Piecemeal Distribution of Cash

The term “Dissolution” stands for discontinuation. Under the Partnership Act 1932, the
dissolution may be either of a partnership or of a firm. The dissolution of partnership
amongst all the partners of a firm is called “dissolution of the firm”. It should be noted that
there is a distinction between dissolution of partnership and dissolution of firm,
Dissolution of Firm means complete breakdown of the relation of partnership amongst all
partners. It is the complete discontinuance of the relationship amongst all the partners of
a firm. However, if this breakdown is relating to a few partners and not all the partners
and the partnership business is continued, it is known as Dissolution of Partnership.
Dissolution of partnership, is thus, a mere reconstitution of partnership. It involves a
change in the relation between or amongst the partners. Admission, retirement or death
of a partner or amalgamation also cause changes in relations of partners. When
partnership business comes to an end, the partnership firm is required to be dissolved.
The assets are realised and the liabilities are paid off. Since assets are realised in pieces,
the liabilities as well as partners capital balances are also paid in pieces. This method of
distribution is called as ‘Piecemeal Distribution of Cash’.
Meaning
On dissolution of firm, the assets are sold and the cash thus made available is used to pay
off firm’s liabilities. In practice the realisation or sale of assets is not an easy job. It may
take time, even months, to sell all of the assets of the firm. Thus, the realisation of assets is
done part by part
- it is gradual - it is piecemeal. The creditors of the firm will not sit quiet till all the assets
are realised and they will demand their dues as and when the firm has sufficient funds.
Thus creditors are paid part by part - the distribution of available funds is gradual - it is
piecemeal.
Now the question arises as to in what order the liabilities of the firm should be paid off or
in other words how should the assets of the firm be applied. In all the examples which we
have seen in the simple dissolution, we have assumed that the realisation of assets and
settlement of debts and partners’ accounts took place on the same day, i.e. the day the
firm was dissolved. This assumption is, however, impractical.
Classification of Liabilities
The liabilities including the amounts due to partners, may be classified in the three
major categories viz. External Liabilities, i.e., dues to outsiders. Internal Liabilities, i.e.,
partners loans; and Capital Accounts of partners. The Figure 1.1 shows the Classification
of Liabilities.

External Liabilitiesi)

Internal Liabilitiesii)
Classification
of Liabilities

iii)
Capital Accounts of
Partners

Fig. 1.1 : Classification of Liabilities

External liabilities may further be sub-classified as ‘Preferential Liabilities’ and “Other liabilities”.
Preferential liabilities include i) dues to Government, such as income tax, municipal taxes etc. ii) dues to
employees, such as outstanding wages, provident fund etc. and
i) realisation expenses. The Other Liabilities may be either i) secured liabilities or ii) unsecured liabilities.
The Figure 1.2 shows the Sub-Classification of Liabilities.
Liabilities
(Dues)

External Internal Capital Accounts

Loan from Partners

Preferential Others

Govt. Employees Realisation

Dues Dues Expenses

Secured Unsecured

Fig. 1.2 : Sub-Classification of Liabilities

Order of Payment :
The assumption of realisation of all the assets and the payments of all the liabilities as
on the date of dissolution is far away from practice. In actual practice, the assets are
realised gradually and the cash available is applied in the following order:
From the external liabilities, first pay the Preferential Liabilities in the
order i.e. i) Realisation Expenses, ii) Government Dues and iii) Employees’ Dues.
Then pay Other Liabilities. In case of other liabilities, secured liabilities will get a
priority over unsecured ones for payment out of the amount realised from sale of assets
charged for securing such liabilities. If any other asset realises, then the secured liability
will stand at par with the unsecured liabilities. e.g. a Bank Loan secured against plant
will be paid off from the amount realised by the sale of plant. If the amount realised is
from any other asset, the loan will stand at par with other liabilities. Another point to be
noted here is that in case there are more than one liabilities of the same category,
then the payment should be made on pro-rata basis i.e., proportionately e.g. bills
payable and creditors are to be paid simultaneous in the ratio of the amounts due.
After paying off all the external liabilities, payment should be made for discharging
Internal Liabilities, i.e., Loans from Partners. Here also if there is more than one such
loan, the payment should be made pro-rata.
When all the external as well as internal liabilities are settled, payment can be made
to partners on their Capital Accounts.
Process of payment out of Assets :
While making the payment i.e. distribution of available cash among various
claimants the following steps should be followed :
Step 1 : First, realisation expenses are paid or provided for.
Step 2 : Then, outside creditors are paid. The point to be noted here is that
whenever an asset charged (i.e., an asset provided by way of security to a
creditor) is realised, the payment is made first to the concerned creditor
(i.e., to whom that asset has been provided as security). Whenever ‘an
asset not charged’ is realised, payment is made to all the creditors
(whether secured or unsecured) in proportion to their respective claims.
Step 3 : After the payment of all outside liabilities, the partners’ loans are discharged
in proportion to their respective amounts.
Step 4 : After the payment of all partners’ loan but before the partners’ capitals
are paid off, as a prudent measure, an adequate provision should be made
for a contingent liability (if any) (e.g. discounted bills receivable the
maturity of which has not yet reached).
Step 5 : Finally, the partners’ capitals are paid off.
Provisions of Indian Partnership Act‚ 1932 :
Section 48 of the Indian Partnership Act, 1932 provides that in settling of accounts
between the partners after dissolution of partnership, the following rules shall, subject
to any agreement, be observed:
 i) Losses, including deficiencies of capital shall be adjusted first out of
undistributed profits, next out of capital, and lastly, if necessary, by the partners
individully in the proportion in which they were entitled to share profits.
ii) The assets of the firm, including the sums, contributed by the partners to make
up losses or deficiencies of capital shall be applied in the following manner and
order:
• in paying outside creditors;
• in repaying advances made by partners (distinct from investment of capital);
• in repaying capital to partners; and
• the ultimate residue, if any, shall be divided among the partners in the
proportions in which profits are divisible.
So the Partnership Act provides for the adjustment of debit balances of capital or current
accounts first from the undistributed profits etc. before the disposal of business. Then on
realisation of assets, to pay off outside creditors first, then partners’ loans, thereafter the
partners’ capital balances. There is no mention of the realisation expenses in the act. But
the provision for the same should be done first because without which the assets can not
be disposed off. Suppose an advertisement is required to be given in the newspapers for
the disposal of assets, then without incurring advertisement expenses, nobody would
come to know about such disposal.

Distribution of Cash among the Partners :

As stated above, after settlement of external and internal liabilities, the cash available
from realisation of assets should be distributed among the partners to settle their capital
balances. Here again, we have to decide in what order and what proportion payment
should be made to partners on their capital accounts. Should the cash be distributed in
the ratio of the capitals of partners. The distribution should be made in such a manner
that the unpaid amount after distribution of all realisations is in profit sharing ratio. The
balance left unpaid in capital accounts is loss on realisation and this must be in profit
sharing ratio.
The partners are sharing profits and losses in a particular ratio i.e. profit sharing
ratio. The amount of exact profit or loss on realisation will not be known till all the
assets are disposed off. The partners may not be having their capitals in the profit
sharing ratio.
The problem arises when the capital balances of partners are not in the ratio in
which they
share profits and losses. In such a case the available cash can not be distributed among
the partners in profit sharing ratio because if it is so done, the amount left unpaid i.e.
loss, will not be in profit sharing ratio. Refer to the example given below. The proceeds
can not be distributed in capital ratio also because if it is so done, then the balance left
unpaid, i.e., loss, will also be in capital ratio, whereas it should be in profit sharing ratio.
 Proportionate Capital Method
OR Maximum Loss Method
OR
Surplus Capital Method
OR Notional Loss Method
Excess Capital Method
OR
High Relative Capital Method
OR
Quotient Method

Methods of
Distribution of Cash
among the Partners

Fig. 1.3 : Methods of Distribution of Cash among the Partners

1.3 SURPLUS CAPITAL METHOD

This is a simple method of distribution of cash among the partners. As the name
indicates, under this method, the surplus capital of the partners is found out first. Such
surplus capital once paid off, will leave the remaining capital in the profit sharing ratio.
Then it can be easily repaid. The balance, if any, indicating the realisation loss, will be
shared by the partners in the profit sharing ratio automatically. If there is any realisation
profit, the partners would get that much amount more than their capital balances.
Surplus Capital means capital that is more than the required capital, according to the
share of profit an individual partner is sharing.
This method is also known as “Excess Capital Method” or, “Highest Relative Capital
Method” or “Quotient Method”. Under this method, the excess capital contribution by
the partners, with reference to their profit sharing ratio is determined. It is already noted
that the proceeds of assets realised cannot be distributed in profit sharing ratio if the
capital balances are not in the profit sharing ratio. Thus, in order to bring the capitals in
profit sharing ratio, the excess capital contributed by a partner over and above his
proportionate capital with reference to his share of profit, is paid off first. To take an
example, if A and B are two partners sharing profits and losses in the ratio of 3 : 1 and
having capitals of ` 45,000 and `25,000, respectively, B’s excess capital is ` 10,000 for his
share and this should be paid off first. Thus, the available cash should be paid only to B
till the time his capital becomes ` 15,000 thereby making it proportionate to his share of
profit. Capital to be considered for this purpose will be after adjustment of General
Reserve, Profit and Loss Account (Credit) balance or Profit and Loss Account (Debit)
balance.
Here, the capital of a partner, who is having the least capital per share is taken as a base.
This is taken as a base because, the partnership is under dissolution and no partner
would be ready to contribute anything further to the firm. They would be interested in
taking the money back from the firm, instead of investing further. The partners capital is
then revised according to the base capital. The difference between the actual capital
and the required capital is called surplus