Stop Guessing Debits And Credits! Master The Golden Rules Of Accounting The Easy Way

Accounting might appear as a foreign language to many people. The way my professor puts it, accounting can be really confusing!

However, with a sound understanding of the accounting golden rules, it can be less intimidating!

These three basic golden rules of accounting are the ultimate secret to successful double-entry bookkeeping.

They basically help you determine when to debit or credit an account with absolute precision!

These rules ensure your personal or business financial records stay in perfect order day to day.

Whether you are just starting out as an enthusiastic student or a professional accountant, these principles will help you maintain your accounts accurately and systematically.

In this short blog post, we’ll go over these fundamental accounting principles one by one and provide some real-world examples for each of them.

Ultimately, mastering them will make tracking your business finances a breeze.

So let’s get started and unveil these essential accounting secrets together.

What Is Accounting?

Accounting is a process of recording your company’s financial activity. It is a detailed account of your business’s money trail.

Moreover, it includes compiling, summarizing, and reporting your financial information to tax agencies, regulators, and management.

It also shows where your money is going and how much is coming in and going out.

In addition, you can monitor your financial position and progress through time by analyzing financial statements.

Why Your Business Needs It

You need to maintain clear records for your business. Good accounting practices offer several benefits. Here is how it can help you:

1. First, it helps you organize your finances by using a systematic approach to record-keeping.
2. In addition, you can use the financial information to make informed business decisions.
3. The accounting records can also serve as evidence in court if it requires legal proceedings.
4. It also ensures that you comply with tax regulations, so you can prepare accurate tax returns.
5. Finally, you can use the accounting records to establish the value of your business.

Accountants use the accounting principles to guide their practices. They include the basic accounting rules used to prepare financial statements and journal entries.

An Overview Of The Golden Rules Of Accounting

Accounting may seem complex, but it follows a logical procedure of double-entry bookkeeping.

In this system, certain golden rules of accounting help accountants record all financial transactions accurately.

The accounting system works on certain principles known as the golden rules.

These rules tell accountants when to debit, when to credit, or when not to record any transaction to ensure accuracy and avoid confusion.

The basic accounting rules relate to different types of accounts, such as Personal accounts, Real accounts, and Nominal accounts.

The accounting principles can be briefly understood using the simple summary given below:

1. Personal Accounts: These specific accounts relate to persons, whether individuals or organisations.
2. Real Accounts: These accounts are related to assets or properties owned by a concern.
3. Nominal Accounts: The normal accounts relate to a concern’s expenses, losses, incomes, and gains.

All three categories of accounts follow specific rules while recording business transactions.

In order to understand these rules, here is a description of each accounting rule along with suitable examples:

Rule 1: Debit The Receiver, Credit The Giver

This accounting rule usually applies to personal accounts. Personal accounts include accounts of individuals, businesses, and banks.

The rule simply means that the person or entity receiving the money or benefit should be debited, and the person or entity giving the money or benefit should be credited.

Example: Suppose a company pays Rs 10,000 in cash to its supplier. It means that the supplier is a receiver of cash and the company is a giver of cash.

According to this rule, they need to debit the supplier account, and the company account should be credited.

Importance of the Rule: This simple rule helps maintain accurate records of what a business or person owes to whom and what is due from whom.

Wrong application of this rule may lead to wrong accounting of payable and receivable amounts.

Rule 2: Debit What Comes In, Credit What Goes Out

This is one of the golden rules of accounting and applies to real accounts. Real accounts record all the assets of a business, which may include cash, buildings, machinery, etc.

According to this rule, a business can acquire an asset and should debit it; when it is sold or disposed of, it should credit it.

Example: A company buys a new computer system for Rs 25,000 in cash.

According to this rule, the computer system, being an asset, should be debited and cash should be credited because cash has gone out of the business.

Importance of the Rule: This rule helps maintain an accurate balance sheet, which shows the true position of the business.

Every business must know the exact worth of its assets and liabilities.

The rule also helps maintain records of intangible assets like goodwill, trademarks, copyrights, patents, etc.

When intangible assets are purchased, the asset is debited, and cash is credited.

Rule 3: Debit The Entire Expenses and Losses, Credit All Incomes And Gains

This accounting rule applies to nominal accounts. Nominal accounts record all the expenses, gains, losses, and incomes of a business.

According to this rule, debit all expenses and losses, and credit all incomes and gains.

Example: A company has paid Rs 3,000 as an electricity bill. According to this rule, the electricity account should be debited, and the cash account should be credited.

The company has received Rs 2,000 as interest on bank deposits. The bank account should be debited, and interest income should be credited to the income side of the account.

Importance of the Rule: This rule helps ascertain a business’s profit or loss.

By recording all the expenses and gains, a business can determine whether it has earned more income than expenditures or vice versa.

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Golden Rules Of Accounting: How Do These Three Rules Work?

Let’s look at exactly how these financial entries work out in practice.

1. Depositing Cash Into The Bank

The Transaction: You deposit ₹20,000 in your bank account.

• The Behind-the-Scenes: Both Bank and Cash are things you own, so they’re Real Accounts.
• The Rule: Debit what comes in, credit what goes out.
• How to think about it: Money is coming into your bank account, but physical cash is leaving your hand.

2. Buying Goods On Credit

The Transaction: You buy inventory worth ₹1,00,000 from EXE Ltd.

• The Behind-the-Scenes: Purchases are a business cost (Nominal Account), while EXE Ltd. is the vendor supplying the goods (Personal Account).
• The Rule: Debit the expense, credit the giver.
• How to think about it: You record the shopping expense, and you credit the vendor who gave you the goods on credit.

3. Selling Goods On Credit

The Transaction: You sell goods worth ₹75,000 to NXE Ltd.

• The Behind-the-Scenes: NXE Ltd. is the customer receiving your goods (Personal Account), and Sales represents your business revenue (Nominal Account).
• The Rule: Debit the receiver, credit the income.
• How to think about it: You debit the customer because they received your product, and you credit the sales account because you earned income.

4. Paying Your Office Rent

The Transaction: You pay ₹82,000 for rent using your bank account.

• The Behind-the-Scenes: Rent is a standard business cost (Nominal Account), and your Bank account is an asset (Real Account).
• The Rule: Debit the expense, credit what goes out.
• How to think about it: You debit the rent because it is a cost of doing business, and you credit your bank account because your money is walking out the door.

5. Earning Bank Interest

The Transaction: You earn ₹3,000 as interest on your bank account.

• The Behind-the-Scenes: Money arrives in your bank asset (Real Account), and interest is free profit (Nominal Account).
• The Rule: Debit what comes in, credit the income or gain.
• How to think about it: New funds are coming into your bank balance, so you debit it. You credit interest because it is extra income you earned.

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