Forms of business entities • The choice of an appropriate business structure is important for individuals contemplating a business. • The basic forms of business structure are: – sole trader – partnership – company – trust. • Many factors must be considered when determining which form of business structure will best suit the needs of the entity. • The four different business structures differ in terms of owner liability, equity structure, funding opportunities, decision-making responsibilities and taxation. • The most common classification of a business entity in Australia is the SME — the small to medium-sized enterprise. • SMEs are defined by the International Accounting Standards Board (IASB) as entities that 'do not have public accountability and publish general purpose financial statements for external users'(para 1.2, IASB 2015).

Definition and features of a sole trader • Definition of a sole trader: – A sole trader is an individual who controls and manages a business, and is solely liable for all the business debts. • Features of a sole trader: – The business is not a separate legal entity. – The general registration requirements involve applying for an Australian Business Number (ABN). – Usually uses accounting software such as MYOB to prepare financial reports.

Advantages and disadvantages of a sole trader • Advantages: – Quick, inexpensive and easy to establish;inexpensive to wind down. – Not subject to company regulation. – Owner has total autonomy over business decisions. – Owner claims all the profits of the business and all the after-tax gains if the business is sold. • Disadvantages: – Unlimited liability — bears full responsibility for business debts and legal actions such as negligence. – Limited by skill, time and investment of owner. – Restrictive structure due to non-legal status of the entity. – Business will cease to exist if owner leaves, retires or dies.

Definition and features of a partnership • Partnership definition: – An association between two or more persons who: • carry on a business as partners • share profits or losses according to partnership agreement. • Partnership features: – Enables sharing of ideas, skills and resources. – Easy and cheap to establish. – No separate taxation payable but does lodge income tax return with ATO. – Some partnerships have a written agreement, others don’t. • Partnership agreement: – Should include details of: • the name of the partnership • the contributions of cash and other assets to the partnership made by each partner. • If there is no partnership agreement, then the law assumes that all profits or losses will be shared equally between the partners. • Partnership agreement: – Methods of sharing profits or losses include: • sharing according to each partner’s capital contribution to the business • splitting profits or losses equally between the partners • sharing them based on salary requirements.

Advantages and disadvantages of a partnership • Advantages: – Relatively easy and simple to set up. – Informal business structure — not bound by accounting standards. – Ability to share capital, skills, talents, knowledge and workload between two or more people. • Disadvantages: – Unlimited liability for business debts and obligations by all partners. – Limited life: if one partner dies or withdraws from the business then the partnership must dissolve. – Mutual agency: each partner is seen as being an agent for the business and so is bound by any partnership contract. – Many partnership disputes arise from profit sharing and decision- making issues.

Definition and features of a company • Company definition: – A company is a business structure that has a separate legal identity from its shareholders and is taxed on its taxable income. • Company features: – Owners of a company are known as shareholders. – Independent legal entity (i.e. separate from the people who own, control and manage it). – Shareholders have limited liability: for the purchase price of their shares only (not company debts). – A company has unlimited life: not dissolved when owners die or change. • Forming a company: – More complicated than forming a sole trader business or partnership. – The individual must apply to the Australian Securities and Investments Commission (ASIC) for registration of the company. – ASIC will allocate a unique Australian Company Number (ACN). – Companies will also register for an ABN.

Types of companies • Proprietary companies and SMEs: – Proprietary companies, also known as private companies, are a common form of business structure adopted by SMEs in Australia. • Public companies: – Four types of public company: 1. whose capital is limited by shares 2. whose share capital is limited by guarantee 3. which are no-liability companies 4. whose share capital is unlimited.

Advantages and disadvantages of a company • Company advantages: – Limited liability for shareholders. – As of 2018, the company taxation rate is 30% (27.5% for SMEs);considerably lower than top personal tax rate. – Business expansion networks made easier due to legal structure. – Can raise additional equity (capital) through public share offerings. • Disadvantages: – More time consuming and costly to set up. – Must comply with complex company rules and other legal requirements. – Taxed from the first dollar of profit. – Limited liability aspect may causes problems: • banks often prefer to have director’s personal guarantees instead. – Separation of ownership and control.

Definition and features of a trust • Trust definition: – A trust is a business structure in which a person/s holds property for others who are intended to benefit from the property or income of that property. – The trustee is personally liable for all the debts and other liabilities incurred on behalf of the trust. • Family or discretionary trusts are often established for the benefit of one family and its members. • Unit trusts hold collections of assets on behalf of various parties. • Trust features: – Common form of business structure in Australia. – A trustee may be: • a person or several people • a proprietary limited company.

Advantages and disadvantages of a trust • Advantages: – Minimises tax payments, as a trust does not pay tax.This is the responsibility of the beneficiaries after the trust income is distributed to them. – Limited liability. – Simple to form. – Little government regulation (unless listed on ASX). • Disadvantages: – Trust law is complex. – Should be administered by qualified accountant. – Business structure can be exploited for tax minimisation purposes.

Comparison of business reports • Accounting entity concept: – Business transactions are recorded separately from personal transactions involving the owner(s) because the business is regarded as a separate legal entity from the owner(s). • Each form of business structure will record and report business transactions separately from the personal transactions of the owner(s). • If the owner uses the business entities funds for personal use, this will be shown as a reduction to equity, not an expense. • Sole trader reports: – The statement of profit or loss shows income less expenses. No taxation is shown. – Statement of financial position has only one capital account. Profit (or loss) added (or subtracted) to capital account (in statement of financial position). • Partnership reports: – Profit and loss split according to original capital contributions as specified in partnership agreement.No taxation is shown. – Statement of financial position has a capital account (and often a current account) for each partner. • Company reports — private company: – Income tax being deducted directly from company profit. – Share capital as opposed to owner's or partner's capital account.Retained earnings. • Company reports — public company

Differential reporting • The AASB (in June 2010) modified the reporting entity concept by classifying disclosing entities who prepare general purpose financial statements as either: – Tier 1 entity: • an entity that is publicly accountable. – Tier 2 entity: • is a non-publicly accountable entity (such as unlisted public companies, not-for-profit private companies, and some public sector entities). • Differential reporting is the difference in reporting requirements for Tier 1 and Tier 2 entities. • The full implementation of these new requirements became applicable from 1 July 2013 and has since been updated with the new standard from 1 July 2015.