What are the golden rules of accounting?

[ecis2016.org] Read on to learn about the golden rules of accounting and the types of accounts. We also discuss the importance of accounting for businesses.

Every procedure has a set of generally applicable rules that everyone must observe. These rules are crucial since they are at the heart of the critical functions. Similarly, there are golden rules of accounting. There are three golden accounting standards that we will discuss in this blog. 

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Accounting may be traced back to Mesopotamian civilizations since the beginning of existence. 

Luca Pacioli, the founder of accounting, was the first to mention Double-Entry bookkeeping, which is being used today. In the nineteenth century, Scotland gave birth to the modern profession of chartered accountancy. 

Accounting refers to the measurement, processing, and sharing of financial and non-financial information related to economic entities. In layman’s words, accounting is the methodical recording of financial transactions to keep track of them. It also necessitates maintaining the accounts up to date with the most recent transactions to provide an accurate picture of the institution’s current financial situation.

The 3 Golden Rules of accounting

1. Debit the receiver, credit the giver.
2. Debit is what comes in, credit is what goes out.
3. Debit all expenses and losses, and credit all incomes and gains.

These three golden accounting standards serve as the cornerstone of the accounting system today. These guidelines ensure that financial transactions are represented consistently across the sector. 

To comprehend these norms, we must examine them individually and in context. Let’s look at the purpose of accounting in a firm, who it affects, and the advantages of strong accounting procedures that adhere to these three golden accounting laws.

Accounting: Importance and role in business

Accounting gives businesses clarity, allowing them to make better decisions based on spending, tax liabilities, and cash flow. Through accounting, three important financial statements are generated.

1. The income and expenses are clearly shown in a profit and loss statement.
2. A balance sheet aids in the understanding of a company’s financial status.
3. The cash flow statement is a financial statement that helps investors analyze a company’s financial health by keeping track of cash generated.

What are the benefits of accounting?

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Maintaining financial transaction accounts according to accounting’s golden standards has several benefits.

• Maintaining business records: Maintaining business records is crucial to a company’s success.
• Recording of transactions: Accounting ensures that all of your business transactions are recorded in a secure location, in the proper order, and, more importantly, systematically.
• Financial statement preparation – If the golden laws of accounting are followed, the financial transactions will be properly recorded. If the accounting is done correctly, financial statements such as profit and loss accounts, trading accounts, and balance sheets can all be created rapidly.
• Comparison of financial results – Accounting according to the golden principles makes it simple to compare financial outcomes from one year to the next. Comparing financial outcomes from year to year becomes more straightforward and reliable.
• Corporate decision making: An accounting procedure based on the three golden accounting standards ensures that financial data are reliable and valuable in the decision-making process of senior management and leadership.
• Evidence in Legal Cases: For easy reference in legal cases, business matters must be recorded methodically and filed away in an organised manner.
• Regulatory compliance: Accounting is critical for organisations to comply with regulatory bodies. It would be difficult to accomplish regulatory compliance without the basis laid down by the three golden accounting rules.
• Helps with tax issues: A tax shortfall caused by poor accounting processes could result in severe penalties from government authorities, harming the company’s image and brand value.
• Business valuation: A solid accounting procedure aids incorrect business valuation, allowing the company to attract more investment and expand.
• Budgeting and Future Projections: A decent budget built on sound accounting principles can serve as a solid basis for any company looking to expand. 

Who needs accounting?

Any business with gross receipts of more than Rs. 1.5 lakhs in the previous three years of operation must keep a record of financial transactions by accounting’s golden principles. The following professions are required to keep a record of financial transactions under Rule 6F of the Income Tax Act:

1. Medical
2. Legal
3. Architectural
4. Engineering
5. Accountancy
6. Interior Decoration
7. Technical Consultation
8. Authorised Representative
9. Film Artists
10. Company Secretary

As to rule OF of the Income Tax Act, the specified books are:

• Cash Book – This book is used to keep track of daily cash receipts and payments and the cash balance at the end of the day or month.
• Journal – A journal is a record of daily transactions in which total credits equal total debits utilising the double-entry accounting method and the golden laws of accounting. Every debit will be matched by a credit, and vice versa.
• Ledger – A ledger is a superset of a journal that lists all account details and can be used to create various financial statements.

These books are needed to be kept at a company’s headquarters. Each year’s books should be retained for at least six years to be scrutinised. If the above-mentioned books are not kept by the rules, a fine of Rs. 25,000 would be imposed. 

If the transactions are international, a penalty of 2% of the total value will be applied for each transaction not completed. As a result, it’s a good idea to stick to the recommended approach of keeping accounting books and keeping track of all income and expenses.

As promised at the start of this essay, let’s return to our golden accounting standards. Each of the laws is straightforward to comprehend on its own.

Types of accounts

There are three different types of accounts:

Personal Account

A general ledger account is a personal account. This category includes all accounts relating to people, whether they are natural people like individuals or artificial people like companies. When a business receives something from another business or individual, the first business becomes the receiver. The second business or individual from whom it was obtained becomes the giver, in the case of a personal account. Debit the receiver, credit the giver, states Golden Rule 1. 

Using the rule, the books should show a debit on the personal account and a credit on the business account in our case. Consider the purchase of a present from a gift shop. The transaction should appear in your account as such.

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Real account

The closing balance of a real account is kept and carried forward at the end of the year. The sums carried forward become the opening balances for the following year. Assets, liabilities, and equity are frequently the topics of these accounts. Debit what comes in, credit what goes out, states Golden Rule 2. If a firm obtains something of value (property or goods), it is debited in the books in a real account. When something valuable leaves the company, it is recorded as credited in the books. 

The following is an example of a cash purchase of furniture worth Rs. 10,000.

Nominal account

A nominal account is one in which all accounting operations are recorded for one fiscal year, with balances transferred to permanent accounts. This permits the balances to be reset to zero and the process to begin again. Revenues, Expenses, Gains, and Losses are the most common nominal accounts. Debit all expenses and losses, credit all profits and gains, according to Golden Rule 3. 

If a company suffers a loss or incurs an expense, the corresponding item in the books is a debit. The entry in the book is shown as credit if the business makes a profit or gains income by offering services. For example, a firm pays rent for its space, which is an expense.

Guidelines to keep in mind while applying the  golden rules of accounting

There are a few guidelines you should keep in mind while using these principles, which are as follows:

• Check to see what type of account is being used in the transaction.
• Check whether the transaction adds to or subtracts from the account’s value.
• With these three accounting golden standards, you can keep your accounts updated and correct.

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Category: Must Knows