Theory Base of Accounting — Account STD 11 Commerce — Question

According to this concept, business is treated as a unit separate and distinct from its owners, creditors, managers and others. In other words, the owner of a business is always considered as distinct and separate from the business he owns. Business unit should have a completely separate set of books and we have to record business transactions from firm's point of view and not from the point of view of the proprietor. The proprietor is treated as a creditor of the business to the extent of capital invested by him in the business. The capital is treated as a liability of the firm because it is assumed that the firm has borrowed funds from its own proprietors instead of borrowing it from outside parties. It is for this reason that we also allow interest on capital and treat it as an expense of the business. Interest on capital reduces the profits of the firm and at the same time it increases the capital of the proprietor. Similarly, the amount withdrawn by the proprietor from the business for his personal use is treated as his drawings. Likewise, goods used from the stock of the business for business purposes are treated as the expenditure of the business but similar goods used by the proprietor for his personal use are treated as his drawings.
Because of the concept of separate entity, the proprietor's house, his personal investment in securities, his personal car and personal income and expenditure are kept separate from the accounts of the business entity. Also, if the proprietor has some other business entity doing another business, the records of that business should also be kept separate. In the absence of the concept of separate entity, the net profits and financial position of a business entity cannot be known. The concept of separate entity is applicable to all forms of business organisations, i.e., sole proprietorship, partnership or a company.