Chapter 3

Business Structures

©2020 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation you should be able to:

3.1 understand the different forms that business
entities take
3.2define the term ‘sole trader’ and discuss the main
features of a sole trader
3.3discuss the advantages and disadvantages of a sole
trader
3.4define the term ‘partnership’ and discuss the main
features of a partnership
 Learning objectives

3.5discuss the advantages and disadvantages of a

partnership
3.6define the term ‘company’
3.7identify the different types of companies and provide
examples of each
3.8discuss the advantages and disadvantages of a
company
3.9define the term ‘trust’
3.10 discuss the advantages and disadvantages of a trust
 Learning objectives

3.11 compare financial statements for different business

structures
3.12 explain the term ‘differential reporting’ and discuss
the implications for disclosing entities.
 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.
 Forms of business entities

• 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.
 Forms of business entities

• 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.
 Advantages and disadvantages of
a sole trader

• 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.
 Definition and features of
a partnership

• 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.
 Definition and features of
a partnership

• 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.
 Definition and features of
a partnership

• 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.
 Advantages and disadvantages of
a partnership
• 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.
 Definition and features of a company

• 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.
 Definition and features of a company

• 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

• Company structures in Australia:

 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.
 Types of companies

• 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.
 Advantages and disadvantages of
a company

• 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.
 Definition and features of a trust

• 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).
 Advantages and disadvantages of
a trust

• 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).
 Comparison of business reports

• 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.
 Comparison of business reports

• Sole trader reports:

– The statement of profit or loss shows income less
expenses. No taxation is shown.
 Sole trader reports

– Statement of financial position has only one capital

account. Profit (or loss) added (or subtracted) to
capital account (in statement of financial position).
 Comparison of business reports

• Partnership reports:
– Profit and loss split according to original capital
contributions as specified in partnership agreement.
No taxation is shown.
 Partnership reports

– Statement of financial position has a capital account

(and often a current account) for each partner.
 Comparison of business reports

• Company reports — private company:

– Income tax being deducted directly from company
profit.
Company reports — private company

– Share capital as opposed to owner’s or partner’s

capital account. Retained earnings.
 Comparison of business reports

• Company reports — public company:

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

• 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.
 Summary

• Comparison of business reports — characteristics:

Sole Trader Partnership Companies
No. of 1 2 – 50 As many as per articles of
owners association.
Liability Unlimited. Unlimited. Limited.
Profit Belongs to owner. Distributed to Distributed to shareholders in
partners as per form of dividends, at discretion
agreement. of board.
Tax Owner taxed as Partners taxed Company taxed on profits.
individual tax as separate Shareholders taxed on dividends
payer (profit individuals. less tax credit for tax paid by
treated as income company.
of owner).
 Comparison of business reports

• Comparison of business reports — financial

statements:
Sole Trader Partnership Companies
Statement of • No tax • No tax shown. • Tax shown as expense.
profit or loss shown. • Profit • Earnings per share shown but
• Prepared to distribution to not dividends.
meet needs individual
of owner. partners
shown.

Equity on • Profit • Individual • Capital = issued shares.

statement of increases partner equity • Retained earnings = all profits
financial capital shown. not distributed to shareholders.
position directly.