In which accounting principles the business is considered a separate entity?

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.

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.

Definition: The business entity concept is an accounting principle that requires a business to be accounted for and treated as a separate entity from its owners. In other words, GAAP realizes that a business and its owner are two different things. The business is the entity that attempts to generate profits from its operations; where as, an owner is someone who attempts to generate returns on his or her investment in the business.

What Does Business Entity Principle Mean?

Despite how the tax code treats different forms of business, GAAP requires that companies must be accounted for as a separate entity from their owners. There are three different forms of business entities: sole proprietorship, partnership, and corporation.

A sole proprietorship is the simplest business structure and doesn’t require any legal forms in order to create. You can think of a sole prop as a one-man shop. There is only one owner who is unlimitedly liable for all the company’s actions.

A partnership is an organization of at least two partners. This too can be formed without any legal paper work. Different forms of partnerships like LLCs and LLPs have limited liability protection.

A corporation is the most popular form of business because it protects the owners with limited liability.

Example

All of these types of entities must be accounted for separately from their owners. You can think of the business entity concept like a bank account. The business has its own checking account and the owners have their own personal accounts. The business doesn’t use the owners’ accounts to purchase supplies and the owner doesn’t use the business accounts to may his mortgage. The owners and the company must maintain separate accounts at all times.

If the company needs money, the owners can either lend money to the company or invest more money by purchases more stock or a great ownership percentage.

What is the separate entity principle in accounting?

What is business entity principle or separate entity concept?

What accounting principle states that the business is separated from its owner's having its own distinct personality?

Is business entity a principle?