Business Entity

Introduction 

The concept of a business entity is a straightforward concept of financial accounting. It simply states that a  business and the business owner are two separate entities and their transactions are to be recorded separately in the book of accounts. Suppose this separation of the recorded transaction of the business from its owner is not to be followed. In that case, it will be confusing with the accounting records, and it will not depict a clear picture of the business. The business transactions done by the business owner, like income, expenses, assets, liabilities, and equity, should be separated from the same owner’s personal spending and transactions.

What is a Business Entity Concept?

The business entity concept, also known as the separate entity concept, is one of the most important concepts. It dictates the fundamental knowledge of recording any transaction in the books of accounts. To understand what a business entity concept is, let us look at an example; imagine that you are the owner of XYZ private limited company and you have rented three rooms on a floor for which you pay twenty thousand rupees each. Now out of these three rooms, you use two spaces for running your XYZ private limited company and one room as a private room. The total rent paid by you will be sixty thousand rupees. But while recording this transaction in the books of accounts of the XYZ private limited company, it will be only forty thousand rupees because of the business entity concept as out of the three rooms, only two are being used for the business.

One for personal use and therefore should not appear on the books of accounts of the XYZ private limited company even though the person using them is the same.

What is the importance of the Business Entity Concept in Financial Accounting?

Following are the importance of the business entity concept:

• For getting a more accurate measure of your business performance, following the idea of a business entity is very important in terms of the cash flows, profitability

• The business entity concept is beneficial in evaluating the financial position of every business separately on a particular date
• While auditing the records of a business, it will become tough if these transactions are intermingled with different entities or individuals
• The concept of a business entity makes sure that the taxation of every business entity is done separately
• It is to be followed strictly by all businesses as processes like taxation, audit, financial comparability, calculating financial performance, etc., would be impossible without keeping the owner’s records separate from the business transactions

Types of Business Entities 

There are mainly 5 types of business entities: sole proprietorships, corporations, general partnerships, limited liability partnerships, and limited liability companies.

• Sole proprietorships: Also known as sole tradership and individual entrepreneurship
• It is called sole proprietorship when one individual owns an enterprise and does not have any legal distinction between the owner and the business entity

• The corporation: It is an independent and legal body that separates personal and business assets
• A corporation is a giant as compared to a sole proprietorship and partnership as it has a large number of shareholders, a board of directors, and officers. In a corporation, profits are taxed twice when profits are made and paid dividends

• General partnerships have two or more owners, and the partners manage the business and share the profits with each other
• In general partnerships, all the partners share risks

• Limited Liability Partnerships: It is a registered business entity
• General partners who control assets and management and limited partners whose personal liability is limited to their investment are this entity’s two types of partners

• Limited Liability Companies: A limited liability company is also called an LLC
• In comparison to a corporation, it is much easier to set up
• Limited liability companies can have one owner or more than that

This was the complete business entity concept for your financial accounting.

Conclusion 

The business entity concept is very simple but can be confused with other financial accounting concepts. The business entity concept states that the transactions of the business and the business owner should be recorded separately as it can create confusion in the book of accounts. Businesses need to follow this concept. It helps in proper auditing and taxation. There are five types of business entities- sole proprietorships, corporations, general partnerships, limited liability partnerships, and limited liability companies. Students should cover this topic thoroughly and understand the difference clearly between this topic and other topics of financial accounting.