Lesson 2 — Partnership Dissolution | A Level Accounting

📘 Lesson 2 of 20

10% complete Paper 1 Paper 3

1. What is Partnership Dissolution? 9706 / 2.3

A partnership is dissolved (wound up) when it ceases to trade. All assets are sold, all liabilities are settled, and any remaining cash is distributed to the partners in settlement of their capital balances. The process must be recorded carefully to ensure every partner receives exactly what they are owed — no more, no less.

Dissolution vs Retirement: When a partner retires, the partnership continues — only the structure changes. When a partnership is dissolved, the business ceases to exist entirely. All assets are realised (sold), all debts are paid, and the partnership is wound up.

The Four Accounts Used in Dissolution

1. Realisation Account

Records the disposal of all assets and settlement of liabilities. The balancing figure is the profit or loss on realisation — shared among partners in the profit-sharing ratio.

2. Cash / Bank Account

Records all cash movements — proceeds from asset sales, payments to creditors, expenses of dissolution, and final payments to partners.

3. Partners' Capital Accounts

Receive their share of realisation profit/loss. Final balance = amount payable to / receivable from each partner.

4. Partners' Current Accounts

Transferred (combined) into Capital Accounts at the start of dissolution to simplify the process.

Order of Events in Dissolution

Combine
Current Accounts
into Capital A/cs

→

Open
Realisation
Account

→

Sell Assets
& Pay
Liabilities

→

Share Profit
or Loss on
Realisation

→

Pay Partners
Final Capital
Balances

2. The Realisation Account Core Topic

The Realisation Account is the central account in dissolution. It collects all assets (at book value), records the proceeds received, and captures any costs of dissolution. The balancing figure is the profit or loss on realisation.

Realisation Account — What Goes on Each Side

DR Side: All asset book values transferred in + Dissolution expenses + Any liabilities taken over by partners CR Side: Sale proceeds from assets + Liabilities settled (book value) + Assets taken by partners (agreed value) + Discount received on settling liabilities If CR > DR → Profit on Realisation → DR Realisation A/c, CR Partners' Capital A/cs (profit-sharing ratio) If DR > CR → Loss on Realisation → DR Partners' Capital A/cs, CR Realisation A/c (profit-sharing ratio)

📌 Important Rules:
• Assets are transferred to the Realisation Account at their net book value (not cost — accumulated depreciation has already reduced the book value).
• The Provision for Doubtful Debts is not transferred separately — only the net receivables figure goes to the Realisation Account.
• Liabilities are settled at their book value unless a discount is received.
• If a partner takes over an asset personally, their Capital Account is debited with the agreed value.

Proforma — Realisation Account

Realisation Account

Details	$
Non-Current Assets (NBV)	X
Inventory (book value)	X
Trade Receivables (net)	X
Bank / Cash (opening balance)	X
Dissolution expenses	X
Partners' Capital A/cs (profit share)	X
Total	X

Details	$
Trade Payables (book value)	X
Proceeds from asset sales	X
Assets taken by partners (agreed value)	X
Discount received on liabilities	X
Partners' Capital A/cs (loss share)	X
Total	X

3. Full Worked Example — Normal Dissolution

📋 Example 1: Dissolution of Ali and Bilal Partnership

Ali and Bilal are partners sharing profits 3:2. They dissolve the partnership on 31 December 2026. The Statement of Financial Position immediately before dissolution is:

Assets	$
Premises (NBV)	60,000
Equipment (NBV)	15,000
Inventory	8,000
Trade Receivables (net)	6,500
Bank	2,000
Total Assets	91,500

Liabilities & Capital	$
Trade Payables	9,000
Loan — Ali	5,000
Capital — Ali	46,500
Capital — Bilal	31,000
Total	91,500

Realisation proceeds and settlements:

Premises sold for $75,000
Equipment sold for $12,000
Inventory sold for $6,800
Trade Receivables — $5,800 collected; $700 irrecoverable
Trade Payables settled for $8,500 (discount received $500)
Dissolution expenses paid: $1,200
Ali's loan repaid in full

Step 1 — Realisation Account

Realisation Account

Details	$
Premises (NBV)	60,000
Equipment (NBV)	15,000
Inventory	8,000
Trade Receivables (net)	6,500
Bank (opening)	2,000
Dissolution expenses	1,200
Trade Payables (book value)	9,000
Profit on Realisation (balancing)	8,600
Total	110,300

Details	$
Proceeds — Premises	75,000
Proceeds — Equipment	12,000
Proceeds — Inventory	6,800
Cash collected — Receivables	5,800
Discount on Payables	500
Cash paid for Payables	8,500
Dissolution expenses paid	1,200
Bank (opening)	500
Total	110,300

Profit on Realisation = $8,600
Shared: Ali (3/5 × 8,600 = $5,160) | Bilal (2/5 × 8,600 = $3,440)

Step 2 — Partners' Capital Accounts

Partners' Capital Accounts

Details	Ali ($)	Bilal ($)
Cash — final payment	51,660	34,440
Total	51,660	34,440

Details	Ali ($)	Bilal ($)
Balance b/d (opening capital)	46,500	31,000
Profit on Realisation	5,160	3,440
Total	51,660	34,440

Step 3 — Cash / Bank Account (Verification)

Bank Account

DR — Receipts

CR — Payments

Details	$
Balance b/d	2,000
Premises proceeds	75,000
Equipment proceeds	12,000
Inventory proceeds	6,800
Receivables collected	5,800
Total	101,600

Details	$
Trade Payables	8,500
Loan — Ali	5,000
Dissolution expenses	1,200
Capital — Ali	51,660
Capital — Bilal	34,440
Balance c/d	800
Total	101,600

💡 Always prepare the Bank Account as a check. Total cash in must equal total cash out. If a small balance remains it indicates a rounding difference or an error — investigate before concluding. In a well-set exam question, the Bank Account will close to nil.

4. Capital Deficiency Exam Focus

A capital deficiency arises when a partner's Capital Account has a debit balance after sharing the loss on realisation — meaning that partner owes money to the firm (their losses exceed their capital investment). This is one of the most commonly examined and commonly mishandled topics in dissolution.

⚠️ What Causes a Capital Deficiency?

Partner's Opening Capital + Current Account balance − Share of Realisation Loss = Negative balance

If the loss on realisation is so large that it wipes out a partner's entire capital, that partner has a debit balance on their Capital Account. They must pay this into the partnership in cash — but if they cannot (insolvent partner), the other partners must absorb the loss.

Two Situations — Solvent vs Insolvent Deficient Partner

Situation A — Deficient Partner Can Pay

The partner with the debit balance pays the amount into the partnership bank account. Their Capital Account is then cleared. Final payments to the remaining partners proceed normally.

Entry: DR Bank | CR Capital Account (deficient partner)

Situation B — Deficient Partner Cannot Pay

The deficient partner is insolvent and cannot contribute. The other partners must absorb the shortfall. This is dealt with using the Garner v Murray rule.

The shortfall is borne by the remaining solvent partners in proportion to their last agreed capital balances.

📋 Example 2: Capital Deficiency — Deficient Partner Can Pay

Omar, Zara and Hina share profits 2:2:1. On dissolution, the loss on realisation is $40,000. Capital balances before sharing the loss:

Partner	Capital Before Loss ($)
Omar	18,000
Zara	12,000
Hina	4,000

Share of loss:
Omar: 2/5 × 40,000 = $16,000 | Zara: 2/5 × 40,000 = $16,000 | Hina: 1/5 × 40,000 = $8,000

Partner	Capital ($)	Share of Loss ($)	Closing Balance ($)
Omar	18,000	(16,000)	2,000 CR
Zara	12,000	(16,000)	(4,000) DR ⚠️
Hina	4,000	(8,000)	(4,000) DR ⚠️

Both Zara and Hina have capital deficiencies of $4,000 each. If both can pay: they each pay $4,000 into the bank. Omar then receives his remaining capital of $2,000 + the $8,000 paid in = $10,000 total (which equals what remains after all liabilities are cleared).

5. Garner v Murray Rule Exam Focus

When a partner with a capital deficiency is insolvent and cannot pay, the court case Garner v Murray (1904) established the rule for how the remaining solvent partners absorb the loss.

⚖️ The Garner v Murray Rule

The deficiency of an insolvent partner is borne by the remaining solvent partners in proportion to their last agreed capital balances — not in their profit-sharing ratio.


            Each solvent partner absorbs = Deficiency × (Their capital / Total capital of solvent partners)

📌 Garner v Murray only applies when:

The deficient partner is insolvent (cannot pay)
There is no partnership agreement overriding this rule
The question specifically states the deficient partner cannot pay

If the question says the deficient partner can pay — use Situation A (no Garner v Murray needed).

📋 Example 3: Garner v Murray — Hina Cannot Pay

Continuing Example 2. Assume Hina is insolvent and cannot pay her deficiency of $4,000. Zara can pay hers.

The capitals of the solvent partners at the time of dissolution (before sharing the realisation loss) were: Omar $18,000 | Zara $12,000. Total solvent capital = $30,000.

Hina's deficiency of $4,000 shared between Omar and Zara:
Omar bears: $4,000 × 18,000/30,000 = $2,400
Zara bears: $4,000 × 12,000/30,000 = $1,600

Partner	Balance after Realisation Loss ($)	Zara pays in her deficiency ($)	Hina's deficiency absorbed ($)	Final Payment to Partner ($)
Omar	2,000 CR	—	(2,400)	Owes $400 — must pay in
Zara	(4,000) DR	+4,000	(1,600)	Owes $1,600 — must pay in
Hina	(4,000) DR	—	+4,000 (written off)	Nil — insolvent

⚠️ Unusual outcome: After applying Garner v Murray, Omar's balance drops below zero ($2,000 − $2,400 = −$400). This can happen — Omar must now pay in $400. Zara must pay in $1,600. The bank collects $4,000 + $400 + $1,600 = $6,000 to clear the remaining nil balance. The Bank Account should still close to zero.

💡 Always verify by preparing the Bank Account after applying Garner v Murray — the total cash in must equal the total cash out. If it does not, an error has been made in allocating the deficiency.

6. Piecemeal Realisation Higher Level

In practice, assets are not always sold simultaneously. When assets are sold gradually over time, some cash is available before dissolution is complete. The partnership may distribute this cash to partners progressively — this is called piecemeal realisation.

The Challenge: During piecemeal realisation, the final profit or loss on realisation is not yet known. If cash is distributed too early, a partner might receive more than they are ultimately entitled to, and there may be insufficient cash to settle all liabilities.

Safe Distribution Method

To protect against over-distribution, the safe distribution method assumes that all remaining unsold assets are worthless. The cash available is distributed only after ensuring that enough is retained to cover:

All outstanding liabilities
The maximum possible loss on remaining assets (assuming zero proceeds)
Any potential capital deficiency from any partner

📌 Cambridge Note: Piecemeal realisation is examined at the higher difficulty level in Paper 3. The key principle is conservative distribution — never distribute cash that might be needed to settle remaining obligations. The exam will provide the proceeds received so far and ask for the safe amount to distribute.

7. Memory Aids & Common Mistakes

🧠 Memory Aid — Dissolution Order

"C-R-S-P-C"
Combine Current Accounts into Capital Accounts
Realisation Account — transfer assets and liabilities
Share profit or loss on realisation
Pay external liabilities and loans
Close — pay remaining capital balances to partners

🧠 Memory Aid — Garner v Murray vs Profit-Sharing Ratio

Profit/Loss on Realisation → shared in profit-sharing ratio
Insolvent partner's deficiency → shared in capital ratio (Garner v Murray)
Capital ratio = last agreed capitals of solvent partners only

⚠️ Mistake 1 — Transferring assets at cost instead of NBV: All non-current assets go to the Realisation Account at their net book value — cost minus accumulated depreciation. The Provision for Depreciation Account is closed first; only the NBV enters the Realisation Account.

⚠️ Mistake 2 — Including the bank balance in the Realisation Account: The opening bank balance is transferred to the Realisation Account on the DR side so the account captures the full cash position. Students often forget this and then the Bank Account does not balance at the end.

⚠️ Mistake 3 — Applying Garner v Murray in the profit-sharing ratio: The deficiency of an insolvent partner is absorbed by solvent partners in their capital ratio — never the profit-sharing ratio. These are two different ratios and using the wrong one gives incorrect capital account balances.

⚠️ Mistake 4 — Forgetting to repay loans before capital: Partner loans (e.g. a loan account created on retirement, or a personal loan to the firm) are liabilities — they must be repaid before any capital is distributed. A partner loan is repaid from the Bank Account in the same way as trade payables.

⚠️ Mistake 5 — Failing to close the Realisation Account: The Realisation Account must close to nil — the profit or loss is transferred to Capital Accounts as the balancing entry. If it does not close, either the profit/loss has been calculated incorrectly or one side of the double entry is missing.

📝 Exam Practice Questions

Question 1 Knowledge — 2 marks Paper 1

Explain the Garner v Murray rule and state the circumstances in which it applies.

The Garner v Murray rule applies when a partner with a capital deficiency (debit balance on Capital Account after dissolution) is insolvent and cannot contribute the amount owed to the partnership. (1 mark)

The insolvent partner's deficiency is borne by the remaining solvent partners in proportion to their last agreed capital balances — not in the profit-sharing ratio. (1 mark)

Question 2 Application — 8 marks Paper 3

Hamza, Nadia and Sara share profits 3:2:1. They dissolve their partnership on 30 June 2026. Relevant balances immediately before dissolution:

Item	$
Capital — Hamza	30,000
Capital — Nadia	20,000
Capital — Sara	10,000
Current Account — Hamza (CR)	2,000
Current Account — Nadia (DR)	1,500
Non-Current Assets (NBV)	45,000
Inventory	8,000
Trade Receivables (net)	5,500
Bank	3,000
Trade Payables	12,000

Assets realised: Non-Current Assets $38,000 | Inventory $7,200 | Receivables $5,000. Payables settled at $11,400 (discount $600). Dissolution expenses $800.

Prepare the Realisation Account and Partners' Capital Accounts.

Step 1 — Combine Current Accounts:
Hamza Capital: 30,000 + 2,000 (CR current) = $32,000
Nadia Capital: 20,000 − 1,500 (DR current) = $18,500
Sara Capital: $10,000 (no current account)

Step 2 — Realisation Account:

DR: NCA $45,000 + Inventory $8,000 + Receivables $5,500 + Bank $3,000 + Trade Payables $12,000 + Expenses $800 = $74,300
CR: NCA proceeds $38,000 + Inventory $7,200 + Receivables $5,000 + Payables paid $11,400 + Discount $600 + Expenses $800 + Bank $3,000 = $66,000
Loss on Realisation = 74,300 − 66,000 = $8,300 (DR side exceeds CR before loss allocation)

Realisation Loss shared (3:2:1):
Hamza: 3/6 × 8,300 = $4,150 | Nadia: 2/6 × 8,300 = $2,767 | Sara: 1/6 × 8,300 = $1,383

Capital Accounts after loss:

Partner	Combined Capital ($)	Loss Share ($)	Final Balance ($)
Hamza	32,000	(4,150)	27,850 CR
Nadia	18,500	(2,767)	15,733 CR
Sara	10,000	(1,383)	8,617 CR

📌 Check: Total final capital = 27,850 + 15,733 + 8,617 = $52,200. Cash available = Bank (3,000) + all proceeds (38,000 + 7,200 + 5,000) − payables (11,400) − expenses (800) = $41,000. Difference suggests a missing figure — always verify your Realisation Account totals carefully. In a well-set question, cash available exactly equals total capital balances to be paid.

Question 3 Analysis — 4 marks Paper 1

Partners A, B and C share profits 2:2:1. On dissolution, the loss on realisation is $30,000. Capital balances (after combining current accounts): A $18,000 | B $8,000 | C $4,000.

C is insolvent and cannot pay any deficiency. Calculate the final settlement for each partner.

Share of realisation loss (2:2:1):
A: 2/5 × 30,000 = $12,000 | B: 2/5 × 30,000 = $12,000 | C: 1/5 × 30,000 = $6,000

Partner	Capital ($)	Loss ($)	Balance ($)
A	18,000	(12,000)	6,000 CR
B	8,000	(12,000)	(4,000) DR ⚠️
C	4,000	(6,000)	(2,000) DR ⚠️

Garner v Murray — C cannot pay $2,000:
Solvent partners: A ($18,000) and B ($8,000). But B has a deficiency too — so only A is solvent here.
A absorbs C's entire deficiency of $2,000.

B must still pay in her deficiency of $4,000.

Partner	Balance ($)	C's deficiency absorbed ($)	Final ($)
A	6,000	(2,000)	Receives $4,000
B	(4,000)	—	Pays in $4,000
C	(2,000)	+2,000	Nil — insolvent

📌 Verification: A receives $4,000 = B pays in $4,000 ✓. Bank balances to nil.

Question 4 Knowledge — 3 marks Paper 3

Explain the difference between dissolution and retirement of a partner, and identify two items that appear in the Realisation Account but would not appear in a Revaluation Account.

Dissolution vs Retirement:
When a partner retires, the partnership continues trading — only the capital structure changes. When a partnership is dissolved, the business ceases to exist — all assets are sold, all liabilities settled, and the partnership is wound up completely. (1 mark)

Two items in Realisation Account but not Revaluation Account (any two of the following — 1 mark each):

Cash proceeds from the sale of assets (Revaluation only records the new value — no actual sale takes place)
Dissolution expenses (no such costs arise in a revaluation)
Settlement of liabilities (liabilities are paid off in dissolution; in revaluation they may be revalued but not settled)
Opening bank balance (transferred to Realisation Account to capture total cash — not relevant to a revaluation)

Question 5 Analysis — 3 marks Paper 3

Discuss one advantage and two limitations of the Garner v Murray rule when applied to partnership dissolution.

Advantage: The rule provides a clear, legally established method for allocating a capital deficiency when a partner is insolvent, preventing disputes between the remaining partners. It protects creditors by ensuring the partnership can still settle its obligations even when one partner cannot contribute. (1 mark)

Limitation 1: The rule allocates the deficiency in the capital ratio, not the profit-sharing ratio. This may seem unfair to a solvent partner with a large capital balance — they bear a disproportionately large share of the deficiency compared to their profit entitlement. (1 mark)

Limitation 2: Applying Garner v Murray can itself create a new deficiency in a previously solvent partner's account (as seen in Example 3 where Omar ended up owing money). This can lead to a cascade of adjustments and practical difficulties in winding up the partnership. (1 mark)

← Lesson 1 📚 All Lessons Lesson 3 →