Ch-2 Forms of Business Organisation

Short Answer Question

Question 1: Compare the status of a minor in a Joint Hindu Family Business with that in a partnership firm.

ANSWER: As per the Indian law, any person below the age of 18 years is considered a ‘minor’. The status of a minor in
a Joint Hindu Family differs from that in a partnership firm. In case of a Joint Hindu Family, membership in the family
business is by birth. This means that as soon as a boy child is born in a Joint Hindu Family, he is automatically entitled
to a share in his family business. In this case, the minor enjoys an equal ownership right over the inherited property as
the other members of the family. However, his liability is limited only to the extent of his share in the joint property.

As per the Partnership Act, 1923, no minor can be a partner in a partnership firm. But a partnership firm, with the
consent of all the partners, can admit a minor to share the profits of the firm; but he cannot be asked to either contribute
capital or bear the losses incurred by the business. A minor is not legally competent to enter into any legal contracts,
and therefore, he or she cannot be considered a partner. However, a minor, after attaining the age of 18 years, has the
option of either continuing with the partnership firm or withdrawing his interest from it.

Question 2: If registration is optional, why do partnership firms willingly go through this legal formality and get
themselves registered? Explain.

ANSWER: Although registration in case of a partnership firm is optional yet many firms voluntarily opt for it. This is
because of the various legal disadvantages associated with non-registration. A few of these disadvantages are listed
below.

(a) The partners of a non-registered firm cannot file a suit against a third party; however, non-registration of a
partnership firm does not prevent other firms from suing it .

(b) The firm cannot file a case against any of its partners. Similarly, a partner of a non-registered firm cannot file a case
against his or her co-partners or the firm.

(c) A non-registered partnership firm cannot enforce its claims against a third party in a court.

Question 3: State the important privileges available to a private company.

ANSWER: A private company enjoys certain exemptions or privileges which are often not available to a public
company. Some of the privileges enjoyed by a private company are given below.

(a) Lesser number of members required: A private company requires only two members for formation, while a public
company requires at least seven members.

(b) Commencement of business: A private company can start its business operations right from the day of receiving the
certificate of incorporation. On the other hand, it is mandatory for a public company to obtain a certificate of
commencement along with a certificate of incorporation before starting business.

(c) No restriction on advancing loans to the directors: In the case of a private company, there is no restriction on the
amount of loans that can be granted to the directors. No prior permissions are required to be sought for advancing such
loans. In contrast, a public company has to seek permission from the government before advancing loans to its
directors.

(d) Lesser number of directors required for operations: A private company can continue operations with just two
directors, whereas a public company must have at least three directors to continue its operations.
Question 4: How does a cooperative society exemplify democracy and secularism? Explain.

ANSWER: In a cooperative society, management is in the hands of a managing committee elected by the members of
the society. The elections in such societies are governed by the principle of ‘one member, one vote’. This implies that all
members have equal voting rights irrespective of the amount of capital they have contributed to the society. This
principle prevents the dominance of the richer members (who may own a higher number of shares) in the decision-
making process. Thus, as in a democracy, a cooperative society treats all its members equally and provides equal
rights to its members. Moreover, there is no discrimination among the members on the basis of their religion, caste or
sex. In addition, the members are free to elect the members of the managing committee of their choice. Therefore, a
cooperative society exemplifies a secularist system.

Question 5: What is meant by 'partner by estoppel'? Explain.

ANSWER: A person can be regarded as a 'partner by estoppel', if he or she through his/her actions or behaviour,
leaves an impression on third parties that he or she is a partner in a particular firm. This means that if a person behaves
in a manner that makes third parties consider this individual as one of the actual partners, then he or she is regarded as
a ‘partner by estoppel’. Such a partner (by estoppel) is actually not a partner, as he or she neither contributes any
capital to the firm nor actively participates in the operations of the firm and is not entitled to any share in the firm’s
profits or losses. Nevertheless, he or she can be held liable for the debts that the firm owes to third parties. Accordingly,
if the funds available to the firm fall short of requirement for the repayment of debts, then the private assets of a partner
by estoppel can be used to repay the debts.

Question 6: Explain the following terms in brief

(a) Perpetual succession

(b) Common seal

(c) Karta

(d) Artificial person

ANSWER:

(a) Perpetual succession: It implies that a company will continue to exist until and unless it is forced by the law to wind
up. This implies that a company, as a separate legal entity, cannot come to an end by itself and will continue to operate
forever. It will not cease to exist even in situations such as death, retirement or insolvency of any of its members—that
is, a company will continue to operate even if all its members die.

(b) Common seal: A company is an artificial entity that is created under the law. Unlike human beings, it cannot sign
official documents. This is where the role of a common seal becomes important. A common seal is the official signature
of a company that is used by its board of directors in almost all the important official documents. The presence of this
seal authenticates the documents, and documents with a common seal can be provided as evidence in a court of law.

(c) Karta: The term karta is used for the head of a joint Hindu family who runs a family business. The karta of a Joint
Hindu family is responsible for carrying out the business operations of the family business and exercising full control
over the business. He is the eldest member of the family and has unlimited liabilities along with absolute decision-
making powers.

(d) Artificial person: By the term artificial person, we mean that a company is created as a separate legal entity under
the law and is a juristic person. However, unlike human beings, a company, as an artificial person, cannot breathe or
talk, cannot sign its documents and cannot negotiate with its customers. In contrast, like human beings, a company
does have its own life that is truly independent of the life of its members. Hence, because of these dissimilarities and
similarities, a company is regarded as an artificial person.
Long Answer Question

Question 1: What do you understand by a sole proprietorship firm? Explain its merits and limitation?

ANSWER: In a sole proprietorship form of business, the business is owned, managed and controlled by a single
individual who is known as the sole proprietor. As the sole owner of the business, the proprietor becomes the single
recipient of all the profits earned by the business and, in the same way, has to bear all losses.

Merits of Sole Proprietorship

A sole proprietor enjoys the following benefits.

(a) Ease in formation and closure of business: There are hardly any legal formalities to be fulfilled for setting up a
sole proprietorship firm. However, if a proprietor is dealing in drugs and liquor products, then a licence has to be
acquired. The procedure for closing down a sole proprietorship firm is also hassle-free and easy.

(b) Quick decision making: A sole proprietor enjoys complete control over the business. This makes decision making
quick and easy.

(c) Direct incentive: A sole proprietor is the sole bearer of all types of risks associated with the business and, at the
same time, is the single recipient of all the profits and gains earned in the business. Thus, this direct link between
efforts and rewards motivates the sole proprietor to operate the business efficiency and effectively.

Limitations of Sole Proprietorship:

The following are a few limitations of a sole proprietor firm.

(a) Limited capital: The financial resources that are available to a sole proprietor are limited merely to this person’s
personal savings and borrowings that can be raised from relatives and friends. Thus, the amount of capital available to
a sole proprietor is limited, which often prevents him or her from expanding the business.

(b) Limited managerial abilities: A sole proprietor manages all the core functions such as purchasing, selling and
planning. As a result, the benefits of specialisation are not available to a sole proprietor. Also, because of limited
resources, a sole proprietor may not be able to employ specialised employees to handle specific business operations.

(c) Uncertain life: In the eyes of the law, a sole proprietor and his or her business are regarded as the same entity. In
the event of death, insanity, bankruptcy or physical ailment of a sole proprietor, the life of the business is adversely
affected.

Question 2: Why is partnership considered by some to be a relatively unpopular form of business ownership? Explain
the merits and limitations of partnership.

ANSWER: Partnership is considered to be a relatively unpopular form of business ownership because of the various
limitations associated with it. These limitations include unlimited liability, limited resources, possibility of conflicts and
lack of continuity.

Limitations of Partnership

(a) Unlimited liability: In a partnership, all the partners have unlimited liability. This means that if the firm’s assets fall
short of the requirement for the repayment of the firm’s debts, then the personal assets of the partners can be used.

(b) Limited resources: A partnership firm faces limited availability of finance, because of the restrictions imposed on
the following fronts:

(i) maximum number of partners allowed in a partnership firm by definition

(ii) maximum number of new partners who can be admitted in the firm

Hence, as a result, a partnership firm faces financial constraints, which in turn impedes its growth prospects.

(c) Possibility of conflicts: In a partnership firm, the power of decision making is shared among the partners. This
further depends on their respective levels of skills, capabilities and foresightedness. The differences in these qualities
may possibly lead to conflicts among the partners.

Merits of Partnership

(a) Easy formation and closure: A partnership firm involves an agreement (either oral or written) between two or more
partners. The registration of a partnership firm is not compulsory, which eases its formation. Similarly, a partnership firm
can be shut down at any time with the mutual consent of all the partners.

(b) Balanced decision making: In a partnership firm, all the decisions related to the business are taken collectively by
all the partners. This makes the decision-making process in a partnership firm comparatively more balanced than in any
other form of business ownership.

(c) Sharing of risks: The risks in a partnership firm are shared jointly by all the partners. As a result, anxiety, burden
and stress of the individual partners are shared among all the partners, which reduces the burden on a single partner.

Question 3: Why is it important to choose an appropriate form of organisation? Discuss the factors that determine the
choice of form of organisation.

ANSWER: The choice of an appropriate form of business organisation is important for the following reasons.

(a) Options to choose among various business forms: As there exist numerous forms of business organisations
such as sole proprietorship, partnership, cooperative society and company, the choice of an appropriate business
organisation is important, because each business form has its own merits and demerits.

(b) Business factors: Every type of business form is influenced by its respective business-related factors, namely,
need of funds, risk involved, amount of profits and legal obligations. Therefore, the choice of the appropriate business
form is made only after the evaluation of all these business factors.

(c) Long-term growth prospects: The growth prospects of each type of business form are different. If a
businessperson opts for a particular business form without correctly evaluating the growth prospects, then the business
may fail or the long-term growth prospects of the business will suffer.

Factors determining Choice of a Business Form

The following are the factors that determine the choice of a business organisation.

(a) Nature of business activity: Any individual first needs to decide upon the nature or kind of business activity that he
or she desires to undertake. In case the business type requires direct personal contact with customers, then the sole
proprietorship form of business proves beneficial. On the other hand, if direct personal contact is not required, then a
partnership or a company form of business is more suitable.

(b) Degree of control: The choice of a business form also depends on the degree of control that a businessperson
wants to exercise over its management. If a businessperson aims to have direct control over all the business
operations, then sole proprietorship may be considered appropriate. However, if he or she does not mind sharing the
decision-making powers with others, then a partnership or company form of business would be more suitable.

(c) Degree and specialisation of managerial abilities: If the business operations are large and require specialised
and skilled professionals for managing them, then a company form of business may be selected. However, if the
business operations are not very complex and the scale of operations is also not very large, then sole proprietorship
proves to be a better alternative.

Question 4: Discuss the characteristics, merits and limitations of cooperative form of organisation. Also describe briefly
different types of cooperative societies.

ANSWER: The word ‘cooperative’ means an organisation in which the stakeholders work with one another. Thus, a
cooperative society is a voluntary association of individuals who join together to protect or promote their common
interests.

Features of Cooperative Societies

(a) Separate legal entity: The registration of a cooperative society is compulsory under the Cooperative Societies Act,
1912. Once the registration is complete, the cooperative society is granted the status of a separate legal entity. This
implies that the cooperative society can hold properties in its own name and enter into contracts. Moreover, it can sue
others and can be sued by others.

(b) Management and control: A cooperative society is a democratic form of organisation as it is managed and
controlled by a managing committee which is elected by the members of the society on the principle of ‘one member,
one vote’.

Merits of Cooperative Societies

(a) Ease of formation: The formation of a cooperative society is quite easy as it requires the induction of only 10 adult
members. The registration procedure of a society under the Cooperative Societies Act, 1912, is quite simple.

(b) Continued existence: A cooperative society is a stable form of organisation as it enjoys the status of a separate
legal entity that is considered distinct from its members. As a result, the life of a cooperative society remains unaffected
by the death, insolvency or insanity of its members.

Limitations of Cooperative Societies

(a) Excessive government control: Cooperative societies have to follow certain rules and regulations as imposed on
them by the cooperative departments of the state government concerned. These rules include submission and auditing
of accounts.

(b) Inefficiency in management: The management of a cooperative society generally comprises part-time or
inexperienced people. They may not be well equipped with the skills required to handle the managerial functions
effectively. Consequently, cooperative societies often lack efficiency.

Types of Cooperative Societies

Cooperative societies are classified into the following six types.

(a) Consumer cooperative societies: These are formed to provide consumer goods at reasonable prices to its
members.

(b) Producer cooperative societies: The objective of producer cooperative societies is to procure raw materials and
other inputs at low costs and supply them to small producers.

(c) Marketing cooperative societies: These societies pool the outputs of the member and perform certain marketing
functions for them such as transportation, labelling, packaging and warehousing.

(d) Farmers’ cooperative societies: Such societies are formed by small farmers who pool their resources to reap the
benefits associated with large-scale operations. These societies ensure the availability of better and advanced inputs at
low rates to farmers.
(e) Credit cooperative societies- These societies ensure the availability of funds to its members at comparatively low
interest rates on reasonable terms.

(f) Cooperative housing societies: The aim of housing cooperative societies is to solve the problem of finding
residential accommodation of its members by constructing houses for them. These societies provide its members with
easy repayment schemes through which the cost of the houses can be repaid in form of installments.

Question 5: Distinguish between a Joint Hindu family business and partnership.

ANSWER:

Difference between Joint Hindu family business and Partnership

Basis of difference Joint Hindu Family Business Partnership

Governance Governed by the Hindu law. Governed by Partnership Act, 1932.

Liability The head has unlimited liability, while the All the partners have unlimited liability.
liabilities of other members are limited to
the extent of their share in the business.

Decision making and The karta is responsible for the All the partners jointly manage and control
control management and control of the business. the firm.

Number of members Minimum: 2 Minimum: 2

Maximum: No limit Maximum: 10 for the banking business and

20 for other businesses

Minor Minors can be members. Minors cannot be members.

Question 6: Despite limitations of size and resources, many people continue to prefer sole proprietorship over other
forms of organisation? Why?

ANSWER: Despite the limitations in terms of size and resources, many people prefer sole proprietorship over any other
forms of business primarily because of the numerous benefits associated with the sole proprietorship business form.

The following are a few important benefits that a businessperson enjoys by being a sole proprietor.

(a) Ease in formation and closure: There are hardly any legal formalities that are required to be fulfilled for setting up
a sole proprietorship firm. However, if a proprietor wants to deal in drugs and liquor, then he or she must to acquire a
licence. Just as setting up a sole proprietorship firm is easy, its closure is also hassle-free.

(b) Quick decision making: A sole proprietor enjoys complete control over the business, facilitating quick and easy
decision making.

(c) Direct incentive: A sole proprietor is the sole bearer of all types of risks associated with the business and at the
same time is the single recipient of all the profits and gains earned from the business. Thus, it is due to this direct link
between the businessperson’s efforts and the rewards which keeps this individual motivated to operate the business
efficiency and effectively.
(d) Flexibility in operations: A sole proprietorship firm is highly flexible in operations. It can adapt itself to various
situations, and vital changes can be incorporated, as per the dynamism of the business environment. The reason for
the high degree of flexibility can be attributed to the fact that a sole proprietor is the only person who is involved in every
aspect of the business.

Application Questions

Question 1: In which form of organisation is a trade agreement made by one owner binding on the others? Give
reasons to support your answer.

ANSWER: It is under partnership that the trade agreement made by one owner becomes binding for others. This is
because every partner acts for each other. In other words, every partner is both a principle as well as an agent. As an
agent he binds others through his actions and as a principle he is bind by the action of others.

Question 2: The business assets of an organisation amount to Rs. 50,000 but the debts that remain unpaid are Rs.
80,000. What course of action can the creditors take if
(a) The organisation is a sole proprietorship firm
(b) The organisation is a partnership firm with Anthony and Akbar as partners. Which of the two partners can the
creditors approach for repayment of debt? Explain giving reasons

ANSWER:

(a) In case of a sole proprietorship the creditors can claim the personal property of the proprietor. This is because the
proprietor has unlimited liability.

(b) The creditors can approach either Akbar or Anthony. Both of them would have the liability to pay according to their
profit sharing ratio. Moreover, in case one of them becomes insolvent the creditors can approach the other partner.

Question 3: Kiran is a sole proprietor. Over the past decade, her business has grown from operating a neighbourhood
corner shop selling accessories such as artificial jewellery, bags, hair clips and nail art to a retail chain with three
branches in the city. Although she looks after the varied functions in all the branches, she is wondering whether she
should form a company to better manage the business. She also has plans to open branches countrywide.

(a) Explain two benefits of remaining a sole proprietor

(b) Explain two benefits of converting to a joint stock company
(c) What role will her decision to go nationwide play in her choice of form of the organisation?
(d) What legal formalities will she have to undergo to operate business as a company?

ANSWER:

(a) The following are two of the benefits of sole proprietorship.

i. A sole proprietor is the single recipient of all the profits of the business.
ii. A sole proprietor takes all business decisions independently and enjoys complete control over the business.

(b) The following are two benefits of converting to a joint stock company.

i. In a joint stock company capital can be easily expanded by issuing fresh, new shares.
ii. The liability of the owners is limited to the amount of capital invested by them.

(c) If she plans to go nationwide then converting to a joint stock company would be more appropriate as it will lead to
large scale business operations.

(d) Some of the legal formalities to be completed for operating a joint stock company are as follows.
i. Promotion of the company
ii. Submitting documents such as Memorandum of Association, Articles of Association, statutory declaration and
agreement
iii. Getting the certificate of incorporation
iv. Getting the certificate of commencement of business