Dissolution of partnership Firm and Piecemeal Distribution?

Dissolution of partnership Firm and Piecemeal Distribution

Concept

Dissolution of partnership firm means discontinuance of relationship between the partners. There is a difference between dissolution of partnership and dissolution of partnership firm. Dissolution of partnership means a  change in the relationship of partnership of partners i.e. either the number of partners increase or decrease or the profit sharing ratio of partner are considered dissolution of partnership. It does not mean the end of the firm itself. The firm continues to function thought with a changed relationship among the partners. Dissolution of partnership firm means the business of the firm is put to an end i.e. assets and disposed off, liabilities are paid off and the accounts of all the partners are also settle. Dissolution of partnership firm includes dissolution of partnership but dissolution of partnership dissolution of partnership firm Nepal partnership Act, 2020 does not partnership Act, 2020, dissolution of firm takes place in the following cases:

a.      Dissolution by agreement or deed, Sec.-29
b.      Dissolution of partnership by written notice, sec,-30
c.      Dissolution of partnership by any time, sec.-31
d.      Dissolution after the expiry of working period, sec.-32
e.      Dissolution of partnership at once, sec.-33

Dissolution by agreement or deed, sec.-29: when all the partner of the firm agrees to dissolve the partnership business, it is called dissolution by agreement.

Dissolution of partnership by written notice, sec.-30: when the duration of the partnership is not fixed and it is at will, then any partner by giving notice to his/her fellow partners can dissolve the partnership on the date of notice or on the endorsed date of notice.

Dissolution of partnership by any time, Sec.-31:  a firm may be dissolved on any time in the following case:

a.        When a partner deliberately and considerately commits branch of agreement relating to the partnership.
b.      When a partner does not pay any payable amount to the firm or a partner transfer his/her share to someone else without the consent of other partners.
c.      When a partner is found guilty of misconduct.
d.      When a partner willfully acts against the partnership agreement.
e.      When the court considered any other ground to be just and equitable for dissolution of the firm.

Dissolution after the expiry of working period, sec.-32: a partnership is dissolve of the expiry of the period or completion of the specific venture for which a partnership firm was firmed.

Dissolution of partnership at once, sec.-33: a partnership is dissolved on the death of a partner or on the insolvency of a partner.

Closing books of account and finalsettlement of accounts

In the case of dissolution of a firm, the normal business of the firm comes to end. In this situation, the firm has to settle the account with the third parties as well as among the partner's themselves. For this purpose, the assets of the firm are sold out and liabilities are paid off. In other words, in settlement of accounts, firm of all, assets are sold and cash realized. The cash so obtained will be firms used to meet all the outside liabilities of the firm. If there is any surplus available, it will be distributed among the partners.

Settlement of Partner's capital accounts when the firm and all the partners are solvent

When a firm has capacity to pay its liabilities, then that firm is called solvent firm. Similarly, if all partners are able to pay liabilities of the firm with their private properties, then such partners are also called solvent partners.

At the time of dissolution of the firm, partner's capital accounts are prepared after adjusting profit or loss on realization. After transfer of profit or loss on realization, undistributed profit or loss balance of current accounts, assets and liabilities taken over by a partner, etc. to the capital accounts of the partners, the balance of capital accounts are closed. In this situation, if the total of the credit side is more partners capital account are closed by paying balancing figure to them, but if debit side is more, their capital accounts are closed  paying balancing figure to the firm:

Settlement of account when a partner is insolvent

In the case of dissolution, if capital account of a partner shows a debit balance, it means he/she has to pay the amount to debit balance to the firm. But if such a partner having a debit balance is insolvent, then he/she cannot pay the amount to the firm. Such irrecoverable amount from an insolvent partner is also a loss which is to be borne by the solvent partners. Now the question arises, should this loss be met by remaining solvent partners on the basis of profit sharing ratio on the basis of adjusted capital. In other words, there are two methods, to bear such deficiency of an insolvent partner by solvent partners:

1. Applying garner vs. Murray Decision
2.  Ignoring Garner vs. Murray Decision

Applying Garner vs. Murray Decision:

In England, Garner, Murray and Wilkins were three equal partners with unequal capital in a business. On June 30, 1990, they decided to dissolve their partnership firm. At the time of dissolution, the capital account of Wilkins showed a debit balance of some amount and nothing dissolution, the capital account of Wilkins showed a debit balance of some amount and nothing could be recovered from his due to insolvent. Garner wanted to share this loss in profit sharing ratio but Murray said loss on account Wilkins's insolvency was to business loss but a capital loss. Thus it should be divided in the capital ratio. A suit was filed:

The case was decided by lord justice Joyee. According to this decision:

a  The solvent partners should bring in cash equal to their share of the loss on realization.
b  Deficiency of the insolvent partner should be shared vb, solvent partners in the ratio of their adjusted capital just before dissolution.
c  If a partner has a debit balance of his/her capital account on the relevant date, her/she will not bear loss an account of insolvent partner even thought he/she may be financially more sound as company to other solvent partners.

According to Garner vs. Murray decision, the following point should be considered in case of an insolvency of a partner while dissolving the partnership firm:

a  First of all, realization account is prepared and its profit or loss is transferred to all partner's capital account including insolvent partner in their profit sharing ratio.

1. b    Solvent partners of the firm should bring the loss on realization in cash. In this situation, bank account is debited and solvent partners' capital accounts are credited.

c    The ratio of last adjusted of the solvent partners should be calculated.
d      Undistributed profit or loss and reserve should be distributed among all partners in their profit sharing ratio.
e    If any amount is received from the insolvent partner from his/her private estate, it should be credited to his/her capital account.
f.       After making all adjustment, the recorded debit balance of the insolvent partner should be transferred to the capital accounts of solvent partner in the ratio of last adjusted capital.

g    The solvent partners, who have credit balance in their capital accounts, should draw out or bank balance of their capital account by debiting their capital accounts and crediting cash or bank account. It's just reverse, if there is a debited balance in the capital account, and then such partner should bring necessary cash in the business to balance off his/her capital account.

The following mentioned points should be considered when capital accounts are fluctuating. In the case of fixed capital, all adjustments are made in current accounts of the partners, and then the balance of current accounts should be transferred to respective capital account.

Ignoring Garner vs Murray decision

If it is not clearly mentioned in the problem to apply Garner vs. Murray case, then it is not necessary to apply the rule of this case. In the case of dissolution of firm due to the insolvency of a partner, his/her recovered amount should be borne by the solvent partner on the basis of specification given in the partnership deed. If partnership deed is also silent regarding this, then it should be borne by the solvent partner's in their profit sharing ratio.

Piecemeal distribution

When the partnership firm is dissolved, its business comes to end. In this situation, generally it is assumed that all the assets are realized immediately on the date of dissolution and the accounts of all the partners and the creditor are settled on the same day. But in real practice, this assumption is unrealistic, because assets of the firm cannot be realized be realized immediately. There are sold gradually, therefore, it takes time. Similarly. Cash received on the sale of assets is paid as and when realized to the rightful claimant. In other words, the processes of realizing the assets takes o long time and cash is distributed as and when it is realized. The process of realizing the assets piece by piece or part by part and distributing the cash to the rightful claimant as and when the cash is received without waiting for the realization of all the assets of the firm is called piecemeal distribution.

On a gradual realization of assets, first of all, realization expenses are paid. After that, the debits of the firm to the third parties i.e. outside liabilities are paid. Then, the amount due to a partner as loan should be paid and finally, the capitals of the partners are paid.

There are two methods for distribution of cash under piecemeal distribution:

1.      Surplus capital method or proportionate capital method

2.      Maximum loss method

Surplus capital method or proportionatecapital method

This method is suitable when the capitals of the partners are not in profit sharing ratio as well as all the partners are solvent.

Under this method, a partner, who has the highest capital i.e. more than proportionate to other partners' capital in view of profit sharing ratio, is paid first the available cash to bring down his/her capital in proportionate to other. After that cash available id distributed to their profit sharing ratio. This process is continued till the available cash is distributed fully. Finally, the balance of capital account represent profit or loss on realization and this will be in the profit sharing ratio of each partner. This is proof of correctness of distribution of cash piece by piece.

The following steps are used in this method:

a.      First of all, adjusted capitals of the partners are determined by adjusting undistributed profit or loss, balance of current accounts, etc.

b.      After that, such adjusted capitals of the partners should be divided by their respective profit sharing ratio and get the minimum amount called. "Base capital.'

c.      Multiply 'Base capital' calculated in step b by respective profit sharing ratio of each partner and get 'Relative Capital.'

d.      Deduct 'Relative' calculated in step d by profit sharing ratio of each partner and get the minimum amount called 'Revised base Capital'.

e.      Again divide 'surplus capital' capital in step d by profit sharing ratio of each partner and get the minimum amount called 'Revised base Capital'.

f.       Multiple "Revised Base Capital' of step e by profit sharing ratio of each partner and get 'Revised Relative Capital'.

g.      Deduct 'Revised Relative Capital' of step F from 'surplus Capital' of step d and get' absolute surplus Capital'.

After all there, absolute surplus capital of a partner is returned first case. In case, the capitals are in profit sharing ratio. The cash is distributed among the partners in their profit sharing ratio.

Maximum loss method

It is an alternative method of piecemeal distribution. After payment of all the outside liabilities and partners' loan, under this method, maximum possible loss an every realization is calculated. In other words, the amount available for distribution among partners is compared with the total amount of capital payable to the partners and the maximum loss is ascertained on the assumption that in future assets will not realize any amount. The maximum possible loss so ascertained is deducted from the capital balance of the partners in their profit sharing ratio and balance left in the capital account after deducting the maximum loss will be the amount payable to the partner.

If a partners' share of maximum possible loss exceeds the amount shown on credit side of such partner's capital account, then such  partner should be treated as insolvent partner and his/her deficiency should be borne by solvent partners as stated under the garner vs. Murray rule. The amount standing to the credit of the partners after share of maximum loss and their share of insolvent partner's deficiency will be equal to the cash available for the distribution among the partners. This process of maximum possible loss is repeated till all the assets are disposed.

Generally, the following steps are used in case of maximum loss method:

• First of all, adjusted capitals of all partners are determined by adjusting undistributed profit or loss, reserve and balance of current accounts.
• In the case of fluctuating capital, capital rations of all partners are calculated form adjusted capital. But, in the case of fixed capital, capital rations of all partners are calculated on the basis of original capitals.
• Determine maximum loss by deducting realized amount from total adjusted capitals of all partners.
• Distribute the maximum loss among, the partners in this profit sharing ratio and calculate the balances of capital accounts after distributing maximum loss to all partners. In this situation, if no capital account shows a debit (negative) balance, then distribute the available cash among all partners, equal to their respective capital balance. But, in the case of negative or debit balance in a partners' capital account, such negative or debit balance should be transferred to other partner's capital accounts in the ratio of their adjusted capital using Garner vs. Murray rule. This process is repeated till the negative balance is abolished.
• Again, follow the step c and on next realization.

Review of Theoretical concept

Define dissolution of a firm.

Dissolution of partnership firm means discontinuance of relationship between the partners. There is a difference between dissolution of partnership and dissolution of partnership firm dissolution of partnership means a change in the relationship of partners i.e. either the number of partner increase or decrease or the profit sharing of partner are considered dissolution of partnership. It does not mean the end of the firm itself. The firm continues to function though with a changed relationship among the partners. Dissolution of partnership firm mean the business of the firm is put to an end i.e. assets and disposed off, liabilities are paid off and the accounts of all the partners are also settled. Dissolution of partnership but dissolution of partnership but dissolution of partnership does not mean dissolution of partnership firm. Nepal partnership act, 2020 does not differentiate dissolution of partnership firm and dissolution of partnership.

Briefly explain the Garner vs. Murraydecision.

In England, Garner, Murray and Wilkins were three equal partners with unequal capital in a business. On June 30, 1990, they deduced to dissolve their partnership firm. At the time of dissolution, the capital account of Wilkins showed a debit balance account of some amount and nothing could be recovered from his due to insolvency. Garner wanted to share this loss in profit sharing ratio but Murray said loss on account of Wilkins's insolvency was to business loss but a capital loss. Thus, it should be divided in the capital ratio. 

A suit was filed:

The cash was decided by Lord Justice Joyee.

According to this decision:

• The solvent partners should bring in cash equal to their share of the loss on realization.
• Deficiency of the insolvent partner should be shared by solvent partners in the ratio of their adjusted capitals just before dissolution.
• If a partner has a debit balance of his/her capital account on the relevant date, he/she will not bear loss on account of insolvent partner even though he/she may be financially sounder as compared to other solvent partners.

What is piecemeal distribution? Write the order of distribution under it.

When the partnership firm is dissolved, its business comes to end. In this situation, generally it is assumed that the assets are realized immediately on the date of dissolution and the accounts of all the same day. But in real practice his assumption is unrealistic because assets of the firm cannot be realized immediately. There are sold gradually, therefore, it takes time. Similarly, cash receive on the sale of assets is paid as and when realized to rightful claimant. Other words, the process of realizing the assets takes a long time and cash is distributed as and when it is piece by or part by part ad distributing the cash to the rightful claimant as and when the cash is received without waiting for the realization of all the assets of the firm is called piecemeal distribution.

On a gradual realization of assets, first of all. Realization expenses are paid. After that, the debts of the firm to the third parties i.e. outside liabilities are paid. Then, the amount due to a partner as loan should be paid and finally, the capitals of the partners are paid.