Chapter 1, Problem 1AP

1.

To determine

Identify the three major legal forms of business organizations, state the advantages and disadvantages of each and recommend a form of business organization for Company G.

Explanation of Solution

The three major legal forms of business organizations are stated below:

• Sole Proprietorship
• Partnership
• Corporation

Business Organizations

Business organizations are individuals or group of individuals formed together to carry out sale and purchase of goods and services with the aim of earning profits, maximizing wealth and to achieve other organizational objectives.

Sole proprietorship: The form of business entity which is owned and managed by an individual is referred to as sole proprietorship.

Partnership: This is the form of business entity which is formed by an agreement, owned and managed mutually by two or more individuals, who invest their assets in the business and share the liabilities and profits among themselves.

Corporation: The form of business entity ,which is incorporated by state law into a separate legal entity, owned by stockholders, and managed by board of directors elected by stockholders, is referred to as corporation.

State the advantages and disadvantages of a business being formed as a sole proprietorship, partnership, and corporation:

Legal form of business	Advantages of a business being a corporation	Disadvantages of a business being a corporation
Sole proprietorship	Low tax rates	Limited resources, unlimited liability and insufficient funds
Partnership	Low tax rates	Limited resources, shared but not limited liability and insufficient funds
Corporation	Limited liability, Easy transferability of ownership  and Easier way to raise funds for business	High tax rate and Government regulations

Table (1)

Sole proprietorship:

• Advantages:
  • The tax rates are low.
  • It is easy to setup sole proprietorship as there are few or no regulations.
• Disadvantages:
  • The resources to carry out the business operations are limited.
  • There is a shortage of funds.
  • The owner is held personally responsible for the losses and debt.
  • Only a small scale business is possible.

Partnership:

• Advantages:
  • The tax rates are low.
  • It is easy to setup partnership as there are minimal regulations.
• Disadvantages:
  • The resources to carry out the business operations are limited.
  • There is a shortage of funds.
  • The partners are held personally responsible for the losses and debt.
  • It is difficult to set up large-scale business.

Corporation:

• Advantages:
  • Stockholders’ of a business are not personally liable for the business debts and legal obligations.
  • It is easy to sell the corporation stocks in the open market, and raise funds for the corporation.
  • Large-scale business operations are feasible.
• Disadvantages:
  • They have to pay higher taxes than sole proprietorship or partnership.
  • It is difficult to establish a corporation than sole proprietorship or partnership, as a business needs to come across more regulations to form a corporation.

Mention the most recommended form of business organization for Company G:

The form of business organization recommended for Company G is Corporation, because it provides limited liability which means that stockholders’ of a business are not personally liable for the business debts and legal obligations. In corporation, it is easy to sell the corporation stocks in the open market, and raise funds. Large-scale business operations are feasible.

2.

To determine

Identify the typical financing, investing and operating activities that the Company G is likely to have.

Explanation of Solution

Statement of cash flows: This statement reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities. Operating activities include cash inflows and outflows from business operations. Investing activities includes cash inflows and cash outflows from purchase and sale of land or equipment, or investments. Financing activities includes cash inflows and outflows from issuance of common stock and debt, payment of debt and dividends.

The typical financing activities that the Company G is likely to have are given below:

• Issuing Common stock;
• Borrowing funds from the bank.

The typical investing activities that the Company G is likely to have are given below:

• Purchase of equipment, machinery;
• Purchase of trekking vehicles;
• Purchase of office building.

The typical operating activities that the Company G is likely to have are given below:

• Collection of fees for the service provided;
• Purchase of utilities;
• Payment of rent, salaries, insurance and taxes.

3.

To determine

Identify the specific account names for assets, liabilities and stockholder's equity, revenue and expenses that the Company G is likely to have.

Explanation of Solution

Assets: These are the resources owned and controlled by business and used to produce benefits for the company. Assets are classified on the balance sheet as current assets, non-current assets, property, plant, and equipment, and intangible assets.

The specific account names for assets that the Company G is likely to have are given below:

• Cash;
• Equipment;
• Accounts receivable;
• Supplies.

Liabilities: The claims creditors have over assets or resources of a company are referred to as liabilities. These are the debt obligations owed by company to creditors. Liabilities are classified on the balance sheet as current liabilities and long-term liabilities.

The specific account names for liabilities that the Company G is likely to have are given below:

• Salaries payable;
• Accounts payable;
• Notes payable.

Stockholder’s equity: Stockholder’s equity refers to the right the owner possesses over the resources of the business. Revenues and the expenses are the components of the owner’s equity.

The specific account names for stockholder's equity Company G is likely to have are:

• Common stock;
• Retained earnings.

Revenues: Revenue refers to the income received from the business activity or sale of the output, during the accounting period.

The specific account names for revenues that the Company G is likely to have are given below:

• Service revenues.

Expenses: Expenses are costs incurred for the operations of a business. The costs incurred for generating revenues are rent expense, depreciation expense, general and administrative expenses, selling expenses, and utilities expense.

The specific account names for expenses that the Company G is likely to have are:

• Salaries expenses;
• Utilities expenses;
• Rent expenses;
• Insurance expenses;
• Taxes expenses.

4.

To determine

Explain the type of information provided by each of the financial statement.

Explanation of Solution

Financial statements: Financial statements are condensed summary of transactions communicated in the form of reports for the purpose of decision making.

Financial statements include the following statements:

·         Cash flow statement

·         Income statement

·         Balance sheet

·         Statement of stockholder's equity

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Statement of stockholder's equity: This statement reports the beginning stockholder's equity and all the changes which led to ending stockholder's equity. Additional capital, net income from income statement is added to and drawings or dividends are deducted from beginning stockholder's equity to arrive at the end result, closing balance of stockholder's equity.

Statement of cash flows: This statement reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period.

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.