Economic Entity Assumption
The accounting principle that a business's financial records must be kept completely separate from the owner's personal finances.
What is Economic Entity Assumption?
The economic entity assumption is one of the foundational principles of accounting, holding that a business is a distinct entity separate from its owners, partners, or shareholders. Financial transactions of the business must be recorded separately from the personal financial activities of those who own or operate it. This applies regardless of the legal structure—whether a sole proprietorship, partnership, or corporation. The assumption enables the preparation of meaningful financial statements that reflect only the business's performance and financial position. Without it, comparing one company's financials to another's would be impossible, and lenders and investors could not assess business risk independently of its owners' personal wealth.
Example
A sole proprietor uses a personal credit card to buy both office supplies for the business and groceries for home. Under the economic entity assumption, only the office supply purchase should appear in the business's accounting records. Mixing personal and business transactions—called 'commingling'—violates this assumption and can create legal and tax problems.