Accounting entity definition

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What is an Accounting Entity?

An accounting entity is a business for which a separate set of accounting records is maintained. The organization should engage in clearly identifiable economic activities, control economic resources, and be segregated from the personal transactions of its officers, owners, and employees. The accounting entity concept is used to establish the ownership of assets and obligation for liabilities, as well as to determine the profitability of a specific set of economic activities.

Accounting for an Accounting Entity

Once established, a chart of accounts and accounting policies are created for an accounting entity, which form the basis for a separate system of accounting. Business transactions are then recorded in a general ledger that reflect the ongoing activities of the entity. The outcome of these recordation activities is financial statements that are specific to the accounting entity. The financial statements report on the financial outcomes, financial position, and cash flows of the entity. The entity should also have a set of internal controls that are designed to maintain control over assets and reduce the risk of fraud.

Examples of Accounting Entities

Examples of accounting entities are corporations, partnerships, and trusts. Each of these entities maintains a separate set of records that documents its business transactions, and produces financial statements from these records.

Internal Accounting Entities

Several accounting entities may be created and maintained within an existing business. Once this is done, assets and liabilities are assigned to each of the entities, while their financial results are also reported separately. This is typically done because management wants to set up separate cost centers or profit centers, for which separate financial statements are generated. Here are some of the internal accounting entities that might be created:

  • Cost centers. Units that incur costs but do not directly generate revenue (e.g., IT department, HR department).

  • Profit centers. Units responsible for generating revenue and managing expenses (e.g., sales departments, business units).

  • Investment centers. Units with authority over revenue, expenses, and investments in assets (e.g., subsidiary companies, divisions with strategic decision-making authority).

  • Revenue centers. Units primarily focused on generating revenue without being responsible for costs (e.g., sales teams, customer acquisition teams).

  • Expense centers. Departments that handle specific expenses and support business operations (e.g., R&D, marketing, administration).

  • Projects. Used to track costs and revenues associated with specific projects (e.g., construction projects, software development projects).

  • Departments. Functional divisions within an organization that manage specific business functions (e.g., finance, operations, legal).

  • Divisions. Large, semi-autonomous parts of a company that might operate as standalone entities (e.g., regional offices, product lines).

  • Funds. Specific pools of money earmarked for particular purposes, often used in non-profits or governmental entities (e.g., endowment funds, capital funds).

  • Programs. Groups of related projects or initiatives aimed at achieving specific objectives (e.g., employee training programs, community outreach programs).

  • Business units. Segments of an organization responsible for specific operations or products (e.g., consumer electronics, cloud computing services).

  • Service centers. Units that provide internal services to other departments or divisions (e.g., shared services centers, centralized procurement).

  • Subsidiaries. Legally distinct entities owned by the parent company but considered part of the overall financial reporting structure.

  • Branches. Smaller, geographically dispersed locations that operate under the main entity (e.g., retail stores, local offices).

These arrangements make it much easier to analyze how efficiently various parts of a business are being run. This approach also makes it easier to create budgets by business segment, since the budgets can be derived based on the specific historical financial statements pertaining to each segment.