What is the Economic Entity Principle?The economic entity principle states that the recorded activities of a business entity should be kept separate from the recorded activities of its owner(s) and any other business entities. This means that you must maintain separate accounting records and bank accounts for each entity, and not intermix with them the assets and liabilities of its owners or business partners. Also, you must specifically associate every business transaction with an entity. Show
A business entity can take a variety of forms, such as a sole proprietorship, partnership, corporation, or government agency. The business entity that experiences the most trouble with the economic entity principle is the sole proprietorship, where an owner routinely mixes business transactions with his or her own personal transactions. It is customary to consider a commonly-owned group of business entities to be a single entity for the purposes of creating consolidated financial statements for the group, so the principle could be considered to apply to the entire group as though it were a single unit. The economic entity principle is a particular concern when businesses are just being started, for that is when the owners are most likely to commingle their funds with those of the business. A typical outcome is that a trained accountant must be brought in after a business begins to grow, in order to sort through earlier transactions and remove those that should be more appropriately linked to the owners. Terms Similar to the Economic Entity PrincipleThe economic entity principle is also known as the business entity assumption, business entity principle, entity assumption, entity principle, and economic entity assumption. What is the Business Entity Concept?The business entity concept states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. Doing so requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner. Without this concept, the records of multiple entities would be intermingled, making it quite difficult to discern the financial or taxable results of a single business. Here are several examples of the business entity concept:
There are many types of business entities, such as sole proprietorships, partnerships, corporations, and government entities. Reasons for the Business Entity ConceptThere are a number of reasons for the business entity concept, including the need to separately track taxes, financial performance, and financial position for each entity. It is also useful for when an organization is liquidated, to determine the amounts of payouts to the various owners. Further, the business entity concept is needed from a liability perspective, to ascertain the assets available in the event of a legal judgment against a business entity. And finally, it is not possible to audit the records of a business if the records have been combined with those of other entities and/or individuals. The business entity concept, also known as the economic entity assumption, states that all business entities should be accounted for separately. In other words, businesses, related businesses, and the owners should be accounted for separately. Even though the tax law looks at a sole proprietorship and the owner as one entity, GAAP disagrees. The owner and the business are two separate entities and should be accounted for separately. The same goes for partnership and corporations. The partners and shareholders’ activities should be kept separate from the partnership and corporate transactions because they are separate economic entities. The economic entity assumption does not always apply to a legal entity. For
instance, a parent corporation and its subsidiaries can issue consolidated financial statements without contradicting the economic entity principle. A single company can also segregate business operations by department if the definition of “entity” is deemed to be within a company. This business separation is useful for financial statement users. They can differentiate between
the actual company activity and the ownership involvement. In other words, an investor can see if the business has good cash flow from it’s profitable operations or because the owner keeps funding the business with owner contributions. – Mike, a partner in Big House Realty, LLC, often uses his company credit card for personal expenses like dry cleaning and new clothes. He insists that these are business expenses because he must wear new clothes in order to show houses. Unfortunately,
these are not 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 accounted for as an owner withdrawal. – Assume Bob, a local landscaping business owner, decides to branch out and buy another existing business: a concrete company. This way his concrete company can pour footings and walkways and his landscaping business can landscape around them. Since Bob owns both companies personally, he thinks that he can combine both companies accounting records into one Quickbooks file. According to the business entity concept, both of these companies are separate entities and must be accounted for separately even though Bob is the owner of both companies. If Bob’s landscaping company had bought the concrete company, both companies would have merged and could be reported together. – Jim, an owner of a pizza shop, decides to buy a new delivery car. Since the company was low on cash, Jim decided to pay for the car himself out of his personal bank account. Jim intends to add the car to the balance sheet of the pizza shop. The economic entity principle requires Jim and his company to keep activities separated, so the car must remain a personal vehicle unless Jim contributes it to the company or the company buys it from Jim personally.
 What is the business entity assumption?A business entity assumption is a term used to refer to an accounting principle that declares the separation of every financial record of the business from any of the financial records of its owners or that of other businesses.
What are the 4 types of assumptions?They make four key assumptions: ontological, epistemological, axiological, and methodological assumptions.
Which of the following assumptions that requires the distinction between business transactions and personal affairs of the owner?Economic Entity Assumption. A key accounting assumption that is especially important for small businesses is the economic entity assumption. This assumption assumes that the accounting records of a business and the personal accounting records of the business' owner will be kept separate.
Which of the accounting assumption distinguishes between owner and the business?The economic entity assumption is an accounting principle that separates the transactions carried out by the business from its owner.
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