Business Entity Concept of Accounting


Definition of Business Entity Concept (Convention, Principle):

“Business entity concept (convention, principle) of accounting entails that business is to be treated as a self-contained entity. Business is different and distinct from its owner or those who are concerned with business. Business entity concept necessitates that owner’s personal transactions must be segregated (separated) from business transactions”.

Explanation, Use and Application of Business Entity Concept in Accounting:

The only time when the owner’s transactions appear in the business records of when owner gives anything to the business (capital), or takes anything out of the business (drawings). For example, rent paid for business premises is treated as business expenditure but payment of rent for owner’s house out of business funds is treated as his drawings. This distinction between the two types of transactions is necessary in determining profitability and assessing financial position in a more objective and fair manner.

In legal terms, a legal entity is the one which has legal standing in the eyes of law and is capable of having legal rights and performing duties. It can enter into legal contracts similar to a natural person. Law, however, differentiates owners and their businesses in limited companies only but from accounting point of view, the owner is always treated as a separate entity in all forms of organizations.

Solved Example of Business Entity Concept:

The owner of a business pays for a holiday out of his personal bank account.

Solution:

The business entity concept of accounting states that this transaction should not be considered while preparing the financial statements as there is no change in any of the business items.