FORMS BUSINESSES E-mail [email protected] MBA-Finance CA-Foundation Kardan Institute of...

FORMSBUSINESSES

E-mail [email protected]

MBA-Finance CA-Foundation Kardan Institute of Higher Education

AMAN ULLAH KHAN

CHAPTER1

The word “Business” includes

“All human legal activities carried on for the purpose of profit”.

In other words, business is an activity in which various persons regularly produce or exchange goods and services for mutual gain or profit.

Types of Business By Ownership

A.Sole proprietorship

B.Partnership

C.Joint Stock company

04/21/23 Kardan Institute of Higher Education 4

SOLE PROPRIETORSHIP

Sole proprietorship is a simple and oldest form of business organization. It is a small-scale work, as it is owned and controlled by one person.

It is also known as “sole ownership”, “individual partnership” and “single proprietorship”.


CHARACTERISTICS

Following are the main characteristics of sole proprietorship:1. CapitalIn sole proprietorship, the capital is normally provided by the owner himself. However, if additional capital is required, such capital can be increased by borrowing.2. Formation & DissolutionFormation & Dissolution of sole proprietorship business is easy as compared to other business, because it dos not require any kind of legal formalities.


4. Easily TransferableSuch type of business can easily be transferred to another person without any restriction.6. Separate Business entityIn sole proprietorship , business has separate entity for accounting purposes than its owners than its owners


12. Unlimited LiabilityA sole proprietor has unlimited liability. In case of insolvency of business, even the personal assets are used by the owner to pay off the debts and other liabilities.


PARTNERSHIPPartnership is the second stage in the evolution of forms of business organization. It means the association of two or more persons to carry on as co-owners, i.e. a business for profit.

According to Mr. Kent“A contract of two or more competent persons to place their money, efforts, labour and skills, some or all of them, in a lawful business and to divide the profits and bear the losses in certain proportion.”


CHARACTERISTICSThe main characteristics of partnership may be narrated as under:1. AgreementAgreement is necessary for partnership. Partnership agreement may be written or oral. It is better that the agreement is in written form to settle the disputes.3. AgentIn partnership every partner acts as an agent of another partner.


7. Number of PartnersIn partnership there should be at least two partners. But in ordinary business the partners must not exceed 20 and in case of banking business it should not exceed 10.


9. Payment of TaxIn partnership, every partner pays the tax on his share of profit, personally or individually.10. Profit and Loss DistributionThe distribution of profit and loss among the partners is done according to their agreement.12. Unlimited LiabilityIn partnership the liability of each partner is unlimited. In case of loss, the private property of the partners is also used up to pay the business debts.


KINDS OF PARTNERSPartners can be classified into different kinds, depending upon their extent of liability, participation in management, share of profits and other facts.1. Active PartnerA partner who takes active part in the affairs of business and its management is called active partner. He contributes his share in the capital and is liable to pay the obligations of the firm.2. Secret PartnerA partner who takes active part in the affairs of the business but is unknown to the public as a partner is called secret partner. He is liable to the creditors of the firm.3. Sleeping PartnerA partner who only contributes in the capital but does not take part in the management of the business is known as sleeping partner. He is liable to pay the obligations of the firm.


4. Senior PartnerA partner who invests a large portion of capital in the business is called senior partner. He has a prominent position in the firm due to his experience, skill, energy, age and other facts.5. Junior PartnerA person who has a small investment in the firm and has a limited experience of business is called junior partner.6. Major PartnerA major partner is a person who is over 18 years of age. A person is allowed to make contract when he has attained the age of majority.7. Minor PartnerA person who is minor cannot enter into a valid contract. However, he can become a partner with the consent of all other partners. A minor can share profits of a business but not the losses.


9. Limited PartnerA partner whose liabilities are limited to his share in business is called limited partner. He cannot take active part in the management of the firm.10. Unlimited PartnerA partner whose liabilities are unlimited is known as unlimited partner. He and his personal property both are liable to clear the debts of the firm.

Types of Partnership

1) General Partnership

2) Limited Partnership

3) Limited Liability Partnership

General Partnership

In a general partnership, each partner has right and responsibilities similar to those of a sole proprietor.

Unlimited personal liability

Limited Partnership

A limited partnership has one or more general partners and one or more limited partners.

The limited partners are basically passive partners.

Limited Liability Partnership

A limited liability partnership is a relatively new form of business organization.

In this type of partnership, each partner has unlimited personal liability for his or her own professional activities, but not for the actions of other partners.

All of the partners in a limited liability partnership may participate in management of the firm.

Practical Questions on

Partnership

The partnership agreement A partnership agreement may be oral or written, will

govern the relationship amongst the partners. Important matters to be covered to be :a. Name of firm, type of business, and duration

b. Capital to introduced by partners

c. Distribution of profit amongst partners

d. Drawings by partners

e. Arrangement of dissolution, or on death or retirement of partners

f. Setting disputes

In the Absence of a Partnership General Conditions to be consider:

Profits should be shared as follows:

No partner should receive salary. No interest on capital should allowed. Profits should be shared equally. Where partners advance funds in excess of agreed

capital amount as loan, they are entitled interest on the excess at 5% pa.

Organizing a Partnership

On 2/15/08, Smith and Jones form a partnership. Smith contributes $80,000 cash. Jones contributes land valued at

$40,000.

On 2/15/08, Smith and Jones form a partnership. Smith contributes $80,000 cash. Jones contributes land valued at

$40,000.

Feb. 15 Cash 80,000 Land 40,000

Smith, Capital 80,000 Jones, Capital 40,000

To record initial investment in partnership

Dividing Income or Loss

Three frequently used methods to divide income or loss are allocation on:

1. Stated ratios.

2. Capital balances.

3. Services, capital and stated ratios.

Three frequently used methods to divide income or loss are allocation on:

1. Stated ratios.

2. Capital balances.

3. Services, capital and stated ratios.

Partners are not employees of the partnership but are its owners. This means there are no salaries reported as expense on the income statement. Profits or losses of the partnership are divided on some agreed upon ratio.

Allocation Based on Stated Ratios

Smith and Jones agree to divide profits or losses

¾ for Smith and ¼ for Jones. For 2008, the partnership reported net income of $60,000.

Dec. 31 Income Summary 60,000 Smith, Capital 45,000 Jones, Capital 15,000

To record division of 2008 net income.

$60,000 × ¾ = $45,000

Allocation Based on Capital Balances

Smith’s capital balance, before division of profits or losses is $80,000 and Jones’s capital balance is $40,000. The partnership agreement calls for income or loss to be allocated based on the relative capital balances. Net income for 2008 is $60,000.


Balance Ratio Income AllocationSmith, Capital 80,000$ 66.67% 60,000$ 40,000$ Jones, Capital 40,000 33.33% 60,000 20,000 Totals 120,000$ 100.00% 60,000$

Allocation Based on Capital Balances



Dr. Cr. Dec. 31 Income Summary 60,000

Smith, Capital 40,000 Jones, Capital 20,000

To record division of 2008 net income.

Allocation Based on Services, Capital, and Stated Ratios

Smith and Jones have a partnership agreement with the

following conditions:• Smith receives $15,000 and Jones receives $10,000 as

annual salaries.• Each partner is allowed an annual interest allowance of

5% on the beginning-of-year capital balance.• Any remaining balance of income or loss is allocated

equally.Net income for 2008 is $60,000.

Smith and Jones have a partnership agreement with the

following conditions:• Smith receives $15,000 and Jones receives $10,000 as

annual salaries.• Each partner is allowed an annual interest allowance of

5% on the beginning-of-year capital balance.• Any remaining balance of income or loss is allocated

equally.Net income for 2008 is $60,000.

Smith Jones Remainder60,000$

15,000$ 10,000$ 35,000 4,000 2,000 29,000

14,500 14,500 - 33,500 26,500

SalariesNet income

Income Distribution

InterestEqual allocationIncome to each partner

Allocation Based on Services, Capital, and Stated Ratios


15,000$ 10,000$ 35,000 4,000 2,000 29,000

14,500 14,500 - 33,500 26,500

SalariesNet income

Income Distribution



15,000$ 10,000$ 35,000 4,000 2,000 29,000

14,500 14,500 - 33,500 26,500

SalariesNet income

Income Distribution



15,000$ 10,000$ 35,000 4,000 2,000 29,000

14,500 14,500 - 33,500 26,500


Net income

Income Distribution

Salaries

$80,000 × 5% = $4,000$80,000 × 5% = $4,000

$29,000 × ½ = $14,500$29,000 × ½ = $14,500

Partnership Financial Statements

TotalBeginning capital balances -$ -$ -$ Investments by owners 80,000 40,000 120,000 Net income Salary allowances 15,000$ 10,000$ Interest allowances 4,000 2,000 Balance allocated 14,500 14,500 Total net income 33,500 26,500 60,000 Less partners' withdrawals (5,000) (1,000) (6,000) Ending capital balances 108,500$ 65,500$ 174,000

Smith Jones

Smith and Jones PartnershipStatement of Partners' Equity

For the Year Ended December 31, 2008

Assume that during 2008, Smith withdrew $5,000 cash from the partnership and Jones withdrew $1,000.

CorporationA corporation is “an artificial person created by law to carry on business activities under its own name and common seal”.

Following are the main characteristics of a corporation.

1. A corporation is created by law ,it has its legal existence apart from its owners. It can carry on business under its name and can enter into contract as a person.

2. The capital of the company is divided into many

units of certain value. Each unit is called as share.

These shares are sold in the market and are

transferable from one person to another.

3. The company is not dissolved at the time a

shareholder dies or transfer his share to another

person. It continues indefinitely or until its life is

terminated on account of legal process.

4. The owners of the company have limited liability up to

the extent of their investment.

5. Each shareholder of the company has legal right of

voting according to his holdings.

6. The management of the company is an elected body.

Types of Company

Private ( 2 – 50 )

Public company ( 7 – unlimited)

Private limited companyPrivate limited company must have at least two members but the maximum number can not exceed from 50.

It also prohibits any invitation to the general public to purchase its shares.

If a person want to enjoy the advantage of limited liability so he can take part in the private limited company.

Public limited company

Must have 7 members to form it and there is no restriction to the maximum number of members.

Public limited company must have issue prospectus to the general public to purchase its shares

Liability of the members is limited to his shares.

The share of public limited company are freely sold and purchases in the stock market.


End Of Chapter

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