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Business Entity Concept Essay Ideas

The concept of consistency means that accounting methods once adopted must be applied consistently in future. Also same methods and techniques must be used for similar situations.

It implies that a business must refrain from changing its accounting policy unless on reasonable grounds. If for any valid reasons the accounting policy is changed, a business must disclose the nature of change, the reasons for the change and its effects on the items of financial statements.

Consistency concept is important because of the need for comparability, that is, it enables investors and other users of financial statements to easily and correctly compare the financial statements of a company.

Examples

  1. Company A has been using declining balance depreciation method for its IT equipment. According to consistency concept it should continue to use declining balance depreciation method in respect of its IT equipment in the following periods. If the company wants to change it to another depreciation method, say for example the straight line method, it must provide in its financial report, the reason(s) for the change, the nature of the change and the effects of the change on items such as accumulated depreciation.
  2. Company B is a retailer dealing in shoes. It used first-in-first-out method of inventory valuation in respect of shoes at Branch X and weighted average inventory valuation method in respect of similar shoes at Branch Y. Here, the auditors must investigate whether there are any valid reasons for the different treatment of similar inventory located at different locations. If not, they must direct the company to use any one of the valuation method uniformly for the whole class of inventory.

Written by Irfanullah Jan

The business entity concept states that the transactions associated with a business must be separately recorded from those of its owners or other businesses. Doing so requires the use of separate accounting records for the organization that completely exclude the assets and liabilities of any other entity or the owner. Without this concept, the records of multiple entities would be intermingled, making it quite difficult to discern the financial or taxable results of a single business. Here are several examples of the business entity concept:

  • A business issues a $1,000 distribution to its sole shareholder. This is a reduction in equity in the records of the business, and $1,000 of taxable income to the shareholder.
  • The owner of a company personally acquires an office building, and rents space in it to his company at $5,000 per month. This rent expenditure is a valid expense to the company, and is taxable income to the owner.
  • The owner of a business loans $100,000 to his company. This is recorded by the company as a liability, and by the owner as a loan receivable.

There are many types of business entities, such as sole proprietorships, partnerships, corporations, and government entities.

There are a number of reasons for the business entity concept, including:

  • Each business entity is taxed separately
  • It is needed to calculate the financial performance and financial position of an entity
  • It is needed when an organization is liquidated, to determine the amounts of payouts to the various owners
  • It is needed from a liability perspective, to ascertain the assets available in the event of a legal judgment against a business entity
  • It is not possible to audit the records of a business if the records have been combined with those of other entities and/or individuals

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