When a partner discharges the liability of the firm.
When a partner discharges the liability of the firm, it is treated as a contribution from that partner towards the settlement of the firm's outside liabilities. The partner becomes entitled to reimbursement from the firm's assets.
According to the settlement rules, the amount realised from assets along with contribution from partners is utilised first to pay off outside liabilities such as creditors, loans, bank overdraft, and bill payables. After settling outside liabilities, the balance is used to repay loans made by partners to the firm, followed by settlement of capital account balances.
If a partner is unable to contribute towards the deficiency of his capital account (showing a debit balance), he/she is said to be insolvent, and the sum not recoverable is treated as capital loss for the firm. Such loss is borne by the remaining solvent partners in the ratio of their capitals as on the date of dissolution as per the Garner vs. Murray case.
Explanation
The textbook context explains the settlement of accounts during dissolution, where partners may need to contribute towards paying off outside liabilities. When a partner personally pays off the firm's liabilities, it is treated as a contribution. The context also covers the Garner vs. Murray principle for handling insolvent partners who cannot contribute towards their capital deficiency.