What is Business Entity Concept? Full Explanation with Example

business entity concept

What is Business Entity Concept?

The Business Entity concept of accounting states that owners and business are separate from each other having separate entity. Henceforth, there is preparation of a separate account for recording the transactions of business which do not include owners assets and liabilities.

In simple words, there is separate account fro the entity which is independent of its owners. An entity is any organization or activity for which accounting reports are prepared.

While recording transaction in accounting, the most important question that you have to first answer is that how these transactions affect entity. Secondly how these transactions affect the person or the owner(s) who are part of that entity.

Business Entity Concept Examples

Example 1

Suppose the owner of a clothing store removes 10,000 from the store’s cash register for his or her personal use. The real effect of this transaction on the owner may be negligible but it is also a fact that cash is withdrawn from the business. The cash has been transfer from business pocket to owners pocket. Though the business and cash belongs to owner but as per business entity concept, now business has less cash compare to earlier situation.

Example 2

Suppose there is a married couple who owns and operate a retail store. When it comes to law, there is no distinction between the financial affairs of the store and those of its owners. So, in case, any default arises, the creditor can sue the business and claim over the assets of the retail store as well as couple’s personal assets.

However in case of accounting, a separate account is maintain for the business transactions and does not include any event which has no relation to it. The expenses of operating the store are completely  separate from the couple’s expenses in clothing, food, housing, etc.

Business Entity Concept in Case of Corporation

For a corporation, one can apply the concept very easily. A corporate is a legal entity, separate from the persons who own it. Moreover, the accounts of many corporations correspond exactly to the scope of the legal entity.

It is also possible that within a single corporation, a business is maintaining  a separate set of accounts for each of its principal operating units. For example, General Electric Company maintains separate accounts for each of its many business units.

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