Have you ever wondered how businesses of varying sizes — from micro and small enterprises to large corporations — consistently account for their incomes, expenses, assets and liabilities in a uniform manner? The secret to this universal homogeneity lies in the rules of accounting, which apply to every financial transaction undertaken by persons and businesses to which they are relevant.
What Are the Rules of Accounting?
The three golden rules of accounting are fundamental principles that guide businesses on how their transactions need to be recorded. These rules make up the double-entry system of accounting, which is so named because each transaction is recorded in two accounts: with a debit in one and a credit in another.
The Different Kinds of Accounts in the Rules of Accounting
To understand the rules of accounting, it’s essential to first become familiar with the different types of accounts used in the double-entry system of accounting. Broadly, you need to be aware of three key types of accounts, such as:
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Real Accounts
A real account is any ledger account that is related to transactions involving assets and liabilities. They include both tangible and intangible assets, as well as short-term and long-term liabilities.
These accounts are ongoing, meaning that they are not closed or settled within any given financial year. Instead, they are carried forward from one year to the next (till the asset is sold/disposed of or the liability is repaid). They are reflected in a business’s balance sheet.
Examples of Real Accounts: Assets like land, building, furniture, goodwill and copyrights, and liabilities like personal loans and equipment loans
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Personal Accounts
Personal accounts, as the name indicates, relate to individuals or other types of persons. They include natural personal accounts (held by the concerned individual directly), artificial personal accounts (held by entities that are not considered individuals by law) and representative personal accounts (which represent the accounts held by natural or artificial persons).
Examples of Personal Accounts: A personal account held by a creditor or a debtor, or an account held by a legal entity or a business that owes or has lent you money
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Nominal Accounts
A nominal account is a type of general ledger account that is used to record incomes, expenses, gains and losses. It pertains specifically to one financial year. So, such nominal accounts are closed and balanced at the end of a financial year.
Examples of Nominal Accounts: Interest accounts, revenue accounts and rental payment accounts
The Three Golden Rules of Accounting
Now that you know what the primary types of accounts are, let’s explore the three golden rules of accounting under the double-entry accounting system and how they tie in with the accounts discussed above.
Rule 1: Debit What Comes In, Credit What Goes Out
This rule pertains to real accounts like assets and liabilities. By default, asset accounts are considered to have debit balances and liabilities have credit balances. So, when you purchase a new asset, it is debited, and when you sell an asset, it is credited. Similarly, when you incur any liability, it is credited, and when you repay it, it is debited.
For example, say you purchase a new computer for your business worth ₹1,00,000. The entry for this transaction, as per the rules of accounting, will be as follows:
| Date | Account | Debit | Credit |
| DD/MM/YYYY | Computer a/c | ₹1,00,000 | — |
| DD/MM/YYYY | Cash a/c | — | ₹1,00,000 |
Rule 2: Debit the Receiver, Credit the Giver
As you may have guessed, this rule applies to personal accounts. Any money received by a business from a personal account is credited to the giver’s account. Similarly, any money paid by a business to a personal account is debited to the receiver’s account.
For example, say a company pays ₹50,000 as salary to an employee via bank transfer. The entry for this payment, as per the rules of accounting, will be as follows:
| Date | Account | Debit | Credit |
| DD/MM/YYYY | Employee’s salary a/c | ₹50,000 | — |
| DD/MM/YYYY | Bank a/c | — | ₹50,000 |
Rule 3: Debit all Expenses and Losses, Credit all Incomes and Gains
This last and third rule of accounting applies to all nominal accounts — which pertain to expenses, incomes, losses and gains. As per this rule, any expenses incurred or any losses sustained by the business are debited. Similarly, any income received or any profits earned by the business are credited. The corresponding entry as per the double-entry system, is made to the cash/bank account.
For example, say a business sells its equipment for ₹4,00,000. The entry for this sale, as per the rules of accounting will be as follows:
| Date | Account | Debit | Credit |
| DD/MM/YYYY | Equipment a/c | ₹4,00,000 | — |
| DD/MM/YYYY | Cash a/c | — | ₹4,00,000 |
Fundamental Aspects of the Golden Rules of Accounting
The golden rules of accounting, as mentioned above, are based on certain fundamental aspects as outlined below:
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Monetary Approach
Every transaction in accounting must be assigned a specific monetary value. This approach ensures that all business activities are quantified in financial terms, providing a clear and measurable record of the company’s operations.
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Futuristic Approach
This principle operates under the assumption that companies are going concerns or entities that exist in perpetuity. It emphasises the importance of accounting for future implications — where businesses should plan and account for their long-term continuity and sustainability.
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Conservative Approach
Accounting tends to be cautious by its very nature, especially in estimating expenses. In scenarios with uncertain costs, it advises estimating the highest possible expenses. This conservative stance helps in prudent financial planning and risk management.
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Pricing Approach
Rooted in conservatism, this approach dictates that all costs must be reflected at their original purchase value in financial statements. It holds that the actual worth of assets, like land or gold, should not be adjusted for appreciation in the books until such gains are realised.
5 Reasons We Need Accounting Rules
The rules of accounting and accompanying procedures are crucial for businesses and professionals for various reasons. Let’s take a closer look at the benefits of accounting rules and procedures.
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Easy Maintenance of Business Records
The rules of accounting provide a standardised framework for maintaining business records. This simplifies the process of recording transactions and tracking assets and liabilities. It also helps businesses organise their financial information systematically, making it easier to retrieve and analyse data as needed.
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Effective Budgeting and Projections
By adhering to established accounting principles, companies can develop realistic budgets that align with their financial goals and market trends. The golden rules of accounting also provide a reliable basis for forecasting future revenues and expenses. This helps businesses make informed decisions about investments, resource allocation and expansion.
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Seamless Comparison of Financial Data
Standardised rules of accounting enable businesses to compare their financial data seamlessly with other entities. This comparability is crucial for stakeholders like creditors and investors in assessing a company’s financial health relative to its competitors. It also allows for benchmarking performance against industry standards.
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Improved Regulatory Compliance
Many jurisdictions have specific financial reporting standards and requirements that businesses must follow. Adhering to accounting rules and procedures ensures compliance with such legal and regulatory requirements. By following these rules, businesses can avoid legal penalties, fines and reputational damage.
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Accurate Business Valuation
Lastly, the rules of accounting also play a critical role in accurate business valuation. They provide a clear and consistent method for assessing a company’s assets, liabilities and overall financial performance. This is particularly important during mergers, acquisitions and funding rounds.
Who is Required to Maintain Books of Accounts?
Businesses and entities like companies, partnership firms, trusts and the like are required to maintain books of accounts following the golden rules of accounting. Additionally, according to the provisions of the Income Tax Act, persons carrying on any of the following professions are also required to maintain books of accounts:
- Medical
- Legal
- Engineering
- Architectural
- Accountancy
- Film artist
- Technical consultancy
- Interior decoration
- Authorised representative
Conclusion
This sums up the fundamental golden rules of accounting, which are the building blocks of bookkeeping and accounting records for businesses of all sizes. Professionals from different sectors also rely on these rules of accounting to ensure their incomes, expenses, assets and liabilities are recorded accurately. Understanding these accounting and revenue recognition rules makes it easier for aspiring entrepreneurs, sole proprietors, businesspersons and accounting professionals to ensure efficient recordkeeping.
FAQs
What is the difference between accounting and bookkeeping?
Bookkeeping is the process of recording daily transactions consistently. It is a part of the larger process of accounting, which is a more comprehensive process that includes interpreting, classifying, analysing, reporting and summarising financial data.
How does the cash basis accounting differ from the accrual basis?
The revenue recognition rules in the cash basis and accrual of accounting are different. As per the accrual basis accounting, you record transactions when they are earned or incurred, irrespective of when the cash is paid or received. As per the cash basis accounting, you record transactions only when cash is exchanged.
What are debit and credit in the rules of accounting?
In the rules of accounting, debit and credit are the two aspects of every financial transaction. Debit, abbreviated as “Dr,” represents either an increase in assets or expenses or a decrease in liabilities or equity. Credit, abbreviated as “Cr,” indicates either an increase in liabilities or equity or a decrease in assets or expenses.
Why is it called the double-entry system of accounting?
It’s called the double-entry system because, in this method of accounting, every transaction must be recorded in at least two different accounts, reflecting both the debit and credit aspects of the transaction. The debit occurs in one account and the credit occurs in another. For example, if a business avails of a loan to increase its assets, it must also record the liability or the obligation of repaying the loan.
To whom do the three golden rules of accounting apply?
The three golden rules of accounting apply to all types of businesses and accountants. They are fundamental principles that guide the recording of financial transactions in the books of accounts, ensuring accuracy and consistency in financial reporting.
