There are three types of business entity types to worry about in accounting: sole trader, partnership and limited liability company.
The following are the characteristics of each one:
1. Sole Trader
- Operated by only one individual although it may employ any number of people (only one owner!)
- No legal distinction between owner and entity so the owner is liable for any litigation claims or taxes personally (unlimited liability for debts and losses)
- The equity part of the capital structure is represented by the capital account which is increased when new capital is contributed by the owner or profits are generated by the entity and reduced by losses of the entity and any withdrawals, typically referred to as "drawings" rather than dividends.
- In some countries drawings by the owner may not be subject to income tax or dividend tax making this type of entity more appealling for small enterprises. Sole trader entities in many countries may have simplified accounting and not be subject to audit requirements.
2. Partnership
- More than one partner
- Unlimited liability to the partners for debts and losses
- Equity capital section consists of two accounts: capital account and current account
- Capital account is normally fixed and is adjusted when partners join and leave
- Current account incorporates the earnings of the business that are earned less any drawings by the partners.
3. Limited liability companies
- established as separate legal entities to their owners so shareholders are not liable for the legal entity debts
- common shareholders have a claim on the residual assets of the limited liability company
- managed by the directors of the entity which may or may not be shareholders
- if the shareholders are not involved in the business, their insolvency or death will not affect the limited liability company they own.
- limited liability companies may be subject to increased regulatory requirements such as production and submission of audited financials, public inspection of accounts
- limited liability companies are separately taxed to its owners
