An organization must track its accounts accurately based on the golden rules of accounting to have a good understanding of its financial condition. The organization must record all its transactions under appropriate accounts to do so.
If an investor or third party wants to take a look at the company’s finances, it will head to the Book of Accounts, in which different expenses are assorted in different accounts. Special attention must be paid to all the accounts to ensure that all the transactions are recorded, and accounts are maintained uniformly.
Three rules are often referred to, which are known as the golden rules of accounting. These golden rules dictate how a journal entry is to be made. However, to understand these rules, we must understand the different types of accounts utilized to journal transactions.
- Different Types of Accounts
- Three Golden Rules of Accounting
- Some Examples To Help Understand The Three Rules of Accountancy
Now let us classify these transactions under appropriate accounts.
Different Accountancy Or Bookkeeping Types
Accounting or bookkeeping can be categorized broadly into two parts; impersonal accountancy and personal accountancy. Within the bracket of impersonal bookkeeping, you get further two classifications which are real account and nominal account. We discuss all these types and their functions in business in this section.
There are three different types of accounts used to classify transactions in different types of ledgers. Any transaction made by an organization will fall into one of these three accounts, based on the golden rules of accounting:
Types of Accounting and Bookkeeping
1. Personal Accounting
It is a general ledger account associated with different persons, associations, and firms. A creditor account can be taken as an example of the same. Suppose a company buys goods from another company, XYZ, worth Rs. X, Company XYZ is credited, and the purchase account will be debited, which means its value will increase, according to the golden rules of accounting.
2. Impersonal Accounting
Impersonal accounting is all about recording financial transactions without getting into the nitty-gritty of individual names or detailed descriptions. Instead, it’s all about summarizing and categorizing transactions into broader accounts. This way, businesses can streamline their bookkeeping and keep things confidential. It’s a method that simplifies record-keeping and helps maintain privacy.
Businesses often opt for impersonal accountancy due to several reasons. Firstly, it simplifies record-keeping, making it more efficient and less time-consuming. By eliminating the need to track individual details, businesses can process a higher volume of transactions swiftly.
It also enhances confidentiality, particularly in larger organizations where numerous employees handle financial data. By depersonalizing transactions, the risk of sensitive information falling into the wrong hands is reduced.
Lastly, it facilitates data analysis by providing aggregated insights into financial trends and patterns, aiding informed decision-making.
2.1 Real Account
A real account lists all the assets and liabilities of an organization that do not close by the end of the year. These accounts carry forward to the next year, and an example of such an account would be a Bank account. At the end of a year, the amount in a real account acts as the beginning balance for the next year. This account keeps track of assets, liabilities, and equities.
2.2 Nominal Account
A nominal account can be referred to as a general ledger account that contains information regarding profits, losses, expenses, and gains. An interesting account can be taken as an example of a Nominal account. A nominal account is essentially the opposite of a real account. Nominal accounts are temporary and are closed at the end of every year. The remaining balance is transferred from this temporary account to the company’s income statement.
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Three Golden Rules of Accounting
Companies need to employ staff with a good understanding of what is to be debited from an account and what is to be credited. However, this still leaves space for error and improvement. However, little errors can cause much trouble and lead to an imbalance in the ledgers.
This can be automated with the help of accounting software. ProfitBooks is one such software that provides accurate bookkeeping services for organizations on all sides. However, if you handle the bookkeeping responsibilities for your company or if you own a business, you must understand the three golden rules of accountancy.
A better understanding of debit and credit and these rules can allow you to enforce uniformity in your accounts. The three golden rules of accountancy can be stated as follows:
3 Accounting & Bookkeeping Rules
1. Debit the One that has Received and Credit the One That has Given
One must follow this rule if a personal account is involved in the transactions. If a person is a giver and an organization is a receiver, the person must be credited in the general ledger. The account that is debited value increases, while the one credited has its value decreased.
2. What Comes in Must be Debited, and What Goes Out Must be Credited.
The second principle is used for real accounts, and it consists of tangible assets which exist physically. Examples of assets recorded in a real account include land, office buildings, machinery, vehicles used for transporting products, etc. These assets possess a debit value by default, and when this account is debited, the balance of this account is increased. Similarly, when a real account is credited, the balance decreases.
According to the golden rules of accounting, such an account is credited when a tangible asset is sold or commissioned out of use by an organization. Therefore, in the case of real accounts, a debit signifies an increase in the balance of the account, while a credit signifies a decrease in the balance.
3. Every Loss or Expense is Debited, and Every Gain or Income is Credited
This principle is followed in the case of a nominal account, which records expenses, losses, gains, and income. The capital held by an organization is a liability, which implies that the default balance of these accounts is credit. The third, and last golden rule that you need to understand, explains that upon crediting all gains and income on an account, the value of the mentioned account will increase. At the same time, that in case of debiting all losses and expenses lowers the value of the account. Thus, credit signifies an increment, and debit signifies a decrement in balance in nominal accounts.
ProfitBooks Accounting And Bookkeeping Software
Some Examples To Help Understand The 3 Accountancy Rules
Let us explain the scenario of a company making purchases and profits, and paying rents and salaries, and classify them with the help of the following tables:
| Transactions made | Account affected | Respective account type |
|---|---|---|
| Capital worth Rs. 2,00,000 that the business started with | Cash account, Capital account | Real account. Personal account |
| Office rented for Rs 30,000 | Rent account, Cash account | Nominal account, Real account |
| Goods worth Rs 30,000 purchased from Company ABC on credit | Purchases account, Company ABC account | Nominal account, Personal account |
| Goods worth Rs 60,000 sold | Cash account, Sales account | Real account, Nominal account |
| Paid Company ABC for goods bought on credit in cash | Company ABC account, Cash account | Personal account, Real account |
| Salary paid for Rs 60,000 in cash | Salary account, Cash account | Nominal account, Real account |
Now Let Us Classify These Transactions Under Appropriate Accounts
- Capital worth Rs. 2,00,000 that the business started with
| Account | Debit (Dr) | Credit (Cr) |
|
Cash account |
2,00,000 | |
| Capital account | 2,00,000 |
- Office rented for Rs 30,000
| Account | Debit (Dr) | Credit (Cr) |
| Rent account | 30,000 | |
| Cash account | 30,000 |
- Goods worth Rs 30,000 purchased from Company ABC on credit
| Account | Debit (Dr) | Credit (Cr) |
| Purchases account | 30,000 | |
| Company ABC account | 30,000 |
- Goods worth Rs 60,000 sold
| Account | Debit (Dr) | Credit (Cr) |
| Cash account | 60,000 | |
| Sales account | 60,000 |
- Paid Company ABC for goods bought on credit in cash
| Account | Debit (Dr) | Credit (Cr) |
| Company ABC account | 30,000 | |
| Cash account | 30,000 |
- Salary paid for Rs 60,000 in cash
| Account | Debit (Dr) | Credit (Cr) |
| Salary Account | 60,000 | |
| Cash account | 60,000 |
Possessing knowledge regarding the three rules of accountancy can help in certain instances. However, you don’t need to be an expert in this field, to enable healthy bookkeeping practices in your company. You can use certain tools in the market that are meant to help perform accurate bookkeeping in companies.
However, the majority of tools and applications do not handle all aspects of Bookkeeping. This creates a requirement for several tools, which can get quite hectic and expensive for businesses. However, some tools are capable of handling all the accounting needs of businesses.
ProfitBooks is one such application and has been created to handle every facet of accounting. ProfitBooks automates all the repetitive tasks, and performs the bookkeeping procedures necessary to handle the financial aspects of your business!
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With ProfitBooks, business owners do not need to know the rules of bookkeeping as the application automatically takes care of it in the background.
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