What are the Golden Rules Of Accounting?
Financial Accounting is more than just bookkeeping. In accounting, all transactions are recorded using a dual-entry system, where debits and credits are used to identify which account needs to be credited and which one needs to be debited. Financial accounting follows three golden rules that ensure systematic recording of financial transactions. These rules are essential for maintaining accurate financial records.
Let's begin by understanding Debit and Credit before we delve into the golden accounting rules.
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 ledger account that deals with individuals or entities such as companies, firms, or associations. For instance, when a company such as A receives payments or credits from another business or individual, the former becomes the receiver, while the latter becomes the giver. This is what a Personal Account entails. A creditor account is a type of Personal Account.
Real Account
A real account is a type of general ledger account that records all transactions related to assets and liabilities. It includes both tangible and intangible assets. Tangible assets include items such as furniture, land, buildings, machinery, and so on. Intangible assets, on the other hand, include items like goodwill, copyrights, patents, and more.
Nominal Account
A nominal account is a type of general ledger account that is used to record all business income, expenses, profits, and losses for a specific fiscal year. At the end of each fiscal year, these accounts are reset to zero, allowing them to start fresh for the next fiscal year. An interest account is an example of a nominal account.
Golden Rules of Accounting
Understanding the golden rules of accounting is crucial for proper bookkeeping. These rules dictate that you must determine the account type for each transaction. Each type of account has its own set of guidelines that must be followed for each transaction. The three golden rules of accounting are as follows:
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| The Golden rules of Accounting |
1) Rule: Debit What's Comes In, Credit What's Goes Out.
This rule applies to a real account, which includes assets such as cash, furniture, land, buildings, banks, and others. Real accounts have a default debit balance, so debit transactions that increase the account balance and credit transactions that decrease the account balance should be recorded accordingly. For example, when a tangible asset leaves the firm, the transaction should be recorded as a credit to reduce the account balance, while a debit should be recorded when an asset is acquired to increase the balance.
2) Rule: Debit the receiver, Credit the Giver.
This rule applies to personal accounts, including individuals, companies, and firms. When a person or entity purchases goods or services or receives cash from another party, they will debit the receiver, resulting in an increase in the receiver's account balance. Conversely, when the person or entity sells goods or services or makes payments to another party, they will credit the giver, resulting in a decrease in the giver's account balance.
3) Rule: All Expenses and Losses are Debit, and All Income and Gains are Credit.
This rule applies to Nominal accounts, which include all types of income, expenses, profits, and losses. A company's capital is its liability, and therefore, crediting all the income and gains leads to an increase in capital. Conversely, the capital reduces when expenses and losses are debited.