Separate Entity Concept

Separate Entity Concept in Accounting and other laws

The laws recognizes a company as a ‘ person ’ in its own right, distinct from the personalities of its owners (known as shareholders). In other words, if a company runs up debts in its own name and then has diffi culty in paying them, its suppliers may be entitled to seize the assets owned by the company. But they have no claim against the personal assets owned by the shareholders: it is the company that owes money, not its owners. In law, this distinction does not exist with other forms of business entity, such as the sole proprietor. If Bill Smith is in business as a plumber, trading under the name of ‘ Smith & Co. Plumbing Services ’ , the law recognizes no distinction between the business and the individual. If there are large debts outstanding for plumbing supplies, and the business assets of Smith & Co. are insuffi cient to pay them, the suppliers can demand payment from Bill Smith the individual, who may be forced to sell his personal assets – home, car, and so on. But in this respect accounting conventions do not correspond with the strict legal form of the business.

Separate Entity concept is Crucial in Accounting

 It is an absolutely crucial concept in accounting that, regardless of the legal form of a business – limited company, sole trader, partnership or whatever – the business is treated as a separate entity from its owner(s). For accounting purposes, Bill Smith the individual is not the same as Smith & Co. Plumbing Services. This refl ects the fact that accounting information relates only to business transactions. What Bill Smith does as an individual is of no concern to the accountant, and his private activities must be kept quite separate from the business transactions of Smith & Co. Students often fi nd this concept hard to grasp, particularly when they notice that, as a consequence of it, Bill Smith the individual can actually have business dealings with Smith & Co. For example, Bill may take some copper piping from the inventories held by Smith & Co. in order to repair the heating system in his own home. From the accounting point of view, a business transaction has occurred: Smith & Co. has supplied an individual called Bill Smith with some piping, and its value must be accounted for.

Despite its apparent artifi ciality, the importance of this convention will become apparent in the next section, where we look at an arithmetic relationship called the accounting equation .