If you are just starting to understand accounting, you have probably come across the term “Golden Rules of Accounting.” These rules form the backbone of financial transactions. They exist so that your books are balanced and accurate.
Let us understand what these golden rules are, why they are essential and how to apply them with examples.
What are the Golden Rules of Accounting?
The Golden Rules of Accounting are fundamental principles used to record business transactions systematically. They revolve around the double-entry system, which means every transaction affects at least two accounts – one debit and one credit.
There are three golden rules of accounting, each applicable to different types of accounts:
| Golden Rule | Types of Accounts | Applies to |
|---|---|---|
| Debit the receiver and credit the giver | Personal account | Individuals, firms or entities |
| Debit what comes in and credit what goes out | Real account | Assets and liabilities |
| Debit expenses and losses, credit income and gains | Nominal account | Income, expenses, profits and losses |
Types of Accounts in Accounting
Before applying these rules, you must know how to identify the type of account for each transaction. There are three main types of accounts:
1. Personal Account
This type of account includes accounts related to individuals or organisations. Personal accounts include capital account, and accounts of debtors and creditors.
2. Real Account
Such accounts are of assets and liabilities. For example, there is a business that sells air conditioners. Its cash account, and plant and equipment account are all real accounts
3. Nominal Account
This represents all the income, expenses, profits and losses of the organisation. Some examples of nominal account include salary, rent, interest and other income.
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The Three Golden Rules of Accounting Explained with Examples
1. Debit the Receiver and Credit the Giver
This rule applies to personal accounts. Whenever a person or an entity receives something, their account should be debited. Similarly, the giver’s account should be credited.
Example:
Let us say you pay a stationery shop ₹1000 for office supplies. In this case, the shopkeeper (receiver) should be debited, and your cash account (giver) should be credited.
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Office Supplies | 1000 | |
| Cash | 1000 |
2. Debit What Comes In and Credit What Goes Out
This rule is for real accounts. Real accounts include assets, liabilities and equity accounts. When you acquire an asset, debit it. When you dispose of an asset, credit it.
Example:
Assume you purchased furniture worth ₹10,000 in cash. Now you should debit the furniture account and credit the cash account. This is because you are acquiring furniture (acquiring asset) and paying cash for it (disposing cash).
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Furniture | 10,000 | |
| Cash | 10,000 |
3. Debit Expenses and Losses, Credit Income and Gains
This rule deals with nominal accounts. All expenses and losses should be debited, while all incomes and gains should be credited.
Example:
Suppose you sold goods worth ₹2000 to a customer. So, now you must debit the cash account (what comes in) by ₹2000 and credit the sales account (income) by ₹2000.
| Account | Debit (₹) | Credit (₹) |
|---|---|---|
| Cash | 2000 | |
| Sales | 2000 |
Why are the Golden Rules of Accounting Important?
Here are the reasons why understanding and applying these golden rules can make recording financial transactions simpler and easier:
1. Accurate Financial Reporting
So, proper accounting practices can lead to reliability and accurate financial statements.This also helps in comparing financial statements such as income and expenditure account and balance sheet.
2. Standardised Form of Recording
The rules help in maintaining uniformity across different financial periods, thus making comparisons easier. So, you can draw comparisons between different companies.
3. Legal and Tax Compliance
These golden rules help avoid issues related to non-compliance of accounting practices and penalties. Thus, companies can comply with regulatory requirements through correct bookkeeping.
Wrapping Up
Golden rules of accounting aren’t just for accountants. It is essential to anyone managing business finances. Such rules are followed across financial systems to maintain a uniform and standardised form of accounting.
By applying these principles, businesses can make sure their financial records are accurate and stay compliant with legal and tax regulations.
FAQs
What are the three golden rules of accounting?
The three golden rules are: Debit the receiver and credit the giver, debit what comes in and credit what goes out, and debit expenses and losses, credit income and gains.
Why are they called the golden rules of accounting?
They are so-called because they form the basis for recording every financial transaction accurately.
What is a nominal account?
A nominal account deals with income, expenses, gains and losses. Examples include Rent, Salary and Commission Received.
What is a personal account?
A personal account relates to individuals or organizations, such as Capital Account, Debtors and Creditors.
What is a real account?
Real accounts refer to assets and liabilities, including tangible assets like machinery and intangible assets like goodwill.
What is the difference between real and nominal accounts?
Real accounts carry over balances to the next period, while nominal accounts reset to zero at the beginning of a new period.
Can a single transaction affect multiple types of accounts?
Yes, a single transaction can impact different accounts at the same time.
What is the purpose of using the golden rules?
They simplify the complex task of recording financial transactions and ensure consistency and accuracy in financial reporting.
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