ACCOUNTING: A Brief History By Viscount, Sir Bradwen Cadfannan Master of the Finance Guild & Exchequer of IronWood. MKA: Gerald Hagen Accounting, as we know it, with its double entry accounting system has been around since the late 1400s. It was created by a Franciscan monk, of all people and quickly became one of the best professions in Europe. Accountants took over pretty quickly, within a matter of a few decades as one of the most trustworthy and respectable professions of medieval Europe. Even today, well, before the scandals of 2001 and 2002, accountants were some of the most trusted people in our society. Members of the Big 5 accounting firms (Arthur Anderson, Deloitte & Touche, Ernst & Young, KPMG and Pricewaterhouse Coopers) were members on several award committees who tallied the votes for performers, from the Oscars to the Emmys and they were also responsible for delivering the award announcements to the emcees just before the show. So, briefly, here is a brief history of the great profession of accounting told to you, in part, as a fairy tale rendering…just for humors sake because this paper will get somewhat technical. Without further ado… Once upon a time, Luca Pacioli wrote a math book. It was just a little survey and should have been treated like ordinary books of the time and read and then disappeared into historical archives and forgotten. A few brief chapters on practical mathematics made this one special. The time was 1494. Columbus had discovered America just two years before. The author was Luca Pacioli, a Franciscan monk. The chapter on practical mathematics addressed mathematics in business. He said that the successful merchant needs three things: sufficient cash or credit, an accounting system that can tell him how he’s doing, and good bookkeeper to operate it. His accounting system consisted of journals and ledgers. It rested on the invention of double-entry bookkeeping. Debits were on the left side because that’s what “debit” meant, “the left”. The numbers on the right were named “credits”. If everything was done right, then the bookkeeper could do a trial balance (“summa summarium”). Add up all the debits and then add up all the credits, he said. If everything had been done right, the totals should match. If not, “that would indicate a mistake in your Ledger, which mistake you will have to look for diligently with the industry and intelligence God gave you.” He wrote. Double-entry bookkeeping was so simple and met the needs of business so well that it caught on immediately. Incidentally, here is how the first people became accountants. First of all, you have to remember that in the late 1400s, there were a lot of people in search of jobs to feed their families and/or to take care of their families. Times were different at this time in feudal Italy; a person did not own the land on which he worked. He served a lord or nobleman and lived in a house on that persons land and farmed or cultivated it, that is until the Black Death or the Bubonic Plague reeked havoc and decimated the population of all of Europe. But I digress a little, lets get back to the subject at hand shall we…anyways after the plague there was a mass exodus into the cities, those that were “chained” to the land or nobleman were, somewhat free now to do something else. Eventually, there were some smart people who were looking for work and they were having no luck finding a job. One person happened upon the book written by Luca Pacioli and was greatly intrigued and he thought he and his friends should read it and then offer their services, as “accountants” to businessman and nobles, and even to the monarch and the Church herself – and man were they successful. Eventually they became so successful and so “powerful” they set up centers of learning to teach their trade to successive generations of people. And like any specialized trade, they developed their own lingo and words for their work. The reason behind this jargon was to make the general populace and others feel inferior in matters of finance that they would allow the accountants to do the job, and pay them handsomely. For example, as noted above “debit” and “credit” got their names for the sole purpose of meaning “left” and “right” respectively. If I wanted a job back in medieval Italy or Europe, heck even in today’s society, I just couldn’t tell you “that entry goes on the left and this one goes on the right in the double entry accounting method,” for one, I would be out of a job if everyone understood what I was saying. Second of all, it makes me look important and knowledgeable to others. In 1850 14 accountants offered services to the public in New York City, 4 in Philadelphia, and 1 in Chicago. The British Isles was the superpower of world commerce. Many enterprises and individuals employed the services of public accountants. Citing the needs of courts to employ public accountants “to aid those Courts in their investigation of matters of accounting” select accountants were titled “Chartered Accountants.” The US equivalent title is “Certified Public Accountant”. These titles are used to this day. The arrival of the income tax laws were another major event in accounting history. Attorneys naturally thought that since income tax returns were legal documents, they would have exclusive rights to prepare them. Accountants replied that since that the bulk of the work in preparing a return involved accounting calculations, they were more properly accounting work. The substance of the tasks trumped legal argumentation. US law firms in the 1920’s were slow to incorporate income tax preparations into their business skills. Public accountants saw a new lucrative opportunity and jumped into tax work with both feet. By the time the lawyers challenged the accountants for practicing law without a license, income tax preparation had been so thoroughly identified with accountants that they lost the case. The Great Depression rocked the integrity of the accounting profession. The British Steamship Company was just one of the large world giants that went bankrupt just after posting large profits. “How could profitable companies go bankrupt?” Investors asked. Court cases showed that the economic reality was that the companies weren’t profitable after all. The profits were the result of bookkeeping tricks. Moreover the reserve funds that were on the books were non-existent. So far, these events could be chalked up as individuals' fraud (albeit widespread fraud) and handled through the ordinary course of justice. What made the events historic was when the accountants testified in court that the bookkeeping practices were “generally accepted accounting principles” and then proceeded to prove that they were. This was more serious than just individual malfeasance. If the basic rules of accounting gave false information, then something was wrong with the basic rules of accounting. Worse, followed. Corporate accounting was anything goes. There were no rules, per se. There were just “generally accepted accounting principles”. They were generally accepted because most accountants did certain things. Since accountants were hired by and answered to corporate management, they served the needs of management, not the public. That meant that in practice, the primary function of accounting was to make management look good. Things had to change. While the profession managed to escape the full New Deal government takeover, rules, standards and legal responsibility had to be shouldered. The American Institute of Certified Public Accountants (AICPA) created their own rule-making body, the Committee on Accounting Procedure. They accepted government licensure. Most importantly, auditing financial statements was limited to CPA’s and they were made personally liable for their audit reports. The new Securities and Exchange Commission (SEC) required audit reports for all publicly traded companies. With these measures, accountants contributed to restoring public trust in the stock market and the economy during the depression years. Time passed by. Criticism mounted that the AICPA’s rulemaking was not keeping pace with the needs of the expanding economy. Around 1960 the American Institute of Certified Public Accountants scrapped the Principles Committee and set up the Accounting Principles Board (APB) in 1959. Still the cry for more uniformity and consistency in accounting continued. In 1973 the Financial Accounting Standards Board (FASB) replaced the APB. It brought two major changes over the previous rules-setting bodies. First it was independent of the AICPA. Second, previous procedural impediments to rule making were overhauled. In short, it was geared to crank out rules – lots of rules. In the next several decades, it did. And for those accounting areas where it did not want to go, other bodies were set up. There was the Cost Accounting Standards Board and The Government Accounting Standards Board. In addition to the statements from these Boards, the accountant had to contend with new rules from such sources as Statements of Position, and Accounting and Auditing Guides from the AICPA, and Technical Bulletins and Interpretations from FASB. By the 1990’s the complaint was “standards overload”. Rule making continued apace. Ronald Reagan set an historic precedent in 1982 by killing an accounting board (the Cost Accounting Standards Board). The idea that society has enough accounting rules in an area remains a unique event in the history of accounting. The auditing standards mirrored the accounting standards. Small business was deeply impacted by new auditing requirements. More audit rules meant more audit work and hence more costs to businesses. In the 1980’s the AICPA announced the Statements on Standards for Accounting and Review Services (SSARS). From that moment on, CPA’s provided three levels of accounting services: 1) Compilation, 2) Reviews and 3) Audits. Auditing: The Expectation Gap covers these. Responding to public pressure, they okayed plain paper “management only” statements in 1998. Other countries had their own rule-making activities. As the gray areas in accounting came to be covered by rules the flexibility of accountants to accommodate the differing practices of different countries disappeared. What to do? More rules, of course! The International Accounting Standards Commission promulgated the rules for international accounting. This was set up in Britain just before the turn of the century. Actually, one could arguably ascertain that the accounting profession is one of the least regulated professions in the United States and in the rest of the world. It was only after the accounting fraud at Enron and Arthur Andersen and the intentional “cooking the books” at Worldcom that Congress actually passed the Sarbanes-Oxley Act to reign in the accounting profession. The accounting profession in the United States is, for the most part, self-governed by the FASB, or Financial Accounting Standards Board. They have the authority to make rules and even strip members of their CPA credentials for committing various crimes. The International Accounting Standards Board governs Europe, Asia, parts of South America and Africa and they have the same policing powers mostly. There is a big difference between the FASB and the IASB, the major difference being that the FASB is rules based and the IASB is principles based. This fact alone causes many disagreements between the FASB and the IASB. However, since globalization has occurred there is a greater trend for the FASB to discuss matters with the IASB to hammer out conjoining resolutions on issues, just to have symmetry in all member nations and to prevent “screw-ups” on an international level. Today, the FASB has been more willing to open up to IASB rules and there is even some talk about joining the two together and have the entire world under this one entity. The Sarbanes-Oxley Act single handedly brought direct Congressional oversight to an otherwise fruitful profession. With this act, Congress set up a continuing committee to oversee the accounting profession and set up an independent oversight board with several members, one of which is a CPA, so at least there will be a voice for the accountants in the deliberations. Congress does not fund this independent board; it is paid for by the large firms in the United States, who will be the targets for most of the oversight, such as your accounting firms and other large corporations throughout America. At least the taxpayers won’t have to foot the bill for this committee, with each member being paid about $150,000 per year for a salary. With the corporate scandals directly involving misleading accounting in the early years of the 2000’s, accounting has come back to the days of 1930’s. This time it did not escape direct government oversight. And they are not living happily ever after. HOME ©2005 The Western Condiferation