What is the difference between ‘separate entity’ and ‘separate legal entity’?

Separate entity is basically an accounting concept where as separate legal entity is a legal concept which overrules the accounting concept of separate entity.

According to separate entity concept (also termed as business entity concept) the business and the owner(s) of the business are two distinct and separate entities which implies that assets and liabilities of the business/organization ARE NOT the assets and liabilities of the owner(s).

However, in the eyes of law, not all the organizations can enjoy this separate status.

There are three different kinds of entities we normally study which are as follows:

  1. Sole Trader
  2. Partnership
  3. Company

In accounting approach all three kinds of organizations are separate legal entities and even the business of sole trader is separate and distinct for its only owner. Same goes for partnership and company.

However, legally, sole traders and partnerships are not separate from its owners and thus does not qualify as separate legal entity. In legal terms, the assets and liabilities of sole trader and partnership organizations are the assets and liabilities of its owners. As the assets and liabilities of these business are attached to its owner completely that is the reason why their owners have unlimited liability towards creditors, lenders etc which means that the resources of the business are not sufficient to pay back all the money owed by the business to its creditors, lenders etc then owners’ private assets will be used to fulfill business liabilities. Even though accounting treat these two kinds as separate entities but legally they are not. Thus legality will overrule accounting approach.

But this is not the case under Company. In the eyes of law, Company (which is third kind of organization) is separate from its owners and thus holds the status of separate legal entity. Because of this fact, owners of companies have their liabilities limited up to interest involved or amount guaranteed in such organizations. And if all the resources of a company are used up and there are sill some lenders and creditors left to pay then owners are not liable pay it as it was the liability of the business not the owners.