Accounting is the language of business and, by extension, the language of all things financial. In the same way that our senses are needed to translate information about our surroundings into something understood by our brains, accountants are needed to translate the complexities of finance into summary numbers that the public can understand. In this article, we will follow accounting from its roots in ancient times to the modern profession that we now depend on.
Bookkeepers most likely emerged while society was still in the barter and trade system (pre-2000 B.C.) rather than a cash and commerce economy. Ledgers from these times read like narratives with dates and descriptions of trades made or terms for services rendered.
|Example - Barter and Trade Bookkeeping
All of these transactions were kept in individual ledgers, and if a dispute arose, they provided proof when matters were brought before magistrates. Although tiresome, this system of detailing every agreement was ideal because long periods of time could pass before transactions were completed.
The New and Improved Ledger - Now With Numbers!
As currencies became available and tradesmen and merchants began to build material wealth, bookkeeping also evolved. Then, as now, business sense and ability with numbers were not always found in one person, so math-phobic merchants would employ bookkeepers to keep a record of what they owed and who owed them. Up until the late 1400s, this information was still arranged in a narrative style with all the numbers in a single column whether an amount paid, owed or otherwise. This is called single-entry bookkeeping and is similar to what many of us do to keep track of our checkbooks.
|Example - Single-Entry Bookkeeping
It was necessary for the bookkeeper to read the description of each entry to decide whether to deduct or add it when calculating something as simple as monthly profit or loss. This was a very time consuming and inefficient way to go about tallying things. (To learn all about the history of money through the ages, see From Barter To Bank Notes.)
The Mathematical Monk
Continuing in the tradition of monks doing high-level scientific and philosophical research, in the 15th century, Italian monk Luca Pacioli revamped the common bookkeeping structure and laid the groundwork for modern accounting. Pacioli published a textbook in 1494 that showed the benefits of a double-entry system for bookkeeping. The idea was to list an entity's resources separately from any claims upon those resources by other entities. In the simplest form, this meant creating a balance sheet with debits and credits separated. This innovation made bookkeeping more efficient and provided a clearer picture of a company's overall strength. This picture, however, was for the owner who hired the bookkeeper only. The general public didn't get to see these records, at least not yet.
|Example - Basic Double-Entry Bookkeeping
Coming to America
Bookkeeping migrated to America with the European colonization. Although it was sometimes referred to as accounting, bookkeepers were still doing basic data entry and calculations for business owners. The businesses in question were small enough that the owners were personally involved and aware of the health of their companies. They didn't need accountants to create complex financial statements or cost-benefit analysis. (For more on the history of American finance, check out Financial Capitalism Opens Doors To Personal Fortune.)
The American Railroad
The appearance of corporations in the U.S. and the creation of the railroad were the catalysts that transformed bookkeeping into the practice of accounting. Of the two factors, the railroad was by far the most powerful. To get goods and people to their destinations, you need distribution networks, shipping schedules, fare collection, competitive rates and some way to evaluate whether all this is being done in the most efficient way possible. Enter accounting with its cost estimates, financial statements, operating ratios, production reports and a multitude of other metrics to give businesses the data they needed to make informed decisions.
The railroad also shrank the country. Business transactions could be settled in a matter of days rather than months, and information could be passed from city to city at a much greater speed. Even time did not run evenly across the country before the railroad. Previously, each township decided when the day began and ended by a general consensus. This was changed to a uniform system because it was necessary to have goods delivered and unloaded at certain stations at predictable times.
This shrinking of the country and introduction of uniformity encouraged investment, which, in turn, put more focus on accounting. Up to the 1800s, investing had been either a game of knowledge or one of luck. People acquired issues of stock in companies with which they were familiar, either by knowing the industry or knowing the owners, or they blindly invested where their relatives and friends encouraged them to. There were no financials to check if you wanted to invest in a corporation or business that you knew nothing about. The risk of this type of investing made it an activity for the wealthy - a rich man's sport with the taint of gambling. This image has never completely faded. (To learn about the early days of investing, see How The Wild West Markets Were Tamed and The Birth Of Stock Exchanges.)
The First Financials
Corporations, eager to attract more capital to expand their operations, began to publish their financials in the form of a balance sheet, income statement and cash flow statement. (To learn how to analyze each of these, see Reading The Balance Sheet, Understanding The Income Statement and Analyze Cash Flow The Easy Way.)
Investment capital from sources outside the company became more important than that provided by the individual owners who had pioneered business. Although bringing in this investment capital increased the range of operations and profits for most corporations, it also increased the pressure on the management to please their new bosses - the shareholders. For their part, the shareholders were unable to completely trust the management, so the need for independent financial review of a company's operations became apparent. (For reading on the flow of corporate information, see Show And Tell: The Importance Of Transparency.)
The Birth of a Profession
Accountants were already essential for attracting investors, and they quickly became essential for maintaining investor confidence. The profession of accounting was recognized in 1896 with a law stating that the title of certified public accountant (CPA) would only be given to people who had passed state examinations and had three years of experience in the field. The creation of professional accountants came at an opportune time. Less than 20 years later, the demand for CPAs would skyrocket as the U.S. government, in need of money to fight a war, started charging income tax.
To continue reading about the history of taxation, see Paying Uncle Sam: From Tobacco To $1 Trillion.