Business Entity Concept

The business entity concept or economic entity assumption, states that all business entities should be accounted for separately i.e. businesses, related businesses, and the owners should be treated as separate accounts. Even though the tax law considers a sole proprietorship and the owner as a single entity, GAAP disagrees. The propreitor and the business are two separate entities and should be treated so. Same is the caes with partnership and corporations. The partners and shareholders’ activities should be kept separate from the partnership and corporate transactions because they are separate economic entities.

Examples

– Ross, a partner in a property deal company, generally uses the credit card of the company for personal expenses like dry cleaning and new clothes. According to him, these are business expenses because he wears them while showing the properties to the customers. Unfortunately, these can not be treated as business expenses. Clothing is a personal expense and can’t be recorded in the company financial statements. This would violate the business entity concept. Instead, these transactions should be treated as an owner withdrawal.

– Brock, a local flex printing business owner, decides to branch out and buy another existing business: graphic design company. By doing this his graphic design company can design the flexes digitally and the flex printing company would print the flexes. Since brock is the owner of both the companies, he would want to merge both companies accounting records into one Quickbooks file. According to the business entity concept, both of these companies are separate entities and must be treated separately even though Brock is the owner of both companies. If Brock’s flex printing company had bought the graphic design company, both companies would have merged and could be reported together.