Golden Rules of Accounting

The accounting process involves recording, classifying, and summarizing the financial transactions of a business or organization. Basically, accounting refers to a process where financial transactions are recorded systematically to keep a chronological record of what happened at each stage.

The financial information of every economic entity must be presented to all stakeholders. To provide a true picture of the entity, the financials must be accurate. Each of its transactions must be included in this presentation. The purpose of accounting is to understand financial status of economic entities by comparing them. In order to ensure uniformity and to account for transactions correctly, there are three Golden Rules of Accounting. Accounting and bookkeeping are based on these rules. Journal entries are the basis of this.

Understanding the types of accounts is the first step toward understanding the Golden Rules of Accounting. There are many different types of general ledgers. Therefore, every account will fall into one of the broad categories below. There are three types of accounts:

• Real Account: In general ledger accounts, Real Accounts refer to Assets and Liabilities other than people accounts. They are accounts that don’t close at year-end and are carried forward. Bank accounts are a good example of these accounts.
• Personal Account: A Personal account is a General Ledger account that is associated with every individual, firm, or association. A creditor account is an example of a Personal Account.
• Nominal Account: A Nominal account is a General Ledger account that reflects all income, expenses, losses and gains. Interest is an example of a Nominal account.

Three Golden Rules of Accounting/ Journal Entry Rules of Accounting

The three golden rules of accounting are as follows:

Rule 1: Debit the receiver, Credit the giver 

Personal accounts are governed by this principle. If someone gives something to an organization, it becomes an inflow, and the person must be credited in the books of accounts. The reverse is also true, which is why the receiver must be debited.

Example

As an example, suppose you purchase Rs.2,000 worth of goods from Company ABC. In your books, you need to debit your Purchase Account and credit Company ABC. Since the giver, Company ABC, is providing the goods, you need to credit Company ABC. Finally, you need to debit your Purchase Account.

Rule 2: Debit what comes in, Credit what goes out

Real accounts follow this principle. In real accounts, machinery, land and buildings are involved. By default, they have a debit balance. In other words, when you debit what comes in, you are adding to the account balance. That is exactly what should be done. When a tangible asset leaves the company, you are also reducing the account balance when you credit what goes out.

Example

Let’s say you bought furniture for Rs. 2,500 in cash. The Furniture Account should be debited (what comes in) and the Cash Account should be credited (what leaves).

Rule 3: Debit All Expenses and Losses, Credit All Incomes and Gains

Nominal accounts are subject to this rule. This represents the liability of the company. It has a default credit balance. If you credit all incomes and gains, the capital will increase. If you debit all expenses and losses, the capital will decrease. For the system to remain in balance, it must be done exactly as described.

Example: (For Expenses or Loses)

Suppose you purchase $2,000 of goods from Company XYZ. To record the transaction, you must debit the expense ($2,000 purchase) and credit the income.

 Example: (Income or Gain)

If you sell Rs.1,000 worth of goods to Company XYZ, you must credit the income to your Sales Account and debit the expense.

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