At the time of dissolution of a partnership firm, if all external liabilities are paid in full, what is the immediate effect in the books?

Correct answer: The balance of the liability becomes nil

When a liability is paid, the liability account is debited and the Cash or Bank Account is credited. Consequently, the liability balance is eliminated and becomes nil. This payment does not automatically create a profit in the Realisation Account; realisation profit or loss depends on the difference between the book values and the amounts realised or settled. Exam tip: payment of a liability reduces both the liability and the cash or bank balance.