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Difficulty: HardAccounting Concepts and Conventions

A sole trader paid ₦250,000\text{₦}250,000 for personal residential rent using funds directly from the firm's bank account. The bookkeeper debited the business rent expense account and credited the bank account. Which fundamental accounting concept has been violated, and how should this transaction be correctly recorded?

  1. The business entity concept has been violated; the amount should be debited to the drawings account and credited to the bank account.Answer
  2. B
    The going concern concept has been violated; the amount should be capitalized as a long-term business asset because the owner and sole proprietorship share the same legal identity.
  3. C
    The scope of bookkeeping has been violated; personal transactions paid via bank transfers must be omitted entirely from all accounting records.
  4. D
    The accrual concept has been violated; the payment must be treated as a prepaid operational expense in the statement of financial position.

Answer

The business entity concept has been violated; the amount should be debited to the drawings account and credited to the bank account.
The business entity concept establishes that a business unit is treated as a separate entity from its owner(s) for accounting purposes. Personal expenses of the owner settled with business money are withdrawals of capital (drawings) and must be debited to the drawings account rather than debited to business expense accounts.

Step-by-Step Solution

1
Analyze the nature of the transaction
The expenditure of ₦250,000\text{₦}250,000 was incurred for personal residential accommodation, making it a personal transaction of the owner.
Identifying whether an expense is business or personal is necessary to apply entity rules correctly.
2
Apply the appropriate accounting concept
The business entity concept requires treating the business entity as distinct from its owner, meaning personal expenses paid from business funds must be classified as drawings.
Charging personal expenses to business rent overstates operational expenses and understates net profit.
3
Determine the correct double entry
Debit Drawings Account (to reduce equity/owner's capital) and Credit Bank Account (to reflect cash outflow).
Drawings reflect owner withdrawals from the entity and keep profit calculations accurate.

Key Concept

Business Entity Concept and Treatment of Drawings
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Topics

Accounting Concepts and Conventions

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