FUNDAMENTALS OF ACCOUNTING

Course Code: ACT001

Unit 1- Business Organizations/Structure/Functions

Organizations are social arrangements for the controlled performance of collective goals. A
business organization is an individual or group of people that collaborate to achieve certain
commercial goals. Some business organizations are formed to earn income for owners. Other
business organizations, called nonprofits, are formed for public purposes

Types of Organization

- Commercial Organizations (sole traders, Partnership, limited liability companies)

- Not for Profit Organizations
- Public Sector organizations
- Private sector organizations
- Non-Governmental Organizations (NGOs)

Commercial (or profit-seeking) organizations see their main objective as maximizing the wealth
of their owners. Generally, there are three types of commercial organizations:

Sole Trader

This type of business may be operated by the owner alone or by a manager he appoints. He may also
employ several people to work in the business however, ownership remains with the one person.

Advantages

1) A small business, hence needs less capital

2) All the profits belongs to one person – the owner
3) The owner is his own boss, makes all the decisions and is involved with every aspect of the
business and his clients
4) decisions can be made promptly
5) new ideas can be put into operation quickly
6) there is a personal incentive to succeed and manage the business efficiently
7) there is no need to publish details about the company

Disadvantages

1) Difficulty in accessing capital

2) Unlimited liability
3) Essential expertise may be lacking
Partnership

One of the ways by which the sole trader can expand his business is to turn it into a partnership. The
minimum number of persons in a partnership is two while the maximum is twenty. Some professional
groups such as banks are only allowed a maximum of ten partners.

Reason for partnership

1) The capital required is more than one person can provide.

2) The experience or ability needed to manage the business cannot be found in one person.
3) Many persons want to share management instead of doing everything on their own.

Characteristics of Partnership

1) It is formed to make a profit

2) If there is no partnership agreement it obeys the partnership act of 1890
3) There can be minimum of two persons. Maximum of twenty
4) Each partner (except for limited liability partners) must pay his/her share of any debt owed by
the business.

Upon the formation of a partnership, it is always wise to draft up a partnership agreement which must
be signed by all the partners. This deed must embody all the important terms or features of the
partnership. With the absence of a partnership agreement, the partners will follow the partnership act
of 1890 which states, among other things that the profits/losses are to be shared equally

Advantages

1) Additional partners will mean more capital.

2) Better decisions may be made since there is more input.
3) Death of a partner need not mean the end of the business
4) The expenses and management of the business is shared
5) Specialization may result in greater efficiency.

Disadvantages

1) If a partner makes a mistake, all partners are affected

2) The decision –making process is slowed down because of the inclusion of other partners.
3) Generally there is unlimited liability
4) Possible disagreement between partners.
5) Membership limit of twenty restricts resources of the business

Limited Liability Companies

These are associations of persons who have contributed capital towards the operating of the business.
Capital is contributed by buying shares. There are two types of limited Company

1) Private Limited Company and

2) Public Limited Company.
Private Limited Company

This type of business is usually a family affair. Its main features are:

1) There is a minimum of two persons, maximum of fifty

2) Shares are issued for sale not to the general public but not only to members of the business or
their immediate relatives. past or present employees may also buy shares

Advantages

1) Limited liability
2) Some degree of privacy exists especially since the company does not need to publish its
accounts.
3) Continuity of existence.
4) The founders will hold the majority of the shares and control the business

Disadvantages

1) Capital can be limited since the appeal for additional capital cannot be made to the general
public.
2) Restricts partners’ ability to transfer shares.
3) Management and ownership may be so separate that communication problems arise.

Public Limited Company

This type of company indicates its public status by including the letters PLC in its title. Its main features
are:

1) There can be minimum of seven persons and no maximum.

2) Unlike private limited company, a public limited company may raise capital by inviting the public
to buy shares in the company.

Advantages

1) Continuity of the business is ensured.

2) There is no restriction on the transfer of shares.
3) Public companies may appeal to the public to buy shares
4) Economies of scale are possible. Economies of scales are the benefits to be derived from large-
scale production.

Disadvantages

1) Shareholders have no say in the policy-making decisions

2) The legal formalities in forming a company are complex.
3) Dividends are sometimes small when the number of shareholders is large and profits are small
4) The accounts must be published annually so there is little privacy.
5) Businesses tend to be large; hence manager and owners lose contact with employees.
The holders of shares are part of the business and will share in the company’s profits by receiving
dividend.

Types of Shareholders

1. Ordinary Shareholders:

Holders of these shares are risk-bearers and will receive no dividend if the company does not make a
profit. If the company makes a large amount of profit, then ordinary shareholders will receive a greater
amount of dividend, however, if the company makes a small amount of profits, then dividends will also
be small.

2. Preference Shareholders:

These are offered at a fixed rate of dividend and must be paid before ordinary shareholders. There are
two types:

a) Cumulative Preference Shareholder

b) Non Cumulative Preference Share holders

Co-operatives

These are owned by a group of people who pool their resources together. Members usually share
common interest and goals.

Advantages

1) Economies of bulk buying through obtaining large trading discounts

2) It is a democratic form of management
3) Guaranteed market for members’ products
4) Employment is created within the organization.

Disadvantages

1) Conflict may arise when members are both employees and employers
2) Management may be inexperienced and poorly trained
3) Lack of capital inhibits expansion
Not for Profit Organizations

Not-for-profit organizations (NFPs or NPOs) do not see profitability as their main objective.
Instead, they seek to satisfy the particular needs of their members or the sectors of society that
they have been set up to benefit.

NFPs include the following:

 government departments and agencies
 Schools
 Hospitals
 charities (such as the Red Cross)
 clubs

Public sector organizations

The public sector is the part of the economy that is concerned with providing basic government
services and is controlled by government organizations. The organizations that make up the
public sector vary from country to country, but generally include:

 Police
 Military
 public transport
 primary education
 healthcare for the poor

Private sector organizations

The private sector consists of organizations that are run by private individuals and groups
rather than the government. The private sector will therefore normally include both profit-
seeking and not-for-profit organizations.

 Businesses
 charities and
 clubs

Non-governmental organizations (NGOs)

A non-governmental organization is one which does not have profit as it’s primary goal and is
not directly linked to the national government. NGOs often promote political, social or
environmental change within the countries they operate.
 STAKEHOLDERS IN BUSINESSS

Stakeholders refer to any individual or group of individuals who have vested interest in the business and
as such want it to be successful.

The following are the major stake holders involved in business activities

1) Owners/Co-owners
2) Employers
3) Employees
4) Customers/Consumers
5) Government
6) All other members of society

ROLE OF STAKEHOLDERS

Roles of Employers

1) To provide a reasonable amount of work

2) To provide a safe and healthy work environment
3) To compensate employees in accordance with the terms of the contract of employment
4) To indemnify employees against liabilities and losses resulting from following managements
instructions.

Roles of Employees

1) To obey a lawful, reasonable order within the terms of the contract of employment
2) To serve faithfully
3) To cooperate with the employer
4) To perform duties with proper care and diligence
5) To account for all money or property received
6) To indemnify the employer in appropriate cases
7) Not to misuse the confidential information acquired while in service

Roles of the Consumers

1) To provide collective insight into customer needs , wants , perceptions, and discoveries are
translated into meaningful objectives that help in the closing the gap between customer
expectations and the firms offerings.

Roles of the Government

1) Promoting of economic growth

2) Ensuring a level of full employment
3) Maintaining a healthy balance of payment position
4) Education
5) Collecting taxes etc.
External factors affecting businesses - Political/Legal/Social/Technological/
Environmental/Competitive.

In order to fully understand an organization, we need to examine the environment that it

operates in – essentially, we need to earn about the world around it. This analysis should
include the following factors:

 Political/legal factors
 Economic factors
 Social/demographic factors
 Technological factors

Reviewing these factors is often referred to as PEST analysis.

Political/legal Factors Affecting Businesses

A political system is:

- a set of institutions, political organizations and interest groups (such as lobby groups);
and the relationship between them.
- the rules and norms that govern their functions (such as constitutions and election law

Governments can affect organizations in two major ways:

1. Government policy.
2. Direct legislation.

Organizations must comply with appropriate legislation. Failure to do so could result in fines,
closure, bad publicity and/or loss of customers. Most industries have specific legislation that
they have to comply with – e.g. food labeling in the food industry. However, there are a
number of pieces of legislation that apply to most or all organizations. These include:

• employee protection
• data protection
• health and safety
• consumer protection

Economic Factors Affecting Businesses

Part of an organization’s external PEST analysis will involve assessing the economic factors
which will affect its industry. The key issue is to identify potential opportunities and threats.

Economics can be defined in various ways, including:

- the study of how society allocates scarce resources, which have alternative uses,
between competing ends.
- the study of wealth creation
There are two aspects of economics:
- micro-economics
- macro-economics

Macroeconomics considers aggregate behaviour, and the study of the sum of individual
economic decisions – in other words, the workings of the economy as a whole.

Macroeconomics is the study of a national economy as a whole. It focuses on issues that affect
the economy as a whole. Some of the most common focuses of macroeconomics include
unemployment rates, the gross domestic product of an economy, and the effects of exports and
imports.

Microeconomics is the study of the economic behaviour of individual consumers, firms, and
industries. It focuses on issues that affect individuals and companies. This could mean studying the
supply and demand for a specific product, the production that an individual or business is capable of, or
the effects of regulations on a business.

Microeconomics focuses on how the individual parts of an economy make decisions about how
to allocate scarce resources. These individual parts include consumers, firms and industries.

Microeconomics attempts to examine how supply and demand decisions made by these
individuals affect the selling prices of goods and services within an industry or market.

Macro-economic Factors Affecting businesses Micro-economic Factors Affecting businesses

1. Taxation 1. Supply
2. Interest rates 2. Demand
3. Inflation 3. Consumer behaviour
4. Economic Growth

Social Factors Affecting Businesses

Society is continually changing. One of the most significant differences is the growing
popularity of social media. Social networking sites like Facebook have become very popular
among the younger people. The young consumers have grown used to mobile phones and
computers.

The younger generation prefers to use digital technology to shop online. Older people will
perhaps stick to their traditional methods.. These changing factors have a toll on businesses and
can impact a firm in many different ways.

Businesses must examine the social and cultural changes which take place in the business
environment. Market research is a critical part of this step. It is vital to see the trends and
patterns of the society.
Some social factors which impact businesses are:

 Education level
 Religion and beliefs
 Health consciousness
 Sex distribution
 Average disposable income level
 Family size and structure
 Attitudes toward saving and investing
 Age distribution and life expectancy rates
 Attitudes toward imported products and services
 Attitudes toward work, career, leisure and retirement
 Attitudes toward customer service and product quality

Environmental factors Affecting Businesses

An organization may affect or is affected by the environment around. Businesses that fail to
look after their environment can often expect a strong negative response from their key
stakeholders, such as governments and consumers.

Before a company can decide on how to look after its environment, it needs to understand the
possible impacts a business and its environment may have on each other.

Business effects upon the Environmental effects upon the

environment business
1. Pollution, such as production of 1. Changing climate may affect a number
rubbish or harmful emissions. of businesses – especially those
2. Wastage of resources, such involved in food production.
as food, water or other raw materials. 2. Lack of resources will increase the cost
3. Destruction of natural habitats. of raw materials – potentially reducing
4. Loss of plant and animal business profits.
species. 3. Loss of sales – if a business has a poor
environmental record, customers may
no longer wish to trade with it.
4. Legislation – polluting companies may
trigger legislation by governments. The
additional compliance costs and fines
may reduce profits.

Technological Factors Affecting Businesses

Technological changes can affect a firm in many different ways, such as:

1. Organizational structures, e.g. employees working from home but still able to access
files and systems at work.
 2. Product developments, e.g. turntables were effectively replaced by CD players which in
turn are being replaced by mp3 players.
3. Production changes, e.g. computer-controlled machinery.
4. Marketing, e.g. using the internet to sell the product.

Technological change has affected organizational structure in a number of key ways:

1. Some administrative and managerial roles have been replaced by more effective IT
systems.
2. Some production roles have been replaced by the use of robots and automated
production lines. This has also reduced the need for as many supervisors.
3. Improved communications (email, use of secure intranets, wireless networks) mean that
employees can work out of the office/at home allowing more flexible work
arrangements.

Technological change has affected product development in a number of key ways:

1. Technological advances allow many products to become increasingly more

sophisticated, e.g. mobile phones are now smaller, can record images and video and be
used to access the internet.
2. New technology can lead to the emergence of substitutes, e.g. the cinema industry
went into decline in the early 1980s as a result of the emergence of the video.
3. Some industries have seen their business model completely transformed, e.g. online
banking has reduced barriers to entry allowing supermarkets, among others, to move
into banking.
4. Customer support is often provided by call centres in countries where wage rates are
lower. However some firms have reinstated call centres into their home countries after
concerns over customer care.

Technological change has affected product process in a number of ways:

1. The most obvious way that technology has affected production is the use of robots and
automated production lines.
2. However, IT systems have also been used for more efficient scheduling and monitoring
of production, resulting in lower inventory levels, higher quality, elimination of
bottlenecks and lower costs.

Technology has affected the marketing function in a number of ways:

1. Pricing – many retailers monitor competitors’ prices to ensure that they are not being
undercut. Most ‘price watch’ schemes are IT-based
2. Promotion – the obvious issue here is the use of websites but promotional methods also
include viral and banner advertisements.
3. Distribution, e.g. the internet has created a huge opportunity for many firms to sell
direct to a wider range of potential customers.
4. Market research, e.g. customer databases.
Additional reading required:
ACCA Study Text: F1 Accountant in Business, Kaplan Publishing - Chapters 6 – 9

Cooperate Governance

Corporate governance is the system by which companies are directed and controlled. (The
Cadbury Report ‘The Financial Aspects of Corporate Governance’, 1992)

Corporate governance involves a set of relationships between a company’s management, its

board, its shareholders and other stakeholders. Corporate governance also provides the
structure through which the objectives of the company are set, and the means of attaining
those objectives and monitoring performance are determined.’ (The OECD ‘Principles of
Corporate Governance’, 2004)

At the core of corporate governance practices is the Board of Directors which oversees how the
management serves and protects the long term interests of all the stakeholders of the
company. The institution of Board of Directors is based on the premise that a group of
trustworthy and respectable people should look after the interests of the large number of
shareholders who are not directly involved in the management of the company. The position of
board of directors is that of trust as the board is entrusted with the responsibility to act in the
best interests of the company.

Committees appointed by the Board focus on specific areas and take informed decisions within
the framework of delegated authority, and make specific recommendations to the Board on
matters in their areas or purview. All decisions and recommendations of the committees are
placed before the Board for information or for approval.

To enable better and more focused attention on the affairs of the Corporation, the board
delegates particular matters to the committees of the board set up for the purpose.
Committees review items in great detail before it is placed before the Board for its
consideration. These committees prepare the groundwork for decision making and report at
the subsequent board meeting.

Some examples of committees that are required as part of corporate governance are:

1. The Board of Directors – an executive committee formed to oversee the running of the
company.
2. The Audit Committee – made up of directors who review the company’s accounting
policies, internal controls and annual financial statements. They also liaise with the
company’s external auditors.
3. The Remuneration Committee – examines the pay and conditions offered to the
directors of the company.
 4. Ethics committees – these oversee the working practices and procedures of an
organization regarding conflicts of interest, confidential information, environmental
issues, etc.

Benefits of Cooperate Governance

Corporate governance will increase costs as well as the complexity of the company's decision-
making process. So why do companies adopt good corporate governance?

1. Business success – improved controls and decision-making will aid corporate success as
well as growth in revenues and profits.
2. Investor confidence – corporate governance will mean that investors are more likely to
trust that the company is being well run. This will not only make it easier and cheaper
for the company to raise finance, but also has a positive effect on the share price.
3. Minimization of wastage – strong corporate governance should help to minimize waste
within the organization, as well as corruption, risks and mismanagement.

Corporate social responsibility

Corporate social responsibility (CSR) refers to the idea that a company should be sensitive to
the needs and wants of all its stakeholders, rather than just the shareholders.

Organizations have an obligation to consider the interests of customers, employees,

shareholders, communities, and ecological considerations in all aspects of their operations.

‘CSR is the continuing commitment by business to behave ethically and contribute to economic
development while improving the quality of life of the workforce and their families as well as of
the local community and society at large.’ (WBCSD meeting in The Netherlands, 1998)

CSR involves being sensitive to the needs of an organization’s stakeholders. This means that in
order to improve its CSR position, an organization must first understand who its stakeholders
are and what they expect.

Key issues in the CSR debate include:

 employee rights, e.g. laws to prohibit ageism and other discrimination at work
 environmental protection, e.g. reducing factory emissions of poisons and pollutants
 supplier relations
 community involvement

Some arguments for and against companies embracing corporate social responsibility are as
follows:
 For Against
Large companies can be very powerful and, as Companies can benefit societies most by
they are not democratically accountable, may operating efficiently and maximizing wealth
infringe on others’ rights if they do not for shareholders
exercise self-restraint
Companies depend on society’s Companies already fund society’s
infrastructure to function infrastructure via taxes
A company’s operations may have social It should be up to shareholders to donate to
consequences that need to be addressed, charities if they wish to, not for companies to
e.g. pollution, environmental damage undertake charitable activities
Adopting corporate social responsibility can Companies should already be focused on
result in a better image and greater anything that will enhance shareholder
customer and employee loyalty value without labeling it corporate social
responsibility

Formal and Informal Organizations

The informal organization and its relationship with the formal organization

the formal structures of an organization have been designed by management to try and ensure
that the organization meets its goals.

Now let us take a look at the informal organization.

The informal organization is the network of relationships that exist within an organization.
This network evolves over time and tends to arise through common interests and friendships
between members of staff. These relationships are often across divisions.

An informal organization will be present to some degree within all formal organizations.
Think of the informal organization as being an aspect of the organization’s culture.

The advantages and disadvantages of informal organization are:

Advantages
 If managers can work with the informal groups within their department, there should
be higher levels of motivation and productivity.
 Interdivisional communication should be better through the informal network. This
could lead to increased innovation which should help the company succeed.
 The informal organization may also help maintain conformity in the organization. For
example, employees will be unlikely to dress too casually if others in the company are
likely to disapprove.
Disadvantages
 If the formal structure is in conflict with the informal structure, the organization may
end up being inefficient at meeting its objectives. This can arise due to, e.g. formal lines
of communication being blocked as informal lines of communication are more efficient
and become more important.
 If managers try to implement change, they may find opposition from not only the formal
but also the informal organization e.g. change in one division, may lead to companywide
unrest as word of the changes spread through the informal network, and other divisions
start to be concerned that ‘they will be next’ (the grapevine effect).
 The informal organization may also encourage conformity. This means that employees
may be unwilling to perform too well in case it ‘shows up’ less productive members of
staff. This will harm the efficiency of the organization.

Communication

Communication is the means by which we create, transmit, and interpret ideas, facts, data, feelings and
opinions. It is, therefore, easy to see communication as a sharing of experience or interchange between
two or more persons.

In organizations, communication flows vertically and horizontally. Horizontal communication is the

transmission of information between people, divisions, departments or units within the same level of
organizational hierarchy. Vertical communication is the transmission of information between different
levels of the organizational hierarchy.

The communication process involves the following elements:

- Sender
- Receiver
- Message
- Channel
- Feedback

Informal communication channels are also features of an organization’s communication system. These
informal communication channels are called the grapevine. The grapevine transmit messages that may
or may not be true about what is happening in the organization.

References:

[Link]

ACCA Study Text: F1 Accountant in Business AB, ISBN 978-1-78415-805-7, Kaplan Publishing