FORMS OF BUSINESS ORGANIZATIONS
Accountants frequently refer to a business organization as an accounting entity or a business entity. A business entity is any business organization, such as a hardware store or grocery store, that exists as an economic unit. For accounting purposes, each business organization or entity has an existence separate from its owner(s), creditors, employees, customers, and other businesses. This separate existence of the business organization is known as the business entity concept. Thus, in the accounting records of the business entity, the activities of each business should be kept separate from the activities of other businesses and from the personal financial activities of the owner(s).
As you will see shortly, the business entity concept applies to the three forms of businesses—single proprietorships, partnerships, and corporations. Thus, for accounting purposes, all three business forms are separate from other business entities and from their owner(s). Since most large businesses are corporations, we use the corporate approach in this text and include only a brief discussion of single proprietorships and partnerships.
- A single proprietorship is an unincorporated business owned by an individual and often managed by that same person. Single proprietors include physicians, lawyers, electricians, and other people in business for themselves. Many small service businesses and retail establishments are also single proprietorships. No legal formalities are necessary to organize such businesses, and usually business operations can begin with only a limited investment.
- A partnership is an unincorporated business owned by two or more persons associated as partners. Often the same persons who own the business also manage the business. Many small retail establishments and professional practices, such as dentists, physicians, attorneys, and many CPA firms, are partnerships.
- A corporation is a business incorporated under the laws of a state and owned by a few stockholders or thousands of stockholders. Almost all large businesses and many small businesses are incorporated. The corporation is unique in that it is a separate legal business entity. The owners of the corporation are stockholders, or shareholders. Stockholders do not directly manage the corporation. They elect a board of directors to represent their interests.
Accounting is necessary for all three forms of business organizations, and each company must follow generally accepted accounting principles (GAAP).
An Accounting Perspective
Although corporations constitute about 17 per cent of all business organizations, they account for almost 90 per cent of all sales volume. Single proprietorships constitute about 75 per cent of all business organizations but account for less than 10 per cent of sales volume.
Test your understanding of the three types of businesses with this quiz. Remember to rate your confidence with your answer: Maybe, Probably Definitely!
Important Points to Remember
- Business entity is any business organization, such as super market, or accounting firm, that exists as an economic unit.
- Business entity principle states that a business must be keep accounting records separate from its owners or other businesses.
- Ownership in business entities can be a sole proprietorship, partnership, or corporation. From the accounting perspective and its purpose these types of business are considered separate entities from their owners. The corporation is only one considered as a separate legal entity.
- A business can be a service company, merchandising company, or a manufacturing company.
Asset Things of value owned by the business. Examples include cash, machines, and buildings. To their owners, assets possess service potential or utility that can be measured and expressed in money terms.
Business Entity is any business organization that exists as an economic unit.
Liabilities Debts owed by a business—or creditors’ equity. Examples: notes payable, accounts payable.
Stockholders’ equity The owners’ interest in a corporation.
Sole Proprietorships are business entities owned by one single person.
Partnerships are business entities owned by at least two people.
Corporations are business entities owned by one person or many people called shareholders.
Service company is a business entity that provides services to the public and does not sell a product.
Merchandising companies are business entities selling a product and possibly a service to the public. A merchandising company purchases the products to be sold from outside vendors.
Manufacturing companies are business entities selling a product to the public that is made by the company using raw materials, direct labor and overhead.