On dissolution of a firm liabilities are transferred to :

Question

Accepted Answer

The correct option is 4:
The **Realization Account** is a specially opened nominal account during the dissolution of a partnership firm, and it is the correct destination for all external liabilities. The accounting objective of dissolution is to close all the firm’s books and determine the final profit or loss from winding up the business. To achieve this, all external assets (excluding cash and bank balances) and all external liabilities are transferred to this Realization Account at their *book values*. The entry involves debiting the liability accounts to close them and crediting the Realization Account. This centralized transfer allows the firm to systematically record the sale of assets and the subsequent payment of all liabilities from one place before the final profit or loss is distributed to the partners.

The incorrect option is 1:
The **Bank Account** is a real account that records the firm's bank balance, and it is not the ledger used for the initial transfer of external liabilities. Its function during dissolution is to record the *actual payment* made for the liabilities (or expenses) and the *receipt* of funds from the sale of assets. For instance, when a liability is paid, the journal entry is to debit the Realization Account and credit the Bank Account, showing a decrease in cash. It is a medium of final settlement, not a clearing house for liability balances.

The incorrect option is 2:
The **Reserve and Surplus Account** is an equity account that represents accumulated profits or reserves belonging to the partners, not an external liability. On dissolution, the balance in this account is *not* used to pay off external parties. Instead, it is directly transferred to the credit side of the Partners' Capital Accounts in their agreed-upon profit-sharing ratio. Its purpose is to distribute past retained earnings to the owners, making it irrelevant for the settlement of the firm’s external obligations.

The incorrect option is 3:
The **Cash Account** is a real account that tracks the physical cash balance of the firm, similar to the Bank Account. Its role is to record the actual flow of money, meaning cash receipts and cash payments. Like the Bank Account, it is kept open until the very end and is one of the few accounts whose balance is *not* transferred to the Realization Account. It is only credited when a payment is made, signifying the outflow of a current asset, but it is not the account to which liabilities are initially transferred for closing purposes.