An economic entity is a unit separate from all other entities — whether individual or a business — that has some financial activity. The term comes from accounting as many national accounting standards define entities based on the economic or financial activity conducted by the firm. A proper economic entity will have to separate its transactions from the individuals within the firm, such as owners or managers. Mixing transactions between multiple entities can result in serious legal implications and harmful penalties levied by government agencies.
National accounting standards typically dictate a few different business forms that may represent an economic entity. The most common forms include a sole proprietorship, partnership, and corporation. Each one has specific attributes that set them apart from each other.
A business form results when an individual starts a company and operates it through his own ability to work and create value. Under each business form, the individual must keep all transactions from the business separate from personal transactions. The business will result in a separate economic entity that has its own traceable activity and will often be liable for taxes and other fees associated with its business actions.
The economic entity concept also applies to public sector units and government agencies. Each agency must operate under its own guidance and keep its transactions separate from other agencies or the different levels of government, such as federal, state, or local municipalities. Government entities are important because the funds received from taxpayers are often designated for specific use. Co-mingling funds will often result in significant audits from watchdog groups as the misuse of government funds is often a serious problem. Corruption charges are possible if an official working in a government agency misuses or misappropriate funds.
Companies operating under mergers and acquisitions also must operate within the economic entity concept. Properly accounting for transactions between these closely related companies is necessary to avoid an investigation by the government. For example, a company that simply states it has an investment in another company cannot be seen as controlling the other business. Directing another company's actions results in a controlling interest and can change the dynamic of the economic entity principle. The accounting process is different for those companies with a controlling interest and can change the tax structure of the two companies. Violating this principle can also result in a larger investigation that results in penalties and reduces the capital of each company.