1.2 Users, Stakeholders & Types of Business Entity

Primary Users vs. Other Stakeholders

Financial statements are designed to meet the information needs of various groups. The IASB Conceptual Framework distinguishes between primary users and other users (stakeholders).

Primary Users

The primary users of general purpose financial reports are those who must rely on these reports for much of the financial information they need. They cannot require the reporting entity to provide information directly to them. The primary users are:

1. Investors (Existing and Potential): They need information to help them determine whether they should buy, hold, or sell equity. They are interested in the risk and return on their investment, assessing the entity's ability to pay dividends and generate capital growth.
2. Lenders: Banks and other financial institutions need information to determine whether their loans and the related interest will be paid when due.
3. Other Creditors: Suppliers and trade creditors need information to determine whether amounts owing to them will be paid when due, especially if they are dependent upon the continuation of the entity as a major customer.

Other Stakeholders

Other stakeholders may find financial reports useful, but the reports are not primarily directed at them. These include:

• Employees: Interested in information about the stability and profitability of their employers to assess their ability to provide remuneration, retirement benefits, and employment opportunities.
• Customers: Have an interest in information about the continuance of an entity, especially when they have a long-term involvement with, or are dependent on, the entity.
• Government and their Agencies: Interested in the allocation of resources and, therefore, the activities of entities. They require information to regulate the activities of entities, determine taxation policies, and as the basis for national income and similar statistics.
• The Public: Entities affect members of the public in a variety of ways, such as through employment and patronage of local suppliers. Financial statements may assist the public by providing information about the trends and recent developments in the prosperity of the entity.

Types of Business Entity

Understanding the legal structure of a business is crucial for accounting, as it dictates how capital is classified and how liability is treated. The three main types of business entity are sole traders, partnerships, and limited liability companies.

1. Sole Traders

A sole trader (or sole proprietorship) is a business owned and operated by one individual.

• Legal Status: In law, the business and the owner are the same. The business is not a separate legal entity.
• Liability: The owner has unlimited liability. If the business fails and has debts, the owner's personal assets (like their house or car) can be seized to pay off those business debts.
• Capital Structure: Capital is introduced by the single owner. Profits belong entirely to the owner and are added to their capital account; withdrawals are treated as drawings.

2. Partnerships

A partnership is a business owned by two or more people (partners) who share the risks, rewards, and responsibilities.

• Legal Status: Like a sole trader, a traditional partnership is not a separate legal entity from the partners.
• Liability: Partners typically have joint and several unlimited liability. This means they are personally responsible for all the debts of the partnership, and a creditor could potentially sue just one partner for the entire debt of the partnership.
• Capital Structure: Each partner contributes capital. The partnership agreement dictates how profits and losses are shared among the partners.

3. Limited Liability Companies

A limited liability company is a business structure that creates a separate legal entity distinct from its owners (shareholders).

• Legal Status: The company is a separate 'legal person' in the eyes of the law. It can own property, enter into contracts, sue, and be sued in its own name.
• Liability: The owners have limited liability. Their liability for the company's debts is limited to the amount they have invested (or agreed to invest) in the company's share capital. Their personal assets are protected if the company goes bankrupt.
• Capital Structure: Capital is divided into shares. The owners are called shareholders.

Limited companies can be further divided into:

• Private Limited Companies (Ltd): Shares cannot be offered to the general public. They are typically owned by founders, management, or a small group of private investors.
• Public Limited Companies (PLC): Shares can be offered to and traded by the general public on a stock exchange. They are subject to more stringent regulatory and reporting requirements.

Summary Comparison