Dissolution of any firm or business is the process of winding up of business when the relationship between partners dissolves or terminates. As per the Partnership Act of 1932, “The dissolution of the firm is the dissolution of a partnership between all the partners of a firm”. The dissolution of a firm differs from the dissolution of a partnership, as the dissolution of a partnership just involves the change of relations of partners of a firm, whereas the dissolution of the firm is the complete winding up of the business. There are different types of reasons for dissolution, such as dissolution by the court, dissolution by agreement, dissolution by notice, and compulsory dissolution. The firm needs to sell all its assets, settle the accounts, and liabilities, and discharge all the claims before the dissolution of the firm. 

Reasons for Dissolution of a Firm

The firm or company dissolution shall occur due to the following given reasons:

• If there is a change in the profit-sharing ratio of the existing partners of the firm
• If there is an admission of a new partner in the firm
• If an existing partner retires
• In case of expulsion or death of an existing partner
• In case of expiry of a partnership period
• If there is any insolvency of a partner

Modes of Dissolution of a Firm

(A)  Without the Intervention of Court: The ways for dissolution of a firm based on mutual decisions and without the court’s intervention are:

1. Dissolution by Agreement: The dissolution by agreement involves the approval of all of its partners. It is stated that a firm is made by the agreement of all its members. Similarly, a firm can dissolve by the agreement or approval of its members. 
2. Compulsory Dissolution: Compulsory dissolution involves two main reasons. The first reason shall be when all or one of its members become insolvent and are now incapable of any agreement. The other reason is when the firm becomes unlawful due to any reason. 
3. Dissolution by Notice: Dissolution by notice involves firms that is not on the duration of the partnership. In such firms, any partner can dissolute the firm by giving notice to other partners of the firm for its dissolution.
4. Dissolution due to a certain event: Besides the above-mentioned reasons, there are three more reasons for the dissolution of a firm. These are:

• On the completion of the reason, the firm was established
• Due to insolvency of any partner
• The expiration of the period of firm formation

(B)  With the Intervention of Court: The dissolution by the court can be due to an application filed by a partner of the firm to the court. The reasons for the dissolution by the court are as follows:

• When one of the partners of the firm becomes unsound mind, i.e. mentally unstable for handling the firm
• When any partner of the firm (other than filing a case) has become incapable of fulfilling his duties and responsibilities towards the firm
• When any partner (other than filing a case) wilfully breaks any law that can harm the partnership
• When any partner (other than filing a case) transfers all of his interests to a third party
• If the court thinks that the firm is incapable of producing any profits in the future and will only carry the loss

Settlements of Accounts

Section 48 of the Partnership Act clearly specifies the modes of settlement of accounts after the dissolution of the firm. These are as follows:

• The amount of loss (including the deficiency of capital) must be paid out of profits, or out of capital
• If required, it needs to be cleared off by the partners’ profit-sharing ratio
• After the dissolution, the amounts of the sale of assets of the firm shall be used in four different ways: to clear all of the outside debts of the firm; to pay the loan advances of the partners; to return balance capital accounts; and lastly, if the amount remains, to divide it among the partners according to their profit-sharing ratio

Accounts Procedure on Dissolution of Firm

For the complete dissolution of the firm, four accounts in the given order are opened by the firm. 

1. Realisation Account
2. Partner’s Loan Account
3. Partner’s Capital Account
4. Cash or Bank Account

Conclusion

Dissolution of a firm is the complete winding up of the business of that firm. It differs from the dissolution of the partnership, which suggests that the relationship between the partner changes rather than the dissolution of the complete firm. The dissolution involves selling all the assets of the company, clearing off all the liabilities and accounts and discharging all the claims. There are different reasons for dissolution, such as dissolution by the court, dissolution by agreement, dissolution by notice, and compulsory dissolution.