Golden Rules of Accounting
One of the most famous and commonly used terms in the field of accounting and finance is “Three golden rules of accounting”. The phrase itself shows that these rules form the very basis of accounting and act as a cornerstone for all bookkeeping. They are also known as the traditional rules of accounting or the rules of debit and credit. Application of three golden rules is only possible if correctly determine the type of account using in business transactions i.e. Real, Personal or Nominal Account.
I hope you have understanding of Accounting Terminologies.
Note: Rules of accounting does not means that in one transaction only one rule will be applicable. There may be two rules will applied. Whenever, transaction will be done on cash basis then only two rules apply, real or nominal. But when it’s on credit basis then Personal account replace with Real account of cash.
3 Types of Accounts
- Real Account: Its relate with Capital nature Expense, Balance Sheet Items
- Nominal Account: Its relate with Revenue nature Expenses, Income Statement Items
- Personal Account: When Transaction will done on credit then person account comes.
Brief introduction of three Golden Rules of accounting
- Real Account: Debit What comes in and Credit What Goes out
- Nominal Account: Debit all Expenses and Losses and Credit all Income and Profit
- Personal Account: Debit the receiver and Credit the giver
Its Traditional rules for posting the transactions into journal and ledgers. Debtors and Creditors are expressed into Personal Accounts, Expense, losses and profit is come into Nominal and Assets come into Real Account. So by remembering 3 rules bookkeeping can be understand within short time.
3 Golden Rules of Accounting with Example
Real accounts: Debit What comes in and Credit What Goes out
These are related to Balance Sheet Items. Example is Land and Building, Furniture and Fixture, Cash, Plant and equipment. Real accounts are those which have effect more than one year.
Real Account treatment rule:
Debit What Comes In,
Credit What Goes Out
This principle is applied in case of real accounts. Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization.
For example (With capital nature items)
Purchased furniture for $10,000 in cash.
Furniture A/C 10,000 Real a/c – Dr. what comes in
Cash A/C 10,000 Real a/c – Cr. what goes out
Because transaction is cash bases that are why both real account come in dual concept. But if the same transaction is done on credit then Cash account replaced with Personal account.
Nominal Account: Expenses and Losses will be debited & All Incomes And Gains will be credited
All Expense and loss Debited
All profit and income Credited
Nominal Accounts are related to Income Statements Item. Examples are Salary and Wages, Commission, Utility bills, Carriage, losses, Income, Profit. Nominal accounts are those which have less than one year effect on business.
This rule is applied when the account in question is a nominal account. The capital of the company is a liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance. For example;
• Paid 1$8,000 as rent.
Accounts Involved Debit/Credit Rule Applied
Rent A/C 18,000 (Nominal a/c) – Dr. the expenses
To Cash $18,000 (Real a/c) – Cr the Giver
- Profit Gained $ 100
Cash Debited With $ 100 (Real A/c)
Profit Credited With $100 (Nominal A/c)
Personal Account: Debit The Receiver, Credit The Giver
As I mention above if transaction is made on credit basis then this rules come into existence. This will replace with one side of Real account. This principle is used in the case of personal accounts. When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. Personal accounts are only the replacement of finance, cash. That is Debitor or Creditor.
• Paid 15,000 cash to Amazon.
Accounts Involved Debit/Credit Rule Applied
Amazon A/C 15,000 Personal a/c – Dr. the receiver
To Cash A/C 15,000 Real a/c – Cr. what goes out
In the above transaction cash is capital nature and balance sheet item so it will be treated under Real account. Amazon relate to the financing item so treated with Personal account.
Before understanding the Golden Rules of accounting you should know the basic accounting terminologies, classification of Capital and revenue Expenditure then you can better understand the types of accounts and rules for debit and credit.