Golden Rules of Accounting – Overview & Types

Accounting rules are statements that establishes guidance on how to record transactions. As per accounting rules all the accounting transactions should be recorded in the books of entity using double entry accounting method. Double entry accounting method means for each transaction two (or more) accounts are involved, one account shall be debited and the other account shall be credited with the same amount. Accounting rules works as a base for any accounting framework. Before applying accounting principles a person is required to know the basic accounting rules that in a transaction which account should be debited and which account should be credited. Accounting rules are used uniformly by all entities and thus using it results in consistent and comparable financial reports.

Every economic entity must present its financial information to all its stakeholders. For this presentation, it must account for all its transactions. Since economic entities are compared to understand their financial statuses, there has to be uniformity in accounting. To bring about uniformity and to account for the transactions correctly there are three Golden Rules of Accounting. These Golden rules of Account form the very basis of accounts in fact passing journal entries which in turn form the basis of accounting golden rules and bookkeeping.

Types of Accounts

To understand the Golden Rules of Accounting we must first understand the types of accounts.

Real Account

A Real Account is a general ledger account relating to Assets and Liabilities other than people accounts. These are accounts that don’t close at year end and are carried forward.

Personal Account

A Personal account is a General ledger account connected to all persons like individuals, firms and associations. There are certain examples of Personal account

Nominal Account

A Nominal accounts is a General ledger account pertaining to all income, expenses, losses and gains.

Golden rules of accounting

Looking at the nature of all the accounts, the accounting rules have been devised. For each account there is a set of Golden Rules and hence there are three Golden Rules of Accounting.

Illustration

An entity named Orange Ltd. has the following transactions.

It deposits Rs.10,000 into Bank
It buys goods worth Rs.50,000 from Apple Ltd.
It sells goods worth Rs.35,000 to Melon Ltd.
It pays Rs.12,000 as Rent for its premises
It earns Rs.3,000 as interest on bank account.

First of all, let us identity the accounts involved in these transactions and classify them into the different types of accounts:

Transaction	Accounts involved	Type of Accounts
Deposit Rs.10,000 in Bank	Bank Account Cash Account	Real Account Real Account
Purchase goods worth Rs.50,000 from Apple Ltd.	Purchase Account Apple Ltd. Account	Nominal Account Personal Account
Sale of goods worth Rs. 35,000 to Melon Ltd.	Sales Account Melon Ltd. Account	Nominal Account Personal Account
Pays Rs.12,000 as rent	Rent Account Bank Account	Nominal Account Real Account
Earn Rs.3,000 as interest on Bank account	Interest received Bank Account	Nominal Account Real Account

Now applying the golden rules to each of the transactions we will get the following journal entries :

Deposit Rs.10,000 in Bank

Both Bank and Cash are real accounts and so the Golden rule is:

Debit what comes into the business
Credit what goes out from the business

So the entry will be:

Bank A/C	Dr.	10,000
To Cash A/ C			10,000

Purchase goods worth Rs.50,000 from Apple Ltd.

The Purchase Account is a Nominal account and the Creditors Account is a Personal account.

Applying Golden Rule for Nominal account and Personal account:

Debit the expense or loss
Credit the giver

The entry will be:

Purchase A/C	Dr	50,000
To Apple Ltd. A/C			50,000

Sale of goods worth Rs.35,000 to Melon Ltd.

The sale account is a Nominal account and the Debtors Account is a Personal account.

Hence the Golden Rule to be applied is:

Debit the receiver
Credit the income or gain

Thus the entry will be:

Melon Ltd. A/C	Dr	35,000
To Sales A/C			35,000

Pays Rs.12,000 as rent

Rent is a Nominal account and Bank is a real account.

The Golden Rule to be applied is:

Debit the expense or loss
Credit what goes out of business

The entry thus will be:

Rent A/C	Dr.	12000
To Bank A/C			12000

Earn Rs.3,000 as interest on Bank Account

Interest and Bank are Nominal account and Real Account.

The Golden rule to be applied is:

Debit what comes into the business
Credit the income or gain

Hence the entry will be:

Bank A/C	Dr	3,000
To Interest Received A/C			3,000

Golden Rules of Accounting (Traditional Approach):

Golden rules of accounting are the basic accounting rules on the basis of which accounting entries are recorded.

Personal Account:

The rule related to Personal account states debit the receiver and credit the giver. In other words, if a person receives something, receiver’s account shall be debited and if a person gives something, giver’s account shall be credited.

For example, if Mr. X receives cash of Rs. 10,000 from Mr. Y then in the books of Mr. Y, Mr. X will be receiver so account of Mr. X will be debited with an amount of Rs. 10,000.

Real Account:

The rule related to real account states debit what comes in, credit what goes out. In other words, if something comes into business, it shall be debited and if something goes out of business, it shall be credited.

For example: An asset purchased for cash would be accounted as per rules of real account wherein asset is what came into business, so asset account will be debited and cash is something that got out of business, so cash account will be credited.

Nominal Account:

The rule related to nominal account states that debit all expenses and losses, credit all incomes and gains. In other words, if any expense or loss is incurred for the business, expense or loss account shall be debited and if any income or gain is earned in business, income account or gain/profit account shall be credited.

For example: If salaries are paid to employees then salary is an expense and hence salary account shall be debited. Likewise any rent received shall be credited to rent account as it is an income.

Modern Rules of accounting (Classification of Accounts):
As per modern rules of accounting, transaction will be categorised into 6 heads or accounts and any increase or decrease in such account will either be debited or credited in the manner shown in the table given below:

*Types of Account*	*Account to be debited*	*Account to be credited*
Assets account	Increase	Decrease
Liabilities account	Decrease	Increase
Capital account	Decrease	Increase
Revenue account	Decrease	Increase
Expenditure account	Increase	Decrease
Withdrawal account	Increase	Decrease

For example: Mr. X sold goods to B for Rs. 6,000 on credit. In such case, Mr. X will record two accounts, one is B (Debtor Account which is an asset account) and the other is sales (which is a revenue account). In this case since revenue has increased and asset account has also increased, asset will be debited and sales will be credited. Entry will be:

B (Debtor) AccountDr.
To Sales Account
(Being goods sold to B on credit)

Hence, it can be concluded that accounting rule is basis of accounting. Once a transaction has been done, it shows how that transaction should be recorded in the books.

Conclusion

To summarize, all transactions of an entity must be accounted for. To account these transactions the entity must pass journal entries which will then summarize into ledgers. The journal entries are passed on basis of Golden Rules of accounting. To apply these rules one must first ascertain the type of account and then apply these rules.

Debit what comes in, Credit what goes out
Debit the receiver, Credit the giver
Debit all expenses Credit all income

These are the foundation of accounting and hence are called the Golden Rules of accounting. They are like the letters of the English alphabet if one does know letters he cannot know words and hence cannot use the language. Similarly for accounting, if one does not know the golden rules, he cannot pass journal entries and hence won’t be able to know to account.