Business entity concept

By: Rashid Javed | Updated on: October 20th, 2021

Definition and explanation

The business entity concept (also known as separate entity and economic entity concept) states that the transactions related to a business must be recorded separately from those of its owners and any other business entity. In other words, while recording transactions in a business, we take into account only those events that affect that particular business; the events that affect anyone else other than the business entity are not relevant and are therefore not included in the accounting records of the entity.

This concept is very important because if transactions of a business are mixed up with that of its owners or other businesses, the accounting information would lose its usability.

The business entity concept of accounting is applicable to all types of business organizations (i.e., sole proprietorship, partnership and corporation) even if a law does not recognize a business and its owner as the separate entities.

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Importance/need of business entity concept

The business entity concept of accounting is of great importance because of the following reasons:

  1. The business entity concept is essential to separately measure the performance of a particular business in terms of profitability and cash flows etc.
  2. It helps in assessing the financial position of each and every business separately on a particular date.
  3. It becomes difficult and impossible to audit the records of a business if they are intermingled with those of different entities/individuals.
  4. The concept ensures that each and every business entity is taxed separately.
  5. The employment of business entity concept is very general among business organizations. If a company ignores this concept, it would not be able to compare its financial performance with that of others in the industry.

Examples

Some examples of the application of business entity concept are given below:

Example 1:

Mr. John has acquired a floor of a building having 3 halls for $1,500 per month. He uses two halls for his business and one for personal purpose. According to business entity concept, only $1,000 (the rent of two halls) is a valid expense of the business.

Example 2:

The owner of a company lends loan to his company. It would be strictly recorded as company’s liability and that has to be paid back to the owner.

Example 3:

Mr. Sam owns a company. He uses two different credit cards – one for the payment of business expenses and one for the payment of personal expenses. He pays $200 as the electricity bill of his company using his personal credit card. According to business entity concept of accounting, the electricity bill of the business should have been paid using company’s credit card. The payment of $200 using personal credit card would therefore be considered as the contribution of additional capital by Sam.

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34 Comments on Business entity concept
  1. John komba

    Nice materials

    1. Niborau.Birimeta

      Nice materials

  2. Elinazi E.E

    So useful materials.congratulations.keep it up.

  3. Fekadu

    hi Mr.
    is it True or False?

    Business entity concept assums that a business entity will continue to exist indefinitly??

    thanks….

    1. Accounting For Management

      It is false because the statement belongs to going concern concept, not to business entity concept.

    2. Surbhi

      What should be written in implications.?

    3. Shadab

      Its false … its is going concern concept

      1. Buyinza musa

        Thanks for this good work

      2. Varsha vinod c

        I have an doubt
        In the following Which type of business organization is not applicable to the business entity concept
        1 Partnership
        2 public company
        3 private company
        4 sole proprietorship

        1. Tanveer hussain

          From point of law only company have legal seperate entity i,e seperate from owners but from accounting point of view all business concerns are seperate from its owners.

    4. troy matz

      its not true

  4. raymond

    WELL EXPLAINED

  5. MUGO_JANE

    Very nice and helpful of you.. Thank you

  6. Muango

    So helpful!!! Thanks a lot

  7. Aruni

    easy to understand…Thank you

  8. Jonkam khimhun

    It is a very helpful dude …..thankyou very much

  9. Niborau.Birimeta

    This text that you have already submitted is very useful to student

  10. Janet

    Nice material. Very useful

  11. martha ambrose

    nice material

  12. Passang

    Is business entity mean business and owner r same or different

  13. Salah Mohamed

    I found it meaningful! Keep on posting such valuable articles.

    1. Me

      Hi!
      True or false?
      The separate entity concept contributes to the objective evaluation of the financial strengths and weaknesses of a business.

  14. Buba

    This material is very helpful

  15. Juliet

    Thank You very usefull
    Regards

  16. Shalini Gupta

    The proprietor of a firm withdrew Rs. 50,000 for his personal use. This was shown as an expense of the firm and hence, profits were reduced thereby. Is this right from an accounting point of view?
    ……………………………………………………………………………………………………………….

  17. Shalini gupta

    The proprietor of a firm contributed Rs. 10 lakhs towards the capital of the firm. Does it means, from an accounting point of view, that the firm had a corresponding liability towards the proprietor?
    ………………………………………………………………………………………………………………………..

  18. Vanessa

    Wow that’s good fact✌

  19. Witness munisi

    Can you assist me coz I haven’t yet understand

  20. Nasasira Noah

    Very nice

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