Chapter 12 Business Organizations and Decision Making.notebook. Chapter 12: Business Organizations and Decision Making

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1 Chapter 12: Business Organizations and Decision Making 1

2 GOALS: To obtain a general understanding of partnerships and corporations. To apply mathematical formulas the help in decision making related to these two forms of ownership. 2

3 12.1 Partnerships Pages partnership a legal arrangement in which two or more people join together in a business and share in its profit or losses. Each province has its own Partnership Act. 3

4 Up to this point, sole proprietorships were the focus. Partnerships are similar with the following exceptions: A partnership has two or more capital and drawings accounts; one for each owner. Most accounting procedures are the same, but any net income/loss is distributed among the partners at the end of the fiscal period. 4

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6 Advantages 1. Greater financial resources compared to sole proprietorship. 2. Combines the varies skills/abilities of the owners. 3. Simpler to organize compared to a corporation. 4. Easier to make decisions compared to a corporation. 5. Does not pay its own income tax so avoids double taxation that exists in corporations. Partners include any income in the business as personal income which is taxed just the once. Partnership Disadvantages 1. Has a limited life; if something happens to one of the partners, the partnership is terminated. 2. Unlimited liability; personal assets may need to be use to settle creditors claims. 3. Each partner has mutual agency; all partners are bound by the actions of each other 6

7 limited partnerships a partnership in which the liability of at least one partner is restricted to the amount that he/she invests in the business. Two classes of partners are created: 1) general partners partners who have unlimited liability and usually run the business. 2) limited partners partners that have limited liability and very little to no role in the daily operations of the business. 7

8 partnership agreement a legal contract that sets for the terms and conditions of the partnership. Allows for the partnership to have a better chance for success and survival. The details included in a partnership agreement are listed on page

9 shotgun clause an exit strategy which protects a partner from accepting an undervalued offer from another partner. If a partner#1 wants to end the partnership by offering to purchase partner #2's share for a certain amount of money, it must be a reasonable offer. If partner #2 does not think so, he/she can by partner #1's share in the business for the same offer. Refer to example on page

10 Partnership Acts a legal document that protects the people entering a partnership. If there is no partnership agreement, profits and losses are to be divided equally. 10

11 Three Factors which Help Determine the Division (apportionment) of Net Income or Net Loss for a Partnership: 1. Salaries the partner who participates in running the business should receive a salary (usually referred to as drawings) 11

12 2. Interest partners will receive interest on their investment in the business in proportion to the amount he/she has invested. Example: 10% interest earned on investments Partner #1 $ investment x 0.10 = $ return Partner #2 $ investment x 0.10 = $2000 return 12

13 3. Income or loss sharing ratio partners who bring additional resources to the business (for example, special talents) may receive extra compensation. includes the percentages by which net income or net loss will be distributed among the partners after salary and interest have been deducted. 13

14 Page 547 Statement of Distribution of Net Income net income > salaries + interest 14

15 Page 548 Statement of Distribution of Net Income net income < salaries + interest 15

16 Accounting for Salaries, Interest and Drawings: Salaries and Interest according to the law, a partner participates in a business for a share of the earnings in the business so are just used to determine how to divide up the net income. salaries and interest are not entered into the accounts. Drawings payments given to partners throughout the year. Payments are debited to each partner's drawings accounts. Any drawings and net income are transferred to the respective capital accounts during the closing process. 16

17 Financial Statements: Include the balance sheet, income statement, statement of distribution of net income, and statement of partner's capital. The above are prepared in the following order: 17

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20 Page 550 shows the changes in the partners' capital accounts for the fiscal period. 20

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22 12.2 Corporations Pages corporation an entity that the law considers to be separate and distinct from its owners. Corporations do more business in terms of dollars than partnerships and sole proprietorships put together. Originally created to raise large amounts of capital for risky and costly ventures. 22

23 share (stock) certificate a piece of paper indicating the amount of a person's share in the business. Allows many people (shareholders) to contribute a small portion and possibly earn a small profit which gives the business the ability to raise large amounts of capital. Each share/stockholder will share in the profits in the same proportion of shares in teh company. 23

24 Characteristics of a Corporation: 1. Common shareholders (the controlling owners) have voting rights. 2. It is a separate legal entity. It will continue even if anything happens to any of its shareholders. 3. Shareholders have limited liability ( they are only liable up to what they have invested in the company). 4. Subject to government control. 5. A board or directors (elected by shareholders at the annual meeting) determine company policy. 6. The board of directors passes bylaws to establish the executive positions of the company. 7. In theory, to control a company, one must own 50% of shares, but, since shares are so widely distributed, control can occur with a smaller per cent. 24

25 Corporation Advantages Disadvantages 1. Limited liability. 1. Lack of direct influence; one vote per share. 2. Ease of raising capital. 3. Continuity. 2. Government regulations can be strict. 3. High organizational costs due to fees and legal expenses. 4. Ease of transferring ownership. 5. No mutual agency. 4. Double taxation; the corporation pays its own tax and shareholders pay tax on any profits they receive since they have to include these as income. 6. Low tax rates for small businesses. 25

26 public corporation a corporation that obtains its capital partly by the sale of shares of the general public. Shares are traded on the stock exchange. Must publish their audited financial statements annually and distribute copies to the shareholders. 26

27 private corporation a corporation that has been incorporated by the owners to retain control of the business and have unlimited liability and meet special conditions: cannot exceed 50 shareholders. must raise funds privately so not allowed to advertise sale of shares to the public. 27

28 Accounts of a Corporation: Capital Stock Account the capital invested by the shareholders when they have purchased company shares. Retained Earnings Account the capital that has come from company profits that have not yet been paid to shareholders. 28

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30 Retained Earnings: represents the company's accumulation of profits over the years minus any profits paid out to shareholders (dividends). Affected by two types of accounting activities: 1. Net income/loss increases/decreases the retained earnings account entered as a credit/debit 30

31 2. Dividends a portion of a company's profits that is paid to the shareholders. Reduces the credit balance in the retained earnings account. deficit a retained earnings account with a debit balance. 31

32 Dividends: Each share receives an equal dividend. If paid in cash, total assets and retained earnings will be reduced. Dividends are declared if two requirements are met: 1. Enough cash is available. 2. A deficit will not be created in the retained earnings account when the dividend is paid. 32

33 Three important dates regarding dividends: 1. Date of Declaration The day on which the directors meet and vote for the dividend. 2. Date of Record The shareholders who own shares on this day will be the ones who receive dividends. 3. Date of Payment The date dividend cheques are to be issued. 33

34 Accounting for dividends are done in two stages: 1. A Dividends Liability account is set up when the dividend is declared and Retained Earnings is reduced by the same amount. 2. When the dividend is paid out, the liability is deleted and cash is reduced. 34

35 Common Stock: Corporation's basic class of stock. Rights of common stock holders include: 1. To vote at shareholder's meetings. 2. Receive common dividends. 3. Share in the assets that remain after creditor's are paid if the corporation is liquidated. 35

36 Preferred Stock: Shares that have special privileges including receiving dividends first and recovering their claims on the assets before common shareholders, but have disadvantages including no voting rights and smaller dividends. Shares are limited to a fixed amount unlike common share holders whose shares are limited by the earning capacity of the company. To make preferred shares more attractive accommodations may be made. Refer to bottom of page

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