An Overview of Contracts and Why They are Important to Business and Society
February 12, 2025
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The entity concept is one of the central tenets of accounting. An understanding of the same is therefore of paramount importance to students. However, the entity concept came as a solution to a problem faced by earlier accountants. To understand the benefits of the solution provided, we must look at the problem first.
In reality a business is just another aspect of a person’s life. When many people get together and start a business, it is their collective effort. However, this can cause confusion for the accountants. Imagine accounting for personal and business expenses together. The accountants would never be able to come to an accurate picture of profits.
To solve this problem, accountants created the entity concept. This was the separation of personal and professional concerns of the entrepreneur. For the purpose of accounting, the business is considered to be an entity which is independent and separate from its entrepreneur.
The separation of concerns in accounting is irrespective of the legal status of the organization. In real life, some forms of organizations like private limited and public limited companies are considered to be separate entities whereas other forms like partnerships and sole proprietorships are considered to be part of the owner’s entity. Accounting does not make this distinction.
The entity concept may seem to be a frivolous and obvious assumption of accounting. However, the implications that thus assumption creates is both start and counterintuitive. Here is a look at the implications.
The entity concept considers the company separate from its owners. Thus, capital is money that owners have lent to the company. This is why it appears on the liabilities side of the company’s financial statements. If you prepare the owners personal financial statements, the same capital will appear as his asset.
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