Definition: The business entity concept is an accounting principle that requires a business to be accounted for and treated as a separate entity from its owners. In other words, GAAP realizes that a business and its owner are two different things. The business is the entity that attempts to generate profits from its operations; where as, an owner is someone who attempts to generate returns on his or her investment in the business.
What Does Business Entity Principle Mean?
Despite how the tax code treats different forms of business, GAAP requires that companies must be accounted for as a separate entity from their owners. There are three different forms of business entities: sole proprietorship, partnership, and corporation.
A sole proprietorship is the simplest business structure and doesn’t require any legal forms in order to create. You can think of a sole prop as a one-man shop. There is only one owner who is unlimitedly liable for all the company’s actions.
A partnership is an organization of at least two partners. This too can be formed without any legal paper work. Different forms of partnerships like LLCs and LLPs have limited liability protection.
A corporation is the most popular form of business because it protects the owners with limited liability.
All of these types of entities must be accounted for separately from their owners. You can think of the business entity concept like a bank account. The business has its own checking account and the owners have their own personal accounts. The business doesn’t use the owners’ accounts to purchase supplies and the owner doesn’t use the business accounts to may his mortgage. The owners and the company must maintain separate accounts at all times.
If the company needs money, the owners can either lend money to the company or invest more money by purchases more stock or a great ownership percentage.