Question

Explain the following theories of Equity:

1. entity theory

2. fund theory

3. commander theory

4. enterprise theory

Answer 1

Entity Theory:

In entity theory, the entity (business enterprises) is viewed as having separate and distinct existence from those who provided capital to it. Simply stated, the business unit rather than the proprietor is the center of accounting interest. It owns the resources of the enterprises and is liable to both, the claims of the owners and the claims of the creditors.

Accordingly, the accounting equation is:

Asset = Equities or

Assets = Liabilities + Shareholders’ Equity

Fund Theory:

The fund theory emphasizes neither the proprietor nor the entity but a group of assets and related obligations and restrictions governing the use of the assets called a “fund.” Thus, the fund theory views the business unit as consisting of economic resources (funds) and related obligations and restrictions in the use of these resources.

The accounting equation is viewed as:

Assets = Restriction of Assets

Commander Theory:

COMMANDER THEORY holds that the goals of the managers of the entity are as equally important as the stockholders. The theory assumes that the "commanders" view will transpose the view of the investor.

Enterprise Theory:

The enterprise theory of the firm is a broader concept than the equity theory, but less well defined in its scope and application. In the entity theory, the firm is considered to be a separate economic unit operated primarily for the benefit of the equity holders, whereas in the enterprise theory the company is a social institution operated for the benefit of many interested groups.