Definition: An entity is an organization established through laws or accounting principles that separates it from its owners, other organizations, and individuals. All business forms are considered entities with the exception of a sole proprietorship. The various forms of partnerships and corporations are legal entities that are legally separated from their owners and other organizations. You can think of an entity as a fictitious person. It’s an organization that only exists on paper.
What Does Entity Mean?
The field of accounting uses the concept of separate entities to properly track and record each business’ transactions and financial information. The business entity principle states that each entity must be accounted for independently. This means that the owners of a corporation can’t comingle funds with the corporation. The corporate income and assets must be separate from the owner’s income and bank accounts.
The legal separation of an entity from its owners carries many benefits. Limited Liability Partnership and Corporation owners enjoy limited liability. This means that the owners of the company are only liable for their investment in the company. In other words, if the company is being sued for damages due to a faulty product, the person filing suit cannot sue the owners. Only the company can be sued because it is a separate legal entity.
In the case of a sole proprietorship where there is no legal separation, a suit could be filed against the business and the owner because the owner of a sole proprietorship is the business. There is no separate entity. The owner and the company are one in the same. This means the owner could lose his house and all his personal belonging due to a business lawsuit.
Owners of a partnership or corporation cannot be sued personally. The only thing these individuals can lose in a business lawsuit is their investment in the stock. In other words, the company could go bankrupt and the owner’s would own stock of a worthless company, but none of their personal possessions would be taken.