3 Golden Rules of Accounting and their importance in Financial Transactions

Every financial transaction impacts at least two accounts. The double-entry accounting system uses debit and credit columns to record these transactions. Therefore, understanding the classification of accounts as debit or credit is important for accurate record-keeping.

Golden Rule of Accounting

Golden rule of accounting provides a framework to record financial transactions by debiting and crediting accounts. The core principle is correctly identifying which accounts to debit and credit for every transaction.

Types of Accounts

Personal Account:

For personal accounts (individuals or organizations), the Golden rules of accounting says: Debit the receiver and credit the giver.

Types of Personal Account –

• Artificial Personal Account: These Not real persons recognized by law. Entities like hospitals, banks, companies, government agencies,etc.
• Natural Personal Account: These are real persons accounts.It includes individual capital accounts, accounts for debtors and creditors, and drawing accounts.
• Representative Personal Account: This type of account represents both human (natural) and non-human (artificial) entities.

Real Account

As per golden rules of accounting real accounts represent the tangible assets of a business, such as furniture and cash. Assets can be further categorized as tangible (physical) and intangible (non-physical). Real accounts focus on the physical, material possessions of the business.

When a real account item (an asset) enters the business, it is recorded as a debit.

When a real account item (an asset) leaves the business, it is recorded as a credit

Nominal Accounts

As per golden rules of accounting nominal accounts are related to expenses, losses, income, and gains.

Expenses and losses are debited.

Income and gains are credited.

Golden Rules of Accounting

Rule 1 of Golden Rules of Accounting

"Debit what comes in & credit what goes out."

This rule applies to personal accounts.

To maintain accurate records by following golden rules of accounting:

When a business receives the value: Debit the corresponding account.

When a business gives the value: Credit the corresponding account.

For ex:- If your business pay 1000 in rent to landlord - “debit the rent expense and credit the cash”

Rule 2 of Golden Rules of Accounting

"Credit the giver and Debit the Receiver."

This applies to real accounts.

Key Points:

Debit what comes in: When a business buys an asset - debit asset a/c

Credit what goes out: When a business sells or gets rid of an asset- credit asset a/c

Rule 3 of Golden Rules of Accounting

"Credit all income and debit all expenses."

This rule applies to all nominal accounts.

Key Points:

Debit Expenses and Losses: Debiting expenses and losses reflects the resources used and costs incurred by the business.

Credit Income and Gains: Crediting income and gains reflects the resources and profits the business earns.

Importance of the Golden Rules of Accounting

• Simplicity in Record-Keeping:

These golden rules of accounting make transaction recording easier and more consistent by providing clear debit and credit guidelines.

• Accuracy:

These golden rules of accounting help businesses keep accurate financial records, minimizing errors and discrepancies.

• Clarity in Financial Statements:

Using the golden rules of accounting result in clear and transparent financial statements, which are crucial for stakeholders to understand a company's financial health.

• Compliance:

Following these golden rules of accounting ensures compliance with accounting standards, which is essential for legal and regulatory requirements.

• Ease of Learning:

For accounting students and professionals, the golden rules of accounting provide a foundational framework that is easy to learn and apply across various transactions.

Golden Rules of Accounting Principles

The golden rules of accounting are based on fundamental principles that ensure accurate and consistent financial reporting. Here are those core principles:

• Futuristic Approach

According to the golden rules of accounting, The going concern principle assumes a business will continue operating indefinitely unless there's evidence to the contrary. Financial statements are prepared on this assumption, anticipating the business will meet its obligations and operate normally in the foreseeable future.

• Monetary Approach

According to the golden rules of accounting, this method adjusts financial reporting for inflation. Instead of using the face value of transactions, it uses their purchasing power at the time they occurred, giving a more accurate picture of the currency's value.

• Pricing Approach

According to the golden rules of accounting, the cost principle requires businesses to record transactions at their original cost, not their current market value. This historical cost provides a consistent and reliable basis for valuing assets on financial statements.

• Conservatism Approach

According to the golden rules of accounting, the conservatism principle dictates that accountants should be cautious and base financial transactions on objective evidence, not personal opinions. This promotes accuracy and minimizes the risk of overstating or misrepresenting financial information.