Key Concepts
Accounting entity theory:The business is treated as a separate entity, distinct from its owner(s). All transactions are recorded from the perspective of the business, not the owner.
Implications:
| Situation | What to do |
|---|---|
| Owner invests cash into the business | Record as Capital (business received cash from owner) |
| Owner withdraws cash from the business | Record as Drawings (business paid cash to owner) |
| Owner takes goods from the business for personal use | Record as Drawings at cost (business lost inventory) |
| Owner pays a business expense from personal funds | Record as Capital contribution (owner gave resources to the business) |
| Owner buys something personal using business cash | Record as Drawings (business resources used for owner's personal benefit) |
| Owner buys something personal using own cash | Do not record in business books |
Exam Tip
When asked whether a transaction should be recorded in the business books, ask: "Did the business gain or give up something?"
- If yes → record in business books
- If no (purely personal — the business neither gained nor gave up anything) → do NOT record
Every entry asks: "Did the business gain or give up something?"
- Owner puts personal money into the business → business gained cash → Capital (Equity ↑)
- Owner takes business cash or goods for personal use → business gave up an asset → Drawings (Equity ↓)
- Owner pays a business liability from personal funds → business's debt is cleared → Capital (Equity ↑), Liabilities ↓
- Owner does something purely personal without touching business resources → do not record
- Imran transferred $4,000 from his personal savings into the business bank account.
- Imran paid his personal phone bill of $150 using his own credit card.
- Imran took $300 cash from the cash register for personal grocery shopping.
- Imran paid a $200 Trade payables balance owed to a supplier using his personal cheque.
Event 1 — Personal savings invested into business
Record? Yes — the business gained cash.
Effect: Assets + $4,000 (Cash at bank); Equity + $4,000 (Capital).
Event 2 — Personal phone bill paid from personal funds
Record? No — the business neither gained nor gave up anything. Purely personal.
Event 3 — Cash taken from cash register for personal use
Record? Yes — the business gave up cash.
Effect: Assets − $300 (Cash in hand); Equity − $300 (Drawings).
Event 4 — Owner settles business Trade payables from personal funds
Record? Yes — the business's liability was cleared by the owner's personal payment.
Effect: Liabilities − $200 (Trade payables); Equity + $200 (Capital contribution). Assets unchanged.
Recording purely personal transactions in the business books. If the owner uses personal funds to pay a personal expense — without involving any business asset or liability — this must NOT be recorded. The business is a separate entity and only records what directly affects it.
Treating the owner's personal payment of a business liability as a business cash payment. When the owner pays a trade payable from personal funds, no business cash is used. The correct entries are: Trade payables decrease (Liability ↓) and Capital increases (Equity ↑). Do not touch Cash at bank.