Global Journal of Management and Business Research, D: Accounting and Auditing, Volume 22 Issue 2

The Effects of Entity Shielding on Claims to Assets: Implications for Financial Reporting Todd Sayre Abstract- Strong entity shielding enables corporations to shield firm assets not only from shareholders but also from each shareholder’s personal creditors. This implies that corporations, not shareholders, own the firm assets. This paper tests this implication by examining legal scholarship on shareholder ownership. The results indicate that, unlike sole proprietors, shareholders have no legal claims to firm assets. This result responds to FASB/ISAB convergence discussions regarding whether corporate reports should take a proprietary or entity perspective. Shareholders have no claims to firm assets, yet balance sheets imply shareholders have exclusive claims to net assets, identical to those of sole proprietors. Therefore, the propriety perspective appears inappropriate for corporate balance sheets. The paper discusses how standard setters can use entity shielding to determine claims to firm assets as a principled approach to differentiate reporting perspectives among reporting entities. Keywords: reporting entity; reporting perspective; entity shielding; liquidation protection. I. I ntroduction he IASB and FASB’s goal to converge accounting standards faltered over conflicts regarding the “nature of the reporting entity,” which is part of the Conceptual Framework Reporting Entity, Phase D. In a 2008 joint Exposure Draft, IASB and FASB recommended that “[a]n entity’s financial reporting should be prepared from the perspective of the entity (entity perspective) rather than the perspective of its owners or a particular class of owners (proprietary perspective)” (IASB 2008, 5). But when FASB realized that a business corporation’s balance sheet from the entity perspective would not label net assets as Shareholders’ Equity, it abandoned plans to converge reporting entity perspectives. 1 An entity perspective for business corporations would have balance sheet simply that the corporation itself holds exclusive ownership claims to the net assets. For example, FASB requires that nonprofit corporations label the net assets as “Net Assets.” In contrast, FASB continues to require business corporations to use the proprietary perspective, which show shareholders with exclusive ownership claims to the firm’s net assets, including the profit. The reporting perspective most appropriate for each reporting entity (i.e., firm) should depend on underlying principles to which standard setters agree. Author: e-mail: sayre@usfca.edu This paper assumes that the claims that various entities (i.e., firm-members) have to the firm’s resources (i.e., firm-assets) implies what reporting perspective is appropriate for each type of reporting entity (i.e., firm- type). The paper finds that shareholders, unlike sole proprietors, of business corporations have no legal claims to the corporation’s net assets or profit. Instead, shareholders of business corporations have similar claims to those of beneficiaries of nonprofit corporations. The reason for the similarity is that both business and nonprofit corporations have liquidity protection because their firm-assets are shielded from firm-members, as well as the firm-members’ creditors. The ability to shield the creditors of firm-members cannot be accomplished through private contracting and, as such, this type of liquidity protection distinguishes the business corporation from other business firm-types (e.g., partnerships). The paper concludes that this unique feature of liquidity protection afforded to business corporations necessarily restricts shareholders’ claims to firm-assets. Specifically, shareholders, because of liquidity protection, have no claims to the firm’s net assets, while sole proprietors with no liquidity protection have exclusive claims to firm-assets. Therefore, requiring business corporations to present net assets as part of Shareholders’ Equity misrepresents shareholders claims to the net assets. Shareholders do not have identical claims to firm-assets to those of sole proprietors; rather the opposite is true, they have no claims. The shareholders’ lack of claims is more similar to those of nonprofit corporation’s beneficiaries, who also lack claims. 1 The shareholders’ lack of claims to the firm- assets implies that the proprietary perspective is inappropriate for the balance sheet of the business corporation. FASB is aware of the inconsistency, recently replacing FASB (1978 paragraph 30) “claims to those resources,” (i.e., firm-assets) with FASB (2008 OB12), “claims against the reporting entity.” Unfortunately, this adjustment was not based on any explicit underlying principle useful to the goal of converging accounting standards. T 21 Global Journal of Management and Business Research Volume XXII Issue II Version I Year 2022 ( )D © 2022 Global Journals 1 www.iasplus.com/en/meeting-notes/iasb/2010/agenda_1011/agenda 1551#entity-versus-proprietary-perspective