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Accounting

3 Golden Rules of Accounting

Accounting is a way of keeping track of a company’s financial transactions. It helps give an idea to the owners, stakeholders, and investors about the company’s direction and the future steps they need to take.

Like other disciplines, accounting has a set of rules by which it functions to achieve maximum effectiveness. These rules are called the golden rules of accounting. 

These golden rules bring uniformity to each step of accounting. They make it easier for the reader to access the reports and study them. One of the best ways to follow these rules is to systematically maintain the records of financial transactions. This way, you can check a company’s performance and get a good idea from the financial reports.

In this article, we will discuss the different aspects of accounting and the golden rules of accounting with examples.

Different Types of Accounts

Before we start talking about the golden rules, we need to understand the different types of accounts. Each golden rule is associated with a type of account. Every account has a credit side and a debit side in its ledger.

The three types of accounts are

  1. Real account
  2. Personal account
  3. Nominal account 

Real Account

In a real account, a ledger shows all the transactions related to assets. These assets may be tangible or intangible. 

Examples of tangible assets are land, building, furniture, machinery, etc. Intangible assets include patents, copyright, trust, goodwill, etc.

Real accounts are not closed at the end of a financial year. They are carried forward to the following year. Every asset has a separate real account (e.g., furniture account, building account, bank account, etc.) and appears on the balance sheet. A real account shows various transactions involving assets, including purchases/creation, sales, depreciation, and disposal of an asset.

Personal Account

Personal accounts are associated with people, either natural, artificial, or representative. 

  • Natural people – Natural people accounts are associated with a real person. For example, Ramesh’s account, Babu’s account, etc.
  • Artificial people – Artificial people accounts are connected to an entity formed by laws. A business firm, company, corporation, bank, etc., are artificial people.
  • Representative people – Representative people accounts are connected to a particular individual or group of people. For example, prepaid expenses, outstanding salary, etc., are representative people.

Nominal Account

A nominal account records the business income and expenditure along with profit and loss. As all the transactions in a financial year are considered in this account, all balances are set to zero at the beginning of a new financial year and are not carried forward.

An interest account is an example of a nominal account.

The 3 Golden Rules of Accounting

The three golden rules of accounting for each account are as follows:

Type of accountGolden Rules
Real AccountDebit: What comes inCredit: What goes out
Personal AccountDebit: The receiverCredit: The giver
Nominal AccountDebit: The expensesCredit: The incomes

Now let us see check the 3 golden rules in details – 

  1. Debit What Comes In and Credit What Goes Out

This golden rule is used for real accounts. A real account is an asset account, a liability account, or an equity account. A real account deals with the various aspects of asset management. When some asset comes into your business, you debit the account. When some asset goes out of your business, you credit the account.

  1. Debit the Receiver and Credit the Giver

This is the golden rule for personal accounts. Suppose you are dealing with a natural person or an artificial person. If they give you something for your business (cash, material, etc.), they create an income. This transaction must be included in the credit side of the account. If they take something from you, the transaction must be included in the debit side of the account.

  1. Debit All Expenses and Credit All Incomes

This golden rule applies to nominal accounts where a company’s capital is considered to be its liability or responsibility. Thus, the company has a negative credit balance. When the company earns revenue and gains profits, its capital is increased and so these transactions are recorded on the credit side of the account. Conversely, when liabilities and losses are incurred, the company’s capital decreases. These transactions are recorded on the debit side of the account.

In other words, we can redraw the above table of golden rules as follows:

Golden Rules of AccountingReal AccountPersonal AccountNominal Account
DebitWhat Comes InThe ReceiverAll Expenses and Losses
CreditWhat Goes OutThe GiverAll Incomes and Profits

Example:

Consider a company X Ltd. Here is a list of its transactions:

  • It starts its business operations using INR 2 lakh.
  • It rents a building for INR 40,000.
  • It buys raw materials worth INR 50,000 on credit from company A.
  • It sells goods worth INR 40,000 to company B.
  • It pays cash to company A for the raw materials.
  • It deposits INR 25,000 in the bank
  • It pays a salary worth INR 50,000 to the employees.
  • It earns INR 2,000 as interest on a bank deposit.

Now, let us see what different types of accounts are involved in these transactions.

TransactionsAccounts InvolvedType of Account
Capital investment of INR 2,00,000Cash a/cCapital a/cReal AccountPersonal Account
Building rent worth INR 40,000Rent a/cCash a/cNominal AccountReal Account
Raw material purchases worth INR 50,000 from A on creditPurchases a/cCompany A a/cNominal AccountPersonal Account
Goods sale worth INR 40,000 to B Sales a/cCompany B a/cNominal AccountReal Account
Cash payment to A for raw materials purchaseCash a/cCompany A a/cReal AccountPersonal Account
Bank deposit of INR 25,000Bank a/cCash a/cReal Account
Salary payment worth INR 50,000 Salary a/cCash a/cNominal AccountReal Account
Bank interest worth INR 2,000Bank a/cNominal AccountReal Account

Now, let us apply the golden rules of accounting to these transactions.

Company X Ltd. started its business with an initial capital of INR 2,00,000.

Cash is a tangible asset. Hence, it is considered in real account. Capital is also considered in a personal account. For real account and personal account, the golden rules are:

  • Debit what comes in
  • Credit the giver

So, you have to make the entry as follows:

AccountDrCr
Cash a/c2,00,000
Capital a/c2,00,000

Company X rents a property worth INR 40,000

Rent is an expense incurred by the business. Hence, it is considered a nominal account. Cash transactions form a part of a real account. According to the golden rules for a nominal account and real account:

  • Debit all expenses
  • Credit what goes out

The entry will be as follows:

AccountDrCr
Rent a/c40,000
Cash a/c40,000

It buys raw materials worth INR 50,000 on credit from company A.

Purchase transactions are expenditures to the company. Hence, they are a part of a nominal account. Company A is a personal account. According to the golden rules for a nominal account and personal account:

  • Debit all expenses
  • Credit the giver

The entry will be as follows:

AccountDrCr
Purchases a/c50,000
Company A a/c50,000

It sells goods worth INR 40,000 to company B.

Sales generate revenue for the business. Hence, it should be written in a nominal account. The transaction has been done with a company that is considered to be a personal account. According to the golden rules of nominal account and personal account:

  • Debit the receiver
  • Credit all income

The entry will be as follows:

AccountDrCr
Company B a/c40,000
Sales a/c40,000

It pays cash to company A for the raw materials.

Company A is a personal account, and the cash paid is a real account. According to the golden rules for a personal account and real account:

  • Debit the receiver
  • Credit what goes out

Hence, the entry will be written as:

AccountDrCr
Company A a/c50,000
Cash a/c50,000

It deposits INR 25,000 in the bank

Both the bank and cash are considered to be real accounts. According to the golden rules for a real account:

  • Debit what comes in
  • Credit what goes out

The entry will look like this:

AccountDrCr
Bank a/c25,000
Cash a/c25,000

It pays a salary worth INR 50,000 to the employees.

Salary is an expenditure to the company. Hence, it must be included in the nominal account. Cash is a part of a real account. According to the golden rules for a nominal account and real account:

  • Debit all expenses
  • Credit what goes out

The entry will be as follows:

AccountDrCr
Salary a/c50,000
Cash a/c50,000

It earns INR 2,000 as interest on a bank deposit.

An interest account adds to the income of the company. Hence, it is a nominal account. A bank account is a real account. According to the golden rules for a nominal account and real account:

  • Debit what comes in
  • Credit all incomes

The entry will be as follows:

AccountDrCr
Bank a/c2,000
Interest a/c2,000

Conclusion

The three golden rules of accounting are the foundation of a good financial statement. Every company needs a strong financial team for bookkeeping. 

Every transaction is entered in a journal which then eventually goes into ledgers. The golden rules of accounting help you make a correct ledger entry. As certain accounts are closed at the end of every financial year, it is very important to make accurate entries as they need to tally at the end of the year.

The three golden rules of accounting will make sure all your entries are tallied to produce a perfect financial statement.

FAQs on 3 golden rules of accounting

What are the 3 golden rules of accounting?

- Debit What Comes In and Credit What Goes Out
- Debit the Receiver and Credit the Giver
- Debit All Expenses and Credit All Incomes

Why do we debit the receiver and credit and giver?

The golden rule for personal accounts is to debit the receiver and credit the giver. Personal accounts mean a company or individual. When you make a transaction with a personal account, if they give you cash, they create an income for your company. Hence, you must credit the giver. On the other hand, if you give them cash in exchange for products, it is an expense for your company. Hence, you must debit the receiver.

Why are the golden rules of accounting used?

The golden rules of accounting help different businesses bring uniformity in their accounts and read results efficiently. The rules also help when you have to compare different financial reports.

Should a sales account be considered a nominal account or a real account?

A sales account can be considered as either a nominal account or a real account. It can be considered a nominal account because it brings in income to the business. As the golden rule for a real account is to debit what comes in and credit what goes out, sales account can be treated as a real account as well.