What are the Golden Rules of Accounting and How to Use Them?

3 Golden Rules of Accounting: Introduction

Accounting is the process of recording a company's financial transactions. Accounting includes summarizing, reviewing, and reporting these transactions to external stakeholders, regulators, and tax collecting authorities.

Accounting financial statements are a process of summarizing a company's expenses, financial status, and cash flows over a period of time. Every economic entity must provide financial information to all its stakeholders. The financial information published must be accurate and represent a true picture of the entity. It must account for all of its transactions for this presentation. Accounting must be consistent because economic entities are compared to understand their financial status.

What are the Golden Rules of Accounting?

Accounting is much more than just book-keeping these days. Debit and credit are two essential aspects of accounting. We cannot enter a transaction until we have determined which account should be debited or credited. When a financial transaction occurs, it affects two accounts, and in the dual entry accounting system, we have two columns to enter our transaction. As one might already know, one is the debit side and the other is the credit side.

Accounts Golden Rules are used to record economic transactions in ledgers. These laws are based on three types of accounts: personal, real, and nominal. An account is a consolidated record of transactions involving a single individual, item, or category of income and cost. There are three Golden Rules of Accounting that must be followed in order to achieve uniformity and accurately account for transactions. These rules serve as the foundation for entering journal entries, which serve as the foundation for accounting and bookkeeping.

What are the Golden Rules of Accounting: Types of Accounts

The golden rules of accounts assist in recording financial transactions in ledgers. Assets, obligations, earnings, gains, expenses, and losses, as well as other ledger records related to business activities, are all subject to these principles. Based on the kind of account, certain guiding principles apply. One of the following three categories of accounts will be the subject of each transaction, which will also have a debit and credit entry.

Personal Account 

A personal account is a general ledger account associated with every entity on a personal level, including people, businesses, and associations. According to the golden rules of accounting, personal accounts include accounts for natural persons, artificial persons, and elected persons. These are the three categories of people that fall under personal accounts:

Natural Persons: Accounts tied to people are referred to as natural person accounts. For example, consider Rohit Sharma or Vijay Agarwal who are creditors for ABC Ltd.

Artificial Persons - By-laws create accounts that lack physical existence and are referred to as artificial persons. A company, corporation, bank, or other types of business accounts are illustrations.

Representative Persons - A representative person is a particular account that speaks for a person or a group of people. Examples include outstanding pay, prepaid expenses, accrued income, pre-received income, and so forth.

Real Account 

A real account is a general ledger account for assets and liabilities that are not related to people. These are open accounts that are carried over from year to year. A bank account is an illustration of a real account. 

Both tangible and intangible assets are included under real accounts. Tangible goods like furniture, real estate, a building, equipment, etc. In contrast, intangible assets like goodwill, copyright, patents, and so forth. Therefore, the following business actions involving asset accounts are covered by this provision:

• Acquisition of an Asset / Formation of an Asset
• Transfer of an Asset
• Depreciation charged on an Asset
• Discarding an Asset

Nominal Account

A nominal account is a general ledger account that records all revenue, costs, profits, and losses for a company. It records every transaction relating to a single fiscal year. The balances are therefore reset to zero and could now restart again. The balances in these accounts at the end of the year are transferred to a permanent account. Accounting transaction data for revenue, expense, gain, and loss transactions, all of which show up in the income statement, is gathered using nominal accounts. Therefore, examples of transactions that are recorded in nominal accounts include income from the sale of services, the cost of items sold, and a loss on the sale of an asset.

3 Golden Rules of Accounting

The foundation upon which the nuances of bookkeeping lie are the golden rules of accounting. Before recording the transactions, it is important to identify the type of account for each transaction in accordance with the golden standards of accounting. Rules specific to each type of account must be followed for every transaction. The reason that there are three Golden Rules of Accounting is that there are separate sets of golden rules for each type of account. The treatment of every business transaction is outlined under the accounting golden rules. The three golden rules which guide the principles of accounting are as follows:

Debit What Comes In, Credit What Goes Out

This pertains to the real account rule. Real accounts contain items like furniture, land, buildings, machines, etc. They have a debit balance by default. Debiting what is coming in as a consequence increases the balance of the current account. Similar to this, crediting what departs the company when a tangible asset does so lowers the account balance.

Debit the Receiver, Credit the Giver

Personal accounts are covered by this rule. When a person, whether actual or artificial, provides something to the organization, it counts as an inflow and the donor needs to be recognized in the financial records. The receiver must, however, be credited. This theory is applied in the case of personal accounts and is also called the personal account golden rule.

Debit All Expenses and Losses, Credit all Incomes and Gains

This rule is applicable if the account in question is a nominal account. The corporation has a duty to manage its finances. It, therefore, has a credit balance that is negative. The capital will rise if all earnings and gains are credited. On the other side, when losses and expenses are debited, the capital decreases. This is exactly what needs to be done to maintain the system's balance.

Using the Golden Rules of Accounting

The accounting rules have been developed while taking into account the nature of all the different accounts. There are three Golden Rules of Accounting since there are separate sets of Golden Rules for each type of account. The treatment of every business transaction is outlined in these golden rules. Let us understand the golden rules of accounting with examples. Let us assume a company named Classmate Ltd. which has the following transactions:

1. Deposit of Rs.15,000 into the Bank
2. Purchase of goods worth Rs.75,000 from Batchmate Ltd.
3. Sale of goods worth Rs.90,000 to Schoolmate Ltd.
4. Payment of Rs.18,000 as Rent for its premises
5. Interest income received on bank account of Rs.5,000

In order to determine their treatment according to the golden rules of accounting, we need to categorize the accounts according to their types into real, nominal, and personal accounts:

• Deposit of Rs.15,000 into the Bank - Both Bank and Cash are real accounts and so the Golden rule is Debit what comes into the business and Credit what goes out from the business. So the entry will be:

Bank A/c Dr. 15,000

To Cash A/c 15,000

• Purchase of goods worth Rs.75,000 from Batchmate Ltd. - The Purchase Account is a Nominal account and the Creditors Account is a Personal account. Applying Golden Rule for Nominal account and Personal account, Debit the expense or loss and Credit the giver. The entry will be:

Purchase A/c Dr. 75,000

To Batchmate Ltd. A/c 75,000

• Sale of goods worth Rs.90,000 to Schoolmate Ltd. - The sale account is a Nominal account and the Debtors Account is a Personal account. Hence the Golden Rule to be applied is, Debit the receiver and Credit the income or gain. Thus the entry will be:

Schoolmate A/c Dr. 90,000

To Sales A/c 90,000

• Payment of Rs.18,000 as Rent for its premises - Rent is a Nominal account and Bank is a real account.   The Golden Rule to be applied is, Debit the expense or loss and Credit what goes out of business. The entry thus will be:

Rent A/c Dr. 18,000

To Bank A/c 18,000

• Interest income received on a bank account of Rs.5,000 - Interest and Bank are Nominal account and Real Account. The Golden rule to be applied is, Debit what comes into the business and Credit the income or gain. Hence the entry will be:

Bank A/c Dr. 5,000

To Interest Received A/c 5,000

These examples help us understand the functioning of the various rules of accounting, which serve as the basis of accounting, thereby earning them the title "Golden Rules of Accounting." They resemble the English alphabet's letters. One cannot form words and, as a result, cannot use the language if they do not know the letters. In the same way, failing to follow the golden principles in accounting prevents one from properly passing journal entries and accounting for transactions.