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The 3 Golden Rules of Accounting

It is no secret that accounting is operated by debits and credits. Credits and debits make a book’s world go ‘round. Before we jump into the three golden rules of accounting, you require to brush up on all things credit and debit.

Credits and Debits are comparable but opposite entries in your accounting editions. Debits and Credits affect the 5 core categories of accounts:

• Assets: Resources occupied by a business that has monetary value you can convert into cash (e.g., equipment, land, cash, vehicles)
• Expenses: Costs that arise during business operations (e.g., supplies, wages)
• Liabilities: Amounts owed to another business or person (e.g., accounts payable)
• Equity: Your assets minus your liabilities
• Income and revenue: Cash earned from sales

A debit is an access made on the left side of an account. Debits gain an expense or asset account and reduce liability, equity, or revenue accounts.

A credit is an access made on the right side of an account. Credits gain liability, equity, and revenue accounts and reduce expense and asset accounts.

You must document debits and credits for each transaction.

The three golden rules of accounting also revolve around debits and credits. Take a look at the three central rules of accounting:

• Debit the receiver and credit the giver
• Debit what comes in and credit what takes out
• Debit expenditures and losses, and credit income and gains

1. Debit the receiver and credit the giver

The law of debiting the receiver and crediting the giver arrives into play with personal accounts. Now a personal account is a general ledger account relating to organizations or individuals. If you obtain something, debit the account. If you provide something, credit the account.

Look into a couple of instances of this first golden rule below.

Example 1

Let’s say you buy $1,000 worth of commodities from Company X. In your books, you require to debit your Purchase Account and credit Company X. Because the giver, Company X, is delivering goods, you are required to credit Company X. Then, you require to debit the receiver, your Purchase Account.

Date	Account	Debit	Credit
XX/XX/XXXX	Purchase Account	1000
	Accounts Payable		1000

Example 2

Let’s say you paid $500 cash to Company X for office allowances. You are required to debit the receiver and credit your Cash Account.

Date	Account	Debit	Credit
XX/XX/XXXX	Supplies Account	500
	Cash Account		500

2. Debit what comes in and credit what takes out

For real accounts, utilize the second golden rule. Real accounts are moreover pertained to as permanent accounts. Real accounts do not shut at year-end. Rather, their proportions are carried over to the following accounting period. A real account can be a liability account, an asset account, or an equity account. Real accounts also comprise contra liability, assets, and equity accounts.

When something comes into your company (e.g., an asset), in a real account, debit the account. When something takes out of your industry, credit the account.

Example

Say you bought furniture for $2,500 in money. Debit your Furniture Account (what arrives in) and credit your Cash Account (what takes out).

Date	Account	Debit	Credit
XX/XX/XXXX	Furniture Account	2500
	Cash Account		2500

3. Debit expenditures and losses, and credit income and gains

The ultimate golden rule of accounting contracts with nominal accounts. The nominal account is an account that you shut at the verge of each accounting period. Nominal accounts are called temporary accounts. Nominal or temporary accounts comprise expense, revenue, and loss and gain accounts.

Debit the account if your company has an expense or loss, with nominal accounts. Credit the account if your company needs to record gains or income.

Example: Expense or loss

Let’s say you buy $3,000 of commodities from Company X. To report the transaction, you must debit the expenditure ($3,000 purchase) and credit the revenue.

Date	Account	Debit	Credit
XX/XX/XXXX	Purchase Account	3000
	Cash Account		3000

Example: Income or gain

Let’s say you sell $1,700 worth of commodities to Company X. You should credit the revenue in your Sales Account and debit the expenditure.

Date	Account	Debit	Credit
XX/XX/XXXX	Cash Account	1700
	Sales Account		1700

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What are the 3 golden rules of accounting examples?

Let’s comprehend the essence of the golden rules and the accounts with the benefit of an example. Subsequent is the list of transactions:

• Company ABC begins company with an equity of INR 1,00,000.
• Leases a property worth INR 25,000.
• Buys goods worth INR 50,000 on credit from Company ABC.
• Sells commodities worth INR 75,000.
• Reimburses cash for goods purchased from Company ABC.
• Reimburses salary worth INR 50,000 to workers.

Firstly, let us specify various accounts implicated and the categories of accounts for each of the transactions:

Transactions	Accounts Involved	Types of Accounts
Capital of INR 1,00,000	Cash A/c; Capital A/c	Real Account; Personal Account
Rent worth INR 25,000	Rent A/c; Cash A/c	Nominal Account; Real Account
Purchases commodities worth INR 50,000 on credit from Company ABC	Purchases A/c; Company Y A/c	Nominal Account; Personal Account
Sells commodities worth INR 75,000	Cash A/c; Sales A/c	Real Account; Nominal Account
Pays cash for goods bought from Company ABC	Company Y A/c; Cash A/c	Personal Account; Real Account
Pays salary worth INR 50,000 to workers	Salary A/c; Cash A/c	Nominal Account; Real Account

Using the Golden Rules of Accounting

Pertaining the golden rules of accounting will enable you to specify the journal entries.

A company ABC begins its business with equity of INR 1,00,000

Since money is a tangible asset, it is a portion of a real account. Capital is known as a personal account. According to the golden rule of real and personal accounts:

• Debit what arrives in
• Credit the giver

Account	Dr	Cr
Cash A/c	1,00,000
Capital A/c		1,00,000

Rents an estate worth INR 25,000

Rent is an expenditure and thus belongs to a nominal account. Money is part of a real account. According to the golden rule of nominal and real accounts:

• Debit all expenditures and losses
• Credit what goes out

Account	Dr	Cr
Rent A/c	25,000
Cash A/c		25,000

Purchases commodities worth INR 50,000 on credit from Company ABC

Buy transactions are payments, and hence they are components of a nominal account. Company ABC is part of the personal account. According to the golden rule of personal and nominal accounts:

• Debit all expenditures and losses
• Credit the giver

Account	Dr	Cr
Purchases A/c	50,000
Company Y A/c		50,000

Sells commodities worth INR 75,000

Selling goods generates revenue for the company, and thus it is part of the nominal account. Cash is a component of a real account. According to the golden rule of real and nominal accounts:

• Debit what arrives in
• Credit all revenue and gains

Account	Dr	Cr
Cash A/c	75,000
Sales A/c		75,000

Reimburses cash for commodities purchased from Company ABC

A personal account and money is a components of a real account. According to the golden rule of personal and real accounts:

• Debit the receiver
• Credit what goes out

Account	Dr	Cr
Company Y A/c	50,000
Cash A/c		50,000

Reimburses salary worth INR 50,000 to workers

Salary is an expenditure to the company and hence is a component of the nominal account. Cash is a component of a real account. According to the golden rule of nominal and real accounts:

• Debit all expenditures and losses
• Credit what goes out

Account	Dr	Cr
Salary A/c	50,000
Cash A/c		50,000

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What are the modern Rules of Accounting?

There are a set of means to reach the art of accounting, modern and traditional. Classification of accounts under both modern and traditional rules of accounting is done very contrarily. The UK or conventional style of accounting classifies all accounts of a business into three major types: Real, Personal, and Nominal. Contrary, American or modern rules of accounting categorize all accounts into six different types: Asset, Capital, Liability, Revenue, Expense, and drawing.

Golden or Traditional rules of accounting pertain to real, personal, and nominal accounts, nonetheless, Modern or American rules of accounting pertain to the modern category of accounts.

Classification of Accounts and Modern Rules

The initial step is to specify the category of account from either of the six categories indicated in the below table. Once the account is inferred correctly, apply modern rules of accounting to formulate a perfect journal entry.

Examples of Modern Rules of Accounting are

Example I – Let’s say Company X bought furniture for 20,000 in cash, formulate the journal entry

Accounts Involved	Amount	Rule Applied
Furniture A/C	20,000	Asset – Dr. the increase
To Cash A/C	20,000	Asset – Cr. the decrease

Example II – Let’s say Company ABC received 1,00,000 in the bank as a loan, formulate the journal entry

Accounts Involved	Amount	Rule Applied
Bank A/C	1,00,000	Asset – Dr. the increase
To Loan A/C	1,00,000	Liability – Cr. the increase

Example II – Let’s say Company Y received 5,00,000 via a cheque from Mr X as a trade receivable, formulate the journal entry

Accounts Involved	Amount	Rule Applied
Bank A/C	5,00,000	Asset – Dr. the increase
To Mr. Unreal A/C	5,00,000	Revenue – Cr. the increase

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Benefits of using Accounting

Stakeholders of a commodity want to learn whether the commodity is earning a profit or incurring penalties. They also hope to know whether the capital investment in the company is decreasing or increasing during the accounting interval. Accounting is a combination of art and science. Accounting is a kind of recording, categorizing, and summarizing monetary transactions in a substantial manner and in terms of money.

Advantages of accounting are

• Maintenance of business records
• Saves Time and Costs
• Increases Financial Visibility
• Preparation of financial statements
• Comparison of results
• Decision-making
• Evidence in legal matters
• Provides information to related parties
• Helps in taxation matters
• Valuation of business
• Replacement of memory

Maintenance of business records

It documents all the monetary transactions relating to the respective year systematically in the books of accounts. It is not feasible for supervision to remember each and every transaction for an extended time due to their complexities and size.

Saves Time and Costs

Bookkeeping is recognized as a very time-consuming chore because there are tons of transactions to count and record. Nonetheless, with an accounting system, all the techniques can be automated so that they can be completed quickly. Your corporation does not need extra accountants to accomplish bookkeeping and other assignments so that you can recoup your company’s expenses for other significant needs.

Increases Financial Visibility

An accounting policy makes it simple for stakeholders to regulate the company’s monetary position more thoroughly. Management can maintain track of revenues and expenses as well as losses and profits across several business departments and units. You can discern all your corporation’s monetary information in a single view through an economic dashboard.

Preparation of financial statements

Monetary statements like Trading and loss and profit accounts, Balance Sheets can be formulated easily if there is an adequate recording of transactions. Adequate recording of all the monetary transactions is very significant for the preparation of the monetary statements of the entity.

Comparison of results

It stimulates the comparison of the monetary results of 1 year with another year simply. Also, the supervision can evaluate the systematic recording of all the monetary transactions as per the policies of the entity.

Decision-making

Decision-making comes to be simpler for management if there is an adequate recording of monetary transactions. Accounting data enables management to schedule its future activities, prepare budgets and coordinate several activities in numerous departments.

Evidence in the legal matter

The adequate and systematic records of the monetary transactions act as indications in the court of law.

Provides information to related parties

It generates the monetary data of the institution available to stakeholders like creditors, owners, employees, government, customers, etc. easily.

Helps in taxation matters

Several tax authorities like indirect taxes and income tax depending on the accounts retained by the management for the concession of taxation matters.

Valuation of business

For sufficient valuation of an entity’s industry accounting data can be operated. Thus, it enables an assessment of the value of the entity by utilizing the accounting data in the case of the deal of the entity.

Replacement of memory

Adequate recording of accounting transactions replaces the necessity to recollect transactions.

Conclusion

Golden rules of accounting set the organization for formulating monetary accounts. The corporation must document every transaction. Every transaction is documented as a journal entry and further as a ledger. You should verify the account each transaction relates to and then do journal entries established on the three golden rules. Thus, it is important to understand the golden rules of accounting for the objective of bookkeeping.

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