3 Golden Rules of Accounting: Overview, Types, and Examples

What are the Three Golden Rules of Accounting?

The golden rules of accounting are simple guidelines that help accountants systematically record financial transactions. They are based on the dual-entry system, which involves debits and credits. The key is to determine which accounts to debit and which to credit for each transaction.

These rules simplify the complex process of bookkeeping by providing clear principles for identifying account actions. To apply them effectively, you first need to identify the type of account involved in the transaction. Each account type follows its own set of principles.

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Types of Accounts

Personal Account:

• Debit the Receiver, Credit the Giver: When dealing with personal accounts like individuals or organizations, debit what comes in and credit what goes out.
• Types of Personal Account –

Artificial Personal Account:

Non-human bodies that act as separate legal entities as per the law. These include hospitals, banks, companies, government bodies, partnerships, and cooperatives.

Natural Personal Account:

This type of account represents human beings. It includes individual capital accounts, debtors account, creditors account, drawings account.

Representative Personal Account:

This account represents the accounts of natural or artificial entities.

Real Account

Real Accounts are a set of tangible aspects of business like furniture, cash, etc. It contains transactions related to the assets and liabilities of the company. The asset category can be further subdivided into tangible and intangible assets. Real accounts deal with material assets of the business.

• If the item that belongs to the real account is coming into the business, it should be written on the Debit side while making the accounting entries.
• If the item of the real account is going out of business, it should be written on the Credit side while making the accounting entries.

Personal Accounts

• Personal accounts can be considered general ledgers related to people, associations, and companies.
• If the person/ group of persons/ legal body is receiving something from the business, then – Debit the receiver.
• If the person/ group of persons/ legal body is paying something to the business – Credit the payer or giver

Nominal Accounts

Nominal Accounts represent all the transactions of business like Expenses, Losses, Income, and gains incurred while doing business. Some common, e.g., are

• Electricity Expenses,
• Telephone Expenses,
• Interest Received,
• Profit on the Sale of Machines, etc.

If it’s an expense or loss for the business – Debit
If it’s an income or gain for the business – credit

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Golden Rules of Accounting

Rule 1

"Debit what comes in - credit what goes out."

This rule pertains to personal accounts and ensures accurate recording of transactions where value is exchanged between parties. It mandates that every financial transaction is properly documented by tracking both the giver (payer) and the receiver (payee).

To maintain accurate records:

• When a business receives value: Debit the corresponding account.
• When a business gives value: Credit the corresponding account.

This approach guarantees clear and reliable financial records, enhancing the accuracy of financial statements.

Example: If your business pays 500 in rent to your landlord:

• Landlord: Giver (providing rental space)
• Your Business: Receiver (benefiting from rental space)

You need to:

• Debit the Rent Expense account by 500
• Credit the Cash/Bank account by 500

Rule 2

"Credit the giver and Debit the Receiver."

The principle for real accounts is "Debit what comes in, and credit what goes out." This rule ensures that all inflows and outflows of resources are accurately recorded, providing a systematic approach for tracking assets and liabilities.

Key Points:

• Debit what comes in: When a business acquires an asset, the asset account is debited to reflect the increase in value.
• Credit what goes out: When a business disposes of an asset, the asset account is credited to reflect the decrease in value.

Importance:

Effective management of assets and liabilities is crucial for maintaining sound financial health. This rule provides transparency in showing both the acquisition and disposal of assets. By adhering to this rule, businesses ensure that their accounting records accurately reflect changes in their assets and liabilities, aiding in clear and organized financial reporting.

Example:

If a business acquires equipment worth 1,000:

• Equipment Account: Debit 1,000 (to record the increase in asset value)

If the business later disposes of the same equipment:

• Equipment Account: Credit 1,000 (to record the decrease in asset value)

Rule 3

"Credit all income and debit all expenses."

"Debit expenses and losses, credit income and gains" applies to all nominal accounts. This rule is essential for accurately recording financial performance, which is crucial for assessing a business’s profitability and sustainability.

Key Points:

• Debit Expenses and Losses: Expenses and losses are recorded as debits. This reflects the outflow of resources and costs incurred by the business.
• Credit Income and Gains: Income and gains are recorded as credits. This reflects the inflow of resources and profits earned by the business.

Importance:

By following this rule, businesses can systematically record all receipts and payments, providing a clear view of financial performance. This helps stakeholders make informed decisions and supports strategic planning. It serves as a fundamental principle in accounting, ensuring a true and accurate depiction of a business’s financial health.

Example:

• If a business incurs an expense of 200 for utilities:
  • Utilities Expense Account: Debit 200
• If the business earns 500 in revenue from sales:
  • Sales Revenue Account: Credit 500

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Examples of golden rules of accounting

The above three golden rules can be better decoded with the help of some illustrative accounting transactions like

• Goods amounted to Rs. 15000 purchased from Mr. Mohan on Credit
• Cash paid to Mr. Mohan for credit purchases
• Goods sold to Mr. Rehman for Rs. 20000
• Rs. 10000 withdrawn from the bank
• The machinery of Rs. 50000 was purchased from M/s Bharti Traders and paid Rs. 25000 in cash, and the remaining to be paid on a future date.
• The balance amount of Rs. 25000 to M/s Bharti Traders is paid in full
• Machinery is sold to John for Rs. 55000.

Let’s apply the golden rules to each of these transactions to formulate a Journal Entry:

Goods amounted to Rs. 15000 purchased from Mr. Mohan on Credit

The Golden rule for Real and Personal Accounts:

• a) Debit what comes in
• b) Credit the giver

The Journal entry will be:

Cash paid to Mr. Mohan for credit purchases

The Golden rule for Real and Personal Accounts:

• a) Debit the receiver
• b) Credit what goes out

The Journal entry will be:

Goods sold to Mr. Rehman for Rs. 20000 in cash

The Golden rule for Real and Real Accounts:

• a) Debit what comes in
• b) Credit what Goes out

The Journal entry will be:

Rs. 10000 withdrawn from the bank

The Golden rule for Real Accounts:

• a) Debit what comes in
• b) Credit what goes out

The Journal entry will be:

Machinery of Rs. 50000 purchased from M/s Bharti Traders and paid Rs. 25000 in cash and remaining to be paid on the future date.

The Golden rule for Real and Personal Accounts:

• a) Debit what comes in
• b) Credit the giver
• c) Credit what goes Out

The Journal entry will be:

Balance amount of Rs. 25000 to M/s Bharti Traders is paid in full

The Golden rule for Personal and Real Accounts:

• a) Debit the receiver
• b) Credit what goes out

The Journal entry will be:

Machinery is sold to John for Rs. 55000.

The Golden Rule for Personal, Real, and Nominal Accounts:

• a) Debit what comes in
• b) Credit the giver
• c) Credit all Income and Gains

The Journal entry will be:

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Benefits of the Golden Rules of Accounting

Simplicity in Record-Keeping:

These rules simplify the process of recording transactions by providing clear guidelines on debits and credits, ensuring consistency.

Accuracy:

By following these rules, businesses can maintain accurate financial records, reducing errors and discrepancies in accounts.

Clarity in Financial Statements:

The application of the Golden Rules leads to clear and transparent financial statements, which are essential for stakeholders to understand a company's financial position.

Compliance:

Adhering to these rules ensures compliance with accounting standards, which is crucial for legal and regulatory purposes.

Ease of Learning:

For accounting students and professionals, the Golden Rules provide a foundational framework that is easy to learn and apply across various transactions.

Well, it is important to maintain your accounts as it helps you keep track of your expenses and income and helps you furnish accurate records and documents while filing your ITR.

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Principles of the Golden Rules of Accounting

The fundamentals of the golden rules of accounting are based on key principles that guide accurate and consistent financial reporting. Here are the principles of the golden rules of accounting -

1. Futuristic Approach

The going concern principle assumes that a business will continue to operate indefinitely unless evidence suggests otherwise. Accountants prepare financial statements with the expectation that the business will meet its obligations and function effectively in the foreseeable future.

2. Monetary Approach

This method accounts for transactions by recognizing the impact of inflation on financial reporting. Transactions are recorded based on their purchasing power at the time of the transaction rather than their nominal value, ensuring a realistic representation of the currency's value.

3. Pricing Approach

According to the cost principle, businesses record all financial transactions at their original cost, regardless of current market value. This historical cost provides a consistent and reliable basis for valuing assets in financial statements.

4. Conservatism Approach

The conservatism principle requires accountants to be cautious and record financial transactions based on objective evidence rather than personal opinions or biases. This ensures accuracy and reduces the risk of overstatement or misrepresentation in financial records.

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