Financial Entity

Background

We've talked at length about how to do transactions and the importance of having the reporting from those transactions being comparable both to former time periods with the same financial entity and also comparable to other financial entity. But what is a financial entity?

Question

Define what a financial entity is. 

A dentist has a home on one side of town. His dental clinic is on the other side of town. For the following transactions, does it affect the dental business or the dentist?

1. Paying the rent on the dental clinic space 
2. Paying the bill for TV cable service at the house
3. Paying the salary of the receptionist at the clinic
4. Paying the car loan on the car the dentist uses 

Answer

A financial entity is a person, group, or organization about which we report on the financial activity. A company or other organization has its activity reported on separate and apart from its owner(s) and also separate from any other financial entity.

1. clinic
2. dentist
3. clinic
4. it depends on which financial entity owns the car - the dentist or the clinic 

Analysis

Let's first talk about what it means to be a financial entity. A financial entity is a person, group, or organization about which we report on the financial activity. A company or other organization has its activity reported on separate and apart from its owner(s) and also separate from any other financial entity.

It isn't always easy to tell what is and what isn't part of a financial entity. The question is designed to highlight this fact.

For many people, they work for a company and are paid a salary for their work (much like the dentist's receptionist - that person works for the dental clinic and is paid a salary for that work). That person is a financial entity - they earn money in the form of a salary, pay for household expenses, perhaps invest for retirement. That person is a financial entity.

On the other end of the spectrum, large corporations such as Apple, Nike, and Amazon are financial entities - they earn money from customers, pay salaries to all the employees, and so on. These companies are financial entities.

So now let's look at the dentist. The dentist owns the clinic, paid money to set it up, earns money based on his education and expertise, approves all the payments, and more. And so in one sense, the dentist and the dental clinic are one and the same - they constitute one financial entity.

However, since we are looking to have the best information available concerning the clinic, we'd want to treat the clinic as a separate financial entity and track all of its activity on its own.

I should note that as the clinic's business speeds up or slows down, the fortunes of the dentist will also change, and so within the dentist's records, we'd show the value of the clinic going up and down accordingly. 

To summarize - the clinic is a separate financial entity - all the activity and transactions related to the clinic will be reflected in any reports done for the clinic. The dentist is also a financial entity and as part of his records, the value of the clinic will increase and decrease.

Let's talk a bit further about this - what would happen if the dentist operated his clinic at his house. Would the whole house be part of the clinic? Part of the house? Any of the house? The answer to this question is up to the dentist - but the best answer would be one that accurately reflects the operations of the clinic separately. So perhaps the clinic pays rent to the dentist for occupying a room of his house?

Let's now answer the second part of the question:

1. For the clinic being in a different part of the city and it needing to operate in a rental space (such as a medical park), the rent paid would be part of the clinic's expenses and so would be reported on the clinic's books:

DR Rent Expense
CR Cash

2. The cable bill for at the dentist's house is not part of the clinic, and so the dentist would report this on his individual books.

DR Cable Expense
CR Cash

3. Paying the receptionist at the clinic is clearly a clinic expense as the receptionist works for the clinic:

DR Salary Expense
CR Cash

4. This one is a bit of a trick question - the question we have to ask is "Who/What owns the car?" If the car was bought by the clinic, then all the expenses related to the car are reported by the clinic. However, if the car was bought by the dentist as an individual, then it'd be reported on the dentist's individual books. In either case, the entry each month, using cash accounting, would be:

DR Interest Expense
CR Cash

(If we used accrual accounting, we'd be reducing the Loan Liability and paying interest this way):

DR Loan Liability
DR Interest Expense
CR Cash

Vocabulary used:

For more information check out these links (comment to add your favourite link):

Where might you have come from?

Fact-orials Index

Accounting Principles:

• Comparability of Transactions

Where might we go?

Accounting Principles:

• Accounting Reports