Golden Rules of Accounting

Golden Rules of Accounting are used to record economic activity in books of accounts. These rules are formulated on the basis of three basic accounts, personal, real and nominal account. An account is a summarized record of the transactions relating to one person or thing or one class of income and expense.

Debit is abbreviated Dr and credit is abbreviated Cr. The term debit means left, and credit means right. They do not mean increase or decrease. The act of entering an amount of the left side of an account is called debiting. Making an entry on the right side is called crediting. Golden rules of accounting are based on blow mentioned accounts which classified into three categories:

Three Golden Rules of Accounting

Accounting golden rules of debiting and crediting are designed according to three basic accounts:

1. Personal Account

Personal accounts are recording transaction with persons or firms. Those accounts recording transactions, which don’t affect particular person, but effects business in general, are called impersonal accounts. Personal accounts may be further classified into three categories:

• Natural Personal Account
• Artificial Personal Account
• Representative Personal Account

Natural Personal Account is an account associated to human like Amna Tabbasum, Usman Khurshid, etc. Artificial personal account is account related to any artificial person like XYZ Ltd, Ramin Trading, Asadullah Industries, etc. on the other hand, representative personal account represents a group of account. If there are a number of accounts of similar nature, it is better to group them like, rent payable account, salary payable account, and insurance prepaid account, etc.

In case of personal account debit the account of the receiver and credit the account of the giver.

2. Real Account

The Real Accounts are those accounts which show dealing in thing or of property or possession ‘Assets’ which are owned by the business organization. Such as cash, building, bank account, office furniture. Thus, asset account is called a real account. There are two types of real account:

• Tangible Account
• Intangible Account

Tangible assets are touchable assets having physical substance, such as machinery, stock, plant, furniture, cash, etc., and intangible assets are non-touchable assets such as patent, goodwill, copyrights, etc.

In case of real account debit the account of assets that comes in the business and credit the account of that which goes out the business.

3. Nominal Account

Since this account does not represent any personal or real account, it is called nominal or fictitious account. They relate to income, expense and gains or losses of a business concern. For example, salaries account, advertising account, discount account, sales account, and commission received account etc. These accounts do not have any existence, form or shape. All kinds of expense account, loss account, gain account or income accounts come under the category of nominal account.

All the business transactions are recorded on the basis of the following golden rules of accounting.

Activities:

Example 1:

Classify the following items into Personal, Real and Nominal Accounts.

1. Purchases                  2. Cash                 3. Drawings                           4. Outstanding salary

5. Building                     6. Rent                   7. Account Payable             8. Discount received

9. Bank                        10. Capital                11. Bank loan                      12.  Sales

Solution:

Golden rules of accounting with examples

March 2018

1. Siam Afsar Khan started business with cash Rs. 250,000.
2. Purchase goods for cash Rs. 15,000.
3. Sold good to Shiza Afridi Rs. 5,000.
4. Purchase furniture for cash Rs. 30,000.
5. Bought goods from Zainab Iftikhar Rs. 45,000.
6. Received from Shiza Afridi on account Rs. 3,000.
7. Goods bought from Hajra Bibi Rs. 10,000.
8. Sold goods to Maha Zia Rs. 8,000.
9. Paid to Zainab Iftikhar Rs. 25,000.
10. Sold goods for cash Rs. 12,000.
11. Paid rent of shop Rs. 17,000.

Solution:

Five Golden Rules of Accounting

Accounting rules are also classified as “5 Golden Rules of Accounting”, which include asset, liability, owner’s equity, revenue and expense.

1. Assets

An asset is worth item of the business, which it can use in its business operations. Assets are of economic value to the business, and can be expressed as a dollar value; assets are what the business owns. There are two classifications of assets:

• Current Assets and
• Non-Current assets

Current assets are assets (future economic value) of the business that will be consumed, or used converted into cash within the next 12 months. For instance, cash in hand, cash at bank, stock, accounts receivable, prepaid, etc. On the other hand, non-current assets are assets of the business expects will still be in use after a year, and not used or converted into cash with in 12 month. Examples of non-current assets are buildings, land, machinery, vehicles, office equipment, investments, etc.

Liabilities

A liability is an obligation of the business that it must eventually repay in the future. Liabilities are what the business owes outside to the business organization. There are two classifications of liabilities, such as:

• Current Liabilities and
• Non-current liabilities.

Current liabilities are obligations that the business is required to satisfy within the next 12 months. Such as accounts payable, payable and outstanding etc. Non-current liabilities are obligations that the business is required to satisfy or pay after or beyond 12 months, for instance, mortgages, bank loan (more than a year), mortgage loan, etc.

Owner’s Equity

Owner’s equity is what the business is worth. It is what the owners have put into or invested in the business; another words, we can say that it is an internal liability of business organization, as it shows what the business owes to the owner. The words ‘proprietorship’ or ‘equity’ or ‘capital’ means the same as ‘owners’ equity’. Examples of owners’ equity are capital, drawings.

Revenue

Revenue is the earnings, proceeds or takings from the operations of a business. The word ‘income’ means the same as ‘revenue’. For example, commission received, sales, fees, interest received, and rent received etc.

Expenses

Expense is what is incurred or spent in making the sales, and in running the business. For our purposes, ‘cost’ means the same as ‘expense’. Examples of expense are cost of goods sold, wages or salaries, rent expense, postage expense,  and stationery expense etc.

5 + 1 Golden Rules of Accounting

If we add one more accounts (Drawing) to previous classification. These six types of accounts arrange alphabetically as described in below diagram:

Using accounting scale, first three accounts are debit balance account and show in debit or left hand side. Similarly, other three accounts in accounting pillars are show in credit or right hand side, as below:

Now account golden rules are described in below mentioned diagram:

>> Read Accounting Cycle.

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