Accounting Entity

An accounting entity is a distinct organization that functions as a separate economic unit of another organization. Separate financial reporting determines asset ownership in the event of bankruptcy. Companies create these entities to separate risk and cash flows from their parent company. It could also be because the products or services this entity deals with differ from those of the parent company and raise additional capital or credit.

They are required to maintain accounting records and create financial statements for the whole organization as one unit. Accounting records include financial statements, annual reports, inventory lists, depreciation schedules, accounting schedules, accounting documents, accounting entries, and books of account. When the entity must maintain accounts for itself and on behalf of other people, the bookings must be made independently. Individual accounting records can be combined to create accounting records with the summary.

Transactions must be accurately and timely reported and recorded by the entity during the relevant timeframe. If this rule cannot be adhered to, such transactions must be documented and reported when the entity identifies the relevant facts. Regardless of the date of payment or collection of those amounts or the date of settlement by other means, the entity must record revenue and expenses in the accounting period as and when they were incurred. An accounting entity must maintain accounts to ensure its financial statements reflect its financial position and subject-matter facts truly and reliably. If the individual item contents match the relevant facts and the presentation in the financial records complies with the relevant accounting principles and accounting policies, the presentation is considered reliable.

Check out these examples for a better idea:

Example #1 

Suppose ABC Ltd., a household items manufacturing company, wanted to explore new areas of business and launched a new range of cosmetics in a new geographical location. Since this is a new venture in a new location, the company wanted to test the waters by establishing a separate company applying the accounting entity concept. This way, the newly formed company functions separately to work toward cosmetic production. Through this method, ABC separated the risk of business collapse from its existing self.

Example #2

The Enron scandal was an infamous accounting scandal involving Enron Corporation. Enron Corporation, an American energy company, was founded in 1985 by merging two natural-gas transmission companies, Houston Natural Gas Corporation and InterNorth. The company initially made it big, but it started to stumble after some time, resulting in many financial losses. It kept building assets through mark-to-market accounting but disappointingly earned less profit and concealed it by transferring it to an off-the-books corporation. Enron had created a special purpose entity (a limited partnership formed in collaboration with outside parties). The goal of the move was to make this entity the dump yard of Enron's troubled assets. This would enable the company to paint a better picture than its grim reality. The shady practices adopted by the company made its losses appear less severe than they were.

Some of the advantages of creating the entity are given below:

• Internal entities allow an organization's management to evaluate operations from various business divisions independently.
• Financial data from various organizations can be separated, making it easier to record, forecast, and analyze financial data.
• A strategic analysis of organizational activities aids in determining whether to expand or discontinue a particular business activity. 
• Tax assessment is simplified because all transactions are recorded systematically and in accordance with the rules.