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tors can file claims against the owner’s personal property. Legally, there is
no distinction between the sole trader’s business and the sole trader as a
person. Unlimited liability is just an extension of that idea, so if the business
goes bankrupt then the business owner is personally liable for all of the
debts of the business.
C
Partnership is created when two or more people agree to form and run
a business jointly. With few exceptions, there cannot be more than twenty
partners in a partnership (although, as with the sole trader, there can be any
number of employees).
Partnerships are a form of business most commonly found in professions such as medicine, dentistry, law, accountancy, and also in professional
services such as plumbing and building.
The partners can agree among themselves the basis of the partnership,
but if they do not, the Partnership Act of 1890 will dictate for them what the
duties and rights of each partner are. The main rights to a partner by the Act
are:
1. To share equally in profits and losses.
2. To prevent the admission of new partners i.e. one partner can exer-
cise a veto.
3. To receive interest of 5% per year on loans to the business above the
agreed fixed capital.
Starting formalities may be negligible although it is advisable that prospective partners consult a solicitor first unless they want to abide by the
contents of the 1890 Partnership Act.
The benefits of a partnership include the fact that responsibility can
now be shared. The financial resources of a partnership will be less limited
than those of a sole tradership. Partners can pool their money capital.
Unlimited liability still remains a problem, meaning that the partners
are personally liable for the debts of the partnership. Added to that is the
fact that the partners are said to be jointly liable for the business debts. This
means that if one partner cannot pay his/her share of the business debts then
the remaining partners, in addition to paying their share, must also pay the
share of the partner who cannot.
Managerial control is retained among very few individuals. Whenever
there are several people participating in management, this division of authority can lead to inconsistent, divided policies. Partners may disagree on
basic policy. For all these reasons, management may be cumbersome.
D
Keeping the accounts of the sole trader business in which all the capital and profit belongs to the owner and is reduced by the amount of money
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which he/she takes out as drawings is straightforward. However, the creation of the partnership will mean that a number of changes will be needed in
his/her books of accounts. So each partner will have:
a) a capital account – which records his/her fixed capital contribution
and any changes which may, by agreement, be made to it;
b) a current account – which records his earnings from the partnership, e.g. from a salary, interest on capital and share of profits, and the
drawings which he has made.
As far as the final accounts of the partnership are concerned, they will
have to provide a statement which demonstrates that the partnership agreement has been complied with – this is an additional account which is added
to the end of the profit and loss account and is called the profit and loss
appropriation account.
What does this term ‘appropriation’ mean? Essentially it means ‘to
take possessions of’ which in this situation suggests that each partner ‘takes
possessions of’ his share of the business profits or losses according to the
terms of the partnership agreement. So the appropriation account shows the
net profit earned by the business and the way in which this has been distributed between the partners as required by the partnership agreement.
Appropriation of profit to partners
Interest on capital to X
Salary to X
Interest on capital to Y
The box represents the total net profit of the business to be shared between the partners. The partnership agreement will give the details of the
way in which the ‘box’ is to be cut up.
In this case X gets a salary, presumably for his additional
work/responsibilities. Each partner gets interest on capital. Y has obviously
invested more capital than X. The remainder of the profit (‘the box’) is then
split equally between them.
E
The limited liability company is created by the law and, in the eyes of
the law, has a corporate personality; that is, as far as the law is concerned,
the limited company is a ‘person’ in its right and exists independently from
its owners. In fact, the owners of this form of business do not own it in the
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Share of profits to X
Share of profits to Y
same way as the owners of sole traders and partnerships own these businesses. Rather, individuals own shares in the company and it is only the
ownership of shares which confers (somewhat restricted) rights.
The starting formalities can be quite complex. Since the law creates
the limited company, it is not too surprising that the law also states a wide
range of formalities which must be gone through before the company may
start trading. Essentially, the new company must prepare a Memorandum of
Association and the Articles of Association which, together, form the rules
and constitution of the company. These documents state how a company
will be run and what it will do and if the company tries to do anything outside these rules, it is breaking the law. Once these documents have been
checked and passed, the Registrar of Companies will issue a Certificate of
Incorporation. This then means that the company has come into existence as
a legal entity. In addition to either ‘doing-it-yourself’ or with the help of a
solicitor, it is also possible to buy a ready-made company from businesses
who specialize in company formation. Advertisements for these can usually
be found in any financial paper.
This format of business has two features which distinguish it from the
sole trader and partnership businesses:
1. There is no limit to the number of people who may become members of the company. The capital of a company is divided up into what are
called shares, which may be of any amount decided by the members. Someone becomes a member or shareholder by purchasing one or more shares in
the company. Therefore a company can find it easier to raise capital than a
sole trader or partnership, as it need only issue more shares.
2. The members of the company have limited liability. This means
that the maximum amount that a member can lose is the capital which he
has actually invested in the company. So unlike a sole trader or a partner,
the shareholder’s private possessions cannot be used to pay for the debts of
the business. This obviously helps in making people more willing to buy
shares in a company. Also, because the law recognizes the company’s independent existence, the death of the shareholders does not mean the death of
the business (obviously the death of a sole trader will have a rather profound effect on the existence of his/her business!). Similarly, if a shareholder is personally bankrupt that does not affect the company.
3. Because of their advantage in attracting money capital, successful
companies find it easier to expand the size and scope of their operations. In
particular, companies may be able to take advantage of mass production
technologies. Similarly, size permits greater specialization in the use of human resources. While the manager of a sole tradership may be forced to
share his time between production, accounting, and marketing functions, a
larger company can hire specialized personnel in each of these areas and
achieve greater efficiency.
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The price to be paid for these advantages may be considered by some
to be considerable. All limited companies must abide by the content of the
Companies Acts which, among other things, requires companies to prepare
annual accounts in a strict format. The affairs of limited companies are not
secret, since anybody can see copies of these annual accounts.
One final disadvantage is that the owners do not control their firm directly. They have to elect a board of directors who have the responsibility of
managing the company. Indeed, individual shareholders do not have the
right of access to any of the books of account of their company. This may
seem a rather stringent limitation on the rights of the owners, but there is a
good reason for it. If shareholders did have the right of access to the internal
management of their company, a rival firm could buy one share and then
take advantage of its ownership of the one share and demand access to the
firm’s secrets – undoubtedly to the disadvantage of the company.
F
There are two types of limited liability company. A public company is
defined by the Companies Act 1985 as one which:
− is registered as a public company with the Registrar of Companies;
− has at least two members or shareholders;
− has at the end of its name the words ‘public limited company’ or
the letters ‘plc’;
− must have a minimum authorised share capital of £50,000 which
must be issued before it can do business.
A private company is then a limited company which is not a public
company. Its name is followed by the word ‘limited’ or letters ‘Ltd’.
What are the differences in practice between the two? There are more
private than public companies in existence. The main advantage which public companies have is that it is possible for them to sell their shares to the
general public. For example, a public company can apply to the Stock Exchange to have its shares dealt in on the Exchange; a private company cannot. Private companies tend to be smaller businesses which do not need to
sell shares to the public e.g. family businesses. Public companies tend to be
larger firms which operate on a large scale, require a lot of finance and are
relatively well known.
G
The accounts of limited liability companies are of two types – the accounts which are produced for internal use by any company and the accounts produced for shareholders and for the Registrar of Companies. We
shall consider those, which would normally be produced for internal use.
How will these accounts differ from those of sole traders and partnerships?
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1. Trading and profit and loss account. The only difference here will
be the introduction of certain types of expenses peculiar to limited companies, e.g. directors’ salaries.
2. Profit and loss appropriation account. As with a partnership, because there is more than one owner of the business, there must be a statement to show how the profits of the business are to be used. In the case of a
company, the profits are either:
a) distributed – paid out in the form of dividends or taxation;
b) retained – held within the business in what are called revenue re-
serves. These reserves may be of two types:
• specific reserves which indicate that these retained profits are not
to be used for dividends to shareholders but are to be held permanently
within the business, e.g. fixed asset replacement reserve or general reserve;
• undistributed profits – profits which have not been paid out to
shareholders as dividends but are carried forward and may be distributed in
future years. This is often called the profit and loss account balance or retained profits.
3. Balance sheet. In the assets part of the balance sheet there will be
no difference. In the finance part the balance sheet must show:
a) the authorised share capital and the issued share capital separately,
unless all of the authorised share capital has been issued, when the
two can be combined;
b) the reserves of the company under their various headings.
H
After a great deal of discussion with his accountant, Tim Weston and
his solicitor, Joe, decided to form Lumley Lampshades Ltd. The company
had an authorized share capital of £200,000 made up of 110,000 £1 ordinary shares and 90,000 10% £1 preference shares. In return for the net assets of his business at their balance sheet value, Joe received 100,000 ordinary shares and 20,000 preference shares from the company. Also 1,000
ordinary shares were issued to Joe's wife Edna and fully paid for.
At the end of the first year's trading the company's results could be
summarized as follows:
1. The net profit for the year was £60,000. Out of this Joe proposed to
transfer £10 000 to a general reserve, to pay the preference dividend and an
ordinary share dividend of 10%.
2. The company had fixed assets of £141,000, current assets totaling
£70,000 and its current liabilities for creditors and expenses were £30,000.
The final accounts of Lumley’s Lampshades Ltd at the end of the
company’s first year would be the following.
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Profit and loss appropriation account for the year ended
31 December
Net profit 60,000
Retained profits brought forward –
Transfers to general reserve 10,000
Proposed dividends:
Ordinary 10,100
Preference 2,000
12,100 22,100
£37,900
Balance sheet as at 31 December
Fixed assets 141,000
Current assets 70,000
Current liabilities:
Creditors and expenses
30,000
Proposed dividends 12,100 42,100
Working capital 27,900
Net assets employed 168,900
Authorised share capital
110,000 ordinary shares 110,000
90,000 10% preference shares 90,000
200,000
Issued share capital:
101,000 ordinary shares 101,000
20,000 10% preference shares 20,000
121,000
Reserves:
General reserve
Retained profits
Net capital employed
10,000
37,900 47,900
£168,900
READING FOR SPECIFIC INFORMATION
1. Scan the text and write the letter of the section where you can
find the following information. Do it as quickly as possible.
___ Registrar of Companies
___ ‘one-persons shows’
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___ Stock Exchange
___ Partnership Act
___ Ltd
___ retained profits
___ Articles of Association
___ three common types of business formats
___ distributed profits
___ Companies Act 1985
___ Lumley’s Lampshades LTD final accounts
___ plc
___ definition of profit and loss appropriation account
___ Memorandum of Association
___ cooperatives and investment trusts
READING FOR DETAILS AND LANGUAGE STUDY:
SECTIONS A, B C AND D
1. Check that you understand the detailed questions below and
answer them:
1. What are the three common types of business format?
2. What other business formats do you know?
3. What are the main features of the sole trader?
4. What industries does the sole trader exist in?
5. What are the usual sources of new capital for the sole trader?
6. What problems does the sole trader face with?
7. What are the main features of the partnership?
8. How many persons does the partnership consist of?
9. How is a partnership formed?
10. Why should partners have a partnership agreement?
11. What if there is no partnership agreement?
12. What are the benefits of a partnership?
13. Where can more capital be raised?
14. What problems do the partners face with?
15. What do both forms of business formats have in common?
16. What are the differences between these two forms?
17. What does a capital account record?
18. What does a current account record?
19. What is the profit and loss appropriation account?
20. What does the term ‘appropriation’ mean?
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2. Complete the blanks in the following sentence to produce a
to control (a company), be in charge of and
a lawyer who gives legal advice, writes legal
ts people in the lower courts
definition of a partnership.
A partnership has 1) ______________ or 2) _____________ owners
who each provide 3) _____________ for the business and are usually
4) ____________ liable for the debts of the business.
3. John was trying to make some notes about the new accounts he
needed now that his business was a partnership. See if you can help by
completing the spaces in the sentences below.
1. We now need 1) ___ ________________ accounts to record the
fixed 2) ______________ contributions which we’ve each agreed to put in.
2. We need 3) ____ ________________ accounts to show what
we’ve each earned from the partnership and what we have actually taken
out in 4) ___________________ .
3. When I prepare the final accounts, I will have to do a profit and
loss 5) ________________ account to show how the profits or losses have
been shared.
a) drawings; b) appropriation; c) two current; d) capital; e) two capital
4. Match each word or phrase on the left to the correct definition
on the right. Check that your ideas make sense in the context of the text.
Words or phrases Definitions
1) peculiarities
2) negligible
3) liable
4) sole
5) restricted
6) solicitor
7) jointly
8) to be aware
9) to retain
10) burden
11) large-scale
12) to run a
company
13) prospective
a) controlled or limited in some way
b) to have knowledge or understanding
c) very unimportant or small, insignificant
d) a heavy duty which is hard to bear
e) together
f) future; likely to be or become a particular thing
g)
cause to work
h) to keep someone or something
i) legally responsible for paying
j) qualities belonging only to a particular person,
place, time, etc.
k)
contracts, and represen
of law
l) only, belonging to one person only
m) involving a large number of people or things, or
happening over a large area
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5. When you have finished, complete the sentences below by
choosing a suitable word or phrase from your table.
1. There was a ___________ rise in unemployment.
2. The US expects to ___________ control over the operation.
3. We need to protect the village from ___________ house building.
4. Unemployment places a heavy __________ on the welfare state.
5. Sue ____________ a mail-order company.
6. I was well ______ of this fact.
7. The firm’s salary system is ______________ .
8. You have to live in the city and understand its ______________ .
9. This is a sales representative with ________ responsibility for
sales in the North East.
11. That is an aircraft that is being developed ______ with the US.
12. It is advisable that the _______ partners consult a ________ first.
6. Classify the following statements according to the table below:
a) unlimited liability;
b) independent decision making;
c) a trading agreement made by one person is binding on the business;
d) it suffers from a lack of continuity in the event of the death of the
owner;
e) greater personal contact with employees and customers;
f) details of profits and losses can be kept private;
g) scarcity of capital is often a problem;
h) disagreements are possible;
i) management can be shared by specialists;
j) a greater amount of capital is available.
Sole Tradership
Partnership
Advantages Disadvantages
7. From the list of different businesses select:
a) two which are most suitable for a sole tradership;
b) two which are most suitable for a partnership.
In each case give a reason for your choice:
1) department store;
2) medical practice;
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3) window cleaner;
4) textile manufacturer;
5) legal firm;
6) airline;
7) village shop.
8. Substitution drill
Statement: If a manufacturer is sure that cash will be available exactly
when expenses have to be paid, no cash reserve will be necessary.
Example: businessman
If a businessman is sure that cash will be available exactly when ex-
penses have to be paid, no cash reserve will be necessary.
1) certain; 6) as soon as;
2) on hand; 7) at the time;
3) money; 8) idle money;
4) needed; 9) increased.
5) salaries;
9. Fill in the spaces in the sentences below using a suitable preposition.
1. The goal is to involve workers ____ the decision-making process.
2. You may be liable ____ tax on any gains you make.
3. You are legally obliged to comply fully _____ any investigations.
4. A process of negotiation leads ____ a peaceful settlement.
5. The sole proprietor has total control _____ the management of the
business.
6. This firm has grown ______ a large-scale enterprise.
7. You should be able to claim ______ the car insurance.
8. They're aware ____ the dangers.
DISCUSSION POINTS
1. Decide which of the following the small shopkeeper has to do.
Which of the points do you think will cause him problems?
1) advertise in foreign newspapers;
2) find cheap premises in an area where his customers can park their
cars;
3) find premises (помещения для ведения торговой деятельности)
which are in good condition;
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