Entity Theory

DEFINITION of 'Entity Theory'

The assumption that the economic activities of a business is distinct from those of its owners. The entity theory maintains that the activities of a business can be accounted for separately from the activities of its owners, therefore the owners are not personally responsible for loans or other liabilities taken on by the company. The entity theory is fundamental to modern accounting.

BREAKING DOWN 'Entity Theory'

From a business liability standpoint, limited liability for owners in certain business structures is very important for commerce. But in order to maintain a system whereby owners are not personally liable for the liabilities of a corporate entity, it must be possible to separate the business finances from those of the owners.

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