Chapter 3
The Accounting Framework
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ties are recorded separately. If the business is unable to pay its debts, creditors of the business
can force the owner to sell his or her personal assets to pay the business debts. This is called
unlimited liability
.
In other words, the owner will receive all the net income, suffer any net loss and be personally
liable for all financial obligations of the business.
We will be using a proprietorship to illustrate various transactions. Figure 3.1 shows the names
of some typical accounts used in a proprietary service business.
Often a proprietary business owner incorrectly records business transactions in the same set of
records as his personal records. This practice makes it very difficult, if not impossible, to monitor the
activities of the business to evaluate its performance.
Consider this scenario: Emilio operates a gardening service and combines all his business and personal
records. He also has a job at night to make more money to pay for personal expenses and to finance the
gardening business. The gardening business has become very busy and he needs to hire some help and
arrange a bank loan to buy more equipment and supplies. By maintaining personal and business records
together, Emilio faces the following challenges.
1. He does not know how much the night job and the gardening business are contributing toward his
income.
2. By not separating business and personal expenses, he will not know which expenses are being used to
generate sales. This is important because business expenses can be tax deductible.
3. He also needs to establish how much is spent to complete each gardening job to help identify the
profitability of the business. These expenses could include insurance, gas for the truck, etc.
Before lending money to Emilio, the bank will want to see financial statements to assess if the business is
capable of servicing the loan. This will be a problem for Emilio in the current situation.
Partnership
A
partnership
is a business owned by two or more
people called partners. As in a proprietorship, the only
legal requirements that must be met to start a partner-
ship are registering the business name and obtaining
a business licence. To manage a business together, the
partners need an oral or a written partnership agree-
ment that sets out how profits and losses are to be
shared. Partnerships use the term partners’ equity as
the title of the equity section on the balance sheet.The
partnership will last as long as the partners continue to run the business, or as long as all partners
are still alive. If the partners decide to end the business, they will sell all the partnership’s assets
and pay all existing liabilities.The remaining cash will be divided among the partners according
to the partnership agreement.
