ACCOUNTING COST: The actual outlays or expenses incurred in production that shows up a firm's accounting statements or records. Accounting costs, while very important to accountants, company CEOs, shareholders, and the Internal Revenue Service, is only minimally important to economists. The reason is that economists are primarily interested in economic cost (also called opportunity cost). That fact is that accounting costs and economic costs aren't always the same. An opportunity or economic cost is the value of foregone production. Some economic costs, actually a lot of economic opportunity costs, never show up as accounting costs. Moreover, some accounting costs, while legal, bonified payments by a firm, are not associated with any sort of opportunity cost.
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LEGAL BUSINESS ORGANIZATIONS:
The alternative ways in which a business or firm can be legally organized. The three primary alternatives are proprietorship, partnership, and corporation. Differences among three are mainly based on: (1) number of owners and (2) the liability of the owners. A proprietorship has a single owner with unlimited liability. A partnerships has two or more ownership with unlimited liability. The owners of a corporation have limited liability. A business firm can be legally structure in different ways. The differences depend on the number of owners (one versus many) and the liability for the payment of debts that each owner faces (limited versus unlimited). The three most noted forms of business organizations are proprietorship, partnership, and corporation. However, at least three other organizations have been devised over the years to compensation for the deficiencies in these basic forms, including S corporation, limited partnership, and limited liability company.
A Word or Two on LiabilityA key difference between different legal forms of business organization is the liability of the owners. Proprietorships and partnerships have unlimited liability. Corporations have limited liability. Liability essentially means the extent to which the owners are responsible for the debts of the business. The two alternatives are unlimited liability and limited liability.
- Unlimited Liability: This is the condition in which owners are personally held responsible for any and all debts created by a business. The liability of the owners is, as such, unlimited. In addition to the assets and wealth of the company, the personal assets and wealth of the owners can be used to pay off company debts.
Suppose, for example, that one of the two partners (Sean) in the Schrumpmeyer and Schrumpmeyer law firm uses the company credit card to engage in an excessive amount of online Internet gambling. The other partner (Sally) is legally responsible for paying the resulting credit card debt. In addition to company assets, Sally might have to sell her home, car, and yatch to raise the necessary payment.
- Limited Liability: This is the condition in which owners are NOT held personally responsible for the debts created by a business. The liability of the owners is limited, usually to the amount that is invested in the business. The personal assets and wealth of the owners cannot be used to pay company debts.
Suppose, for example, that Sally Schrumpmeyer also owns a few hundred shares of OmniConglomerate, Inc. stock. Should the OmniConglomerate lose a multi-billion dollar product liability lawsuit that wipes out all assets and forces the company into bankruptcy, then Sally's liability is limited to value of her corporate stock. She does not have to sell her home, car, or yacht to help pay OmniConglomerate's debts.
ProprietorshipOne of the three basic forms of business organization is proprietorship. A proprietorship is a business that is owned and operated by one person. The owner and the business are legally considered one and the same. The owner receives any and all profit and is responsible for any and all debts.
One example of a proprietorship is Phil Gardener, a Shady Valley zucchini grower. Phil owns and controls all of the resources used to produce zucchinis--the property, the tools and equipment, and his labor.
He shares the zucchini-growing responsibilities with no one. Neither does he share the zucchini-generated profits. Of course, he also has unlimited liability for any debts of the firm. Should Phil lose a lawsuit brought against him by neighbors harmed by chemicals he applied to his zucchinis, then any and ALL of Phil's assets, including those unrelated to the zucchini business, might be needed to pay the damages.
Proprietorships have a couple of features that make them attractive from an economic perspective.
- First, as relatively small operations, markets populated with proprietorships tend to be relatively competitive. With greater competition comes a greater likelihood of efficiency.
- Second, because ownership and control is in the hands a single individual, what is best for the business is also best for the owner. A proprietorship is not encumbered by the complex bureaucracy that can thwart the operation of a larger organization.
However, proprietorships have couple of disadvantages worth noting:
- One, as small, competitive businesses, proprietorships are seldom able to accumulate the resources needed for large-scale production. Proprietorships seldom operate multi-million dollar factories that are able to take advantage of long-run economies of scale and short-run decreasing average total cost.
- Two, proprietorships also have more difficulty developing and distributing product innovations. Such innovative activity frequently requires more resources than available to a proprietorship.
PartnershipA second of the three basic forms of business organization is a partnership. A partnership is a business that is owned and operated by two or more people. The owners and the business are legally considered one and the same. The owners receive any and all profit and are responsible for any and all debts.
One example of a partnership is the legal firm of Schrumpmeyer and Schrumpmeyer, Attorneys at Law, owned and operated by Sally Schrumpmeyer and Sean Schrumpmeyer. Sally and Sean provide their own labor and share ownership of the land, building, equipment, and all other assorted resources used to provide legal services. They also share the profit.
However, like a proprietorship, their partnership includes unlimited liability. Should Sean order unneeded and overpriced office supplies or take extended "fact-finding" company trips to tropical resorts, then Sean and Sally are both responsible for the debts.
A partnership has both pros and cons.
- On the Pro Side: The primary advantage of a partnership is greater access to resources. Not only does a partnership have access to the personal wealth of more than one person, it also has access to the specialized skills of different partners. One can manage production, another can handle sales, and a third can maintain the accounting books.
- On the Con Side: The primary disadvantage of a partnership is risk associated with unlimited liability. Because each partner is liable for ALL debts, each partner must have a great deal of trust in the others. Any one partner can drive the partnership out of business and force the other partners into personal bankruptcy.
CorporationA third of the three basic forms of business organization is a corporation. A corporation is a business established through ownership shares (termed corporate stock). A corporation is considered a distinct legal person that exists separately from the owners. As such, the owners cannot be held personally responsible for corporate debts.
One example of a corporation is The Wacky Willy Company, which was established by William J. Wackowski to facilitate the production of Wacky Willy Stuffed Amigos. As a corporation, thousands of people own shares of ownership in the company. With limited liability, each owner is liable ONLY for their value of their ownership share. However, the receive ONLY that share of profits that the corporation managers decide to pay as dividends.
A corporation also has a few pluses and minuses.
- On the Plus Side: The primary advantage of a corporation is the ability to accumulate large sums of funds that can be used to purchase large amounts of capital goods, which can then be used to undertake large scale production.
- On the Minus Side: The primary disadvantage of a corporation is the separation of ownership and control. The corporation managers controlling the corporation might pursue personal objectives that conflict with the profit-maximizing goal of the owners.
Other OrganizationsWhile these three legal forms of business organization dominate the modern landscape, other variations are worth noting.
- S Corporation: A type of corporation, with limited liability for the owners, that makes use of a special section of the Internal Revenue Service tax code (Chapter S) to avoid the double taxation of income. The profit of an S corporation is considered the income of its owners and is thus taxable only as individual income. There are, however, limits on who can be an owner of an S corporation.
- Limited Partnership: A partnership in which one or more of the partners has limited liability. This differs from regular partnerships in which each partner has unlimited liability. The limited partnership legal structure was created to provide liability protection to "partners" seeking investment opportunities, who did not want to participate in the actual management of the firm. While these limited partners are very much like corporation shareholders, the difference is that at least one partner must have unlimited liability.
- Limited Liability Company: A firm that operates very much like a partnership, but in which each owner has limited liability. The advantage of a limited liability company, over a limited partnership, is that every owner has limited liability. It also has advantages over an S corporation in that very few restrictions exist on who can be an owner.
LEGAL BUSINESS ORGANIZATIONS, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: March 4, 2024].
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