In case of dissolution of a firm, the firm ceases to conduct business and has to settle its accounts. For this purpose, it disposes off all its assets for satisfying all the claims against it. In this context, it should be noted that, subject to agreement among the partners, the following rules as provided in Section 48 of the Partnership Act, 1932 shall apply. As per those rules,
The following order of settlement will be followed.
(i) Treatment of Losses: Note Losses: including deficiencies of capital, shall be paid
(a) First out of profits,
(b) Next out of capital of partners, and
(c) Lastly, if necessary, by the partners individually in their profits sharing ratio.
(ii) Application of Assets: The assets of the firm including any sum contributed by the partners to make up deficiencies of capital, shall be applied in the following manner and order
(a) In paying the debts of the firm to the third parties;
(b) In paying each partner proportionately what is due to him/her from the firm for advances as distinguished from capital (i.e., partner’s loan);
(c) In paying to each partner proportionately what is due to him on account of capital; and
(d) The residue, if any, shall be divided among the partners in their profit sharing ratio.