written by khatabook | December 2, 2022

Everything You Should Know About Separate Entity Concept

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Table of Content


The Concept of a separate legal accounting entity gets its substance from the legal structure in India. For example - A company or a corporation set up on an act of parliament like LIC, LLP, Registered Society, etc, all these entities are governed under their respective act which establishes that the reporting entity has a separate existence from that of its members. It can conduct its affairs in its own name and enter into legal contracts in its own name.

It is very important that a distinction shall be made. Every reporting entity is a separate entity but all reporting entities are not separate legal entities. For example - a sole proprietary firm is not a separate legal entity but it is a separate entity for financial reporting purposes from their members

Did You Know? The Concept of Separate Entity was established for the first time in the famous English case law Salomon Vs. Salomon and Co Ltd. The House of Lords laid down that a company is a person distinct and separate from its members

What is the Separate Entity Concept in Accounting?

The Indian Accounting Standards issued by the Ministry of Corporate Affairs lays down the framework for the preparation and presentation of financial information. Nothing in the Accounting standards clearly defines the concept of a separate entity. However, the principle of accounting states the separate entity concept.

Thus, the Separate Entity Concept in accounting means that the transactions entered by the members in their personal capacity do not affect the books of reporting entity and therefore, The Entity shall not record the asset and liabilities of members nor does their personal expenses and any expanse of members paid by the entity will be recognized as drawing in the books of accounts of the reporting entity.

Also Read: Learn about Inventory Accounting - Meaning, Objectives, Types & Method

What is a Separate Legal Entity?

Separate Legal entity is a broad concept arising from the legal structure in India. Sec. 9 of the Companies Act, 2013 states that from the date of incorporation, The Company can exercise all the functions of the Incorporated Entity (Including a Separate Legal entity). 

Under the Legal framework, a separate legal entity means that the entity is a person distant from its members who are capable to sue or being sued, enter contracts financially or otherwise in its own name. The Companies cannot sign and therefore can have a common seal to enter into binding contracts.

What are the various Legal Entities in India?

There are various different forms and types of entities that are treated separately from their members in the eyes of law - 

  1. Companies incorporated under The Companies ACT, 2013
  2. A Registered Society
  3. A Limited Liability Partnership (LLP)
  4. Any Corporation set up under an act of parliament
  5. A Banking Company
  6. A Non - Banking Financial Company
  7. An Insurance Company
  8. A Foreign Body Corporate

Also Read: What are Expenses in Accounting? Meaning & Types of Expenses in Accounting

 Benefits of the separate legal Entity

There are various benefits of a separate legal entity both to the members and the entity itself. Following are a few of them -

  • Legal Immunity

Under non-corporate forms of businesses, when the business gets liquidated due to consistent losses, the creditors can claim their losses from the personal estate of the members in proportion to their interest in the entity in case the business is not sufficiently solvent. However, Under a separate legal entity, the members have limited interest in the entity to the extent of their capital in the business, any shortfall of insolvency will be borne by the creditors. Thus, the members are not held personally liable for business losses. Also, the corporate veil can be lifted in case of members involving fraud. 

  •  Capacity to enter Contract

A separate legal entity can enter into legal contracts in its own name and can sue others and be sued for non-performance. Since A business entity is an artificial person, it can enter a contract through common seals, by the authorized signatories. In the case of companies, these are Directors. In the case of LLP, the designated partners.

  •  The Business can own an Asset 

Since the business has a legal substance of its own. It can hold property in its own name and will be obligated to its creditors for the debt and other obligations either financial or otherwise. For tax purposes, the legal entity is separately assessed from its members and therefore holds a separate PAN. Thus, It can open bank accounts in its own name.

Also Read: Cost Accounting vs Management Accounting

How does being a Separate Entity help business owners?

A separate legal entity has many benefits for the members. The important question is who are the members? A member is a person who holds a financial interest in a business entity having the highest risk factor for the amount of capital contribution. Such a member can be an Individual or other body corporate like a company or LLP. However, the following are a few help to the members - 

  • The Creditors are seized to claim their dues from the personal property of the members.
  • Where the affairs of the company are mismanaged, the members are legally immunised to be sued unless the wrongdoing involves the members.
  • The maximum liability of the members is the amount of capital contribution to the business.

Conclusion

A separate accounting Entity is best understood as a separate legal entity. The concept has underlying benefits in accounts and laws. It helps to establish the barrier of personal affairs of the members and the affairs of the entity. While it is the underlying assumption to draw books of accounts as separate entities distinct from their members. It is not quite true that every entity is legally separated from its members. Businesses running in form of sole proprietorship firms or partnership firms are not considered separate legal entities but for reporting purposes, they are separate from the members. This is why proprietorship and partnership firms are not considered as a corporate form of an entity or as it is called body corporate. Throughout the article, we talked about the various implications of a separate entity in accounting, its legal effects, its benefits, and how it helps the members. Hope you enjoyed reading it.

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FAQs

Q: What are the various other entities that are not considered separate legal entities from their members?

Ans:

Following are the entities that are not separate from their members legally -

  • A Sole Proprietorship firm
  • A partnership firm whether registered or not
  • A Registered Trust Under The Income Tax Act, of 1961
  • A Hindu Undivided Family whether Separated or not
  • Any unregistered association of persons conducting commercial business exceeding 200 is considered an illegal association. Thus, Such an association will also be considered as not separate from the members.

Q: What are the Effects of Separate Legal Entity?

Ans:

Following are a few effects of a separate legal entity -

  • The entity is separately liable for tax assessment
  • The entity can sue others or be used for any wrongdoing
  • It can enter into legally binding Contracts
  • A minor cannot be a member of a legal entity unless his capacity is only limited to the benefits from the entity
  • It can open bank accounts in its name
  • A Separate legal entity inherently has a foreseeable future unless an intention appears to curtail its operation.
  • Though, the entity cannot be sentenced for precision punishment. 
  • The Directors involved in the wrongdoing may be sentenced to prison and the entity may be penalized with fines.

Q: Companies incorporated under The Companies ACT, 2013?

Ans:

  1. A Registered Society
  2. A Limited Liability Partnership (LLP)
  3. Any Corporation set up under an act of parliament
  4. A Banking Company
  5. A Non - Banking Financial Company
  6. An Insurance Company
  7. A Foreign Body Corporate

Q: What are the various Legal Entities in India?

Ans:

There are various different forms and types of entities that are treated separately from their members in the eyes of law - Let's have a look at the list of various legal entities in India

  • Public limited company
  • Private limited company
  • Partnership firm
  • Joint venture companies
  • One person company
  • Sole proprietorship
  • Branch office
  • Non-government organization (NGO)
  • Limited Liability Partnership (LLP)

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.