Every business entity must present its financial information to all its stakeholders. The information provided in the financials must be correct and present a true picture of the entity. For this presentation, it must account for all its transactions. Since business entities are compared to understand their financial status, there has to be uniformity in accounting.
What is Accounting
Accounting is the method of keeping track of a company's financial transactions. Summarizing, reviewing, and reporting these transactions to oversight bodies, regulators, and tax collecting authorities are all part of the accounting process.
Accounting financial statements are a description process of financial activities over a period that summarises a company's expenses, financial status, and cash flows.
Benefits of Accounting
- It assists in maintaining business records.
- It prepares financial statements.
- It proves as a comparison for financial results.
- It assists in corporate decision-making.
- It is evidence in legal matters.
- It has regulatory compliance.
- It helps in tax matters.
- It has the role of valuation of the business.
To bring about uniformity and to account for the transactions correctly there are three Golden Rules of Accounting. These rules form the very basis of passing journal entries which in turn form the basis of accounting and bookkeeping.
What are the golden rules of accounting?
Accounting's Golden Rules are used to document economic transactions in ledgers. These laws are based on three different types of accounts: personal, actual (real), and nominal. An account is a consolidated record of transactions involving a single individual, item, or category of income and cost.
Dr. stands for debit, and Cr stands for credit. The words debit and credit refer to the left and right sides of a coin. They don't imply an increase or decline in value. Debiting is the process of entering a number from an account's left hand.
Crediting is the process of making an entry on the right side of the page. The three golden rules of accounting are based on the accounts mentioned below, which are divided into three categories
Types of Accounts
The golden principles of accounting are applied to all ledger records involved with corporate operations, such as assets, obligations, incomes, gains, costs, and losses. Accounting rules are primarily based on three types of accounts:
1.Personal Account
Personal accounts are those accounts that are related to all categories of individuals, including natural persons, artificial persons, and elected persons, according to the golden laws of accounting. Below are the three groups of people. -
- Natural People - Natural person's accounts are those that are connected to human beings.
- Artificial People - Artificial persons are accounts that do not have a physical life and are formed by by-laws Any business account, for example, maybe a firm, corporation, bank, or entity.
- Representative Persons - Representative persons are certain accounts that represent an individual or a group of people Outstanding Salary, Prepaid Expenses, Accrued Income, Pre received Income, and so on are examples.
2.Real Account
Real accounts are those accounts that are linked to the assets of the company, according to the basic principles of accounting. As a result, this provision applies to the following business activities involving assets accounts: -
- Purchases/Creation of asset
- Sales of asset
- Depreciation charged on the asset
- Disposal of an assets
3.Nominal Account
Nominal budgets are those accounts that are applied to both expenses/losses and incomes/gains, according to accounting's golden principles.
How do the three golden Rules Work?
1. Debit the Receiver, Credit the Giver
In the case of personal accounts, this theory is applied. When someone donates something to the organization, it becomes an inflow, and the individual must be credited in the records. This is also valid in reverse, which is why the recipient must be debited.
2. Debit What Comes In, Credit What Goes Out
In the case of actual (real) accounts, this theory is extended Machinery, soil, and buildings, among other things are included in real records by nature, they have a negative balance. As a result, the debit that comes in adds to the current account balance. This is precisely what must be achieved. Similarly, when a tangible commodity leaves the company, crediting what goes out reduces the account balance.
3. Debit All Expenses and Losses, Credit All Incomes and Gains
In case of nominal account, this rule would be applied. The company's money is a responsibility. As a result, it has a negative credit balance. Capital is increased when all incomes and profits are credited, while capital is decreased when liabilities and deficits are debited.
Golden Rules of accounting with an Example
Transaction | Accounts involved | Type of Accounts |
|---|---|---|
Deposit Rs.20,000 in Bank | Bank Account | Real Account - Asset account |
Cash Account | Real Account - Asset account | |
Purchase goods worth Rs.1,00,000 from EXE Ltd. | Purchase Account | Nominal Account - Expense account |
EXE Ltd. Account | Personal Account - Creditor’s account | |
Sale of goods worth Rs. 75,000 to NXE Ltd. | Sales Account | Nominal Account -Income Account |
NXE Ltd. Account | Personal Account - Debtors Account | |
Pays Rs.82,000 as rent | Rent Account | Nominal Account |
Bank Account | Real Account - Asset account | |
Earn Rs.3,000 as interest on Bank account | Interest received | Nominal Account - Income Account |
Bank Account | Real Account - Asset Account |
Now applying the golden rules to each of the transactions we will get the following journal entries:
Deposit Rs.20,000 in Bank
Both Bank and Cash are real accounts and so the Golden rule is:
- Debit what comes into the business
- Credit what goes out from the business
So, the entry will be:
Bank A/C | Dr. | 20,000 | |
To Cash A/C | 20,000 |
Purchase goods worth Rs.1,00,000 from EXE 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
- Credit the giver
Purchase A/C | Dr | 1,00,000 | |
To EXE Ltd. A/C | 1,00,000 |
Sale of goods worth Rs.75,000 to NXE 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
- Credit the income or gain
Thus, the entry will be:
NXE Ltd. A/C | Dr | 75,000 | |
To Sales A/C | 75,000 |
Pays Rs.82,000 as rent
Rent is a Nominal account and Bank is a real account. The Golden Rule to be applied is:
- Debit the expense or loss
- Credit what goes out of business
The entry thus will be:
Rent A/C | Dr | 82000 | |
To Bank A/C | 82000 |
Earn Rs.3,000 as interest on Bank Account
Interest and Bank are Nominal account and Real Account. The Golden rule to be applied is:
- Debit what comes into the business
- Credit the income or gain
Hence the entry will be:
Bank A/C | Dr | 3,000 | |
To Interest Received A/C | 3,000 |
Conclusion
All transactions of an entity must be accounted for. To account these transactions the entity must pass journal entries which will then summarise intoledgers. The journal entries are passed on the basis of the Golden Rules of accounting. To apply these rules one must first ascertain the type of account and then apply these rules:
- Debit what comes in, Credit what goes out
- Debit the receiver, Credit the giver
- Debit all expenses Credit all income
These lay the foundation of accounting and hence are called the Golden Rules of accounting. They are like the letters of the English alphabet. If one does not know the letters he cannot put words and hence, will not be able to use the language. Similarly for accounting, if one does not know the golden rules, he cannot pass journal entries and hence won’t be able to accurately account for the transactions.
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