The Proprietary versus the Entity Theory Essay Example | Topics and Well Written Essays - 2000 words

The Proprietary versus the Entity Theory - Essay Example The proprietary theory suggests that business or other organizations tend to belong to one or more persons thought of as proprietors or owners, and their views are reflected in the accounting process used by the business. So assets of the business are considered as assets of the proprietors and their liabilities are considered as their liabilities. The balance sheet equation would thus be "Assets—Liabilities = Proprietorship.'' (Riahi-B, 2004) The stockholders are seen as individuals joined in owning a business and a corporation is thus not seen as fundamentally different from a sole proprietorship. The corporation is seen as a "device of a representative nature by means of which the association's business affairs may be conveniently administered with certain legal privileges and within certain legal limitations."' (Riahi-B, 2004) Using a proprietary theory, in accounting practice, the emphasis is on the proprietor's equity and the proprietors' net income and changes in income or other aspects of the proprietorship. The retained earnings also belong to the proprietors. However stockholders are distinct from creditors and the distinction is based on proprietorship as creditors may not be proprietors but stockholders are usually proprietors so proprietors in a business organisation include all stockholders. Usually most accountants consider shareholders as owners and proprietorship is more easily determined in a small business enterprise although proprietorships could range from individual proprietorships for each, a partnership, or corporation. Some features that proprietors seek are high profit (including minimizing taxes), little risk, continued existence, ease of sale of interests, etc (Lewis-Pendrill, accessed 2011; Riahi-B, 2004). One criticism of proprietorship is that it is not possible to determine the profits of individual common stockholders of a corporation and corporate profit when equated with personal gain of proprietors defines the propriet ary concept yet there isn't much support to this. The stockholders' share of increase in proprietorship through residual equity shows the applicability of the proprietary concept and stockholder control. Yet stockholders have to be responsive to the wishes of equity interests as they are the owners and have greater control and bear greater risks and rights of residual equity (Riahi-B, 2004, Mourik, 2010). Usually large businesses have stock option plans for their executives along with incentive bonus plans. This has resulted in management interests to increase profits and identify interests with those of proprietors (Hendriksen and Breda, 1992). The entity concept suggests that a business or unit accounted for or considered within accounting practice must be considered as entirely separate from shareholders and owners of the business. Thus the business is seen as not an ownership but a separate entity. The entity is thus seen as having a separate and distinct existence from its owne rs and the owners are almost seen as long term creditors. The balance sheet equation suggests that " Assets=Equities." (Mourik, 2010) However despite the simplicity of the concept , the entity theory faces some confusion and uncertainty and the nature of equities is not completely clear. There are also difference of opinions and although creditors and owners are seen as distinct, accounting processes treat them similarly