BUSINESS ENTITY CONCEPT

BUSINESS ENTITY CONCEPT:
              It is also called Separate Entity Concept.Business is treated separate from its owners. All the transactions are recorded in the books of business and not in the book of proprietor. On the basis of this concept the proprietor is treated as a creditor of the business. When he contributes capital, he is treated as a person who has invested his amount in the business and therefore, capital appears in the liability side of balance sheet of the proprietor's business. Thus, this concept thus requires to make a distinction between (i) personal transactions and (ii) business transactions of the entity in order to ascertain financial position and operating results of business entity.
Effects of this  Concept:

• Financial position of the business can be easily found out.
• Earning capacity of the business can be easily ascertained.

Importance/need of  business entity concept:

The business entity concept of accounting is of great importance because of the following reasons:

1. The business entity concept is essential to separately measure the performance of a particular business in terms of profitability and cash flows etc.
2. It helps in assessing the financial position of each and every business separately on a particular date.
3. It becomes difficult and impossible to audit the records of a business if they are intermingled with those of different entities/individuals.
4. The concept ensures that each and every business entity is taxed separately.
5. The employment of business entity concept is very general among business organizations. If a company ignores this concept, it would not be able to compare its financial performance with that of others in the industry.

Examples

1. Mr. John has acquired a floor of a building having 3 halls for $1,500 per month. He uses two halls for his business and one for personal purpose. According to business entity concept, only $1,000 (the rent of two halls) is a valid expense of the business.
2. The owner of a company lends loan to his company. It would be strictly recorded as company’s liability and that has to be paid back to the owner.
3. Mr. Sam owns a company. He uses two different credit cards – one for the payment of business expenses and one for the payment of personal expenses. He pays $200 as the electricity bill of his company using his personal credit card. According to business entity concept of accounting, the electricity bill of the business should has been paid using company’s credit card. The payment of $200 using personal credit card would therefore be considered as the contribution of additional capital by Sam.