Every procedure is regulated by a set of generally applicable guidelines that are adhered to by everyone. In order to add uniformity to the presentation and overall structure of the notion, these rules refer to the process of basic functions.
Similarly, in accounting, three golden rules form the basis of accounting. Learn the accounting fundamentals that will help you to streamline the challenging process of recording financial transactions. Let’s explore more thoroughly.
What are the Golden Rules of Accounting?
The golden rules of accounting are a collection of fundamentals that accountants can use to record financial transactions systematically. You need to understand which accounts should be charged and which should be credited.
These rules will make it easier to decide which account to credit and which to debit. The three concepts that make up the accounting golden rules help the company to simplify the bookkeeping regulations.
These rules require you to identify the kind of account for each transaction. Specific rules for each type of account must be followed for each transaction.
Let’s look at the different account types to have a better understanding.
Types of accounts
Every debit or credit transaction entry in financial accounting will fall under one of the following three categories of accounts:
- Nominal account
A nominal account is a general ledger that includes a business’s expenses, income, profits, and losses. It includes every transaction that takes place throughout a fiscal year. Additionally, it restarts at zero when the new fiscal year starts.
- Personal account
It can be divided into three subcategories:
- Artificial Personal account
An artificial personal account represents bodies that are not human beings but act as separate legal entities according to the law. For example, government bodies, hospitals, banks, companies, cooperatives, partnerships, etc.
- Natural Personal Account
A natural personal account, such as a Capital account, a Drawings account, Creditors, Debtors, etc.
- Representative Account
A representative’s account, for instance, can include details on an employee’s unpaid wages from the previous year. It may also refer to the amount of rent a business has already paid for the upcoming year.
- Real Account
The real account is a general ledger, but contains transactions pertaining to a company’s liabilities and assets. The assets, in this case, can be further subdivided into tangible and intangible assets.
Tangible assets include land, buildings, machinery, furniture, etc. Alternatively, intangible assets include goodwill, patents, copyrights, etc.
Real accounts do not close at the end of the fiscal year, unlike nominal accounts. Instead, it is carried over to the subsequent year. Additionally, the balance sheet of the corporation includes a real account.
Now that you are aware of the various types of accounts, let’s explore how they relate to the golden rules of accounting.
Golden Rules of Accounting
- Debit The Receiver, Credit The Giver
Personal accounts fall under the umbrella of this principle. A person must be given credit in the books of accounts when they donate something to the company since it counts as input. The converse of this is also true, which is why the receiver needs to be debited.
- Debit What Comes In, Credit What Goes Out
This rule is applied in the case of real accounts. Real accounts involve things like buildings, land, and machinery. By default, they have a debit balance. Therefore, when you debit what is received, you are increasing the balance of the account. Similar to crediting what comes in, when a tangible asset leaves the company, the account balance is decreased.
- Debit All Expenses And Losses, Credit All Incomes And Gains
This rule is applied when the account in question is a nominal account. The company’s capital is a liability. As a result, there is a default credit balance. Capital is increased when all gains and losses are credited and decreased when losses and expenses are debited.
Benefits of the Golden Rules of Accounting
Following the golden rules of accounting has these benefits:
- Proper maintenance of business records
- Comparing financial results
- Calculating the valuation of a business
- Helps in budgeting as well as future projections
- Evidence during legal cases
- Assists in tax-related matters
- Helps comply with regulatory authorities
When it comes to complying with regulatory authorities, proper accounting is of the utmost importance. Any organization will struggle to attain regulatory compliance without solid accounting practices.
Now that you have a clear idea of the golden rules of accounting, you know which type of transaction belongs under which specific account. Consequently, the journal entries for financial transactions must be correct and appropriate.