Business Entity Concept in Accounting

Introduction

• The business entity concept in accounting treats the business as separate from its owner.
• Applies to all business types: single-owner, partnership, or corporate.

Key Concepts

• Business vs. Owner: Always treated as separate entities.
• Capital: Money invested by the owner, considered a liability of the business to the owner.

Example

• Scenario: Ms. Harshita invests in her pharmacy business.
  • Investment is termed as 'Capital'.
  • From the business perspective, this capital is a liability, as it owes this amount back to Ms. Harshita.

Business Operations

• Involves purchasing assets, goods, paying expenses, etc.
• Profit/Loss:
  • Profit increases capital if reinvested.
  • Owner can withdraw profit, termed as drawings.

Drawings vs. Expenses

• Drawings:
  • Money withdrawn by the owner for personal use, not considered an expense.
  • Debited from capital, not expensed in profit and loss.
• Incorrect Treatment:
  • If drawings recorded as an expense, profit appears incorrectly reduced.
  • Drawings should be deducted from capital, not posted to profit and loss.

Accounting Treatment

• Example:
  • If Ms. Harshita withdraws money to pay school fees, it's treated as drawings.
  • Not accounted as an expense because it doesn't benefit the business.
• Separate Records:
  • Business and owner must keep separate accounting records.

Conclusion

• The entity concept ensures business is viewed independently of the owner.
• Capital viewed as a liability, and drawings reduce this capital.
• Helps maintain clear and accurate financial records.