Question

A business owner is not keeping financial statements and is paying for everything out of pocket. The violation the Entity Concept of Accounting is recognized . Explain the Entity Concept of Accounting and how to improve the accounting / management of his business by adhering to the concept.

Answer 1

Entity concept of Accounting : Entity concept of accounting is a concept which treats the owner and business as two separate legal entities. The business is differentiated from the owner. Here it is assumed that the business is a separate legal entity which borrows money from owner in form of capital and repays the owners in terms of profits. Separate legal entity means that business's revenue and expenses are it's own and are different from that of owners. In many corporations owners also have limited liability, i.e., they are only liable for any liability of corporation only to the extent of their investment. This requires use of separate accounting records to records assets and liabilities of corporations which are completely different from the owners'.

Accounting/management of his business by adhering to this concept can be improved in the following ways :

1. Valuation / Future projections : By recording assets and liabilities and revenue and expenses of business separately, the owner can determine the profitability of the business, make future projections and actually perform a valuation of the business to decide whether it is worth continuing the same or not.

2. Calculation of accurate project : It helps the owner to calculate the profit accurately to see where the business actually stands.

3. Ease in tax calculation : It helps to calculate taxes separately for both owner and business.

4. True & Fair View : It helps in providing a true and fair view of the operations of the business. Without this concept the owner would not be able to actually differentiate between his own expenses and business expenses as all expenses are being incurred from the same place.

5. Evaluation of performance of business : It helps to evaluate the performance of business in an efficient and effective manner which might also attract other investors to invest in the business.

6. Accounting made easy : By making a distinction between owner and business, this concept allows easy accounting.