Basically, accounting is the most fundamental matter for any financial system of businesses. It gives a skeleton through which transactions are recorded and managed. One of the essential concepts of accounting is the golden rules of accounting. It defines the basis upon whether the financial data is on right track or not.
These rules add a lot of transparency, consistency, and accuracy in personal and corporate finances. In this blog, we shall look at these three rules and see how they will apply in different types of transactions in day-to-day accounting.
Conceptualizing the 3 Golden Rules of Accounting
- Accounts are maintained in the accounting system using 3 golden rules of accounting.
- That is directly based on double entry book keeping method.
- All transaction effect two accounts from general to sub head one as debit and other credit.
- It helps create a dual effect that maintains the balance sheet’s integrity.
- Whatever be the accounting, these rules govern across all transactions and financial activities.
3 types of Account that follow Golden Rules
The three types of accounts that follow the golden rules of accounting are:
Personal Accounts
These accounts relate to individuals, companies, or organizations.
Golden Rule: Debit the receiver, Credit the giver.
Example: When you pay a supplier, you debit the supplier’s account (receiver) and credit your bank account (giver).
Real Accounts
These accounts represent tangible or intangible assets owned by the business.
Golden Rule: Debit what comes in, Credit what goes out.
Example: When you purchase machinery, you debit the machinery account (what comes in) and credit the cash account (what goes out).
Nominal Accounts
These accounts deal with income, expenses, gains, and losses.
Golden Rule: Debit all expenses and losses, Credit all incomes and gains.
Example: When you pay salaries, you debit the salary expense account (expense) and credit the cash account.
Rule #1: Debit the Receiver, Credit the Giver
This rule states that whatever comes to one party is the outflow for another. When it is giving, credit the account; when it is receiving, debit the account. Consider your company gets a loan from a bank. In such a case, you will debit the cash account that received the amount and credit the bank from where it was received. On the contrary, if your company pays to a supplier, then a supplier’s account needs to be debited.
Example:
Transaction: Your company repays a loan to a bank.
Entry: Debit the Bank’s Account, Credit the Company’s Cash account
Rule #2: Debit What Comes In, Credit What Goes Out
This rule involves visible and physical things. When the business buys a machine or inventories, you debit an account to record its arrival. When the asset is going out, say inventory sold, the account will be credited. In this way, the books will correctly reflect the value of assets over the period.
Example:
Transaction: Your company will buy an office furniture for $2,000 Transaction Impact:
Entry: Debit the Furniture account & Credit the Cash account
Rule #3: Debit the Expenses & Losses, Credit, Incomes & Gains
This rule pertains to the income statement. Any cost, like salary or utility bills would be debited; while any revenue, including sales revenues or interests earned are to be credited. It shows you the profitability and loss of any business.
Example:
Transaction: Your company pays salaries amounting to $ 1,000.
Entry: Debit the salary account and credit the cash account.
How Golden Rules of Accounting Affects Balance Sheet
The balance sheet depicts the financial position of an entity, and the golden rules link with its accuracy directly.
In this way, companies accurately record the transactions that consequently provide them with an appropriate balance sheet depicting real-life financial data.
Examples of Application of Golden Rules in Accounting
Let’s illustrate an example to show the golden rules of accounting in action:
Personal Account: When the raw materials are paid to a supplier
When you pay a certain amount to your supplier, you need to debit his account because he is the receiver and credit your bank account because it is the giver.
Real Account: When the company is purchasing new computers for office
Debit the computers because it is the asset that comes in. On the other hand, Credit the cash or bank account because cash goes out.
Nominal Account: In case of utility bills on a monthly basis
Debit utility expenses under the head of expenses, and credit the cash account.
Conclusion: Mastery of the Golden Rules for Correct Accountancy
Mastery of golden rules in accounting is quite essential for any financier or entrepreneur. In fact, these rules ensure that all financial records are correctly and clearly presented for decision-making purposes. The more you practice the rules by applying them to different circumstances, the better your financial literacy will be in assisting their business to prosper over the long term.
Following these simple tips, you will be confidently able to manage the accounting tasks and maintain proper financial records. For more updates and professional tips and tricks about finance, visa and human resource management, keep in touch with FastLane HR .