A double-entry system is a method of bookkeeping that is typically used for recording in detail all of the financial activities of businesses and individuals. With every transaction, changes are made for both debtors and creditors in this system. These changes impact everything from credit notes and debit notes to profit and loss estimation. To learn more about credit and debit messages click here. To keep the transactions organized and sequential, a fixed set of rules are followed, referred to as the golden rules of accounting. Hence an accountant or a business owner needs to understand how these work.
To understand the golden rules of accounting, one must understand the different types of accounts:
- Personal account: These accounts are associated with persons, including both human beings and artificial persons like companies, firms and associations. The example consists of things like salary or prepaid rent. Personal accounts can be of three types, namely:
a. Natural personal accounts: These deal with natural human beings, including debtors, creditors and proprietors
b. Fake personal accounts: These contract with legal entities and not directly with people. Examples include charitable trust, bank etc.
c. Representative personal account: These could encompass both single or groups of individuals like prepaid account, outstanding liability interpretation etc.
- Impersonal accounts: These do not deal directly with persons. These are of two types:
a. Real account: these are associated with the assets of a firm. These are of two types, namely tangible and intangible real accounts. Example of actual charges is building understanding, investment account, furniture accounts etc. The ethereal versions include intellectual property accounts, goodwill accounts etc.
b. Nominal account: These fictitious accounts reflect a company’s losses, revenues, and expenses. Hence things like travelling expenses and interest paid are taken care of through nominal charges.
Business transactions are typically divided into three parts:
- Personal transactions – these are recorded in personal account
- Transactions associated with business assets- these are recorded in real accounts
- Transactions related to expenses, incomes, gains and losses are recorded in nominal charges.
The golden rules of accounting are applicable based on the type of account you deal with in a financial transaction.
Depending on the type of accounts, the golden rules of accounting adhere to the following principles:
- Personal account rule: The receiver is debited, and the person sending the money is credited.
- Real account rules: Whatever comes in is debited, and whatever goes out is credited.
- Nominal account rule: All the losses and expenses are debited, whereas the gains and incomes are credited.
Hence the three golden accounting rules are created depending on the nature of accounts. These rules apply to everyone from persons to organizations and businesses.