The Separate Entity Concept
In accounting, a business is treated as an entity separate from its owner. This means the owner's private transactions are not mixed with those of the business. Money the owner puts in is recorded as capital, while money taken out for personal use is recorded as drawings.
Three Forms of Business Entity
- Sole proprietorship — owned by one person; easy to set up; the owner bears unlimited liability.
- Partnership — owned by 2 to 20 partners; governed by the Partnership Act 1961; partners share profits and bear unlimited liability.
- Limited company — a separate legal entity; owned by shareholders; enjoys limited liability; registered with SSM (the Companies Commission of Malaysia).
Key idea
Unlimited liability: the owner's private property can be used to pay business debts. Limited liability: shareholders lose only up to the capital they invested.
Example
Mr Lim opens a burger stall as a sole proprietorship. He puts in RM10,000 as capital. If the stall owes RM15,000 and cannot pay, Mr Lim's private property can be claimed because his liability is unlimited. If he had set up a Sdn. Bhd. instead, his liability would be limited to just RM10,000.
Choosing an Entity Form
The choice of entity depends on the needs of the business. A sole proprietorship suits a small business because it is cheap and easy to set up, but its capital is limited and the owner bears all the risk. A partnership lets more people contribute capital and expertise. A limited company can raise large capital through shares and protects the owner's private property through limited liability, but it costs more to run and faces more regulation.
Remember
Sole proprietorship = one owner; partnership = 2–20; company = a separate legal entity with limited liability, registered with SSM.