Settlement of Accounts

Indian Partnership Act 1932 defines partnership as the relation between two or more persons who have agreed to manage and operate a particular business and share profits and losses among themselves. Generally, the partnership could be dissolved in certain events, which means the business activities are halted, and the accounts need to be settled. To settle the accounts fully, the assets are disposed of in order to pay off the creditors. After selling all the assets, if the amount is insufficient to pay the creditors, the remaining would be recovered from the personal properties of the partners.

Types of Dissolution of a Partnership Firm

A partnership firm could be dissolved voluntarily by the partners or by a court order. The ways of dissolution are:

•   Dissolution by agreement: A firm could be dissolved if all the partners agree to the dissolution of the firm. Through an already made contract, the partnership could be dissolved.
•   Dissolution by notice: When one of the partners sends a written notice to other partners looking for the dissolution of the firm, then the firm may be dissolved.
•   On the happening of certain eventualities: Sometimes, a firm is established for a fixed period; in that case, it may be dissolved after the completion of that term. Some firms are made to carry out certain ventures and maybe dissolved after that. Death and insolvency of a partner are also events that lead to the dissolution of the firm.
•   Compulsory dissolution: A firm may be dissolved compulsorily if one or more partners become insolvent, the business they were carrying out becomes illegal, or one of the partners dies.
•   Dissolution by the court: The court may order to dissolve the firm if a partner becomes insolvent, a partner is guilty of misconduct and is affecting the business adversely, or if the business is only running losses.

Settlement of Accounts

After the partnership firm is dissolved, the firm can no longer carry out any business and all that is left is to settle the accounts. The firm then disposes of all its assets in order to fulfil all claims against it. Under section 48 of the Partnership Act, 1932, the following are the rules that are provided regarding the dissolution of the firm:

Treatment of losses

The losses and insufficiencies of capital would be paid off in the following order:

• Firstly, the losses will be paid off from the profits earned by the firm.
• After the exhaustion of profits, the remaining must be paid from the partners’ capital.
•  Lastly, if any losses still remain, they will be shared among the partners in their profit-sharing ratio.

Application of assets

The assets of the firm consist of any sum contributed by the partners to make for the deficiencies of capital and shall be used in the following order:

• First of all, any third-party debts will be paid. The third parties could be creditors, bank loans, bills payable, etc. However, the first preference is given to secured loans over unsecured loans.
• If any partner has provided any loan to the firm, it will be settled next on a proportionate basis.
• If there is a residue amount after the partners’ loan account is settled, it will be distributed among the partners on account of the capital investment made by them.
• If there are still any remaining profits after settling all liabilities, they shall be divided among the partners in their profit sharing ratio.

Hence, the amount that is released from the assets of the firm along with the partners’ contribution shall be utilised to pay off the liabilities of the firm, such as creditors’ loans, bank overdrafts, bank loans, etc. It is stated that secured loans have preference over unsecured loans.

Private Debts and Firm Debts

According to section 49 of the Partnership Act 1932, if the private debt of partners and the firm’s debts co-exist, then the following rules shall apply:

• The assets of the firm must be used first to clear the debts of the firm, and if in case there is a surplus amount, then it shall be divided among the partners, which they can use to meet their private liabilities.
• The private asset of any partner must be used to pay their personal debts, and the remaining amount is used to meet the firm’s debts.

Conclusion

The settlement of accounts is a necessary action to be taken in the event of the dissolution of a partnership. The debts are paid off using the amount realised from disposing of the assets. Certain rules are to be kept in mind regarding the treatment of losses, the application of assets, and the private debts and debts of the firm. All the debts must be paid off in a certain order as prescribed by the Partnership Act 1932. Hence, the debts can be paid off through the available profits or by selling the firm’s assets.