Golden rules of accounting represent the basic rules that govern the recording of day to day financial transactions of a business. Also known as traditional accounting rules, golden rules of bookkeeping, or the rules of credit and debit, these accounting rules play an essential role in the accounting realm. They form the basis for recording entries in a Journal Book without which the whole accounting would become an erratic mess.
To understand how the golden rules of accounting work, we need to know the types of accounts first. This is because these rules apply to transactions based on a particular account type.
Types of Accounts
According to the golden rules of accounting, there are three kinds of accounts: Personal, Real, and Nominal.
#1. Personal Account:
These are the accounts that belong to individuals. These individuals may be human beings or artificial persons. Basically, the individuals are of three types:
- Persons: representing natural persons like Ram’s account, John’s account etc.
- Artificial Persons: representing partnership firms, associations, and companies like ABC Charitable Trust, XYZ Industries Ltd, and Tata and Sons etc.
- Representative Persons: representing person or group of persons like Salary payable A/c, Prepaid Expenses A/c, and Outstanding Salary A/c etc.
#2. Real Accounts:
These are the ledger accounts that represent all assets belonging to a business enterprise. Real accounts are further divided into two types- tangible and non-tangible.
- Tangible real accounts include assets that have a physical existence, such as property A/c, inventory A/c, furniture A/c, investment A/c, etc.
- Intangible real accounts include all accounts for non-physical assets such as Trademark A/c, Patent A/c, Goodwill A/c, Copyright A/c, etc.
#3. Nominal Account:
These accounts represent expenses, losses, gains, and revenues of a business. The Nominal accounts may include wages A/c, Rent A/c, Electricity Expenses A/c, salary A/c, travelling expenses A/c, and commission received A/c etc.
Three Golden Rules of Accounting
Now, after understanding all kinds of accounts, let’s explore how accounting rules apply to transactions. Given below is the explanation of types of accounting rules with their examples.
A personal account is an account to be used by an individual for his or her own needs. If a person/legal body/group of person receives something from the business, then he is a receiver, and in books of business, his account is represented as debited. Alternatively, if a person/legal body/group of the person grants something to the business, then he is a giver. His account in the books of business is represented as credited.
Example: You purchased goods worth Rs 10,000 from Shyam.
In this transaction, you are a receiver of goods, therefore in your books of account, you will debit your purchase account and credit Shyam. Since Shyam is a giver of goods, his account will be credited.
|XX/XX/XXXX||Purchase account||Rs. 10,000/-|
|Account Payable||Rs. 10,000/-|
According to real account rule, if a business receives something (property or goods), then in accounting entry, it is represented as debited. If something goes out from business, then in accounting entry, it is represented as credited.
Example: Let’s say you purchased furniture for Rs.10,000 in cash.
In this transaction, accounts affected are furniture A/c and cash A/c. Furniture comes into the business, debit furniture account. Cash goes out of business, therefore, credit cash account.
|Cash account||Rs. 10,000/-|
As per nominal account rule, if a business incurs any expense or loss, then in books of business, its accounting entry shall be represented as debited. On the other hand, if business gains income or profit by rendering services on any transaction, then its accounting entry is represented as credited.
Example: Suppose you paid Rs.1,000 as your office rent.
Here, rent paid is an expense for your business; therefore, it should be debited in books of business.
|XX/XX/XXXX||Rent account||Rs. 1,000/-|
|Cash account||Rs. 1,000/-|
Key Takeaway from Golden Rules of Accounting
Golden rules of accounting are the cornerstone of the entire accounting process. By providing the basis for recording transactions, these rules help in the systematic presentation of financial statements. Using them, one can easily record expenses and income, thereby facilitating better management of business accounts book. To apply these rules:
- First, ascertain the type of account involved in the transaction.
- Check whether the value has increased or decreased.
- Once done, diligently apply the golden rules of debit and credit.
So, if you want to keep your business’s books of accounts up-to-date and accurate, stick to these golden rules.