Notes on Organizational Forms and Accounting for Business Decisions
Sole Proprietorship
Definition: A form of business owned (and usually operated) by one individual.
Ease of start: The easiest form to start; no special legal procedures required.
Start-up step: Owner obtains a business licence and begins operations.
Tax treatment: Profits (or losses) become part of the owner’s taxable income.
Liability: Owner is personally liable for all debts of the business; personal assets at risk.
Partnership
Definition: A business owned by two or more owners.
Shared responsibilities: Profits, taxes, and legal liability are the responsibility of two or more owners.
Formation cost: Slightly more expensive to form than a sole proprietorship; typically requires a partnership agreement drawn up by a lawyer.
Partnership agreement: Describes how profits are shared and how the agreement would change with new or departing partners.
Advantage: More resources available (capital, skills), which can help the business grow faster.
Corporation
Definition: A separate entity from its owners, legally and for accounting purposes.
Liability and taxes: The corporation is responsible for its own taxes and debts; owners cannot lose more than their investment (limited liability).
Disadvantages: Legal fees to create a corporation can be expensive; income taxes must be paid by both the corporation and its owners (potential double taxation).
Financing: Can raise large amounts of money by selling shares; ownership is evidenced by share certificates.
Share trading: Shares can be bought and sold privately or publicly on a stock exchange if the company is registered.
Public vs private: Most start as private companies; may go public to obtain financing through issuing new shares to investors (Supp. 1B explains the process). Examples of private vs public firms are provided in the text: private—London Drugs, Kal Tire; public—Rogers Communications, Boston Pizza International.
Go public: A path to large financing needs by selling shares to public investors.
Limited Liability Partnership (LLP)
Definition: A form of ownership that offers limited liability to partners.
Liability based on contribution: Partners’ liability depends on their contributed amount.
Active involvement: Some partners may contribute financially but not participate in daily management.
Focus of the book: The text notes that it focuses on corporations rather than LLPs.
Accounting for Business Decisions
Primary goal of most companies: Earn profits for shareholders by selling goods/services for more than their cost of production.
Prairie Proud scenario: A casual apparel company that seeks limited liability and financing via a private corporation (Prairie Proud Apparel Corp.).
Accounting system purpose: An information system designed to capture (analyze, record, and summarize) activities affecting a company’s financial condition and performance, and report results to decision makers inside and outside the organization.
Accounting as the language of business: Businesspeople frequently use accounting terminology to describe company activities.
How to obtain accounting help: Hire a private accountant (employee) or contract with a public accountant (e.g., Nitanis).
Prairie Proud arrangement: Prairie Proud will pay Nitanis for basic accounting services to set up an accounting system and advise on key business decisions.
Core function of the accounting system: Capture information about operating, investing, and financing activities; report results to decision makers.
Exhibit 1.1 concept (reports): The accounting system produces two kinds of reports—financial statements for external users and managerial accounting reports for internal users.
Managerial accounting (internal users): Detailed financial plans and continually updated reports about operating performance; used by managers for decisions related to production, marketing, human resources, and finance.
Examples of managerial decisions: Build vs. buy vs. rent a building; continue or discontinue certain products; how much to pay employees; how much to borrow.
Prairie Proud use: Cole will need managerial reports to monitor quantities of supplies and inventory on hand and to evaluate costs related to designing, making, and selling apparel.
External vs Internal Users and Financial Statements
Internal users: Managers within the company who use managerial accounting reports.
External users: People outside the company who rely on financial statements; internal records are not shared with them.
External user groups (the four main):
(1) Creditors
(2) Investors
(3) Directors
(4) Government
External financial statements: Financial statements prepared periodically to provide information to people not employed by the business.
Purpose of external financial statements: Help external users assess financial position, performance, and cash flows; such statements are relied upon by lenders, investors, regulators, and others.
Creditors (suppliers and banks): Evaluate credit history and ability to repay; banks require periodic financial reports to monitor risk.
Investors: Assess the financial strength and value of the business; decide on investing or divesting.
Directors: Board members who oversee management and ensure decisions serve shareholders’ interests.
Government: Use financial statements to regulate and enforce taxes; Canadian securities regulations are managed by provincial/territorial securities commissions (thirteen in Canada). Governments use the information to ensure taxes are computed correctly.
Exhibit 1.2: Illustrates external and internal users and uses of financial statements.
Prairie Proud example: The bank is the main external user; Cole must prepare financial statements to obtain the loan and provide updated reports until the loan is repaid.
Common concern for new business owners: “I want to sound intelligent when I talk to my banker, but I don’t know much about accounting.”
The response framed in the material: the most basic thing you need to know about accounting is that the accounting system records and reports information to aid decision making.
Financial statements are the means by which external users evaluate and monitor the company’s resources, performance, and compliance with rules.
Key Formulas and Numbers (illustrative)
Profit concept (revenue vs cost):
Example financial inputs for Prairie Proud:
Personal funds contributed:
Bank loan sought:
Contextual note: Canada’s securities regulation structure involves governance by provincial/territorial authorities across jurisdictions.