What is an accounting entity?

During the major accounting scandals of 2001, Enron attempted to transfer significant business and debt losses to special purpose entities in order to keep negative financial information out of its publicly disclosed financial statements.

An accounting entity is an organization that records and reports business or financial information separately from other companies. Accounting entities must have economic transactions resulting from transactions at a distance in the business environment; these transactions indicate that the entity is a legal company and has important financial information that must be reported to internal or external users. Accounting entities can be an independent company or subsidiary or individual division of a parent company. A subsidiary or divisional accounting entity must have its financial information reported separately from the parent’s financial information or statements. Parent companies must follow specific accounting or legal rules when conducting business transactions with their subsidiaries.

Major scandals rocked the accounting industry in the early 2000s.

To be considered an independent business operation, accounting entities must not have more than 50% of their voting shares owned by another company. Generally accepted accounting principles (GAAP) require parent companies to report business information in the consolidated financial statements if they own more than 50% of the voting shares of another company. This rule also applies to the ownership levels that parent companies have in subsidiary companies. The percentage of ownership interest between a parent company and an individual accounting entity is a basic guideline for determining how each company reports business information in the financial statements.

Companies should proceed with extreme caution when reporting financial information about individual accounting entities or subsidiary businesses. Attempting to transfer major debts or other obligations from the parent company to a separate accounting entity can have serious legal implications. Transferring income or business assets from an accounting entity to a parent company can also have serious complications as it will present false information to private investors. Public companies may also be subject to independent investigations by the United States Securities and Exchange Commission (SEC) regarding their activities in using a separate accounting entity to conduct business operations. These independent investigations date back to the early 2000s, when some major accounting scandals rocked the accounting industry.

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During the major accounting scandals of 2001, Enron attempted to transfer significant business and debt losses to special purpose entities in order to keep negative financial information out of its publicly disclosed financial statements. This transfer of financial information was later ruled illegal by federal regulators; Enron was forced to restate its earnings in the financial statements of several prior accounting periods, resulting in operating losses instead of earnings. Enron is now considered a classic example of the misuse of an individual accounting entity to distort financial information.

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