What is Realisation Account? | Simple Explanation for Class 12

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What is Realisation Account Preparation?

Grade Level:

Class 12

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Definition

What is it?

The Realisation Account is a special account prepared when a partnership firm closes down (dissolves). Its main purpose is to show how all the firm's assets (like land, machinery) are sold off and how all the firm's liabilities (like loans, bills payable) are paid back. It helps calculate the final profit or loss made during the dissolution process.

Simple Example

Quick Example

Imagine your family decides to close down a small chai shop. Before closing, you need to sell the chai counter, the utensils, and the chairs. You also need to pay back the money borrowed from the neighbour for milk. The Realisation Account is like a detailed list that keeps track of all these sales and payments to see if you made extra money or lost some in the process of closing the shop.

Worked Example

Step-by-Step

Let's say a partnership firm, 'Star Traders', is dissolving. Here's how a Realisation Account would be prepared:

Step 1: Transfer all assets (except Cash/Bank) to the Debit side of Realisation Account. Suppose, Stock is Rs. 50,000 and Furniture is Rs. 20,000.
---Step 2: Transfer all external liabilities to the Credit side of Realisation Account. Suppose, Creditors are Rs. 30,000.
---Step 3: Record the sale of assets on the Credit side. Suppose, Stock sold for Rs. 55,000 and Furniture sold for Rs. 18,000.
---Step 4: Record payment of liabilities on the Debit side. Suppose, Creditors paid Rs. 28,000.
---Step 5: Record any dissolution expenses on the Debit side. Suppose, expenses were Rs. 2,000.
---Step 6: Calculate the balance. Total of Credit side (Rs. 30,000 + Rs. 55,000 + Rs. 18,000 = Rs. 1,03,000). Total of Debit side (Rs. 50,000 + Rs. 20,000 + Rs. 28,000 + Rs. 2,000 = Rs. 1,00,000).
---Step 7: Credit side total (Rs. 1,03,000) is more than Debit side total (Rs. 1,00,000). So, there is a profit of Rs. 3,000 (Rs. 1,03,000 - Rs. 1,00,000).
---Step 8: This profit of Rs. 3,000 will be transferred to partners' capital accounts.

Answer: The Realisation Account shows a Profit on Realisation of Rs. 3,000.

Why It Matters

Understanding Realisation Accounts is crucial for anyone interested in finance or business management. It's a foundational concept for accountants, financial analysts, and even entrepreneurs who might one day need to close a business. Knowing this helps in understanding how businesses manage their finances during major changes, which is relevant in FinTech and Economics.

Common Mistakes

MISTAKE: Transferring Cash/Bank balance to the Realisation Account. | CORRECTION: Cash and Bank balances are NOT transferred to the Realisation Account; they are used to prepare the Cash/Bank Account directly.

MISTAKE: Recording partners' loans or capital accounts in the Realisation Account. | CORRECTION: Only external liabilities (like creditors, bank loans) are transferred to the Realisation Account. Partners' loans and capital accounts are handled separately.

MISTAKE: Not recording dissolution expenses or unrecorded assets/liabilities. | CORRECTION: All expenses incurred during dissolution and any unrecorded assets sold or liabilities paid must be shown in the Realisation Account.

Practice Questions

Try It Yourself

QUESTION: A firm has assets (excluding cash) of Rs. 1,00,000 and external liabilities of Rs. 30,000. Assets are sold for Rs. 90,000 and liabilities are paid at Rs. 28,000. What is the profit or loss on realisation? | ANSWER: Loss of Rs. 2,000. (Assets transferred: Dr. 1,00,000. Liabilities transferred: Cr. 30,000. Assets sold: Cr. 90,000. Liabilities paid: Dr. 28,000. Total Dr: 1,28,000. Total Cr: 1,20,000. Difference = 8,000 Loss)

QUESTION: A firm's machinery (book value Rs. 70,000) is taken over by a partner for Rs. 65,000. Creditors (Rs. 40,000) are paid at a 5% discount. Realisation expenses are Rs. 1,500. Calculate the total debit and credit entries related to these transactions in the Realisation Account. | ANSWER: Debit entries: Rs. 70,000 (Machinery) + Rs. 38,000 (Creditors paid) + Rs. 1,500 (Expenses) = Rs. 1,09,500. Credit entries: Rs. 65,000 (Machinery taken over).

QUESTION: On dissolution, Furniture (book value Rs. 40,000) is sold for Rs. 45,000. Stock (book value Rs. 60,000) is taken over by a partner, Ravi, for Rs. 55,000. Creditors of Rs. 30,000 are paid in full. There was an unrecorded investment of Rs. 5,000 which was sold for Rs. 6,000. Calculate the profit or loss on Realisation. | ANSWER: Profit on Realisation of Rs. 6,000. (Dr side: Furniture 40k, Stock 60k, Creditors paid 30k = 130k. Cr side: Furniture sold 45k, Stock by Ravi 55k, Creditors 30k, Unrecorded Inv sold 6k = 136k. Profit = 136k - 130k = 6k)

MCQ

Quick Quiz

Which of the following items is NOT transferred to the Realisation Account?

Creditors

Bank Loan

Cash at Bank

Machinery

The Correct Answer Is:

Cash at Bank (or Cash in Hand) is not transferred to the Realisation Account. It is used to prepare the Cash/Bank Account directly. All other options are either assets or external liabilities that are transferred.

Real World Connection

In the Real World

When a small business, like a local kirana store or a startup, decides to shut down, the owner and their accountant will prepare something similar to a Realisation Account. They will list all the items to be sold (like shelving, inventory) and all the bills to be paid (like supplier payments, rent). This helps them figure out the final financial position and ensure all dues are cleared properly, just like managing finances for a Swiggy or Zomato partner restaurant when it closes.

Key Vocabulary

Key Terms

DISSOLUTION: The process of closing down a partnership firm completely. | ASSETS: Things of value owned by the business, like furniture, stock, machinery. | LIABILITIES: Money owed by the business to others, like creditors, bank loans. | EXTERNAL LIABILITIES: Debts owed to parties outside the partnership, not to the partners themselves. | REALISATION PROFIT/LOSS: The final profit or loss calculated after selling assets and paying liabilities during dissolution.

What's Next

What to Learn Next

Now that you understand Realisation Account, you should learn about 'Partners' Capital Accounts' and 'Cash/Bank Account' during dissolution. These concepts build on what you've learned here, showing how the final profit/loss from realisation is distributed and how cash is finally settled among partners.