Golden Rules of Accounting
The Golden Rules of Accounting form the foundation of double-entry bookkeeping, ensuring that every transaction is recorded in a systematic way. There are three main Golden Rules, each of which applies to a specific type of account. Let’s go over each rule with examples:
Personal Account
A Personal Account in accounting refers to an account that is related to a specific individual, business, or organization. This type of account represents the entities or parties involved in transactions with the business.
Personal accounts are used to record transactions that involve the receivers and givers of value. The key feature of personal accounts is that they deal with real people, companies, or institutions.
Types of Personal Accounts:
Natural Persons: These are individual human beings.
Example: Accounts of individuals like customers, employees, or vendors (e.g., Mr. John’s Account, ABC Ltd. Account).
Artificial Persons: These are legal entities such as companies, firms, or institutions.
Example: Accounts of businesses like “XYZ Pvt. Ltd.” or “State Bank of India Account.”
Representative Personal Accounts: These accounts represent amounts owed or receivable on behalf of an individual or entity.
Example: Outstanding salaries (which represent amounts owed to employees), prepaid expenses, etc.
Golden Rule for Personal Accounts:
The Golden Rule for Personal Accounts is:
“Debit the receiver, credit the giver.”
Debit the receiver: If an individual or organization receives value (like money or goods), their account is debited.
Credit the giver: If an individual or organization gives value, their account is credited.
Examples:
Receiving money from a customer:
If your company receives ₹5,000 from a customer, the customer’s account (a personal account) is debited.
Journal Entry:
Debit: Customer’s Account ₹5,000 (Debit the receiver)
Credit: Cash Account ₹5,000 (Credit the giver)
Paying money to a supplier:
If your company pays ₹2,000 to a supplier, the supplier’s account (a personal account) is credited.
Journal Entry:
Debit: Accounts Payable ₹2,000 (Debit the receiver)
Credit: Cash Account ₹2,000 (Credit the giver)
Summary:
Personal accounts are related to specific people or entities that the business interacts with. These accounts follow the principle of debiting the receiver and crediting the giver, ensuring that the financial transactions are accurately recorded.
Real Account
A Real Account in accounting refers to an account that deals with assets of a business, whether they are tangible or intangible. These accounts represent physical or non-physical resources owned by the business that provide future economic benefits.
Types of Real Accounts:
Tangible Assets: These are physical assets that the business owns.
Examples: Cash, machinery, buildings, land, inventory, equipment, etc.
Intangible Assets: These are non-physical assets that have value but do not have a physical presence.
Examples: Patents, trademarks, goodwill, copyrights, etc.
Golden Rule for Real Accounts:
The Golden Rule for Real Accounts is:
“Debit what comes in, credit what goes out.”
Debit what comes in: When an asset enters the business (i.e., when you acquire or receive an asset), the account is debited.
Credit what goes out: When an asset leaves the business (i.e., when you sell or dispose of an asset), the account is credited.
Examples:
Purchasing Equipment:
If your company buys a new machine worth ₹10,000, the machinery (a tangible asset) account is debited.
Journal Entry:
Debit: Machinery Account ₹10,000 (Debit what comes in)
Credit: Cash/Bank Account ₹10,000 (Credit what goes out)
Selling Inventory:
If your company sells inventory worth ₹5,000, the inventory (a tangible asset) account is credited.
Journal Entry:
Debit: Cash/Bank Account ₹5,000 (Debit what comes in)
Credit: Inventory Account ₹5,000 (Credit what goes out)
Amortizing an Intangible Asset (e.g., Patents):
If the company writes off some value from its intangible asset like a patent, the patent account is credited.
Journal Entry:
Debit: Amortization Expense Account ₹500
Credit: Patent Account ₹500 (Credit what goes out)
Key Characteristics of Real Accounts:
Permanent Accounts: Unlike nominal accounts (which are reset at the end of each accounting period), real accounts carry their balances over to the next period. They are considered permanent accounts.
Asset-related: Real accounts only deal with resources or assets the business owns. They do not represent liabilities or equity (which are handled in separate accounts).
Summary:
Real accounts represent the assets of a business, and they follow the rule of debiting what comes in (acquisition of assets) and crediting what goes out (disposal or use of assets). These accounts help in tracking the company’s assets over time.
Would you like to explore more real account examples or see how they work with other types of accounts in financial statements?
Nominal Account
A Nominal Account in accounting refers to an account that is related to expenses, losses, incomes, and gains. These accounts track the costs and revenues of a business during a particular accounting period. Unlike real accounts (which represent assets) and personal accounts (which represent individuals or entities), nominal accounts help measure the performance of a business over a specific period, typically a year.
Types of Nominal Accounts:
Expense Accounts: These accounts track the costs incurred by the business in its operations.
Examples: Rent expense, salary expense, utilities expense, insurance expense, etc.
Loss Accounts: These accounts track losses faced by the business during the period.
Examples: Loss on sale of asset, depreciation, bad debts, etc.
Income Accounts: These accounts track the revenues earned by the business from its activities.
Examples: Sales revenue, service income, interest income, etc.
Gain Accounts: These accounts track gains resulting from business transactions.
Examples: Gain on sale of asset, profit from investments, etc.
Golden Rule for Nominal Accounts:
The Golden Rule for Nominal Accounts is:
“Debit all expenses and losses, credit all incomes and gains.”
Debit all expenses and losses: When the business incurs an expense or a loss, the account is debited.
Credit all incomes and gains: When the business earns income or makes a gain, the account is credited.
Examples:
Paying Salary (Expense):
If the company pays ₹10,000 in salaries, the salary (an expense) account is debited.
Journal Entry:
Debit: Salary Expense Account ₹10,000 (Debit all expenses)
Credit: Cash/Bank Account ₹10,000 (Credit what goes out)
Selling Goods (Income):
If the company earns ₹15,000 from selling goods, the sales (an income) account is credited.
Journal Entry:
Debit: Cash/Bank Account ₹15,000 (Debit what comes in)
Credit: Sales Revenue Account ₹15,000 (Credit all incomes)
Incurring Loss (Loss):
If the company incurs a loss of ₹2,000 from the sale of an asset, the loss account is debited.
Journal Entry:
Debit: Loss on Sale of Asset ₹2,000 (Debit all losses)
Credit: Asset Account ₹2,000 (Credit what goes out)
Earned Interest Income (Gain):
If the company earns ₹500 as interest income, the interest income (a gain) account is credited.
Journal Entry:
Debit: Cash/Bank Account ₹500 (Debit what comes in)
Credit: Interest Income Account ₹500 (Credit all gains)
Key Characteristics of Nominal Accounts:
Temporary Accounts: Nominal accounts are temporary accounts because they are closed at the end of each accounting period. At the end of the period, their balances are transferred to the Income Statement (Profit & Loss Account), and they start fresh in the new period.
Performance Measurement: These accounts help in determining the profit or loss of the business by comparing incomes and gains against expenses and losses.
Summary:
Nominal accounts track the financial performance of a business during a specific period. They record expenses and losses on the debit side, and incomes and gains on the credit side. At the end of the accounting period, the balances of these accounts are closed to the Profit & Loss account to determine the net profit or loss.
Would you like further examples or explanations on how nominal accounts impact the preparation of financial statements like the Income Statement?
