It is always suggested in accounting that the owner should be treated separately from the business. This creates a separate identity for the business. That means it is treated as a separate person. This goes to the extent that a business can file cases for its receipts against anyone with its own name.
The business entity concept states:
“Business should have a separate identity from its owner”
Example of The business entity concept:
Soon after the definition coming of the example makes the thing a little unclear to some but, go through the example and then the instances for you.
PQR co. has a claim against GHI co. for their payment of $ 20,000 which is not yet received by them. So, can they do anything for that?
PQR co. can file a case against GHI co. in court with its own name and there is no need for the announcement of the names of the owners or, the stakeholders.
The entity has an inflow of $.20,000 from the owner within the accounting period and records it in the name of capital. Why?
The reason is, the amount taken from the owner is not any permanent amount and that is treated as a balance which should be paid back to the owner at the end of the lifetime of the business. The difference is that capital gives return in the form of profit not conventional method of interest for loans. And also, the return is not guaranteed profit because, if there is loss the owner should bear it. So, this is the distinguishing feature of the business from its owner.
The recording of drawing is the same. Think for yourself and work it out.
Can’t do it?
Drop us a line if you want more on the business entity concept ; we are here to help.