Economic Entity Principle

Ownership and Management are two integral functions in any specific organization. The bigger the organization in terms of size, these functions will keep on separating and becoming prominent. For instance, in the case of the sole proprietorship, the said functions are concentrated in one single person, however, in the corporation there can be hundreds of man representing the ownership function in the form of shareholders and likewise there can be hundreds of man representing and discharging the management of the organization function.

Concept of the Principle

It is very important accounting principle and is a fundamental on which the accounting standards are based and the further requirements are set out. The principle emphasizes upon keeping the two functions separate and application of the same spirit in the financial records and statements. The personal and domestic financial records will be kept distinct from the business records and statements. The principle may be commonly referred to by the other nomenclature such as business entity assumption, business entity principle.

Importance of the Economic Entity Principle

The keeping of the separate records will help in the realization of the true financial picture of the business and the stakeholders can make their decisions in favor or against the organization using the fair financial information about the organization that is not mixed with the financial information of the owner. The records are neither overstated nor understated and henceforth represent the true financial picture of the concern. In addition if the records of the owner and business are integrated, then it would not be possible to audit the financial affairs of the organization which will put question mark on the financial records of the organization.

Economic Entity Principle and the Legal Perspective

Legally the things are quite different. The law makes no distinction in the ownership and management and regards the sole proprietorship as the single entity. However, in the case of the partnerships and corporations the ownership and management functions are separated and corporation and partnership are treated as separate legal entity just like the Economic Entity Principle.

Economic Entity Principle and Consolidation

In the contemporary business world, the businesses have surpassed the international and domestic borders giving rise to the multi-establishment businesses operating in different geographical locations. The affairs of the business are controlled by the central management. This group of entities or alternatively companies is treated as single entity in real time for the preparation of the consolidated financial records in relation to the group. In that case, the economic entity principle will be applied in relation to the whole of the group and treat it as a single entity in real-time for the reporting purposes.

The concept of the economic entity principle becomes of increasing importance in relation to the businesses that have just commenced owing to the fact that there is increasing likelihood of the owners to commingle their personal funds with the financial capital of the business. The distortion of the results of the financial operations of the organization would necessitate the employment of a qualified accountant that will help with the reclassification of the transactions and events and thus present the true and fair financial results of the organization.