ACC/ACF1200 Self-study questions SOLUTIONS

Topic 1 – Business Structures

Question 1

You are a friend of Lucy Lu who is thinking about starting a business to sell her handmade quilts. Advise Lucy on
the four factors that should be considered before deciding on what form of business structure to operate under.

Four factors that one should consider before deciding on what form of business structure to operate under:

(i) Whether the owner will be the only contributor of capital to the entity;
(ii) The degree of risk that the owner(s) are willing to take with the entity
(i.e.) whether the entity should have limited or unlimited liability;
(iii) The potential for growth of the entity in the future;
(iv) Issues of taxation i.e. sole trader/partnership forms do not pay tax on the entity’s profits. The owner’s will
include their share of the entity profit in their individual taxation returns.

Question 2

What are two major advantages and disadvantages of a company structure? Provide an illustration with a
company listed on the ASX (such as JB Hi-Fi Ltd, CSL Ltd, and BHP Billiton Ltd).

Two major advantages of a company structure are:

(i) access to additional capital;
(ii) limited liability for the shareholders in relation to the debts of the business.

Two major disadvantages of a company structure are:

(i) The time and money to establish the company form of business structure;
(ii) The more complex regulatory requirements imposed on the company.

Question 3

Illustrate with an example how sole traders and partners are taxed in Australia. How does this compare to
Australian company tax?

The sole trader and partnership form of business do not pay separate income tax; each individual owner must report
business income or losses on his or her individual income tax return. Partners would submit their own individual tax
returns including their respective shares of the partnership profit. However, companies such as JB Hi-Fi Ltd and
Qantas Group do pay separate income tax. The current rate is 30 per cent.

Question 4

What does the term ‘mutual agency’ refer to in the context of partnerships? Provide an example where 'mutual
agency' could be both an advantage and disadvantage for a partnership.

Mutual agency refers to the right that each partner has in a partnership, where each partner is seen as an agent for
the entity and has a right to enter into contracts for the entity which bind the other partners. An example of where
this would be an advantage is that each partner can operate as an agent so there can be an allocation of tasks and
more than one partner can make decisions so the decision making can be spread over several different partners. An
example where this would be a disadvantage is if Cerise a partner in the partnership of "Tom, Cerise and Livia"
decides to enter into a contract with a friend "Martha" who is in a related industry. This would mean that Martha's
business would become the main supplier of goods to the partnership. Unknown to the partnership, Martha's
business is currently in a financial crisis and is unlikely to honour the arrangement of providing goods to the
partnership. Cerise was acting as an agent for the partnership and had a right to enter into a contract with Martha
on behalf of the other partners. The contract is binding and if Martha cannot provide the goods, then the
partnership must face the consequences of Cerise's actions.

Question 5

From the six scenarios described below, indicate (giving your reasons) the business form each one is likely to take
— sole trader, partnership, company or trust.

a. Connor and Ella wish to start an internet business, marketing cosmetics. They are concerned about the legal
issues (for example, their personal liabilities) for this business once they start trading.

Connor and Ella could enter into a partnership or a proprietary company. A partnership would suit them as they are
probably bringing into the entity individual skills and knowledge about cosmetics and the internet. However, they
have stated that they are concerned regarding their personal liabilities so therefore a proprietary company would
mean the entity would be incorporated as a separate legal entity which would ultimately result in Connor and Ella
only being held responsible to the extent of their capital contributions.

b. Gregory has just commenced a home maintenance business by himself, with the help of $2000 inherited from
a rich aunt. He wishes to employ his wife as the bookkeeper.

Gregory appears to be the sole contributor of capital for his home maintenance business. Therefore, the sole trader
form seems to be the appropriate form of business. Even though his wife will work as bookkeeper, Gregory appears
to be not only the sole contributor of capital but also the sole decision maker.

c. As friends at university, Paul, Ingrid and Jasmine studied commerce. They are now setting up a small
accounting business specialising in taxation returns and investment advice.

Paul, Ingrid and Jasmine should consider the partnership form of business which is perfect for a group of people who
band together combining skills, talent and knowledge. Many accounting entities are in fact partnerships.

d. Two married brothers (Will and Sam), who are both trained and practising plumbers, wish to combine their
businesses into one so that they can share resources and take more holidays.

Will and Sam could enter into a partnership or even a proprietary company. The partnership would combine their
skills and talent of plumbing and also would split profits and losses and decision-making etc. However, the attraction
of the proprietary company is the limited liability aspect and the separate legal entity.

e. Three engineers (Azil, Daniel and Timothy) wish to set up a prospecting business searching for gold, and they
want to list their business on the Australian Securities Exchange.

If Azil, Daniel and Timothy are serious about listing their entity on the ASX, then the only form appropriate is the
public company. This form of entity is characterised by rigorous reporting requirements (i.e. Corporations Act, ASX
Listing Rules) and also liability limited to the subscription price of the shares.

f. Four members of the Ng family wish to establish an investment business, with the proviso that additional
family members can be admitted as they reach the age of 18 years.

For the four members of the Ng family wishing to establish an investment business, the discretionary/family trust
would be an appropriate business form. This type of trust is established for the benefit of families.