Types of Business Entities

This textbook emphasizes accounting for profit-making business entities. The three main types of business entities are sole proprietorship, partnership, and corporation. A sole proprietorship is an unincorporated business owned by one person; it usually is small in size and is common in the service, retailing, and farming industries. Often the owner is the manager. Legally, the business and the owner are not separate entities. Accounting views the business as a separate entity, however, that must be accounted for separately from its owner.

A partnership is an unincorporated business owned by two or more persons known as partners. The agreements between the owners are specified in a partnership contract. This contract deals with matters such as division of income each reporting period and distribution of resources of the business on termination of its operations. A partnership is not legally separate from its owners. Legally, each partner in a general partnership is responsible for the debts of the business (each general partner has unlimited liability). The partnership, however, is a separate business entity to be accounted for separately from its several owners.

A corporation is a business incorporated under the laws of a particular state. The owners are called stockholders or shareholders. Ownership is represented by shares of capital stock that usually can be bought and sold freely. When the organizers file an approved application for incorporation, the state issues a charter. This charter gives the corporation the right to operate as a separate legal entity, separate and apart from its owners. The stockholders enjoy limited liability. Stockholders are liable for the corporation's debts only to the extent of their investments. The corporate charter specifies the types and amounts of capital stock that can be issued. Most states require a minimum of two or three stockholders and a minimum amount of resources to be contributed at the time of organization. The stockholders elect a governing board of directors, which in turn employs managers and exercises general supervision of the corporation. Accounting also views the corporation as a separate business entity that must be accounted for separately from its owners.

In terms of economic importance, the corporation is the dominant form of business organization in the United States. This dominance is caused by the many advantages of the corporate form: (1) limited liability for the stockholders, (2) continuity of life, (3) ease in transferring ownership (stock), and (4) opportunities to raise large amounts of money by selling shares to a large number of people. The primary disadvantage of a corporation is that its income may be subject to double taxation (it is taxed when it is earned and again when it is distributed to stockholders as dividends). In this textbook, we emphasize the corporate form of business. Nevertheless, the accounting concepts and procedures that we discuss also apply to other types of businesses.