What are the Golden Rules Of Accounting?
Financial Accounting is not just bookkeeping. In accounting, transactions are recorded in a dual entry system debit and credit. It must be Important to identify which account has to be credited and which has to debit. Financial accounting revolves around three rules, known as the golden rule of Accounting. These golden rules ensure systematic recording of the financial transaction.
Before we start the golden rules of accounting, let's understand Debit and Credit.
What are Debit and Credit?
Debits and credits are equal but opposite entries in your accounting books.
Debit
A debit is an accounting entry that either increases an asset or expense account, or decreases a liability or equity account. It is positioned to the left in an accounting entry.
Credit
A credit is an accounting entry that either increases a liability or equity account or decreases an asset or expense account. It is positioned to the right in an accounting entry.
Credit and debits affect the five core types of accounts:
- Assets: Assets are the resources owned by a business that has economic value. You can convert assets into cash. (Example, Land and Building, Plant and Machinery, Furniture and Fixtures, computer, Vehicle, and cash.)
- Expenses: Expenses are the costs that occur by running a business. (eg Salary, Wages, Supplies)
- Liabilities: Liabilities are the amounts owed to another person or business.
- Equities: Equities means, your assets minus your liabilities
- Income and Revenue: Cash earn from Sales.
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| Debit and Credit affects five core type of account |
Types of Accounting.
The golden rules of accounting help in recording financial transactions into the ledgers. These golden rules are based on the type of account. Each transaction will have a debit and credit entry and belong to one of the following three types of accounts.
- Personal Account
- Real Account
- Nominal Account
Personal Account
A personal account is a general ledger account relating to persons. It can be natural persons like individuals or artificial persons like companies, firms, associations, etc. When company A receives money or credit from another business or individual, company A becomes the receiver. And, the other business or individual who gives it becomes the giver, in the case of a personal account. A creditor account is a type of personal account.
Real Account
A real account is a general ledger account that reflects all the transactions relating to assets and liabilities. It comprises tangible and intangible assets. Tangible assets such as furniture, land, building, machinery, etc. On the other hand, intangible assets such as goodwill, copyright, patents, etc.
Nominal Account
A nominal account is a general ledger account relating to all business income, expenses, profit and losses. It accounts for all transactions pertaining to one fiscal year. As a result, the balances are reset to zero and can start afresh. An interest account is a type of nominal account.
Three Golden Rules of Accounting
Golden rules of account form the basis for bookkeeping. As per the golden rules of accounting, you must ascertain the type of account for each transaction. Each type of account has its own set of rules that needs to be applied for each transaction. Following are the three golden rules of accounting:
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| The Golden rules of Accounting |
1) Rule: Debit What's Comes In, Credit What's Goes Out.
This rule is applicable to a real account. Cash, furniture, Land, Building, Banks, e.t.c. are included in real account. Real Account have Debit balance by default. As a result, debit what is coming in adds to the existing account balance. Similarly, when a tangible asset leaves the firm, credit what goes out reduces the account balance.
2) Rule: Debit the receiver, Credit the Giver.
This rule is applicable on Personal account. It includes persons or artificial persons like Company, Firm, Individuals. When a person or artificial persons purchase goods or services or received cash from the other persons, they will debit receiver, As result the amount add to the receiver account. And when the persons sale goods or services or make payments to other persons, they will credit giver, As result the amount is deducted from giver account.
3) Rule: All Expenses and Losses are Debit, All Income and Gains are Credit.
This rule is applicable on Nominal account. A Nominal Account include all Income, Expenses and Profits and losses. A companys capital is its liability. As results Crediting all the income and gains will increase the capital. On the other hand, the capital reduces when expenses and losses are debited.