3 Golden Rules of Accounting with Examples
3 Golden Rules of Accounting with Examples
When a business operates, multiple transactions are happening on a single day. Whether it is a purchase of machinery or sale of goods or a simple bank withdrawal, everything falls under financial transactions. Now, for the management to understand the current position of the company financially and take a suitable decision for the future, it is crucial to have all the data in a single place. This is where accounting comes in. And for that, you should be aware of the modern rules of accounting.
What is Accounting?
One of the most important aspects of practically every business is ‘Accounting’. Small businesses may have a bookkeeper or accountant manager, whereas bigger corporations tend to have bigger finance departments with many people. Accounting is essential to running a company because it makes it easier to keep track of income and expenses, ensures legal compliance, and gives investors, management, and the government access to quantitative financial data that can be used to make decisions. Management tends to make better and well-informed business decisions thanks to the information and data produced by different streams of accounting, including cost accounting and financial reporting. Accounting refers to the process of documenting a business’s financial transactions. Summarizing, analyzing, and summarizing these operations to other organizations, regulatory bodies, and organizations in charge of tax collection are all part of the accounting process. A company’s activities, financial status, and cash flows are summarized in these financial statements, which in turn provide a succinct overview of financial events during an accounting period. Read on to learn about the golden rules of accounting with examples.
Who needs Accounting?
Any firm that had gross sales that exceeded Rs. 1.5 lakhs during the previous three years of an active profession is required to keep financial records following the basic principles of accounting. If the concern’s revenues from the profession are not more than Rs. 1,50,000 in any of the three years before, they are not required to keep books of accounts as per section 44AA of the Income Tax Act. In this case, the professional must keep books of accounts that an accounts officer can use to determine the taxable income. You can understand more by solving the variety of golden rules of accounting quiz.
Who uses Accounting Information?
Accounting data is created to meet the requirements of both internal and external stakeholders. Internal stakeholders who tend to use accounting data are:
Employees Marketing department Human resources department Finance directors Top management
External stakeholders who need the financial and accounting records of a firm are:
Investors Customers Community Special interest groups Banks Government
Golden Rules of Accounting
The ‘golden rules of accounting’ are based on debit and credit accounting concepts. Every transaction in accounting contains a debit and a credit entry. Knowing which account needs to be credited and the one needs to be debited is crucial. This is also called the double-entry accounting method. The three principles that make up the ‘golden rules of accounting’ govern financial accounting. Double-entry accounting has an equal and varying influence on both sides. On the right side of the account, a credit entry is made, and on the left, a debit entry. On the credit side, income, liabilities, and equity decrease while money for assets or costs increases. Credits signify a decrease in an asset or cost account and an increase in the payment, weakness, and equity accounts. The documentation of the transactions is ensured by these golden principles. The golden rules reduce the intricate bookkeeping regulations to a collection of straightforward concepts that can be understood easily and used in further analysis. Understand the golden rules of accounting with examples that will help in better bookkeeping.
Types of Accounts under Golden Rules
Journal entry as per the golden rules of accounting provides the very foundation of bookkeeping. You must decide which type of account to use for each transaction following these golden principles. Each type of account has specific rules that must be followed for every transaction. The three golden guidelines classify 3 different sorts of accounts.
Real account
A real account is a type of general account that keeps track of all transactions that involve assets and liabilities. Real accounts are not closed at the end of the fiscal year because the governing rule is continued over to the following fiscal year. These accounts are made up of tangible and intangible assets. Furniture, real estate, buildings, machines, etc. are some examples of tangible assets. On the other hand, intangible assets include things like goodwill, copyright, and patents. Additionally, the balance sheet displays an accurate report on real accounts.
Nominal Account
To track income, costs, profits, and losses, a nominal account is used as a general ledger account. It records each transaction for a certain fiscal year. As a result, the balances are reset to zero, and the process may repeat. On nominal accounts, on the other hand, interest accumulates.
Personal Account
A personal account is a general ledger account for people. It might be either real people, like individuals, or made-up people, like businesses, associations, companies, etc. When Company ‘A’ receives money or credit from some other company or person, it becomes the receiver. The other company or person who gives it becomes the giver in the case of a personal account rule. A creditor account is a personal account. Also Read: 15 Best Budget Planner Books to Manage Your Money
3 Golden Rules of Accounting
You must identify the kind of account for each transaction as per the golden standards of accounting. There are certain guidelines for each type of account that must be followed for every transaction. Here is everything you need to know about the golden rules of accounting with examples.
Rule 1: Debit What Comes In and Credit What Goes Out
For actual accounts, this regulation is applicable. Real accounts contain items like furniture, land, buildings, machines, etc. all these types of accounts tend to have a debit balance. Debiting what is coming in as a consequence increases the balance of the current account. Similarly to this, crediting what leaves the company like a tangible asset lowers the account balance. In simple words, if you are giving something, then credit the same account and if you are on the receiving end then debit the account. To have a better understanding, let’s see an example. You paid $1000 to XYZ Company for toiletry supplies on 2/10/2021. The journal entry will be: Here, cash is going out and toiletry supplies are coming in. therefore, the supplies account will be debited and the cash account will be credited.
Rule 2: Debit the Receiver and Credit the Giver
Personal accounts are covered by this rule. When a person, whether real or made up, provides anything to the company, it counts as an inflow and the donor needs to be acknowledged in the books. So, the giver account is credited and the company is debited as they are the receiver. Let’s see an example to have a better understanding of this rule. You purchased furniture worth $2000 from ABC Company. The journal entry will be: Your purchasing account will be debited because you are receiving the furniture. Likewise, the ABC Company’s account will be credited because they are the givers in this case.
Rule 3: Debit the Expenses and Losses and Credit the Incomes and Profits
Nominal accounts are covered under this rule. Capital is a company’s liability. It, therefore, has a credit balance. The capital will increase if all earnings and gains are credited. On the other side, when losses and costs are debited, the capital decreases. In simple words, if your company incurs expenses or suffers a loss, debit the account while using nominal accounts. If your company has to report income or gain, credit the account. Let’s see an example to have a better understanding of this rule. Your company sold goods worth $2000 to XYZ Company. The journal entry will be: Here, when you sell the goods, the goods account will be debited as it is a loss or expense and the cash account will be credited because it is increasing as in earnings. Let us know go over these golden rules of accounting with examples.
Example Using 3 Golden Rules
Now you know, exactly what the three golden rules of accounting are. However, to understand how entries are made in bookkeeping, let’s see a complete illustration of the golden rules of accounting with examples of a company. For example,
INR 20000 worth of goods were bought on credit from Mr. Rakesh on 2nd November 2021. Rakesh received cash payment for credit purchases on 3rd November 2021. The bank received a withdrawal of INR 30,000 on 4th November 2021. Goods sold to Mr. Ajay for INR 20,000 on 5th November 2021. The machinery costing INR 60,000 was acquired from M/s Kriti Traders; INR 30,000 was paid in cash, with the balance to be paid at a later time on 6th November 2021. Remaining INR 30,000 to M/s Kriti Traders on 7th November 2021. Goods sold to Brent for INR 75,000 for a profit of INR 5000 on 8th November 2021.
2nd November 2021 INR 20000 worth of goods were bought on credit from Mr. Rakesh on 2nd November 2021. Accounts involved:
Mr. Rakesh: Personal account (credit the giver) Goods or Inventory Account: Real account (debit what comes in)
3rd November 2021 Mr. Rakesh received cash payment for credit purchases on 3rd November 2021. Accounts involved:
Mr. Rakesh: Personal account (debit the receiver) Cash Account: Real account (credit what goes out)
4th November 2021 The bank received a withdrawal of INR 30,000 on 4th November 2021. Accounts involved:
Bank A/C: Real account (credit what goes out) Cash A/C: Real account (debit what comes in)
5th November 2021 Goods sold to Mr. Ajay for INR 20,000 on 5th November 2021. Accounts involved:
Goods or Inventory: Real account (credit what goes out) Cash Account: Real account (debit what comes in)
6th November 2021 The machinery costing INR 60,000 was acquired from M/s Kriti Traders; INR 30,000 was paid in cash, with the balance to be paid at a later time on 6th November 2021. Accounts involved:
Machinery Account: Real account (debit what comes in) M/s Kriti Traders: Personal account (credit the giver) Cash Account: Real account (credit what goes out)
7th November 2021 Remaining INR 30,000 was paid to M/s Kriti Traders on 7th November 2021. Accounts involved:
M/s Kriti Traders: Personal account (debit the receiver) Cash Account: Real account (credit what goes out)
8th November 2021 Goods sold to Brent for INR 75,000 for a profit of INR 5000 on 8th November 2021. Accounts involved:
Goods Account: Real account (credit what goes out) Cash Account: Real account (debit what comes in) Profit On Sale Account: Nominal account (credit gains and income)
Also Read: Average Starting Salary of CA in India Per Month
Modern Rules of Accounting
The modern version of the accounting rules divides the accounts into six types. Dividing the transactions into categories impacts both the debit and credit sides. The original regulations focused on three accounts: real, personal, and nominal. In the modern set of rules, asset, liability, revenue, expense, capital, and withdrawals are taken into account. Here is a table that will help you understand which account to debit and which to credit in a transaction as per the modern rules of accounting.
Example Using Modern Rules
Well, now that you know that modern rules have 6 accounts to take into consideration, here are some examples that will help in throwing some light on how to do journal entries. 4th November 2021 Received a loan of INR 2,00,000 in the bank from XYZ Company. Accounts involved:
Bank Account: Asset account (debit the increase) Loan Account: Liability account (credit the increase)
5th November 2021 Bought furniture with cash for INR 20,000. Accounts involved:
Furniture Account: Asset account (debit the increase) Cash Account: Asset account (credit the decrease)
6th November 2021 Received a check for INR 10,000 from Mr. Abhay as a trade receivable. Accounts involved:
Bank Account: Asset account (debit the increase) Mr. Abhay Trade Receivable Account: Revenue account (credit the increase)
What role Accounting plays in Business?
Now, that you have a clear picture of what the 3 golden rules of accounting are and how the approach has changed in the modern rules of accounting. Let’s understand why accounting plays such a crucial role in businesses of all types.
Maintaining the Records of Transactions
Accounting is crucial to record all systematic business activities in books of accounting, which are then utilized to make strategic business choices. It helps the company in understanding how to minimize loss and maximize profit. In general, accounting is a general concept and method for presenting data about company transactions.
Prepare and Compare Financial Statements
If transactions are properly recorded, financial statements such as the trading and profit and loss account and balance sheet can be created quickly and efficiently. The creation of the firm’s financial statements depends heavily on the accurate documentation of all financial transactions. It also makes it efficient to compare the financial statements of one year with those of another. Additionally, the management can review the financial activities in accordance with the entity’s standards.
Compliance and Taxation
As per law, accurate and organized records of financial transactions serve as evidence for any type of circumstance. It makes it simple for stakeholders like proprietors, creditors, workers, consumers, the government, etc. to access the organization’s financial information. The management’s accounts are used to resolve tax concerns by various tax authorities including income tax and indirect taxes if the financial records are presented.
Evaluation and Decision Making
Accounting for all the company-related transactions correctly can improve overall management. The management’s ability to make decisions is facilitated by accurate financial transaction recordkeeping. Accounting data is used by management to coordinate operations across departments, plan for the future, and create budgets. Additionally, it enables management to assess the performance of the company and take prompt corrective action to address any issues that are seriously harming the company. Also Read: Gratuity Rules in India: Eligibility, Calculation, Taxation
Valuation and Future Projections
Accounting data may be used to determine how well an entity is valued. As a result, in the event of a sale of the entity, it aids in determining the value of the organization by employing accounting data. A solid budget built on ethical accounting procedures can serve as the basis for the expansion of any firm. A sound accounting procedure in place improves the accuracy of future estimates and projections as well. The foundation for creating financial accounts is laid by the golden rules of accounting. You can learn more by studying these golden rules of accounting with examples. If you are a professional, have a business of your own, or simply plan to become an accountant, learning the very basics of bookkeeping is the starting point. You can later learn about modern rules of accounting. This will not only help in record keeping for future reference, law, and tax compliance but will also help in taking better decisions for the business.
