Economic Entity Assumption is a concept that proposes that the activities of any economic entity, such as a hospital, municipality, or business, should be separate from the activities of its stakeholders.
Every economic entity should be constantly analyzed in terms of profitability and overall efficiency. In order to make this possible, analysists have determined that each economic unit should keep its transactions separate from the financial operations of its owners or stakeholders. An economic entity is any type of organization or company that involves business activity. A stakeholder refers to a person or organization that can impact or be impacted by the entity. In addition to separating the transactions of the company and its owners, sometimes a large company can also divide itself into autonomous economic units in terms of profitability. This separation is intended to make the most objective evaluation of a particular business or organization.
The key to an economic entity assumption lies in the credibility of the data provided to the entities that are interested in a certain business. When potential investors are considering financially collaborating with a business, they need to have access to detailed information regarding the entity’s profitability and financial flow. It is important that this data reflect only the transactions of the business, and not those of the stakeholders. This policy also benefits the owners of the company. When they have objective data on the financial transactions of their business, they are able to notice the slightest increase or decline of its profit. Consequently, those stakeholders can avoid investing money in an entity that does not bring any financial advantage to them or the company in general.