What is the rule of 3 in accounting?

The Rule of Three: A Misnomer in Accounting

The phrase “rule of three” pops up in various fields, from writing and design to mathematics. However, in accounting, there isn’t a formally recognized “rule of three.” The term often gets misused, leading to confusion, especially among those new to the field. What people often mistakenly refer to as the “rule of three” is actually a core concept of double-entry bookkeeping built on three fundamental principles that work together to maintain balance within the accounting equation (Assets = Liabilities + Equity).

It’s crucial to understand these three interconnected principles, which, when combined, create the foundation of double-entry bookkeeping, rather than thinking of them as a separate “rule of three.” These principles are:

1. The Dual Nature of Transactions: Every transaction has two aspects – a debit and a credit. This principle ensures that the accounting equation remains balanced. It dictates that for every debit entry, there must be a corresponding credit entry of equal value. This principle further clarifies how specific account types are treated:
   • Expenses and Losses are Debited, Incomes and Gains are Credited: When a business incurs an expense, the expense account is debited, increasing its balance. Conversely, when a business earns income, the income account is credited, increasing its balance. The same logic applies to losses and gains.
2. The Treatment of Receipts and Payments: This principle explains how cash transactions impact the accounting equation:
   • Receipts are Debited, Payments are Credited: When a business receives cash, the cash account is debited, increasing its balance. When a business makes a payment, the cash account is credited, decreasing its balance. This principle highlights the flow of cash within the business.
3. The Handling of Assets: This principle focuses on the movement of assets, both tangible and intangible:
   • Assets Received are Debited, Assets Disbursed are Credited: When a business acquires an asset, the asset account is debited, increasing its balance. When a business disposes of an asset, the asset account is credited, decreasing its balance. This mirrors the logic applied to cash transactions.

These three principles, when applied in conjunction, ensure the integrity of the accounting equation. They are not separate rules but rather facets of the double-entry system. Mistakenly referring to them as the “rule of three” oversimplifies a complex and interconnected system, potentially leading to errors and misunderstandings. Therefore, it’s essential to understand these principles individually and as integral components of the double-entry framework, rather than as a standalone rule.