Difference between Dissolution of partnership and Dissolution of firm

Difference between Dissolution of partnership and Dissolution of firm

Many times, people confuse “dissolution of partnership” with “dissolution of firm”.

However, the dissolution of a firm is different from the dissolution of a partnership. In the event of dissolution of the firm, the firm ceases to operate, i.e., its business ceases to exist. But in the event of the dissolution of the partnership, the firm’s operations are continued.

What is meant by Dissolution of Partnership and Dissolution of Firm?

Dissolution of partnership simply means a change in the relation of the partners. Such a change usually takes place when a firm is reconstituted.

In other words, a partnership is dissolved when the term for which it is entered expires or when the stated venture is completed, or when a partner dies, retires, or becomes insolvent. However, if the surviving partners decide to continue running the business, the partnership firm is not dissolved.

If they do not continue, then the firm will be dissolved automatically.

Thus, when a partnership is dissolved, it doesn’t mean that the firm no longer exists. It may or may not give rise to the dissolution of the firm.

Because even when a partnership is dissolved, the partners or remaining partners (in case of death or insolvency) may continue to do the business in pursuance of an agreement to that effect. It is only that the existing relationship among partners changes or comes to an end. But the firm continues to operate as a reconstituted firm. The firm will be said to be dissolved only when the business comes to an end.

Hence, the dissolution of a firm implies that the firm’s operations are terminated, assets are disposed of, obligations are paid off, and the accounts of all partners are settled. In this case, the assets of the firm, including goodwill, are realized. And the amount so realized is then applied towards the repayment of liabilities. Also, the surplus, if any, is distributed amongst the partners according to their share in the firm.

Circumstances leading to Dissolution of Partnership

A partnership gets dissolved or comes to an end in the following circumstances:

  • When the partnership is constituted for a fixed term, then on the expiry of that term
  • When it was formed to carry out a specific venture, then on the completion of the venture
  • On the death of a partner
  • On the insolvency of a partner
  • On admission of a partner
  • On the retirement of a partner

In all of the preceding circumstances, the old partnership comes to an end, but the firm may continue under the same name and style with the formation of a new partnership. Technically, even when there is a change in the profit sharing ratio of the existing partners, the old partnership dissolves and a new one comes into existence.

Circumstances leading to Dissolution of Firm

A partnership firm stands dissolved in the following circumstances:

  • When all the partners agree that the firm should be dissolved
  • When all the partners except one become insolvent
  • When the business of the firm becomes illegal
  • When the partnership is at will and a partner gives notice w.r.t dissolution
  • On Court’s order for dissolution

The following are the cases when the Court has an option to order the dissolution of a firm:

a. A partner has become of unsound mind.

b. A partner suffers from permanent incapacity.

c. A partner is held guilty of misconduct in the business.

d. A partner disregards the partnership agreement.

e. A partner transfers his share or interest to a third party.

f. It becomes impossible to carry on the business except at a loss.

g. The Court finds it just and equitable to dissolve the firm.

It must be clearly understood that dissolution of the partnership is merely a legal modification known to the insiders only, whereas dissolution of the firm is a real physical break-up and discontinuance of the business, resulting in the cessation of all trade activities.

An example

Let us take an example.

Suppose A, B, C, and D are running a trading business as a partnership firm. The Court declares A as insolvent. Now, the partnership between A, B, C, and D ends, and a new partnership between B, C, and D comes into existence. This new partnership of B, C, and D will be referred to as the “reconstituted firm”.

As a result of A being declared insolvent, the existing partnership is dissolved, but the firm continues to operate with the remaining partners B, C, and D. However, had all the partners been declared insolvent, the firm would have dissolved in that case. Because the business of the firm would have completely stopped.

Comparison between Dissolution of partnership and Dissolution of firm

The table given below highlights the main differences between the dissolution of a partnership and the dissolution of a firm:

BasisDissolution of partnershipDissolution of firm
MeaningDissolution of a partnership means discontinuance of the relationship between the partners of the firm.Dissolution of a firm means that the entire firm ceases to exist, including the relationship among all the partners.
ScopeThe dissolution of a partnership does not imply the dissolution of the firm.The dissolution of a firm necessarily indicates the dissolution of the partnership.
Death/RetirementIn this case, there can be a change in the profit sharing ratio or admission/death/retirement of a partner.Here, the entire firm dissolves.
Closure of businessIn event of the dissolution of a partnership, the business continues to operate as usual. Only the partnership is reconstituted.Where the firm is dissolved, its business comes to an end.
Court interventionThere isn’t any intervention by the Court.The Court has an inherent power to intervene. In certain cases, the Court has an option to order the dissolution of a firm. By its order, the firm will be dissolved.
Economic relationshipThe economic relationship amongst the partners (i.e., the share of interest/profit) may remain the same or may change.The economic relationship among the partners comes to an end.
Assets and liabilitiesOnce the existing partnership is wound up, all assets and liabilities are revalued and a new Balance Sheet is prepared.On winding up of the firm, assets and liabilities are settled. Assets are sold and realized. And liabilities are paid off.
Accounting treatmentA revaluation account is prepared to find out the profit (loss) on the revaluation of assets and liabilities.A realization account is prepared to find out the profit (loss) on the realization of assets and settlement of liabilities.
Books of accountThe books of account are not closed.The books of account are closed.
NatureIt results in the reconstitution of the firm.It results in the dissolution of the firm.

Takeaway

Dissolution is synonymous with discontinuance. When it deals with the relationship between the partners, this is referred to as “dissolution of partnership”, and when it deals with the business of the partnership, this is referred to as “dissolution of the firm”.

It won’t be wrong to say that under the dissolution of the firm, the partnership is automatically dissolved.


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