Double Entry refers to the bookkeeping system which uses a self-balancing set of accounts, where every entry is double-sided, a debit and a credit. Author Jane Gleeson-White subtitled her book, How the Merchants of Venice Created Modern Finance.
The book starts with a speech by Bobby Kennedy decrying the things that Gross National Product does not include, such as the health of our children and the quality of their education. She states that our way of calculating national wealth is profoundly wrong.
My reaction was, what does this have to do with accounting? The author complains that financial statements are ‘arbitrary and illusory.’ I was left wondering what planet she inhabits. After this inauspicious beginning, the book gets much better.
The middle part of the book, and the bulk of the book, provide the history of bookkeeping and accounting, the impact on capitalism, and make for a fascinating read. Really, it is wonderful.
It is speculated that writing started with accounting. That is, traders made indentations in soft clay to create a record of a transaction. These bits of small clay dried and hardened and are still found today. They are the equivalent of notes on scraps of paper.
In about 1200, Leonardo da Pisa brough the Arabic system of numbers to Italy from Barbary, now Algeria. It used nine symbols plus the 0 sign to write any number. This allowed arithmetic to be done, which couldn’t be done with Roman numerals. Leonardo da Pisa wrote several books on the advantages of this new system. We know him now by the name Fibonacci.
There is some evidence that double-entry bookkeeping was used in ancient Asia and/or India, perhaps for thousands of years. By the 14th Century, there were business empires that stretched for thousands of miles. Venice was at the crossroads of trade and the merchants there used a sophisticated bookkeeping system for about 200 years before anyone bothered to write a textbook about it. When Luca Pacioli wrote the first written treatise on The Venetian method of bookkeeping, he also advocated for the use of Arabic numbers.
Pacioli’s achievements reflect the coming together of several key factors which together altered the world: printing, the popularization of Hindu-Arabic numerals and the rise of mercantile capitalism. Pacioli’s double-entry bookkeeping treatise was published in his mathematical encyclopedia in Venice in 1494, forty years after the invention of movable type in Europe. More than 500 years later, Pacioli’s bookkeeping method is still in use throughout the world.
The double-entry system that Pacioli lays out allows a businessman to always know how well his business is running. In this time, merchants dealt with a great variety of goods. Some trading was by barter and some for currency. Almost every large city had its own currency, so foreign exchange was also important.
Pacioli starts by instructing one to take a careful inventory of everything owned. Then every transaction is recorded in one or more of the three ledgers. All entries include a debit and a credit, the double-entry system. Debit comes from the Latin debere, to owe. Credit is from the Latin credere, to believe. (This is why, to this day, debit is abbreviated Dr, despite there being no r in Debit.) By laying out the Venetian system of double-entry bookkeeping for the first time in writing and using the latest communication technology—the printed book—Pacioli was made justly famous.
The first large industrial scale test of double entry was the pottery works of Josiah Wedgwood in England. Wedgewood’s vases were so popular that there was a ‘violent madness’ in 1769 that almost overwhelmed the company’s ability to keep up with demand. In 1772, Wedgewood switched to double-entry bookkeeping to aid management decision making. Wedgewood found that the firm’s pricing was haphazard, and the production runs too short to be economical. The firm also had cash flow problems from not collecting receivables fast enough. (Some things never change.)
Wedgewood also discovered the importance of and distinction between fixed and variable costs and understood the implications of cost behaviors in management of his business. Wedgewood had discovered the commercial benefits of mass production and economies of scale. The field that Josiah Wedgewood was dabbling in is now called cost accounting or management accounting.
As a result of his discoveries, Wedgewood made a fortune, rigorously managing the pottery works. He made enough money to fund his grandson Charles Darwin’s famous voyage on the Beagle. The Wedgewood pottery works is still in business today.
Next came the application of double entry to the railroads. In this case, the challenge was in the vast amounts of capital required for an enterprise to build the infrastructure for a new railroad system. By 1850, the largest railway company in England employed 15,000 people. Joint stock companies allowed the raising of sufficient capital by selling stock and paying dividends.
But the joint stock companies brought fraud, and this brought regulation. Included in this regulation was the requirement for audits of the financial statements of these public companies. This brought work to the accounting profession as did the subsequent bankruptcy act.
Increased regulation served to define the new profession of accounting. Challenges, such as the concept of depreciation to deal with the declining values of assets through wear, were dealt with using the double entry system.
By the end of the 19th century, double-entry bookkeeping wasn’t called the Italian-system any longer, had gone global and had become a profession. The Industrial Revolution and the advent of the joint stock company transformed the double entry system. Double entry was able to adapt to the new demands placed upon it by increased size and complexity of business.
Audits became annual and more formal in format. Auditing had a long history in England, dating back to 1311. Records were to be ‘heard’ because few people could read. (Audit is Latin for ‘to hear.’)
In time, professional societies of accountants were formed, the first in Scotland in 1854. They petitioned the Queen for a charter, thus the start of Chartered Accountants. The trend soon moved to England and to Europe.
In America, the first incorporation law in 1778, unleased an enthusiasm for joint stock companies. With resources, entrepreneurial spirit and the large domestic market, America’s economy took off and has never really abated. During the 19th century, America overtook Europe as the world’s largest economy. John D. Rockefeller, one of the titans of this period, started out as a bookkeeper. He attributed his success to his mastery of double entry bookkeeping, especially cost accounting.
The British approach to accounting was the attitude that accounting was an art. America’s approach was that it was more of a science. (I think it is both.) The first CPA licenses were granted in the U.S. in 1896. Accounting became a college degree program in the early 1900s.
Historians have held that capitalism isn’t possible without double-entry bookkeeping. Previously, wealth was a vague increase in possessions. Pacioli’s system made the calculation of profit mathematical and open to empirical test.
The word capitalism was coined about 1900, but the practice as we understand it had existed for a long time. One of the first to use the term capitalism was Karl Marx. Marx, oddly, had a fascination with double-entry bookkeeping; he considered bookkeeping to be ‘the control and ideal synthesis’ of the production process. But where did Marx learn about double-entry?
His collaborator and editor, Friedrich Engels, taught him. While Marx’s published works mostly lamented the two classes—owners and workers—and how one subjected the other, correspondence between Marx and Engels shows how Engels instructed Marx on the particulars of double-entry.
And how did Engels know about double-entry bookkeeping, so that he might inform this father of socialism? Engels’s family owned a cotton mill in Manchester, England, the center of Britain’s textile industry. Engels worked as a clerk in the mill for 20 years. He found the work repugnant, but carried on, mostly to support Marx and his family during their long years in the British Library in London, researching Das Kapital.
Ironic then, that the socialist revolutionary was supported by a British factory practicing capitalism. And that his main thesis was that capitalism was exploitation of the workers! Thus, British factories directly funded two of the great revolutionary thinkers of the 19th century: Charles Darwin through his grandfather Josiah Wedgwood’s pottery works and Karl Marx through the Engels’ cotton mills.
After this wonderful history of double entry and the impact that bookkeeping had on the rise of capitalism, the author takes a wrong turn in my view. She gets into the Great Depression and the creation of national measures of economies, such as Gross National Product and Gross Domestic Product. The author’s belief is that these national measures of the size of an economy use the double entry system of accounting. I’m not buying it.
For example, John Maynard Keynes’s equation is that Real Income = Consumption + Investment. Being an equation, the two sides must be equal. Thus, the use of double entry for the measurement of national economies, or so claims the author. But one can add anything they want to the right side of this equation and Real Income simply goes up. This is not double entry.
The author then goes on to complain about the era of accounting scandals and audit failures, most notably Enron, but has no examples within the last fifteen years.
The final part of the book deals with the lack of accounting for the cost of environmental damage and how accounting is the last hope for saving the world. All this seems misguided and coming from the world of an academic.
In conclusion, I recommend the first seven chapters to you and don’t recommend the last three.
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