Forms of Business Organization Accounting Help

1. Describe the basic characterisucs of a sale proprietorship .
.2. Identify factors 10 consider _in evaiuating the profitability and solvency of a sale proprletorshtp.
3, Describe the basic characteristics of a general partnership and of partnerships that limit personal liability.
4. Describe the basic characteristics of a corporation.
5. Account for corporate income taxes; explain the’ effects or these taxes on before-tax profits and losses
6. Account for the issuance of capital stock,
7.Explain the nature of reo tained earnings, account for dividends, and prepare a statement of retained earnings.
8. Explain why the financial statements of a corporation are interpreted differently from those of an unincorporated business.
9. Discuss the principal tactors to consider in selecting a form of business organization.
10. Allocate partnership net ‘income among the partners.

Reprinted by permission 'ur Forbes () Forbes Inc., 1997.

Reprinted by permission ‘ur Forbes () Forbes Inc., 1997.


A sole proprletorship is an unincorporated business owned by one person. Proprietorships are the most common form of business organization because’ they are so’ easy to start.

A sole proprietorship excellent model for demonstrating accounting principles because it is the’simplest form of business organization. But inthe business world. you will seldom encounter financial statements for these organizations. Most sole proprietorships are relatively small businesses with few-if any-financial reporting obligations. Their needs for accounting information consist primarily of data used in daily business operatlons=-the balance in the company’s bank account and the amounts receivable and payable, In fact, most sole proprietorships do not prepare formal financial statements’ ‘unless some special need arises

The Concept’of the separate Business ‘Entity

In the eyes of the law, however. a sole proprietorship is’ not an entity separate from its owner. Under the .law; the proprietor is the “entity,” and a sole proprietorship merely represents some of this Individual’s financial activities. The fact that a sole proprietorship and its owner ‘legally are one and the same explains many. of the distinctive characteristics of this form of organization.

Characteristics of a Sole Properletership

Among the key characteristics of sole proprietorships are:

•Ease off on nation. (This explains why these organizations are so common.)
• Business assets actually belong to the proprietor. As the business is not a legal entity, it cannot own property. The business assets actually belong to the proprietor, not, to the business. Therefore, the proprietor may transfer assets in or out of the business at Ivill.
• The business pays no income taxes. Tax laws do not view a sole proprietorship as separate from the other financial activities of its owner. Therefore, the proprietorship does not file an income- tax return or pay income taxes. Instead, the owner must include the income of the business in his or her personal income tax return.
• The business pays no salary to the owner. The owner of a sole proprietorship is not working for a salary. Rather, the owner’s compensation consists of the entire net income (or net loss) of the business. Hence, any money withdrawn from the business by its owner should be recorded by debiting the owner’s drawing account, not recognized as salaries expense.
• The owner is personally liable for the debts of the business. This concept, called unlimited personal liability, is too important to be treated as just one item in a list. It deserves special attention-from us and from you.

Accounting Practices of Sole. Proprietorships

In the balance sheet of a sole proprietorship, totalowner’s equity is represented by the balance in the owner’s capital account. Investments of assets by the owner are recorded by crediting this account. Wiihdrawals of assets by the owner are recorded by debiting the owner’s drawing account. At the end of the accounting.period, the drawing account and the income Summary account are closed into the owner’s capital account. The only financial reporting obligation of many sole proprietorships is the information that must be included in the owner’s personal income tax return. For this reason, many sole proprietorships base their accounting procedures on income tax rules. rather than generally accepted accounting principles.

Evaluating the financial Statements of a Proprietorship

The Adequacy of Net Income

Sole proprietorships do not recognize any salary expense relating to the owner, nor any interest expense on the capital that the owner has invested in the business. Thus, if the business is to be considered successful, its net income should at least provide the owner with reasonable compensation for any personal services and
equity capital that the owner has provided to the business.

In addition, the net income of a sole proprietorship should be adequate to compensate the owner for taking significant risks. Many small businesses fail. The owner of a sole’ proprietorship has unlimited personal liability for ‘the debts of the business. Therefore, if a sole proprietorship sustains large losses, the owner can lose .mucli more ‘than the amount of his or her equity investment.

Evaluating Solvency

For a business organized as a corporation, creditors often base their lending decisions on the relationships between assets and liabilities in the corporation’s But if.the business is organized as a sole lance sheet, IS less useful to creditors.


A partnership is an unincorporated business owned by-two Or more partners  often is referred to as  Partnerships are the least common form of business or~anizatipn:”:”prOl:tAbiy because they often wind up with “too many bosses.” However, they are widetY’ll~ed .for professional practices, such as medicine,law, and public accounting.3 p.rln’l’I,~ip~a:l~o are used for many small businesses, especially those that are family-owned. Mostpilrinerships are small businesses-e-but certainly not all

For accounting purposes, we view a partnership as all eJltit)’ separate from the other , activities of its owners. But under the law, the,partnership is not “<eparate” from its owners. Rather: the law regards the partners as personally~j{/u! joilztly-responsible for the activities of the business

The term “partnership” actually includes three distinct types of organizations: general partnerships limited partnerships, and limited liability partnerships. We will begin our discussion with the characteristics of general.partnerships

General Partnerships

In a,general partnership, each partner. has rights and responsibilities similar to those of a sole proprietor. For example, each general partner can withdraw cash and many other assets from the business at will.4 Also. each partner has the full authority of an owner to negotiate contracts binding upon the business. This concept is called mutual agency. Every partner also has unlimited personal liability for the debts of the firm.

In summary, general partnerships involve the same unlimited personal liability as sole proprietorships. This risk is intensified, however, because you may be held financially responsible for your partner’s actions, as well as for your own.”

Partnerships That Limit Personal Liability

Over the years, state laws have evolved to allow modified forms of partnerships. including limited partnerships and. limited liability partnerships, Th.e purpose of these modified forms of partnerships is to place limits oti the potential liability of individual partners, .

limited Partnerships

A limited partnership has one or more general partners and one or more limited partners. The general partners are partners in ihe traditional sense, with unlimited personal liability for the debts of the business and the right to make managerial decisions.

The limited partners are basically passive investors. They share in the profits and losses of the business, but they do not participate actively in management and are not personally liable for debts of the business: Thus, if the firm “goes under,” thelosses incurred by the limited partners are limited to the amounts ‘they have invested in the business

case in ponit

case in ponit

Mike Mazzaschi Stock Boston

Mike Mazzaschi Stock Boston

In the past, limited partnerships were widely used for various im ventures, such as drilling’ for oil, developing real estate, or making a motion picture. These businesscs often lost money-at least in the early years: if they ~ere profitable, the profits came in later years

For such ventures, ‘the limited partnership .concept had great appeal to investors. Limited partners could include their share of any partnership nct loss in \their ‘personal income iax returns, thus offsetting taxable income from other sources.. And as limited partners. their financial risk was limited to the amount of their equity investment.

limited liability Partnerships

A limited liability partnership is a relatively new form of business organization. States traditionally have required professionals, such as doctors, lawyers, and accountants, to organize their practices either as sole proprietorships or as partnerships. The purpose of this requirement was to ensure that these professionals had unlimited liability for their professional activities

Over the years, many professional partnerships have grown in size. Several public accounting ‘firms, for example, ‘now have thousands of .partners and operate in countries all over the world. Also, lawsuits against professional firms have increased greatly in number and in dollar amount. To prevent ‘these lawsuits from bankrupting innocent partners, the’ concept’ of the limitedIiability partnership, has emerged. In this type of partnership, each partner has unlimited personal liability for his or her OWII professional , activities, but not for the actions of other -partners. Unlike a limited partnership, all of the partners in a limited liability partnership may participate in management of the firm.

Posted on November 23, 2015 in Forms of Business Organization

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