Entity Concept | Meaning of Entity Concept with Example & Effect

Entity Concept – Entity concept states that business enterprise is a separate identity apart from its owner. Accountants should treat a business as distinct from its owner. Business transactions are recorded in the business books of accounts and 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 in uence of the personal affairs of the owner. This basic concept is applied to all the organizations whether sole proprietorship or partnership or corporate entities.

Entity Concept

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

In Simple Words

Entity Concept – Business is separate from its owner.

Example

Let us take an example. Suppose Mr. Sahoo started business investing Rs100000. He purchased goods for Rs40000, Furniture for Rs20000 and plant and machinery of Rs30000. Rs10000 remains in hand. These are the assets of the business and not of the owner. According to the business entity concept Rs100000 will be treated by business as capital i.e. a liability of business towards the owner of the business.

Now suppose, he takes away Rs5000 cash or goods worth Rs5000 for his domestic purposes. This withdrawal of cash/goods by the owner from the business is his private expense and not an expense of the business. It is termed as Drawings. Thus, the business entity concept states that business and the owner are two separate/distinct persons. Accordingly, any expenses incurred by owner for himself or his family from business will be considered as expenses and it will be shown as drawings.

Effects:

  • Owner’s Capital is shown as a Liability in the Business
  • Amount taken by Owner from business is recorded as Drawings.
  • Owner’s expenses are not recorded in the books of business and if payment is made from business, it is recorded as Drawings.
  • Proprietor cannot use the bank account of business for his personal transactions.

Business entity concept

This concept assumes that, for accounting purposes, the business enterprise and its owners are two separate independent entities. Thus, the business and personal transactions of its owner are separate. For example, when the owner invests money in the business, it is recorded as liability of the business to the owner. Similarly, when the owner takes away from the business cash/goods for his/her personal use, it is not treated as business expense. Thus, the accounting records are made in the books of accounts from the point of view of the business unit and not the person owning the business. This concept is the very basis of accounting

Significance

The following points highlight the significance of business entity concept :

  • This concept helps in ascertaining the profit of the business as only the business expenses and revenues are recorded and all the private and personal expenses are ignored.
  • This concept restraints accountants from recording of owner’s private/ personal transactions.
  • It also facilitates the recording and reporting of business transactions from the business point of view
  • It is the very basis of accounting concepts, conventions and principles.

INTEXT QUESTIONS

Fill in the blanks with suitable word/words

  • (i) The accounting concepts are basic ………………….. of accounting.
  • (ii) The main objective of accounting concepts is to maintain ………………….. and ………………….. in the accounting record.
  • (iii) ………………….. concept assumes that business enterprise and its owners are two separate independent entities.
  • (iv) The goods drawn from business for owner’s personal use are called …………………..