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Accounting relies on many assumptions. Among these concepts business entity is a considerable concept.
The business entity concept which is also known as separate entity and economic entity concept states that the business and its owners are two different identifiable parties. In other words, the transactions which affect the business will only be taken into accounts. All the other events which do not affect the business are not recorded in accounts. Simply, that is the accounting records are made from the view point of the business and not from the view point of the owners.
The only time that personal resources of the proprietor affect the accounting records of a business is when they introduce new capital into the business, or take drawings out of it.
This requires the use of separate accounting records which completely exclude the assets and liabilities of any other business entity or the owner. This concept is very important because if transactions of a business gets mixed up with transactions of its owners, it may lose the usability of the information.
Businesses are organized in many forms such as sole proprietorships, partnerships, companies, corporations etc. Although they differ on the level of control exercised by the owners, all the above business forms maintain separate records for those of the owners and the business separately. Therefore, even if a law does not recognize business and its owners as two separate entities the business entity concept is applicable to all types of businesses.
This concept plays a key role in financial statements preparation.
Allows accountants to examine businesses separately regardless of their ownership status.
It is a guideline that every transaction must be assigned to a single entity.
The business entity concept is essential to separately measure the performance of the business in terms of profitability and cash flows.
Helps to assess the financial position of the business on a particular date.
Convenient to audit the records of the business.
This concept ensures that each and every business is taxed separately.
To determine the amounts of payouts to the various owners at the time of liquidating the business.
From a liability perspective, to ascertain the assets available in the event of a legal judgement against the business entity.
Ability to compare its financial performance with that of other businesses in the industry.
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