The Golden Rules of Accounting – Explained

There are three Golden Rules of Accounting that need to be taken care of. In this article, let's understand the types of accounts, the golden rules of accounting, how to apply these and what is debit and credit.

Index

  1. Introduction
  2. Types of Accounts
  3. Golden Rules of Accounting
  4. How to apply Golden Rules of Accounting?
  5. What is Debit and Credit in Accounting?

 

Introduction

Accounting refers to the process of keeping financial records. Every economy must present the financial information to its stakeholders and must account for all the transactions. For this purpose, there needs to be uniformity in accounting for which there are a few Golden Rules of Accounting.

 

Types of Accounts

There are majorly three types of accounts, namely:

  • Real Account
  • Personal Account
  • Nominal Account

 

a) Real Account

This is a general ledger account for the Assets and Liabilities. Such accounts do not close at the year’s end plus are carried forward. The rule applies to transactions like purchase, sale, and depreciation of an asset. 

An asset a valuable property that any business owns and then get benefits from it in the future — for example, Furniture, Vehicles, Trademarks, etc. 

 

b) Personal Account

This is a general ledger account that is connected to all Individuals. These Individuals are of 3 types: 

  • Persons – Natural persons.
  • Artificial Persons – The person created by humans like Reliance Industries.
  • Representative Persons – Accounts that represent a person or a group of people like Outstanding Salary.

 

c) Nominal Account

This is a general ledger account for all incomes, expenses, gains, and losses.

The accounts on which the Nominal Account is applicable include:

  • Expenses Accounts – Sales, Commission Received, and so on. 
  • Losses Accounts – Loss on Sale of an asset, etc
  • Profits Account – Profit on sale of any asset. 

 

Golden Rules of Accounting

Golden Rules of Accounting

Accounting rules have been decided by looking at the nature of all three types of accounts. For every type of account, there are a few golden rules which need to be kept in mind. Accounting rules are statements that establish guidelines on how to record the transactions. These transactions are recorded in the books of the entity using the method of double-entry accounting. This method states that for each transaction, two or more accounts are usually involved. One account shall be debited, and others shall be credited with the same amount.

 

a) Real Account

Debit – what comes into the business 

Credit – what goes out of the business

 

b) Personal Account

Debit – The Receiver

Credit – The Giver

 

c) Nominal Account

Debit – All expenses and losses

Credit – All income and gains

 

How to apply Golden Rules of Accounting?

Golden Rules of Accounting

The correct application of these rules is very important to ensure that authenticity in debit and credit amounts. The rules of application are mentioned below:

 

a) Golden Rules of Accounting for Real Accounts

Example – Purchase any furniture for INR 10,000. 

Step 1: Scan and select the affected accounts from the transactions- INR 10,000 in cash. 

Step 2: Select the types of Accounts: both are Asset Accounts. 

Step 3: Select the rule which will be applied to the account: both are Real Account. 

Step 4: Effect of this transaction on the accounts: 

  • For furniture- purchased
  • For the cash- payment made

Step 5: Golden Rule applied:

  • For furniture- comes in (becomes debit)
  • For the cash- goes out (becomes Credit)

 

b) Golden Rules of Accounting for Personal Account

Example- Purchase any furniture for INR 10,000 from Person A.

Step 1: Scan and select the affected accounts from the transactions- Furniture from Person A. 

Step 2: Select the types of Accounts:

  • Furniture- Asset Account
  • Person A- Person Account

Step 3: Select the rule which will be applied to the account:

  • Furniture- Real Account
  • Person A- Personal Account

Step 4: Effect of this transaction on the accounts: 

  • For furniture- Purchased
  • Person A- Selling furniture

Step 5: Golden Rule applied:

  • For furniture- comes in (becomes debit)
  • For the cash- giver (becomes Credit)

 

c) Golden Rules of Accounting for the Nominal Account

Example: Salary paid to employee INR 6000. 

Step 1: Scan and select the affected accounts from the transactions- 

Salary: INR, 5000. 

Step 2: Select the types of Accounts:

  • Salary- Expense Account
  • 5000 cash- Asset Account

Step 3: Select the rule which will be applied to the account:

  • Salary- Nominal Account
  • 5000 cash- Real Account

Step 4: Effect of this transaction on the accounts: 

  • Salary- Expenses paid
  • 5000 cash- Payment made

Step 5: Golden Rule applied:

  • Salary- All expenses and Losses (becomes debit)
  • 5000 cash- Goes out (becomes Credit) 

 

What is Debit and Credit in Accounting?

The terms Debit and Credit are used to record business transactions in accounting. For this purpose, every account in a business transaction is made in the format of letter T. Thus; the accounts are also referred to as T-accounts. Such accounts have a left and a right side which record the increase or decrease in any item. 

Recording an account on the left side means debiting. 

Recording the amount on the right side means crediting the account. 

 

There are primarily two approaches to decide whether the account has to be debited or credited:

a) Modern Approach – Here, business transactions are divided into five categories, which include transactions relating to Owner, Assets, Expenses, Revenues, and so on. 

b) Traditional Approach – Herein, the user needs to identify the account that is impacted plus the type of the account. This includes personal accounts, real accounts, and nominal accounts. 

To brief, all the transactions of any entity must be accounted for, and for this purpose, an entity is required to pass journal entries, which soon summarizes into ledgers. Then the entries are passed according to the golden rules of accounting, and to apply these, one must ascertain the type of account to apply it. 

a) Debit comes in, and Credit goes out. 

b) The debit is the receiver, and Credit is the giver. 

c) Debits are all expenses, and Credit is all income. 

 

They are the foundation of accounting and, thus, are called the Golden Rules of Accounting. Without these rules recording transactions cannot be relied upon and is therefore inauthentic. These rules are basic, and the application is easy to comprehend. 

Saumya Uniyal
Saumya Uniyal
Saumya describes herself as a writer with words running down her veins as phrases follow her down every path she walks on. The Journalism student is on a constant never-ending quest for finding her next best vacation. You can also spot her sipping coffee while solving puzzles at endearing cafes and bars.

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