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Business Definition for: entity theory
Dictionary of Accounting Terms
entity theory

view in which a business or other organization has a separate accountability of its own. It is based on the equation:
Assets = Liabilities + Stockholders' Equity

The entity theory considers liabilities as equities with different rights and legal standing in the business. Under the theory, assets, obligations, revenues, and expenses and other financial aspects of the business entity are accounted for separately from its owners. In other words, the company has an identity distinct from its owners or managers.The firm is viewed as an economic and legal unit.

See also proprietary theory
Related Terms:
proprietary theory

theory that assets are owned by the proprietor and liabilities are owed by him. The accounting equation is:

Assets - Liabilities = Capital

Capital is the net value of the business to the owner.

Under the proprietary theory, revenues increase capital, while expenses reduce it. Net income belongs to the owner, representing an increase in the proprietor's capital.

The proprietary theory best applies to single proprietorship entities because there exists a personal relationship between the management of the business and the owner. Often, in fact, they are the same person. It also applies to a partnership where net income is added each period to the partners' capital accounts.

Copyright © 2005, 2000, 1995, 1987 by Barron's Educational Series, Inc., Reprinted by arrangement with Publisher.
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