Before you can come up with the right plan to run your business, you need to figure out what kind of business you want. After all, there are several different types of companies that you could choose from, such as sole proprietorship and corporation. To make this decision, it’s essential to understand what a proprietor is and how they differ from a business entity. With that understanding, you will figure out why to pass the interest on capital journal entry for your contributed capital.
A business entity and the owner are two different things.
A business entity is an artificial person created by law. On the other hand, an owner represents the person who controls, manages and owns the business assets. In a nutshell, a business entity is distinct from its owners regarding its legal status and function within its respective business operations.
Business is a separate legal entity.
A business entity is created by law, having a separate legal entity, rights and liabilities of its own. The business is not the owner. It must have an individual identity in law and be distinct from the owners. It has rights, duties and liabilities, which may differ from those of its owners.
In the case of a sole proprietorship or partnership, the owner is solely in charge of the business entity. The owner is legally responsible for all business financial obligations, including any contractual obligations and taxes.
In contrast, there are two different roles in a corporation (also known as a limited liability company). One person controls manage and owns all business assets, and another function is where this person represents himself as an officer that legally stands in place of his corporation. The shareholders are not personally responsible for debts incurred by their corporation. Instead, they are only liable up to their initial investment in the company’s assets before its liabilities were taken on. And the same is true for what the business owes them for their initial contribution. They are not entitled to all the profits from the company, but their reward is limited to the extent of their risk.
All those transactions are carried out in the name of the business.
In simple words, we can say that all those transactions carried out in the business’s name and all the company’s rights and liabilities are called business entities. In contrast, all those individuals who manage and control these transactions are called proprietors or owners of businesses. However, there is no single definition for both terms as each entity can perform one or more functions simultaneously. Still, if we look at it from a general point, then the following points may prove helpful in understanding both entities better:
- Business Entity performs commercial activities while Owner manages them through various managerial roles such as CEO etc.
- Business Entity owns property while Owner uses it.
- Business Entity enters into contracts while Owner signs them on behalf of Company.
- Business Entity becomes liable to pay taxes while Owner pays them on behalf of Company.
A business is an economic activity carried out to earn profits or income. So, if a company takes a loan from the owner or manager of the business in the form of capital, then it owes the owner interest on that capital contribution. Once you calculate the interest, there is an interest on a capital journal entry that needs to be passed in the books of the business, where the P&L is debited, while the owner’s capital is credited to effectuate the transaction.
