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Suppose you open a book store, so, in common parlance, it would be said that the business is being carried on by you, and you are earning profit or incurring loss.
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However, Accounting sees it differently.
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According to the Business Entity Principle, a Business Entity is considered to be separate and distinct from its owners.
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This means that the Business Entity is doing the business and not you; the Business Entity has earned the profit and not you; the Business Entity has incurred loss and not you!
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This is done basically to distinguish between the Business Transactions and Personal Transactions. For example: If you go out for a movie with your friends, you wouldn’t record it in the books of accounts of your business → This is your personal expense, not a business expense. If the Separate Entity concept was not there, you would have recorded your movie expenses in the books of accounts of the business, and that would have led to an incorrect profit.
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Business transactions, therefore, are recorded in the books of account from the business’s point of view and not from that of the owner’s.
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Owners being regarded as separate and distinct from business, they are considered creditors of the business to the extent of their capital (Capital is the amount of money invested in the business by the Proprietor/Owner).
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Therefore, any money that the Proprietor invests in Business is a liability of the Business towards the Proprietor, i.e. the Business owes that money to the Proprietor.
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So, if the Proprietor withdraws some money, out of his investment in the business, for his personal use, the Capital reduces, i.e. Liability of the Business towards the Proprietor reduces.
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Similarly, if the Proprietor invests some additional money in the business, the Capital increases, i.e. Liability of the Business towards the Proprietor increases.
