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Golden Rules of Accounting
Avail the advantage of their quick understanding with easy examples
A budding chartered accountant should be an expert in the golden rules of accounting. Any and every account follows these golden rules.
Read our blog to become
familiar with these standards of accounting.
So you are thinking of being an accountant, a number crusher, and a bookkeeper. If you wish to become an accountancy wizard, you should know that an accountant handles all the financial records of a company or organisation.
A specific set of rules has been established to bring uniformity in the maintenance of accounts and the necessary calculations regarding finances. These core fundamentals
are called the Golden Rules of Accounting.
How to understand the Golden Rules of Accounting?
Accounting is all about debit and credit, And they form the foundation of all the transactions. To comprehend the golden rules of accounting, you require a firm grasp of Debit and Credit and their role in different accounts.
The different types of accounts are:
deals with persons and artificial judicial accounts like companies, government organisations, etc. The personal accounting rules can be comprehended better if you know the types of personal accounts.
Natural Personal Account:
are for real human beings, including debtors,
Artificial Personal Account:
includes all businesses, as they are a separate legal entity in the law. They are different from humans. Examples are Social Club Account, Disaster Relief Charitable Trust Account, etc.
Representative Personal Account:
representing a person or a group like Capital Account, Prepaid Expenses account, Outstanding Liability Account and so on.
in the golden rules of accounting, these are the accounts not related to persons or individuals.
includes all the accounts related to a company’s assets, including tangible accounts (related to things that are physical)like Furniture Account, Machinery Account; and intangible accounts ( like Intellectual Property Account, Patent Account.
covers the accounts related to revenue, expenses, and losses: Travel Account, Rent Paid Account, Wages Account.
The golden rules of accounts have to be understood in the context of these accounts. We have prepared an easy way for you to remember the rules and how they vary for each account.
|Type of Account||Golden Rule|
|Personal||● Debit the receiver|
● Credit the giver
|Real||● Debit what comes to business|
● Credit what goes out of business
|Nominal||● Debit the expense or loss of business|
● Credit the income or gains of business
Applying Golden Rules of Accounting in Real Life
The golden rules of accounting have many uses and advantages in our day-to-day life.
- Maintaining records: Financial records are crucial for every organisation, and the golden rules of accounting help do that.
- Recording of transactions: Accounting ensures that your business transactions are recorded in a secure location, in the proper order, and, more importantly, systematically.
- Financial statement preparation – To record financial transactions effectively, you require the golden rules of accounting. Profit and loss accounts, balance sheets, etc., can be created without the assistance of the golden rules.
- Comparison of financial results – To rapidly compare and understand the financial outcomes over the years, accountants use the golden principles of accounting. The rules make the whole process reliable.
- Corporate decision-making: Senior management expects tha financial data is definitive and accurate to enable the decision-making process. And the golden standards of accounting come in handy to create valid data.
- Evidence in Legal Cases: The golden rules are applied to the financial data to avoid the hassle of dealing with confusing financial and business figures during legal issues. They help in creating and storing the data in an organised manner
- Regulatory compliance: Regulatory bodies expect organisations to comply with the set norms, and it would not be possible for the organisation to do so without the rules.
- Helps with tax issues: Tax filing gone wrong due to substandard accounting practices can harm an organisation tremendously. So to ensure that the brand value and image are not harmed, the accounting rules have to be followed.
- Business valuation: A genuine accounting practice aids in building a company’s reputation in the market and getting more investment.
- Budgeting and Future Projections: A budget supported by solid accounting principles helps a company’s growth and expansion.
Let’s understand 3 Golden Rules of Accounting with examples
There are a few guidelines you should keep in mind while using these 3 golden rules of accounting, which are as follows:
- Check to see what type of account is being used in the transaction.
- Check whether the transaction adds or subtracts from the account’s value.
- With these three accounting golden standards, you can keep your accounts updated and correct.
- Based on the first rule, Debit the money from the Receiver, i.e. the receiver of goods, and Credit, the person who sells the goods called the Giver. This involves the Personal Account.
- Suppose you intend to set up a business and buy goods worth $20,000 from MS Enterprise. So, you will debit your purchase account and credit the account of MS Enterprise.
- This transaction is done through the Personal Account, where the person or enterprise receiving something from the business is a receiver and the person’s, or enterprise’s account is shown as debited. In the same way, if a person or enterprise gives /sells something to the business, the person’s/ enterprise’s account is shown as credit.
|__/__/__||Purchase Account||$ 20,000|
|__/__/__||Payable Account||$ 20,000|
- The first part of the 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 related to the business’s assets, including tangible and intangible assets.
- Let’s presume you purchased tables from a seller for $ 20,000 in cash.
- 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.
- If the enterprise receives anything, it is debited. If anything goes out of the enterprise, it is shown as credited in accounting.
|__/__/__||Table Account||$ 20,000|
|__/__/__||Cash Account||$ 20,000|
- The third and final rule states that all expenses must be debited, and all income and gains must be credited.
- To understand it better, we can say that a company will pay its employees $ 2,00,000 in salaries. It is an expense it incurs in running its business. Therefore it should be debited in its accounting books
- If the company sold goods of $ 50,000 to SB Pvt. Ltd., you must credit the money in your Sales Account and debit the expense. It is an income/ gain that it has made.
|__/__/__||Salaries Account||$ 20,0000|
|__/__/__||Cash Account||$ 20,0000|
|__/__/__||Cash Account||$ 50,000|
|__/__/__||Sales Account||$ 50,000|
A jedi-like precision in handling these golden rules in accountancy goes a long way in establishing your credibility as an accountant. A few important tips you should always adhere to are:
- 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.
Streamlining credit and debit is crucial for any organisation, and it would be your responsibility to facilitate the calculations and maintenance of records. Preparing the financial statement will depend on how strong your foundations are regarding the golden rules of accountancy. Constant practice and having an eye for figures help to master this skill.
The golden rules of accounting given above with their examples might sound a bit overwhelming to you. And this is where the accountancy faculty of Edulyte can help you out. With each being an expert in the accounting field, our mentors personalise the curriculum for you and assess how learning would be easy for you. Click here to get in touch with us and become an accountancy pro.
Frequently Asked Questions
The three golden accounting rules crucial for any CA aspirant are
Rule 1: Debit What Comes In, Credit What Goes Out.
Rule 2: Debit the Receiver, Credit the Giver.
Rule 3: Debit All Expenses and Losses, Credit all Incomes and Gains.
The golden accounting rules are vital in terms of the types of accounts.
The different types of accounts are:
Accountancy is done in 2 different ways: traditional and modern. The traditional accounting style classifies all business accounts into 3 main types i.e. Real, Personal & Nominal. Whereas the modern rules of accounting classify all accounts into 6 different types i.e. Asset, Liability, Capital, Revenue, Expense & Drawings.
GAAP (Generally Accepted Accounting Principles) is a collection of accounting rules and standards for financial reporting that are commonly followed. It deals with definitions of concepts and principles and industry-specific rules. The aim of GAAP is to ensure that financial reporting is transparent and consistent.
Many CA aspirants get mixed up in the types of accounts and how to differentiate one from another. We give you an easy way to identify the accounts:
Real account − related to assets and liabilities; it does not include people accounts. These accounts carry forward every year.
Personal account − is related to individuals, firms and associations accounts.
Nominal account − Related to all income, expenses, losses and gains accounts.
Examples of personal accounts include accounts of customers, vendors, salary accounts of employees of an organisation, drawings and capital accounts of owners of a firm, etc.
The rule of accounting that applies to Nominal accounts is to debit the account if your business has incurred an expense or loss. Credit the account if your business has to show an income or gain.
The golden rule for real accounts is simple you debit what comes in and credit what goes out.
The golden rule that applies to Personal account is that you debit the receiver, and credit the giver. It means when someone gives something to an organisation, it becomes an inflow and the giver has to be credited in the account books. At the same time, the receiver must be debited.
This rule comes into play in handling the personal account. By debit, the receiver means the person receiving goods on credit will be debited, and the person giving will be credited. Suppose you purchased goods worth $3000 from XYZ Company. In your accountancy records, you have to debit your Purchase Account and credit the XYZ Company. The giver, XYZ Company, is providing goods, so you have to credit XYZ Company. After that, you need to debit the receiver, which is your Purchase Account.
Both the sales and purchase accounts are nominal accounts. Sales is a Nominal account. It relates to incomes and gains of business. The purchases account records the inventory purchases of a business. It is a general ledger account.