What is Entity concept in Accounting

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Entity concept in Accounting-By this post, we shall study in detail the important Entity concept out of 12 various accounting concepts on which accounting is based. If you have a business then you should know about these important Entity concepts.

What is the Entity concept?

The entity concept is an important accounting concept that states a business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner. And that’s why this concept is also called the separate entity concept.

How can you explain the separate entity concept?

As discussed above, The entity concept is an important accounting concept that states a business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner. Hence, Business transactions are recorded in the business books of accounts and the owner’s transactions in his personal books of accounts.

The practice of distinguishing the affairs of the business from the personal affairs of the owners originated only in the early days of the double-entry book-keeping. This concept helps in keeping business affairs free from the influence of the personal affairs of the owner. This basic concept is applied to all organizations whether sole proprietorship or partnership or corporate entities.

Can you describe the entity concepts with an example?

The entity concept means that the enterprise is liable to the owner for the capital investment made by the owner. Since the owner invested capital, which is also called risk capital, he has a claim on the profit of the enterprise. A portion of the profit that is apportioned to the owner and is immediately payable becomes a current liability in the case of corporate entities.

For Example, Mr. Ram started a business by investing 500000₹, and with this amount, he purchased machinery for 300000₹ and maintained the balance in hand. The financial position of the will be as follows:

ParticularAmount
Capital500000₹
Machinery300000₹
Cash200000₹

This means that the enterprise owes to Mr. Ram 500000₹. Now if Mr. Ram spends 5000₹ to meet his family expenses from the business fund, then it should not be taken as business expenses and would be charged to his capital account (means his investment would be reduced by 5000₹). Following the entity concepts, the revised financial position would be

ParticularLiabilityAssets
Capital 500000₹495000₹ 
Less: Drawings (5000₹)
Machinery 300000₹
Cash195000₹

What is the meaning of the separate entity concepts?

The entity concept is also called the separate entity concept due to the separate identification of an individual owner from his business that may be a sole proprietorship or partnership or corporate entity.

What is the meaning of the business entity concepts?

An entity concept of accounting is also called the business entity concept because any business such as sole proprietorship or partnership or corporate entity will be treated as a separate entity from the owner of that business.

What is the importance of the business entity concept?

It is very important to the owner of any business due to many reasons such as

Increased accountability – Any utilization of business capital for personal expenditure is considered an expense, it increases the owner’s liability. It obligates the owner to be accountable for the loss of funds and requires them to repay.

Separate Taxation – When it comes to tax filing, you will be thankful you kept your personal and business records separate. If you were to mix them, it would not only get cumbersome. It may cause disruptions to the cash flow and profitability.

Measure Business Performance – The business entity concepts are important because it allows individuals to determine a specific business’s financial performance. For example, investors look through a company’s financial reports to compare them with others in the industry to determine what business to invest in for the best returns. Having separate accounting records will enable you to distinguish how well a company performs.

Competitor Comparisons – A critical part of any business model is to have the ability to compare its performance with the competitors. A key component of the SWOT analysis( Strengths, Weaknesses, Opportunities, and Threats) comes from analyzing the competition and determining where your business fits in the industry. Through this technique, you can determine what is working for you and what needs to be changed. However, it will be a challenge to compare your business to others accurately without proper accounting records.

Auditing – If the financial records are compromised or become mixed, it makes it nearly impossible for auditors to separate the information. The purpose of audits is to assure a business’s financial integrity and confirm all events affecting a company’s performance.

Shareholders/ Stakeholders – For those involved in the business, such as shareholders and stakeholders, accurate financial data is critical for making certain business decisions.

Keeps Multiple Businesses Separate – Just like how you would compare your business to the competition, you can compare your companies to one another accurately to determine how well they are performing.

How does the entity concept work?

In accounting, the business entity concept prevents personal and business expenses from becoming jumble, interfering in determining the correct taxable information. Any money moving to or from the company should be recorded in a separate accounting journal to avoid confusion.

The business entity concept should be applied to every type of business such as sole proprietorship, partnership, and corporation to retain financial integrity for those involved in the company. The purpose of the concept is to ensure the business’ financial statements reflect the company’s performance. It allows shareholders and other stakeholders to determine its financial performance and positioning.

Further Faqs related to entity concept

What is the definition of the entity concept?

The business entity concept declares that a business stands separate from its owner, and hence the two should be treated as separate entities when recording transactions. Therefore, all business transactions (income, expenses, assets, liabilities, and equity) must be kept separate from the owner’s account to ensure accurate accounting records.

What happens when the business entity concept is not observed?

The concept ensures that each and every business entity is taxed separately. 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.

What is the implication of the entity concept?

The business entity concept states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. Doing so requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner.

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