1.3: Business Organizations

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Henry Dauderis and David Annand
Athabasca University via Lyryx Learning

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learning objective

Identify and describe the forms of business organization.

An organization is a group of individuals who come together to pursue a common set of goals and objectives. There are two types of business organizations: business and non-business. A business organization sells products and/or services for profit. A non-business organization, such as a charity or hospital, exists to meet various societal needs and does not have profit as a goal. All businesses, regardless of type, record, report, and, most importantly, use accounting information for making decisions.

This book focuses on business organizations. There are three common forms of business organizations — a proprietorship, a partnership, and a corporation.

Proprietorship

A proprietorship is a business owned by one person. It is not a separate legal entity, which means that the business and the owner are considered to be the same entity. This means, for example, that from an income tax perspective, the profits of a proprietorship are taxed as part of the owner's personal income tax return. Unlimited liability is another characteristic of a sole proprietorship meaning that if the business could not pay its debts, the owner would be responsible even if the business's debts were greater than the owner's personal resources.

Partnership

A partnership is a business owned by two or more individuals. Like the proprietorship, it is not a separate legal entity and its owners are typically subject to unlimited liability.

Corporation

A corporation is a business owned by one or more owners. The owners are known as shareholders. A shareholder owns shares of the corporation. Shares (Shares are also called stock.) are units of ownership in a corporation. For example, if a corporation has 1,000 shares, there may be three shareholders where one has 700 shares, another has 200 shares, and the third has 100 shares. The number of shares held by a shareholder represents how much of the corporation they own. A corporation can have different types of shares; this topic is discussed in a later chapter. When there is only one type of share, it is usually called common shares.

A corporation's shares can be privately held or available for public sale. A corporation that holds its shares privately and does not sell them publicly is known as a private enterprise (PE). A corporation that sells its shares publicly, typically on a stock exchange, is called a publicly accountable enterprise (PAE).

Unlike the proprietorship and partnership, a corporation is a separate legal entity. This means, for example, that from an income tax perspective, a corporation files its own tax return. The owners or shareholders of a corporation are not responsible for the corporation's debts so have limited liability meaning that the most they can lose is what they invested in the corporation.

In larger corporations, there can be many shareholders. In these cases, shareholders do not manage a corporation but participate indirectly through the election of a Board of Directors. The Board of Directors does not participate in the day-to-day management of the corporation but delegates this responsibility to the officers of the corporation. An example of this delegation of responsibility is illustrated in Figure 1.4.1.

Figure \(\PageIndex{1}\): Generalized Form of a Corporate Organization

Shareholders usually meet annually to elect a Board of Directors. The Board of Directors meets regularly to review the corporation's operations and to set policies for future operations. Unlike shareholders, directors can be held personally liable if a company fails.

The focus of these chapters will be on the corporate form of business organization. The proprietorship and partnership organizations will be discussed in more detail in Chapter 13.