Copyright Australian Society of Accountants Jul 1994Accounting today faces many complex problems such as the development of a conceptual framework, uniformity versus diversity of accounting practice, government regulation of financial reporting and the introduction of alternatives to the historical cost system. But where did it all begin? While the scope of modern accounting is broadening all the time, a major component of its base remains the double-entry bookkeeping system and an accountant is still defined by some as "a person who records, in a set of books, the financial transactions of a business" (Heinemann Australian Dictionary, 1970).
Few people may be aware of the origins of the double-entry system or the historical events surrounding its creation: most people just take it for granted. Yet not long ago C W Childs described it as "a beautiful system -- a science in fact, based upon true mathematical principles, all the elements composing it being so interwoven that a derangement of one can be traced by the effect upon the others; a perfect and evenly balanced system of checks and counter-checks, every detail being adjusted with that nicety and precision which produces absolute correctness in results".
It is important, I think, for everyone to have an idea of their roots and we, as accountants, should have some knowledge of our profession and its tools of trade. In this article, I will look as far back as ancient Sumeria, trace the development of single-entry bookkeeping, look at the development of double-entry bookkeeping in Italy in the early part of the 14th century, discuss Pacioli's work and the subsequent spread of double-entry bookkeeping to England until the beginning of the 18th century.
ANCIENT AND MEDIEVAL BOOKKEEPING
"Need for a system by which Man might keep a record of his business transactions with his fellow man was felt early in the history of civilisation and many and varied have been the methods used for this purpose" (Vickery, 1923).
The civilisation with the first organised form of government probably existed 7000 years ago. The Chaldean-Babylonian, Assyrian and Sumerian civilisations all had highly organised systems of government and it is from them that we have the oldest surviving business records, dating as far back as 3500 BC.
The scribe, predecessor of the accountant, would place himself either at the gate of the city or in the court of the ruler and from there record all business transactions that might occur. Using a wooden rod with a blunted triangular end, he would engrave into the moist clay tablets the information required. Depending on the importance of the records, the tablets were then either left in the sun or kiln fired. Basically the scribes were concerned with recording what produce went into the city stores and what went out. From these records the ruler would ascertain roughly how production was going, who owed him what and what the shortages were. These records were simple, not to mention fragile.
The ancient Greeks and Romans kept more detailed accounts, recording being made easier by the use of papyrus. Although currency was in use, most transactions were recorded in physical quantities. Recording of transactions in the Roman Empire stemmed from the household where it was common practice for the head of the family to keep a detailed record of all payments and receipts. This record (the adversaria) formed the basis of Roman accounting and was extended to use in business and government. Nominal as well as personal accounts were used and there were even systems of dual-entry -- not double-entry, as capital and income were ignored, but the recording of the same transaction in more than one account to describe its effect more fully.
The oldest financial record from England is the Pipe Roll of 1130-31. The exchequers of England and Scotland had to keep extensive records of amounts received from various sheriffs in the levying of taxes.
In England, the basis of the records was the Domesday Book. The Treasurer's Roll was an account of receipts from which the Pipe Roll was compiled annually. Every six months the sheriffs were summoned to account for revenue from their farms or villages, this accounting being at Easter and Michaelmas. After entering the amount received in the Treasurer's Roll, the exchequer would issue the sheriff with one half of a split stick marked with notches representing the amount paid. The other half with identical marks was kept by the exchequer and then checked against the sheriff's half when he returned six months later to pay the balance. These tally sticks were a new idea and quite infallible because the notches were identical in both halves. An inscription was made on the flat side of the stick giving details of the payment. Tally sticks were not used in Scotland but other records kept resembled those used in England. They were simple but they fulfilled their purpose for tax collection and maintaining the accountability of the sheriffs.
All of these methods of bookkeeping could basically be described as single-entry systems. More refined systems of single-entry bookkeeping were used by merchants in Italy and other parts of Europe during the Middle Ages. Indeed, Childs describes the extensive use of single-entry bookkeeping on the West Coast of the United States up until 1900. So what was the single-entry bookkeeping system, and how was it used?
SINGLE-ENTRY BOOKKEEPING
Single-entry bookkeeping, as the name implies, is a system by which an entry is made in only one account, and which uses only personal accounts (i.e. debtors and creditors). No nominal accounts such as expenses or revenue, or real accounts such as inventory or fixed assets were recognised.
All business transactions for the day were originally recorded in the Journal or Day Book. From there only transactions affecting accounts of persons were posted to the Ledger, a book containing all the individual accounts. The product of the system was not a statement of business done, but what was owing or owed.
Concepts of capital and income were ignored. Neither a complete balance sheet nor a profit and loss statement could be produced by the system because not all the relevant information was included. It would have been possible to get a rough idea of expenses and revenue by tracking back through the Journal, but this would have been rather arduous.
Single-entry was a simple system, requiring little effort to operate, yet useful for the small, easily controlled family concerns that existed in Medieval Europe. However, in the rapidly changing world of the Renaissance single-entry would prove inadequate and something better would be needed. That something better was the double-entry system that has remained with us until today. The first book to make mention of the double-entry system was written in 1458 and the oldest extant records of it date back to 1340, but the events that led up to the creation of the system began some time earlier.
THE CREATION OF DOUBLE-ENTRY BOOKKEEPING
In 1075 the Turks invaded Jerusalem, setting in motion the events that would create the need for an alternative to the single-entry system and the development of double-entry bookkeeping. For the next 200 years, thousands upon thousands of Crusaders from Europe would pass through Italy either on their way to recapture the Holy Land or on their way home. This put centres such as Genoa and Venice in the ideal situation to benefit from commerce and trade with the passing multitude. Merchants made more money than they had dreamed of and turned the excess wealth towards more profitable trade. People returning from the East had acquired a taste for the various delights they had found there and the Italian merchants were quick to meet the demand by undertaking trade across the s Mediterranean. Business was no longer small and simple.
Due to the capital required to finance trade voyages to the East it became necessary for businessmen to pool their resources, forming partnerships. Merchants of Genoa and Venice made use of travelling partners in their overseas ventures. Usually upon the conclusion of a voyage or perhaps in the agreed time, the partnership would be dissolved necessitating the division of profits and return of capital. Accounts therefore had to be kept of expenses, stocks in, sales, and stocks rebought in order for profit to be determined.
Agents were also needed in distant ports to coordinate business for the Italian traders. Agency accounting developed from the need for the agent to keep a record for his accountability to the principal. The agent established a personal account for the principal, debiting for expenses incurred and crediting for revenues received. An inventory account was also needed to record merchandise entrusted to the agent. Quantities of goods sold and received were entered in a separate book from the ledger which contained only personal accounts (as in single-entry). A cash account and an account for the principal were also used. Dual entries were made, making the ledger self-balancing and a trial balance could be drawn from it. There was no consideration, however, of profit or loss or capital: it was only a statement of the discharge of the agent's responsibilities.
Along with the use of partnerships, agencies and sea trade came banking, insurance and credit. Florence became the banking centre of Europe, with large family banks dominating the scene. Credit was extended to traders, military expeditions of foreign monarchs were funded, and bills of exchange were common before the year 1200. Detailed accounts were kept for customers and branch accounts were made necessary by the extension of banking facilities to trade centres.
By 1300, Italy had experienced a period of favourable economic change unknown anywhere else in the world. Genoa and Venice were trade centres for goods from the East and Europe, and Florence was the banking capital of Europe. Partnerships and agents were common and private property rights had been extended to a large percentage of the population. Literacy was widespread and the clumsy Roman numerals were being replaced by Hindu-Arabic numbers. Paper had been invented and money had become a stable medium of exchange.
The single-entry system was now unable to cope with the demands being made upon it by the increasing size and complexities of commerce. The Renaissance was dawning and with the power of the Catholic Church to back education and invention, all the antecedents specified by Littleton in his book Accounting Evolution to 1900 were present.
Already changes had been made to the single-entry system to cater for specific enterprises but, if businessmen were to maintain control over their operations, some other definite system of bookkeeping was needed. From the various bookkeeping methods used for partnerships, agencies and banking there evolved the wondrous double-entry system.
THE DOUBLE-ENTRY BOOKKEEPING SYSTEM
'Double-entry' is a rather simplistic description of this system of bookkeeping. It was much more than just making two entries for each transaction -- a dual-entry system had existed in Roman accounting.
"The significance of double-entry lies in its unique ability to produce, from one integrated set of accounts, an interlocking record of enterprise and achievement" (Winjum, 1972).
Each transaction was recorded twice, debit and credit, but now bilateral personal, real and nominal accounts were integrated in the ledger. A proprietorship account was included, thus allowing increases or decreases of capital from operation or contributions to be recorded. Similar items and accounts were grouped together enabling easier analysis. The Journal was still the book of original entry, but now all journal entries were posted to the ledger, not just the personal account items.
Double-entry has many advantages over the single-entry system:
* Equalising entries allows a check of arithmetical accuracy.
* Both aspects of each transaction are recorded.
* The risk of fraud is decreased by the balancing effect.
* It creates a classification system.
* It allows the production of timely and relevant profit or loss calculations and analysis.
* The financial position is readily ascertainable from the balance sheet, thus providing further arithmetic checks and decreasing the uncertainty facing the business.
* The business entity can be seen separately from its owners.
* The concept of capital is fully developed through the use of the proprietorship account.
The most important of these advantages are the ability to calculate profit or loss and the concept of capital.
Winjum considers that it may be better to describe the system as 'capital income accounting'. Although other methods did make capital and income calculation possible, double-entry made them much easier because the entire system was intended to produce these figures. In 1924 Werner Sombart theorised that "accounting, identified with the double-entry system, played an important part in releasing, activating, stimulating or accentuating the 'rationalistic pursuit of unlimited profits', an essential element in the capitalistic spirit".
Previously, merchants were concerned with survival, earning enough to buy essentials and a few comforts. Through the double-entry system they began to see profits and the possibilities for increased profits. So profit overtook subsistence as the aim of business. It was basically a Hicksian income approach that merchants took. Capital was to be maintained, profit was the excess that would be distributed while keeping capital intact for continuing profit production.
Accounting is therefore more than a reactive response from society: it may help to transform the commercial environment. Chatfield (1977) uses the Renaissance German States as an example: he points out that those that used double-entry grew faster than those that continued to use single-entry.
The double-entry bookkeeping system began replacing single-entry before 1340 and as time passed it became more sophisticated and more popular. As early as 1299, the Farolfi Company of Florence had produced a profit and loss statement and prepaid rent appeared as a deferred expense in an account book dated 1299-1300. Depreciation on equipment was recorded as early as 1324 and bad debt reserves were used by the Medici Bank in the 15th century in an attempt to prevent over-extension and over-distribution of profit (the Medici Bank finally collapsed due to these factors).
Some of the interesting features of records from the 14th century are the accruals, depreciation, lower of cost or market value inventory valuation, the bilateral account form developed in Florence, and the use of foreign exchange amounts. The balance sheets and profit and loss statements differ little from what would be produced today.
One important difference though is that the statement of profit and loss was not always produced annually as it is today. It was not until 1606 that the Dutch mathematician Simon Stevin proposed that the profit and loss statement should be produced at the end of every year. A profit and loss statement was not required by law in England until 1929.
By the time Pacioli had completed his exposition of the double-entry system, it was widely used in Italy and very refined, the methodology remaining virtually the same for the next 300 years.
PACIOLI
Luca Pacioli was born in Borgo San Sepulcro, Tuscany around 1445. In his most famous work, Summa de Arithmetica, Geometrica, Proportioni et Propotionalita (Everything about Arithmetic, Geometry and Proportion), he included a general guide to the practice of bookkeeping in Venice. Although Pacioli wrote long after the double-entry system (or, as it was also known, the 'Method of Venice') had been established, his was the first exposition of it. Among the subjects he discusses are inventory, the Memorial or Daybook, the Journal, the Ledger, barter, company or joint venture, agency and bank accounts, income and expenditure accounts, the balance sheet, and the general rules of bookkeeping.
The 'Method of Venice' that Pacioli describes has three books. The Memorandum or Daybook is the book of original entry, the equivalent of our receipts, invoices or disbursement slips. Informal, descriptive entries were made, denoting the currency and the details of the transaction. Items other than transactions would also find their way into the Memorandum or Daybook because it was used to keep a record of events so that they would not be forgotten. From the Memorandum, the entries were formalised and the currency converted to a standard monetary unit for entry to the Journal, much the same as the journal entries of today. Only one column was used in the Journal and it was not summed. A line was ruled across after the narrative to separate the entries and a diagonal line was ruled through the entry after it was posted to the Ledger as a check on completeness. Posting of journal entries required entry to both the accounts affected (always debit and credit) and dating in the margin. All accounts had to be totalled and closed where appropriate for a trial balance. A profit and loss account was produced by closing invoice and expense accounts and sometimes this was transferred to the capital account.
Although the use of nominal and dual accounts as well as personal accounts is clear in the 'Method of Venice', Pacioli explains that these accounts must be treated as if they were persons. This concept, used as a teaching device by Pacioli, demonstrates what became known as the personalistic theory of accounts and it can be related back to the single-entry system (Kafer, 1966).
Although Pacioli's examination is very detailed, it is incomplete in that it fails to mention many of the good practices that were in use at the time. It neither added anything to the pracice of bookkeeping nor attempted to discuss theory. However, it was very important because it promoted the spread of double-entry bookkeeping around the world by enabling its practice, in the form of the 'Method of Venice', to be better understood and accessible to more people.
THE SPREAD OF DOUBLE-ENTRY TO ENGLAND
Double-entry bookkeeping developed simultaneously in Italian cities such as Florence, Genoa and Venice and yet it was the 'Method of Venice' which became most widely known. Of course, Pacioli was important in this, but other factors also played a part. Firstly, the teachers in Venice were more refined and able to impart their knowledge than those in other cities, and it was in Venice that the first society of accountants was formed, in 1581. This society held a virtual monopoly over accounting. Entry to it required six years' apprenticeship culminating in an oral examination. Before this, the people who did accounting work were writers or mathematicians with an interest in business.
The 'Method of Venice' was also flexible and easily adapted to different situations. Another reason for its dominance was the fact that Venice was a major port and the centre of the book business. Foreign traders could obtain working knowledge of the method in Venice and assist in propagating it by word of mouth and the distribution of books. Pacioli's book was the first on the subject and so it is no wonder that it became so widely known. The books on the subject which came after Pacioli's were essentially copies, translations or very similar in their origin and with a tendency to fit their material to the 'Method of Venice'.
The English became acquainted with double-entry bookkeeping through trade contacts. Italian merchants had been in England since the 12th century and by the 15th century they dominated trade there. These Italian merchants brought with them the bookkeeping system they used at home and it was through them that many English merchants would have become exposed to the double-entry system. English merchants would also have come across double-entry bookkeeping in their visits to ports in Spain or the Netherlands where the system was adopted early in its history.
According to Winjum, bookkeeping in England at this time was "haphazard, scattered and disorganised; memoranda often formed the only basis for a merchant's record of his business activity".
Double-entry was a means of reducing the uncertainty faced by the merchants and the incidence of bankruptcy which was often due to poor bookkeeping.
The 'manorial accounting' system which existed in England before the advent of double-entry was a system of charge and discharge kept open by the stewards of the manor for their own protection. It was open to internal and external audit, but it did not really serve to provide information about profit or capital. Therefore, works in English about the double-entry system were welcomed by merchants and landlords.
Hugh Oldcastle, an English schoolmaster, wrote the first English work on double-entry, A Profitable Treatyce, in 1543. It was basically a translation of Pacioli's De Computis et Scripturis. This was followed by a handfull of other publications, most of which were translations or which plagiarised previous books.
The aim of most of these early English writers on bookkeeping was to teach the double-entry system. Many of their expositions improved on Pacioli's original by including illustrative examples which were often based on actual records. In this way, the literature came to resemble actual practice and filled in some of the gaps left by Pacioli. However, these basic manuals did not include everything.
Readers and students were expected to learn by remembering the rules -- a general rule from debits and credits and specific rules for specific transactions. The books contained these rules to be learnt by rote not reason. The Journal was the centre of attention and teaching was aimed at getting pupils to apply a rule and recite the journal entry required for a transaction, perhaps using practice exercises from an actual or specially prepared Waste-Book similar to Pacioli's Memorandum.
Richard Dafforne outlined 15 'Rules of Aide' in The Merchants Mirrour . . . Below are the first four:
Rules of aide, very requisite in Trade continuance, to be learned without booke.
1. Whatsoever commeth unto us (whether Mony or Wares) For Proper, Factorage, or Company account, the same is ... Debitor. 2. Whosoever Promiseth, the Promiser is ... Debitor.
3. Unto whom we pay (whether with Mony, Wares, Exchanges, Assignations) being for his own account: that man is ... Debitor. 4. Unto whom we pay (as above) for another man's account: The man for whose account we pay is ... Debitor.
1. Whatsoever goeth from us (whether Mony or Wares) Proper, Factorage, or Company account, the same is ... Creditor. 2. Unto whom we Promise, the Promised man is . . . Creditor. 3. Of whom we receive (whether Mony, Wares, Exchanges, Assignations) being for his own account: that man is ... Creditor 4. Of whom we receive (as above) for another man's account: The man for whose account we receive is ... Creditor.
Snell took 11 pages to put forward his 70 rules of bookkeepeing. Obviously memorising so many rules was difficult. Authors attempted to make learning easier by methods of display, verse and classification.
An abbreviated form of rules was translated by Dafforne from Johannes Buingha;
IS DEBTOR
Who the Debitor is, or oweth 1. What we have 2. Whoso receiveth 3. What we buy 4. Unto whom we sell 5. For whom we buy 6. Whoso must pay 7. For whom we pay 8. What we cause to be insured 9. For whom we insure 10. Whither-wards we send 11. That which is gained upon 12. Profit and Losse
IS CREDITOR
Who the Creditor is, or must have 1. Whence it arriveth 2. Whoso giveth out 3. Of whom we buy 4. at which is sold 5. They of whom we buy 6. They that must have 7. Wherewith we pay 8. The Assuror 9. Insurance reckoning 10. What we send away 11. That which is lost 12. Profit and Losse
This may perhaps be summarised by the verse from the beginning of Dafforne's ledger:
In Brief The owner, or the owing thing, Or whatsoever comes to thee: Upon the LEFT hand thou must bring For there the same must placed be. But They unto whom thou dost owe, Upon the RIGHT let them be set: Or whatsoe'er doth from thee go To place them there do not forget.
After 1701 this rote learning peaked, a little later there appeared a work of theory and it wasn't long before more detailed questions of the theory of double-entry were being investigated, even an alternative proposed. Double-entry had arrived in England, its virtue appreciated and written about, it was being taught, and it was widely used. Our bookkeeping system of today was firmly in place.
REFERENCES
1 Brown, R, History of Accounting and Accountants (1986).
2 Burdon H G, Pitman's Full Course in Intermediate Bookkeeping(Melbourne, 1938).
3 Chatfield, M, History of Accounting Thought (New York, 1977).
4 Childs, C W, The Essentials of Bookkeeping for Public Schools (San Francisco, 1901).
5 Eldridge, H J, Evolution of the Science of Bookkeeping (London, 1954).
6 Goodwin, J H, Goodwin's Improved Bookkeeping and Business Manual(New York, 1895).
7 Henderson, S, and G Peirson, Financial Accounting Theory: Its Nature and Development (Melbourne, 1983).
8 Kafer, K, Theory of Accounts in Double-Entry Bookkeeping (Centre for International Education and Research in Accounting, 1966).
9 Littleton, A C, Accounting Evolution to 1900, Second Edition (New York, 1966).
10 Littleton, A C, and B S Yamey, Studies in the History of Accounting (Illinois, 1956).
11 Murray, D, Chapters in the History of Bookkeeping and Accountancy and Commercial Arithmetic (Glasgow, reprinted New York, 1978).
12 Peragallo, E, Origin and Evolution of Double-Entry Bookkeeping (New York, 1938).
13 Reid, C A, Junior Course in Bookkeeping (Melbourne, circa 1952).
14 Snell, C, Rules for Bookkeeping, According to the Italian Manner; Now in General Use (John Place, London 1701).
15 Vickery, B G, Principles and Practice of Bookkeeping and Accounts (London, circa 1923).
16 Winjum, J O, The Role of Accounting in the Economic Development of England 1500-1570, (Centre for International Education and Research in Accounting, 1972).
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