Golden Rules Of Accounting You Need To Follow Today
What is Financial Accounting? Financial accounting is a specific type of accounting dealing with documenting, recording, reporting, and summarising business transactions over a distinctive period. These transactions include the income statement, balance sheet, and cash flow statement that summarize the business’s financial operations for a specific period.
What is Financial Accounting?
Financial accounting is a specific type of accounting dealing with documenting, recording, reporting, and summarising business transactions over a distinctive period. These transactions include the income statement, balance sheet, and cash flow statement that summarize the business’s financial operations for a specific period.
Financial accounting mainly revolves around the golden rules of accounting. These golden rules of account ensure a systematic way of recording business transactions.
Types of Accounts
The golden rules of account help in recording business transactions. These golden rules of accounting can vary for different types of accounts. Each financial transaction has a credit and debit history, which is based on the three account types specified below:
- Real Account
- Personal Account
- Nominal Account
1. Real Account
A real account is a general ledger account reflecting all assets and liabilities of a business. It consists of intangible and tangible assets.
Intangible assets are patents, copyright, goodwill, etc., and tangible assets are building, furniture, machinery, land, etc. This sort of account is carried over. Therefore, they are not settled at the end of the financial year. A bank account is a typical example of a real account.
2. Personal Account
It is a general ledger account related to the person. It can be a natural person named Rajesh, Vikas, or anyone, or an artificial person such as a firm, association, etc.
When one person or business gets money from another, that person or company becomes the recipient, and the business that gave the money becomes the giver. A creditor account is an example of a personal account.
3. Nominal Account
This general ledger account relates business expenses, income, losses, and profit. It keeps track of all transactions for a single financial year. In the nominal account, the balance is reset to zero at the beginning of the fiscal year. An interesting account is an example of a nominal account.
Golden Rules Of Accounting
Financial accounting can be dated back to the Mesopotamian civilization. Luca Pacioli, the father of accounting, was the first person to introduce the double-entry bookkeeping practice, which is still used today.
Golden rules of accounting are the basis of bookkeeping. According to these accounts’ golden rules, each type of account has its set of rules that must be applied for every transaction in the account.
These are the 3 golden rules of accounting-bookkeeping practice:
- What comes in is debit and what goes out is credit.
- Debit the receiver and credit the giver.
- All expenses and losses come under debit, and all income and gains come under credit.
|Type of account
|What comes in is debit
What goes out is credit
|Debit the receiver
Credit the giver
|All expenses and losses are debit
All income and gains are credit
Rule 1: What comes in is Debit & what goes out is credit
It is an account golden rule that applies to the real account, also known as a permanent account. Land, furniture, machines, buildings, and other tangible and intangible assets come under real account.
In a real account, the governing rule is that every real account has a debit balance. Therefore, what comes in is debited and added to the existing account. When a new asset comes into your business, the account is debited. The real account is credited when assets are sold or moved out of the business.
For example, you buy a piece of metal sheet for Rs. 20,000 in cash. The metal sheet account is debited (what comes in), and the cash account is credited (what goes out)
|Metal sheet Account
Rule 2- Debit the receiver and credit the giver
When an individual delivers or provides something to the business, it comes under inflow, and the giver must be acknowledged in bookkeeping. Also, the receiver must be credited. This golden rule of accounting applies to a personal account.
For example, an individual purchased a product worth Rs. 10,000 from company XYZ. In their bookkeeping records, they will require to debit the purchase account and credit to the XYZ account because the XYZ company provided them with products.
|Company XYZ (account payable)
Rule 3- Debit expenses and losses, credit income and gains
The final rule of accounting applies to nominal accounts. These types of accounts are also temporary and include expense, revenue, profit, and loss accounts.
The capital of the company is its liability. It already has a credit balance. If the company has losses or expenses, the account will be debited. The account will be credited if the business has income or gain.
For example, an entrepreneur purchase products of Rs. 5000 from an XYZ company. To keep a record, debit the expense of Rs. 5000 and credit the income.
|Cash Account (XYZ Company)
Example for Income or Gain:
A vendor sells goods worth Rs. 10,000 to a specific company. The income shall be credited to the vendor’s account, and the expenses will be debited from the company’s account.
|Cash Account(ABC Company)
Uses Of The Golden Rule Of Accounting
All businesses need to maintain a steady record of their transactions. To maintain these transactions, they must record journal entries, which are subsequently added to ledgers. The journal entries are recorded as per the accounting golden rules. Before using these criteria, it is necessary to determine the account type.
These rules form the basis of accounting and include the golden rules of accounting. Learning the golden accounting rules is similar to learning a language. A person cannot write a poem or letter without knowing a language. Similarly, a business cannot record and maintain its financial transactions without learning the accountancy golden rules.
After understanding the types of accounts and the 3 golden rules of accounts, let’s dive deeper into the golden rules of accounting with examples:
The list of transactions documented by the owner, Mr. Y, is as follows:
- Y started business in cash worth Rs. 1,00,000
- He purchases goods amounting to Rs. 60,000
- He makes employee salary payments worth Rs. 20,000
- He received interest from the bank of Rs 3000
- He made machinery investments worth Rs 2,00,000
Now, let’s solve this problem.
The primary step is determining and categorizing the accounts in the following transactions.
It may be understood with the use of the table below:
|Types of Accounts
|1. Commenced business with cash ₹1 lakh
|2. Purchase goods in cash for 60,000
|3. Pays salary of ₹20,000
|4. Received interest from Bank ₹3000
|Interest Received A/c
|5. Purchased machinery for ₹2,00,000
After identifying the account types in the transactions, the next step is to enter them as journal entries by following the golden rules of accounting.
Transaction 1: Started business with 1 lakh in cash
In this case, the cash account is a real account, but the capital account is recognized as a liability to the firm under a personal Account.
Following the application of the golden rule to the real account and personal account, the entry will be as follows:
|Cash A/c …………………Dr
|To Capital A/c
Transaction 2: Purchase goods worth Rs. 60,000 in cash.
In this instance, the purchase is a nominal account, and cash is a real account.
Following the application of the golden rule to nominal and real accounts, the entry will be:
|To Cash A/c
Transaction 3: Payment of salary of Rs 20,000
Salary is a nominal account, whereas cash is a real account.
Following the application of the golden rules of accounting to nominal and real accounts, the entry will be:
|To Cash A/c
Transaction 4: Received interest from bank Rs 3,000
In this case, the interest account is a nominal account, whereas the bank Account is a real account. Therefore, the entry will be:
|To Interest Received A/c
Transaction 5: Machinery investment worth Rs 2,00,000
Here, both the Machinery A/c as well as the Bank A/c are Real Accounts. Therefore, as per the real account rules, the entry will be:
|To Bank A/c
The transactions of an enterprise are recorded by following these three steps:
- Step 1: Categorize the type of accounts
- Step 2: Determining the nature of the transaction
- Step 3: Make journal entries.
Benefits of Accounting
The different types of accounting books contain financial transactions that reveal the financial health of an individual, business, or financial entity. Maintaining the account books according to the 3 golden rules of accounting provides the following advantages for a business:
Systematic maintenance of records
Financial data is critical to every business. It helps companies evaluate their economic growth every quarter, six months, and year. When a business keeps its records according to the golden rules of accounting, it creates a method of systematic account keeping.
The maintenance of systematic records is easy as it follows a specific order. Also, it keeps them safe and accessible in the future.
1. Facilitates easy preparation of financial statements
When a business follows the golden rules of accounting, it becomes easier to record financial transactions correctly. The financial transactions help them to prepare financial statements such as trading accounts, balance sheets, profit and loss accounts, etc. Reconciliation of balance sheets and other accounts also becomes smoother when a business follows these rules of accounting.
2. Enables Quick Year-on-Year or Quarter-by-Quarter Growth Comparison
The companies must compare their financial growth year by year or quarter by quarter. When accounting is done according to the golden rules of accounting, it becomes easier for them to compare their profits, revenue, and other financial aspects on a quarterly or yearly basis.
3. Facilitates Better Decisions Making
Data-driven decisions are always more fruitful because they are based on facts and figures. When the accounting is done transparently, businesses tend to grow as leaders can make well-informed decisions backed by data.
4. Adhering To Regulatory Compliance
Businesses need to adhere to the regulatory compliance guidelines set by regional authorities. When their financial aspects are handled through the golden rules of accounting, it becomes easier for them to maintain regulatory compliance. It protects them from legal risks.
5. Aids In Taxation
Failing to comply with tax policies can force the government to impose heavy penalties on a company. It affects them financially and spoils their image in the market. When the accounting practices are transparent, businesses can file their taxes correctly.
6. Makes Business Valuation Easy
Business valuation is an essential criterion that investors consider before investing in a particular company. A good accounting process helps them evaluate their business properly and attract FDI (Foreign Direct Investment), retail investors, and mutual fund houses. These types of investors invest in the business and help it to grow and expand.
Forecasting & Budgeting
Businesses often need to forecast consumer demands and prepare production plans accordingly. Also, they must be careful about the budget while buying raw materials and inventory.
If the company’s account books accurately reflect all the financial records, it can forecast and plan production according to the budget.
Jobs In Accounting
An auditor verifies a company’s financial statements to determine whether they are accurate and reliable. The job of auditors depends on the company or the type of auditor they work as. The types of auditors include internal, external, government, and forensic auditors. An auditor’s duties generally include:
- Arranging and evaluating financial accounts to ensure compliance with regulations.
- Recommending best practices to businesses.
- Verifying taxes are submitted on time and correctly.
The salary ranges from Rs 20,000 to Rs 50,000 per month.
2. Staff accountant
It is among the most prevalent job roles in accounting. They are the field’s generalists. They are generally responsible for managing things:
- Creating financial statements
- Keeping a firm’s primary and subsidiary finances
- Executing account reconciliations
- Managing payroll records
- Controlling cash
- Overseeing clerical employees.
Usually, small-business staff accountants have to manage greater accounting responsibilities as they don’t have access to accounting tools and software solutions. Those who work for big organizations may be assigned only extra supervisory duties.
It is so because they manage organizational accounts using accounting tools and applications. Therefore, the specific duties can differ significantly depending upon the organization in which they work. Their salary ranges from Rs 10,000 to Rs 30,000 per month.
3. Management accountant
When making crucial strategic decisions, business executives must be aware of the current and potential impact of an organization’s financial condition. A management accountant’s role is to give this data so that a firm’s future decisions are accurate.
The daily responsibilities of such accountants include budgeting and planning, risk management, and profitability assessment, among others. Their salary ranges from Rs 13,000 to Rs 60,000 per month.
You can also read out blog on Salary of a Chartered Accountant in India.
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Frequently Asked Questions
Q1. What are the golden rules of accounting?
Ans. The 3 golden rules of accounting are
- Rule1- Debit the receiver and credit the giver.
- Rule2- Debit what comes in and credit what goes out.
- Rule3- Debit all expenses and credit all incomes. Debit all losses and credit all gains.
Q2. What are the 3 types of accounts?
Ans. These accounts have each financial transaction history of individual and business accounts. Each account follows the rule of accounting.
Three different types of accounts in financial accounting are explained below:
Real account: Real account is permanent and doesn’t close at year-end. It can be a liability, equity, or asset account.
Personal accounts: They are related to individuals, firms, companies, etc. A natural person like Karen’s a/c, artificial accounts like booker club a/c, and representative accounts like prepaid expenses a/c are types of personal accounts.
Nominal account: Nominal accounts are also called temporary accounts. They close at the end of the financial year and include expense, loss, revenue, and gain accounts.
Q3. How are golden rules of accounting helpful?
Ans. These golden rules of accounts assure the systematic documentation of financial transactions. They edit the complex ledger rules into principles that are easy to study, understand, and apply.
Q4. Is accounting a good job?
Ans. Accounting is one of the most satisfactory and highly regarded career options, with opportunities for career advancement and job security. One can work as a financial analyst, tax accountant, auditor, controller, bookkeeper, or accounting manager.
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