What are Accounting Rules?
Golden Rules of Accounting is set of frameworks for recording day to day transactions in the entity books using the double-entry system, wherein each transaction has a debit as well as a credit and involves two accounts for each transaction.
The Top 3 Golden Accounting Rules are:
- Debit the “Receiver” and Credit the “Giver” (Personal Accounts)
- Debit – What Comes IN and Credit – What Goes OUT (Real Accounts)
- Debit – Expenses and Losses and Credit – Incomes and Gains (Nominal Accounts)
Let us understand each one of them in detail.
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For eg:
Source: Accounting Rules (wallstreetmojo.com)
Personal Account
We classify Personal Account into three Accounts:
- Artificial personal account- Accounts which are artificially created by persons like companies, legal bodies, partnership firms, etc
- Representative Personal Accounts- Which directly or indirectly represents a person, e.g., bank accounts, etc.
- Natural Personal Accounts-Accounts which are directly related to a person, e.g., Krishna A/c.
Debit the “Receiver”
Credit the “Giver”
Real Account
This Account represents the assets which are Tangible and Intangible.
- Tangible AssetsTangible AssetsAny physical assets owned by a firm that can be quantified with reasonable ease and are used to carry out its business activities are defined as tangible assets. For example, a company's land, as well as any structures erected on it, furniture, machinery, and equipment.read more – Assets which have a physical form, e.g., Machines, buildings, etc
- Intangible AssetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more – Assets that don’t have a physical form, e.g., patent, goodwill, etc.
Debit – What Comes IN
Credit – What Goes OUT
Nominal Account
- All profits, gains, expenses, and losses come under this Account.
Debit – Expenses and Losses
Credit – Incomes and Gains
Modern Rules of Accounting
As per Modern rules, each account in a transaction will be either debited or credited based on the six categories of Accounts.
| Account Type | Account Debited | Account Credited |
|---|---|---|
| Capital Account | Decreases | Increases |
| Assets Account | Increases | Decreases |
| Liability Account | Decreases | Increases |
| Revenue Account | Decreases | Increases |
| Expense Account | Increases | Decreases |
| Withdrawal Account | Increases | Decreases |
Based on the type of account the transaction is recorded, the value increases or decreases as per the above table.
Examples of Accounting Rules
Example #1 – Golden Rules
Let us consider if we purchase machinery with cash. There are two accounts involved in this asset (machinery), a cash account and this come under real accountReal AccountReal accounts do not close their balances at the end of the financial year but retain and carry forward their closing balance from one accounting year to another. In other words, the closing balance of these accounts in one accounting year becomes the opening balance of the succeeding accounting year.read more the journal entry will be based on real account rule as below
Rule – Real Account
Debit – What Comes IN – Machinery (asset)
Credit – What Goes OUT – Cash
Journal Entry
Example #2 – Modern Rules
Consider the same example the Machinery purchased through Bank loan is the Asset, and Bank Loan is a Liability, the journal is passed as per the table:
Modern Rule
Journal Entry
How to Use Accounting Rules?
- As per the double-entry systemDouble-entry SystemDouble Entry Accounting System is an accounting approach which states that each & every business transaction is recorded in at least 2 accounts, i.e., a Debit & a Credit. Furthermore, the number of transactions entered as the debits must be equivalent to that of the credits. read more, if a transaction happens in a business, it affects two or more accounts, and these accounts must be recorded in books of the entity.
- As per the transaction, we have to find which accounts, i.e., Real, Nominal AccountNominal AccountNominal Accounts are the general ledger accounts which are closed by the end of an accounting period. Their balance at the end of period comes to zero so they don't appear in the balance sheet.read more, or Personal Accounts, is involved in the transaction and see whether the value has increased or decreased.
- Once the Accounts are found, the journal is passed based on the Debit and credit.
- The Credit and Debit Must be matched in each transaction, and they must always be equal.
Benefits
- They are used to know what accounts are involved and how they should be treated.
- All entities should use the same rule; hence there will be uniformity and consistency in recording transactions.
- Financial reports prepared using these rules are comparable and understandable easily.
- Any error can be easily found if the rules are followed.
Accounting Rules Vs. Accounting Principles
- Rule-based accounting is a set of rules to prepare financial statements, while principle-based are standards that help to develop understandable statements.
- Rule-based accounting is more reliable than the principle-based, as everyone follows the same rule.
- Principle-based will be easier to prepare statements while rule-based is complex as all the rules have to be met by the statement.
- Legal action can be taken if the statement is wrong, which is prepared under the accounting principleAccounting PrincipleAccounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts.read more, but this is eliminated in rule-based accounting.
- As principle-based is easier and more comprehensive; hence managers can manipulate the financial reportsFinancial ReportsFinancial Reporting is the process of disclosing all the relevant financial information of a business for a particular accounting period. These reports are used by the stakeholders (investors, creditors/ bankers, public, regulatory agencies, and government) to make investing and other relevant decisions. read more, but this cannot happen in rule-based.
Conclusion
Accounting Rules, by its name, lays the foundation for preparing other financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more. Since golden rules are used for recording main journal entries and journals are further recorded in the books. Hence it is imperative to follow the rules to prepare a fair report.
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