An economic entity is a separate unit with financial activity that must keep transactions separate from individuals. National accounting standards dictate business forms, including sole proprietorship, partnership, and corporation. The concept applies to government agencies and mergers and acquisitions. Violations can result in legal implications and penalties.
An economic entity is a unit separate from all other entities, whether individual or commercial, that has any financial activity. The term comes from accounting, as many national accounting standards define entities based on the economic or financial activity carried out by the company. A proper economic entity will need to separate its transactions from individuals within the business, such as owners or managers. Combining transactions between multiple entities can result in serious legal implications and damaging penalties imposed by government agencies.
National accounting standards generally dictate a few different business forms that can represent an economic entity. The most common forms include a sole proprietorship, a partnership, and a corporation. Each have specific attributes that distinguish them from one another.
A business form results when an individual starts a business and operates it through their own ability to work and create value. Under each business form, the individual must keep all business transactions separate from personal transactions. The business will result in a separate economic entity that has its own traceable activity and will often be responsible for taxes and other fees associated with its business actions.
The concept of economic entity also applies to public sector units and government agencies. Each agency must operate under its own guidance and keep its transactions separate from other agencies or different levels of government, such as federal, state, or local municipalities. Government entities are important because funds received from taxpayers are often designated for a specific use. The combination of funds will often result in significant audits by watchdog groups, as the misuse of government funds is often a serious problem. Corruption charges are possible if an official working in a government agency misuses or embezzles funds.
Companies operating under mergers and acquisitions must also operate within the concept of economic entity. Transactions between these closely related companies need to be properly accounted for to avoid a government investigation. For example, a company that simply declares that it has an investment in another company cannot be seen as controlling the other business. Directing the shares of another company results in a controlling interest and can change the dynamics of the economic entity principle. The accounting process is different for those companies with a majority stake and the tax structure of the two companies may change. Violation of this principle may also result in a broader investigation resulting in fines and reducing the capital of each company.
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