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The three major legal forms of business entity are the sole proprietorship, the partnership, and the corporation. In general the accounting process is the same for all three forms of business. Later in the book you will study the different ways certain transactions are handled depending on the type of business entity. For now, however, you will learn about the different types of business entities. SOLE PROPRIETORSHIPSA sole proprietorshipA business entity owned by one person who is legally responsible for the debts and taxes of the business is a business entity owned by one person. The life of the business ends when the owner is no longer willing or able to keep the business going. Many small businesses are operated as sole proprietorships. The owner of a sole proprietorship is legally responsible for the debts and taxes of the business. If the business is unable to pay its debts, the creditorsOne to whom money is owed (those people, companies, or government agencies to whom the business owes money) can turn to the owner for payment. The owner may have to pay the debts of the business from personal resources, including personal savings. When the time comes to pay income taxes, the owner’s income and the income of the business are combined to compute the total tax responsibility of the owner. It is important that the business transactions be kept separate from the owner’s personal transactions. If the owner’s personal transactions are mixed with those of the business, it will be difficult to measure the performance of the business. The term separate entity assumptionThe concept that a business is separate from its owners; the concept of keeping a firm's financial records separate from the owner's personal financial records describes the concept of keeping the firm’s financial records separate from the owner’s personal financial records. PARTNERSHIPSA partnershipA business entity owned by two or more persons who carry on a business for profit and who are legally responsible for the debts and taxes of the business is a business entity owned by two or more people. The partnership structure is common in businesses that offer professional services, such as law firms, accounting firms, architectural firms, medical practices, and dental practices. At the beginning of the partnership, two or more individuals enter into a contract that details the rights, obligations, and limitations of each partner, including
The partners choose how to share the ownership and profits of the business. They may share equally or in any proportion agreed upon in the contract. When a partner leaves, the partnership is dissolved and a new partnership may be formed with the remaining partners. 4 4. OBJECTIVE Compare and contrast the three types of business entities. Partners are individually, and as a group, responsible for the debts and taxes of the partnership. If the partnership is unable to pay its debts or taxes, the partners’ personal property, including personal bank accounts, may be used to provide payment. It is important that partnership transactions be kept separate from the personal financial transactions of the partners.
CORPORATIONSimportant! A corporationA publicly or privately owned business entity that is separate from its owners and has a legal right to own property and do business in its own name; stockholders are not responsible for the debts or taxes of the business is a business entity that is separate from its owners. A corporation has a legal right to own property and do business in its own name. Corporations are very different from sole proprietorships and partnerships. StockCertificates that represent ownership of a corporation, issued in the form of stock certificates, represents the ownership of the corporation. Corporations may be privately or publicly owned. Privately owned corporations are also called closely held corporations. The ownership of privately owned corporations is limited to specific individuals, usually family members. Stock of closely held corporations is not traded on an exchange. In contrast, stock of publicly owned corporations is bought and sold on stock exchanges and in over-the-counter markets. Most large corporations have issued (sold) thousands of shares of stock. An owner’s share of the corporation is determined by the number of shares of stock held by the owner compared to the total number of shares issued by the corporation. Assume that Alicia Martinez owns 300 shares of Sample Corporation. If Sample Corporation has issued 1,000 shares of stock, Martinez owns 30 percent of the corporation (300 shares ÷ 1,000 shares = 0.30 or 30%). Some corporate decisions require a vote by the owners. For Sample Corporation, Martinez has 300 votes, one for each share of stock that she owns. The other owners have 700 votes.
One of the advantages of the corporate form of business is the indefinite life of the corporation. A sole proprietorship ends when the owner dies or discontinues the business. A partnership ends on the death or withdrawal of a partner. In contrast, a corporation does not end when ownership changes. Some corporations have new owners daily because their shares are actively traded (sold) on stock exchanges. Corporate owners, called stockholdersThe owners of a corporation; also called shareholders or shareholders, are not personally responsible for the debts or taxes of the corporation. If the corporation is unable to pay its bills, the most stockholders can lose is their investment in the corporation. In other words, the stockholders will not lose more than the cost of the shares of stock. The accounting process for the corporate entity, like that of the sole proprietorship and the partnership, is separate from the financial affairs of its owners. Usually this separation is easy to maintain. Most stockholders do not participate in the day-to-day operations of the business. Table 1.1 summarizes the business characteristics for sole proprietorships, partnerships, and corporations.
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