Question

Explain the purpose of the Conceptual Framework. List one asset and one liability and describe why they meet the definition of an asset and a liability.

For the four scenarios described below, indicate the business structure each one is likely to take — sole trader, partnership or company (public or proprietary) and why.

(i) James and Liam have been running separate physiotherapy businesses but are finding the costs and hours are very high for one person and are only just keeping their businesses operational. They have decided to combine their businesses so they can share resources and have more time off to spend with their families.

(ii) Four scientists wish to set up a business developing robots. They want to be able to raise capital by issuing shares to the public.

(iii) Luke has commenced a lawn mowing and garden maintenance business by himself.

(iv) John and Chelsea wish to start a donut van business. They are concerned about the legal issues (for example, their personal liabilities) for this business once they start trading.

Answer 1

Conceptual Framework sets rules and standards for accounting purposes and these statements set the functions and the nature of accounting and financial statements.

(a) An asset is basically a resource that provides 'economic value' to the business organisation that owns it with the expectation that this asset will provide a benefit in future. Example- Machinery- This machinery set up in a factory will help in producing goods throughout the life of the asset. Hence, the company will make a one time investment when purchasing the machinery and reap the benefits not immediately but throughout the useful life of the machinery.

(b) What a business organisation owes to another person or entity, it is called a liability. Example- Car Loan- When an entity takes out a loan on car purchased, it is liable(owes) to repay this amount/loan to the financial institution/individual from whom this loan ws borrowed.

i) James & Liam will form a Partnership Firm because they would be sharing common resources in order to provide the same services to their clients. The profits of this physiotherapy business will be shared between James & Liam and will depend on their agreement which is the basic nature of partnership firm.

ii) The four scientists will form a Public Company to set up a business developing robots because they want to be able to raise capital by issuing shares to the public. In order to raise capital from the public, shares have to be issued to the public, which is an essential feature of a public company.

iii) Luke will set up a Sole Trader firm since he has commenced a lawn mowing and garden maintenance on his own. Sole propreitorship ensures complete autonomy over one's own business and Luke will earn all the profits from the business and also bear all the losses incurred by his business.

iv) John and Chelsea will set up a Private Company to start their donut van business. They are concerned about the legal issues (for example, their personal liabilities) for this business once they start trading, they want to ensure that they aren't personally liable for the debts of their business. Private company are ideal for such scenarios because the shareholders have limited liabilty and their liability is limited to the shares owned by them.