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Question

'Capital is a liability for the business'.Explain this statement with the principle applied.

                                            Or

Explain the business entity principle with the help of an example.


Solution

According to business entity principle, business is treated as a separate entity distinct from its owners. Accounting information is recorded considering this principle. All transactions are recorded from the point of view of business and not from the point of businessman/owner.

The capital introduced by the owner is treated as a liability from the point of view of a business. The business owes money to the owner to the extent of his capital just like it owes money to lenders and creditors.

Due to this reason, interest on capital is treated as a business expense. Also, because of this principle, the owner's personal property, investments, expenditures are kept separate from the recording of business transactions in the books.

Example Ram started his business with cash. Purchased stock, machinery, and furniture and deposited money into the bank account and also kept some cash in hand. From an accounting point of view, cash introduced by Ram is a liability for the business and is referred to as capital.

The assets purchased are of the business and not of the owner. Also, if the owner withdraws some money for his personal use, it will be termed as drawings and it will reduce the cash (assets) and capital at the same time.


Accountancy

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