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 -
- Companies incorporated under The Companies ACT, 2013
- A Registered Society
- A Limited Liability Partnership (LLP)
- Any Corporation set up under an act of parliament
- A Banking Company
- A Non - Banking Financial Company
- An Insurance Company
- 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 -
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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.
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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.
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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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