nothing.
 Maximum loss=Total of balances of partners capital account less cash available for
realisation
5. Then distribute the maximum loss (step 5) among the partners in profit sharing ratio.
6. If capital account shows
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 No negative balances (Dr balances)- distribute the cash available to the partners in
their profit sharing ratio
 If any capital account shows a negative balance (dr balance) then that particular
partner is treated as insolvent and remaining partners(having cr balance) have to
share the loss in their capital ratio (step 1).(application of Garner Vs Murray
ruling).repeat this till negative balances is abolished.