Proprietorships are businesses with a single owner like you and me. These types of businesses tend to be small retail businesses started by entrepreneurs. The accounting for these proprietorships includes only the records of the business—not the personal financial records of the proprietor of the business.
Alert! Don’t Mix and Match: The financial records of an individual owner of a business should never be combined with those of the business. They are two separate entities and need to be accounted for separately. Taking money from one of these entities (the business) for the other (the owner), must be accounted for by both entities.
Partnerships are very similar to proprietorships, except that instead of one owner, there are two or more owners. In general most of these businesses are small to medium-sized.
However, there are some exceptions, such as large national or even international accounting or law firms that may have thousands of partners. As with the proprietorships, accounting treats these organizations’ records as separate and distinct from those of the individual partners.
Finally, there are corporations. These are businesses that are owned by one or more stockholders. These owners may or may not have a managerial interest in the company. Many of these stockholders are simply private citizens who have money invested in the company by way of stocks that they have purchased.
In a corporation a person becomes an owner by buying shares in the company and thus becomes a stockholder. The stockholders may or may not have a vote in the company’s long-term planning depending on the type of stock they have purchased. However, simply by being stockholders (owners), they do not have decision-making authority in the day-to-day operations.
These investors (or stockholders) are not much different than the bankers that loan money to a proprietorship or a partnership. These bankers have a financial interest in the business, but no daily managerial decisionmaking power. As is the case with the stockholders who have invested money into the corporation, in general they have a nonmanagerial interest in the business.
As with the other two types of business organizations discussed here, the accounting records of the corporation are maintained separately from those of the individual stockholders or owners.
The accounting records of a proprietorship are less complex than those of a corporation in that there is a simple capital structure and only one owner. In the case of a corporation, there are stockholders who buy a piece of the ownership of a company by buying stock. As we will discuss later, because of this stock ownership, the financial statements become more complex. Some of the basic differences between these three types of businesses are shown in Figure 1 :
In this chapter you have learned what accounting is, why you and other people in business need to understand accounting, what businesses use accounting for, and what the basic financial statements used in these businesses are.
Accounting : The process of recording, classifying, and summarizing economic events through the preparation of financial statements such as the Balance Sheet, the Income Statement, and the Statement of Cash Flows.
American Institute of Certified Public Accountants (AICPA): The professional organization of CPAs in the United States. The AICPA is charged with preparation of the CPA Examination, the establishment and enforcement of the code of professional ethics, and working with the Financial Accounting Standards Board in the proclamation of accounting standards.
Corporations: Corporations are businesses that are given the right to exist by an individual state in the United States. With this right to exist, the corporation is then allowed to sell stock. Those buying this stock become owners of the corporation. Corporations can be set up as for profit or not for profit, and make that decision when applying for their charter with the state.
Financial Accounting Standards Board (FASB): The FASB sets the accounting standards to be followed for the preparation of financial statements. All rulings from the FASB are considered to be GAAP.
Financial Statements: Reports prepared by companies on the financial status of their business; examples are Balance Sheets, Income Statements, Statement of Cash Flow, and Statement of Retained Earnings.
Generally Accepted Accounting Principles (GAAP): The rules that govern the preparation of financial statements. These rules are developed by the American Institute of Certified Public Accountants, the Financial ccounting Standards Board, the Security and Exchange Commission, and other government agencies.