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What is Business Entity Concept: Definition and Importance
Handling a business is one of the trickiest things, as small mistakes can result in major losses. Thus, it is important to know various theories and concepts to avoid making these mistakes. Here, a business entity concept requires separate transactions for the owners or other businesses. This helps to avoid the intermingling of various entities, causing errors in tax calculation.
What Is the Business Entity Concept?
According to this business entity’s notion, a firm's transactions must be recorded independently from those of its owners. For this, an organisation must keep separate accounting records, free from the owner's or any other entity's assets or liabilities.
Hence, without this idea, the records of several organisations would be mixed together. This will make it very challenging to distinguish a single company's financial or tax outcomes.
What Is the Business Entity Concept in Accounting?
This idea considers a wide range of people and organisations. They include the proprietors if it is a proprietary business, the partners if it is a partnership firm and the owners who are the stakeholders if it is a corporation.
While owners and active partners operate privately held businesses and partnerships, many corporations are run by persons chosen by the shareholders or handle day-to-day operations.
The management hierarchy may include the Chairman, Managing Directors, and Board of Directors. Also, section heads might choose to oversee particular business endeavours. In addition to these administrators, some employees and labourers carry out particular responsibilities as needed.
What Are the Examples of Business Entity Concept?
If you are an owner and receive a salary, you must include these occurrences in your company's financial data. On the other hand, because there is no impact on the firm's financial situation, it is not recorded in the financial accounts if you invest your funds available in another business or open a money market account.
An example of the business entity principle includes that you are a business owner and borrow money from your company to pay for your child's education. Since it involves using business funds, this withdrawal does not count as a business expense. To imply that the transaction is for the owner's own use, it should be identified as a proprietor's drawings. It excludes paying proprietors' or owners' salaries and business-related expenses.
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Debit |
Credit |
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Cash |
₹100,000 |
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Owner’s equity |
₹100,000 |
What Is the Significance of the Business Entity Concept?
The significance of this concept is multifarious, and a few reasons include the following:
- Separate metrics are used to assess the performances of different business segments or divisions.
- If distinct financial records are kept, auditing is made simpler. The auditors' job of performing their evaluations would be a nightmare if their documents were mixed.
- The taxation of each business division varies.
- Comparing a company's financial performance to others in the industry would be challenging if it violated this premise.
What Are the Limitations of the Business Entity Concept?
Apart from its significance, a few of its limitations of it includes the:
- Since the business is separate, the owner's true value or net worth is hidden.
- The owner makes a budget for the company; it reflects the worth of the company, not the owner.
- Since owners are separate, it will be for the business when he needs to withdraw money from the company.
Hence, simply put, this business entity concept contends that the company's assets, liabilities, revenue, and expenses should be handled independently of the owners' assets, liabilities, income, and expenses. For this reason, the firm as a distinct entity must be linked to the accounting idea of a business entity.