MGT101 - Financial Accounting - I - Lecture Handout 31

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TYPE OF BUSINESS ENTITIES

There are two types of entities:

  • Commercial organizations
  • Non-commercial organizations

Commercial Organization

Commercial organization is the entity that is working to earn profit. At the end of the financial year, the profit is distributed among the owners of the business. Normally, commercial organizations include:

  • Sole proprietorship
  • Partnership, and
  • Limited Company

Non Commercial Organization

Non Commercial organization is the entity that is not working to earn profit. At the end of the financial year, the profit is not distributed among the owners, but is used for the objective of the organization. Normally, commercial organizations include:

  • Co-Operative institutions
  • NGO’s
  • Trusts

Types of Commercial Organization

Sole proprietorship business

It is a business that is owned by an individual. He may have employed any number of persons to work for him, but he is the sole owner of the business.

Partnership

Partnership is the type of business where more than one person (called partners) enters into a legal agreement to run a business on a profit and loss sharing basis.

Limited Company

Limited company is a legal entity, separate from its owners (called shareholders). The basic difference between a partnership and a limited company is the concept of limited liability.

  • If a partnership business runs into losses and is unable to pay its liabilities, its partners will have to pay the liabilities from their own wealth.
  • Whereas, in case of limited company, the shareholders don’t lose anything more than the amount of capital they have contributed in the company. i.e., their personal wealth is not at stake and their liability is limited to the amount of share capital they have contributed.

The concept of limited company is to mobilize the resources of a large number of people for a project, which they would not be able to afford independently and then, get it managed by experts.

Accounting Requirements

Sole Proprietorship

In case of sole proprietor, owner is the sole owner of the business. So, there is no restriction on him for drawing money for his personal use.

For accounting purposes, an account titled Proprietor’s Drawings is opened in the General Ledger and all payments and receipts, if any, from the proprietor are recorded in this account.

Accounting Entries

Cash Drawn by Proprietor:
Debit

Proprietor’s drawing
Credit
Cash
Amount paid in by proprietor through cheque:
Debit
Bank
Credit
Proprietor’s drawing

The balance in drawings account is transferred to Capital Account at the year end.

The sample of general ledger of Capital account, in case of profit earned by the business, is as follows:

Capital Account
Debit Side Credit Side
Date No Narration Dr. Rs. Date No Narration Cr. Rs.
Jun
30
  Drawings
a/c
45,000 Jul 01   Balance B/F 100,000
        Jun 30   P & L
Account
50,000
               
Jun
30
  Balance
C/F
105,000        
    Total 150,000     Total 150,000

The sample of general ledger of Capital account, in case of loss sustained by the business, is as follows:

Capital Account
Debit Side Credit Side
Date No Narration Dr. Rs. Date No Narration Cr. Rs.
Jun
30
  P & L Account 10,000 Jul 01   Balance B/F 100,000
Jun
30
  Drawings 45,000        
               
Jun
30
  Balance
C/F
45,000        
    Total 100,000     Total 100,000

The balance sheet of sole proprietor is as follows:

Name of Business
Balance Sheet
As At ----
Particulars Amount Rs. Amount Rs.
Assets
Fixed Assets
Long Term Assets
Current Assets
  X
X
X
Total   X
Liabilities
Capital
Add: Profit / Loss For The Year
Less: Drawings
X
X
(X)
X
Long Term Liabilities   X
Current Liabilities   X
Total   X

Partnership

There are two types of capital accounts in partnership:

  • Fixed capital
  • Fluctuating capital

Fixed Capital

In this case, capital account shows movement in capital account only i.e. actual increase or decrease in capital, by partners and all other transactions, such as Drawings and Profit etc. are not recorded in capital account.

Fluctuating capital

In fluctuating capital account, all transactions relating to partners, such as drawings, salaries etc. are recorded in capital account, in addition to entries relating to capital account.

Current Account

In case of fixed capital accounts, other transactions such as Drawings and Profit etc. are recorded in a separate account called Current Account.

Journal Entries

Capital Introduced by Partner:
Debit

Cash / Bank
Credit
Partner’s Capital Account

Separate capital account is opened in general ledger for each partner.

Drawing by Partner:
Debit

Individual Partner’s Current Account
Credit
Cash / Bank

Excess Drawn Amount Returned by Partner:
Debit

Bank / cash
Credit
Individual Partner’s Current Account

Profit Distribution:

Debit

Profit and Loss Appropriation Account
Credit
Partner A’s Current Account
Credit
Partner A’s Current Account
Credit
Partner A’s Current Account

Balance Sheet of Partnership Accounts

Name of Business
Balance Sheet
As At ----
Particulars Amount Rs. Amount Rs.
Assets
Fixed Assets
Long Term Assets
Current Assets
  X
X
X
Total   X
Liabilities
Capital A
B
C
X
X
X
X
Current Account A
B
C
X
X
X
X
Long Term Liabilities   X
Current Liabilities   X
Total   X

Limited Companies

There are two types of companies:

  • Public Limited Companies
  • Private Limited Companies

Public Limited Companies

In public limited companies, there is no restriction on number of persons to be its members. There is one restriction. i.e., there should be a minimum of three members to form a public limited company.

Private Limited Companies

Two to fifty persons can form a private limited company. Minimum two members are elected to form a board of directors. This board is given the responsibility to run day to day business of the company.

Share Capital

Capital of the company is divided into small units / denominations. These units / denominations are called shares and the capital is called share capital. Owners purchase these shares and are, therefore, called shareholders. As, there are so many shareholders in a company, profit is distributed among the members/shareholders of the company on the basis of number of shares held by each shareholder. The profit distributed among shareholders is called DIVIDEND.

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