Question

Define the entity concept and the historical cost concept of financial accounting.

Answer 1

Answer

• Entity Concept

--The entity concept of accounting states that BUSINESS and BUSINESS OWNER are two separate accounting entities.
--Accounting transactions are recorded from BUSINESS’s or Company’s point of view.
--It is therefore that capital provided by business owner is treated as Equity capital and not as ASSET of business, because it had to be returned to Owner.
--For same reason, personal expenses paid by owner from business cash are accounted for as “Drawings or Withdrawals” and not as an EXPENSE of the business.
--As per Entity concept, transactions of a business are separately recorded from those of its owner(s).

• Historical Cost concept.
  --This is a simple concept.
  --It is based on recording of ASSET.
  --It states that all assets (usually fixed) are to be recorded and shown in Balance Sheet at their ‘historical’ cost, that is, the cost at which they were originally acquired.
  --This restricts updation or changes in the value of asset when the market value of asset changes.
  --Historical cost method is used for assets in US under generally accepted accounting principles (GAAPs)