Mode of settlement of accounts between partners
Mode of Settlement of Accounts Between Partners, especially in the context of dissolution of a partnership:
✅ Mode of Settlement of Accounts Between Partners
When a partnership is dissolved, it’s necessary to settle the accounts among the partners to ensure a fair distribution of assets, liabilities, profits, and losses. The settlement of accounts refers to this final balancing and distribution of the partnership’s financial matters.
This process is generally governed by partnership laws such as:
The Indian Partnership Act, 1932 (Section 48),
The UK Partnership Act, 1890 (Section 44),
Or similar statutes in other jurisdictions.
📌 General Order of Settlement
The typical order of settlement of accounts after dissolution is as follows:
1. Pay Debts Owed to External Parties
The partnership must first pay all its debts and liabilities to third parties (creditors outside the firm).
2. Repay Loans/Advances from Partners
Any loans or advances made by partners to the firm (not as capital contributions) are repaid next.
3. Return Capital to Partners
After paying debts and loans, the original capital contributed by each partner must be returned.
4. Distribute Surplus (or Losses) Among Partners
Any remaining balance (profit) is distributed among the partners in the profit-sharing ratio.
If there is a deficit or loss, it is also shared in the agreed ratio or equally if no ratio is agreed upon.
📊 Flowchart of Settlement Process
Assets Realized (Cash from sale of assets) ↓ + Amounts due from partners or third parties ↓ = Total Available Funds ↓ → Pay outside creditors ↓ → Repay partners' loans/advances ↓ → Return capital to partners ↓ → Distribute remaining balance (profit or loss) among partners
📍 Special Points to Note
Private debts vs. Partnership debts: Partnership assets are first used for partnership debts before settling partners’ personal debts.
Losses from Insolvency: If a partner is insolvent, the loss is usually borne by the remaining partners (e.g., under the rule in Garner v. Murray).
Agreements override law: If the partners have an agreement on a different mode of settlement, that agreement prevails over default rules.
📘 Example:
Suppose a firm has:
Assets worth ₹1,000,000
Owes ₹300,000 to external creditors
Has partner A’s loan of ₹100,000
Capital contributions: A – ₹300,000, B – ₹200,000
Profit-sharing ratio: A : B = 3:2
Settlement would follow:
Pay creditors: ₹300,000
Repay A’s loan: ₹100,000
Return capital: A – ₹300,000, B – ₹200,000
Remaining ₹100,000 (surplus): shared 3:2 → A: ₹60,000, B: ₹40,000
⚖️ Legal Reference (Indian Partnership Act, 1932 – Section 48):
“In settling the accounts of a firm after dissolution, the following rules shall, subject to agreement by the partners, be observed…”
✅ Summary Table
| Step | Details |
|---|---|
| 1. Pay outside creditors | All third-party liabilities |
| 2. Repay partner loans | Not part of capital contribution |
| 3. Return partner capital | As per actual contributions |
| 4. Share remaining surplus/loss | Based on profit-sharing ratio |
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