Study: What are corporations and what are some of its advantages and disadvantages?
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Study the (8m:45s) video for this topic provided below: Forms of Business Ownership - Corporations - Video Slides 1-19 (8m:45s)
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Slide 1:
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Corporations
Welcome to Introduction to Accounting Preparing for a User's Perspective. What are the common forms of business ownership structure in the United States and what are some advantages and disadvantages of each? Corporations.
The following discussion will focus on the key characteristics C corporations, the C refers to Chapter C of the Internal Revenue Code (IRC) which legally created this type of corporation. S corporations (per Chapter S of the IRC) also exist, the advantages of which, I will only touch upon shortly at the end of this topic.
Slide 2:
Links to an external site. You should use the Summary of Business Structures table provided in the video to guide you as you learn more about corporations, both their advantages and disadvantages.
Slide 3:
Links to an external site. Shared decision-making authority: Even though a corporation
Links to an external site. can be 100% owned by a single individual, such sole ownership does not make it a sole proprietorship
Links to an external site.. It remains a corporation regardless of the number of shareholders. The benefit of 100% ownership is that the 100% owner retains the final decision-making authority for key decisions. However, large corporations have hundreds of thousands of shareholders with each individual share having a vote thus diluting any given shareholder's decision-making authority. This lack of complete control can be a disadvantage to someone desiring to control the direction of the corporation. The shareholders' influence over the corporation will largely be affected by what percentage of the outstanding shares the owner possesses.
Slide 4:
Links to an external site. Shareholders
Links to an external site. are often absentee owners and are not normally involved in the day-to-day operations of the business, that is why they elect a board of directors. The board of directors
Links to an external site. is responsible for hiring key executive officers to run the corporation on behalf of the shareholders, such executives are the Chief Executive Officer (CEO), the Chief Operations Officer (COO), the Chief Financial Officer (CFO) and possibly a Chief Information Officer (CIO). The chairman of the board has the highest executive power at the corporation. The board holds the chief executives responsible for building out the rest of the management team (i.e. Vice President level) to help them achieve the corporate objectives. Unless a shareholder is also an employee of the corporation, s/he has no day-to-day operational responsibilities in a corporation.
Slide 5:
Links to an external site. Difficult set-up: Each state in the United States has its own rules and laws for the incorporation
Links to an external site. and/or registering of new corporations. In general, states require corporations to file articles of incorporation and, once they are approved, the corporation’s board of directors will be expected to create the corporation's bylaws. The administrative burden to create the articles of incorporation, to file for incorporation, and to create the bylaws results in significantly more red tape for corporations than what is required of sole proprietorships and partnerships.
Slide 6:
Links to an external site. Significant regulations: If the corporation plans to “go public” and thereby become publicly traded on a stock market
Links to an external site. and subject to regulatory oversight by the SEC, a corporation's administrative burden increases significantly resulting in additional requirements such as the submission of three years of audited financial statements
Links to an external site., five years of summary financial information, as well as signed statements from the CEO and CFO indicating that the company has reliable internal controls over its financial reporting system.
Slide 7:
Links to an external site. Because a corporation is a separate legal entity from its shareholders, it is essential that its accounting records and its general purpose financial statements are kept totally separate and distinct from any of the personal assets of any of the shareholders.
Slide 8:
Links to an external site. Once a company has become publicly traded, it is required to submit audited financial statements to the Securities and Exchange Commission
Links to an external site. (SEC) each year.
Slide 9:
Links to an external site. The submission of audited financial statements is especially critical for corporations because the individual shareholders have no physical ability to obtain the original financial data themselves and must rely on the corporation’s management to provide the audited financial reports.
Slide 10:
Links to an external site. The reports are audited to help negate any bias management may have in trying to make the corporation look better or worse than it really is. For example, without an audit, corporate managers may be tempted to manipulate the financial statements for personal gain by inflating Net Income and Earnings Per Share (EPS). Such inflated Net Income and Earnings Per Share (EPS) could result in investors overpaying to purchase a share of the company's stock.
Slide 11:
Links to an external site. Double taxation
Links to an external site.: A corporation’s Net Income Before Taxes is taxed by the federal government and state governments (if applicable), when reported for tax purposes. Any remaining Net Income after taxes then becomes available to either be paid out to shareholders as a dividend
Links to an external site., or to be retained in the corporation as Retained Earnings
Links to an external site.. ONLY when the dividend is paid out, will the shareholder need to report that dividend as income on his/her own personal income tax return and be taxed on it. This second level of taxation results in a "double-tax", first at the corporate level when reported (Net Income Before Taxes) and second at the individual shareholder level when the dividend is received. This double-taxation, is a significant disadvantage of the corporate form of business as compared to the single-taxation available to sole proprietorships and partnerships.
Slide 12:
Links to an external site. High access to expertise: Because corporations can potentially have millions of shareholders, they have very high access to expertise. Having said that, the expertise provided to a corporation usually comes in the form of a great board of directors and the executive management team they hire.
Slide 13:
Links to an external site. High access to capital: Corporations are able to sell shares of ownership on publicly traded stock markets. This ability to sell their shares on a stock market provides the corporation unlimited access to capital from investors throughout the world. This access to capital
Links to an external site.is significantly greater than that provided to partnerships and especially to sole proprietorships.
Slide 14:
Links to an external site. Limited legal liability
Links to an external site.: A corporation is a legal entity in-and-of itself. Corporations can take legal actions and enter into legal agreements just like human beings can. Corporate law indicates that when a corporation agrees to a contract of some type, the corporation, and not the shareholders, will be held responsible for fulfilling it.
Slide 15:
Links to an external site. This separation of the corporation’s legal responsibilities from those of its shareholders is a key advantage of corporations. If a corporation becomes worthless but still has debts to be paid, the shareholders cannot be required to pay the difference out of their own personal resources. The most that the shareholders can lose is the amount that they have invested in the shares.
Slide 16:
Links to an external site. Unlimited life; Easy transfer of ownership: Because corporations are separate legal entities from the owners that created them, they effectively have indefinite lives and can exist for hundreds of years. If a shareholder dies, his/her shares will simply pass on to the shareholders’ beneficiaries and the corporation continues to exist without interruption. If a shareholder of a publicly-traded corporation wants to sell a share, s/he can easily sell it on the public stock market without interruption to the corporation.
Slide 17:
Links to an external site. Multiple websites provide a stock investing game that allows the user to practice buying and selling shares with fake money, but at true market prices. This is not required, but if you want to try out a fun game that allows you to buy and sell shares of stock at true market prices, log into and try out howthemarketworks.com
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Note: This site will require you to register for a free account, so it is up to you if you want to try it out.
Slides 18-19:
Links to an external site. As a side note, another type of corporation is called an S Corporation
Links to an external site. (S Corp for short). The main benefits of an S Corp is that it has limited legal liability to protect its investors, just like a regular corporation, but has the benefit of single taxation, similar to a sole proprietorship and a partnership; however, the taxes are paid at the corporate level and not at the owner’s level. Two significant restrictions on S Corporations are that they may not have more than 100 shareholders or more than one class of stock. If you would like to read more about the requirements for S Corporation status, please go to the irs.gov
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