Have you heard about the 3 golden rules of accounting? Most likely, you would have heard about the golden rule of life — treat others the way you want to be treated. However, are you aware that there’s also a golden rule in accounting? Perhaps no.
As a matter of fact, there are, actually, three golden rules of accounting. And yes, one of these rules is not treating your accounts the same way you want to be treated by others. It’s quite an irony in comparison to the golden rule of life. No? Maybe, yes.
You must adhere to the three golden rules of accounting if you are committed to keeping your account books accurate and up-to-date.
Every accounting practitioner should be fully aware that the accounting sphere is all about debits and credits. “Money makes the world go round,” they say. In accounting, credits and denits make a book’s world go round.
Just before we take a deep dive into the golden rules of accounting, let’s take a little brushing up about the concepts of debit and credit.
Credits and debits are equal, but opposite entries in accounting record books. Practically, debits and credits play roles in affecting the five core types of accounts.
- Assets: They are properties owned by a business entity that have economic value which can be readily liquidated into cash. Examples include land, cash, equipment, vehicles, machinery, etc.
- Expenses: Costs that arise as a result of business functions. Examples include wages, supplies, taxes, etc.
- Liabilities: They are amounts which are owed to other business entities or individuals. Examples include credit loans, accounts payable, etc.
- Equity: The difference between a business’ assets and the liabilities.
- Income & Revenue: Money earned as a result of sales.
A debit is an entry that’s made on the left hand column of an account. Debits raise an espense or asset account and reduce liability, equity, or revenue accounts.
A credit is an entry that’s made on the right hand column of an account. Credits raise liability, equity, and revenue accounts and reduce expense and asset accounts.
You are required to make records of debits and credits of each business transaction.
The golden rules of accounting operates around credits and debits. Let’s take a look at the three golden rules of accounting. Shall we?
1. Debit the receiver and credit the giver
With regards to personal accounts, the principle of debiting the recipient and crediting the giver applies. A general ledger account for persons or organizations is referred to as a personal account.
Debit the account if something is received. Donate to the account by crediting it.
Here are a few illustrations of the first golden rule in action.
Let’s say you spend $10,000 on products from Company XYX. You must credit Company XYZ and debit your Purchase Account in your records. You must give credit to Company XYZ because they are the giver and are supplying the goods. After then, you must debit the recipient’s Purchase Account.
Let’s say you paid Company XYZ in cash $2000 for office supplies. You must credit your (the giver’s) Cash Account and debit the recipient.
2. Debit what comes in and credit what goes out
Use the second golden rule while analyzing real accounts. Permanent accounts are another name for real accounts. At year’s end, real accounts don’t close. Their remaining balances are instead carried over to the upcoming accounting quarter.
Asset, liability, or equity accounts are all examples of real accounts. Accounts for contra assets, liabilities, and equity are also included in real accounts.
Debit the account when an item enters your company (such as an asset) while using a real account. Credit the account when anything occurs that is not within your control.
Let’s imagine you paid $4,500 cash for some furniture. Credit your Cash Account (money going out) and debit your Furniture Account (money coming in).
3. Debit expenses and losses, credit income and gains
Nominal accounts are covered by the final golden rule of accounting. You close a nominal account at the conclusion of each accounting cycle. Temporary accounts are another name for nominal accounts. Income, expenditure, and gain and loss accounts are examples of temporary or nominal accounts.
If your company incurs expenses or suffers a loss, debit the account while using nominal accounts. If your company has to record income or gain, credit the account.
Example 4: Loss or expense
Let’s say you spend $5,000 on products from Company XYZ. You must debit the cost ($5,000 purchase) and credit the revenue in order to register the transaction.
Example 5: Gain or income
Let’s say you sell Company XYZ $1,500 worth of goods. Your Sales Account must debit the expense and credit the income.
Bottom Line — Golden Rules of Accounting
At the end of this post, we hope you now fully understand that we have golden rules of accounting, just as we have a golden rule about life and every other principle of human existence.
If you have further questions for us, you can drop them in the comments section. We will take our time to respond to them as soon as possible.
Thanks for stopping by!