I. Text economic entity assumption

An economic entitycan be any organization or unit in society. It may be a business enterprise such as General Electric Company; a governmental unit such as the state of Nevada; a municipality such as Seattle; a school district such as St. Louis District 48; or a social organization such as a church (Southern Baptist).

This assumption requires that the activities of the entity be kept separate and distinct from (1) the activities of its owner and (2) all other economic entities.

The economic entity assumption is generally discussed in relation to a business enterprise, which may be organized as sole proprietorship, partnership, and corporation.

Sole Proprietorships

A sole proprietorship is a business owned by one person, and it is the easiest and the least expensive form of business to start. Many farms, retail stores (antique shops, clothing stores, jewelry stores), and small service businesses (barber shops, law offices, cafes, and auto-repair shops) are often sole proprietorships. Usually only a limited amount of money (capital) is necessary to start business, and the owner receives any profits, suffers any losses, and is personally liable for all debts of the business. Although there is no legal distinction between the business as an economic unit and the owner, the records of the business activities are kept separate from the personal records and activities of the owner. Sole proprietorships represent the largest number of businesses in the United States, but they are typically the smallest in size and volume of business.

Sole proprietorships have a number of advantages. One is ease of establishment. All you have to do to launch a sole proprietorship is to obtain any necessary licences, start a checking account and open your doors. As a sole proprietor, you have the satisfaction of working for yourself. You can make your own decisions, such as which hours to work, whom to hire, what prices to charge, whether to expand, and whether to shut down. Best of all, you can keep all the profits, which are taxed at your personal income rate tax and not the higher corporate rate. As a sole proprietor, you also have the advantage of privacy; you do not have to reveal your performance or plans to anyone.

Disadvantages of sole proprietorships include the limited potential for profit as the company’s financial resources are limited. A single person starting a company generally has less capital than a group of people, and an individual may also have more difficulty getting a loan. The major disadvantage of a sole proprietorship is the proprietor’s unlimited liability. It means that any damages or debts of the business can be attached to the owner. As a sole proprietor, you might have to sell personal assets, such as your family home, to satisfy a business debt. Managerial problems may also develop, as often the owner can’t afford to hire experienced managers. A final disadvantage is that sole proprietorships often have a limited life, in other words the business may cease when the owner dies. Even if the business transfers to an heir, the owner’s unique skills may be crucial to the successful operation of the business.