golden rules of accounting

Golden Rules of Accounting: Basic rules of accounts

ACCOUNTING

Golden rules of accounting-In the system of book-keeping, You can notice that transactions are recorded in the books of accounts. A transaction is a type of event, which is generally external in nature and can be determined in terms of money.

In an accounting period, every business has a huge number of transactions which are analyzed in financial terms and then recorded individually, followed by a classification and summarization process, to know their impact on the financial statements.

A transaction is a two-way process in which value is transferred from one party to another. In it either a party receives a value in terms of goods etc. and passes the value in terms of money or vice versa.

Therefore, one can easily make out that in a transaction, a party receives as well as passes the value to other parties. For recording transactions, it is very important that they are supported by a substantial document like purchasing invoices, bills, pay-slips, cash memos, passbooks, etc.

Transactions analyzed in terms of money and supported by proper documents are recorded in the books of accounts under the double-entry system.

To analyze the dual aspect of each transaction, two approaches can be followed:

  1. Accounting Equation Approach-The relationship of assets with that liabilities and owners’ equity in the equation form is known as ‘Accounting Equation’.
  2. Traditional Approach-Under the traditional approach to recording transactions one should first understand the terms debit and credit and their three Golden rules.

What are the Golden rules of accounting?

Golden rules of accounting mean the maintaining of accounts with the help of three basic accounting rules which are refers to the traditional approach of recording transactions. The transactions are recorded on the basis of a double-entry system. The double-entry system refers to the rules of debit of one account and credit of other accounts.

What is the classification of accounts as per the traditional approach?

Under the traditional approach of recording transactions, one should first understand the terms debit and credit and their rules. Transactions in the journal are recorded on the basis of the rules of debit and credit only. For the purpose of recording, these transactions are classified into 3 groups:

  1. Personal transactions.
  2. Transactions are related to assets and properties.
  3. Transactions related to expenses, losses, income, and gains.

What are the types of accounts on which golden rules of accounting works?

Here are the types of accounts on which the golden rules of accounting works-

golden rules of accounting
  1. Personal Accounts-Personal accounts relate to persons, trade receivables, or trade payables. For example-Shyam & Co. (Creditor), Madhav Enterprises (Debtor), and Capital Account of Proprietor (Kishan Gupta). Personal Accounts are further classified into the 3 categories-
    1. Natural-Natural accounts refer to the transaction with human beings such as Shyam, Suman, and Shamu Gupta.
    2. Artificial -Artificial legal Personal Accounts include business entities that are treated as separate entities. They are recognized as persons in the eye of law for dealing with other persons. For example- Government, Companies (private or limited), Clubs, Co-operative societies, etc.
    3. Representative-Representative personal accounts are not in the name of any person or organization but are represented as personal accounts. For Example- outstanding liability account or prepaid account, capital account, or drawings account.
  2. Impersonal Accounts-Accounts which are not personal accounts such as machinery accounts, cash accounts, rent accounts, etc. These can be further subdivided as follows:
    1. Real Accounts-Accounts which relate to assets of the firm but not debt. For example, accounts regarding land, building, investment, fixed deposits, etc., are real accounts. Cash in hand and cash at the bank accounts are also real.
    2. Nominal Accounts-Accounts which relate to expenses, losses, gains, revenue, etc. like salary account, interest paid account, the commission received account. The net result of all the nominal accounts is reflected as profit or loss which is transferred to the capital account. Nominal accounts are, therefore, temporary.

What are the 3 golden rules of accounting?

The three basic golden rules of accounting are given below which have two rules each one related to Debit and one related to Credit for recording the transactions-

  1. Debit the receiver and credit the giver
  2. Debit what comes in and credit what goes out
  3. Debit expenses and losses, credit income and gains
Types of AccountAccount to be DebitedAccount to be Credited
Personal AccountReceiverGiver
Real AccountWhat comes inWhat goes out
Nominal AccountExpense and lossesIncome and gains

Examples of the golden rule of accounting

Question 1-From the following information, state the nature of the account and state which account will be debited and which will be credited.

  1. Started business with a capital of 500000 ₹.
  2. Wages and salaries paid 8,000 ₹.
  3. Rent received 10,000 ₹.
  4. Purchased goods on credit 80,000 ₹.
  5. Sold goods for 810,000 ₹ and received payment in a cheque.

Answer-

TransactionACCOUNTS INVOLVEDNATUREDEBIT OR CREDITJournal Entry
Started business with a capital of 5,00,000 ₹.Bank account
Capital account		Personal PersonalDebit (Receiver) Credit (giver)Bank A/c       Dr.
To Capital A/c
Wages and salaries paidWages/salaries BankNominal PersonalDebit (expense) Credit (giver)Wages/ Salaries Dr. To Bank A/c
Rent receivedBank RentPersonal NominalDebit (Receiver) Credit (income)Bank A/c        Dr. To Rent A/c
Purchases made on creditPurchases CreditorNominal PersonalDebit (expense) Credit (giver)Purchases A/c Dr. To Creditor A/c
Goods sold and payment received in chequeBank SalesPersonal NominalDebit (Receiver) Credit (gains)Bank A/c        Dr. To Sales A/c

Question 2-Show the classification of the following Accounts under the traditional and accounting equation approach:

(a) Building; (b) Purchases; (c) Sales; (d) Bank Fixed Deposit; (e) Rent; (f) Rent Outstanding; (g) Cash; (h) Adjusted Purchases; (i) Closing Inventory; (j) Investments; (k) Trade receivables; (l) Sales Tax Payable, (m) Discount Allowed; (n) Bad Debts; (o) Capital; (p) Drawings; (q) Interest Receivable account; (r) Rent received in advance account; (s) Prepaid salary account; (t) Bad debts recovered account; (u) Depreciation account, (v) Personal income-tax account.

Answer-

Sl. No.Title of AccountTraditional ApproachAccounting Equation Approach
(a)BuildingRealAsset
(b)PurchasesRealAsset
(c)SalesRealRevenue
(d)Bank Fixed DepositPersonalAsset
(e)RentNominal (Expense)Expense
(f)Rent OutstandingPersonalLiability
(g)CashRealAsset
(h)Adjusted PurchasesNominal (Expense)Expense
(i)Closing InventoryRealAsset
(j)InvestmentRealAsset
(k)Trade receivablesPersonalAsset
(l)Sales Tax PayablePersonalLiability
(m)Discount AllowedNominal (Expense)Temporary Capital (Expense)
(n)Bad DebtsNominal (Expense)Temporary Capital (Expense)
(o)CapitalPersonalCapital
(p)DrawingsPersonalTemporary Capital (Drawings)
(q)Interest receivablePersonalAsset
(r)Rent received in advancePersonalLiability
(s)Prepaid salaryPersonalAsset
(t)Bad debts recoveredNominal (Gain)Temporary Capital (Gain)
(u)DepreciationNominal (Expense)Temporary Capital (Expense)
(v)Personal Income TaxPersonal (Drawing)Temporary Capital (Drawings)

How golden rule of accounting work?

As we know the recording of any transaction made by a journal entry. Journal entries are recorded on the basis of debit and credit rules as per the concept of a double-entry system of recording transactions. The 3 golden rules of accounting work on rules of debit one and credit other. Hense these rules tell us to whom should debit and to whom should credit by understanding the nature of accounts. Here the given below table shows how golden rules work.

Types of AccountAccount to be DebitedAccount to be Credited
Personal AccountReceiverGiver
Real AccountWhat comes inWhat goes out
Nominal AccountExpense and lossesIncome and gains

What is the difference between the traditional approach, and the Modern approach?

Traditional ApproachUnder the traditional approach to recording transactions, one should first understand the terms debit and credit and their three Golden rules.
Modern ApproachWhile traditional rules revolved around three accounts – real, personal, and nominal, the modern approach classifies the accounts into six types, making the transactions split into these categories, affecting the debit and credit sides. These accounts include asset, liability, revenue, expense, capital, and withdrawal.

What do you mean by Debit and Credit?

As you know that in T-accounts increase and decrease entries are made on the left and right side of the accounts for assets respectively and vice-versa for liabilities. But, formally accountants use the term Debit (Dr.) to denote an entry on the left side of any account and Credit (Cr.) to denote an entry on the right side of any account.

Why is the golden rule important in accounting?

Golden rules of accounting are important because it facilitates a better interpretation of financial information. The golden rules of accounting are for making it simple to decide what transaction must go in where, in each type of account. It helps to decide which account should be debited or credited as per the nature of an item.

Further Faqs on the Golden rule of accounting

1. What are natural accounts?

Natural accounts refer to the transaction with human beings such as Shyam, Suman, and Shamu Gupta.

2. What are Artificial legal Accounts?

Artificial legal Personal Accounts include business entities that are treated as separate entities. They are recognized as persons in the eye of law for dealing with other persons. For example- Government, Companies (private or limited), Clubs, Co-operative societies, etc.

3. What are representative personal accounts?

Representative personal accounts are not in the name of any person or organization but are represented as personal accounts. For Example- outstanding liability account or prepaid account, capital account, or drawings account.

4. What are real accounts?

Accounts that relate to assets of the firm but not debt. For example, accounts regarding land, building, investment, fixed deposits, etc., are real accounts. Cash in hand and cash at the bank accounts are also real.

5. What are nominal accounts?

Accounts which relate to expenses, losses, gains, revenue, etc. like salary account, interest paid account, the commission received account. The net result of all the nominal accounts is reflected as profit or loss which is transferred to the capital account. Nominal accounts are, therefore, temporary.

6. Expenses and losses should be debit or credit as per golden rules?

Expenses and losses will be debited as per the golden rules of accounting.

7. What do you mean by incomes and expenses?

Incomes: These represent those accounts that show the revenue amounts earned by the enterprise.
Expenses: These represent those accounts that show the amount spent or even lost in carrying on operations.

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