Why profit is added to capital and loss subtracted from capital.

Sir in the definition of capital it is written that :-
Capital decreases when it is withdrawn or loss is
incurred by business.
I want to know why is it written that loss is incurred
by business... I mean how can a business incur loss,it
is to be incurred by the owner and shouldn't the sentence
be "loss incurred in business."?
Plz help.

asked Mar 14, 2017 in Terminology in Accounts by cute shanaya (18 points) 995 views

1 Answer

0 votes
According to Separate Accounting Entity concept, the business is considered separate from its owners.  While writing the books of accounts, we write the books of business and not the owner.  Owner may have other business also.  So if we are writing the books of business, then loss is incurred or profit is made by the business and not the owner.  According to Separate Accounting Entity concept the amount invested by the owner in the business is a liability of the business towards the owner.  Hence any earnings made by the business are added to capital and any loss incurred is subtracted from capital.
answered Mar 15, 2017 by jbsclasses (3,971 points)
But if we would have considered it from the point of
view of the owner then also the concepts would have
been the same,isn't it?
Then why we write the books from business point
of view?
I mean why didn't we make it according to owner point
of view.
If we write the books of accounts from the perspective of the owner, then his personal expenses and incomes will get mixed up with the incomes and expenses of the business and we will not be able to exactly know the profit/loss of the business and its position at the end of an accounting period.
Plz explain through example.
Let us assume that I start a furniture manfacturing business by investing Rs.2500000.  If I sell my old sofa  to someone for Rs.5000, should it be entered in the books of my firm or not?  It should not be entered in the books of business because it is not the sale of business but it is sale of my personal sofa.  If you record this sale in the books of business, then sale of business will be inflated.  If I pay the college fee of my son, should it be entered in the books of business?  Of course not, because it is not a business expense, it is my personal expense. If I pay rent for my residence, should it be recorded in the books of business?  Of course not, because it is my personal expense and not a business expense.  If I pay Rs.5000 as rent for shop, it should be entered in the books of business because it is a business expense.  If this rent is paid out of the money invested in the business, journal entry should be:

Rent A/c    Dr.   5000

   To Cash A/c                5000

If the rent for the shop is made by me out of my personal money, then the journal entry should be:

Rent A/c   Dr.     5000

   To Capital A/c             5000

In this case since I have paid the rent out of personal money, it becomes a further investment by me in the business, hence capital account is credited.  Since business is considered separate from the owner, now business owes me Rs.5000 more

This is the reason why while writing the books of accounts, we view every transaction from the perspective of business and not the owner.  I hope now the concept is clear to you.
But in both cases whether we record it with business
perspective or owner's perspective, sale of personal
things will not be recorded. Then what is the difference
that owner's perspective makes? I couldn't understand.
Your reply above indicates that now you understand the concept.  When you say that personal things will not be recorded, it means you recognise that while writing the books of business, only transactions relating to business should be recorded.  While writing the transactions relating to business, you view every transaction from thr angle how it effects the business.  For example if the owner introduced some more amount in the business, it means business is getting cash and it also means that it has also incurred a liability towards the owner.  If business pays some money on behalf of the owner, for example owner's son's college fee, it means cash has gone out from the business and business has also reduced its liability towards the owner.

I hope now you understand why we need to view every transacxtion from the perspective of the business and not the owner.
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