Entity Concept

In accounting, a business or an organization and its owners are treated as two separately identifiable parties. This concept is called business entity concept. In accounting, the separate entity concept treats a business as distinct and separate from its owners. The business stands apart from other organizations as a separate economic unit. It is necessary to record the business's transactions separately, to distinguish them from the owners' personal transactions. This helps to give correct determination of true financial condition of the business. This concept can be extended to accounting separately for the various divisions of a business in order to ascertain the financial results for each division.

The idea here is that the financial transactions of one individual or a group of individuals must be kept separate from any unrelated financial transactions of those same individuals or group.

An example is a sole trader or one-man business: the sole trader takes money from the business by way of 'drawings': money for his own personal use. Despite it being his business and apparently his money, there are still two aspects to the transaction: the business is 'giving' money and the individual is 'receiving' money. Even though there is no other legal distinction between the sole trader and the business, and the sole trader is liable for all of the debts of the business, business transactions will probably still be taxed separately from personal transactions, and the proprietor of the business may also find it useful to see the financial results of the business. For these reasons, the affairs of the individuals behind a business should be kept separate from the affairs of the business itself.

Examples

Mr. X has three rooms in a house he has rented for $3,000 per month. He has set up a single-member accounting practice and uses one room for the purpose. Under the business entity concept, only 1/3 of the rent or $1,000 should be charged to business, because the other two rooms or $2,000 worth of rent are expended for personal purposes.

"The entity view holds the business 'enterprise to be an institution in its own right separate and distinct from the parties who furnish the funds"The Entity Concept in Accounting