Accounting History and Terminology

Reviewed by Michael J BoyleReviewed by Michael J Boyle

What Are the Origins of Accounting?

Accounting is more than just the act of keeping a list of debits and credits. It’s the language of business and, by extension, of all things financial. Our senses collect information from our surroundings that our brains then interpret. Accountants translate the complexities of finance into information that the public can understand.

Key Takeaways

• Bookkeepers came to be when societies used the barter system and needed to record the agreements they were making regarding goods or services transactions.
• Accounting ledgers were later completed by hand. They used either a single- or double-entry system.
• Luca Pacioli, a monk, laid the groundwork for modern accounting by creating an independent record that provided a clearer picture of an entity’s financial activities: the financial statement.
• Railroads and the emergence of corporations were the stimulus for the establishment of accounting professionals.

History of Accounting

Accounting is a language that dates back thousands of years and has been used in many parts of the world. The earliest evidence of this language comes from Mesopotamian civilizations more than 7,000 years ago.

The Mesopotamians kept the earliest records of goods traded and received and these activities are related to the early record-keeping of the ancient Egyptians and Babylonians. The Mesopotamians used primitive accounting methods, keeping records that detailed transactions involving animals, livestock, and crops.

Philosopher and economist Chanakya wrote “Arthashastra” in India during the Mauryan Empire around the second century B.C. The book contained advice and details on how to maintain record books for accounts.

The Bookkeepers

Bookkeepers most likely emerged when society was still using the barter system to trade rather than a cash-and-commerce economy before 2000 B.C. Ledgers from these times read like narratives with dates and descriptions of trades made or terms for services rendered.

These ledger entries may have looked like this:

• Monday, May 12: In exchange for three chickens, which I provided today, William Smallwood (laborer) promised a satchel of seed when the harvest is completed in the fall.
• Wednesday, May 14: Samuel Thomson (craftsman) agreed to make one chest of drawers in exchange for a year’s worth of eggs. The eggs are to be delivered daily when the chest is finished.

All these transactions were kept in individual ledgers. They provided proof when matters were brought before magistrates if a dispute arose. This system of detailing every agreement might have been tiresome but it was ideal because long periods could pass before transactions were completed.

New and Improved Ledgers

Bookkeeping evolved as currencies became available and tradesmen and merchants began to build material wealth. Business sense and ability with numbers were not always found in one person so math-phobic merchants would employ bookkeepers to maintain a record of what they owed and who owed debts to them.

Until the late 1400s, this information was arranged in a narrative style with all the numbers in a single column whether an amount was paid or owed. This is “single-entry” bookkeeping.

You can see in this sample of a bookkeeper’s single-entry system how the entries are laid out with a date, a description, and whether it was owed or received by the symbols in the amount column.

The bookkeeper had to read the description of each entry to decide whether to deduct or add the amount when calculating something as simple as monthly profit or loss. This was a time-consuming and inefficient tallying method.

The Mathematical Monk

Italian monk Luca Pacioli revamped the common bookkeeping structure as part of the tradition of learned monks conducting high-level scientific and philosophical research in the 15th century. Pacioli laid the groundwork for modern accounting. Commonly known as “the father of accounting,” he published a textbook called “Summa de Arithmetica, Geometria, Proportioni et Proportionalita” in 1494. It showed the benefits of a double-entry system for bookkeeping.

The idea was to list an entity’s resources separately from any claims on those resources by other entities. This meant creating a balance sheet with separate debits and credits. The innovation made bookkeeping more efficient and provided a clearer picture of a company’s overall strength but this record was only for the owner who hired the bookkeeper. The general public had no access to such records, at least not yet.

This is what the double-entry system may have looked like back in the day. You can see the two separate columns for debits and credits along with the description of each transaction and how it was paid: in cash or commodities. It was chickens, seeds, eggs, and furniture in this case.

Coming to America

Bookkeeping migrated to America with European colonization. It was sometimes referred to as accounting but 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 financial health of their companies. Business owners didn’t need professional accountants to create complex financial statements or cost-benefit analyses.

The American Railroad

The appearance of corporations in the United States and the creation of the railroad were the catalysts that transformed bookkeeping into the practice of accounting based on accounting postulates. The railroad was by far the most powerful of the two factors.

Distribution networks, shipping schedules, fare collection, competitive rates, and some way to evaluate whether all of this is being done in the most efficient way possible are all necessary for goods and people to reach their destinations. 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 railroads also allowed information to be passed from city to city at great speed. Business transactions could be settled in days rather than months. Timing was uneven across the country before the railroad. Each township previously decided when the day began and ended by general consensus. This was changed to a uniform system in 1883 because it was necessary to have goods delivered and unloaded at certain stations at predictable times.

Important

The shrinking of the country thanks to the railroads and the introduction of uniformity encouraged investment that in turn put more focus on accounting.

Investing had been a game of either knowledge or luck up until the 1800s. People acquired issues of stock in companies with which they were familiar through industry knowledge or acquaintanceships with the owners. Others blindly invested according to the encouragement of relatives and friends.

There were no financials to check if you wanted to invest in a corporation or business. The risks involved therefore ensured that investing was only for the wealthy, a rich man’s sport tantamount to gambling.

Early Financial Statements

Corporations began to publish their financials in the form of balance sheets, income statements, and cash flow statements to attract investors. These documents were proof of a company’s profit-making abilities.

Investment capital stimulated operations and profits for most corporations but it also increased the pressure on management to please their new bosses: the shareholders. These shareholders didn’t completely trust management and this exposed the need for independent financial reviews of a company’s operations.

Birth of a Profession

Accountants were already essential for attracting investors and they quickly became essential for maintaining investor confidence. The American Association of Public Accountants (AAPA) was established in 1887 and the accounting profession was formally recognized in 1896 with the establishment of the professional title of certified public accountant (CPA).

How Has Modern Accounting Evolved?

Technology has changed accounting. Bookkeeping has become automated. Bookkeepers have used several tools since the first records were kept in America. William Seward Burroughs’ adding machine was created in 1887 and perfected for commercial sale in the 1890s. It helped early accountants calculate receipts and quickly reconcile their books.

IBM’s first large computer was based on the vacuum tube when it was first released in 1952. It was small enough to make it possible for businesses to buy them and this led to accountants being among the first to use them. Transistors were replacing the tubes and making computers even more accessible by 1959. They were being supplanted by microchips as early as 1961, which eventually led to computers for everyone.

What Is the Double-Entry System for Bookkeeping?

Double-entry bookkeeping requires dual account entries. An opposite entry must be made into one account for every entry in another account. The ideal end result is that the company’s books will achieve balance.

What Are the Requirements to Become a CPA?

The CPA title is awarded to those who pass state examinations and have one or more years of experience in the field. The number of years can vary by state.

The creation of professional accountants came at an opportune time. The demand for CPAs skyrocketed as the U.S. government found itself in need of money to fight a war and began charging income tax in 1913.

How Does a Barter System Work?

The barter system predates money and currencies but it’s still used in modern times. It’s the exchange of goods and/or services between two parties. Goods and/or services are acquired by trade.

The Bottom Line

The concept of accounting has been around in one form or another for centuries. Initially designed to record trades made in barter systems, the practice has evolved over generations thanks to contributions made by second-century B.C. economist Chanakya, Luca Pacioli, and the Mesopotamians.

Technology has brought about the advent of accounting software such as QuickBooks. These advancements are much more intuitive, helping accountants do their job more quickly, more accurately, and with more ease.

Read the original article on Investopedia.