BAF3M

Chapter One – Introduction to Accounting, Types of Business and Forms of Business Ownership

A. What is Accounting?

1. Information Gathering

·  Based on financial events that occur

2. Information Measuring

·  Expressed in monetary terms

3.Recording Information

·  Keeping track of events

4.Information Classification

·  Classify data into appropriate categories

5. Summarizing and Reporting Information

·  Based on written reports

6. Interpret and Controlling

·  Review statements to ensure accuracy and efficiency of operations and to assist in decision making.

B. What is the Purpose of Accounting?

  • To provide information to decision makers.

More specifically…

  • The basic purpose of financial statements is to assist decision makers in evaluating the financial strength, profitability, and future prospects of business.

C. Who Uses Accounting Information? And For What?

Managers and Business Owners

  • Planning and controlling daily operations as well as long-term goals

Investors (current and potential)

  • Should I continue, discontinue, increase, and/or decrease my investment

Creditors (i.e. Banks)

  • Should I give the loan? Will I get my money back?

Government Regulatory Bodies

  • Canadian Revenue Agency (Is this person or business paying all their taxes)

Employees

  • Job security, career advancement, flexibility, potential investors

Unions

  • For contract negotiations as well as other interests of the employees (raise, better benefits?)

D. Types of Business

Most business fall into one of the four categories:

1. The Merchandising Business

2. The Service Business

3. The Manufacturing or Producing Business

4. The Non-Profit Organization

The Merchandising Business

  • Buys goods and resells them at a higher price for a profit.
  • Examples: Future Shop, Sport Chek, Staples, etc.

The Service Business

  • sells a service to the public
  • it does not sell a product as its main activity
  • usually provides skills or expertise and the customer is involved in the delivery of
    the service
  • Examples: Hairstylist, Lawyer, Doctor

Note:

  • Sometimes a service company will sell products (i.e. hairdresser selling shampoo), but it is a sideline and not the main business.
  • Sometimes a merchandising business will offer services (i.e. computer repair or hemming clothes), but it is also just a sideline and not the main business.

The Manufacturing Business

  • Buys raw materials, converts them into a product and sells these products to earn a profit.
  • Consider a construction company, a paper mill, or steel plant.

The Producing Business

  • Closely related to manufacturing
  • Examples include farms who may produce milk, grain, etc. Other examples include oil extraction, mining, forestry, hunting, and fishing

Non-Profit or Not-for-Profit Organization

  • An organization that does not seek to make a profit, but instead raises money/funds for a specific goal. (churches, charities, recreational sports clubs)
  • Examples include: Canadian Cancer Foundation, Amnesty International, Junior Achievement etc.


Forms of Business Ownership

1. Sole Proprietorship

  • owned by one person

2. Partnership

  • Usually owned by two or more partners

3. Cooperative

  • Owned by its workers or by members who buy from the business

4. Franchise

  • One business licenses (allows) another to use its name, operating procedure, etc.
  • Can have any form of ownership

5. Corporation

  • Business is an artificial “person” created by law and owned by shareholders

1. Sole Proprietorship

  • Simplest form of business ownership
  • One owner of a business

Advantages

J  Keep all the profits

J  Make all the decisions

J  You are your own boss

J  (i.e Financial information can be kept secret. from competitors), but not the government

Disadvantages

L  Unlimited Liability

L  Facing personal and financial risks and challenges on your own

L  Borrowing money may be more difficult

L  Huge time commitment

Examples may include individuals who are:

  • Artists
  • Authors
  • Carpenters
  • Computer specialists
  • Digital designers
  • Ecotourism guides
  • Farmers
  • Industrial designers
  • Photographers
  • Web designers
  • Chefs or Bakers
  • Hair stylists

2. Partnership

  • More complex and needs a written agreement
  • Partners must discuss and agree on issues such as:

«  How much time and money each partner will put
into the business

«  How the profits will be shared

«  Who will make decisions about different aspects of
the business

«  Who will manage the employees

«  How the partnership might be ended

All partners must sign the partnership agreement which includes:

þ  The name and location of the business

þ  Its purpose

þ  The amount of partner’s investment

þ  The way that the profits and losses are to be
divided

þ  The duties and responsibilities of each partner

þ  The procedures for ending the partnership

Advantages

J  Inexpensive to set up and organize ($1000)

J  Two people to invest and it is easier to borrow from a bank

J  More brains filled with different knowledge, experience, skills

J  Shared responsibility eases stress and workload

J  Share debt and can more easily take a vacation

Disadvantages

L  Unlimited liability

L  Your personal assets (home, care etc may need to be used to pay off business debts)

L  Conflicts between partners that can not be worked out

Examples of Typical Partnerships

1. Small independent service or retail businesses such as:

  • bakeries, hair salons, flower shop, convenience store, landscaping or décor store, consignment shop, restaurants, retail stores,plumbers, electricians, mechanics, carpenters

2. Professional Designations or Apprenticeships such as:

  • accountants, lawyers, doctors, veterinarians, mechanics, plumbers, electricians, carpenters

3. Co-operatives

  • Also called Co-ops
  • Business owned and operated by a group of people with a strong common interest
  • Start-up costs are shared among members
  • Members own and control and make all the business decisions

Examples of Coops

1. Farmers

  • Belong to producer co-ops
  • Members bring crops to a central location to sell them
  • Coop monitors the supply of the crop and controls its sale and price
  • Farmers do not compete against each other or undercut other’s prices
  • Farmers can combine to buy equipment and reduce costs and share expertise
  • Example: Saskatchewan Wheat Pool sells products all over the world.

2. Consumer Co-ops

  • Join together to operate a business that provides them with goods and services
  • Profits are divided among the members in proportion to the amount of business that each member does
  • Examples: Omish Community Furniture Co-ops

3. Credit Unions/ Caisses Populaires

  • Financial co-ops
  • Like banks but profits are distributed annually to their members

Advantages

J  Shared skills and experiences

J  Less risk than for sole proprietor and partnership

J  Liability is limited to the amount of your share in the capital of the coop

J  Each member gets one vote – equal decision making and influence

J  If you have more shares, you still get one vote, but more share of the profits

J  Coops get discounts due to volume purchasing by many people

J  Control sale and price of goods

Disadvantages

L  Individual members hesitant to invest more – only one vote

L  Decision-making can be difficult because of multiple members

L  Commitment of members may vary because some have more money at stake and some may take things more seriously than others

4. The Franchise

  • One of the fastest growing forms of business ownership
  • The franchisor sells to another person (the franchisee) the rights to use the business name and to sell a product or service in a given territory.
  • Available in many different sectors (fast food, wine, funeral homes)
  • Franchise can be any form of business ownership (i.e. sole proprietorship, partnership, corporation)

Franchise Agreement

  • Written contract between the franchise seller and buyer
  • Permit the franchisee to use the franchisor’s name, products, packaging
  • Franchisor will specify how the franchise is to be operated, what products can be sold, the advertising, etc.
  • Provide more than 1 million jobs directly, many more indirectly
  • Annual sales of $100 billion

Advantages

J  Proven track record and nationally or internationally recognized name

J  Personal ownership like a sole proprietorship

J  Less stress in initial set up as most issues like process, products and location, equipment, décor are spelled out by the franchisor

Disadvantages

L  Expensive to buy

L  Must pay royalties for your sales

L  Little say in many of the business decisions

L  If the franchisor fails, so does the franchisee

5. Corporation

v  Legal entity that exists independently of its owners who are the shareholders.

v  Has the same rights and obligations under Canadian law as a natural person

v  It can be found guilty of committing a crime

v  Brought into existence by drawing up and filing with the proper government agency a document called the articles of incorporation

v  A lawyer and accountant are often needed to prepare this document

Articles of Incorporation include information such as:

þ  Name of corporation

þ  Headquarters of corporation

þ  Type of corporation

þ  Number of shares allowed to be issued to the public for purchase

Classification of Corporations

1. Non-Profit Corporation

2. Crown Corporation

3. Private Corporation

4. Public Corporation

Non-Profit Corporations

  • Purpose is to undertake fundraising, to do research and to lobby for a particular cause in order to help people
  • Example: United Way, Museums, Religious organizations, athletic and artistic organizations.

Crown Corporation

  • Owned by the federal, provincial, or municipal governments
  • Function is to provide a special service to the public
  • Examples: Bank of Canada, Royal Canadian Mint, Canada Post, Canadian Broadcasting Corp. (CBC)

Private Corporation

  • Can have up to 50 shareholders
  • A single person who incorporates may have only one shareholder – him or herself.
  • Usually small but not always
  • Eatons now owned by Sears was a private corporation

Public Corporation

  • Does not have a restriction on the number of shareholders. (unlimited number)
  • Shares are bought and sold (traded) on the stock exchanges, such as the Toronto Stock Exchange, the Vancouver Stock Exchange.
  • Examples include: Tim Hortons, Google,

Structure of a Corporation

  • Structured like a triangle with the shareholders starting at the top….
  • The shareholders elect a board of directors, who direct the overall affairs of the corporation
  • The BOD hires the officers (i.e. the President of the corporation) who decide on the objectives for the company and hire the managers and essentially run the day to day operations of the business.
  • The managers supervise the employees.

Advantages

J  Owners are only liable for the amount they invest – Limited liability

J  Has more financial resources to expand and grow (money collected from the selling of shares)

J  Easier to get a loan from a bank because it has more assets to use as security collateral”)

J  The tax rate is lower than for a sole proprietorship. (40-50% versus 23%)

J  Ownership is easily transferable

Disadvantages

L  More complicated to set up due to government regulations

L  Must be registered in every province it operates

L  Time consuming process and expensive

L  Closing a corporation can be time consuming and expensive

L  Business is managed by employees who may or may not be shareholders.

L  Must publish an annual report outlining the companies financial position which can benefit competitors

L  Changes in stock market could impact future financial resources raised through issuing new stock to sell to the public

Corporations and the Stock Market

  • Once the company has been incorporated and the articles of incorporation have been approved, the company issues shares to the general public who may purchase them for ownership of the company.
  • The first time a corporation issues shares to the public to purchase is called an IPO.

The Initial Public Offering (IPO)

  • A Stock brokerage (business that sells and buys shares on behalf of other businesses and individuals for a fee) is usually hired to handle the sale of shares to the public.
  • An initial price offering is made the day the market opens
  • For example, when Google went public in 2004, its shares were initially offered at $85.
  • Supply and demand for the shares will determine by how much the initial price of the share increases or decreases.
  • The money collected from the initial shares being offered goes back to the corporation to be used by the business.
  • Once a share is purchased, it is now out in the stock market where the shareholder can hold or sell his/her shares to another interested buyer for an agreed price.

The Stock Market

  • Market where people come to sell and buy shares/stocks of companies.
  • Person A wants to sell his/her shares of Google.
  • Person B wants to purchase shares of Google.
  • The stock brokers hooks Person A and B together to make the deal.
  • The stock brokers receives a fee for their services from the buyer and seller.
  • The price of the shares will depend on supply and demand. If more people want to buy then sell, the price may higher than it was the previous day.

How do people make money in the stock market?

1. Purchase shares of a company and sell them at a higher price to another interested buyer
later on.

  • Example: In 2004, Google shares issued at $85 a share. In November of 2006, they were selling at $500+ a share
  • If you purchased 100 shares at $85 per share and sold them for $500 per share, how much money have you made?

Purchase price = $85 x 100 = $8 500

Selling price = $500 x 100 = $50 000

Personal Profit (Return on Your Investment )

= $50 000 - $ 8500 = $41 500

ROI = (50 000 – 8 500) / 8 500 X 100 = 488% increase

2.  Shareholders receive dividends on the shares they own.

  • Board of Directors declare a .50 cent dividend at year end)
  • Each shareholder will receive .50 cents for every share s/he owns in the company.
  • Dividends are like interest. A bank pays you a certain % of interest (i.e. 2% per year) on the money you have in your savings account.
  • Dividends, however, are not guaranteed to be paid out every year, as it depends on how profitable the company has been and what its cash flow is.

Example: You own 100 shares of Google. At the end of a business year, Google has
made a significant profit and the BOD declares a .50 cent dividend.

How much money did you make: $.50 x 100 = $50.00

Additional Sources Used

1.  Liepner, Michael E. et al. Exploring Business For the 21st Century. Toronto:McGraw-Hill Ryerson Limited, 2001

2. Wilson, Jack et al. The World of Business (5th ed.) Toronto: Nelson Education Ltd.,
2007