Accounting is the common language used by businesses and financial institutions to manage their financial transactions and evaluate performance. The “Three Golden Rules of Accounting,” which act as the guiding principles for the recording of financial transactions, are at the core of accounting.
In order to answer, ‘What are the golden rules of accounting?’ This article aims to explore the golden rules of accounting with examples.
Understanding the Golden Rules of Accounting
The foundations of preserving financial records are known as the “golden rules of accounting.” They are a collection of rules that specify how transactions ought to be recorded in order to guarantee the consistency and correctness of financial statements. To guarantee the reliability of financial data, accountants and other financial experts around the world adhere to these principles.
Rule 1: The Golden Rule of Personal Accounts
Personal accounts are covered by the first golden rule of accounting. As it says, “Debit the receiver, and credit the giver.” When people, businesses, or other entities trade money or other forms of value, this rule is applicable. Here are a few illustrations of the golden rule in action:
Example 1: Payment Received From a Customer
Let’s say you own a bakery and get INR 100 for a cake from a client. The golden rule states that if your Cash Account is receiving money, you should debit (record on the left side) it. However, since the customer is the one who gave the money, you should credit (record on the right side) their account.
Example 2: Withdrawal of Funds by the Owner
You should debit your Drawings Account (which represents your withdrawal) and credit the Cash Account since, as the bakery’s owner, you are the receiver if you take INR 500 out of the company for personal use.
Rule 2: The Golden Rule of Real Accounts
The second among the golden rules of accounting addresses actual accounts that comprise assets and liabilities. It reads, “Debit what comes in, and credit what goes out.” Let’s examine this maxim using the following examples:
Example 1: Purchase of Equipment
Let’s say your bakery spends INR 1,000 on a new oven. The Equipment Account (an asset) should be debited in accordance with the golden rule because it represents what has been brought into your company. Since money left your company to complete the purchase, you should credit the Cash Account at the same time.
Example 2: Loan Repayment
You should debit the Loan Account (a liability) if your bakery repays an INR 2,000 loan because you are lowering the amount your company owes. You should also credit the Cash Account to reflect the cash outflow for loan repayment.
Rule 3: The Golden Rule of Nominal Accounts
Nominal accounts, which include revenues and expenses, are subject to the third golden accounting rule. Debit all costs and losses, and credit all gains and revenues. Let’s use real-world instances to demonstrate this accounting rule:
Example 1: Sales Revenue
Let’s say sales at your bakery total INR 5,000. The golden rule states that since the payment represents revenue coming into your company, you should debit the Cash Account or Accounts Receivable (depending on how the money was received). To represent the income, you need to credit the Sales Revenue Account.
Example 2: Payment of Rent
If you pay INR 1,200 for rent, you should deduct it from the Rent Expense Account because it is a cost that your company has to bear. Since you are lowering your cash balance to pay for the charge, you should credit the Cash Account concurrently.
Why Are These Rules Golden?
After thoroughly examining the three golden rules of accounting with examples, it’s critical to comprehend why these guidelines are referred to as “golden.”
These regulations are fundamental because they guarantee the accuracy and consistency of every financial transaction’s recording. This is why they are essential:
1. Universal Applicability
The golden rules of accounting are widely acknowledged and followed since they are applicable to all commercial endeavors and financial dealings.
2. Clarity and Consistency
These guidelines ensure that financial statements are consistent and understandable over time, supporting financial analysis and decision-making.
3. Audit Trail
Transparency and confidence are improved by properly recorded transactions because they leave an audit trail that external auditors may easily verify.
4. Financial Reporting
The preparation of financial statements, including the balance sheet, income statement, and cash flow statement, which are critical for evaluating a company’s financial health, requires adherence to the golden principles.
Conclusion
The “Three Golden Rules of Accounting” are the cornerstone upon which precise and trustworthy financial records are constructed in the world of finance. In order to ensure clarity, consistency, and correctness in financial reporting, these accounting rules provide a systematic approach to recording financial transactions.
Golden Rules of Accounting FAQs
- Are the Golden Rules of Accounting applicable to all types of businesses?
Everywhere, these accounting rules hold applications. They act as the bedrock for all accounting procedures, from small start-ups to big multinationals, and all organizations must follow them.
- What are the Golden Rules of Accounting?
The ‘Golden Rules of Accounting’ govern the recording of financial transactions. They encapsulate principles that strive for correctness and consistency in these records. Specifically, these rules pertain to personal accounts, real accounts, as well as nominal ones.
- Why are the three Golden Rules of Accounting considered important in finance and business?
The golden accounting rules are essential as they offer a uniform framework for recording financial transactions. They provide accuracy, consistency, and transparency in financial reporting.