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3 Golden Rules of Accounting With Examples

Learn the three golden rules of accounting simplifying financial record-keeping. Understand nominal, real, and personal accounts with examples for better comprehension of accounting principles.
authorImageMridula Sharma12 Jun, 2024
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Golden Rules of Accounting

The three golden rules of accounting are fundamental principles that simplify bookkeeping and ensure consistency in financial records. These rules are essential for standardizing accounting practices.

In this article, we will explore the three golden rules of accounting, their definitions, and their purposes.

Need for 3 Golden Rules of Accounting

The three golden rules of accounting form the foundation of accounting and bookkeeping. Accountants use these guidelines to systematically record financial transactions. Golden Rules of Accounting make bookkeeping easier and ensure consistency in accounting practices.

Types of Accounts

There are three types of accounts governed by the three golden accounting rules. Let's break down these accounts to understand their connection to these rules:

1. Nominal Account

A nominal account is a general ledger used to record financial transactions over one fiscal year. Examples include salary, rent, and interest accounts. At the end of the fiscal year, the balance in the nominal account is transferred to a permanent account, reflecting either profit or loss, which is then moved to the capital account. These balances can be transferred to an income summary account or directly into a retained earnings account, resetting the nominal account balance to zero for the new fiscal year. Examples of transactions in nominal accounts are the cost of goods sold, losses on asset sales, and sales of services.

2. Real Account

A real account, also known as a general ledger, appears on the company's balance sheet and includes transactions related to the company’s assets and liabilities. Unlike nominal accounts, real accounts carry their balances over to the next fiscal year, becoming the opening balance for the new period. These accounts are not listed on the income statement but are moved to retained earnings at year-end. Real accounts are divided into two categories:
  • Tangible Real Accounts: Record physical assets like cash, inventory, and stationery.
  • Intangible Real Accounts: Record non-physical assets that have monetary value, such as trademarks, copyrights, goodwill, and patents.

Also Read: Elements of Cost in Cost Accounting

3. Personal Account

Personal accounts are general ledgers used by individuals, firms, and companies. They are further divided into three subcategories:
  • Natural Personal Account: Accounts for human beings, including creditors, debtors, capital, and drawings accounts.
  • Artificial Personal Account: Accounts for entities that act as separate legal entities, such as government bodies, cooperatives, partnerships, and companies.
  • Representative Personal Account: Accounts that represent actual or artificial persons, often in cases of prepaid or outstanding expenses or accrued income. Examples include prepaid rent and unearned brokerage accounts.

3 Golden Rules of Accounting

Let's explore the three Golden Rules of Accounting with examples and understand how they connect to different types of accounts.

'Debit all expenses and losses; Credit all incomes and gains'

This rule applies to nominal accounts. It treats the company's capital as a liability, which means it has a credit balance. When income and gains are credited, the company's capital increases. Conversely, when expenses and losses are debited, the capital decreases.

'Debit the receiver, Credit the giver'

This rule is relevant to personal accounts. When an individual or entity gives something to the company, it creates an inflow. In this scenario, the receiver is debited, and the giver is credited in the company's books.

'Debit what comes in, Credit what goes out'

This rule applies to tangible real accounts, which typically have a debit balance. Anything that comes into the company is debited, adding to the account balance. When a tangible asset leaves the company, the account balance is credited.

Golden Rules of Accounting Examples

Imagine you start a lemonade stand business with $1,000. You rent a spot in the park for $200 per month. You buy lemons and sugar worth $300 on credit from a local supplier. Later, you sell your lemonade for $500 in cash. To replenish your supplies, you pay the supplier $100 in cash. Lastly, you pay your friend $50 for helping you set up the stand. Now, let's break down each step:
  1. Initial Investment: You invest $1,000 to start the business. So, you record this as capital.
  2. Rent Expense: Paying rent is an expense. You debit the rent account and credit the cash account with $200.
  3. Inventory Purchase: Buying lemons and sugar is an expense. Since it's on credit, you credit the supplier's account and debit your inventory account with $300.
  4. Sales Income: Selling lemonade brings in money, so it's income. Credit the sales account and debit cash with $500.
  5. Cash Purchase from Supplier: When you buy more supplies and pay in cash, debit the supplier's account and credit cash with $100.
  6. Payment to Friend: Paying your friend is a personal transaction. Debit the friend's account and credit cash with $50.
Master the essentials of accounting with  PW CA courses. Enroll now to enhance your skills and advance your career in the dynamic field of finance. Start today!
Also Check
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Golden Rules of Accounting FAQs

What are the three golden rules of accounting?

The three golden rules are: Debit all expenses and losses, credit all incomes and gains; Debit the receiver, credit the giver; Debit what comes in, credit what goes out.

How do nominal, real, and personal accounts differ?

Nominal accounts record expenses and incomes for a fiscal year, real accounts track assets and liabilities, and personal accounts involve individuals, entities, or representatives.

What transactions fall under each accounting rule?

Expenses and losses fall under the first rule, while incomes and gains fall under the same. Personal transactions are governed by the second rule, and tangible asset transactions follow the third rule.

Why are these rules crucial for bookkeeping?

They ensure consistency and accuracy in recording financial transactions, simplifying bookkeeping and facilitating clear financial analysis and reporting.

Can you explain the application of these rules with practical examples?

Yes, for instance, when starting a lemonade stand, expenses like rent are debited, incomes like sales are credited, and personal transactions like payments to friends are recorded accordingly.
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