Question

"The capital provided by the owner is treated as a liability of the firm." Explain the concept on which the above depends.

“The capital provided by the owner is treated as a liability of the firm.” Explain the concept on which the above principle depends.

Answer 1

1. According to this concept, a business firm is treated as a unit separate and distinct from its owners. A completely separate set of books is kept for the firm and business transactions are recorded from the firm's point of view. The capital provided by the owner is treated as a liability of the firm. Interest on capital is treated as an expense of business.
2. Similarly, the money/goods withdrawn by the proprietor from the firm for his personal use is treated as drawings. The concept of separate entity is necessary for ascertaining the true net profits and financial position of a business firm.
3. In the absence of this concept, the affairs of the firm will be all mixed up with the private affairs of the proprietor and the true picture of the firm will not be available. The assumption of business entity is applicable to all types of business sole proprietorship, partnership and company.

Answer 2

It depends on the 'business entity concept.' According to this concept, a business and a businessperson are treated as two different identities and hence the capital contributed by the owner of the business is treated as liability from the point of view of the business.