The business entity concept is a fundamental principle in accounting that recognizes the separation between the business entity and its owner for financial reporting purposes.
It emphasizes that the business's financial transactions should be treated separately from the personal transactions of its owner.
Let's consider an example involving Mr. XYZ, who starts a business by investing Rs. 200,000. He allocates Rs. 80,000 for purchasing goods, Rs. 40,000 for furniture, and Rs. 60,000 for plant and machinery. Additionally, Rs. 20,000 remains in hand. These assets are owned by the business, not by Mr. XYZ personally..
In accordance with the business entity concept, the Rs. 200,000 investment is recorded as Capital, representing a liability of the business to its owner. This highlights the distinction between the business and its owner.
Now, let's say Mr. XYZ withdraws Rs. 10,000 in cash or goods for personal use. Such withdrawals are categorized as "drawings" and are considered the owner's private expenses. They are not considered as business expenses.
When the owner invests money into the business, it is recorded as a Capital (liability) of the business to the owner. Similarly, when the owner withdraws cash or goods from the business for personal use, it is regarded as a drawings (private expense) and not an expense of the business.
Key suggestions of the business entity concept:
Profit Determination: By segregating business expenses and revenues from personal transactions, this concept facilita tes the accurate calculation of the business's true profit.
Exclusion of Personal Transactions: The concept ensures that personal transactions of the owner are not included in the business's financial records. This promotes transparency and precision in financial reporting.
Business Perspective: By treating the business as a separate entity, the concept enables accounting for business transactions from the perspective of the business unit itself. This provides a comprehensive view of the business's financial position and performance.
Basis of Accounting: The business entity concept forms the foundation for other accounting concepts, conventions, and principles. It guides the overall framework of accounting practices.
The business entity concept asserts the distinction between the business and its owner. The owner's investment is recorded as a Capital (liability) of the business, and any personal withdrawals are treated as drawings (private expenses).
This concept underscores the separation between the business and its owner for accounting purposes and enabling accurate financial reporting and analysis from a business perspective.