Golden Rules of Accounting
Bookkeeping is a key part of financial accounting, but it is only one aspect of the overall process. In accounting, every financial transaction is recorded using the dual entry accounting system, which means each transaction affects two accounts: debit and credit. The challenge lies in determining which accounts to debit and which to credit.
The three golden rules of accounting serve as guiding principles that help ensure financial transactions are recorded accurately and systematically. These rules simplify the complexities of bookkeeping into straightforward concepts that are easy to understand, apply, and study. Below are the three golden rules of accounting explained in detail with examples.
The Golden Rules of Accounting
1. Rule One: "Debit What Comes In, Credit What Goes Out"
This rule applies to real accounts (accounts related to tangible assets such as furniture, land, buildings, machinery, etc.). Real accounts represent the physical assets owned by a business, and they generally carry a debit balance. When a business receives an asset (something "comes in"), it increases the asset's value, so the asset account is debited. Conversely, when an asset leaves the business (something "goes out"), the account is credited to reduce the value.
2. Rule Two: "Debit the Receiver, Credit the Giver"
This rule governs personal accounts, which are related to individuals or entities (such as customers, suppliers, and creditors). When a business receives something from an individual or organization, that person or entity is the "giver" and must be credited. On the other hand, the person or entity receiving something from the business is debited, as they benefit from the transaction.
3. Rule Three: "Debit All Expenses, Credit All Income"
This rule applies to nominal accounts, which are related to expenses, losses, income, and gains. A company's capital is considered an obligation and carries a credit balance. When the company earns revenue or income, the capital increases, so income is credited. Conversely, when the company incurs an expense or loss, it reduces the capital, so expenses are debited.
Why the Golden Rules of Accounting Are Important
These golden rules form the foundation of the double-entry accounting system, which ensures that every financial transaction is recorded in two accounts: one is debited and the other is credited. By following these rules, businesses can:
- Maintain accurate financial records
- Track all inflows and outflows of assets, income, and expenses
- Provide a transparent and clear financial position of the company to stakeholders
Summary of the Golden Rules:
- Rule 1: Debit what comes in, credit what goes out (applies to real accounts).
- Rule 2: Debit the receiver, credit the giver (applies to personal accounts).
- Rule 3: Debit all expenses, credit all income (applies to nominal accounts).