Golden Rules of Accounting: The 3 Rules With 15 Worked Examples

TL;DR: The three golden rules of accounting are: debit the receiver and credit the giver (personal accounts), debit what comes in and credit what goes out (real accounts), and debit all expenses and losses and credit all incomes and gains (nominal accounts). Classify each account in a transaction first, then apply its rule. The table below works through 15 everyday transactions, including GST lines.

The golden rules of accounting are three rules that decide which account is debited and which is credited in a journal entry. Each rule belongs to one type of account: personal accounts follow "debit the receiver, credit the giver", real accounts follow "debit what comes in, credit what goes out", and nominal accounts follow "debit all expenses and losses, credit all incomes and gains". Every transaction touches at least two accounts, so you apply the rule for each account separately and the debit total always equals the credit total.

What are the 3 golden rules of accounting?

The 3 golden rules of accounting are the classical (also called traditional or British) method of applying double entry. They are taught in Indian commerce syllabi and used by most Indian bookkeepers. A US-trained accountant learns the same outcome through the accounting equation instead; Harold Averkamp of AccountingCoach notes that the golden rules do not appear in the US accounting textbooks he reviewed (AccountingCoach).

The words "debit" and "credit" go back to Luca Pacioli's Summa de Arithmetica, printed in Venice in 1494, which documented the double entry system Venetian merchants already used (Wikipedia: Debits and credits).

What are the types of accounts in accounting?

Accounts in the traditional approach fall into three types: personal, real and nominal. You must classify an account before you can apply a golden rule, and most errors happen at this step, not at the rule itself.

Personal accounts

A personal account records dealings with a person or entity. It has three sub-types:

• Natural personal accounts: human beings. Examples: Ramesh (a customer), Priya (a supplier), the owner's Capital account, the owner's Drawings account.
• Artificial personal accounts: legal persons that are not human. Examples: HDFC Bank, Tata Steel Ltd, a partnership firm, a hospital, a cooperative society, a government department.
• Representative personal accounts: accounts that stand for a person who is owed money or owes it. Examples: Outstanding Salary (owed to employees), Prepaid Rent (owed by the landlord), Income Received in Advance (owed to customers).

Real accounts

A real account records an asset the business owns. Tangible real accounts: Cash, Stock, Land, Building, Machinery, Furniture, Vehicles. Intangible real accounts: Goodwill, Patents, Trademarks, Copyrights, Software licences. Real accounts carry their balance forward to the next year and appear in the balance sheet.

Nominal accounts

A nominal account records an expense, loss, income or gain. Examples: Salary, Rent, Electricity, Purchases, Sales, Commission Received, Interest Received, Discount Allowed, Loss by Fire, Profit on Sale of Asset. Nominal accounts are closed at the end of each period by transferring them to the Trading and Profit and Loss Account, so they start the next year at zero.

How do you apply the rules to a transaction?

Applying the golden rules takes four steps:

1. Name the accounts. "Paid rent ₹15,000 by UPI from the bank" touches Rent and Bank.
2. Classify each one. Rent is nominal (an expense). Bank is personal (HDFC Bank is an artificial person).
3. Apply each account's rule. Rent: debit all expenses. Bank: the bank is the giver, so credit the giver.
4. Check the totals. Rent Dr ₹15,000, Bank Cr ₹15,000. Debits equal credits.

The journal entry is written debit line first, with "To" in front of the credit line:

`` Rent A/c ................ Dr 15,000 To Bank A/c 15,000 (Being rent for October paid by UPI) ``

Worked table: 15 everyday transactions

The table below applies the same four steps to the transactions a small Indian business records every month. Amounts are in rupees; GST is shown at 18% split into CGST 9% and SGST 9% for an intra-state supply.

Check the GST rows the same way as any other entry. Row 14: 10,000 + 900 + 900 = 11,800 credited, equal to the debit to Anita. Row 15: 9% of ₹20,000 is ₹1,800 per tax head, so debits are 20,000 + 1,800 + 1,800 = 23,600, equal to the credit to Kaveri Ltd. For an inter-state supply, replace the CGST and SGST lines with a single IGST line at 18%.

Why does the bank get debited when money comes in?

The bank account is debited when money comes in because, in your books, the bank is a person that receives your money and now owes it to you. "Debit the receiver" applies. This confuses people because the bank statement shows the same deposit as a credit. Both are right: the statement is the bank's own book, where your balance is a liability the bank owes you, and an increase in a liability is a credit (Wikipedia: Debits and credits). Your books are the mirror image.

Some textbooks classify Bank as a real account, treating the balance like cash. Both classifications give the same entry: money in is a debit and money out is a credit.

What is the modern approach and how does it compare?

The modern approach (the American or accounting equation approach) uses five account types instead of three and builds on the equation Assets = Liabilities + Equity (Wikipedia: Accounting equation). Its rules are:

The two approaches always produce the same journal entry. The mapping is direct: real accounts are assets; personal accounts are debtors (assets), creditors and loans (liabilities) and capital (equity); nominal accounts are revenue and expenses. Accounting software, including Tally, Zoho Books and QuickBooks, groups ledgers by the five modern types, so learning both lets you read any chart of accounts.

Use the golden rules when you are recording by hand, studying for an Indian exam, or explaining an entry to someone who learned that way. Use the modern rules when you set up a chart of accounts or read financial statements.

Where do drawings, capital and GST fit?

These three accounts cause the most classification mistakes:

• Capital is a personal account of the owner. Money the owner brings in is credited to Capital (the owner is the giver).
• Drawings is also a personal account of the owner. Cash or goods taken for personal use are debited to Drawings (the owner is the receiver). At year end Drawings is set off against Capital. If the owner takes goods, credit Purchases, not Sales, because the goods were never sold.
• GST ledgers are personal accounts of the government. Output tax is credited when you sell; input tax is debited when you buy.
• Depreciation is a nominal account (an expense). Debit Depreciation, credit the asset (real: value goes out).
• Purchases and Sales are nominal, but Stock is real. Opening and closing stock pass through the Trading Account; the goods themselves are not debited to Stock on each purchase in the periodic system.

What are the most common mistakes with the golden rules?

The most common mistakes come from misclassifying an account or applying the wrong party's view:

• Treating Capital as a real account. Capital is the owner, a person. Credit it when the owner invests.
• Debiting Sales. Sales is income: always credited, except when you reverse a sale with a credit note (Sales Returns is debited).
• Recording from the customer's side. When Ramesh pays you, Ramesh is the giver in your books, so Ramesh is credited.
• Mixing up Purchases and assets. Goods bought for resale go to Purchases (nominal). A laptop for office use goes to Computer (real). The same item can be either, depending on why you bought it.
• Forgetting the representative accounts. Unpaid expenses at year end need an Outstanding account; advance payments need a Prepaid account. Without them the profit is wrong.

Do the golden rules still matter for a small business?

The golden rules matter because Indian law requires double entry for companies. Section 128(1) of the Companies Act, 2013 requires every company to keep books "on accrual basis and according to the double entry system of accounting", and section 128(5) requires those books and their vouchers to be kept for at least eight financial years (Companies Act, 2013, section 128). Section 2(12) allows the books to be kept in electronic form. Sole proprietors and partnerships are not bound by section 128, but double entry is the only way to produce a trial balance, a profit and loss account and a balance sheet that agree with each other.

Software applies the rules for you: when you record a sale, the ledger posts the customer debit and the sales and GST credits automatically. Knowing the rules still matters when you read a ledger, post an adjustment, or check why a trial balance does not tally. The LuckPanda ledger posts each invoice, bill and payment as a balanced double entry, and you can check the result against a trial balance format or a balance sheet format.