Adjusting Entries & Trial Balances

Adjusting Entries & Trial Balances

The simplest form of business entity is the sole proprietorship. If you choose this legal Structure, then legally speaking, you and the business are the same. You can continue operating as a sole proprietor as long as you're the only owner of the business. Establishing a sole proprietorship is cheap and relatively uncomplicated. If you're going to conduct your business under a trade name such as Smith Furniture Store rather than John Smith, you'll have to file an assumed name or fictitious name certificate at a local or state public office. This is so that people who deal with your business will know who the real owner is. In addition, you may have to obtain a business license to do business under state laws or local ordinances (Friedland & Petersen, 1992).

States differ on the amount of licensing required. In California, for example, almost all businesses need a business license, which is available to anyone for a small fee. In other states, business licenses are the exception rather than the rule. But most states require a sales tax license or permit for all retail businesses. Dealing with these routine licensing requirements generally involves little time or expense. However, many specialized businesses -- such as an asbestos removal service or a restaurant that serves liquor -- require additional licenses, which may be harder to qualify for.

From an income tax standpoint, a sole proprietorship and its owner are treated as a single entity. Business income and business losses are reported on your own federal tax return (Form 1040, Schedule C). If you have a business loss, you may be able to use it to offset income that you receive from other sources (VanDuzer, 1997).

Personal Liability

A potential disadvantage of doing business as a sole proprietor is that you have unlimited personal liability.

Example 1: Lester is the sole proprietor of a small manufacturing business. When business prospects look good, he orders $50,000 worth of supplies and uses them up. Unfortunately, there's a sudden drop in demand for his products, and Lester can't sell the items he's produced. When the company that sold Lester the supplies demands payment, he can't pay the bill.

As sole proprietor, Lester is personally liable for this business obligation. This means that the creditor can sue him and go after not only Lester's business assets, but his other property as well. This can include his house, his car, and his personal bank account.

Example 2: Shirley is the sole proprietor of a flower shop. One day Roger, one of Shirley's employees, is delivering flowers using a truck owned by the business. Roger hits and seriously injures a pedestrian (Burton & Bosner, 1985). The injured pedestrian sues Roger, claiming that he drove carelessly and caused the accident. The lawsuit names Shirley as a codefendant. After a trial, the jury returns a verdict against Roger -- and Shirley as owner of the business. Shirley is personally liable to the injured pedestrian. This means the pedestrian can go after all of ...