Forms of Business Organisation (Part - 1) CA CPT Notes | EduRev

Business and Commercial Knowledge

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CA CPT : Forms of Business Organisation (Part - 1) CA CPT Notes | EduRev

The document Forms of Business Organisation (Part - 1) CA CPT Notes | EduRev is a part of the CA CPT Course Business and Commercial Knowledge.
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While elaborating business as an economic activity we have seen that forms of business may be discussed on a variety of criteria. For example, on the basis of the nature of activity undertaken a business may be engaged in industry, trade or other services; and on the basis of size and scale of the activity undertaken, business may be classified as micro, small, medium and large. Generally, however, whenever we refer to forms of business organisation, the attention is drawn to the types of private business ownership. Before

we take up a brief discussion of the various forms of business ownership it is important to take note of the following points about business ownership.

  • Business ownership is a bundle of rights: Ownership is a bundle of rights. These rights accrue because a person has invested money in it. First such right is the titular exclusiveness. If you own a book, no one else can claim its ownership (others may own their respective copies). You may use it that is derive benefit from. You may also lend it or sell it or donate it on your will. Likewise, business ownership occurs by investment of capital. Profits stet belong to the owners. However, if there are losses, these have also to be incurred by the owners. Business owners also have a right to run the business that is manage and operate it on a day-to-day basis. However, in certain forms of business ownership can be separated from management. An important right associated with business ownership is the right to dispose off and transfer the ownership of business. It also includes transfer of ownership by succession after the owner’s death. Such a succession occurs smoothly when the person acts prudently and divides the ownership in business among the successors by a registered will.
  • Business may be owned singly or jointly: A business may be owned singly i.e. as a sole-proprietorship concern. Else it be organised as a partnership or even a larger collective such as a cooperative. When owned singly, if all the profits belong to the single owner, so do the losses. Shared ownership by pooling of capital will facilitate undertaking large projects. However, there is a prudential reason for shared ownership too and that is sharing of risks.
    Joint family business – a concept equalier to Hindu Undivided Families in India- views business as a family property and vests its ownership among the members of the family. Here the sharing of ownership is guided not as much by the possibility of raising large sums of capital or diffusion of business risks as it is guided by the consideration of equitable distribution of ownership rights among the family members.
    In fact, business/ organisational theorists and thinkers keep contemplating on forms of ownership whereby the impact of business adversities on owners- whether single or joint- can be minimised. One such innovation is the idea of limited liability. Since business persons own the business –with all its assets and liabilities, all its usufructs whether favourable (profits) or unfavourable (losses) accrue to them. And in the event business liabilities are more than business assets, their personal wealth wouldbe utilised for meeting the business liabilities. There is no distinction between the businessperson and business. The idea of limited liability caps the liability of the businessperson just to the extent of their investment in business. This idea was initially implemented in company form of business and later in partnership form as well (Limited Liability Partnership - LLP).
    Business may be organised as a proprietary or a corporate concern: In proprietary concerns, business owners actively participate in the day-to-day working of the enterprise. Known as ownermanagers, businesspersons / entrepreneurs are thus not passive providers of investment capital alone. Business, thus, automatically becomes subservient to the self-interests of its owners. Obviously, such a situation would be more feasible when there are 4-5 co-owners and the nature and size of business is such that it can draw on their competencies and capabilities. Let us think of businesses where number of persons holding a share in the capital of the enterprise is large (in hundreds, thousands and hundreds of thousands) who are also geographically dispersed. In such cases a separation of ownership from management would be inevitable. The managers act as the agents of and in the interest of the shareowners (the principals). Further, organisation of business as a corporate entity endows it with certain other peculiar characteristics too that we will take up as we describe company form of business. We have already seen that such a form is characterised by limited liability of the shareowners. A serious limitation of proprietary businesses is that the life of the business is entwined with the health and life of the owners. Corporate form does away with this limitation as a company exits as a separate person distinct from its owners in the contemplation of law. As a separate legal person, it can thus have a life of its own independent of the lives of its owners.
    Having familiarised ourselves as to the facts that (a) business ownership is a bundle of rights; (b) abusiness may be owned singly or jointly; (c) and, that a business may be organised as a proprietary or a corporate concern let us examine the various forms of private business more closely

Sole Proprietorship

When an individual makes a choice to start a business of one’s own, to be one’s own boss sole-proprietorship emerges. As such it can be regarded as the easiest and the earliest form of business as a human occupation. One may open a daily needs store in a room of a corner of one’s house. Or may just set-up a shop on the pavement in weekly bazars. Or may open a machine shop in the backyard or in a thinly habituated lane of a not so distinct locality. This form of business organisation is much appreciated in entrepreneurship

literature. The sole entrepreneur is regarded as an economic hero, an autonomous individual who organises production, uses creativity and ingenuity in innovation, bears risks and uncertainty. Drawing analogy from music, the sole entrepreneur is not merely the composer and director of the enterprise orchestra but also a one-person band. Of course, when the business grows such an autonomous behaviour becomes a limiting

factor, as the entrepreneur/ sole-proprietor is required to share decision-making and let go control over the business.

The business undertaken could be on such a small-scale that it may be hardly  distinguished from selfemployment. It may not be even registered as a micro or a small-scale business enterprise or industry. It is an interesting fact that a very high proportion of micro and small businesses in India are unregistered. Usually these enterprises, more so local retailers and street vendors are so well integrated with the communities that these enjoy people’s trust and provide personalised services. Together, these comprise the unorganised or informal sector of the economy. It is significant to note that even though individually these might appear of not much impact, yet collectively such enterprises make a tremendous contribution to the national economy. You have seen that numerically these enterprises are the largest. Their collective contribution to GDP, Employment and even exports is very impactful. This impact is even more considerable when  we take into account their indirect contribution as suppliers to larger and even multinational enterprises. Their importance is summed up in the cliché ‘small is beautiful.’

On the flip side, products from such enterprises are often derogatorily called “local” (to distinguish from branded). In common perception, working conditions in these enterprises are poor. These enterprises are believed to follow hire and fire policy, lack employee welfare measures and lack systems to effectively deal with social and environmental concerns. Fate of the enterprise is linked with the personal well

being of the owner. This adversely affects consistency of service of such enterprises as the suppliers to large and multinational enterprises. It also affects adversely those desirous of long-term contracts with these enterprises. For these reasons, large and multinational enterprises prefer to transact business with corporate entities.

The foregoing paragraphs briefly evaluate the role of small sole proprietary firms in the economy. From the BCK perspective, and this is going to be our focus henceforth, it would be more useful to examine this and other forms of business organisation from the point of view of those create it.

In sole (sole = single individual) proprietorship, the individual essentially relies on personal savings and assets (e.g. room of the house; home furniture; personal bicycle/ vehicle) to comprise the initial capital of the business (Note investment of cash or in kind by the owner is called capital). However, in a modern economy where the financial system is fairly developed, it is often possible to obtain micro-finance (loans in small denominations, say a thousand or two) and bank finance. In even better developed a financial system where the importance of entrepreneurship and business is recognised, there may be business facilitators who may assist the individual in obtaining finance and other help. We shall be reading about them later. Good news is that in India there is a lot of emphasis on business start-ups and entrepreneurship. As a result, sole-proprietary firms are able to quickly attain a commercial scale distinguishable from mere selfemployment. All the profits of the enterprise accrue to the sole proprietor and so do the risks of business.

Features#1: Sole Proprietorship

Features

Whether merit or limitation and how

Autonomy of being one's own bossMerit. Because of freedom from the restrictions of paid employment. Ample scope for experimentation and expression of one's creativity and innovativeness.
Sole provider of capitalLimitation. This limits the size of business. Yes, banks and lenders may provide additional resources. However, borrowing capacity too is determined by capital adequacy. This feature also limits the capacity to grow.
Visibility of the owner and personalised servicesMerit. For example, the personal rapport with the customers engenders trust and loyalty.
Sole bearer of risksLimitation. This arises from being the sole provider of capital. If all the profits belong to her, so do the losses.
Unlimited liabilityLimitation. It is a common limitation of proprietary forms ofbusiness organisations. In the event of insolvency i.e. Liabilities > Assets, the owners' personal assets are invoked to make up the deficit.
Fate as a going concern (going concern= enduring life of business in the foreseeable future)Limitation. Sole proprietary entities going concern status depends on the owner's personal health and life span. And, after his death upon the willingness and the ability of the heirs/ successors in the family.
Succession of ownershipBy will [aka. Testament] or application of the law of inheritance. A will or testament is a legal document by which a person, the testator, expresses their wishes as to how their property is to be distributed at death, and names one or more persons, the executor, to manage the estate until its nal distribution. If the will is nonexistent [i.e. for intestate succession] the applicable law of inheritance will come into force. For example, for the Hindus, Parsis, Buddhists, Jains and Sikhs, The Hindu Succession Act, 1956 is applicable. 

Hindu Undivided Family (HUF) Business

HUF is an entity formed automatically by members of the common ancestry including their wives and daughters. A HUF cannot be formed by a group of people who do not constitute a family. As such, a joint Hindu family in India is, in fact and by default, a HUF. A HUF enjoys a separate entity status under the Income Tax Act. The Income Tax Act considers HUF as a separate entity if the joint family wishes to register itself as such for reporting income under the following heads: Profits from business or profession; Income

from house property; Capital gains; Income from other sources. Since under the Income Tax Act HUF is a separate entity from the joint family that comprises it, a HUF cannot earn income from salary. We are concerned here with business owned by a HUF or simply stating Joint Hindu Family Business (JHF) or Hindu Undivided Family (HUF) Business. Before we describe its features, it would be appropriate to clarify a few points on its meaning. The meaning becomes clearer with reference to the prevalence of Joint Family System in India. Family is formed by marriage. Let’s call it the first generation. Marriage in most societies is a means to creating progenies /children. Thus, there is second generation comprising the siblings. These siblings grow up, get married and have children. Now there is a third generation, a consortium of cousins. In the paternal lineage, thus there is grandfather, father and grandchildren. These three successive generations

of an undivided family are known as HUF. Secondly, though the word Hindu is conspicuous, the definition of HUF includes Buddhist, Jain, Parsi and Sikh families as well. Thirdly, for the purposes of understanding HUF’s features as a business entity, another important relevant law is the Hindu Succession Act, 1956.
Features #2: HUF Business

FeaturesWhether merit or limitation and how
Formed by birth in a Hindu (Buddhist, Jain,
Parsi and Sikh) family
Merit. Family members may naturally join each other in business. In contrast, in a Muslim family if the siblings wish to associate in a business, they will have to do it contractually e.g. Partnership Agreement
Family pool of
resources

Merit. It is possible to start / expand a large business. Moreover, the common pool of capital may be utilised to diversify business in sync with the aspirations of the
members of the successive generations of the family.
Social capital through
family involvement

Merit. There is an instant trust among the family members as compared with the
situation of partnership with strangers. Family members toil hard to build the
family business. Moreover, they may specialise in different business functions for
greater complementarity of the mutual skills

The family members
are the automatic
co-owners (called coparceners)
by birth

Limitation. Ownership in family business is an ascribed rather than earned status.
It can actually be quite frustrating for the outsiders e.g., hired managers who help
build the business

Decision making is
quick

Merit. In the absence of other active major members of the family, the head of the
family known as Karta takes all the decisions. Subsequently decisions are taken
by and in the family. Prevalence of mutual trust, informality of communication
makes decision-making quick.

Unlimited liability of
the Karta

Limitation. It is a common limitation of proprietary forms of business organisations.
In the event of insolvency i.e., Liabilities > Assets, the owner’s (here the Karta) personal assets are invoked to make up the deficit. However, the liability of the
other family members is limited to the extent of their share in the co-parcenry.
Fate as a going concern (going concern= enduring
life of business in the foreseeable future)

Limitation. Few family businesses last beyond third generation. Often family feuds result in business splits. In India the splits in the business houses of Birla, Modi, Goenkas and more recently the split in the second generation of Ambanis are instances to this effect.
Succession of ownership

By will [aka. Testament] or application of the law of inheritance. A will or testament is a legal document by which a person, the testator, expresses their wishes as to
how their property is to be distributed at death, and names one or more persons, the executor, to manage the estate until its final distribution. If the will is nonexistent
[i.e. for intestate succession] the applicable law of inheritance will come into force. For example, for the Hindus, Parsis, Buddhists, Jains and Sikhs, The
Hindu Succession Act, 1956 is applicable.


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