What Is an Entity Assumption?

Alex Newth
Alex Newth
Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

"Entity assumption" is an accounting term that means a business is considered to be a financial entity, with its own status from a financial point of view. While many people are involved in and work for the business, entity assumption excludes these people from being considered part of the business’s status. The business owner often relies on and receives most of his or her money from the business and, while the owner and business may make the same money, both are still considered separate entities. This is easier for accounting purposes, because the accounting department does not have to worry about the owner's and employees' finances to do the business's taxes and make reports.

In entity assumption, the business is treated as if it is a living entity with its own monetary status. This means the business has its own tax number and is regarded as its own being. While the business is not afforded human rights, because it is not human, it can take out loans and make other financial transactions.

Few businesses have just one person doing everything; most businesses have many people who act as employees, managers, supervisors, technical assistants and salespeople. Regardless of the amount of people, they are not considered part of the business in entity assumption. Even the owner or owners are not considered part of the business in this regard, because the owner or owners and the business are classified as separate entities.

At the same time, the owner or owners have a status with the business in entity assumption that most other workers do not have. Owners tend to make most, if not all, of their money from the business, so it would be unfair to tax both the business and the owners; this would result in heavy taxation that can easily take away most of the owners' profits. Instead, the owners can report their earnings and the business's earnings as being the same, and they are then taxed as one entity.

The main reason for entity assumption is that it is much easier for accountants to perform a business's financial work without having to worry about how others are doing financially. For example, if the owners were considered the same entity as the business, then everything they spent money on would have to be reported and filed, which can be difficult for both owners and accountants. Instead, the business is separate and all of its transactions can be easily recorded, monitored and taxed.

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      Businesswoman talking on a mobile phone