Sole proprietorship - Essay Example

?ACCOUNTING PART A: INTRODUCTION: John and Christine are looking forward to carry on their practice as tax agents. They have the sufficient capital required to carry on the business as tax agents. The business structures available to carry on business as tax agents are sole proprietorship, partnership, company and trust. However, before selecting any structure for this business, the relative advantages and disadvantages of each are needed to be considered. FINDINGS: SOLE PROPRIETORSHIP: An entity where the person opening the business constitutes without any contract with others or incorporation of the entity. The person is solely responsible for all the debts and liabilities of the business. Advantages: It is the cheapest and easiest business structure. Sole proprietorship is under complete control of the person organizing it. Sole proprietor may retain and reinvest all the incomes of the business on its own motion. The payment of tax is easy and may flow directly to the tax return of the sole proprietor. The business may be dissolved easily. Disadvantages: The liability of sole proprietors is unlimited. So, the businesses as well as the personal assets of the sole proprietor are at risk. There are very limited sources available for the raising of funds as opposed to companies where fund raising is very high. PARTNERSHIP: An association/relationship of two or more persons to carry on a business for the purpose of earning profits is known as partnership. (Revised UPA, Section 101) Advantages: Partnerships are easier to establish as compared to companies. The two or more partners may increase funds more easily as compared to sole proprietorship. They may also have increased borrowing capacity. The pool of skills, knowledge and expertise is made wider due to the combination of more than one person. Partnerships also allow brainstorming which is more creative than the brainstorming carried out by sole proprietor. Disadvantages: Partners are liable for the actions of other partners as they act as agents for one another. The decisions between all partners are shared and this may cause disagreements which is the most drastic situation for a partnership. The liability of all the partners is unlimited.. However, this limitation may be overcome by constituting limited partnership. In limited partnership, the investments of the partners are liable for the debts of the firm and the partners’ personal assets are not liable. COMPANY: A company is a separate legal entity from its owners. So, the shareholders and members of the company are liable for the debts of the company only to the extent of their share/ interest in the company. The company which offers its shares to the general public for subscription is known as public company. The company which does not offer its shares to general public is known as private company. Advantages: The liability of the shareholders and/or members of the company are restricted to the value of shares purchased by him. The company is a separate legal entity i.e. separate from its members. Therefore, any suit against the company does not involve the members personally as opposed to partnerships where the partners are personally got involved in the suits. In private limited companies, the shareholders and directors of the company are usually same person keeping the ownership and management of the company in same hands. Disadvantages: The formation of company is costly as compared to partnerships and may require large amount of capital initially. Whereas, partnership and sole proprietorship does not require any such large amounts. The accounts of companies are complex in nature. Moreover, the statutory regulations and the company law of the country require the companies to follow the regulations regarding bookkeeping and certain types of accounts. The raising of funds and capital by the companies is also restricted to the authorized capital of the company. Moreover, in case of a private company, the increasing of capital is also usually restricted by the provisions of the company law of the country. In some countries, the law governing the acts of accountants and tax agents do not permit them to practice as a limited liability company. In such cases, such professionals cannot form a limited liability company. TRUST: Trust is an arrangement where the trusted gives the charge of property to the trustee for the benefit of another person (beneficiary). Advantages: Trusts have reduced liability. It is the main benefit of trusts. Trustee is responsible to take care of the asset given to him. So, the asset is secure. Disadvantages: Trusts are relatively more complex and expensive than partnerships. The establishment and administration of trusts is also difficult. The alteration in the constitution of trust is difficult. The losses incurred by the trusts cannot be distributed. CONCLUSIONS AND RECOMMENDATIONS: SELECTION OF BUSINESS STRUCTURE: Considering the advantages and disadvantages discussed above and the finance contained by Christine and John, it is recommended that the business structure should be of limited partnership. The reasons behind this recommendation are as follows: Partnership is relatively easier and cheaper to establish as compared to companies. John and Christine can start up the business with their savings easily. In limited partnership, the extent of partners’ liability towards the debts of firm is up to the limit of their respective interest in the business. Both of them can share knowledge and expertise of each other and can also carry out active brainstorming. They are not required to prepare complex accounts as required in companies. Fund raising in partnership is not restricted by any law and partners can increase their capital as much as they like. In some countries, the relevant laws of professional practitioners prohibit them to be formed as a limited liability company. This may also bar John and Christine to practice as a limited liability company. BUSINESS REGISTRATION REQUIREMENTS: 1. Registration with registrar of firms: To register and operate as a limited liability partnership, they are required to register themselves as a partnership firm with a firm name with the registrar of firms. Although it is not obligatory but a registered firm enjoy many privileges which a non-registered firm does not. 2. Registration with AICPA: To practice as a tax agent, both John and Christine are required to be registered as qualified accountants with AICPA or any other relevant body that has authority to register the qualified accountants. 3. Licensing with Tax Authority: After being constituted as a partnership firm, the firm is also required to be registered with tax authority as a body whose income will be taxable under tax laws. PART B: John Pound and Christine Boston shall enter into the partnership agreement with each other to carry on the practice as tax agents. The document containing this agreement is known as ‘Partnership deed’. The agreement contains the various terms and conditions applicable on the partners. It contains the agreements regarding the partner’s salaries, limit of any drawings, treatment of any advances to the firm by any partner, the rights, duties and liabilities of partners etc. This deed also contains agreement between the partners regarding the share of profits and losses between each other. The proportion or ratio with which the partners wish to share profits and losses among them is known as ‘Profit Sharing Ratio’. John and Christine are free to include in the deed any proportion or ratio with which they want to share profits and losses between themselves. However, there are some rules which are required to be considered for the apportionment of profits and losses: 1. Partners are free to select any ratio for profit sharing and to mention such ratio in the deed. 2. The partners may also agree between themselves that the profit will be distributed between the partners on the basis of ‘capital-ratio’. ‘Capital Ratio’ is a ratio with which the partners have contributed capital in the business. It means that the profits shall be distributed in the same ratio in which the capital is contributed by each partner in the total capital of the business. 3. However, if the partners have not decided any ratio in the agreement, it shall be deemed that the partners have agreed upon to share profits equally. 4. It is worth-mentioning here that whatever the ratio has been decided by the partners, the losses of the business shall also be distributed between the partners in the same ratio in which the profits are being shared among themselves. In certain countries, a partner having share in profits only is permissible by the partnership law of the country. Under this case, that partner has the right to share the profits of the business only and is not required to contribute towards the losses. So, in the case of John and Christine, if any one of them has been admitted as a ‘partner in profits only’, he shall be entitled to the profits of the business but is not liable for the losses incurred by the partnership. PART C: JOHN AND CHRISTINE Work Sheet For the period Ending July 31, 2010 JOHN AND CHRISTINE BALANCE SHEET AS AT JULY 31, 2010 JOHN AND CHRISTINE INCOME STATEMENT For the Period ending July 31, 2010 JOHN AND CHRISTINE CASH FLOW STATEMENT For the Period ending July 31, 2010 NOTES: N-1: According to International Financial Reporting Framework, revenue shall not be recorded as unless it is accrued. So, the signing of contract with ABC Ltd by Christine shall not be recorded as revenue unless the revenue is accrued. N-2: Where a person obtain loan to purchase any asset for his own private use, such asset is not presented in the books of accounts. Moreover, the loan obtained for the purpose is not shown in the books. (IFRS Framework) N-3: It is assumed that all the payments made up to the receipt of cash are made through banks. And thus the payments are deducted from ‘Bank Account’. N-4: The bank payments and receipts have also been taken in Cash Flow Statement (CFS) to determine the net cash flow of the business during the period. N-5: The advance rent for premises, advance lease rental payment to professional office Supplies Pvt Ltd and payment of advance lease rental for BMW has been adjusted at the end of the month. WORKINGS: W-1: Calculation of Accumulated Depreciation for computer Cost of computer = $4000 Residual Value of computer = $400 Depreciable Amount (Cost – Residual Value) = $3600 Useful life = 3 years Depreciation (Depreciable Amount/ Useful Life) = $3600 / 3 = $1200 Depreciation for one month = $1200 / 12 = $100 W-2: Calculation of stationery expense for the period: The stationery bought in the month of July is expected to be used evenly throughout the period of 1 year. Thus, the stationery expense for the month of July can be calculated as follows: Cost of stationery purchased = $840 Period of use of stationery = 1 year Stationery expense for one month = $840 / 12 = $70 W-3: Calculation of adjustable Lease rental paid in July for BMW: The total payment made for the lease rental of BMW for one month is $2000. As the payment was made on 16th of July, half of the lease rental shall be expensed out at the end of the month of July 2010. The amount to be expensed out thus becomes $1000 REFERENCES: 1. Cheema, K., 2006. Business Law. Revised Ed. Lahore. 2. Residual- rewards. Sole Proprietorship Advantages and Disadvantages. [Online] Available at: [Accessed 19th April 2011]. 3. Incorporating Wealth. Limited Liability Companies (LLC's) Concept, Similarities and Advantages. [Online] Available at: [Accessed 19th April 2011]. 4. FARLEX. Partnership. [Online] Available at: [Accessed 19th April 2011]. 5. Adrian, 2010. Advantages and Disadvantages of a Limited Company. [Online] Available at: [Accessed 19th April 2011]. 6. Investor Words. Trust. [Online] Available at: [Accessed 19th April 2011]. 7. Small Business Development Corporation. Trust. [Online] Available at: [Accessed 19th April 2011]. Read More