Question

Which principle of Generally Accepted Accounting Principles (GAAP) distinguishes between Business transactions and Personal transactions? Briefly explain about it.

Answer 1

The principle that distinguishes between business transactions and personal transactions is the Business Entity Concept.

This concept treats a business firm as a separate and distinct entity from its owner. The firm has its own set of books, and commercial transactions are recorded from the perspective of the firm rather than the owner.

Implications of the concept:

1. The capital given by the owner is considered a liability of the firm.
2. Interest on capital is considered a business expense because it is paid to the owner.
3. Money or goods withdrawn by the proprietor for personal use are classified as draws.
4. Personal assets and expenses of the owner are kept separate from business records. For instance, if A owns property worth ₹20 lakhs and invests ₹10 lakhs in the firm, only ₹10 lakhs will be considered business property.

This concept is required to ascertain the true net profit and financial status of the company.