The "golden rules" are a set of guidelines used in the accounting sector. The accounting golden rules offer fundamental guidelines for keeping accurate and trustworthy financial records, much like the well-known Golden Rule in life, which encourages treating people how you want to be treated. Businesses can make sure their accounts are accurate and reflect the real financial situation of the company by following these standards. In this article, we will explore the three accounting "golden rules" and learn how important they are for maintaining effective financial management.
Types of Accounts
The "golden rules of accounting," with precise guidelines varying depending on the type of account concerned, help to record financial transactions in ledgers.
The following three types of accounts will each receive a debit entry and a credit entry for every transaction.
- Personal Account
- Real Account
- Nominal Account
Three Golden Rules of Accounting
The ideas of Debits and Credits serve as the foundation for accounting. The accounting industry is driven by debits and credits, which serve as its driving force. It is essential to have a thorough understanding of the complexities relating to Debits and Credits before diving into the golden rules of accounting.
Accounting entries known as debits and credits have identical values but different outcomes. The five basic types of accounts used in accounting are affected by these entries:
- Assets: Assets are things that a company owns that have economic value and may be sold for money, such as cash, equipment, real estate, and automobiles.
- Expenses: Expenses include charges for materials, salaries, and other operational costs incurred during business operations.
- Liabilities: Such things as accounts payable and loans are amounts owing by the company to an individual or entity.
- Equity: Liabilities are subtracted from assets to determine equity, which is the net worth of the company.
- Income and revenue: These terms relate to the money made from sales, services, or other commercial endeavors.
Generally, The golden rules of accounting are essential principles for financial record keeping, guiding how assets, liabilities, and equity are handled. However, for accurate accounting processes, the following are the 3 technical golden rules of accounting,
- Debit the receiver and credit the giver
- Debit what comes in and credit what goes out
- Debit expenses and losses, credit income and gains
1. Debit the receiver and credit the giver
Personal accounts, which are general ledger accounts linked to specific people or entities, are subject to debiting the receiver and crediting the giver principle. In personal accounts, the account gets debited when you receive something. On the other hand, when you give something, your account gets credited.
Let's examine a case that demonstrates the first golden rule in action:
Assume you purchase $1,000 worth of items from Company ABC. You would need to add two entries to your books by the first golden rule. First, you would give Company ABC credit because they are the ones who provided the items. Second, as you are the recipient of the items, you would debit your Purchase account.
2. Debit what comes in and credit what goes out
Real accounts, which are permanent accounts that do not close at the end of the accounting period, are covered by the second golden rule. Assets, liabilities, and equity are all included in real accounting, as well as accounts for contra-assets, contra-liabilities, and contra-equity.
Simply said, for real accounts, you should debit the account whenever something enters your company (such as an asset). On the other hand, you should credit the account when something departs your business (such as a decrease in an asset).
Let's say you paid $2,500 cash for some furniture. You would make the following entries if you were to follow the second golden rule of accounting:
Debit the Furniture account for incoming funds and credit the Cash account for outgoing funds.
The credit entry to the Cash account reflects the drop in cash as it leaves your company to make the purchase, while the debit entry to the Furniture account reflects the increase in the value of the furniture.
3. Debit expenses and losses, credit income and gains
Nominal accounts, which are transient accounts that are closed at the end of each accounting period, are covered under the third golden rule of accounting. Revenue, expenditure, gain, and loss accounts are examples of nominal accounts.
When it comes to nominal accounts, you should debit the account whenever your company experiences an expense or loss. In contrast, you should credit the account if your company generates money or makes a profit.
Let's have a look at an example that demonstrates how the third golden rule can be applied:
Let's say you spend $3,000 on items from Company XYZ. The third golden rule is that two entries must be made to properly record this transaction. To record the increase in expenses incurred, you would first debit the expense account ($3,000 purchase). To record the appropriate decrease in income, you would next credit the income account.
Benefits of following the Golden Rules of Accounting
- Maintains secure and organized documentation of business transactions through accurate record-keeping.
- Proper business valuation is made possible by business valuation, which also attracts investors and supports growth.
- The ability to create a reliable budget allows for precise future forecasting.
- Enables the quick preparation of financial statements including balance sheets and profit and loss statements.
- An improved financial analysis that makes it easier to compare financial success year over year.
- Aids businesses in adhering to regulations and avoiding fines.
- Prevents tax omissions and related fines, preserving brand value.
Best Accounting Services
The "golden rules" of accounting provide systematic instructions for recording financial transactions to accountants. Accountants can identify which accounts should be credited and which should be debited by using the rules above, ensuring the accuracy and completeness of financial records.
BMS Auditing is a leading accounting firm in the world to offer professional accounting services in UAE, USA, UK, Qatar, Oman, Bahrain, Saudi Arabia and India with the biggest team of chartered accountants. We follow the accounting standards accepted in the respective countries and of course the three golden rules of accounting as well to offer a most tailored services.
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