Golden Rules of Accounting with Examples

Books of accounts are meticulous records of finances where the income and expenses are perfectly balanced, showing a complete picture of an organisation or individual’s financial health. Accounting is often seen as a complex field, but its essence boils down to a few fundamental principles, aptly called Golden Rules. Knowing these rules is crucial for anyone aspiring to a career in finance or to become a business manager and entrepreneur. Let's delve into these rules, using examples to illustrate each one.

Golden Rules in Accounting :Understanding the Basics

Accounting includes recording, summarising, and interpreting financial information. It helps businesses track their income and expenses, ensuring they remain profitable and sustainable. The Golden Rules of Accounting are universally accepted principles that guide how these transactions are recorded. These rules fall under three main categories: Personal, Real, and Nominal accounts.

Three Golden Rules Of Accounting 

Personal Accounts

Rule: “Debit the Receiver, Credit the Giver.”

Personal accounts are records of transactions with individuals or entities like creditors, debtors, banks, etc. When a natural or artificial entity, such as a person or organisation, makes a payment, it becomes an inflow. Thus, the receiver must be debited, and the organisation or person receiving the payment must be credited in the books.

Example Of Personal Account 

 For instance, suppose your school buys books from M/S Mehta & Sons, a local stationery supplier, on credit. M/S Mehta & Sons is the giver of the books, so you credit their account. Now, if the school later pays M/S Mehta & Sons, you will debit their account, as they are the receiver of the payment.

Real Accounts

Rule: “Debit What Comes In, Credit What Goes Out.”

Real accounts are records of the business's tangible and intangible assets, such as cash, machinery, furniture, buildings, etc. When a new asset is bought for the business, the balance is debited, and when an asset leaves a business, the account balance is credited. 

Examples of Real Account 

For instance, if your school receives a new computer lab setup. The computers are assets in the school, so you debit the computer account. Conversely, if the school sells an old projector, this asset leaves, and you would credit the projector’s account.

Nominal Accounts

Rule: Debit All Expenses and Losses and credit All Incomes and Gains.

Nominal accounts track the business's income, expenses, losses, and gains. All the business earnings and profits are credited to signify a capital increase. The expenses and losses are deducted to signify the capital decline. The nominal account considers the company’s capital a liability and has a credit balance. Thus, when capital rises, income is credited; conversely, when expenses or losses occur, the balance is debited.

Example of Nominal Account 

 For instance, if the school conducts a special short-term course, it earns money from the fees paid by students who sign up for it. The income from sales will be credited. However, the expenses for setting up the event, such as hiring a venue, the tutor’s fees, study material, etc., will be debited, as these are expenditures.

Practical Application Of Golden Rules Of accounting 

Now that we understand the rules, let's see how they can be applied in real-life scenarios. Consider a simple example of a school cafeteria:

• Transaction 1: The cafeteria purchases food supplies worth Rs. 2700.

• Personal Account: The supplier is credited Rs. 2700 (goes out).

• Real Account: The stock of food supplies is debited at Rs.2700 (comes in).

• Transaction 2: The cafeteria sells fruit salad at Rs. 20/plate.

• Real Account: The cash account is debited Rs.20/plate (comes in).

• Nominal Account: The sales account is credited Rs. 20/Plate (income).

Accounting Golden Rules : Their Entries Explained with Examples 

Example 1: Combined Transactions for Office Setup

A company purchased office equipment worth ₹3,00,000, paid ₹1,00,000 in cash, and the remaining was financed through a vendor, who provided a discount of ₹20,000.

Example 2: Loan Repayment with Interest

The business repaid ₹1,00,000 of a bank loan along with ₹10,000 as interest via bank transfer.

Example 3: Sale of Goods with Partial Payments and Discount

Sold goods worth ₹2,00,000 to a customer, receiving ₹1,50,000 in cash, and allowing a discount of ₹10,000. The balance is on credit.

Example 4 : Investment Purchase with Commission Charges

Purchased shares worth ₹5,00,000, paid ₹4,90,000 in cash, and incurred a brokerage fee of ₹10,000.

Example 5: Building Purchase with Loan, Cash, and Down Payment Discount

A company purchased a building worth ₹10,00,000. The payment was structured as follows:

1. ₹3,00,000 was paid in cash.

2. ₹6,50,000 was financed through a bank loan.

3. A discount of ₹50,000 was provided by the seller.

Why Are Golden Rules Of Accounting Important?

The golden accounting rules form the bedrock upon which financial reporting is built. These foundational principles are followed globally for maintaining accurate records and preparing financial statements, which are critical for decision-making. They give a concise system of categorising different income and expenses, how to treat them, and their overall implication on the company’s health. They provide a structured approach to handling financial data, ensuring nothing is overlooked or incorrectly recorded. This is important for the company’s internal record keeping, reporting to shareholders and other stakeholders and for tax filing.