The Four Major Types of Firm in the U.S.

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  1. What are the four major types of firm in the U.S, how are they defined, and what are the key differences between them?

In sole proprietorships, the business is owned by a single owner. In partnerships, business is owned and run by more than one owner. In a limited liability company, partners own the company but have limited liability. Apart from these three firms, the corporation is a legal entity, separate from the owners, and is solely responsible for the it’s own obligations but not the employees or the customers whereas in the other three organizational forms, owners are not different from the business and for any other obligations, they themselves are responsible.

Ch. 1 – 1P

  • Corportations

Advantages:

  • In corporation, there is no limitation on owning the shares of the stock
  • The Corporation provides free and anonymous trading system
  • Corporation gives rising capital very easily than other firm types
  • Sole Proprietorships
  • Partnerships

Limited Liability Companies: A limited liability company is the form of corporate structure which has the element of partnership with limited liability.

Limitited liability to the owners to the extent of their share in the business, if anything happens which is not expected then the owners liability will not pass to their own assets. The limited liability company is a limited partnership without general partner. The members have limited liability, but the business can run by them as managing members. It is a business organization that has some of the apects of a corporation with those of a sole proprietorship.

The meaning of Limited Liability in a corporate context is that the liability faced by the owners is limited. That means, in a limited liability partnership, the firm could not have a right to use the owner’s personal property to pay off outstanding debts. The owners have limited liablility based on their investment and the maximum liability owners have is their investment in the company.

  1. How can corporate bankruptcy be viewed as a change in firm ownership? Describe why a corporation would want to file for bankruptcy as well as the benefits and drawbacks of such a decision.

Ch1.2 – 3CC

A corporation gathers its preliminary funds by selling its stocks. The owners who aquire these shares are called the shareholders or equity holders. In the porecess of expansion or acquisitions, a corporation often borrows funds from outsiders. In such cases, the debtors become the investors in the firm. However, the ownership of the corporation rests with the equity holders.

In case of its inability to pay back the funds to its debtors, a firm may file for bankruptcy. Bankruptcy does not necessarily bring about a closure to the existing businesses of a corporation. It reflects the inability of the firm to satisfy the claims of the people from whom the funds were borrowed.

Upon being declared as bankrupt, the ownership and control of the corporation passes on from the equity holders to the debt holders who become the decision makers of its future course of action.

  1. List the four major financial statements required by the SEC for publicly traded firms, define each and explain why they are valuable.

Four basic financial statement:

1. Balance Sheet.

2. Income statement.

3. Satement of retained earnings.

4. Statement of cash flows.

Praimary purpose of preparinf the basic financial statement:

1. Balance Sheet: It shows the financial health of an entity. The praimary purpose of preparing Balance Sheet is to report the financial position of an entity at the end of a particular period. It includes the assets, liability, and equity of the company.

2.Income statement: The praimary purpose of income statement is to report the net income or the net loss of the entity. The net income or net loss is calculated by matching the expenses with the revenue.

3. Statement of retained earnings: The purpose of preparing retained earnings statement is to identify the effect of net income and distribution of dividend on the financial position of the company.

4. Satement of cash flows: The purpose of preparing satement of cash flows is to identify the inflow and outflow of cash for a partcular period. It catagorises the total activity in to operating, financing, and investing activities. It shows the net cash generated or used in each activitirs.

Important financial statement:

All the four basisc financial stsement is important for an enterprise, because all the four statement reflects the financial highlights of the company. But as the investment is concerned the income statement, and Balance sheet are the most important financial statement of the company. Because, the income statement shows the profitability of the entity, and the Balance Sheet shows the financial health of the company.

An investor while investing in a company praimarily wants to know the profitabilty and the financial stability of the commpany. On itsbalance sheet,Maxidrive overstated the economic resources it owned and understated its debts to others.

On itsincome statement,Maxidrive overstated its ability to sell goods for more than the cost to produce and sell them.

On itsstatement of retained earnings,Maxidrive overstated the amount of income it reinvested in the company for future growth.

On itsstatement of cash flows,Maxidrive overstated its ability to generate from sales of disk drives the cash necessary to meet its current debts.

  1. Define what is included in a management discussion and analysis section of a financial statement (that cannot be found elsewhere)

Ch2.7 – 2CC

Financial Statements (issued by a firm usually quarterly and annually) are accounting reports that present past performance information to provide a snapshot of a firm’s assets. In the US the public companies are required to file their financial statements with the US securities and Exchanges.

Companies provide extensive notes with additional details on the information provided in the statements in addition to the four financial statements i.e. Balance Sheet, Cash Flow Statement, Income Statement, and Income Statement.

The information that the notes to the financial statements are:

  1. They provide information related to a firm’s subsidiaries or its separate product lines.
  2. They show the detail of different types of debt the firm has outstanding and firm’s stock-based compensation plans for the employees.
  3. The notes are also contain the details of acquisitions, spin-offs, leases, taxes, and risk management activities.

Off-balance sheet transactions do not appear on the balance sheet or the transactions or arrangements but they can have a material impact on a firm’s future performance.

The off-balance sheet transactions are disclosed as part of the managerial decision and analysis (MD&A). Managerial Decision and Analysis is a state of the financial statement in which the company’s management discusses about the recent year or quarter, taking into consideration about the significant events that have occurred and the company. Management must also discuss the coming year, and outline goals and new projects

Thus, the off-balance sheet transactions appear in Management Decision and Analysis in a firm’s financial statement and cannot be found elsewhere.

5

  1. Discuss the Sarbanes-Oxley Act in wake of the financial reporting misdeeds of Enron and WorldCom. Compare and contrast the two companies, why they were caught, and how policies have changed for companies today. You can use examples of other companies to help in your discussion.

Ch2.8 – 1CC & 2CC

Sarbanes-Oxley Act (SOX) legislation was passed by congress in 2002, intended to improve the accuracy of financial information provided to both boards and to shareholders. This act was passed because of the numbers of scandals faced before.

For Example:

Problems at Enron and elsewhere kept hidden from boards and shareholders. After all these scandals many people felt that accounting statement of these companies, did not present an accurate picture of the financial health of a company, while often remaining true to the letter of GAAP.

WorldCom executives effectively fudged the company's accounting numbers, inflating the company's assets by around $12 billion dollars. The swift bankruptcy that followed led to massive losses for investors

The mark-to-market practice led to schemes that were designed to hide the losses and make the company appear to be more profitable than it really was. In order to cope with the mounting losses, Andrew Fastow, a rising star who was promoted to CFO in 1998, came up with a devious plan to make the company appear to be in great shape, despite the fact that many of its subsidiaries were losing money. That scheme was achieved through the use of special purpose entities (SPE). An SPE could be used to hide any assets that were losing money or business ventures that had gone under; this would keep the failed assets off of the company's books. In return, the company would issue to the investors of the SPE, shares of Enron's common stock, to compensate them for the losses.

Sarbanes-Oxley Act attempted to do this in three ways:

  1. By offering incentives and independence in the auditing process:

The duty of the accounting firm is to ensure that the company’s financial statements accurately reflect the financial state of the firm but if an audit team refuses to accommodate the request by a client’s management than that client will not choose the same accounting firm again for its next contract. SOX addresses this concern by placing strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from the same firm that it audits.

  1. By suffering penalties for providing false information:

Sox also put the criminal penalties on providing the false information to the shareholders i.e. $5 million and inprisionment of a maximum of 20 year. So, it is for both the CEO and CFO to personally attest to the accuracy of the financial statements presented to the shareholders and to sign a statement to that effect.

  1. Finally, Section 404 of SOX requires senior management and the boards of public companies to attest to the effectiveness and validity with the process through which functions are allocated and controlled, and outcomes monitored through the firm.

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