What are the types of accounts? What are the golden rules of accounting?

Introduction

Accounting is a fundamental process in financial management that involves recording, classifying, summarizing, analyzing, and interpreting financial transactions. It provides stakeholders with an accurate and reliable understanding of a company’s financial position. In this article, we will explore the golden rules of accounting and the different types of accounts. We will also discuss the benefits of following these rules and how they can help businesses maintain accurate records, avoid errors, and comply with regulatory requirements.

What is accounting?

Accounting is the process of recording, classifying, summarizing, analyzing, and interpreting the financial transactions of a business or organization. The primary purpose of accounting is to provide an accurate and reliable financial position of the company to its stakeholders. These stakeholders may include investors, creditors, management, employees, and other interested parties.

What are the golden rules of accounting?

The golden rules of accounting ensure that financial statements are recorded in a systematic manner. These rules are based on the dual entry system, where each transaction has a corresponding debit and credit entry. It is important to identify which accounts should be charged and which should be credited. If you follow these rules, you can easily determine which account to credit and which to debit. The three principles of the accounting golden rules simplify the complicated rules of bookkeeping. Each type of accounting has its own set of rules that are required to be applied to every financial transaction.

What are the types of accounts?

The following are the three types of accounts:

1. Nominal Accounts

Nominal accounts are also known as income statement accounts. This type of accounting is a normal ledger account that is related to all the expenses, profits, income, and losses of the company. Examples of nominal accounts include salaries, rent, advertising expenses, interest, and commission.

2. Personal Accounts

Personal accounts are used to record transactions related to individuals or organizations with whom the company has financial dealings. Examples of personal accounts include suppliers, customers, creditors, debtors, and banks. Under the personal account, there are three subcategories:

• Natural Personal Accounts: Natural personal accounts refer to human beings. For instance, debtors, capital accounts, creditors, and drawing accounts.
• Artificial Personal Accounts: Artificial personal accounts are the ones that are not human beings but act as separate legal entities in the eyes of the law. They can enter into agreements and operate the functions in the name itself. For example, companies, partnerships, banks, cooperatives, hospitals, and government bodies
• Representative Personal Accounts: Representative personal accounts refer to the accounts of natural or artificial people. In this account, the transactions either belong to the previous year or the following year.

3. Real Accounts

The real account is also the normal ledger, just like the other two types of accounting in the accounting system. They are used to record transactions related to the company’s assets, liabilities, and capital. Examples of real accounts include cash, inventory, land, buildings, equipment, accounts payable, accounts receivable, and owner’s equity.

The 3 Golden rules of accounting

The following are the 3 golden rules of accounting:

Rule 1: Debit all expenses and losses, credit all income and gains

This accounting rule applies to nominal accounts and regards a company’s capital as a liability, resulting in a credit balance. When gains and income are credited, the capital increases. Conversely, debiting losses and expenses reduce the capital balance.

For example, Company A pays the rent worth Rs. 28,000 on 3rd April 2023. This transaction will be recorded as follows:

Rule 2: Debit is the receiver, credit is the giver

According to Rule 2 of accounting, the concept of “Debit is the receiver, credit is the giver” applies to personal accounts. When an individual or an entity donates something to an NGO, it leads to an inflow, and as per accounting principles, the person or entity making the donation should be credited to the books. Conversely, the recipient should be debited to record the transaction accurately.

For example, Company A donates Rs. 1,00,000 in cash to NGO on 23rd February 2023. This transaction will be recorded as follows:

Rule 3: Debit what comes in, credit what goes out

This rule of accounting applies to real accounts where tangible assets such as furniture, land, buildings, etc. are taken into account. These accounts have a by default debiting balance, where everything that comes in is added to the existing balance. Similarly, when a tangible asset departs from the company, the corresponding account balance should be credited.

For example, Company A sells its machinery for Rs. 40,000 on 2nd February 2023. This transaction will be recorded as follows:

Benefits of golden rules of accounting

The following are the benefits of the golden rules of accounting:

• One of the benefits of the golden rules of accounting helps to maintain business records and make sure that the records are stored in a safe, and systematic manner.
• A proper accounting of the financial statements will help you avoid mistakes when filing taxes. An improper accounting will lead you to pay hefty penalties.
• Businesses can compare their year-over-year financial statements because these golden rules of accounting make sure that the financial statements are recorded properly.
• One of the common benefits of the golden rules of accounting is that it helps you to comply with compliance and regulatory authorities.

Conclusion

In conclusion, accounting is the backbone of financial management for businesses and organizations. By following the golden rules of accounting, companies can maintain accurate records, make informed financial decisions, and comply with regulatory requirements. As businesses strive for financial success, understanding and implementing the golden rules of accounting are essential for maintaining transparent and reliable financial information.