Business Types & Accounting Assumptions

Module 1:
Foundations of Accounting

Duration:
45-60 minutes

Level:
Beginner to Diploma-Level

➛ Identify the three main types of businesses.

➛ Explain the advantages and disadvantages of each type.

➛ Understand key accounting assumptions required for preparing financial statements.

➛ Apply these assumptions to simple real-world scenarios.

➛ Sole Proprietorship
➛ Partnership
➛ Corporation | Company
➛ Economic Entity Assumption
➛ Going Concern Assumption
➛ Monetary Unit Assumption
➛ Time Period Assumption
➛ Legal Entity
➛ Unlimited Liability
➛ Limited Liability

1. Sole Proprietorship
A business owned and run by one person.

Features
➛ Easy to start
➛ Owner controls everything
➛ Owner receives all profits

Advantages
➛ Simple to form
➛ Full control
➛ Fewer regulations

Disadvantages
➛ Unlimited liability | owner is personally responsible for debts
➛ Limited capital
➛ Business ends when owner dies

Examples
➛ Small shops
➛ Salons
➛ Freelancers
➛ Small farms.

2. Partnership
A business owned by two or more people.

Features
➛ Shared responsibilities
➛ Partnership agreement recommended

Advantages
➛ More capital
➛ Shared skills and expertise

Disadvantages
➛ Conflicts may occur
➛ Partners share profits
➛ Unlimited liability

Examples
➛ Law firms
➛ Medical practices
➛ Real estate agencies.

3. Corporation | Company
A business that is a separate legal entity from its owners | shareholders.

Features
➛ Managed by directors
➛ Owners invest and receive dividends

Advantages
➛ Limited liability
➛ Easy to raise large capital
➛ May live indefinitely

Disadvantages
➛ More regulations
➛ More expensive to form
➛ Profits may be taxed twice | corporate tax + dividends

Examples
➛ Banks
➛ Manufacturing companies
➛ Supermarkets
➛ Tech companies.

These are the foundation rules accountants follow when preparing financial statements.

1. Economic Entity Assumption
The business is separate from the owner and other businesses.

Example
Owner’s personal car is NOT recorded as a business asset.

2. Going Concern Assumption
The business is expected to continue operating in the foreseeable future.

Example
Assets are recorded at cost, not liquidation price.

3. Monetary Unit Assumption
All financial transactions must be recorded in one currency, and non-financial information is not recorded.

Example
You cannot record employees’ happiness, but you can record salaries.

4. Time Period Assumption
Financial activities can be divided into standard time periods | month, quarter, year.

Example
A business prepares monthly reports even though it runs continuously.

➛ One person selling fruits in a stall

➛ A law firm with five partners

➛ Safaricom PLC

➛ A family-owned restaurant run by a husband and wife

Classify whether each phrase is an advantage or disadvantage.

➛ Unlimited liability
➛ Easy to raise capital
➛ Easy to set up
➛ Possibility of partner conflict
➛ Limited liability
➛ Ends when owner dies

➛ The owner uses his personal money to buy food for his home - not recorded in business books.

➛ Financial reports are prepared every month.

➛ A business records transactions only in Kenya Shillings.

➛ Assets are not listed at liquidation value because the business will continue next year.

A new electronics shop is being created by three friends. They plan to contribute money equally and share profits.

Questions

➛ What type of business is this?

➛ Name two advantages and two disadvantages.

➛ Which accounting assumptions apply when they prepare their first financial reports?

➛ What is a sole proprietorship?

➛ Who owns a partnership?

➛ What does limited liability mean?

➛ True or False | A corporation is a separate legal entity.

➛ Name one accounting assumption.

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Answers ➧ Here

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Accounting Principles ➧ Here