The 3 golden rules of accounting take complex bookkeeping rules and convert them into easy to study principles.
As well as having good organisational skills, business accountants also need to be able to read and correctly interpret the meaning of accounting records, communicating them to a wider audience.
Using the 3 golden rules of accounting, an accountant is able to communicate his actions according to a well defined set of rules.
When a business owner is familiar with this set of rules, they can better understand how the accounts have been calculated.
The golden rules of accounting
As you might expect with the field of accounting, there are some rules that professional accountants needs to follow when performing their duties and tasks.
They may seem straightforward, but they are actually more complex than both the account and his clients would like. This can make these principles tricky to explain to a novice.
The golden rules of accounting have been listed below:
1. Debit the Receiver, Credit the Giver
This principle is always used with personal accountants.
When someone gives something to the company, it is an inflow and therefore must be credited to the books of accounts.
The converse of this is also true, the receiver needing to be debited at the same time.
2. Debit What Comes In, Credit What Goes Out
This principle must be used with real accounts. Accounts known as real accounts involve land, building, machinery, etc.
By default they have a debit balance. In this way, when you debit something that comes in, you are adding it to the existing account balance.
So, this is exactly what you need to do. In the same way, when you credit something that goes out, you are reducing the balance of the account when an asset that is tangible goes out of the company.
3. Debit All Expenses and Losses, Credit All Incomes and Gains
This principle is applied when the account in question is what is known as a nominal account. The capital the company has is a liability.
For this reason, it has a default credit balance. When you credit gains and incomes, you are increasing the capital by debiting losses and expenses, decreasing the capital.
In order for the accounting system used to stay balanced, this is exactly what needs to be done.
What is An Account?
In order to ensure that a company’s financial data remains organised, accountants have developed a system that sorts all transactions into records known as accounts.
Once an accounting system is set up by a company, the accounts that will be most affected by business transactions are identified and then listed out.
This list, once compiled, is known as the chart of accounts. Depending on the complexity of the company operations and the size of the business, they may be as few as 30 accountants, or many thousand.
A business is able to tailor its own chart of accounts so that it meets its needs the best way possible.
The first thing to be listed in the chart of accounts is the balance sheet, this being followed by the income statements. What this means is that the chart of accounts of a company would be organised as follows:
- Stockholder’s (Owner’s) equity
- Income or revenues
Double Entry Accounting
When a double-entry accounting system is used, transactions are recorded in terms of credits and debits.
Since a credit in one account offsets a debit in another, the sum of all credits must equal the sum of all debits.
A double-entry system for keeping books standardises the process of accounting.
Double-entry accounting also improving the accuracy of the financial statements that have been prepared, allowing for an improvement in the detection of errors.
Essentially, the representation equates all assets (uses of capital) to all capital sources (where equity capital leads to shareholder’s equity and debit capital leads to liabilities).
When a company keeps accounts accurately, each and every transaction made by the company will be represented in two or more of its accounts.
What is Debit and Credit?
Credit and debit are key parts of your accounting entries. There are known as the fundamental effect of every individual financial transaction.
You must have a good knowledge of what credit and debit are in order to maintain accounting records correctly.
There are 3 different types of account. The different classifications for these accounts are personal, real, and nominal. The rules for transactions for these 3 different groups of accounts are as follows:
Real accounts are used for assets like land, road, machinery, building, plants, equipment, and furniture. On purchase of such assets, you debit the amount from the respective account.
When it is removed or sold, the correct value must be credited to the account.
Personal accounts constitute accounts of partners, owners, shareholders (capital and drawing account), suppliers (both creditors and debtors), customers, etc.
When a payment is made to any of the above, you must debit the receiver of the payment as well as crediting the bank or cash, as money is paid by means of cheque or from cash.
When cheques of money are received, you debit the cash or bank and credit the person who is paying you.
Here all must credit all gains and incomes, nominal accounts constituting all income and expenses accounts as well as profit or loss.
Whenever expenditure is incurred, you must debit the expenditure account; when income is received you must credit the income account.
Income accounts can include rent received, interest received, and surplus or profit, etc.
Debits and Credits in Action
Money doesn’t just appear out of nowhere or disappear. It has to go somewhere and more importantly it has to come from somewhere.
That’s what debits and credits allow you to see; where you money is coming from and where it’s going.
Once you have identified the 2 or more accounts that are involved in a business transaction, you must credit at least one account and debit at least one account.
When you debit an account, an amount must be entered on the left hand side. When an account is credited, the amount is entered on the right hand side of the account.
In general, the following types of accounts are increased with debits:
- Draws (Dividends)
In order to remember the type of accounts that are increased with a debit, you might like to think of D-E-A-L.
In general the types of accounts that are increased with a credit are as follows:
- Stockholder’s Equity (Owner’s Equity)
When trying to remember the types of accounts that are increased with a credit, you might like to think of G-I-R-L-S.
When decreasing an account, you are doing the opposite of what you do when you are increasing an account.
For example, an asset account is decreased with a credit and therefore increased with a debit.
The abbreviation for credit is cr. The abbreviation for debit is dr.
If you want to learn more about the 3 golden rules of accounting, there are a number of options available for learning at home.
If you a business owner looking to improve your accounting skills learning accounting skills as a business owner can help your business grow.