Are you an accountant, a CA, a tax professional, or someone connected to finance? If so, you probably know how important accounting is for recording and reporting the financial transactions of a business or an individual. Accounting helps you keep track of the income, expenses, assets, liabilities, and equity of your clients and provide them with accurate and reliable financial statements.
However, accounting is not always easy. There are many rules and principles that you need to follow to ensure that your accounting is consistent and compliant with the standards and regulations. One of the most fundamental and essential rules that you need to know and apply is the golden rules of accounting.
The golden rules of accounting are a set of three rules that simplify the process of bookkeeping and accounting. They help you classify the accounts into three types: personal, real, and nominal. They also help you determine the debit and credit entries for each transaction involving these accounts.
In this blog post, we will explain the golden rules of accounting with examples and show how they can help you in your accounting work. By the end of this post, you will be able to:
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Understand the meaning and definition of the three types of accounts and the three golden rules of accounting.
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Apply the golden rules of accounting to record the transactions using debit and credit entries.
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Appreciate the benefits and advantages of using the golden rules of accounting.
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Avoid some common mistakes and challenges that accountants face while using the golden rules of accounting.
So, let’s get started!
What are the Three Types of Accounts?
Before we dive into the golden rules of accounting, let’s first understand what are the three types of accounts that they apply to. The three types of accounts are:
Personal Accounts
These are the accounts that relate to persons or entities. They can be further classified into three subtypes: natural, artificial, and representative.
Natural persons are human beings, such as customers, suppliers, employees, etc.
Artificial persons are legal entities, such as companies, banks, governments, etc.
Representative persons are accounts that represent a group of persons or transactions, such as outstanding expenses, prepaid income, etc.
Real Accounts
These are the accounts that relate to assets or properties. They can be tangible or intangible.
Tangible assets are physical objects, such as land, buildings, machinery, inventory, cash, etc.
Intangible assets are non-physical objects, such as goodwill, patents, trademarks, etc.
Nominal Accounts
These are the accounts that relate to income, expenses, gains, or losses. They are also called temporary accounts, as they are closed at the end of the accounting period. Examples of nominal accounts are sales, purchases, rent, salary, interest, etc.
What are the Three Golden Rules of Accounting?
Now that we know the three types of accounts, let’s see what are the three golden rules of accounting that apply to them. The three golden rules of accounting are:
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For personal accounts, debit the receiver and credit the giver. This means that when a person or entity receives something, their account is debited, and when they give something, their account is credited.
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For real accounts, debit the account when something comes in and credit the account when something goes out. This means that when an asset or property is acquired, its account is debited, and when it is disposed of, its account is credited.
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For nominal accounts, debit the account when there is an expense or loss and credit the account when there is an income or gain. This means that when an expense or loss is incurred, its account is debited, and when an income or gain is earned, its account is credited.
These three rules can be summarized in a table as follows:
| Type of account | Debit | Credit |
|---|---|---|
| Personal | Receiver | Giver |
| Real | Inflow | Outflow |
| Nominal | Expense/Loss | Income/Gain |
How to Apply the Golden Rules of Accounting with Examples?
To apply the golden rules of accounting, you need to follow these steps:
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Identify the accounts involved in the transaction and their types.
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Apply the appropriate rule for each account based on its type.
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Record the debit and credit entries for each account using journal entries and ledger accounts.
Let’s see some examples of how to apply the golden rules of accounting for different transactions.
Example 1: Purchase of machinery for cash
Suppose a business purchases machinery worth $10,000 for cash. The accounts involved in this transaction are:
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Machinery: This is a real account, as it is an asset.
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Cash: This is also a real account, as it is also an asset.
According to the rule for real accounts, we debit the account when something comes in and credit the account when something goes out. Therefore, we debit the machinery account and credit the cash account. The journal entry and the ledger accounts for this transaction are:
Example 2: Sale of goods to a customer on credit
Suppose a business sells goods worth $5,000 to a customer on credit. The accounts involved in this transaction are:
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Sales: This is a nominal account, as it is an income.
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Customer: This is a personal account, as it is a natural person.
According to the rule for nominal accounts, we debit the account when there is an expense or loss and credit the account when there is an income or gain. Therefore, we credit the sales account. According to the rule for personal accounts, we debit the receiver and credit the giver. Therefore, we debit the customer account. The journal entry and the ledger accounts for this transaction are:
Example 3: Payment of salary to an employee
Suppose a business pays a salary of $2,000 to an employee. The accounts involved in this transaction are:
Salary: This is a nominal account, as it is an expense.
Employee: This is a personal account, as it is a natural person.
Cash: This is a real account, as it is an asset.
According to the rule for nominal accounts, we debit the account when there is an expense or loss and credit the account when there is an income or gain. Therefore, we debit the salary account. According to the rule for personal accounts, we debit the receiver and credit the giver. Therefore, we credit the employee account. According to the rule for real accounts, we debit the account when something comes in and credit the account when something goes out. Therefore, we credit the cash account. The journal entry and the ledger accounts for this transaction are:
What are the Benefits and Advantages of Using the Golden Rules of Accounting?
Using the golden rules of accounting can help you in many ways, such as:
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Simplifying the process of bookkeeping and accounting by providing a logical and consistent framework for recording the transactions.
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Ensuring the accuracy and reliability of the financial statements by avoiding errors and discrepancies in the debit and credit entries.
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Enhancing the understanding and analysis of the financial transactions by showing the impact of each transaction on the accounts and the financial position of the business or the individual.
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Facilitating the compliance and audit of the accounting records by following the standards and regulations of the accounting profession and the authorities.
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Mixing up the debit and credit entries for each account. For example, some accountants may debit the sales account instead of crediting it, or credit the cash account instead of debiting it.
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Not adjusting the accounts for the accruals, prepayments, depreciation, bad debts, or other adjustments that affect the financial statements. For example, some accountants may forget to record the accrued expenses or the prepaid income at the end of the accounting period.
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Not following the double-entry system of accounting, which requires that the total debits must equal the total credits for each transaction. For example, some accountants may record a single entry or a triple entry instead of a double entry, or make arithmetic errors in the calculations.
To avoid these mistakes and challenges, accountants need to be careful and diligent while using the golden rules of accounting. They also need to review and verify their accounting records regularly and seek professional guidance or assistance when needed.
Conclusion
The golden rules of accounting are a simple and effective way to record and report the financial transactions of a business or an individual. They help you classify the accounts into three types: personal, real, and nominal. They also help you determine the debit and credit entries for each transaction involving these accounts. By using the golden rules of accounting, you can simplify the process of bookkeeping and accounting, ensure the accuracy and reliability of the financial statements, enhance the understanding and analysis of the financial transactions, and facilitate the compliance and audit of the accounting records. However, the golden rules of accounting are not without some challenges and limitations. You need to be careful and diligent while using them and avoid some common mistakes and errors that can affect your accounting work. You also need to follow the standards and regulations of the accounting profession and the authorities and seek professional guidance or assistance when needed.
