Boundaries
Entity and the boundary of the entity
One of the principles of accounting is that is done from the point of view of single entity. Here we have two, the investor and the business. If the investor is self employed and investing in their own business then the boundaries between the two get blurred. In the UK the tax authority HMRC will normally require a self employed person to complete a tax return on behalf of you and your business, ie as a single entity.
From the point of view of transactions there are two separate entities with a transaction between them (an investment into the business):
Business as a single separate entity
The great Venetian addition was to consider the business entity as separate from the owners and to record the transactions that happen within the business entity. This is at the heart of double entry book keeping practice.
The diagram above presents a problem in that we have movements of resources from outside the business to inside the business. This is dealt with by keeping matching input and output accounts which account for all the flows in and out of the business.
The details of the accounts used will come in the next section. The important thing is that Equity Input node/account corresponds to the Investor account. This follows Venetian practice in the the most important is the owners equity. It also shows that we have accounts that represent state within the business and not outside it, eg the assets.
This change of viewpoint from looking at multiple entities to the interactions of a single entity is conceptually a big change. There is a parallel with the first law of thermodynamics where energy is preserved in a closed system. Arguably it is this change in view point that the Northern Italian merchants made in there large trading companies that gave rise to double entry book keeping. In the initial diagrams each entity is regarded by itself as a single entry book keeping system.
In contrast to the system for thermodynamics the system overall is not closed. The entrepreneur node denotes input to the system. You can also have exit nodes as we will see later.
From now on we are only going to look at the accounting records of a single business. This is one of the main tennets of double entry accounting. Following Kleppmann 2011 each node represents an account and each edge (vector) represents a transaction.