Entity Theory: Separation of Business and Owners The Entity Theory is a legal and accounting doctrine that holds business firms to be separate entities from their owners, directors and other stakeholders. This principle is used in accounting, taxation and regulation to create clarity and order and to separate the interests of the company from those of the stakeholders. It allows for the calculation of profits and losses among a set of related transactions and the formation of incorporated and limited liability companies. The Entity Theory is based on the Latin legal maxim “societas separatis suis membris” meaning a corporation is distinct from its members.

The Entity Theory has a long history in law. As early as the fourteenth century, a form of this theory was articulated by the English legal philosopher Thomas Hobbes. In his classic work, Leviathan, Hobbes declared that "A Company has a perpetual succession and hath a distinct corporate life and the members have the deeds of one into the other, in no way violates the state, nor the rights of the members are infringed,” which has been interpreted to mean that the corporation is distinct and separate from its members and as such would fall under the Entity Theory.

The Entity Theory has a number of benefits. It helps to provide legal and economic clarity since it clearly separates the interests of the company from those of the individual members. This way, company directors, businesses and owners can plan their operations with a more objective and informed approach. Further, while the doctrine provides limited liability protection to the owners, it also allows them to gain profit or loss on the transaction separately from the other members’ profits or losses. This helps to prevent conflicts of interests within the corporation.

The Entity Theory however is not without its criticisms. It has been said to have an inherent detached view of reality and to possibly contribute to agency problems. Its focus on a separation between members of the company and its legal entity which make it difficult to extend the doctrine to informal organizations, partnerships and non-profits. Further, in some cases, the doctrine has been criticized for its rigidity and its lack of recognition for the true nature of certain enterprises.

In closing, the Entity Theory is a long-standing legal and accounting doctrine that unanimously holds business companies as distinct and separate entities from their owners and directors. This doctrine provides many benefits in terms of clarity and in preventing conflicts of interests. However, it is not without its criticisms and should be used with caution and in the context of the overall business environment.