The author shows that accountancy 1 has constantly changed to meet the requirements of society and indicates that further development is now called for to meet the special requirements of the developing countries. A later article will deal with the nature of the change that the author believes should now be taking place.

Abstract

The author shows that accountancy 1 has constantly changed to meet the requirements of society and indicates that further development is now called for to meet the special requirements of the developing countries. A later article will deal with the nature of the change that the author believes should now be taking place.

Adolf J.H. Enthoven

SOME RECORDING of economic transactions—the basis of accounting—was undertaken in ancient Babylonia and Egypt. In Greece and even more in Rome the keeping of accounts for private and public purposes was well developed, although neither Greeks nor Romans discovered the principles of double entry bookkeeping, which did not come into being until it was called for by wider commercial and governmental activities. In Italy the principle of double entry can be traced back to the fourteenth century, but it was not until 1494 that Paciolo actually set forth this method in the form of a system. Double entry bookkeeping may accordingly be considered as the form of accounting brought into being by the commerce that developed in the later Middle Ages and which reached its full fruition in the Renaissance.

The idea of productive capital—the idea that commerce must be profitable in order to create additional capital for further re-employment—forms the basis of a bookkeeping system. Until the end of the Middle Ages, the idea of productive capital did not exist; it developed only with the emergence of extensive commerce, and later, of large-scale industry. Trade creates capital, and capital seeks employment, thus expanding again the productive cycle of trade. The city states of Italy in the period after 1200 gave a spurt to the effective use of capital.

There was of course capital in the sense of wealth in the traditional world, but to serve as an effective feeder of production, wealth has to be productive. The wealth of older civilizations, instead of being active in the form of ships or equipment, was stagnant in the form of palaces, pyramids, and so on. Money also became more and more a medium of exchange, and bookkeeping is of course based on a money economy; barter trade does not call for an extensive bookkeeping system.

The Double Entry System

The double entry system was, until the sixteenth century, confined to Italy, but with the expansion of trade it gradually spread throughout Europe. For centuries thereafter there was little change in the type of commercial enterprise, and the double entry system underwent no fundamental change, although it demonstrated some interesting technical development.

The system of double entry bookkeeping rests on two principles, one the form of the account and the other—of greater importance—the equilibrium of the complete set of accounts. Historically, it was devoid of any theoretical discussion and norms, being almost purely descriptive and based upon rules for resolving transactions.

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The Illustrated London News

Citation: Finance & Development 0006, 002; 10.5089/9781616352943.022.A003

A calculating machine shown at the 1855 Paris Exhibition. “The nineteenth century saw a move from bookkeeping to accounting—a move away from the relatively simple recording and analysis of transactions.”

The first double entry book to appear was the ledger, which was a logical outcome of the debtor and creditor relationship of medieval commerce. The increasing amount of trade gave rise in time to the inclusion of assets, liabilities, income, and expense. The journal entry, the posting medium for the ledger, was developed much later.

In the Netherlands, during the period of Prince Maurits and Oldenbarneveldt, at the end of the sixteenth century, the double entry system reached its highest point of development. As the financial administration of real estate and the army became unsatisfactory, the Prince requested Stevin to look into the Italian system. Stevin was not content to examine the system; he went much further and provided a general theory of the principles of debit and credit transactions. He recognized the distinction between the capital of an enterprise and that of the owner, i.e., commercial capital and private capital. Stevin’s work not only played an important part in the development of accountancy and public administration in the Netherlands but influenced writers abroad.

Banking and Taxation

There were of course other factors that contributed to the development of accounting, influencing its course and adding to its importance. Loans to commerce and governments led to the beginning of investment banking, and the great merchant houses added commercial banking to their operations. The bankers belonged to a guild, and its members were required to keep records for inspection by guild agents. Governments also gradually required the maintenance of records for revenue purposes. The Italian cities levied a tax on property and the Medici drew up statements for that purpose. In Germany—in the cities of the Hanseatic League—the municipal law also required statements from proprietors for tax purposes; these statements had to be sworn before a commission. Such growths and diversifications were challenges that provoked accountants to respond to them.

Proprietorship Bookkeeping

The early records of medieval commerce were merely agency bookkeeping, to enable an agent or partner to report upon his activities. Gradually the proprietorship aspects entered into the economic operations, and a new form of bookkeeping—proprietorship bookkeeping—developed. Agency bookkeeping moved into proprietor bookkeeping, and only when bookkeeping started to serve the enterprise as a unit were the full potentials of bookkeeping—and gradually those of accounting—achieved.

In the nineteenth century, with the emergence of extensive industrial operations, further complications occurred, bringing with them still other new requirements. There was a need, for example, to keep cost records, and with these emerged a requirement for professionals to audit them. As funds for investment became larger and the need to protect creditors and shareholders became more widespread, they gave support to the development of a professional accounting body.

Transformation: Bookkeeping Becomes Accounting

The nineteenth century saw a move from bookkeeping to accounting—a move away from the relatively simple recording and analysis of transactions toward a comprehensive system. The active employment of capital gave rise to such record keeping. Bookkeeping, or even accounting, became the process of recording and classifying financial data in a systematic manner for showing the effect of changes in wealth. The purpose of nineteenth century bookkeeping had been the portrayal of visible profits by means of comparing financial statement balances at the beginning and end of transactions. In twentieth century accountancy we still attach prime value to this concept, but our approach has been changed. Profit calculation is no longer a simple comparison of financial values at the beginning and end of a transaction or series of transactions, or based upon the price obtained and the price paid for a commodity; it relates to a complex set of allocations and valuations pertaining to the operational activities of the company, and the maintaining of the real capital of the company. Nowadays the concept of accountancy might be so far extended as to qualify for the description of the recording, processing, classifying, evaluation, interpretation, and supplying of eco-financial information for statement presentation and decision making purposes. Bookkeeping may now be regarded as merely the outward expression of accountancy’s inward purpose.

It was actually the industrial revolution—with its complex industry and commerce—which brought about the move toward the development of accountancy that constitutes the basis of our present methodology.

The transformation of bookkeeping into accounting was also largely influenced by the corporation and the corporate structure. The corporation, with its outside interests, required, largely for distribution purposes, a correctly managed split between capital and income. Principles guiding the calculation of income gradually had to be developed. Depreciation accounting became a vital component, although this was not developed until fixed capital constituted a sizable part of the entity; up to that time depreciation was treated as connected to the variation in inventory. The growth and complexity of the corporation with its limited liability changed these concepts.

The contribution of the corporation and the corporate structure toward accounting theory was based upon (1) limited liability, (2) the obligation to maintain the capital or productive power intact, and (3) to give investors an insight into the results of operations. To serve these purposes financial statements had to be clear and comprehensive.

The corporation also influenced accounting by the need for outside control of auditing, and the amount of profit available for distribution became a central issue for accountants. This gave rise to the proper distinction between capital and income, and the related problem of valuation. Thus while corporations, with their absentee ownership, stimulated the growth of business, they created many problems of recording and of preparing financial statements, and in this way again challenged accountancy and stimulated its growth and development.

Practice and Theory

For centuries after the system of double entry bookkeeping appeared, accounting was devoid of methodology or any form of theory. It was not until the nineteenth century that a theoretical framework began to develop. This framework or methodology consisted of the technical means to measure, value, and communicate information of an eco-financial nature.

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A calculating machine mechanism from the eighteenth century. The photographs are from the Smithsonian Institution, Washington, D.C.

Accountancy “theory,” resulting from bookkeeping, has been created from experience; it is essentially descriptive and has a utilitarian bias. Historically, in fact, the accounting data were used to give an insight into the historical activities of a business enterprise, and accountancy was thus retrospectively and inductively—and is still practically—oriented to the recording and verification of microeconomic enterprise information.

While it may be said that technically and methodologically accountancy has been successful, it has not yet completed—and in most countries hardly begun—the development of a comprehensive theory, with a secure intellectual relationship to the economic environment in which it operates. We are still searching for such a theoretical foundation, and its scope and objective in society. In the nineteenth century the function of accountancy was the relatively simple one of recording and summarizing the impact of prior transactions, and conservatism was the guideline. The essence was to record in order to report, to audit in order to trust, and to analyze in order to understand. The concept of accountability—of the verification of past transactions—constituted a vital aspect of accountancy.

Even within the field of Littleton’s definition, however, there has been some development in recent decades. For several generations the balance sheet, which is essentially an historical document, was considered to be of superior importance, but during the last 40 years it has been realized that the earnings and the information on revenue and expense that pertain to performance over a period of time are of greater significance in evaluating a company and comparing operations.

An important development in the history of accountancy has been the comparatively recent emergence of the need to prepare cost calculations based upon industrial production techniques, which brought into being in the early part of the twentieth century a new branch of the profession—cost, or management accountancy.

The Development of Cost Accounting

Although cost accountancy as it has been developed today is new, it has deep roots. Its origins may in all probability be traced to Florence, Italy, which since the twelfth century has been famous for silk and wool industries. International banking, as has been mentioned, began as an adjunct to these industries for trading in Europe. Industries were incorporated into separate guilds in Florence, and each guild guarded its own secrets. The Florentine bookkeeping system had to adapt itself to the guild system, and separate cost records had to be maintained of each manufacturing process, as much work was channeled out to home workers or to other establishments. By the fourteenth century, handling of these segregated costs resulted in a crude kind of industrial or cost bookkeeping, although only prime costs were set forth. Gradually two sets of records developed, one dealing with the mercantile aspects, the other with the processing phase of the business. The merchants of Italy also made a crude beginning to use cost records as a tool of management control.

For many generations, however, business was largely commercial rather than industrial, and the need for cost accounting was minimal; cost accounting could not reach a condition of mature development until this was called for by the factory system of production.

Indeed the real impetus and development of cost accounting only came in the twentieth century. With industrial production, the pricing of goods by constituent parts became essential. The use of machinery and power established the need to allocate various costs and determine the profit by production item; the cost problem basically was a problem of pricing and profit measurement. Fixed property accounting and depreciation policies were a later development, as the need to charge the products for the decline in value of the fixed assets became apparent. In spite of its roots in Renaissance Italy, it may well be that we cannot speak accurately of cost accounting before 1900; in earlier periods there was only a combination of factory bookkeeping and cost record keeping.

When it did develop in the twentieth century, cost accounting offered radically new insights into the nature of industrial developments and the commercial transactions associated with them. It was an achievement equal in stature to the development of double entry bookkeeping itself, meeting the needs of business in an age of highly developed industry and thereby enabling accountancy to continue to contribute powerfully to the formation of a new phase of modern civilization. Cost accounting above all gave bookkeeping the spurt to make it more useful for decisionmaking and managerial purposes. The development from bookkeeping to accountancy is largely attributed to the development of industrial techniques and financial requirements. Like double entry bookkeeping before it, cost accounting was a powerful response to an important change in the environment and to the growing needs of industrialization.

Refinements in cost or management accounting came later in this century with mass production techniques and high capital investments. A need arose to allocate costs correctly over the units of production, and also as a measure of productivity and efficiency. While in the past an expense had been considered a loss, the idea became more prevalent that it was an acquired service with various outputs. The old idea that anything spent (expense) was a cost gradually gave place to the concept that cost should refer to economically unavoidable services rendered or materials absorbed.

Another major development took place during the twentieth century—especially in the United States—with the need to adapt cost accounting to the recognized managerial requirements of mass production, pricing, and costing for competitive purposes and the setting forth of operational information for decisionmaking purposes. Standard costings are also of recent development.

The Development of Auditing

Auditing, meaning the examination of financial records with the aim of passing a judgment on the figures presented, became a profession and a separate discipline in England only in the middle of the nineteenth century, although its origins are much older; since to audit means literally “to hear,” it clearly dates from a time when reading and writing were rare accomplishments. Originally auditing was designed as a check upon the honesty of persons charged with financial responsibilities, both in the private and governmental section; the question of fiscal responsibility played an important role in its development. Gradually auditing started to emphasize the scrutiny of records and the verification of the underlying statements or evidence.

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Detail of a counting table from a Darius vase in the Museo Nazionale, Naples, Italy.

The development of auditing in Britain laid stress upon the stewardship function, and the Government’s interest in the reduction of fraud; the British Companies Act of 1862 was intended to protect investors against fraudulent practices. The protection of the investing public from fraudulent company practices in Britain was at the core of the development, although gradually the requirement of expanding commerce and industry, and the need for credit facilities from companies, were added to this original need.

By stating that capital must be separated from profits, and that companies’ books must be audited regularly, the Companies Act gave official recognition to the profession of accountancy. In the United States the profession dates back to 1896, although its real growth occurred during World War I and subsequent decades with the passing of the securities acts and the regulations of the Securities and Exchange Commission. Thus, historically, the distinguished professional bodies founded during the nineteenth century in the United Kingdom, the United States, and other highly industrialized countries have been oriented to the auditing requirements.

Government Accounting

When we turn to public funds we find that the concept of accountability dates back to the Nile Kingdoms and to classical antiquity; no public official in Greece was exempt from “public audits.” Before and during the Middle Ages we find that local officials, or servants, had to render account for receipts and expenditures to their master, the king, or to the royal auditors.

The ruin of the royal finances and chaotic state of accounts in France in the eighteenth century was one of the main causes of the French Revolution, which proclaimed the doctrine of popular sovereignty over public finance, so that no tax could be levied without the assent of the nation. Control over expenditure, however, came much later than control over taxation. The separation of governmental lawmaking and executive power, during the period of de Montesquieu, upset the existing accountability system, and the executive had to request and render account to the legislature.

A high degree of accountability also existed in Great Britain; the long historical struggle in Britain for parliamentary control of funds was of course in large part a struggle for control of taxation, although a comprehensive financial statement was not established and accountability of public funds was not rigorously required until the end of the eighteenth century. Beginning about 1840, the budget became more than a statement of accounts; it became a “public balance sheet,” and started to reflect the Government’s program.

Since 1789 the Secretary of the Treasury of the United States was required to prepare and report upon estimates of public revenue and expenditures. The budget gradually became the mechanism whereby the President set forth his program to Congress and resulted in an effective means whereby the President could be held responsible. The U.S. Budget and Accountancy Act of 1921 became the basis for responsible and responsive government, and budget execution became as significant as budget formulation.

In Japan, a budget was introduced in 1889, and government budgeting in the country had a major influence upon economic development. In very few other developing countries—with the exception of India and Pakistan—did effective budgets exist prior to World War II, and generally we find that the government budget is not adequately visualized as a major instrument in planning. Inadequate and cumbersome government accounting and budgeting systems often prevail in developing countries to serve the narrow vision of accountability and accountancy.

While originally government accounting was linked to taxation and revenue control, and subsequently to the recording of, and accountability for, receipts and expenditures, development of budgeting and budgets gave a much larger scope to the area of government accounting. The budget became a managerial and policymaking instrument and developed into forward planning of receipts and expenditures. Budgeting nowadays has developed in such a manner that it forms one of the bases of, and is closely associated with, economic programing.

Social Accounting

The development of enterprise accounting toward social or national accounting is largely a development of the last decade. For purposes of economic policy and economic planning these national data—to a large extent derived from commercial data—became of great importance; they have given rise to a new concept of social or economic accounting which has presented the professional with a new sphere of operations and perspective. Social accounting—as it may be called—has particular importance in helping to build the bridge between economics and accountancy, and thus in offering accounting scope to make a contribution toward macroeconomic policy.

Lessons of History

Accountancy, then, has already gone through many phases: double entry bookkeeping, proprietorship accounting, auditing, and government and cost and management accounting; it has most recently moved towards social accounting. These phases have all been largely a product of their economic and social environment—accountancy has continuously adapted itself to the changing requirements of society. The history of commerce, industry, and government has itself reflected to a large degree the history of accountancy.

For the developing nations, this historical progress is of great significance. Although an understanding of bookkeeping and basic accounting is of course necessary in developing countries, their greatest and most typical need tends to be for cost accounting and the presentation of statements for planning purposes and decisionmaking instead of, for example, auditing. Sophisticated exercises in financial accounting are of little use in developing countries. The economic development process is in need of effective cost-benefit measurements for project and program evaluation, operating measurement, internal organization, pricing, and other management and economic policies. In addition to this cost, management, or project accountancy, government accounting, and accounting for public enterprises are probably even more characteristically important for developing countries than for the highly developed.

What is most important, however, is to realize that accounting, if it wants to serve as a valuable instrument for society, should not follow its own independent course of action, but must continue to gear itself to the objectives of its economic environment. The historical record in this connection is encouraging, and that is why it is recounted here. For some encouragement is needed. Although accounting, generally, has grown with the needs of its surroundings, at times it has appeared to be out of touch with them—moments when it has felt the challenge but has not yet responded to it. It is possible—it is even likely—that this is such a moment, and that the needs of the developing countries, and the dynamic process of economic growth and development, represent the new challenge to the scope and function of accountancy.

To serve the objectives of the economic (development) process more effectively, we might well have to adhere to a new form of accountancy, i.e., “economic development accountancy.” We accountants must not assume that what might have been good for the developed countries will be automatically good for the emerging nations. Some of the presently prevailing rules and principles in the developed nations actually might not be conducive to economic development. The socioeconomic circumstances in the developing nations are more complex, and their requirements tend to be of a different magnitude; as to the nature of these requirements, so large a subject calls for separate treatment.

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IFC RECRUITS CAPITAL FOR DEVELOPMENT

This booklet is reprinted from the November-December 1968 issue of Columbia Journal of World Business, published by the Columbia University Graduate School of Business. The 10-page article by Martin M. Rosen, Executive Vice President of the International Finance Corporation, discusses IFC’s role as a mobilizer of capital for investments in the private sector of the less developed countries, as well as future opportunities for IFC investments.

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1

The words accountancy and accounting are being used synonymously in this article, although the author prefers the term accountancy, which refers to the field of knowledge and its methodology. Accounting applies to the practice.