Dissolution of a Firm

Dissolution of a Firm: Meaning

Dissolution of a firm is the process of winding up the affairs of a business that has reached the end of its life. It is the termination of a business entity and the cessation of its commercial and legal existence. It is the final stage of liquidation of a business.

Modes of Dissolution: 

Dissolution of a firm may be voluntary or involuntary. Voluntary dissolution is when the partners take an affirmative action to dissolve the firm, while involuntary dissolution is when the firm is dissolved by law due to breach of contract, fraud, insolvency or death of a partner.

Settlement of Accounts: 

• Settlement of accounts is the process of determining the exact position of the firm in terms of its assets and liabilities. 
• It involves the determination of the capital, profit and losses of the firm. 
• This is done by ascertaining the value of the assets of the firm, deducting its liabilities and then dividing the net amount among the partners in accordance with their profit-sharing ratio.

Accounting Treatment For Dissolution of a Firm: 

• On dissolution, the assets of the firm are sold and its liabilities are paid off. 
• The net proceeds from the sale of assets are then divided among the partners in accordance with their profit-sharing ratio. 
• All the assets and liabilities should be accounted for in the books of the firm and the profits or losses arising out of the dissolution should be recorded.

Insolvency of a Partner: 

Insolvency of a partner is a situation where a partner is unable to pay his/her share of the debts of the firm. In such a case, the other partners will have to bear the losses arising out of the insolvency of the partner.

Insolvency of all the Partners: 

Insolvency of all the partners is a situation where all the partners are unable to pay their share of the debts of the firm. In such a case, the creditors of the firm will have to bear the losses arising out of the insolvency of the partners.

Accounting Treatment: 

In such a situation, the assets of the firm should be sold and the proceeds should be used to pay off the creditors of the firm. The remaining amount should be divided among the partners in accordance with their profit-sharing ratio.

Piecemeal Distribution: 

• Piecemeal distribution is a method of distributing the assets of the firm among the partners. 
• In this method, the assets are divided into parts and each part is distributed among the partners in accordance with their profit-sharing ratio.

Methods: 

There are two methods of distribution: Proportionate Capital Method and Maximum Loss Method.

Proportionate Capital Method: 

Under this method, the assets of the firm are divided into parts and each part is distributed among the partners in proportion to their capitals.

Maximum Loss Method: 

Under this method, the assets of the firm are divided into parts and each part is distributed among the partners in such a way that the maximum loss is suffered by the partner who is withdrawing from the firm.