The Golden Rules of Accounting offer a structured approach to record financial transactions, ensuring clarity and accuracy in the books of accounts. These rules categorize accounts into three types: Personal, where you debit the receiver and credit the giver; Real, where what comes in is debited, and what goes out is credited; and Nominal, where all expenses and losses are debited while incomes and gains are credited.
Almost every economic entity must provide financial data to all its stakeholders. The financial statements prepared must be to the point and present a true picture of the entity. It must account for all of its transactions for the presentation. Accounting must be consistent because economic entities are compared to understand their financial status. This blog discusses about Golden Rules of accounting in detail.
Golden Rules of Accounting
Here, there are three golden rules of accounting that one must follow to achieve uniformity as well as correctly account for transactions. Using these golden rules, you can serve as the foundation for entering journal entries, which serve as the foundation for accounting and bookkeeping. You must review everything related to debit and credit before we go into the accounting golden rules.
The Golden Rules of Accounting
| Account Type | Real Account | Personal Account | Nominal Account |
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Account Classifications
We must first understand the different sorts of accounts to understand the golden rules of accounting. All general ledger types must adhere to the account classification. Each account would fit into one of the broad categories indicated below, in other words.
Accounts are classified into three types:
- Real Account
- Personal Account
- Nominal Account
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Real Account
Real Account is a general ledger account that deals with assets and liabilities that are not people accounts. All those are accounts that do not close at the end of the financial year and are managed to carry forward. A bank account is an example of a Real Account.
- Tangible real accounts are those that can be physically touched and felt. Examples are buildings, machinery, stock, land, and other tangible real accounts.
- Intangible real accounts are those that cannot be physically touched or felt. Goodwill, patents, and trademarks are examples of such real accounts.
Example: Loan repayment completed
Cash is transferred in this transaction, and the loan is paid off. As a result, the Bank account will be credited, and the Loan account will be debited in the journal entry.
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Personal Accounts
Every person, including individuals, companies, and organisations, is associated with a personal account, which is a general ledger account. An illustration of a personal account is a creditor account.
1. Natural Personal Accounts:
A natural personal account is a type of personal account that is simple & easy to understand, which includes all of God’s creations with the ability to deal, which are usually people.
2. Artificial Personal Accounts:
These are personal accounts created artificially by law, such as corporate bodies and institutions—private companies, LLPs, LLCs, schools, clubs, etc.
3. Representative Personal Accounts:
Personal accounts that represent a specific person or group, either directly or indirectly. Example: If an employee’s wages are paid in advance, a wage prepaid account will be opened in the books of accounts. This wage prepaid account is a personal account that is indirectly connected to the person.
Example: Paying employees’ wages
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Nominal Accounts
A Nominal account is a general ledger account that easily keeps track of all the income, losses, expenses, and even acquisitions.
Example: Salary account and the account for shipping charges.
3 Golden Rules of Accounting
The field of accounting operates on three fundamental principles known as the Accounting Golden Rules. These rules serve as guiding principles in the recording of financial transactions. The three golden rules are:
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Debit the Receiver and Credit the Giver
According to this rule, any transaction that involves the receiving of benefits or assets is debited, while transactions that involve giving or providing assets are credited. Here are a few examples to illustrate this rule:
- When a business receives cash from a customer, it is recorded as a debit to the cash account (receiver) and a credit to the accounts receivable account (giver).
- If a business purchases equipment and pays cash for it, it is recorded as a debit to the equipment account (receiver) and a credit to the cash account (giver).
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Debit What Comes in and Credit What Goes Out
This rule states that any inflow of assets is debited, while any outflow of assets is credited. Here are a couple of examples to demonstrate this rule:
- When a business receives cash from sales, it is recorded as a debit to the cash account (what comes in) and a credit to the sales account (what goes out).
- If a business pays cash for office supplies, it is recorded as a debit to the office supplies account (what comes in) and a credit to the cash account (what goes out).
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Debit Expenses and Losses, Credit Income and Gains
This rule signifies that expenses and losses are debited, while income and gains are credited. Here are a few examples to illustrate this rule:
- When a business pays rent expense, it is recorded as a debit to the rent expense account (expense) and a credit to the cash account (decrease in assets).
- If a business earns interest income from investments, it is recorded as a debit to the cash account (increase in assets) and a credit to the interest income account (income).
Benefits of the Golden Rules of Accounting
The Golden Rules of Accounting provide several benefits to the field of accounting. Some of these advantages include:
- Consistency: The golden rules establish a consistent framework for recording financial transactions. They ensure uniformity across different accounting processes and systems.
- Accuracy: Golden Rules reduce the likelihood of errors in recording transactions. They ensure accurate financial statements.
- Transparency: The golden rules enhance transparency by clearly categorizing different types of transactions. They provide a standardized approach for recording transactions.
- Financial Analysis: The consistent application of the golden rules enables easier financial analysis, as transactions are recorded in a structured manner.
- Compliance: Adhering to golden rules helps businesses ensure compliance with accounting principles and regulations, enabling smooth audits and regulatory reporting.
Primary Types of Accounts Impacted by Credits & Debits
In your accounting books, debits and credits are identical but opposing entries.
Credits and debits impact the five primary types of accounts:
- Assets: Resources that a company has and may sell for money are called assets (e.g., land, equipment, cash, vehicles)
- Expenses: costs associated with conducting business (e.g., wages, supplies)
- Liabilities: Cash due to another person or company (e.g., accounts payable)
- Equity: Assets minus liabilities equals equity.
- Revenue and Income: money received from sales
Conclusion
All transactions involving an entity shall be documented and recorded. The entity is required to produce journal entries, which will be tallied in ledgers, to account for these transactions. The accounting “golden rules” are followed when approving the journal entries. Prior to putting these criteria into use, the type of account must be determined. As the cornerstone of accounting, these are known as the “Golden Rules of Accounting”.
They have an English alphabet look-alike quality. The ability to utilise a language and form words depends on one’s knowledge of the alphabet. Similarly, it is impossible to pass journal entries and accurately account for transactions when the golden rules of accounting are broken. If you have any queries regarding the accounting rules, feel free to contact the experts at Vakilsearch, India’s best legal service provider. From there, you can easily do your paperwork in a hassle-free manner.
FAQs
What are the 3 golden rules of accounting?
The three golden rules of accounting are: Personal Account: Debit the receiver, Credit the giver. Real Account: Debit what comes in, Credit what goes out. Nominal Account: Debit all expenses and losses, Credit all incomes and gains.
What is the modern and golden rule of accounting?
Accounting principles have traditionally been guided by the golden rules, which categorise accounts into Personal, Real, and Nominal types. Specifically, for Personal Accounts, you debit the receiver and credit the giver. For Real Accounts, you debit what comes in and credit what goes out. Lastly, for Nominal Accounts, all expenses and losses are debited, while all incomes and gains are credited.
What are the 5 basic principles of accounting?
The five basic principles of accounting are: Revenue Recognition Principle: Revenue is recognized when earned. Historical Cost Principle: Transactions are recorded at their original cost. Matching Principle: Expenses should be matched with revenues. Full Disclosure Principle: All necessary information should be disclosed in financial statements. Objectivity Principle: Entries should be based on objective evidence.
Why is the golden rule important in accounting?
The golden rules provide a foundation for recording transactions consistently, ensuring the accuracy and integrity of financial data, which is essential for reliable financial reporting and analysis.
Who is the father of accounting?
Luca Pacioli, an Italian mathematician and Franciscan friar, is often referred to as the father of accounting due to his contributions in systematizing double-entry bookkeeping.
Who wrote the golden rules of accounting?
The golden rules evolved over time as the practice of accounting developed. While they aren't attributed to a single individual, Luca Pacioli's work laid down the groundwork for modern accounting principles, including these rules.
Who is the father of Indian accounting?
Prof. R. N. Carter is often referred to as the father of Indian accounting due to his significant contributions to the development of accounting education in India.
What is contra entry?
A contra entry refers to transactions involving cash and bank accounts where both the debit and credit aspects are recorded in the same entry. For example, withdrawing cash from a bank will decrease the bank balance (credit) and increase the cash balance (debit).
Who is the grandfather of accounting?
While Luca Pacioli is recognized as the father of accounting, there isn't a commonly recognized grandfather of accounting. The term might be used colloquially but isn't a standard title in the accounting profession.
What is the language of accounting?
The language of accounting refers to the standardized system of recording, presenting, and interpreting financial information, enabling clear communication and understanding among stakeholders, like investors, managers, and regulators. It includes terms, principles, and concepts foundational to accounting.
What are ledger books?
Ledger books are specialized accounting books used to record and categorize financial transactions. They record assets, liabilities, equity, revenue, and expenses.
Who created the golden rules of accounting?
The golden rules of accounting were developed over time by accounting professionals and experts based on the principles of consistency, accuracy, and transparency in financial recording.
What is an accounting cycle?
The accounting cycle refers to the series of steps followed in recording, processing, and reporting financial transactions of a business. It typically includes activities such as journalizing transactions, posting to ledger accounts, preparing trial balances, making adjusting entries, and generating financial statements.
Which professions require accounting?
Several professions require accounting knowledge and skills, including but not limited to: - Certified Accountants (CAs) - Financial Analysts - Auditors - Tax Professionals - Bookkeepers - Financial Managers - Corporate Controllers
In accounting, why do we debit the receiver and credit the giver?
By debiting the receiver, we increase the asset value, and by crediting the giver, we increase the liability or equity value, maintaining the balance.
Which accounting standards are applicable as per Section 133 of the Companies Act, 2013?
As per Section 133 of the Companies Act, 2013 in India, the applicable accounting standards are the Indian Accounting Standards (Ind AS).
Is a sales or a purchases account a real or a nominal account?
A sales account and a purchases account are considered nominal accounts in accounting.
