GOLDEN RULES OF ACCOUNTING

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  • Personal Account – These are accounts of parties with whom the business is carried on. Personal accounts may be:
    1. Accounts of natural or physical persons. For example: Rama Account, Krishna Account.
    1. Accounts of artificial or legal persons. For example: XYZ & Co.
    1. Representative personal account. For example:
      Outstanding Expenses – represents the accounts of parties whom expenses or due.
      Prepaid Expenses – represents accounts of parties to whom some expenses have been paid in advance.
      Outstanding Income – represents accounts of parties from whom some incomes are due.
      Income Received in Advance – represents accounts of parties from whom income has been received in advance.
  • Real Account – These are asset accounts that appear in the Balance Sheet. They are referred to as Real Accounts (or Permanent Accounts) as these are owned by businesses and the balances in these accounts at the end of an accounting period will be carried over to the next period. For example: Cash, Land, building, etc.
  • Nominal Account – These are accounts of expenses and losses which a business incurs and income and gains which a business earn in the course of business. For example: Rent account, Interest account.

ALTERNATE TO GOLDEN RULE OF ACCOUNTING

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  • Assets – Asset is a resource owned/controlled by a business entity as a result of transactions that have happened in the past and from which future monetary benefits are expected to accrue. They are not meant for resale.
  • Liability – Liability is an entity’s present obligation arising from a past transaction, the settlement of which will result in an outflow of economic benefits from the entity.
  • Income – Income includes both revenue and gains. Income is increase in economic benefits in the form of inflows or asset enhancements or reduction in liabilities that result in equity enhancement, other than direct contributions made by investors or equity holders.
  • Expenses – Expenses include both expenses and losses. Expenses lead to reduction in economic benefits during the period in the form of outflows or depletions of assets or increases in liabilities that result in reduction in equity, other than distributions made to investors/ equity participants.

DEBITS AND CREDITS IN ACCOUNTING

  • Debits and credits are the backbone for accounting systems. Every accounting entry in the books of accounts should contain a debit and an equal and corresponding credit. If the debit and credit balances do not tally, then the Balance Sheet of the business entity will be out of balance.
  • Therefore, the accounting system must have a mechanism to ensure that all entries balance. Indeed, most automated accounting systems won’t let you enter an out-of-balance entry-they’ll just beep at you until you fix your error. Ending on what type of account you are dealing with, a debit or credit will either increase or decrease the account balance.

Notes:

  • Debits are denominated by abbreviation Dr. and Credit are denominated by abbreviation Cr.
  • All the assets have Debit balance.
  • All the liabilities have Credit balance.
  • All the incomes have Debit balance.
  • All the expenses have Credit balance.

JOURNAL ENTRIES BASED ON GOLDEN RULE OF ACCOUNTING

    Example-1: X Ltd bought goods from A Ltd. for sum of $1,000.
    Solution:

      Dr. Purchases Account → $1,000
      Cr. A Ltd. Account → $1,000
    Explanation:
    1. In the above entry, two accounts are involved, i.e., Purchases Account (Real Account) and A Ltd. Account (Personal Account).
    1. Here, the goods are coming in and A Ltd. is the provider or giver of those goods.
    1. Hence, as per the Golden Rule, we will debit the Purchase Account (debit what comes in) and credit the A Ltd. Account (credit the giver).
    Example-2: X Ltd sold part of the goods for $600 cash.
    Solution:

      Dr. Cash Account → $600
      Cr. Sales Account → $600
    Explanation:
    1. In the above entry, two accounts are involved, i.e., Cash Account (Real Account) and Sales Account (Real Account).
    1. Here, the cash is coming in and goods (sales) are going out.
    1. Hence, as per the Golden Rule, we will debit the Cash Account (debit what comes in) and credit the Sales Account (credit what goes out).
    Example-3: X Ltd. paid $200 cash for electricity expenses.
    Solution:

      Dr. Electricity Expenses Account → $200
      Cr. Cash Account → $200
    Explanation:
    1. In the above entry, two accounts are involved, i.e., Electricity Expenses Account (Nominal Account) and Cash Account (Real Account).
    1. Here, the cash is going out by making payment of electricity expenses.
    1. Hence, as per the Golden Rule, we will debit the Electricity Expenses Account (debit all expenses and losses) and credit the Cash Account (credit what goes out).
    Example-4: X Ltd received Rent $500.
    Solution:

      Dr. Cash Account → $500
      Cr. Rent Received Account → $500
    Explanation:
    1. In the above entry, two accounts are involved, i.e., Cash Account (Real Account) and Rent Received Account (Nominal Account).
    1. Here, the cash is coming in by the means of rent received (income).
    1. Hence, as per the Golden Rule, we will debit the Cash Account (debit what comes in) and credit the Rent Received Account (credit all incomes and gains).
    Similarly, we can pass any kind of journal entry by applying the Golden Rule Of Accounting.

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