There are three general legal forms that a business can take: the sole proprietorship, the partnership and the corporation. Unlike proprietorships and partnerships, corporations are considered to be a separate legal entity distinct from its owners.
The main advantage of the corporate form is that the owners of a corporation have limited liability. Limited liability means that if the corporation is sued or goes bankrupt, the corporation’s owners cannot lose any more than what they invested. They may lose their investment, but creditors cannot come after the owner’s own assets to settle the corporation’s obligations. It is also very rare that plaintiff’s are able to sue the owner’s of the corporation for injury resulting from the corporation’s actions.
Another general advantage is that corporations, by issuing shares, have better access to markets to raise capital. This is especially true where the corporation’s shares are publically traded (but this need not be the case – lots of corporations are privately owned). Corporations that are publically traded are required by law to follow U.S. GAAP as well as the SEC’s rules when preparing their financial statements.
The main disadvantage of the corporate form is that corporations are required to pay taxes as a separate legal entity. This means that the profit of a corporation is taxed when it is earned, and is also taxed when it is distributed to shareholders as dividends. This creates a double taxation. According to the IRS, a corporation cannot deduct dividends from income and shareholders cannot deduct corporate losses.1
Small business corporations or an S-corporation is a corporation that elects to pass its corporate income, losses, deductions and credits through to their shareholders for federal tax returns. It is the exception to the rule that corporations are taxed as a separate legal entity and; as a result, there are a number of limitations on the types of corporations that can register as an S-corporation.2
References:
1. IRS "S Corporations." Retrived from: http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/S-Corporations
2. IRS. "Corporations." Retrieved from: http://www.irs.gov/Businesses/Small-Businesses-%26-Self-Employed/Corporations
Accounting for Corporations
BrainMass Categories within Accounting for Corporations
Issuing Shares
Like getting a loan, or issuing bonds (debt), issuing shares is a way that corporations can raise cash to finance the operations of their business.
Repurchasing Shares
Share buybacks are a way to return cash to shareholders, decrease the number of shares outstanding, and improve share-based performance ratios such as earnings per share.
Cash Dividends
Corporations pay cash dividends to return cash to distribute earnings to shareholders. When a corporation pays dividends in the form of cash (or other assets - but not stock) the shareholders' equity of the firm decreases. Corporations are not allowed to distribute dividends in excess of retained earnings.
Stock Dividends and Stock Splits
A stock dividend is a dividend paid by the distribution of additional shares to existing shareholders rather than paying cash. A stock split occurs when a corporation divides its existing shares into multiple shares. A stock split is conceptually the same as a stock dividend but is treated differently by U.S. GAAP.
Stock-Based Compensation
Stock-based compensation such as the direct award of stock or the granting of compensatory stock options is a way for corporations to compensate employees with ownership of the corporation in lieu of salary or bonuses.
Accounting for Corporate Income Tax
A corporation is required to pay income taxes as a separate legal entity. The Internal Revenue Code requires different rules for calculating taxable income than GAAP requires for calculating accounting income.
Shareholders' Equity
Shareholders's equity is the value of the shareholders' investment in the firm. It is equal to total assets minus total liabilities.
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