Question

L02. What are the organizations and rules that govern accounting? I a) Briefly describe the purpose of each of the following: i) Financial Accounting Standards Board (FASB) ii) Securities and Exchange Commission (SEC iii) Generally Accepted Accounting Principles (GAAP) b) Describe each of the following types of business organizations: i) Sole Proprietorship ii) Partmership iii) Corporation iv) Limited-Liability Company (LLc

Answer 1

   a)

           i) Financial Accounting Standards Board (FASB)

The Financial Accounting Standards Board is an independent entity responsible for generally accepted accounting principles in the United States. The FASB was formed in 1973 to succeed and carry on the mission and activities of the Accounting Principles Board.

                        The Financial Accounting Standards Board (FASB) is a nonprofit organization dedicated to setting the guidelines and standards for accounting practices and procedures in the United States. The organization outlines the fundamental principles for the preparation of financial reports so that reporting and accounting procedures are consistent and accurate across all types of industries and financial markets.

The FASB's stated mission is to establish and improve financial accounting and reporting standards, and to provide useful information to investors and other people who use financial reports.

  ii) Securities And Exchange Commission (SEC)

SEC stands for the United States Securities and Exchange Commission.

                  The SEC implements those acts/laws by issuing rules (i.e. SEC rules) that must be followed by security market participants in order to be compliant. The main purpose of the SEC is to regulate the securities industry and protect investors against fraudulent investment related practices.

The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud.

SEC also monitors the Financial Accounting Standards Board (FASB) to promote accuracy in accounting reporting.

                   The SEC promotes transparency by requiring public companies to register with the SEC and disclose information relevant to potential investors. The SEC further requires any public company to provide information about its business, and risk associated with investing in their company.

All Company fillings filed under SEC are open to public and can be viewed through www.sec.gov.in . An investor can view the company financial reports with respect to several years.

iii) Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles (GAAP) refer to a common set of accepted accounting principles, standards, and procedures that companies and their accountants must follow when they compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP improves the clarity of the communication of financial information.                 

                    GAAP is meant to ensure a minimum level of consistency in a company's financial statements, which makes it easier for investors to analyze and extract useful information. GAAP also facilitates the cross comparison of financial information across different companies.            

                  GAAP must be followed when a company distributes its financial statements outside of the company. If a corporation's stock is publicly traded, the financial statements must also adhere to rules established by the U.S. Securities and Exchange Commission (SEC).

Note - Putting it all together, financial statements filed with the S.E.C. by public companies follow the GAAP accounting guidelines established by the FASB - providing a consistent overview of the view of how companies have performed financially at least in terms of GAAP accounting rules.

b)

1) SOLE PROPRIETORSHIP - Sole Proprietorship in simple words is a one-man business organisation. It is the type of entity that is fully owned and managed by one natural person (not a legal person/entity) known as the sole proprietor. The business and the man are the same, it does not have a separate legal entity. A sole proprietorship, also known as the sole trader, individual entrepreneurship or proprietorship. In legal terms, the business and the owner are one and the same. No separate legal identity will be bestowed upon the sole proprietorship. So the owner will be responsible for all the activities and transactions of the business.

A sole proprietorship usually does not have to be incorporated or registered. It is the simplest form of business organisations and the ideal choice to run a small or medium scale business.

Some important features of a proprietorship.

1. Lack of Legal Formalities - A sole proprietorship does not have a separate law to govern it. So there are not many special rules and regulations to follow. It does not require incorporation or registration of any kind. In most cases only a license is required to carry out the desired business. It allows for ease of doing business with minimum hassles.
2. Liability - There is no separation between the owner and the business, So the liability of the owner is also unlimited. So if the business is unable to meet its own liabilities, it will fall upon the proprietor to pay them. All of his personal assets like his car, house, other properties etc may have to be sold to meet the liabilities of the business.
3. Risk and Profit - The owner is the only risk bearer in a sole proprietorship. If the business fails or suffers losses he will be the one affected.However, he also enjoys all the profits from the business. He does not have to share his profits with any other stakeholders since there are none. So he must bear the full risk in exchange for enjoying full profits.

2)   PARTNERSHIP - Partnership can be defined as “the relation between two or more persons who have agreed to share the profits from a business carried on by either all of them or any of them on behalf of/acting for all”.                                                 There should be a minimum of two members for a partnership. So in such a case two or more persons come together as a unit to achieve some common objective, and the profits earned in pursuit of this objective will be shared amongst themselves.         

              The entity is collectively called a “Partnership Firm” and all the individual members are the “Partners”.

Some important features of a Partnership:-

a) Formation/Contract - A partnership firm is not a separate legal entity. But according to the act, a firm must be formed via a legal agreement between all the partners. So a contract must be entered into to form a partnership firm.

Its business activity must be lawful, and the motive should be one of profit. So two people forming an alliance to carry out charity and/or social work will not constitute a partnership. Similarly, a partnership contract to carry out illegal work, such as smuggling, is void as well.

b)Unlimited Liability - In a unique feature, all partners have unlimited liability in the business. The partners are all individually and jointly liable for the firm and the payment of all debts. This means that even personal assets of a partner can be liquidated to meet the debts of the firm. If the money is recovered from a single partner, he can, in turn, sue the other partners for their share of the debt as per the contract of the partnership.

c) Continuity - A partnership cannot carry out in perpetuity. The death or retirement or bankruptcy or insolvency or insanity of a partner will dissolve the partnership. The remaining partners may continue the partnership if they so choose, but a new contract must be drawn up. Also, the partnership of a father cannot be inherited by his son. If all the other partners agree, he can be added on as a new partner.

There are different types of partners and each partner has different responsibilities . Types of partner for example - Active Partner,Dormant Partner, Secret Partner, Nominal Partner, Partner by Estoppel

3)CORPORATION -

The business entity and the owner is different and separate in a corporation. The share of stock represents the ownership in a stock corporation. The board of directors controls the activities of the corporation.

1. Formation of the company - The formation of the company is a complicated process. Before starting functioning of the company, preparation of several documents and compliance with several legal requirements is required.
2. Separate legal identity - A company is separate legal identity. It exists independent of its members. A company can own property, borrow money, enter into contracts, sue & be sued.
3. Liability - The liability of the members is limited. It is limited to the extent of the capital contributed by them in a company.

Board of directors controls and manages the affairs of the company. The directors are accountable to the shareholders for the working of the company.

4)  LLCOMPANY – Limited Liability Company is the U.S. term wherein the members of the corporate structure are not personally liable for the debts and obligations. It may or may not be an incorporated association. One needs to file the “Articles of Organizations” within his state. It is the combination of both the features of sole proprietorship or partnership and corporation. It has a feature of limited liability of a corporation and the flexible tax structure of partnership or sole proprietorship. The owners of the beneficial rights are called “members” rather in normal terms “shareholders”

An LLC is formed in the state in which it operates. An LLC is formed by filing Articles of Organization with the state in which you will be doing business

1. Separate entity - LLC is a separate legal entity in almost many states; meaning thereby that it can own a property, retain attorneys, sell or buy a property, etc on its own. It is distinct from its owners. Owners are not responsible for the obligations of the corporation.
2. Limited liability - One of the features of LLC is the limited liability of the employees, members, managers, etc. It simply means that the members are not responsible for the misdeeds, legal faults of the other members. Hence, they have protection for the same. But they are responsible for their own wrong legal misconducts.
3. Simplicity - There is a simplicity in the case of documentation and carrying out operations of the company. There is a less record keeping comparatively.