Accounting in Focus-Incorporated vs Unincorporated Entities: Part 2 of 2
Bodies Sole, otherwise termed as unincorporated entities, are classified as either sole traders or partnerships who have unlimited liability and no separate legal identity. Sole traders are proprietors with sole responsibility for the ownership of the business whereas a partnership is owned by two or more people.
Being susceptible to unlimited liability results in the owners facing the prospect of being forced to sell their personal wealth in the event of business losses exceeding net assets. As a result, individuals setting up such entities are exposed to greater risk than shareholders and may, as a result, have a greater aversion to risk and potential expansion for fear of incorrect judgement. This can restrict the potential of such businesses and prevent them from competing with larger firms in the industry.
More specific to the accounting for such businesses, sole traders and partnerships are unable to group their expenses. Instead, they are required to disclose them in detail, but the accounts need not be published with Companies House, in turn, maintaining secrecy of sensitive financial information since this can’t be accessed by competitors. The absence of a separate legal identity results in the business being taxed at the income tax rate appropriate to the level of profits earned by the business rather than the corporate tax rate.
Partnerships prepare two additional accounts in the form of the appropriation account subsequent to the statement of profit or loss to attribute the amount of residual profit or loss amongst the partners. This account takes into consideration any interest on drawings, capital, and salary to partners prior to distribution of profits to partners. Secondly, a current account is prepared to compare each partners’ incomes and expenses whilst maintaining a fixed capital balance which facilitates the calculation of interest on capital.
On the bright side, there are fewer legal formalities required to commence as an unincorporated business as compared to a limited company. The greater degree of laxity afforded to such businesses explain, to a certain extent, their popularity with individuals who wish to begin their own business but don’t want to go through the cost and time involved in setting up an incorporated business. Their agility and lack of cumbersome administrative structures enables them to respond swiftly to changing needs of their target market. However, due to the burden placed on the owners of such businesses to be responsible for all the aspects of management, it isn’t always possible to keep up with changing regulations and legislation in relation to the preparation of accounts and holding of relevant records.
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