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What are the golden rules of accounting [debit & credit]

The golden rules of accounting are based on the traditional classification of accounts i.e personal, real and nominal accounts. It simplifies the rules of debit and credit of the double-entry system.

golden rules of accounting for all accounts
Golden rules of accounting

To understand the golden rules of accounting clearly, we must know first, “What is Account and its type?

Account Definition:

Accounts are the basic storage units for accounting data. We use them to accumulate amounts from similar transactions.

An accounting system has a separate account for each asset, each liability, and each component of owner’s equity, including revenues and expenses.

In manual accounting, An account is created in the general ledger in a T shape which has a left‐hand side, called the debit side, and a right‐hand side called the credit side.

T-Account

An account is debited when an amount is entered on the left‐hand side and credited when an amount is entered on the right‐hand side.

In accounting,  we use accounts to record all the financial transactions and events. 

The transactions and events are recorded in the accounts on the basis of the rules of debit and credit only. Debit and Credit are important concepts of the double-entry system of accounting.

The double-entry system of accounting follows two rules:

  1. Every transaction affects at least two accounts.
  2. Total debits must equal total credits.


Traditional Classification of Accounts:

In the traditional approach for recording transactions, there are three types of accounts that have two rules for each type of account, one related to Debit and one related to Credit for recording the transactions which are termed as golden rules of accounting.

In the double-entry system, each transaction must be recorded with at least one debit and one credit, and the total amount of the debits must equal the total amount of the credits.

All accounting systems, no matter how sophisticated, are based on the principle of duality.

The types of accounts for application of golden rules of accounting are :

  1. Personal Accounts,
  2. Real Accounts and
  3. Nominal Accounts.

Personal Accounts:

Accounts that deals with persons, i.e. human beings and artificial judicial persons such as companies, government organizations, HUF, etc. Personal Accounts are classified into:

(a) Natural Personal Accounts:- All personal accounts that are concerned with natural human beings are called natural personal accounts. It includes Accounts of individuals, debtors, creditors, proprietor, etc.

(b) Artificial Personal Accounts:- All the entities which have a separate legal identity in the eye of the law are covered under this category.

Therefore, the accounts of clubs, charitable trust, company, bank, etc are artificial personal accounts.

(c) Representative Personal Accounts:-  These are not in the name of any person or entity but they represent a person or group of persons. Examples of these accounts are :

  • Capital Account
  • Drawing Account
  • Accounts payable
  • Accounts receivable
  • Tax payable
  • Tax receivable 
  • Outstanding expenses

Golden Rules for Personal Accounts:

  • Debit the Receiver.
    Write on the left side of an Account which represents a person, if that person receives money from the business.
  • Credit the Giver.
    Write on the Right side of an Account which represents a person, if that person gives money to the business.

See Examples:

Transaction:1 Mahesh started a business with capital of Rs. 100000 by depositing into the bank. 

Analysis of Transaction: In the transaction, two accounts are involved capital account and bank account.

The capital account is a representative personal. It represents Mahesh who is the owner of the business. Bank account is an artificial personal account.

In the transaction, Bank is the receiver of the money, so bank account will be debited with Rs. 100000 and Mahesh is the giver of the money, so capital account will be credited with Rs. 100000.

Bank account                Dr 100000
          Capital account                       Cr 100000
(Business started with capital of Rs. 100000)

Transaction:2 Payment of Rs. 50000 to Rohit from bank (for earlier credit purchases)

Analysis of Transaction: In the transaction, two accounts are involved bank account and Rohit’s account and both are personal accounts.

In the transaction, Rohit is the receiver of the money, so you will debit Rohit’s account with Rs. 50000. Bank is the giver of the money, so you will credit bank account with Rs. 50000.

Rohit’s account                Dr 50000
          Bank account                           Cr 50000
(Payment of Rs. 50000 to Rohit)

Transaction:3 Paid outstanding expenses of Rs. 10000 from bank

Analysis of Transaction: In the transaction, two accounts are involved outstanding expenses and bank. Outstanding expense is a representative personal account because it represents those people whose payments are due now.

We will debit the receiver (Outstanding expense) with Rs. 10000 and credit the giver (bank account) with Rs 10000 by applying golden rules of personal accounts.

Outstanding expenses       Dr 10000
          Bank account                              Cr 10000
(Payment of outstanding expense)

Transaction:4 Received Rs. 8000 into the bank from a customer Ramesh.

Analysis of Transaction: In the transaction, two accounts are involved i.e. Bank account and Ramesh’s account.

We will debit the receiver i.e Bank account with Rs. 8000 and credit the giver i.e. Ramesh’s account with Rs 8000

Bank account                Dr 8000
          Ramesh’s account                Cr 8000
(Money received from customer Ramesh)

Summary of above transactions:

Real Accounts:

Assets are the resources that a business owns and that can be usefully expressed in monetary terms.

Assets are items of value used by the business in its operations. For example;

Machinery, Vehicles, Land & building, Equipment, etc are assets that are used by the business in its operations.

Hence, assets provide economic benefits to the business. 

All assets except personal accounts, which are tangible or intangible, fall under the category “Real Accounts“.

Tangible real accounts are related to things that can be touched and felt physically. Few examples of tangible real accounts are

  • building,
  • machinery,
  • stock,
  • land, 
  • cash
  • office equipment

Intangible real accounts are related to things that can’t be touched and felt physically. Few examples of such real accounts are

  • goodwill,
  • patents,
  • trademark
  • software
  • website

Golden Rules for Real Accounts:

  • Debit what comes in.
    Write on the left side of a Real A/c, if an asset comes into the business.
  • Credit what goes out.
    Write on the right side of a Real A/c, if an asset goes out of business.

See some examples:

Transaction:1 Furniture purchased of Rs. 1500 in cash. 

Analysis of Transaction: In the transaction, two accounts are involved furniture account and cash account and both accounts are real accounts.

In the transaction, Furniture is an asset and due to buying it comes in the business, so we will debit the furniture account with Rs. 1500 and cash is going out of the business due to payment, so the cash account will be credited with Rs. 1500.

Furniture account           Dr 1500
          Cash account                       Cr 1500 
(Furniture purchased of Rs. 1500)

Transaction:2 Paid an amount of Rs. 50000 to Rohit in cash. 

Analysis of Transaction: In the transaction, two accounts are involved Rohit’s account and cash account and Rohit’s account is a personal account and cash is a real account.

In the above transaction, Rohit is the receiver of the money, so we will debit Rohit’s account with Rs. 50000 and cash is going out of the business due to payment, so the cash account will be credited with Rs. 50000.

Rohit’s account           Dr 50000
          Cash account                       Cr 50000 
(Paid an amount of Rs. 50000 to Rohit)

Transaction:3 Machinery purchased of Rs. 45000 from ABC Ltd on credit. 

Analysis of Transaction: In the transaction, two accounts are involved machinery account and ABC Ltd.

Machinery is a real account and ABC Ltd is an artificial personal account.

In the above transaction, Machinery is an asset and due to buying it comes in the business, so we will debit the machinery account with Rs. 45000 and ABC Ltd is the giver of the machinery, so ABC Ltd will be credited with Rs. 45000.

Machinery account      Dr 45000
          ABC Ltd                                 Cr 45000 
(Machinery purchased of Rs. 45000 from ABC Ltd.)

Transaction:4 Cash received from customer Ramesh Rs. 8000. 

Analysis of Transaction: In the transaction, two accounts are involved Cash account and Ramesh’s account.

Cash account is a real account and Ramesh’s account is a personal account.

In the above transaction, Cash is an asset and due to receiving, it comes in the business, so we will debit the cash account with Rs. 8000 and Ramesh is the giver of the cash, so Ramesh’s account will be credited with Rs. 8000.

Cash account      Dr 8000
          Ramesh’s account              Cr 8000 
(Cash received from Ramesh.)

Summary of above transactions:

Nominal Account:

Those accounts which are associated with income, gains, losses or expenses are known as Nominal Account. The net result of all nominal accounts is reflected as a profit or loss which is transferred to capital account.

Here are some examples of nominal accounts:

Income & Gains Accounts:

  • Sales account
  • Interest earned
  • Commission earned
  • Profit on sale of investment

Expense & Losses Accounts:

  • Purchase account
  • Rent account
  • Wages & salary
  • Office expense
  • Printing and stationary
  • Loss on sale of fixed asset

Golden Rules for Nominal Accounts:

  • Debit all expenses & losses.
    Write on the left side of an account, which represents an expense/loss.
  • Credit all incomes & gains.
    Write on the right side of an account, which represents an income/gain.

Examples:

Modern Classification of Accounts:

Under the traditional classifications, accounts are divided into three categories i.e. Real, nominal and personal accounts.

But in the modern classification of accounts, all accounts are divided into five categories for the purposes of recording the transactions:

  1. Asset
  2. Liability
  3. Capital
  4. Expenses/Losses
  5. Revenues/Gains

Modern Rules of Debit & Credit

On the above modern classification of accounts, We apply the following golden rules of accounting as mentioned below:

Asset Account:

For recording changes in Assets, the following rules are applied:

  • Increase in asset is debited.
    All the transactions which increase the balance of Assets i.e. Purchase of Fixed Assets, Investments, etc. are entered on the left side of the respective asset account.
  • Decrease in asset is credited.
    All the transactions which decrease the balance of Assets i.e. Sale of Fixed Assets, Investments, etc. are entered on the right side of the respective asset account.
    debit & credit rules for asset

Expense/Loss Account:

For recording changes in Expense/Losses, the following rules are applied:

  1. Increase in expenses/losses is debited.
    All the transactions which increase the expenses i.e. incurring Salary, Rent, Interest, and Other Expenses are entered on the left side of the respective expense or loss account.
  2. Decrease in expenses/losses is credited.
    The transactions which decrease the expenses i.e. reimbursement of expenditure by way of grants, etc are entered on the right side of the respective expense or loss account.
    debit & credit rules for expense and losses

Liability Account:

The following rules are applied for recording changes in Liabilities :

  • Increase in liabilities is credited.
    The transactions which increase liabilities i.e. Purchase of goods on credit, taking fresh loans, etc are entered on the right side of the respective liability account.
  • Decrease in liabilities is debited.
    The transactions which decrease liabilities i.e. Payment to Creditors, repayment of Loans taken, etc are entered on the left side of the respective liability account.
    debit & credit rules for liabilities

Capital Account:

Amount invested by the owner in the business is known as capital.

It may be brought in the form of cash or assets by the owner for the business entity.

Capital is an obligation and a claim on the assets of the business because the owner of the business is considered a separate entity for accounting purposes.

It is, therefore, shown as capital on the liabilities side of the balance sheet.

For recording changes in Capital, the following rules are applied:

  • Increase in capital is credited.
    The transactions which increase capital or equity i.e. Introduction of fresh Capital etc are entered on the right side of the respective capital or equity account.
  • Decrease in capital is debited.
    The transactions which decrease capital or equity i.e. withdrawal of Capital by Proprietor, Partners, etc are entered on the left side of the respective capital or equity account.
    debit & credit rules for capital

Revenue/Gain Account:

For recording changes in Revenue/Gains, the following rules are applied:

  • Increase in revenue/gain is credited.
    The transactions which increase revenue or gain i.e. Sale of goods, Interest, Rent, Dividends, Discount earned, etc are entered on the right side of the respective revenue or gain account.
  • Decrease in revenue/gain is debited.
    The transactions which decrease revenue or gain i.e. Sales Returns, etc are entered on the left side of the respective revenue or gain account.
    debit & credit rules for revenue and gain

For every transaction, one or more accounts must be debited, or entered on the left side of a T account, and one or more accounts must be credited, or entered on the right side of a T account, and the total dollar amount of the debits must equal the total dollar amount of the credits.

Practical Examples:

(1) Purchase of machinery for 40000 by paying cash.

Analysis of transaction: The transaction increases machinery (asset) on one hand and decreases cash (asset) on the other hand. Increases in assets are debited and deceases in cash are credited. Therefore record the transaction with debit to machinery and credit to cash.

(2) Goods purchased from M/s Kabir Traders for Rs. 25000

Analysis of transaction : This transaction increases purchases (expenses) and increases  M/s Kabir Traders (liabilities)  by Rs. 25000. Increases in expenses are debited and increases in liabilities are credited. Therefore record the transaction with debit to Purchases account and credit to M/s Kabir Traders account.

(3) Payment of cash Rs. 15000 to M/s Kabir Traders

Analysis of transaction : This transaction decreases cash(asset) and decreases  M/s Kabir Traders (liabilities)  by Rs. 15000. Decreases in liabilities are debited and decreases in asset are credited. Therefore record the transaction with debit to M/s Kabir Traders (liabilities) account and credit to cash account.

(4) Payment of Rs. 10000 to M/s Kabir Traders from bank overdraft

Analysis of transaction: This transaction increases bank overdraft (asset) and decreases  M/s Kabir Traders (liabilities)  by Rs. 10000. Decreases in liabilities are debited and increases in liabilities are credited. Therefore record the transaction with debit to M/s Kabir Traders (liabilities) account and credit to bank overdraft account.

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