What are the 3 Golden Rules of Accounting: Types & Example

Introduction

Every business needs to maintain transparent and accurate financial records. Knowledge of the basic principles underpinning financial transactions forms the foundation for proper accounting practice. These rules are encapsulated in what are considered the three golden rules of accounting. These rules ensure accuracy and consistency in financial statements. 

In this blog, we will understand these golden rules of accounting through examples and journal entries, explaining their application, their relation to account types, and its importance. 

The Three Golden Rules of Accounting 

These three golden rules of accounting: debit the receiver and credit the giver; debit what comes in and credit what goes out; and debit expenses and losses credit income and gains, form the bedrock of double-entry bookkeeping. They regulate the entry of financial transactions with precision and consistency.

These golden rules help sustain the integrity and transparency of financial records and convey a clear and accurate picture of its finances.

Types of Accounts

The three rules of accounting govern the treatment of l three key account types. These rules dictate how these accounts should be debited and credited. 

1. Nominal account

   These are temporary accounts that record income, expenses, losses, and gains for a specific period. These accounts get closed at the end of each accounting period, and their balances are transferred to the profit and loss account to determine the net profit or loss. Examples of nominal accounts are sales revenues, rent expenses, and utility expenses. 

2. Personal account

   Personal accounts are used to record transactions related to persons, firms and companies. Journal entries in personal accounts include those for individual customers or creditors, corporations or institutions,as well as outstanding expenses or incomes. 

3. Real account

   Real accounts are also known as permanent accounts, deal with asset, liability, and equity accounts. These appear on the balance sheet and carry their balances forward from one period of accounting to the next. Examples include cash, inventory, property, equipment, and accounts payable. Real accounts do not close at the end of an accounting period, unlike nominal accounts. They provide a continuous record of the financial position of the company. They offer insight into the management of long-term assets and liabilities.

Debit the Receiver and Credit the Giver

This rule applies to personal accounts and guides the recording of transactions where value is exchanged between parties. It ensures that the giver (payer) and the receiver (payee) are properly accounted for in the books. 

It makes sure that every financial exchange of value between two entities is accounted for and that value is transferred properly from one party to the other. The key aspect to remember here is that if a business receives anything, they need to debit the related account and if they give something, they need to credit the related account. This ensures the maintenance of accurate and clear records, enhancing the accuracy and reliability of financial statements. 

Example: Imagine your business pays $500 in rent to your landlord. In this transaction, the landlord is the giver (providing the rental space), and your business is the receiver (benefiting from the rental space). Therefore, you need to debit the Rent Expense account and credit the Cash/Bank account.

Debit What Comes In and Credit What Goes Out 

Debit what comes in and credit what goes out is the ruling factor in real accounts. It ensures that all resource inflows and outflows are noted and accounted for in the accounting records, providing a systematic and organized approach for recording transactions related to assets and liabilities.

To ensure sound financial health, businesses cannot afford to compromise on the effective management of assets and liabilities. This rule helps in transparently showing the acquisition and disposal of the asset. The rationale of the rule is that when an asset is acquired, it should be debited to account for its inflow in value, and when the same asset is disposed of, it has to be credited for its outflow in value. 

Example: Suppose your business purchases a new computer for $2,000. In this case, the computer (an asset) is what comes in, and the cash (used to pay for the computer) is what goes out. Hence, you need to debit the Computer Equipment account and credit the Cash/Bank account.

Debit Expenses and Losses, Credit Income and Gains 

Accurate recording of financial performance is indispensable to measuring a business’s profitability and sustainability. The third golden rule of accounting, “Debit expense and loss, credit income and gain,” applies to all nominal accounts. This rule ensures that all expenses and losses are accounted for through debits, while all incomes and gains are accounted for through credits. 

This rule enables the systematic recording of all receipts and payments, helping stakeholders make informed decisions and aiding in strategic planning. It serves as a core accounting principle that helps gauge the true picture of a business’s financial health. 

Example:Assume your business earns $3,000 from providing consulting services. Here, the income from consulting services is recorded as a credit, and the cash received is recorded as a debit.

By applying these examples, you can see how the three golden rules of accounting help maintain accurate and consistent financial records, ensuring that all transactions are properly documented.

Advantages of Accounting Rules

The three golden rules of accounting are the backbone of any business, ensuring financial integrity and transparency. These rules ensure that all financial transactions are consistently and accurately recorded, leading to error-free bookkeeping and increased reliability of financial statements.

This is important for businesses in order to retain stakeholder faith, to keep up with regulatory demands, and also make informed data-led decisions. Let us now examine some advantages below:

• Consistency in financial recording

  All business financial activities are recorded in exactly the same manner, thus painting a clear and accurate financial picture over a period of time. This ensures that organizations can compare financial performance over different periods of time.. 

• Transparency in financial statements

  Following these rules helps businesses maintain their financial statements in a transparent way so that they could be understood with much ease by every user and be subjected to auditing without any fear of error or misstatement.

• Compliance with accounting standards

  Adherence to these principles of accounting enables businesses to comply with accounting standards such as GAAP and government regulations, preventing legal liabilities and penalties.

• Informed decision-making

  Accurate financial records based on these rules facilitate better decision-making by providing reliable data about the health of the business.

• Error Reduction in financial reporting

  These rules help minimize errors in financial reporting, ensuring with certainty that all transactions are properly recorded and classified.

How HighRadius Can Help?

Closing entries are of significant importance when it comes to the accuracy of financial records and ensuring adherence to the golden rules of accounting. HighRadius offers an end-to-end Record to Report suite that transforms your accounting processes from disorganized and inaccurate to organized and accurate operations. Anchoring this all-encompassing suite is the Financial Close Management Solution, simplifying and speeding up activities related to the financial close in a way that ensures compliance and eliminates errors.

LiveCube Task Automation, offered in the R2R product suite, is an excel-like platform designed to automate repetitive tasks for more efficiency and real-time collaboration across teams. This no-code platform enables advanced workflow management, ensuring all closing tasks are run correctly and on time, reducing the manual efforts involved in the process and minimizing the risk of errors. Thisl helps attain a 40% increase in close productivity, hence streamlining the financial close process to let your team do what really matters.

Another key module in the Record-to-Report suite is Journal Entry Management. It enables automated journal entry posting to your ERP. Organizations can achieve up to 95% automation of journal posting with a pre-filled template that minimizes errors and discrepancies for an accurate view of their important financial data.

FAQs

1) How do you apply the golden rules of accounting?

First classify first whether the type of account involved in the transaction is a personal, real, or nominal account. Then apply the golden rules of accounting as follows: 

• Personal account: Debit the receiver and credit the giver
• Real account: Debit what comes in and credit what goes out 
• Nominal account: Debit expenses and losses, credit income and gains

2) What are the three types of accounts?

Personal, real, and nominal accounts are the three types of accounts in accounting. In the first case, personal accounts deal with persons and entities primarily; real accounts show property and liabilities of a business; and lastly, nominal accounts record events about income, expenses, gains, and losses. 

3) What are the two rules of double-entry accounting?

• In every accounting entry, for each debit entry, a credit entry must be made. This would maintain the balancing nature of the accounting equation, Assets = Liabilities + Equity. 
• Every transaction would have at least an effect on two accounts, which would represent dual effects on one’s financial position.