Separate Entity Concept
In accounting, a business entity is treated as a separate entity from the owner(s). Therefore, any capital injections made by the owner(s) are recorded as capital contribution from owners in the books of the business entity. The owner(s)’ private expenditure/spending are not recorded in the books of the business entity.
There are many instances whereby the owner(s) withdrew money from the business for their personal use. This is actually a lending of money from the business to the owner(s) and should be recorded as such in the books of the business entity. On the other hand, when the owner(s) inject cash into the business to help easing tight cash flow situation faced by the business entity, it is a lending of money from the owner(s) to the business and should also be recorded as such in the books of the business entity.
Many owner(s) of small businesses fail to see this “line” drawn between the business and the owner(s). The direct consequence is the recording of private/personal expenditure in the books of the business entities and therefore the financial position and results of the business entities do not show a “true picture” of the business entities. The business entities may face the following problems: –
• Private/personal expenses not adjusted from the profit/income reported for income tax purposes and therefore understating the income subject to tax. Unnecessary penalty and more seriously, jail terms are possible outcome.
• It may cause the application for banking facility unsuccessful should the assessor of the application notice that the owner(s)’ private expenditure is included in the financial statements of the business entities.
• In general, this does not do good to the application submitted by the business entities whereby financial statements are to be included in the application (e.g. project tender, grant application & etc.)
This problem of keeping the books/accounts of business entities “clean” from owner(s)’ private expenditure can be further compounded if the transactions record keeping of the business entities is poor, making any effort to identify these private expenditure recorded in the books of the business entities for adjustment purposes difficult.