Financial Accounting-II MGT401 VU

Lecture 01
Types of Business Entities

Profit Oriented / Commercial Entities

Profit oriented or commercial entities are those entities where the main aim of carrying out business is to earn
profit for the owners of the business. Profit oriented entities are of following types:

Sole Proprietorship
Partnership
Companies

3 Sole Proprietorship Is the type of business is owned by a single individual. There may a number of
employees of the business but ownership and risks and returns rest with a single owner. All assets and
liabilities of the business are the assets and liabilities of the owner.

3 Partnership Is the type of business that is owned by more than one person. These persons form a
Partnership Firm through an agreement called Partnership Agreement. Partnership firms and
agreements are governed by the Partnership Act 1932.

All partners of a firm are jointly and severally liable to liabilities of the firm. This means that in case of
bankruptcy of the firm personal properties of the partners would also be utilized for payment of liabilities
of the firm.

3 Companies are separate legal entities formed under the Companies Ordinance 1984. The main
difference between companies or limited companies as they are commonly called is that companies are
separate legal entities and the liability of the owners is also limited whereas characteristics are not there in
case of sole proprietorship and partnership.

Non Profit Oriented Entities

Non-profit oriented entities are those business entities / concerns where the main purpose of doing business
is not to earn profits for the owners / sponsors but to provide benefit to general public or to carryout a social
cause. Profits of a non-profit oriented entity can only be utilized for the purpose for which the entity is
established
NGOs
Trusts
Societies

Separate Entity Concept

This concept forms the basis of the accounting principles. It means that for the purpose of accounting The
Business is treated independently from The Owners.

This means that although anything owned by the business belongs to the owners of the business and anything
owed by the business is payable by the owners but for accounting purposes we assume that the business is
independent of its owners.

If the business purchases a machine or piece of equipment it will own and obtain benefit from that
equipment. Likewise if the business borrows money from someone it will have to repay the money. This
someone includes even the owner of the business.

This treatment of the business independently from its owners is called the Separate Entity Concept.

Separate Legal Entity (Corporate Entity) / Limited Liability

Limited company is a legal entity separate from its owners (called shareholders). The basic difference between
a partnership and a limited company is the concept of limited liability. In case a sole proprietor or partnership
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Financial Accounting-II MGT401 VU
business runs into losses and is unable to pay its liabilities, its proprietor / partners will have to pay the
liabilities from their own wealth.

Whereas in case of limited company the shareholders dont lose anything more than the amount of capital
they have contributed in the company i.e. their personal wealth is not at stake and their liability is limited to
the amount of share capital they have contributed.

Limited company is an artificial legal person. It has a legal entity separate from its owners (shareholders). It
can enter into agreements under its own name, can sue and can be sued.

Companies Limited By Shares

Company Limited by Shares" is a company in which the liability of the members (shareholder) of the
company is limited to the amount of share capital that they have contributed. This means that the owners will
only suffer a loss to the extent of the amount contributed as capital, in case the company is closed and its
assets are insufficient to repay its liabilities.

Section 2 (8) of the Companies Ordinance 1984 sates:

"company limited by shares means a company having the liability of its members limited by the
memorandum to the amount, if any, unpaid on the shares respectively held by them.

Types of Companies Limited by Shares

3 Private Limited Companies

3 Single Member Companies
3 Public Limited Companies
Public Listed Companies
Public Unlisted Companies

3 Private Limited Companies are those companies that restrict the right of shareholders to transfer
their shares to a person other than the existing shareholders.

If a member wishes to sell his shares he will first have to offer the shares to the existing members. In
case, none of the existing members accepts the shares and at the same time does not object to the selling
of the shares to an outsider only then the shares can be sold to an outsider. Private Limited companies
use the words Private Limited or (Pvt) Ltd at the end of their name.

The maximum numbers of shareholders allowed in a private limited company is 50.

Private Limited Company is defined in Companies Ordinance 1984 in Section 2 (28) as:

"Private company" means a company which, by its articles,

(i) restricts the right to transfer its shares, if any;

(ii) limits the number of its members to fifty not including persons who are in the employment of the company;
and
(iii) prohibits any invitation to the public to subscribe for the shares, if any, or debentures of the company:

Provided that, where two or more persons hold one or more shares in a company jointly, they shall, for the purposes of this
definition, be treated as a single member;

3 Single Member Companies are also private limited companies but there is only one shareholder in
the company. Before 2002 there was a limit of two for the minimum number of shareholders in a private
limited company. However the limit was relaxed and companies with only one member were also allowed.

In case of a single member company two persons are required to be nominated to takeover the company
in case of the death of the member.

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Financial Accounting-II MGT401 VU
3 Public Limited Companies are those companies in which there is no restriction of transfer of shares.
There is also no limit as to the maximum number of shareholders. However, the minimum number
cannot be less than three. Public Limited Companies uses the words Limited or Ltd at the end of
their name.

Public Limited Company is defined in Companies Ordinance 1984 in Section 2 (30) as:

"Public company" means a company which is not a private company

3 Public Listed Companies are those public companies whose shares are traded on stock exchanges.
These are also called quoted companies.

3 Public Unlisted Companies are those public limited companies whose shares are not traded on any
stock exchange. These are also called public unquoted companies.

Limited Companies not Formed for Profit [Section 42]

Companies Ordinance also permits formation of non-profit oriented companies which means that the
company will not distribute its profits among its share holders. These companies have to take special
permission from SECP and are also allowed to dispense with the phrases Private Limited or Limited

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