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Introduction to Financial

Accounting

Assignment No. 2

FORMS OF BUSI NESS
ORGANI ZATI ONS

Name: Syed Muhammad Adnan Jawed
ID # : 13949
Serial #: 39

Submitted to:
Ms. Fatima Ahmed
Introduction to Financial Accounting Ms. Fatima Ahmed
Syed Muhammad Adnan Jawed ID # 13949
All businesses must adopt some legal configuration that defines the rights and liabilities of participants
in the businesss ownership, control, personal liability, life span, and financial structure. As a business
owner, the first decision which should be taken is to how the business should be structured. While
making a choice, the followings must be taken in account:
Vision regarding the size and nature of business.
The level of control on business and structure one want to deal with.
The businesss vulnerability to lawsuits.
Tax implications of the different organizational structures.
Expected profit (or loss) of the business.
Whether or not one need to re-invest earnings into the business.
Basic Legal Forms of Organizations
1. Sole Proprietorship
2. Partnerships
3. Corporations
Sole Proprietorship
A sole proprietorship is a type of business entity that is owned and run by one individual and in which
there is no legal distinction between the owner and the business. The owner receives all profits (subject
to taxation specific to the business) and has unlimited responsibility for all losses and debts. Every asset
of the business is owned by the proprietor and all debts of the business are the proprietor's. These firms
are owned by one person, usually the individual who has day-to-day responsibility for running the
business. Professionals, consultants, and other service businesses that require minimum amounts of
capital often operate this way.
Characteristics:
I. The business is owned and controlled by only one person.
II. The risk is borne by a single person and hence he derives the total benefit.
III. No distinction is made between the enterprise and its owner and both are looked upon as one
any same person. Death or insolvency of the sole proprietor brings his business to an end.
IV. The liability of the owner of the business is unlimited. It means that his personal assets are also
liable to be attached for the payment of the liabilities of the business.
V. Due to limited finance and managerial ability, the sole proprietor has a limited area of
operation. Unlimited liability also restricts the proprietor from taking bold decisions and
expands its area of operations.
VI. The business firm has no separate legal entity apart from that of the proprietor, and so the
business lacks perpetuity.
VII. To set up sole proprietorship, no legal formalities are necessary, but there may be legal
restrictions on the setting up of particular type of business.
VIII. The proprietor has complete freedom of action and he himself takes decisions relating to his
firm.
IX. The proprietor may take the help of members of his Family in running the business.


Introduction to Financial Accounting Ms. Fatima Ahmed
Syed Muhammad Adnan Jawed ID # 13949
Advantages:
I. Easiest and least expensive form of ownership to organize.
II. Sole proprietors are in complete control, and within the parameters of the law, may make
decisions as they see fit.
III. Profits from the business flow-through directly to the owners personal tax return.
IV. The business is easy to dissolve, if desired.
Disadvantages:
I. Sole proprietors have unlimited liability and are legally responsible for all debts against the
business. Their business and personal assets are at risk.
II. May be at a disadvantage in raising funds and are often limited to using funds from personal
savings or consumer loans.
III. May have a hard time attracting high-caliber employees, or those that are motivated by the
opportunity to own a part of the business.
IV. Some employee benefits such as owners medical insurance premiums are not directly
deductible from business income (only partially as an adjustment to income).

Partnerships
In a Partnership, two or more people share ownership of a single business. Like proprietorships, the law
does not distinguish between the business and its owners. The Partners should have a legal agreement
that sets forth how decisions will be made, profits will be shared, disputes will be resolved, how future
partners will be admitted to the partnership, how partners can be bought out, or what steps will be
taken to dissolve the partnership when needed; Yes, its hard to think about a break-up when the
business is just getting started, but many partnerships split up at crisis times and unless there is a
defined process, there will be even greater problems. They also must decide up front how much time
and capital each will contribute, etc.
Characteristics:
I. The formation of partnership does not involve any complicated legal formalities. By an oral or
written agreement, a Partnership can be created. Even the registration of the agreement is not
compulsory.
II. The capital of a partnership is contributed by the partners but it is not necessary that all the
partners should contribute equally. Some may become partners without contributing any
capital. This happens when such partners have special skills, abilities or experience. The
partnership firm can also raise additional funds by borrowing from banks and others.
III. The control is exercised jointly by all the partners. No major decision can be taken without
consent of all the partners. However, in some firms, there may partners known as sleeping or
dormant partners who do not take an active part in the conduct of the business.
IV. Every partner has a right to take part in the management of the firm. But generally, the
partnership Deed may provide that one or more than one partner will look after the
management of the affairs of the firm. Sometimes the deed may provide for the division of
responsibilities among the different partners depending upon their specialization.
V. The duration of the partnership may be fixed or may not be fixed by the partners. In case
duration is fixed, it is called as partnership for a fixed term. When the fixed period is over, the
partnership comes to an end.
Introduction to Financial Accounting Ms. Fatima Ahmed
Syed Muhammad Adnan Jawed ID # 13949
VI. The liability of each partner in respect of the firm is unlimited. It is also joint and several and,
therefore any one of the partner can be asked to clear the firms debts in case the assets of the
firm are inadequate for it.
Advantages:
I. Partnerships are relatively easy to establish; however time should be invested in developing the
partnership agreement.
II. With more than one owner, the ability to raise funds may be increased.
III. The profits from the business flow directly through to the partners personal tax return.
IV. Prospective employees may be attracted to the business if given the incentive to become a
partner.
V. The business usually will benefit from partners who have complementary skills.
Disadvantages:
I. Partners are jointly and individually liable for the actions of the other partners.
II. Profits must be shared with others.
III. Since decisions are shared, disagreements can occur.
IV. Some employee benefits are not deductible from business income on tax returns.
V. The partnership may have a limited life; it may end upon the withdrawal or death of a partner.

Corporations
A Corporation, chartered by the state in which it is headquartered, is considered by law to be a unique
entity, separate and apart from those who own it. A corporation is a legal entity that has most of the
rights and duties of a natural person but with perpetual life and limited liability. The owners of a
corporation are its shareholders. Shareholders of a corporation appoint a board of directors and the
board of directors appoints the officers for the corporation, who have the authority to manage the day-
to-day operations of the corporation. The corporation has a life of its own and does not dissolve when
ownership changes. Corporations are more expensive to form than partnerships and sole
proprietorships.
Characteristics:
I. It should be easy to form the organization. The formation should not involve many legal
formalities and it should not be time consuming.
II. The liability of stockholders is limited to the amount each has invested in the corporation.
Personal assets of stockholders are not available to creditors or lenders seeking payment of
amounts owed by the corporation. Creditors are limited to corporate assets for satisfaction of
their claims.
III. The corporation is considered a separate legal entity, conducting business in its own name.
Therefore, corporations may own property, enter into binding contracts, borrow money, sue
and be sued and pay taxes. Stockholders are agents for the corporation only if they are also
employees or designated as agents.
IV. Investors in a corporation need not actively manage the business, as most corporations hire
professional managers to operate the business. The investors vote on the Board of Directors
who are responsible for hiring management
Introduction to Financial Accounting Ms. Fatima Ahmed
Syed Muhammad Adnan Jawed ID # 13949
V. Stockholders, who are owners of the corporation, are not liable for its debts or acts. The
premise of separate legal entity means that the no one represents or acts on behalf of the
company as it represents itself. In instances where a corporation is being wound up, the
shareholders are only liable up to the unpaid amounts of their shares.
VI. A corporation can obtain capital by selling stock or bonds. This gives a corporation a larger pool
of resources because it is not limited to the resources of a small number of individuals.
VII. In accordance to the going concern principle of accounting, corporations have an endless life. A
corporation exists indefinitely, up to the foreseeable future. There is no connection between the
life of a corporation and that of its members.
VIII. Shares of corporations, whether private or public, are transferable from one person to the
other. By transferring shares, the ownership of the corporation also changes hands. Transfer of
ownership is accomplished simply by selling and buying of shares at the prevailing market
prices.
IX. Regardless of the type of corporation, whether sole, aggregate, statutory or chattered, there is a
centralized management system. Shareholders do not manage the day-to-day operations of the
corporation, instead appointed mangers act as stewards over the corporation's business
Advantages:
I. Shareholders have limited liability for the corporations debts or judgments against the
corporation.
II. Generally, shareholders can only be held accountable for their investment in stock of the
company. (Note however, that officers can be held personally liable for their actions, such as the
failure to withhold and pay employment taxes.)
III. Corporations can raise additional funds through the sale of stock.
IV. A Corporation may deduct the cost of benefits it provides to officers and employees.
Disadvantages:
I. The process of incorporation requires more time and money than other forms of organization.
II. Corporations are monitored by federal, state and some local agencies, and as a result may have
more paperwork to comply with regulations.
III. Incorporating may result in higher overall taxes. Dividends paid to shareholders are not
deductible from business income; thus this income can be taxed twice.