Financial Accounting and Reporting-CPA Practice Exam

Which of the following signifies that an entity is a legal business entity?

1. It operates purely as a nonprofit organization

2. It has a majority owned subsidiary that generates profits

3. It is an employee benefit plan

4. It conducts activities on behalf of other companies

The correct answer is: It has a majority owned subsidiary that generates profits

A legal business entity is one that has been established under the laws of a jurisdiction and is recognized as a separate entity that can engage in business activities, such as entering into contracts, suing or being sued, and holding property. The correct choice highlights a situation in which an entity has a majority-owned subsidiary that generates profits, indicating it has the characteristics of a legal business entity. Having a majority-owned subsidiary suggests that the entity is structured for profit-making activities and signifies a level of business operation complexities and responsibilities that are associated with a corporate structure. This scenario is typical for corporations that operate through various subsidiaries to manage risks and expand their operations. The other options do not indicate legal business entity status as clearly. Operating purely as a nonprofit organization does not signify an entity's ability to engage in commercial business, even if it is legally established. Similarly, an employee benefit plan does not conduct business activities on its own or generate profits, and conducting activities on behalf of other companies may indicate agency relationships rather than the existence of a standalone legal entity. Therefore, the presence of a majority-owned subsidiary involved in profit generation is the strongest indicator indicating that the entity operates as a legal business entity.