The Problem with Debit Credit Rules
The system of debit and credit is right at the foundation of double entry system of book keeping. It is very useful, however at the same time it is very difficult to use in reality. Understanding the system of debits and credits may require a sophisticated employee. However, no company can afford such ruinous waste of cash for record keeping. It is generally done by clerical staff and people who work at the store. Therefore, golden rules of accounting were devised.
Golden rules convert complex bookkeeping rules into a set of principles which can be easily studied and applied. Here is how the system is applied:
Ascertain the Type of Account
The types of accounts viz. real, nominal and personal have been explained in earlier articles. The golden rules of accounting require that you ascertain the type of account in question. Each account type has its rule that needs to be applied to account for the transactions. The golden rules have been listed below:
The Golden Rules of Accounting
Debit The Receiver, Credit The Giver This principle is used in the case of personal accounts. When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. The converse of this is also true, which is why the receiver needs to be debited.
Debit What Comes In, Credit What Goes Out This principle is applied in case of real accounts. Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. This is exactly what needs to be done. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization.
Debit All Expenses And Losses, Credit All Incomes And Gains This rule is applied when the account in question is a nominal account. The capital of the company is a liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance.
The golden rules of accounting allow anyone to be a bookkeeper. They only need to understand the types of accounts and then diligently apply the rules.