ACCOUNTING FRAMEWORK

History of Accounting

That's Summa Story!

From the oaves to Cafe Paoioli
By Derry Cotter, FCA
Accountants are generally recognised as making a valuable contribution to society, by providing the information that allows entrepreneurship to flourish, business to operate efficiently, stakeholders' interests to be protected, shares to be fairly priced, and taxation and audit requirements to be satisfied. Accounting, however, has not always enjoyed such an established position, and today there is often a tendency to take our profession's status for granted. It is interesting, therefore, to examine the factors that have brought accounting to the preeminent place that it occupies today. Our story begins in primitive times, when cave dwellers collected enough food to satisfy their daily requirements. Before long, the more enterprising among them would set aside some for future use. In effect that was surplus capital, and it represented the first step towards the accumulation of wealth. Soon, they
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were exchanging their surplus for commodities owned by different cave dwellers. This exchange, which constituted a form of barter, was the first step in the development of a system of commerce.' Record keeping is thought to have begun around 4,000 BC in Babylonia and Assyria. Chatfield- describes the Babylonians as obsessive bookkeepers, with records being kept by scribes, who are regarded as the predecessor of today's accountants. Hundreds of scribes were recruited by the governments of Babylonia to record the collection of taxes, which were paid in the form of cereals, cattle and other farm commodities. Although barter remained popular as a method of exchange, its limitations soon became apparent. For a trade to take place the parties needed to want what each other had, and the items needed to be of similar value. Chatfield describes the dilemma vividly:

One is reminded of the Andaman Islander, carrying his surplus possession to the marketplace and waiting there, sometimes for days, in the iiope of fmding another trader who wanted his goods and iiad something of equal value which he in turn wisiied to have. Traders therefore began to seek a unit of value, or currency, in which the worth of all commodities could be measured. Woolf observes how the Lydians are credited with the invention of coinage around 900 BC, and how gradually this became the common unit of currency. Paper money was invented in China at the end of the 8th century AD. A system of numeration was then required. Woolf recalls Sir Francis Galton's travels of Africa where '... he found men from whom he was required to buy one sheep at a time, because they could not understand that for two sheep, at two plugs of tobacco each, he must give them a lump sum of four plugs of tobacco.'

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It was common at that time to represent numbers with pebbles arranged in sets of ten, a practice which was to lead to the invention of the abacus. Although these pebbles jirovided the stepping stones for the advancement of accounting, Chatfield describes how the backwardness of accounting systems used by the Greeks and Romans can be attributed to their methods of numerical notation. These methods were inferior partly due to the large variety of symbols used for numbers (the Greeks, for example, used twenty eight). A second problem was that the Greeks and Romans failed to represent the value of a number by reference to its position in relation to other numbers. Thus, as numbers could not be added like Arabic numbers, there was little point in arranging amounts in columns. As C^hatfield points out, without a columnar separation of receipts and payments, giving rise to the concept of debit and credit, double-entry bookkeeping was not possible. Ihis problem was overcome by the development of Arabic numerals in India by the Hindus around 600 AD. The most important event in the history of accounting, however, occurred in 1494, with the publication by Italian friar, Luca Pacioli, oí Summa de Arithmetica, Geometría, Proportion i et Proportionalita (everything about

Arithmetic, Geometry and Proportion). The Summa contained the first printed description of double entry bookkeeping, and facilitated by improved literacy levels, and the invention of paper two centuries earlier, the Summa was translated into five languages as the Italian Method spread throughout Europe.

Aithough double-entry bookkeeping facilitated the move from a feudal to a commercial society its use was limited mainiy to summarising accounting records, and bringing order to the venture accounts of business merchants.
No effort, however, was made to match income with the expenditure incurred in creating it, and consequently there was no clear concept of profit, nor any means of evaluating the performance of a business over time. Given the lack of outside investment in firms, there was little external accountability and the production of financial statements was not considered important. Nonetheless, a knowledge of double entry bookkeeping was seen as promoting economic expansion at the beginning of the 16th century.' Accounting was to come centre stage with the arrival of the industrial

revolution in the 19th century. The UK Joint Stock Companies Act of 1844 provided access to incorporation, which had previously been possible only by royal charter or by private act. This resulted in the widespread separation of ownership from control, and with most companies adopting double-entry bookkeeping after 1850, the preparation of financial statements for shareholders bolstered an emerging accounting profession. The Importance of double-entry bookkeeping at that time cannot be overstated, some even controversially viewing its existence as a prerequisite for the spread of capitalism.'' The accounting profession continued to expand during the following decades, with 1888 being a landmark year, marking the foundation of the Institute of Chartered Accountants in Ireland. Accounting succeeded in establishing itself as a conservative discipline, its primary function seen as the recording of business transactions and events, and the provision of reliable information on firms' performance and financial position. Throughout much of the 20th century, accounting maintained its traditional role as an impartial and neutral observer of the business world. Indeed, during that time, the entire corporate world was benignly regarded as the primary driver of wealth creation. Employees and other stakeholders

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History of Accounting offered unconditional loyalty to the corporate ethos, and accountability was rarely an issue. Such a neutral role provided accounting with little scope to effect change, or to be regarded as a discipline with the potential to have economic consequences. f,^ however, explains how in the ' 1970s, society began to hold its institutions responsible for the consequences of their actions. An example was the link between asbestos and lung disease which, although established as far back as 1924, did not result in the first could have a significant economic impact, and the perception of accounting as an impartial observer of the business world began to change. employers to replace definedbenefit pension plans with defined-contribution plans. The allegation related to the publication of FRS 17, Retirement Benefits, which required that pension scheme deficits should be recognised immediately as a liability, rather than continue to be amortised over the expected service lives of employees in the scheme. • During the 2008 US presidential election, the Republican candidate, John McCain, blamed accounting's fair value rules for contributing to the global financial crisis. Those concerns were echoed by Nicolas Sarkozy, who held the presidency of the European Union at that time. Amid falling stock prices, investment banking firms such as Lehman Brothers were forced to write down the value of their assets, spreading panic among investors, and triggering further falls in stock prices which led to a deepening of the crisis. • When the IASB issues a new leasing standard later this year, it is expected that lessees will be required to include all leased assets and the associated liability in their balance sheet. This will result in higher gearing ratios, and in a lower return on investment ratio for lessee firms. The effect will be significant, for example, in the airline industry, where some carriers own few of the aircraft in their fleet. In terms of economic consequences, the capitalisation of operating leases may result in investors adjusting their share portfolios, leasing becoming less attractive as a means of financing, and providers of goods and services reassessing the credit limits of customers that make extensive use of operating leases.

Economic impact of financial statements
Today, it is widely accepted that financial statements affect overall wealth levels, and can lead to the redistribution of wealth between interest groups. There are several documented examples of the

Image: Cafe Pacioli at Chartered Accountants House, Pearse Street, Dublin 2.

successful litigation against an asbestos manufacturer until 1971. The late 1970s also saw an explosion of lawsuits in the United States. Huge awards were made against companies, resulting in an insurance crisis, as insurers refused to provide companies with an adequate level of product liability cover. Consequently, as society demanded increased accountability of its institutions, regulatory bodies such as the Financial Accounting Standards Board (FASB) in the US and the Accounting Standards Steering Committee (ASSC) in the UK were increasingly judged on the economic consequences of their rules. It became apparent that financial statements
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economic consequences of accounting standards, and some examples are outlined below:

In 1975, the ASSC's proposal in ED 14 to write off all R&D expenditure to expense provoked an angry response from the UK aerospace industry, on the grounds that government funding was based on balance sheet asset levels.*" Under intense pressure to withdraw its proposal, the ASSC issued ED 17, and later SSAP 13, which permitted the inclusion of certain R&D expenditure as an asset. In 2000, the ASB was held partly culpable for the decision by

Conclusion
Since the first known records were kept in 4,000 BC, accounting has provided the means for business transactions to be recorded. The development of .'\rabic numerals around 600 AD provided the foundation for double-entry bookkeeping, which was first

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documented in Luca Pacioli's Summa in 1494. The industrial revolution of the 19th century brought about the separation of owners and managers, greatly increasing the demand for external accountability, and leading to the development of today's accounting profession. The perception of accounting as an unbiased recorder of business transactions continued throughout most of the 20th century. Since the 1970s, however, there has been a realisation that accounting information also has the power to affect wealth levels in our society. This impact is called economic consequences, and it emphasises the fact that accounting is a living science that shapes and changes the world in which we live. Throughout its history, accounting has adapted to a myriad of changes, not least of which have occurred during the last century. Although economic influences have shifted and changed over time, as a discipline accounting has continued to increase in importance. Bruce'

maintains that the technological revolution has, in fact, given our discipline a new-found standing.
Once upon a time financial reporting was little more than just the figures ... And then there was an evolution of information technology. As soon as screens appeared on everyone's desks everyone was involved in all of the business. Finance was no longer a back-room function. Everyone had been given the ability to participate.

Note A facsimile edition of Luca Pacioli's Siiinnia de Arithinctiiii, ik'ometriii, Proportivni li Proportionalila is held in the Chartered Accountants Ireland library. Enquiries: risigcharteredaccountants.ie.

References ' Woolf, A. H. (1912). A Short History of Accountants and Accountancy. Gee, London. 2 Chatfield, M. A. (1974). History ofAcamnting Thought. Krieger Publishing Co. Inc. New York. ^ Eucken, W. (1951). TIK Foundations of Economics: History and Theory in tiie Analysis of Economic Reality. University of Chicago Press, Chicago. ' Sombart, W. (1916). Der Moderne Kapitalismus, München, Leipzig: Duncker and Humbolt. = Zeff, S. A. (1978). 'The rise of economic consequences', journal of Accountancy 146 (6), pp. 56-63. " Gray, R. and Hope, A. J. B. 'Power and Policy Making: The Development of an R&D Standard', (1982). Journal ofliusiness Finance ami Accounting, Vol.9, No.4, pp 531-558. ' Bruce, R. Accountancy, Aug 2005. Vol. 136, Issue 1344; p 25.

Our story ends with a visit to the beautiful new headquarters of Chartered Accountants Ireland in Dublin. On the ground floor is the Luca Pacioli restaurant, and considering his influence on modern accounting, it is appropriate that such a place should be set aside where people can socialise and debate the state of the world. Fittingly, the restaurant has two entrances, a detail that would no doubt have satisfled the great man's reputation for exactness.

Derry Cotter, FCA is a lecturer in Accounting & Finance at University College Cork, and the author of the business novel, Creat Eagic Wood, published by Chartered Accountants Ireland.

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