Accounting | Types of Accounts | Importance | Benefits | Needs | Golden Rules

Every profession has a set of rules that govern its operations. Individuals and businesses must use the rules to define and regulate core business functions. This way, there is uniformity in the general structure and application of the process. This also applies in accounting. Accounting has its core rules that guide the public process. These are some golden rules of accounting. They form the fundamentals of the profession. The following contents will cover this definitive guide to the three accounting rules.

golden rules of accounts
Source: Image by Steve Buissinne from Pixabay

What is Accounting?

Accounting is a business operation that involves documenting, summarising, and classifying the financial statements of an organization or a business entity. Simply put, accounting is a process whereby businesses document their financial activities systematically. They maintain a chronological account of all financial events. The accounting process involves continuously updating business transactions to show the true and accurate picture of the financial statement of a business.

Check out the details on GST on a flat purchase.

What are the Different Types of Accounts?

One important thing to know is the different categories of accounts based on modern accounting rules. Account classification will help us to understand the concept behind these rules properly. Based on modern accounting systems, there are three main types of accounts. These are

Personal Account

This is a general ledger account owned by an association, a firm, or a person. These accounts are divided into three accounts:

  • Natural personal account,
  • Artificial personal account,
  • Representative personal account. 

Real Account

You can use this type of ledger account to depict all the assets that belong to an organization. An honest account is a part of the balance sheet. It evaluates the financial standing of an organization. The assets can be classified as intangible assets or tangible assets.

Nominal Account

Businesses use this ledger account to document a business’s gains, incomes, losses, and expenses. They can adjust the nominal account by modifying the Profit and loss account and trading account. This is usually done at the end of the financial year of a business.

The Importance of Accounting to Businesses

To fully understand the golden accounting rules, we must appreciate their importance to businesses and organizations. Applying accounting principles to companies creates a basis for making the right decisions concerning expenses, cash flow, and tax liabilities. Accounting helps to generate three critical financial statements. They are:

  • Businesses use a profit and loss record to provide a clear picture of the expenses and incomes of a business.
  • They use a business’s cash flow statement to monitor all generated revenue. Investors use this as a performance baseline to assess the financial health of a business.
  • A balance sheet creates a clear picture of the business’s financial standing.
golden rules of accounting
Source: Image by Lucia Grzeskiewicz from Pixabay

What are the Benefits of Accounting?

Accounting benefits businesses are maintaining financial transactions based on the golden accounting rules. It leads to various advantages:

To Maintain Proper Business Records

Proper maintenance of business transaction records is critical to business success. Reasonable accounting practices help ensure that you correctly record your business financial activities in the right location and in a systematic manner.

Creating Accurate Financial Statements

Correctly applying the golden accounting rules means maintaining financial records appropriately. You can quickly create financial statements such as balance sheets, trading accounts, and profit and loss accounts with the help of suitable accounting procedures.

Accurately Comparing Financial Results

If businesses maintain accounts with the proper application of the golden rules, it will be easy for them to compare one year’s financial result to another. This means you generally get a trustworthy and credible evaluation of the business’s economic activities and year-on-year results. 

Accurate Decision-Making by Management

Any accounting procedure applied according to the three golden accounting rules yields valuable and trustworthy financial results. This is highly valuable when it comes to the decision-making process by corporate management.

Applicable For Legal Processes

There should be a systematic recording of business matters. They file these records usually to support any quick references in the case of litigation or any legal issue.

Regulatory Compliance

Accounting helps businesses comply with various regulatory frameworks and policies. A business operating within an economic jurisdiction expects to always abide by the regulatory frameworks of the authorities. They meet any deviation from these frameworks with stiff penalties. The three golden accounting rules lay a foundation to ensure compliance with various regulatory policies and procedures.

Assistance in Tax Issues 

Any shortfall in tax payments may attract stiff penalties from government agencies based on inappropriate accounting procedures. Sometimes, you can apply these penalties in such a way that it adversely affects the brand value and image of the company.

Accurate Business Valuation

 The golden accounting rules create a robust accounting procedure. This usually helps in accurate business valuation. This way, the business can attract more investment opportunities to expand its brand in the marketplace.

Future Financial Projections and Budgeting

 The golden accounting rules can be used to create good accounting practices. This proper accounting procedure can quickly help create an accurate budget. This is usually important for businesses to scale up quickly. You have more accurate projections with robust accounting processes informed by the golden accounting rules.

Who Needs Accounting?

Any organization or business with gross receipts over 1.5 lakhs in the oncoming three years of a profession has to maintain a good record of its financial transactions. And this has to be done based on the golden rules of accounting. Certain businesses should maintain proper financial records based on the income tax act. They are

  • Company Secretary
  • Film artists
  • Authorised representative
  • Technical consultation
  • Interior decoration
  • Accountancy
  • Engineering companies
  • Architectural firms.

What are the Golden Rules of Accounting?

The golden accounting rules are applied to each type of account related to a financial activity. There are different rules for each respective account.  The table below shows the various rules used to administer financial transactions.

Account TypeGolden rule
Personal accountThe receiver should be debited, and the giver should be credited
Real accountWhatever comes in should be debited, and whatever goes out should be credited.
Nominal accountAll losses and expenses should be debited, and all gains and incomes should be credited.

These golden rules of accounting form the fundamentals of bookkeeping. Based on these golden accounting rules, each transaction must belong to a particular account type. Each account type is governed by its collection of practices you should implement for every transaction.

Rule 1: Debit – The receiver, and credit – the giver.

This is a rule that applies to personal accounts. Donation to the company is an inflow. You should record the donations as credit in the books. Similarly, the receiving party will have to be debited. 

Rule 2: Debit – Whatever comes in; Credit – whatever goes out.

This is one rule that applies to the real account. Some essential elements of the actual charges include machinery, buildings, land, furniture, etc. By default, this account only has a debit balance. Due to this, if you can debit whatever comes in, it adds up to the available account balance. In the same way, if there is an outgoing tangible asset, accountants use crediting the outflow to reduce the balance in the account.

Rule 3: Debit should be all losses and expenses, and credit should be all gains and incomes.

This is an accounting rule that applies to nominal accounts. The capital of a company acts as its liability. Because of this, it usually has a credit balance. If you credit all the gains and income, you increase its capital. Consequently, they will reduce the money each time you debit the losses and the expenses.

Check out some color combination ideas for the study room.