Golden rules of account form the basis for bookkeeping. As per the golden rules of accounting, you must ascertain the type of account for each transaction. Each type of account has its own set of rules that needs to be applied for each transaction. Following are the three golden rules of accounting:
Rule 1: Debit What Comes In, Credit What Goes Out.
This rule applies to real accounts. Furniture, land, buildings, machinery, etc., are included in real accounts. By default, they have a debit balance. As a result, debiting what is coming in adds to the existing account balance. Similarly, when a tangible asset leaves the firm, crediting what goes out reduces the account balance.
Rule 2: Debit the Receiver, Credit the Giver.
This rule applies to personal accounts. When a real or artificial person donates something to the organisation, it becomes an inflow, and the person must be credited in the books. Conversely, the receiver must be debited.
Rule 3: Debit All Expenses and Losses, Credit all Incomes and Gains.
This rule applies to nominal accounts. A company’s capital is its liability. As a result, it has a credit balance. Crediting all the income and gains will increase the capital. On the other hand, the capital reduces when expenses and losses are debited.
Let’s understand the nature of the golden rules and the accounts with the help of an example. Following are the list of transactions:
- Company ABC starts its business with a capital of AED 1,00,000.
- Rents a property worth AED 25,000.
- Purchases goods worth AED 50,000 on credit from Company XYZ.
- Sells goods worth AED 75,000.
- Pays cash for goods purchased from Company XYZ.
- Pays salary worth AED 50,000 to employees.
Golden rules of accounting lay the foundation for preparing financial accounts. The company must record every transaction. Each transaction is recorded as a journal entry and then as a ledger. You should ascertain the account each transaction belongs to and then do journal entries based on the three golden rules. Therefore, it is a must to know the golden rules of accounting for the purpose of bookkeeping.