Separate Entity Concept forms the base of the accounting principles. It means that for accounting ‘The Business’ is treated independently from The Owners”.
This means that even though anything owned by the business belongs to the owners of the business and anything owed by the business is payable by the owners but for accounting purposes we assume that the business is independent of its owners.
If the business purchases a machine or piece of equipment it will own and obtain benefit from that equipment. Likewise, if the business borrows money from ‘someone’ it should repay the money. This somebody includes even the owner of the business.
This treatment of the business independently from its owners is called the Separate Entity Concept.
Separate Legal Entity (Corporate Entity) / Limited Liability
Limited company is a legal entity separate from its owners (called shareholders). The basic difference between a partnership and a limited company is the concept of limited liability. In case a sole proprietor or partnership business runs into losses and is unable to pay its liabilities, its proprietor / partners should pay the liabilities from their own wealth.
Whereas in case of limited company the shareholders don’t lose anything more than the amount of capital they have contributed in the company i.e. their personal wealth is not at stake and their liability is limited to the amount of share capital they have contributed.
Limited company is an artificial legal person. It has a legal entity separate from its owners (shareholders). It can enter agreements under its own name, can sue and can be sued.
What are the different types of business entities are?
In sole proprietorship, there is one person who runs it, and take all the profits. As we studied above the business entity principle, even if a single person runs the business, they should be considered as two separate entities for all account purposes.
Types of partnerships are in entity concept i.e.
In general partnership there is an agreement between two or more come up together to start a business. Each partner invests money called capital to start the company. Except money partner also invest their time and skills. The benefits are shared upon pre-decided terms depending on the capital, skill, and labor they have provided in the business. As like sole proprietorship, the partners can cover all the losses of business from their savings or assets.
Limited Liability Company
Limited liability gives a legal structure for the company where the owner’s assets are not utilized to cover its business loss. Company alone is legally responsible for covering up for its losses in business. These business entities combine the sole proprietorship’s pass-through taxation advantages and the corporation’s limited liability advantage.
Article of incorporation forms a corporation. The stockholders have limited liability in the loss of the corporation. The drawback is ‘double-taxation’ where the company pays tax on its profits, and then shareholders give tax on the dividends they get.
October 04, 2021