What are the Golden Rules of Accounting?
Do you believe that the ability to carry out accounting is better than any superpower? Well if you are aiming to be an accounting fanatic, it is crucial to understand that Debits and Credits are the cornerstones of accounting.
An organisation can work efficiently to an extent based on the company’s maintenance of its accounts. In the Double Entry System, due to its dual nature, every transaction has an impact on two sides of the accounts, one of which is debited and the other that is credited. If the transactions aren’t maintained in a sequential manner, the record will be in a mess and would become meaningless leading to adverse effects. To reduce the headache of this record-keeping, a few rules have been devised, which are referred to as the Golden Rules of Accounting.
What is an Account?
Accounting is all about dealing with accounts and transactions. An account is a general ledger in which all transactions are recorded. In other words, it is a concise form of all the transactions in an accounting period. It gives a bird’s eye view of the company’s operations, financial position and cash flows, considering the thousands of transactions that happen in the company. For instance when a company enters into business with regard to suppliers and customers, both suppliers and customers act as separate accounts.
The golden rules of accounting are applied to the various such accounts maintained by an enterprise. An account is prepared in the following manner:
|Particulars (Dr)(Debit Side)||Amount(In Rupees)||Particulars (Cr) (Debit Side)||Amount (In Rupees)|
But knowledge of rules isn’t enough to deal with the mammoth task. Accounts should be thoroughly understood to be able to carry out the golden rules. There are two types of accounts which are further subdivided into different categories. Read on to become familiar with them.
- Personal Accounts : deals with persons and artificial judicial accounts like companies, government organisations, etc.
- Natural Personal Account: are for real human beings including debtors, creditors, proprietors, etc.
- Artificial Personal Account: include all businesses, as they are a separate legal entity in terms of law. They are different from humans. Examples are Social Club Account, Disaster Relief Charitable Trust Account, etc.
- Representative Personal Account: which represents a person or a group like Capital Account, Prepaid Expenses account, Outstanding Liability Account and so on.
2. Impersonal Accounts: are the accounts not related to persons or individuals.
- Real account: include all the accounts related to a company’s assets, including tangible accounts (related to things that are physical in nature)like Furniture Account, Machinery Account; and intangible accounts ( like Intellectual Property Account, Patent Account.
- Nominal account: covers the accounts related to revenue, expenses, losses: Travel Account, Rent Paid Account, Wages Account.
How to understand the Golden Rules of accounting?
Now that accounts have been understood, we can move on to the Golden Rules of Accounting and how they affect accounting. The rules can be understood in the context of these accounts.
- Debit the money from the Receiver i.e. the receiver of goods, Credit the person who sells the goods called the Giver: Personal Account
- Debit what comes in i.e. your cash account is indebted, Credit what goes out i.e. outside businesses are indebtors to your business : Real Account
- In transactions, Debit all Expenses and Loses , Credit all incomes and gains : Nominal Account
Based on the first rule, Debit the money from the Receiver i.e. the receiver of goods, Credit the person who sells the goods called the Giver . This involves the Personal Account.
Suppose you intend to set up a business, and you buy goods worth Rs. 20,000 from MS Enterprise. So, you will debit your purchase account and credit the account of MS Enterprise.
|–/–/—-||Purchase Account||Rs. 20,000|
|Payable Account||Rs. 20,000|
This transaction is done through the Personal Account, where the person or enterprise receiving something from the business is a receiver and the person’s or enterprise’s account is shown as debited. In the same way, if a person or enterprise gives /sells something to the business, the person’s/ enterprise’s account is shown as credit.
The first part of second rule states, Debit what comes in i.e. when cash comes in the business has to give something in return so Cash Account gets indebted to outsiders.
The second part conveys, Credit what goes out i.e. the money you have sent out should fetch you something in return. So outside business is indebted to your business.
This transaction is done through Real Accounts that are related to the assets of the business including tangible and intangible assets.
Let’s presume that you purchased tables for Rs. 20,000 in cash, from a seller.
Due to this transaction, the accounts involved are Tables Account and Cash Account. Tables come into the business, debit the Table Account. Cash goes out , so you have to credit the Cash Account.
|–/–/—-||Table Account||Rs. 20,000|
If the enterprise receives anything, it is represented as debited. If anything goes out of the enterprise, in accounting, it is shown as credited.
The third and final rule states that all expenses have to be debited and all income and gains are to be credited.
To understand it better, we can say that a company will pay its employees Rs. 2,00,000 in salaries. It is an expense it incurs in running its business. Therefore it should be debited in its accounting books
|–/–/—-||Salaries Account||Rs. 2,00,000|
If the company sold goods of Rs. 50,000 to SB Pvt. Ltd. the you must credit the money in your Sales Account and debit the expense. It is an income/ gain that it has made.
|–/–/—-||Cash Account||Rs. 50,000|
|Sales Account||Rs. 50,000|
A thoroughness of working with these rules are a boon to your career. Along With being able to present financial statements they also facilitate better management of books. A few tips are to be kept in mind while learning how to make entries in the accounts:
- Surety about the accounts involved in the transactions.
- Determining whether the values increase or decrease.
- Checking and re-checking the details, while applying the golden rules of accounting.
The example above shows the step by step maintenance of accounts done for running a business and streamlining credit and debit during transactions.
The preparation of the financial statement of an enterprise depends on the detailed and comprehensive coverage of these rules of credit and debit. Constant practice and having an eye for figures, helps to master this skill.
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