The business entity concept states how the transactions of a business must become separately recorded via those of the owners or various other businesses. Doing so requires the employment of separate accounting records for that organization that fully exclude the assets and liabilities of every other entity or the master. Without this idea, the records associated with multiple entities could well be intermingled, making it very difficult to discern your financial or taxable results of a single business.
Here are several examples of the business entity concept:
- A business issues a $5,000 allocation to its sole shareholder. This is a decrease in equity in the records of the business, and $5,000 of taxable income to the shareholder.
- The owner of a corporation individually acquires an office building, and rents space in it to his company at $15,000 per month. This rent costs is a valid expense to the corporation and is taxable income to the proprietor.
- The owner of business loans $100,000 to his business. This is recorded by the corporation as a liability, and by the proprietor as a loan receivable.
There are several types of company entities, such as sole proprietorships, partnerships, corporations, and government entities.
There are a number of reasons for the business entity concept, including:
- Each company entity is taxed individually
- It is needed to estimate the financial performance and financial situation of an entity
- It is needed when an association is liquidated, to determine the amounts of payouts to the different owners
- It is needed from a liability perspective, to ascertain the assets available in the event of a lawful decision against a business entity
- 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