What are the Golden Rules of Accounting
27

Jun 2022

Financial accounting is different from bookkeeping, and accounting has a dual entry for every transaction - debit and credit.

In the dual entry system of accounting, the accountant must first identify which account should be debited and which one should be credited. Accounting revolves around three rules, collectively called the Golden Rules of Accounting. These rules ensure that financial transactions are recorded systematically, thus simplifying the rules of bookkeeping into a set of easily understandable, studied, and applied principles.

The golden rules of accounting help in recording a company’s financial transactions in ledgers. These rules are based on the types of accounts. Every transaction will have a debit entry on the left side of the account and a credit on the right and belong to any of the following accounts:

  • Real Accounts- refer to transactions about assets and liabilities. Assets include land, furniture, machinery, buildings, etc.). These accounts are not closed at the end of the financial year but taken out the following year. A furniture account is an example of a real account.
  • Personal Accounts - refers to persons, individuals, or artificial persons (companies, organisations, firms, associations, etc.). A creditor account is an example of a personal account.
  • Nominal Accounts - relate to all business profit and losses, income and expenses, and accounts for all transactions that are done in one fiscal year. An example of a nominal account is an interest account.

The 3 Golden Rules of Accounting are as follows:

Rule 1: Debit the receiver and credit the giver.

This rule applies to real accounts (furniture, land, buildings, machinery, vehicles, etc.). Real accounts have a debit balance by default, so when you debit what is coming in, it will add to the existing account balance; in the same way, that when a tangible asset leaves the company, crediting it will lessen the account balance.

Example 1: Say you bought goods from Company A for $1,500, and you will have to debit your purchase account and credit Company A. Your purchase account is the receiver of goods, and Company A is the giver.

Date Account Debit Credit
XX-XX-XXXX

Purchase Account

Accounts Payable

1,500 1,500

Example 2: Say you paid $600 in cash to Company A for office supplies; you have to debit the receiver and credit your cash account.

Date Account Debit Credit
XX-XX-XXXX

Supplies Account

Cash Account

600 600

Rule 2: Debit What Comes in and Credit What Goes Out

This applies to Personal Accounts, which are sometimes called Real Accounts. When your business acquires something, such as an asset, debit the asset account; when something goes out, you credit the account.

Example: Let’s say you bought a set of furniture for $2,000 and paid in cash, debit the furniture account in your books, and credit the cash account.

Date Account Debit Credit
XX-XX-XXXX

Furniture Account

Cash Account

2,000 2,000

Rule 3: Debit Expenses and Losses; Credit Income and Gains

This 3rd rule deals with nominal accounts (revenue, expense, gain, and loss). You debit the account if the business incurred an expense or loss credit the account if you have an income or profit.

Example for Expenses or Loss: Say you purchased $2,800 worth of goods from Company B. You record this transaction by debiting the expense and crediting the cash account.

Date Account Debit Credit
XX-XX-XXXX

Purchase Account

Cash Account

2,800 2,800

Example for Income or Gain: Say you sold $1,900 worth of goods to Company Z; you debit the cash and credit the income in your sales account.

Date Account Debit Credit
XX-XX-XXXX

Cash Account

Sales Account

1,900 1,900

Conclusion

The Golden Rules of Accounting establish the foundation for preparing financial accounts. Every transaction must be recorded as a journal entry and then as a ledger. The accountant must first determine to what account a transaction should be recorded before making journal entries based on the 3 Golden Rules of Accounting.

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