Essentials Of Entrepreneurship And Small Business Management 6th Edition by Scarborough - Test Bank

Essentials Of Entrepreneurship And Small Business Management 6th Edition by Scarborough – Test Bank

 

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Sample Questions Are Posted Below

 

Essentials of Entrepreneurship & Small Business Management, 6e (Scarborough)

Chapter 5   Forms of Business Ownership

 

1) The key to choosing the right form of ownership is:

1. A) envisioning where your business will be in 10 years.
2. B) understanding the characteristics of each form and knowing how they affect your business and personal circumstances.
3. C) forming either an S corporation or a limited liability company since they are the only forms that offer owners liability protection.
4. D) irrelevant since choosing a form of ownership is merely a technicality and has little impact on the business and its owner(s).

Answer:  B

Diff: 2             Page Ref: 134

AACSB:  Analytic Skills

 

2) Which of the following issues would influence an entrepreneur’s choice of a form of business ownership?

1. A) Tax considerations
2. B) Management succession plans
3. C) Liability exposure
4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 134-135

AACSB:  Analytic Skills

 

3) The most common form of business ownership that is also the simplest to create is the:

1. A) sole proprietorship.
2. B) partnership.
3. C) corporation.
4. D) S corporation.

Answer:  A

Diff: 1             Page Ref: 135, 137

AACSB:  Analytic Skills

 

4) Marco is opening a new computer repair shop.  He is owner and sole employee.  He has paid the appropriate fees and licensing costs and begun his business.  This is an example of a(n):

1. A) S corporation.
2. B) partnership.
3. C) corporation.
4. D) sole proprietorship.

Answer:  D

Diff: 1             Page Ref: 137-138

AACSB:  Reflective Thinking

 

 

5) The most critical disadvantage of the sole proprietorship is:

1. A) the owner’s unlimited personal liability.
2. B) limited access to capital.
3. C) lack of continuity.
4. D) limited skills and abilities of the owner.

Answer:  A

Diff: 3             Page Ref: 138-139

AACSB:  Analytic Skills

6) Which form of ownership generally has the least ability to accumulate capital?

1. A) Partnership
2. B) Sole proprietorship
3. C) Corporation
4. D) S corporation

Answer:  B

Diff: 1             Page Ref: 139

AACSB:  Analytic Skills

 

7) A partnership agreement defines how the partners will be compensated.  Normally,

1. A) partners are not entitled to salaries or wages, but are compensated by a share of the profits of the business.
2. B) the general partner’s salary is set at two times the salaries of the limited partners.
3. C) both general and limited partners are permitted salaries, but all silent or dormant partners are compensated only by sharing in the profits.
4. D) while the agreement establishes payout schedules, it does not spell out what constitutes profit.

Answer:  A

Diff: 3             Page Ref: 139-141

AACSB:  Analytic Skills

 

8) Probably the most important reason to have a partnership agreement is that:

1. A) it identifies the name of the partnership and protects that name from infringement by others.
2. B) it states the location and the purpose of the business.
3. C) it determines how the partnership and the partners will pay taxes.
4. D) it resolves potential sources of conflict that, if not addressed in advance, could later result in partnership battles and dissolution of an otherwise successful business.

Answer:  D

Diff: 2             Page Ref: 139-140

AACSB:  Communication

 

9) Which of the following issues would a typical partnership agreement address?

1. A) The contributions of each partner to the business
2. B) How the partnership profits (or losses) will be distributed
3. C) How a partner can sell her ownership in the business
4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 140-141

AACSB:  Communication

 

10) All of the following are advantages of a partnership EXCEPT:

1. A) partnerships are relatively easy and inexpensive to establish.
2. B) partnerships avoid double taxation since the partnership itself is not subject to federal taxation.
3. C) partnerships have the greatest ability to accumulate capital of all of the forms of ownership.
4. D) partnerships offer the ability to combine the management and business skills of two or more people in a complementary and powerful fashion.

Answer:  C

Diff: 1             Page Ref: 141-142

AACSB:  Analytic Skills

11) In a partnership, the ________ partner(s) has (have) unlimited liability for the partnership’s debts.

1. A) limited
2. B) dormant
3. C) nominal
4. D) general

Answer:  D

Diff: 1             Page Ref: 142

AACSB:  Analytic Skills

 

12) In a general partnership:

1. A) each partner is held responsible for an agreement/decision made by any one of the partners.
2. B) partners can be held responsible only for decisions they make personally.
3. C) no partner can be held legally responsible for decisions since the partnership itself is a legal entity.
4. D) no decision is binding unless all partners agree to it in writing.

Answer:  A

Diff: 3             Page Ref: 142

AACSB:  Analytic Skills

 

13) Which of the following is required to form a partnership?

1. A) A general partner
2. B) A limited partner
3. C) A secret partner
4. D) A silent partner

Answer:  A

Diff: 2             Page Ref: 142

AACSB:  Analytic Skills

 

 

14) A special type of limited partnership in which all partners who, in many states must be considered to be professionals, are limited partners.

1. A) Limited liability partnership (LLP)
2. B) Master limited partnership (MLP)
3. C) General partnership
4. D) Limited partnership

Answer:  A

Diff: 2             Page Ref: 142

AACSB:  Analytic Skills

 

15) Which of the following is not true of a limited liability partnership?

1. A) All partners are limited partners.
2. B) Most states restrict this form of ownership to certain types of professions such as attorneys, physicians, dentists, accountants, etc.
3. C) Although LLPs have many of the characteristics of partnerships, they are taxed as a corporation.
4. D) It must involve a general partner, a limited partner, a silent partner, and a dormant partner.

Answer:  C

Diff: 2             Page Ref: 145

AACSB:  Analytic Skills

16) A ________ is a relatively new form of partnership whose shares are traded on stock exchanges, just like a corporation’s shares.

1. A) limited liability partnership (LLP)
2. B) master limited partnership (MLP)
3. C) general partnership
4. D) limited partnership

Answer:  B

Diff: 3             Page Ref: 146

 

17) Acme Corporation is chartered in Delaware, but its primary area of operation is in South Carolina. In South Carolina, Acme would be considered a(n) ________ corporation.

1. A) alien
2. B) domestic
3. C) foreign
4. D) local

Answer:  C

Diff: 2             Page Ref: 146

AACSB:  Reflective Thinking

 

 

18) The “Das Spelunker” corporation, formed in Germany and conducting business in the U.S., is considered to be a(n) ________ corporation.

1. A) alien
2. B) domestic
3. C) foreign
4. D) distant

Answer:  A

Diff: 2             Page Ref: 146

AACSB:  Reflective Thinking

 

19) Which of the following is true regarding the corporate form of ownership?

1. A) Generally has the greatest ability to accumulate capital
2. B) Most complex form of ownership
3. C) Separate legal entity in the eyes of the law
4. D) All of the above

Answer:  D

Diff: 1             Page Ref: 146

AACSB:  Analytic Skills

 

20) A corporation receives its charter from:

1. A) the federal government.
2. B) the state.
3. C) the board of directors.
4. D) the stockholders.

Answer:  B

Diff: 2             Page Ref: 146-147

AACSB:  Analytic Skills

21) Which of the following generally is not required by a Certificate of Incorporation?

1. A) The names and the addresses of the incorporators
2. B) A statement of the corporation’s purpose
3. C) A statement of how stock proceeds will be used
4. D) The corporation’s bylaws

Answer:  C

Diff: 2             Page Ref: 147

AACSB:  Analytic Skills

 

22) Which of the following statement(s) is/are true?

1. A) Closely held corporations are owned by only a few shareholders, often family members.
2. B) Most closely held corporations require shareholders interested in selling their stock to offer it first to the corporation. This is known as the right of first refusal.
3. C) Shares of stock the corporation itself owns are called treasury stock.
4. D) All of the above

Answer:  D

Diff: 2             Page Ref: 146-147

AACSB:  Analytic Skills

 

 

23) Which of the following is not an advantage of the corporate form of ownership?

1. A) Limited liability for the owners
2. B) It is the easiest and least expensive form of ownership to create.
3. C) Easy transfer of ownership
4. D) Perpetual life

Answer:  B

Diff: 2             Page Ref: 148-150

AACSB:  Reflective Thinking

 

24) Which of the following is a disadvantage of the corporation form of ownership?

1. A) An inability to accumulate capital
2. B) The unlimited liability to the members of the board
3. C) Double taxation on profits
4. D) The lack of continuity

Answer:  C

Diff: 1             Page Ref: 148-150

AACSB:  Analytic Skills

 

25) In the ________ form of ownership, the business itself pays income taxes.

1. A) proprietorship
2. B) partnership
3. C) corporation
4. D) All of the above

Answer:  C

Diff: 1             Page Ref: 150

AACSB:  Analytic Skills

26) Carlos founded the “Taco Factory” 20 years ago as a family-oriented restaurant.  Over the years as they grew the business, he incorporated and sold stock to outside investors.  Recently the stockholders voted to seek liquor licenses and to sell beer and hard liquor in the restaurants.  Carlos opposed this, citing the history of the restaurant’s “family” environment, but was voted down.  Carlos has experienced which drawback of the corporate form of ownership?

1. A) The inability to accumulate capital
2. B) The potential for diminished managerial incentives
3. C) Legal requirements and red tape
4. D) The potential loss of control

Answer:  D

Diff: 2             Page Ref: 150

AACSB:  Reflective Thinking

 

 

27) An S corporation form of ownership overcomes which disadvantage of the regular or C corporation form of ownership?

1. A) The double taxation issue
2. B) The expense and difficulty of formation
3. C) The amount of regulation and red tape involved in its operation
4. D) The potential loss of control by the founder

Answer:  A

Diff: 2             Page Ref: 150

AACSB:  Analytic Skills

 

28) Which of the following would be most likely to benefit from choosing S corporation status?

1. A) Startup companies anticipating net losses
2. B) Corporations where net profits before any compensation to shareholders is less than $100,000 per year
3. C) Highly profitable firms with substantial dividends to pay out to shareholders
4. D) A and C only

Answer:  D

Diff: 3             Page Ref: 151-153

AACSB:  Analytic Skills

 

29) Which of the following statements is not true regarding the liquidation of an S corporation?

1. A) The owners pay all taxes, debts, and creditors.
2. B) The owners obtain the written approval of shareholders to dissolve the company.
3. C) The owners file a statement of intent to dissolve with the secretary of state’s office in each state where they conduct business.
4. D) The owners distribute all assets of the corporation to the shareholders.

Answer:  C

Diff: 2             Page Ref: 153

AACSB:  Analytic Skills

 

30) A limited liability company:

1. A) is similar to an S corporation in that it is a cross between a partnership and a corporation.
2. B) prevents owners who want to maintain their limited liability status from actively managing the company.
3. C) can have a maximum of 50 owners.
4. D) All of the above

Answer:  A

Diff: 2             Page Ref: 153

AACSB:  Analytic Skills

31) A limited liability company is most like a(n):

1. A) general partnership.
2. B) master partnership.
3. C) sole proprietorship.
4. D) S corporation.

Answer:  D

Diff: 2             Page Ref: 153

AACSB:  Reflective Thinking

32) Which of the following documents must an entrepreneur file to create a limited liability company?

1. A) The articles of organization
2. B) The articles of incorporation
3. C) The operating agreement
4. D) A and C only

Answer:  D

Diff: 2             Page Ref: 153

AACSB:  Analytic Skills

 

33) Which of the following is not true regarding the limitations of professional corporations?

1. A) Seventy-five percent of the shares of stock must be owned and held by individuals licensed in the profession of the corporation.
2. B) At least one of the incorporators, one director, and one officer must be licensed in the profession.
3. C) The Articles of Incorporation, in addition to all other requirements, must designate the professional services to be provided by the corporation.
4. D) The professional corporation must obtain from the appropriate licensing board a certification that declares the shares of stock are owned by individuals who are duly licensed in the profession.

Answer:  A

Diff: 3             Page Ref: 153

AACSB:  Analytic Skills

 

34) A joint venture is different from a partnership in that the joint venture:

1. A) can be formed only by two individuals.
2. B) is formed for a specific purpose.
3. C) continues indefinitely.
4. D) requires that profits be shared equally.

Answer:  A

Diff: 2             Page Ref: 155

AACSB:  Analytic Skills

 

35) Income from a joint venture is taxed as the income from a(n):

1. A) sole proprietorship.
2. B) partnership.
3. C) corporation.
4. D) S corporation.

Answer:  B

Diff: 2             Page Ref: 155

AACSB:  Analytic Skills

36) Changing from one form of ownership to another once a business is up and running can be difficult, expensive, and complicated.

Answer:  TRUE

Diff: 1             Page Ref: 134

AACSB:  Analytic Skills

 

37) Some forms of ownership are much more costly and involved to create.

Answer:  TRUE

Diff: 1             Page Ref: 134

AACSB:  Analytic Skills

 

38) Entrepreneurs should not spend much time selecting a form of ownership for their businesses because making the choice is merely a technicality, which has little impact on the business and its owner(s).

Answer:  FALSE

Diff: 1             Page Ref: 134-135

AACSB:  Analytic Skills

 

39) The sole proprietorship is the best form of ownership for entrepreneurs launching their first businesses.

Answer:  FALSE

Diff: 1             Page Ref: 137-139

AACSB:  Reflective Thinking

 

40) Of all U.S. business firms, sole proprietorships are the most common, accounting for approximately 71 percent of businesses.

Answer:  TRUE

Diff: 1             Page Ref: 135, Figure 5.1

AACSB:  Analytic Skills

 

41) The sole proprietorship is the easiest form of ownership to create, but once formed, it is subject to the greatest number of regulations.

Answer:  FALSE

Diff: 1             Page Ref: 138

AACSB:  Reflective Thinking

 

42) All the profits of a sole proprietorship are taxed as current income of the owner even if they are not withdrawn from the business.

Answer:  TRUE

Diff: 1             Page Ref: 138

AACSB:  Analytic Skills

 

43) If a sole proprietorship fails, the owner is not liable for its debts since the business is a separate legal entity.

Answer:  FALSE

Diff: 1             Page Ref: 138-139

AACSB:  Analytic Skills

 

44) In a sole proprietorship, the owner has limited liability.

Answer:  FALSE

Diff: 1             Page Ref: 138-139

AACSB:  Analytic Skills

 

45) The sole proprietorship is the form of ownership with the least ability to accumulate capital.

Answer:  TRUE

Diff: 1             Page Ref: 139

AACSB:  Analytic Skills

 

46) If a sole proprietor dies, retires, or becomes incapacitated, the business automatically terminates.

Answer:  TRUE

Diff: 2             Page Ref: 139

AACSB:  Analytic Skills

 

47) The most common form of business ownership in the United States is the partnership.

Answer:  FALSE

Diff: 1             Page Ref: 139

AACSB:  Analytic Skills

 

48) Although not required by law, a written partnership agreement that spells out the terms of operating the partnership and the status of each partner should be developed.

Answer:  TRUE

Diff: 1             Page Ref: 139

AACSB:  Analytic Skills

 

49) State law requires that individuals creating a partnership file the Articles of Partnership with the secretary of state.

Answer:  FALSE

Diff: 2             Page Ref: 140-141

AACSB:  Analytic Skills

 

50) Defining the duties, responsibilities, contributions, and roles of the partners in a partnership agreement is not necessary since the law covers these provisions automatically.

Answer:  FALSE

Diff: 2             Page Ref: 141, 143

AACSB:  Analytic Skills

 

51) In a partnership, profits (and losses) must be shared according to the ratio of capital originally invested in the partnership.

Answer:  FALSE

Diff: 2             Page Ref: 142

AACSB:  Analytic Skills

 

52) If a partnership agreement does not exist, the partnership will be governed by the Uniform Partnership Act.

Answer:  TRUE

Diff: 2             Page Ref: 141

AACSB:  Analytic Skills

 

 

53) There is no limit to the number of general partners a partnership may have, but it must have at least one general partner.

Answer:  TRUE

Diff: 2             Page Ref: 142

AACSB:  Analytic Skills

54) Profits earned by a partnership are taxed in the same fashion as those earned by a sole proprietorship.

Answer:  TRUE

Diff: 1             Page Ref: 142

AACSB:  Analytic Skills

 

55) The partnership, like the proprietorship, avoids the disadvantage of double taxation.

Answer:  TRUE

Diff: 1             Page Ref: 142

AACSB:  Analytic Skills

 

56) In a partnership, the business itself is subject to federal income tax.

Answer:  FALSE

Diff: 1             Page Ref: 142

AACSB:  Analytic Skills

 

57) A general partner is personally liable only for the amount of money he has invested in the partnership.

Answer:  FALSE

Diff: 1             Page Ref: 143

AACSB:  Analytic Skills

 

58) One of the advantages of a partnership over a proprietorship is the increased sources of capital and credit it offers.

Answer:  TRUE

Diff: 1             Page Ref: 143

AACSB:  Analytic Skills

 

59) One disadvantage of the partnership form of ownership is the great potential for personality and authority conflicts.

Answer:  TRUE

Diff: 1             Page Ref: 143

AACSB:  Analytic Skills

 

60) If a limited partner withdraws, sells his ownership in the partnership, or dies, the partnership is not forced into dissolution.

Answer:  TRUE

Diff: 2             Page Ref: 143

AACSB:  Reflective Thinking

 

 

61) A common denominator in many partnership disputes is the lack of a written agreement clearly spelling out the roles, rights, and responsibilities of each partner.

Answer:  TRUE

Diff: 1             Page Ref: 143-144

AACSB:  Reflective Thinking

 

62) A limited partner is personally liable only for the amount of money she has invested in the partnership.

Answer:  TRUE

Diff: 1             Page Ref: 144

AACSB:  Analytic Skills

63) A limited partner is treated as an investor in a business venture and does not take an active role in managing it.

Answer:  TRUE

Diff: 1             Page Ref: 144

AACSB:  Analytic Skills

 

64) Each partner in a limited liability partnership is a limited partner; there are no general partners.

Answer:  TRUE

Diff: 2             Page Ref: 144-145

AACSB:  Analytic Skills

 

65) Limited liability partnerships (LLP) are where all partners in a business are limited partners, which offers the advantage of limited liability for the debts of the partnership.

Answer:  TRUE

Diff: 2             Page Ref: 145

AACSB:  Reflective Thinking

 

66) A master limited partnership (MLP) is like a regular limited partnership, except that its shares are not traded.

Answer:  FALSE

Diff: 3             Page Ref: 146

AACSB:  Analytic Skills

 

67) A corporation formed and chartered in Kansas is considered a domestic corporation when doing business in Kansas, and a foreign corporation when doing business in Missouri.

Answer:  TRUE

Diff: 2             Page Ref: 146

AACSB:  Analytic Skills

 

68) A corporation formed in Taiwan doing business in the United States is a foreign corporation.

Answer:  FALSE

Diff: 2             Page Ref: 146

AACSB:  Analytic Skills

 

 

69) Most states do not require a Certificate of Incorporation or a charter to be filed for a new corporation.

Answer:  FALSE

Diff: 1             Page Ref: 147

AACSB:  Reflective Thinking

 

70) Corporations must obtain a federal charter before they can conduct any business.

Answer:  FALSE

Diff: 2             Page Ref: 147

AACSB:  Analytic Skills

 

71) Stockholders in the corporation have the same kind of liability as do general partners in a partnership.

Answer:  FALSE

Diff: 2             Page Ref: 148

AACSB:  Reflective Thinking

72) When filing the corporate charter, a corporation must file in the state in which its headquarters are located.

Answer:  FALSE

Diff: 2             Page Ref: 147

AACSB:  Analytic Skills

 

73) A business with more than five owners must be a corporation.

Answer:  FALSE

Diff: 2             Page Ref: 148-149

AACSB:  Reflective Thinking

 

74) One significant advantage of a corporation is the ability to attract capital.

Answer:  TRUE

Diff: 2             Page Ref: 149

AACSB:  Analytic Skills

 

75) The corporation has the advantage of transferable ownership, which easily enables the corporation to sell shares to others or to transfer stock through inheritance.

Answer:  TRUE

Diff: 2             Page Ref: 149

AACSB:  Analytic Skills

 

76) “Double taxation” refers to the fact that corporations are required to pay both federal and state income taxes.

Answer:  FALSE

Diff: 2             Page Ref: 150

AACSB:  Analytic Skills

 

 

77) “Double taxation” refers to the fact that the corporation itself must pay taxes on its net profits, and the stockholders must also pay taxes on the portion of those same profits distributed to them as dividends.

Answer:  TRUE

Diff: 1             Page Ref: 150

AACSB:  Analytic Skills

 

78) Company founders can become minority stockholders in a corporation but can never lose their final authority or control over business decisions because they are the founders.

Answer:  FALSE

Diff: 2             Page Ref: 150

AACSB:  Analytic Skills

 

79) An S corporation maintains the advantages of the corporate form of ownership while having the ability to be taxed as a partnership.

Answer:  TRUE

Diff: 1             Page Ref: 151

AACSB:  Analytic Skills

 

80) An S corporation can issue both voting and nonvoting common stock to its shareholders.

Answer:  TRUE

Diff: 2             Page Ref: 151-152

AACSB:  Analytic Skills

81) One disadvantage of an S corporation is that the cost of many benefitsinsurance, meals, lodging, and othersthat are paid to shareholders with 2 percent or more of stock cannot be deducted as business expenses for tax purposes and are considered taxable income.

Answer:  TRUE

Diff: 3             Page Ref: 152

AACSB:  Analytic Skills

 

82) Liquidating an S corporation involves several steps, including paying all taxes and debts, obtaining the written approval of shareholders to dissolve the company, filing a statement of intent to dissolve with the secretary of state’s office, and finally distributing all remaining assets of the corporation to shareholders.

Answer:  TRUE

Diff: 3             Page Ref: 152

 

83) Choosing S corporation status is usually beneficial to startup companies anticipating net losses and to highly profitable firms with substantial dividends to pay out to shareholders.

Answer:  TRUE

Diff: 3             Page Ref: 152-153

AACSB:  Analytic Skills

 

 

84) A limited liability company must have at least two owners.

Answer:  TRUE

Diff: 2             Page Ref: 153

AACSB:  Analytic Skills

 

85) The limited liability company, like an S corporation, is a form of ownership that is a cross between a partnership and a corporation.

Answer:  TRUE

Diff: 2             Page Ref: 153

AACSB:  Analytic Skills

 

86) To form a limited liability company, an entrepreneur must file both the articles of incorporation and the operating agreement with the secretary of state.

Answer:  TRUE

Diff: 2             Page Ref: 153

AACSB:  Analytic Skills

 

87) As in a limited partnership, owners of a limited liability company who want to maintain their limited liability status cannot actively participate in the management of the company.

Answer:  FALSE

Diff: 2             Page Ref: 153-154

AACSB:  Reflective Thinking

 

88) Like an S corporation, a limited liability company does not pay income taxes; its income flows through to its owners, who pay taxes on their shares of the limited liability company’s net income.

Answer:  TRUE

Diff: 2             Page Ref: 154

AACSB:  Analytic Skills

89) A limited liability company cannot have any more than two of the following corporate characteristics: limited liability, continuity of life, free transferability of interest, and centralized management.

Answer:  TRUE

Diff: 2             Page Ref: 154

AACSB:  Analytic Skills

 

90) In a professional corporation, all shares of stock must be owned and held by individuals licensed in the profession of the corporation.

Answer:  TRUE

Diff: 2             Page Ref: 154-155

AACSB:  Analytic Skills

 

 

91) A professional corporation is created in the same way as a regular corporation, and exists to provide the advantages of corporate ownership, including limited liability, to professionals such as doctors and lawyers.

Answer:  TRUE

Diff: 2             Page Ref: 154-155

AACSB:  Analytic Skills

 

92) A joint venture is much like a partnership except that it is formed for a specific limited purpose.

Answer:  TRUE

Diff: 1             Page Ref: 155

AACSB:  Analytic Skills

 

93) What factors should an entrepreneur consider when choosing a form of ownership?

Answer:  Factors an entrepreneur should consider when choosing a form of ownership include:

• Tax considerations
• Liability exposure
• Start-up capital requirements
• Control
• Business goals
• Management succession plans
• Cost of formation

Diff: 2             Page Ref: 134-135

AACSB:  Reflective Thinking

94) What is a sole proprietorship?  Explain the advantages and the disadvantages of a sole proprietorship.

Answer:  A sole proprietorship is a business owned and managed by one (1) individual.

Advantages of a sole proprietorship:

• Simple to create
• Least costly form of ownership to begin
• Profit incentive
• Total authority
• No special legal restrictions
• Easy to discontinue

Disadvantages of a sole proprietorship:

• Unlimited personal liability
• Limited skills and capabilities
• Feeling of isolation
• Limited access to capital
• Lack of continuity for the business

Diff: 2             Page Ref: 137-139

AACSB:  Reflective Thinking

 

 

95) What is a partnership?  Explain the advantages and the disadvantages of a partnership.

Answer:  A partnership is an association of two or more people who co-own a business for the purpose of making a profit.

Advantages of a partnership:

• Easy to establish
• Complementary skills
• Division of profits
• Larger capital pool
• Ability to attract limited partners
• Little governmental regulation
• Flexibility
• Taxation

Disadvantages of a partnership:

• Unlimited liability of the general partner(s)
• Not effective in capital accumulation
• Difficulty in disposing of partnership interest without dissolving partnership
• Lack of continuity
• Potential conflicts

Diff: 3             Page Ref: 139-145

AACSB:  Reflective Thinking

96) John and Bill are considering starting a partnership.  Why is it important for them to develop a formal partnership agreement?  List at least ten of the provisions their partnership agreement should include.

Answer:  The partnership agreement is important because it states in writing all of the terms of operating the partnership and protects each partner involved.  The standard partnership agreement should include the following:

1. Name of partnership
2. Purpose of business
3. Domicile of the business
4. Duration
5. Partner names and addresses
6. Contributions of each partner
7. How profits/losses are distributed
8. Agreement on salaries and draws
9. Procedure for expansion of new partners
10. How assets will be distributed
11. Sale
12. Salaries, draws, and expense accounts
13. Partners’ absence or disability
14. Dissolution
15. Alterations or modifications

Diff: 3             Page Ref: 139-145

AACSB:  Reflective Thinking

 

 

97) Outline the incorporation process.

Answer:  When incorporating, a Certificate of Incorporation or charter must be filed with the secretary of state.  The Certificate of Incorporation includes such things as:

• The type and value of capital stock the corporation wants
• Time horizon (50 years, perpetuity)
• Restrictions, if any, on transferring shares
• Rules under which corporation will operate
• Statement of purpose
• Corporation name
• Name and address of incorporators

Diff: 3             Page Ref: 146-148

AACSB:  Analytic Skills

98) What is a corporation?  Explain the advantages and the disadvantages of a corporation.

Answer:  A corporation is a separate legal entity apart from its owners that receives the right to exist from the state in which it is incorporated.

Advantages:

• Limited liability of stockholders
• Ability to attract capital
• Ability to continue indefinitely
• Transferable ownership

Disadvantages:

• Cost and time of incorporation
• Double taxation
• Diminished managerial incentives
• Regulatory red tape
• Founderloss of control potential

Diff: 2             Page Ref: 146-151

AACSB:  Reflective Thinking

 

99) What is an S corporation?  Explain the advantages and the disadvantages of an S corporation.

Answer:  A corporation that retains the legal characteristics of a regular (C) corporation but has the advantage of being taxed as a partnership if it meets certain criteria.

Advantages of as S corporation:

• Continuity of existence
• Transferability of ownership
• Limited liability for owners
• Income taxed onceat individual’s rate
• Avoids “C” corporation tax on assets
• Owners can get year-end payouts
• Can have “S” corporation subsidiaries

Disadvantages of an S corporation:

• Lower rate than top individual tax rates
• Many fringe benefits cannot be deducted

Diff: 3             Page Ref: 151-153

AACSB:  Reflective Thinking

 

100) What kinds of companies would benefit most from S corporation status?  Least?

Answer:  S corporation status is usually beneficial to start-up companies anticipating net losses and to highly profitable firms with substantial dividends to pay out to shareholders.  In these cases, owners can use the losses to offset other income.  In addition, owners who plan to sell in the near future prefer “S” corporations because taxable gains on “S” corporations are lower.

 

S corporation status would be least beneficial for companies whose characteristics include:

• Higher individual tax rates
• Profitable service companies that pay out much of their profits to shareholders in the form of benefits
• Fast growing companies that retain most of earnings to finance growth
• When loss of fringe benefits exceeds tax savings
• Sizeable net operating losses that cannot be used against “S” corporation earnings
• Income before any compensation is less than $100,000 per year

Diff: 3             Page Ref: 151-153

AACSB:  Reflective Thinking

101) What is a limited liability company?  How is one formed?  What benefits does an LLC offer?

Answer:  A relatively new form of ownership that, like an S corporation, is a cross between a partnership and a corporation; however, it is not subject to many of the restrictions imposed on S corporations.

The process of creating an LLC is much like creating a corporation.  The articles of organization actually create an LLC by establishing its name, address, method of management, its duration, and the names and addresses of each organizer.  An operating agreement, similar to an organization’s bylaws, is also created.  An LLC must have at least two owners (called members).

Unlike an S corporation, it offers limited liability without imposing any ceilings on their numbers and does not restrict the partners from participating in day-to-day operations and management of the business.  The LLC also avoids double taxation because its income flows through to its members who divide it as they see fit.

Diff: 3             Page Ref: 153-154

AACSB:  Reflective Thinking

 

102) Compare and contrast the following forms of ownership:  a corporation, an S corporation, and a limited liability company.

Answer:

• All have limited liability.
• The LLC and S corporation are both similar to a partnership in the way they see fit to divide income. They both avoid double taxation.
• Both the C and S corporation have continuity of existence and transferability of ownership.
• The LLC is not subject to the same restrictions as an S corporation. For example, an S corporation cannot have more than 75 shareholders, no shareholders may be foreigners or corporations, and it may have only one class of stock.  This is not the case with the LLC.
• Unlike the corporation, an LLC does not have perpetual life.

Diff: 3             Page Ref: 146-154

AACSB:  Reflective Thinking

 

Mini Case 5-1: “Today, You Gutta’ Be a Corporation”

 

Duke has been a successful used car dealer for 25 years in the same location, operating as a proprietorship. In those 25 years, he has expanded his operation and become the largest independent car dealer in a city of 85,000 people. Few people in town can boast of a business reputation better than Duke’s. As he says, “I’ve always done business in a fair and honest fashion, and I’ve tried to give my customers an honest deal. The public has responded well, and last year the business revenue increased to an all-time high of $830,000.”

 

As the business has grown, so have Duke’s liabilities. On a given day, Duke will have cars worth from $350,000 to $450,000 as inventory on the lot. “Twenty years ago, if I’d asked the bank for a line of credit of $200,000, they’d have tossed me out the front door. There’s no question today business is different.”

 

Duke’s only daughter recently married a garage mechanic who has worked in the area for the past three years. Though Duke thinks the boy is certainly nice enough, he does not believe he is very smart. “The kid sure knows how to fix a car, but that’s as far as it goes,” says Duke. “On my last visit to the accountant, he suggested I consider incorporating. I guess he knows what he’s talking about. That’s all you hear today’you gutta’ be a corporation.’ I guess he’s right. But, to tell you the truth, I don’t know.”

 

103) Should Duke incorporate or should he remain a proprietorship?  Why?

Answer:  There are significant advantages for Duke to investigate other alternatives. The sole proprietorship does not offer limited liability and incorporating would provide that benefit.

Diff: 3             Page Ref: 146-150

AACSB:  Analytic Skills

 

104) Would you recommend Duke establish an S corporation?  What conditions would he have to meet?

Answer:  Duke’s business looks as though it would qualify for S corporation status, and, as the text describes, there are tax advantages and, given the volume of sales and the “good living” Duke makes, he should consider this form of ownership.

Diff: 3             Page Ref: 151-153

AACSB:  Analytic Skills

 

105) Would a limited liability corporation be any better for Duke?  Why or why not?

Answer:  A limited liability corporation offers many of the same advantages as an S corporation. Future ownership may be one consideration. If Duke wishes to take on additional owners, an S corporation may better facilitate that transition.

Diff: 3             Page Ref: 153-154

AACSB:  Analytic Skills