Accounts are kept for business entities, rather than for the persons who own, operate, or otherwise are associated with the business. The business entity concept assumes that a business enterprise is separate and distinct from the owner or investor.
For example, Mr. A is the sole owner of Bed Linens Online, a sole proprietorship. Mr. A withdraws $100.00 from the business. In preparing financial accounts for the business, we should record the effect of this transaction on the accounts of Bed Linens Online.
In this transaction, Mr. A exchanges $100 of owner’s equity for $100 in cash. Mr. A is no better or worse off than he was before. We have seen that Mr. A is just as well off after this transaction as before. What about the business? It now has $100 less in assets.
Evidently, transactions such as this can affect the owner in one way and the business in another. Financial accounts of Bed Linens Online, however, will report only the effect that the transaction has upon the business.
The fact that accounts are kept for business entities as distinguished from the persons associated with those entities is called business entity concept.
A business may be organized under any one of several legal forms, such as corporation, partnership, or unincorporated proprietorship. The business entity concept applies regardless of the legal status.
Supposing John joined Mr. A to run Bed Linens Online as partners. Each removes $1,000 from the business and puts it in his savings toward the college education of his children. An accounting report of the financial status of the partnership would show that the business has $2,000 less cash.
Personal properties and liabilities of the owner are not included in the business financial statements. Let us assume that Mr. A bought two computer sets, one for his personal use and the other for Bed Linens Online. Only the computer for use in the business should be recorded in the books of the partnership.
It is also required under this concept that if the owner has more than one business firms, the records and financial statements of each should be separately maintained. The accounting process is primarily for the enterprise and secondarily for the owner or investor.
Let us assume that Mr. A, aside from his personal assets and Bed Linens Online, owns two more enterprises, a laundry service and a delivery service. Records and financial statements of the three enterprises should be separately maintained so that decisions can be made for each one of the businesses.
If they are kept in the same set of accounting records, or if the personal activities of the owner are included, it would be difficult to find out which business is financially profitable or solvent.
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