Golden Rules of Accounting (2024)

What are the Golden Rules of Accounting?

Financial accounting is more than just book-keeping. In accounting, every transaction has a dual entry – debit and credit. It is important to identify which account has to be credited and which one debited. This is the dual entry system of accounting. Financial accounting revolves around three rules, known as the golden rules of accounting. These golden rules ensure systematic recording of financial transactions. The golden rules simplify the complex book-keeping rules into a set of principles that are easily understood, studied, and applied.

Types of Accounts in Commerce

The golden rules of accounting help in documenting the financial transactions in ledgers. These golden rules are based on the type of account. Each transaction will have a debit and credit entry and belong to one of the following three types of accounts.

1. Real Account
2. Personal Account
3. Nominal Account

1. Real Account

A real account is a general ledger account that reflects all the transactions relating to assets and liabilities. It comprises tangible and intangible assets. Tangible assets such as furniture, land, building, machinery, etc. On the other hand, intangible assets such as goodwill, copyright, patents, etc.

Real accounts are carried forward to the following year, therefore, are not closed at the end of the financial year. Furthermore, a real account appears in the balance sheet. A furniture account is a type of real account.

2. Personal Account

A personal account is a general ledger account relating to persons. It can be natural persons like individuals or artificial persons like companies, firms, associations, etc. When company A receives money or credit from another business or individual, company A becomes the receiver. And, the other business or individual who gives it becomes the giver, in the case of a personal account. A creditor account is a type of personal account.

Following are the subcategories of personal accounts:

• Artificial Personal Account: This type of account represents legal entities that are not considered human beings by law. Examples of artificial personal accounts are hospitals, banks, partnerships, government bodies, etc.
• Natural Personal Account: This represents human beings. For example, creditor, debtor, capital account, drawings account, etc.
• Representative Personal Account: This account represents accounts of both natural and artificial entities. The transactions in this account either belong to the previous year or the coming year. For example, salary drawn in advance, or salary due from the previous years, etc.

3. Nominal Account

A nominal account is a general ledger account relating to all business income, expenses, profit and losses. It accounts for all transactions pertaining to one fiscal year. As a result, the balances are reset to zero and can start afresh. An interest account is a type of nominal account.

3 Golden Rules of Accounting

Golden rules of account form the basis for bookkeeping. As per the golden rules of accounting, you must ascertain the type of account for each transaction. Each type of account has its own set of rules that needs to be applied for each transaction. Following are the three golden rules of accounting:

1. Debit What Comes In, Credit What Goes Out
2. Debit the Receiver, Credit the Giver.
3. Debit All Expenses and Losses, Credit all Incomes and Gains.

1. Debit What Comes In, Credit What Goes Out.

This rule applies to real accounts. Furniture, land, buildings, machinery, etc., are included in real accounts. By default, they have a debit balance. As a result, debiting what is coming in adds to the existing account balance. Similarly, when a tangible asset leaves the firm, crediting what goes out reduces the account balance.

For example, Company X pays rent worth INR 75,000 on August 1st 2023. This transaction will be recorded as follows:

2. Debit the Receiver, Credit the Giver.

This rule applies to personal accounts. When a real or artificial person donates something to the organisation, it becomes an inflow, and the person must be credited in the books. Conversely, the receiver must be debited.

For example, Company X donates INR 1,50,000 in cash to an NGO on 2nd October 2023. This transaction will be recorded as follows:

3. Debit All Expenses and Losses, Credit all Incomes and Gains.

This rule applies to nominal accounts. A company’s capital is its liability. As a result, it has a credit balance. Crediting all the income and gains will increase the capital. On the other hand, the capital reduces when expenses and losses are debited.

For example, Company X sells its machinery for INR 50,000 on 1st Aug 2023. This transaction will be recorded as follows:

Summing Up

Example

Let’s understand the nature of the golden rules and the accounts with the help of an example. Following are the list of transactions:

• Company X starts its business with a capital of INR 1,00,000.
• Rents a property worth INR 25,000.
• Purchases goods worth INR 50,000 on credit from Company Y.
• Sells goods worth INR 75,000.
• Pays cash for goods purchased from Company Y.
• Pays salary worth INR 50,000 to employees.

Firstly, let us identify the different accounts involved and the types of accounts for each of the transactions:

Using the Golden Rules of Accounting

Applying the golden rules of accounting will help you determine the journal entries.

A company X starts its business with a capital of INR 1,00,000

Since cash is a tangible asset, it is part of a real account. Capital is a personal account. As per the golden rule of real and personal accounts:

• Debit what comes in
• Credit the giver

Rents a property worth INR 25,000

Rent is an expense and hence belongs to a nominal account. Cash is part of a real account. As per the golden rule of nominal and real accounts:

• Debit all expenses and losses
• Credit what goes out

Purchases goods worth INR 50,000 on credit from Company Y

Purchase transactions are an expense, and hence they are part of a nominal account. Company Y is part of the personal account. As per the golden rule of nominal and personal accounts:

• Debit all expenses and losses
• Credit the giver

Sells goods worth INR 75,000

Selling goods generates income for the business, and hence it is part of the nominal account. Cash is part of a real account. As per the golden rule of real and nominal accounts:

• Debit what comes in
• Credit all income and gains

Pays cash for goods purchased from Company Y

Company Y is a personal account, and cash is part of a real account. As per the golden rule of personal and real accounts:

• Debit the receiver
• Credit what goes out

Pays salary worth INR 50,000 to employees

Salary is an expense to the business and hence is part of the nominal account. Cash is part of a real account. As per the golden rule of nominal and real accounts:

• Debit all expenses and losses
• Credit what goes out

Advantages of Golden Rules of Accounting

The following are the advantages of golden rules of accounting:

• Proper Maintenance of Books of Accounts: Following the golden rules of accounting will ensure uniform maintenance of company accounts and business records.
• Analysis: The company’s management can easily analyse its performance across the years with well-maintained records.
• Valuation: While performing a company’s valuation, these financial statements will help understand the business revenues and expenses.
• Budgeting: Properly maintaining the financial transactions and accounting practices will help in budgeting and also estimating future projections of the company.
• Taxation and Regulatory Affairs: Following the golden rules of accounting will help in avoiding any shortfalls in tases and regulator matters. Lack of accounting discipline will attract penalties and other regulatory complications.

Conclusion

Golden rules of accounting lay the foundation for preparing financial accounts. The company must record every transaction. Each transaction is recorded as a journal entry and then as a ledger. You should ascertain the account each transaction belongs to and then do journal entries based on the three golden rules. Therefore, it is a must to know the golden rules of accounting for the purpose of bookkeeping.