MBA 404: ACCOUNTING FOR MANAGERS

MBA 424: ACCOUNTING FOR HUMAN RESOURCE MANAGERS

Week 1: Additional Lecture Notes - Business Structures

Choosing a structure
Very important to choose the best type of business structure that you want to
operate
The choice of legal structure (also called a business entity or association or
legal entity) depends on a number of factors:
Sometimes there is need to get advice from accountants, lawyers or business
advisors.
Important factors that one has to consider before making such decision:
o The number of intended participants in the business, present and future
o The types of assets which the business will need to acquire
o Cost of establishing the structure
o Expected duration of the business
o Taxation
Certain small businesses begin as a sole trader or partnership. After it survives the first
year or two, a different structure can be adapted, e.g. A Company
Sole Traders
Most simple and straightforward legal structure
Operate as one person
Complete independence in running the business
No need for a sole trader to consult with other partners
No need to share profits
No formal legal requirements for setting up the business, except the registration of
a business name if the business is to be run in any name other than the name of
the owner of the business
There may also be government requirement that persons offering certain kinds of
services hold certain qualifications and/or licences, such as electricians, builders
and lawyers.
Advantages
Easy and inexpensive formation
Owner has total control of the operation of the business
Owner has retention of all profits
Ease of closing the business

Disadvantages
Unlimited liability if the business fails (goes bankrupt), creditors can seize the
assets of the business as well as personal assets of the owner in order to recover
the debts
Lack of continuity if the owner dies the business will cease operation
Borrowing limitations the amount of finance available to the business will be
restricted to the owners personal assets, or his/her personal ability to borrow
funds. Lending institutions are less likely to lend to borrowers who have few
personal assets to provide as security
Tax the sole trader will be required to pay income tax on the earnings of the
business at the personal rate, which is higher than the corporate rate.
Registering a Business Name
A sole trader who wishes to trade under a name that is any other than his/her own,
MUST register the name under the relevant legislation

Partnership is also required to register a business name of the partnership

if the name is to be other than just the name of the partners.
Example:
If John Singh wished to set up business as an electrician and wished to trade under the
name John Singh Electrical, he would need to register the name under the relevant Act.
Registering a business name is compulsory unless the words in the name of the business
contain only the name of the sole trader (e.g. John Singh) and no other words.
Most sole traders want to use more words in a business name than just their own name, so
they will need to register.
Why register a business name?
- to be obligatory if the business name is different from the owners name
- once registered, no other trader can use that name or a name that can be confused
with that name
Can any name be chosen?
There are limited restrictions on the names that can be registered
The name cannot be one that is already registered
The name must not mislead the public by suggesting a type of business is
provided when it is not.
Legal Status of a Business Name
Business name is not a separate legal entity.
Any debts or other liabilities of the business must be met personally by the person
who owns the business name
Contracts and other transactions of the business would normally be entered into
using the business name E.g. John Singh Electrical, but John Singh himself will
be personally liable for all obligations arising out of the business.
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John Singh cannot hide behind the business name because there is no separate
legal entity in a business name.

PARTNERSHIPS
A business jointly owned and operated by two or more persons working in
common with the purpose of profit making
Each partner has equal responsibility to take part in the business for the benefit of
the other partners.
Profits of the partnership will usually be shared equally but this can be varied by
the partnership agreement
Is not a separate legal entity
The members of the partnership can sue or be sued in relation to the running of
the business.
Act governing partnerships:
Fiji: Partnership Act, Cap 248
Formation of Partnerships
Easy to form
No formal requirements needed (Usually a written partnership contract is used)
Written agreement should show that the partnership exists and should clearly spell
out the rights and obligations of each partner and the amount of capital
contributed by each partner plus other important details
If there is no written agreement or the agreement is incomplete, the provisions of
the relevant Partnership Act will be applied to fill in the gaps where necessary.
No formal registration requirements but there is a requirement to register the
business name
Can there be any number of members?
There is no restriction on the number of partners in a partnership in most regional
countries, although there are such restrictions in many countries outside the region.
Joint Liability of partners
Key feature of partnership: Each partner is jointly and severally liable with the
other partners for the debts and liabilities of the partnership. (is spelt out in s.10
Partnership Act Fiji)
Jointly and severally liable a creditor may sue any one of the partners or more
than one of the partners to recover a debt of the partnership.
If the creditor sues only one partner and is successful, all the other partners will
have to contribute to satisfy the debt that the one partner had to pay out.
Once the debt is satisfied, the creditor cannot take further action against any of the
other partners he has not sued

One partners actions can bind all the other partners, therefore there is a high
degree of trust in the partnership relationship (i.e. a fiduciary relationship)
It is important that each partner has the trust and confidence of the others.
The obligation of each partner to contribute the satisfaction of all liabilities of the
partnership applies to the estate of a partner after his death, as well as during the
partners lifetime.

Advantages
Easy and inexpensive to form
Flexibility in providing for new partners and new areas of business.
More expertise (ideas / skills)
More capital contributed
Losses can be shared
There is no tax payable on the partnership itself, but each partner will be liable to pay
income tax on his or her personal income at the personal rate.

Disadvantages
Unlimited liability
Profit will be shared
Each partner is an agent for all the others
The consent of all partners is required for the new partners, and for transfer of
major assets of the partnership.
LIMITED LIABILITY COMPANIES
Incorporation of company creates a new legal entity, separate from those
individual persons who are members of a company.
Means that persons who set up the company are not personally liable for the debts
of a company
Is a separate legal entity a company has its full capacity to enter contracts and
take legal action through its officers as if it was a person
Statutes governing trading as a limited company:
The relevant legislation is Companies Act
Types of limited company
A company limited by shares or guarantee
A private (proprietary) company
Public company
Formation of a Company
Complex and expensive
Those who wish to incorporate a company must lodge an application with the
Registrar of Companies under the statutes of each country, including an
application to reserve the name of the company
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Day to day management of the company will be in the hands of the directors
(may or may not be shareholders of the company)
Shareholders can have certain limited powers: they can adopt resolutions at
shareholders meetings, which the directors must follow, subject to the
legislation.
Once the company is registered, its registered name must appear on the common
seal and other documents issued by the company.
It must then open bank accounts in the company name, appoint directors and a
public officer and allocate shares to subscribers.
It must lodge annual returns with the Registrar of Companies, and there are
other reporting requirements, depending on the type of company.

Advantages:
Has limited liability each person holding shares in the company is liable to pay
to the company only the amount that is needed to fully pay for the value of shares
held by the shareholder in the company. Beyond this, shareholders and officers of
the company are not personally liable to pay debts of the company.
Continuous life even if the individual member dies or becomes bankrupt, the
company can continue its operations.
Shares can be transferred
Tax rates on companies are lower than the personal tax rates.
Disadvantages
Expensive and complex procedures in formation
The complexity of reporting and accounting requirements
Lack of privacy in the activities of the business since records are on a public
register
The limited role of shareholders in the management of the company.
Questions:
Kelvin started running a computer graphics business as a sole trader. The business has
become quite successful and he is now employing two other people in the business.
However, the two people, who are generating a high proportion of income for the
business, have expressed dissatisfaction with their salary and conditions and would like
to become partners (thus sharing in the profits), or more involved in some other way in
the business. Kelvin feels the future of the business depends on retaining these
experienced people. He would like some advice on how to restructure the business so that
he can keep basic control of running the business, but also enable staff to be more
involved in profit sharing and decision-making.
Recommend a business structure that would best serve his needs.
Vinod is a sole trader and operates a very successful computer business. Apart from his
computer business, Vinod is looking after his elderly father at his fathers farm. He has
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many workers who assist in the day to day running of the business. Vinod is thinking of
expanding his services to provide Internet services. Internet services require specialized
personnel and resources and Vinod would need additional finance to venture into Internet
services. As a result it becomes necessary for Vinod to change his business structure to
accommodate these changes, which he is contemplating.
Vinod seeks your advice as to which business structure would suit his needs.