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Want to learn about the Golden rules of accounting? But first, learn what accounting means- It’s something where numbers rule and every penny counts! Accounting is not just about crunching numbers and balancing books; it’s an art that requires precision, skill, and a keen eye for detail. Whether you’re a business owner, student, or simply curious about the subject, understanding the golden rules of accounting is essential for success.
In this blog post, we’ll walk you through the basics of accounting – from financial statements to double-entry systems – and share with you three golden rules that will help keep your finances in check. So grab your calculator and get ready to dive into this fascinating world!
Basic Accounting Equation
The link between assets, liabilities, and equity is reflected in basic accounting. This equation provides a clear picture of the company’s financial position at any point in time.
Assets are the resources owned by a business that have economic value and can provide future benefits. Example- cash, inventory, equipment, and property.
Liabilities are obligations owed by a business to others such as loans, mortgages, or accounts payable.
Equity represents what remains after all liabilities have been paid off. It includes contributions made by owners plus net income earned by the company over time.
Assets = Liabilities + Equity (Capital) |
This equation must always balance for accurate accounting records. If assets increase then either liabilities or equity must also increase to maintain this balance. Understanding this fundamental concept is essential for anyone involved in finance or accounting to ensure proper record-keeping which translates into better decision-making for businesses today!
Different Types of Financial Statements
Financial statements are the backbone of any accounting system. They provide a snapshot of a company’s financial health and help stakeholders make informed decisions. There are several types of financial statements, each serving its own purpose.
- Income statement is one type of financial statement that shows a company’s revenue and expenses over a period of time, typically one year. It helps determine the profitability or loss of the business during that time frame.
- Balance sheet is a snapshot of a company’s assets, liabilities, and equity at a certain point in time. This statement helps investors understand how much capital is available for investment and how much debt exists.
- Cash flow statement is also significant as it tracks incoming and outgoing cash flows throughout an accounting period. This document highlights changes in working capital, investments made by the business, and financing activities undertaken to sustain operations.
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Kinds of Accounts
-
Real Account
It keeps a record of all the assets and liabilities. Assets include both tangible and intangible assets. Tangible assets include assets that can be touched and seen such as buildings, Machinery, and computer. Intangible Assets include assets that can not be touched or seen such as patents, Goodwill, and copyright.
-
Personal Account
It keeps a record of all the persons i.e. the natural ones humans, and also the artificial ones such as a company, or an organization. All the Debtors and Creditors of the company come under this category.
-
Nominal Account
It keeps a record of all the Income, Expenses, Gains, and losses of the company. The balances are reset to zero, and the procedure is restarted. An interest-bearing account is one that pays no interest. Examples- salary accounts, commission accounts, and rent accounts.
Different Types of Accounts under them
When it comes to accounting, there are different types of accounts that businesses need to keep track of in order to organize their finances. Here are some of the most common types of accounts:
- Assets: These are things that a business owns and have value, such as cash, inventory, or property.
- Liabilities: These are debts or obligations owed by the company, like loans or unpaid bills.
- Equity: This refers to the amount left over after liabilities have been subtracted from assets; it represents the owner’s share in the business.
- Revenue: This is money earned from sales or services provided by the company.
- Expenses: These are costs incurred by running the business, such as rent, salaries, and supplies.
- Gains/Losses: These refer to increases (gains) or decreases (losses) in value due to non-operational activities like selling an asset for more than its purchase price.
Each account type serves a specific purpose and helps businesses understand how their financial resources flow through various areas within the organization. Keeping accurate records of these accounts regularly updated with current information about each account’s balance sheet status allows you better decision-making processes when working towards your goals within your organization!
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How to record transactions
Recording transactions is a crucial part of accounting. It involves documenting every financial activity that occurs in the business, such as sales, purchases, payments, and receipts. Here are some tips on how to record transactions effectively.
- Ensure that you have all the necessary documentation related to the transaction. This could include invoices, receipts, or bank statements. You should also create a system for organizing these documents so they can be easily accessed when needed.
- Determine which accounts the transaction will affect. This will depend on whether it’s an income or expense transaction and what type of account it falls under (e.g., cash, accounts receivable).
- Once you’ve identified the accounts involved in the transaction, record them using either a manual ledger or an accounting software program like QuickBooks.
- When recording transactions manually, use ink instead of pencil to prevent any alterations from being made after the fact. For electronic systems like QuickBooks make sure that your data input follows specific instructions and guidelines.
- Double-check your work for accuracy before finalizing the entry. Any errors made during this process can lead to incorrect financial records and potentially costly mistakes down the line.
3 Golden Rules of Accounting
Rule one
The first rule is the “Debit-Credit” rule.
“Debit what comes in, credit what goes out”
It states that for every transaction recorded in an account, both debit and credit entries should be made with equal amounts. Debit whatever is coming, and credit whenever your asset or cash goes.
For ex- ABC Ltd. buys an asset worth ₹45000 as rent on 1st April 2023. So, this transaction would be recorded in the following manner.
Date |
Account |
Debit |
Credit |
1st April |
Asset A/c |
45000 |
|
1st April |
Cash A/c |
45000 |
Rule two
“Credit the receiver, Debit the Giver”
When someone contributes to your business, it is considered an inflow. The same person is credited in the books of accounts. Conversely, the receiver is debited.
Example- Payment of salaries of ₹50,000 on 31st March 2022
Date |
Account |
Debit |
Credit |
31st March |
Employee’s Salary A/c |
50,000 |
|
31st March |
Cash A/c |
50,000 |
Rule three
“Debit All Expenses and Losses, Credit all Incomes and Gains”
It applies to all the nominal accounts. By default, the company’s capital remains on the credit side of the account and holds a credit balance. Hence, all the incomes and gains that are increasing the capital are credited. Conversely, all the expenses and losses that reduce the amount of capital are debited.
For example- Goods purchased worth ₹6,000 from a company
Date |
Account |
Debit |
Credit |
1st June |
Purchase A/c |
6000 |
|
1st June |
Cash A/c |
6000 |
Conclusion
As we come to the end of our discussion on accounting, it’s important to remember that while it may seem daunting at first, mastering the fundamentals can be incredibly beneficial for both personal and professional reasons.
Understanding the basic accounting equation is crucial in order to properly record transactions and prepare accurate financial statements. With this knowledge, you’ll have a solid foundation upon which to build more complex accounting processes.
The different types of accounts and financial statements are also important concepts to grasp. Being able to differentiate between them will help you analyze your finances more effectively and make informed decisions about spending, investing, or borrowing money.
And finally, let’s not forget about the three golden rules of accounting – assets = liabilities + equity; revenue – expenses = net income; debits must always equal credits. These principles serve as the backbone of modern-day bookkeeping practices.
In conclusion, learning these fundamental concepts can be challenging but ultimately rewarding in terms of gaining financial literacy and making sound decisions regarding your finances.
Frequently Asked Questions (FAQs)
The most important rule in accounting is to maintain accurate and timely records of all financial transactions.
Following the golden rules of accounting helps ensure that your financial statements are accurate, reliable, and consistent with generally accepted accounting principles.
It’s possible but not advisable. Understanding basic accounting concepts can help you make informed decisions about your business and avoid costly mistakes.
Yes, there are many other important principles and concepts related to accounting such as accruals, deferrals, depreciation, inventory valuation methods, and more. It’s important to have a good grasp of these concepts if you want to be an effective accountant or bookkeeper.
The golden rules of accounting include maintaining accurate records, keeping track of all income and expenses, separating personal finances from business finances, reconciling bank statements regularly, and producing timely financial reports. By following these principles consistently over time, you can ensure that your financial data is reliable for decision-making purposes.
Golden rules of Accounting come under a double-entry book-keeping system and is invented by Fra Luca Pacioli and Leonardo da Vinci.
Heydon’s rule
There are three different types of accounts-
- Real Account
- Personal Account
- Nominal Account