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Understanding the Three Golden Rules of Accounting

Table of Contents

Accounting is an important part of managing any business efficiently. For business owners, it helps to track money coming in and going out. It shows if the business is making a profit or a loss. Accounting rules help ensure money is recorded accurately.
Accountants have long followed three key rules. They are called the “Golden Rules of Accounting”. These simple rules are still used today. They help businesses record all financial transactions. Let’s explore each rule in more detail.

The First Golden Rule

What is it?

The first golden rule applies to asset accounts. Asset accounts record things a business owns. These things have monetary value, like cash, inventory, equipment, or property.

How does it work?

When a business receives an asset, the asset account increases using a debit. For example, when a store receives cash from a sale, the asset account “cash” is debited to show the increased funds.
When an asset is used or sold, the asset account decreases using a credit. If the store uses inventory to fulfill an order, inventory is credited to show the reduction in stock.

Example

A supermarket receives a delivery of groceries worth $1,000. The inventory asset account would be debited by $1,000 to record the increased stock level.

The Second Golden Rule

What is it?

The second rule applies to owner’s equity accounts. These record the money and assets initially contributed by the owner to start the business.

How does it work?

When an owner invests money into the business, it is recorded as a credit to their equity account. For example, if an owner deposits $50,000 to start a shop, it is credited to their equity.
When the business spends money or distributes profits, it is debited from the owner’s equity. If the shop owner withdraws $2,000, it is debited.

Example

Julie starts a cafe by investing $100,000 of her savings. This is recorded as a credit to her owner’s equity account.

The Third Golden Rule

What is it?

The third rule applies to income and expense accounts. These records money flowing in from sales, or out to pay costs of operating the business.

How does it work?

When revenue is earned from sales or services, it is credited. For example, if a store sells an item for $10, it credits their income account.
Expenses reduce the income which are debited. When inventory for $5 is purchased, it debits the expense account.
Losses are also debited, like damaged goods worth $2. Profits are shown by the balance of credits over debits.

Example

A restaurant serves food worth $500. They credit their income account and debit their cost of goods account for ingredients of $200.

Conclusion

Following the three golden rules of accounting lays the foundation for accurately tracking finances and preparing compliant financial statements. While business environments and regulations may change over time, the fundamental principles of debiting increases and crediting decreases remain applicable.
In the UAE, properly applying these rules is especially important. Both corporate tax and VAT require transparency into revenue, expenses and owner’s equity. Records kept according to the golden rules facilitate reporting, audits and meeting compliance obligations.
For business owners, having a solid grasp of the rules delivers numerous benefits. Financial reports provided to managers and investors accurately portray profitability and cash flow status. Compliance risks and penalties are avoided through systematic record keeping. And audit processes become simpler with clear bookkeeping.
While double-entry accounting may seem complex initially, the golden rules break it down into easy to understand concepts. For any UAE business looking to strengthen financial administration, focusing first on mastering these fundamentals sets them up for long-term recordkeeping success. Do not hesitate to seek help from accounting professionals to clarify or implement the principles.
In conclusion, proper application of the three simple yet powerful golden rules forms the accounting building blocks for both operational and regulatory needs in the UAE’s evolving business environment.

FAQs

Do the golden rules still apply with corporate tax?

Yes, the fundamental accounting principles remain the same. Tax requires extra procedures but debit-credit concepts still apply.

How are the rules used for VAT?

Rules still govern basic transaction recording. But VAT accounting has additional input/output tax considerations.

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VIBHA MALIK MODI

Ms. Vibha Modi, CA, is supported by 13+ Years of Corporate Tax, International Taxation and Accounting Expertise.

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