Accounting Theory Topic 1 Accounting History 1 Accounting

Accounting Theory Topic 1: Accounting History 1

Accounting History Early history of accounting Emergence of double entry bookkeeping Contribution of Luca Pacioli 2

Accounting History The history of accounting is as old as civilization, key to important phases of history, among the most important professions in economics and business. 3

Accounting History A. C. Littleton in his “Accounting Evolution to 1900” contended that for double entry system to emerge , certain prerequisites or antecedents had to be present. He classified his antecedents into two: 1) Materials antecedents : private property, capital, commerce and credit. 2) Language antecedents : writing, money and arithmetic. 4

Accounting History Littleton claimed that these antecedents , although present, did not posses the proper intensity in the ancient civilization to cause double entry system to emerge. The ancient civilizations referred to are; Egypt, Babylonia, Greece and Rome. 5

Alternate Explanation of Vernon Kam Littleton's antecedents need to be explained further to have a fuller understanding of the evolution of accounting from ancient time. He identified three factors that create and promote the growth of business entities: 6

Three factors 1) 2) 3) Capitalistic spirit Economic and political events Technological innovations These three factors (termed as social forces) are the reasons for the development of the business organization which in turn result the development of double entry system. 7

Capitalistic spirit is the motivating force that drives people to form business entity for the sake of making a profit. Of course accounting is used by both profit and non profit organizations. The term Capitalistic spirit is used because historically it has been under Capitalism that accounting has flourished. 8

Capitalistic spirit in the ancient civilization A class of merchants existed in all the ancient. Evidence support that the desire for profit was present in ancient civilizations. But Littleton's view was that desire for profit did not existed in the ancient time. 9

Economic and political events Commerce: an important variable to form and grow business entities. Interpretation of the extent of commerce in the ancient times is a matter of disagreement by the historians. there may have been a great deal of trade but a complex market system did not existed. There was no need for sophisticated book keeping tool vis. a vis. double entry system. 10

Economic and political events Complex market: a complex market consisted aa variety of separate but interrelated activities. First: there is market for consumer and producer goods. Then there are markets for factors of production In each of these market the forces of demand supply should be considered. 11

Economic and political events The necessity for efficient accounting method depend on whether the supply side is complicated. Land was owned for the most part by govt and wealthy people. If they were engaged in business activities they posed no problem Labor was furnished by the family members and slaves, therefore keeping record of labor cost was not a significant matter. There was no capital market. Borrowing funds by merchants was normally a direct transactions with specific individuals. 12

Economic and political events So keeping track of costs and profit for the purpose of accountability to outside parties was not critical. Most part of the business was extension of the household. 13

Technological innovations Laggard technology: ancients resisted the technology. There were lack of incentive to develop the technology, because of cheap labor, cultural attitudes. Writing and arithmetic: Littleton mentioned writing, arithmetic and money as the language antecedents of the double entry book keeping. Writing is verified to be existed in ancient civilization. With respect to arithmetic Egyptians used a system of counting. Babylonians were skilled in arithmetic and astronomy. Littleton concluded that arithmetic in the ancient time was difficult to employ. It depends on ability training and experience. 14

Technological innovations Money: the employment of money as a medium of exchange in the metal form of gold and silver was known to Egypt and Babylonia. Despite the fact that money was utilized medium of exchange , but markets remain simple because of uncomplicated nature of demand supply functions. 15

Emergence of double entry book keeping The first record of double entry system is the Massari (treasurers) accounts in the city of Genoa in 1340. it is probable that double entry system made it appearance in the mid thirteenth century. why double entry system emerged in this time? The reasons are two fold: 16

Emergence of double entry book keeping Firstly : it was the natural outcome of the evolutionary process in response to the need of the time. As Littleton spoke of the evolution of the accounting. the notion implies that what took place in the preceding culture is believed to have some effect on the subsequent culture. Or civilization. 17

Emergence of double entry book keeping Second: a second reason for the appearance of the double entry system at this time is that the particular setting in the Italian city state called it forth. Thee setting is discussed in terms of three major forces: a) Capitalistic spirit b) Economic and political event c) Technological innovation 18

Emergence of double entry book keeping Capitalistic spirit: in the middle ages , conduct was governed by the religious belief. Making a profit was almost immoral. After the thirteen century, position of the business improved greatly. The Italian city state realized this very early recognizing the legitimacy of making a profit as a means to support a family, or to have enough to give the poor or as reward for public service , Italian Church did not regard economic goals and spiritual motives as necessarily conflicting. 19

Economic and political event 1) Demand: By the end of the thirteen century the complexity of the market become evident. On the demand side the more customer goods were desired. 2) Supply: on the supply side , labor market had improved, banking business flourished, 20

Economic and political event 3) Politics: power and politics in Italy was also contributing factor. By the thirteenth century Italian cities was controlled by those who favored business interest. Therefore, commerce and insdustry flourished. 21

Technological innovation In contrast to the Greek and Roman period, the middle ages saw a great interest in the Technological innovation. The particular innovation that stimulated the development of book keeping were paper making, printing etc. 22

Contribution of Luca Pacioli’s bok in 1494 was the first book on the double entry system . However the first person to write on double entry system was probably Benedetto Cotrugli whose book was completed in 1458 but published in 1573 23

The first printed piece of bookkeeping in the world is the Summa de Arithmetica, Geometria, Proportioni et Proportionalita written by Luca Pacioli. The treatise was published in Venice in 1494, and was reprinted in 1523. This work is one of the most important books on mathematics and has had an enormous impact on the field of accounting ever since. 24

The first accounting book actually was one of five sections in Pacioli's mathematics book titled "Everything about Arithmetic, Geometry, and Proportions. " This section on accounting served as the world's only accounting textbook until well into the 16 th century. 25

Contribution of Luca Pacioli The term we employ today debit and credit were mentioned by Pacioli debito(Owed to) and Credito(Owed by). In explaining the double entry system Pacioli said all entries have to be double entries ie if you make one creditors you must make some on a debtor. 26

Contribution of Luca Pacioli First activity a person must undertake when starting a business , V said, is to prepare an inventory. This inventory is to be record in the journal at current values. For sales price he advised…………. 27

Contribution of Luca Pacioli Day book in his book each entry is stated in paragraph form. From the journal entries, entries are to be posted ot the accounts of the ledger. But Pacioli made no mention of accruing and deferring of revenue and expenses. 28

Contribution of Luca Pacioli The determination of profit or loss was different from eh procedure we used today. Each venture was seen as a unit , when the venture closed, the account represent it was closed and profit and loss ascertained. Example of the salt…. 29

The bookkeeping method of Luca Pacioli has several distinct characteristics: 1. Pacioli wrote that there are three things needed by one who wished to carry on business diligently. The most important of these is cash or any other substantial power (altra faculta substantiale). The second is a good accountant (buon ragioneri) and a sharp bookkeeper. The third is good order in order to arrange all business to debit (debito) and credit (credito). 2. Pacioli explained the opening inventory (inventario), but he did not describe the closing inventory. 3. Pacioli's account book system is three account books-that is, a day book. The day book is the first book, the journal is the second book and the ledger is the third book. Pacioli thought of the day book as the formal account book, because he wrote that the day book must be presented to a certain mercantile office (certo officio de mercatâti). 4. All things pertaining to a transaction must be written in the day book, without omission. Pacioli wrote that no point must be omitted in the day book. 5. Pacioli described debit and credit--that is, "per" and "A" in the journal, and "die dare" and "die havere" in the ledger. 30