Business Entity Concept 2

Topics: Balance sheet, Generally Accepted Accounting Principles, Double-entry bookkeeping system Pages: 15 (3734 words) Published: September 4, 2011

Business Entity Concept- The business and the businessman are two different and distinct entities. I.e. that the firm and the partners, the company and the shareholders, the owners and the organization have their own distinct identities. All accounting is done from the perspective of the business. The accountant regards owners, creditors, suppliers, customers as parties transacting with the business. All transactions are viewed from the point of view of the business.

Money Measurement Concept- Only those facts that can be expressed in monetary terms are to be recorded. Thus important elements of a business enterprise like morale of workers, honesty of management etc. though important, can’t be recorded. The use of a monetary yardstick serves as a common denominator to express other elements of business such as land, equipment, goodwill etc.

Going Concern Concept- This assumes that the business entity will remain in existence in perpetuity.

Cost Concept- Assets acquired by a business are recorded at their actual cost. This concept in tandem with the going concern concept does not consider the existing market price of the assets because such assets would never be sold and hence should be valued at cost. The depreciation is also therefore charged on the original cost.

The principle of Conservatism- This principle modifies the cost concept to the extent that it asks accountants to “anticipate no profit but expect all kinds of losses”. Thus inventory and stocks are valued at cost price or market price, whichever is less.

Accrual Concept- Incomes are what the business earns and expenses are what the business incurs. As a rule any transaction which leads to the increase in the owner’s equity is an income and anything that reduces the owner’s equity is an expense.

The Dual Entity Concept- It is the fundamental concept in accounting. The whole accounting mechanism depends on the function of this concept. According to this concept, each transaction has two aspects.

The Basic Accounting Equation - Assets = Liabilities + Capital. To understand and verify this equation one first needs to be sure as regards the terms used. Assets are defined as anything owned or receivable by the business. They are the resources owned by the business. E.g. Land, building, machine, cash, debtors etc. Liabilities - Anything owed or payable by the business, liabilities are the claims of various parties against the assets of the firm. Capital - Amount required to start or expand business given by the owners and could be in any form. I.e. the owner may give capital in cash or in the form of any other asset. The basic accounting equation states that the total assets of any enterprise would always be equal to the sum total of its liabilities and capital. One could understand this equation intuitively as assets of the business would necessarily have to be financed and this could be funded by either the owners or outsiders and generally such funding is a combination of the two. A more comprehensive understanding of the basic equation would involve taking up a few business transactions and analyzing their effect on the basic equation. Mr. A started business with cash Rs. 100,000 and land Rs. 60,000. 1,00,000 + 60,000 = 0 + 1,60,000

Cash Land Liability Capital

Purchases of merchandise Rs. 60,000.
40,000 + 60,000 + 60,000 = 0 + 1,60,000
Cash Stocks Land Liability Capital

We see the effect of the two business transaction on the basic equation. In the first instance two assets namely cash and land come into existence and against these two on the right hand side we have the owner’s equity. In the second instance we notice that cash reduces but also gives rise to another asset that is the merchandise purchased. We’ll further see how other transactions get incorporated in this...
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