Business Entity Concept explained

The business entity concept explains why founders must separate their personal spending and income from their business. This accounting concept states that a business must be operated from the owners. Therefore, money introduced to the business is referred to as capital, and the amount and goods withdrawn as drawings.

Applying the Business Entity Concept

Equity

Business owners can introduce their personal funds into the business. Also, investors may contribute funds for the business. When this is done, it is necessary to capture it as funds coming from business owners. Therefore, the funds are called Equity capital.

Drawings

For a one-man business, that is, a business registered as an Enterprise may encounter difficulties. When the business owner withdraws cash or goods from the entity. This is not treated as an expense, but rather a withdrawal from the capital the owner contributed to the entity. 

Dividends

For companies, dividends are paid from profit. This is an application of the business entity concept. Therefore, dividends are not business expenses posted in the statement of profit or loss but in the owners’ referred to as the statement of changes in equity. If dividends are not paid, the profit is added to the equity thereby increasing the capital.

Salary

Separating business from ownership also means that the business owners, if involved in the entity, should be paid salaries as company employees. Executive directors who are founders are paid salaries, both fixed and variable. And if the company is listed in a stock exchange, they may get share options as part of their remuneration.

Bank accounts

Business owners must separate their company's bank accounts from their personal accounts. Doing so is in compliance with the business entity concept. Also, it helps in managing the business accurately and with integrity.

Taxes

For taxes, individual business owners who do not separate their business bank accounts from their personal accounts may risk paying higher taxes. More so, they will risk not having access to their bank account when they are a defaulting taxpayer. 

We have heard of situations where the tax authority ordered a post-no-debit to an entity's bank accounts. This will affect the owner if he uses them as personal accounts. 

In conclusion, business entity concepts aid accountants in ensuring financial statement accuracy. Because owners’ funds are operated from the business. This will boost investors' confidence in the company's financials.