Entity theory

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Entity theory assumes that economic activity performed by a business is separate from individual opinions of the owners. Therefore owners are not personally responsible for the company's problems, e.g. liabilities.

The entity theory is a fundamental assumption in todays business around the world. The company is separate from personal finances of the owners. This in case of company problems, owners are responsible only to the level of the money invested in that company. But they cannot be asked to pay debts from their own pocket.

Criticism of entity theory

In real world owners are connected with the company, and their opinions impact performance of the company. Therefore some ask why loaners of the company cannot get back their money from owners in case of company bankruptcy. The owners expect return from money invested in company, so why shouldn't they take also the risk of loss? This leads to change of the legislation in some countries, where only in some special cases it is allowed to claim money also from owners of limited liability company.

References

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