How Accounting Changed The World

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Podcast Transcript

There are some subjects that are perceived to be mind-numbingly dull and boring. One such subject is accounting. 

Yet, believe it or not, accounting and bookkeeping have not only have been around since the dawn of human civilization, but they also had a hand in shaping it. 

Without it, the world would be a very different place today.

Learn more about accounting and bookkeeping, and how they really aren’t as boring as they seem, on this episode of Everything Everywhere Daily.

It is easy to think of accounting as a stodgy, boring profession of number crunchers bent over a spreadsheet. However, accounting and the related field of bookkeeping have been around since the dawn of civilization.

In fact, you can make an argument that accounting was the reason for the rise of civilization. 

When humans moved from hunter-gatherer lifestyles to more sedentary agricultural lifestyles, there were a whole bunch of things that came along with it that weren’t an issue before. 

Taxes had to be paid, grain storage had to be recorded, trades and exchanges had to be documented. 

It is no coincidence that the earliest examples of written language that we have come from Mesopotamia and they are basically receipts.

One of the oldest known examples comes from the ancient Sumerian civilization in modern-day Iraq. It is a clay tablet that records a transaction of five goats. 

Other ancient writing systems arose independently in China, Egypt, and Mesoamerica. As far as we can tell, all of them began for the purpose of recording simple transactions. 

If we go back even further, about 10,000 years, we’ve found evidence of bones with hash marks cut into them which indicate that someone was counting something. 

Writing and counting were not originally invented for recording abstract thought and mathematics. It was invented for the practical purpose of documenting economic transactions. Only later were those symbols adapted for other purposes. 

The people who knew those symbols became important people in whatever kingdom or empire they lived in. They would hold positions as scribes or priests. This class would control the collection of taxes and religious donations. 

They certainly did other things such as perform religious rituals, but at their core, they performed the function of accountants. 

It wasn’t just developing a system of record-keeping. We know by the 4th century BC that the Babylonians and the Egyptians both had developed systems for maintaining inventory in warehouses. 

In ancient Rome, keeping the accounts for an entire empire was a daunting task. If you remember back to my episode on the Cursus Honorum, one of the highest-ranking elected positions in Rome was the Quaestor, who was responsible for budgets and spending. 

Each Roman province or legion had its own Quaestor whose job was to keep track of finances. 

Some of the best information about day-to-day life during the Roman empire has come from accounting documents that have been discovered. 

With the rise of Islam, there were special accounting requirements that the religion required. In particular, Islam required an accounting of assets of someone’s estate so they could be distributed to their family. 

An accounting of all assets and debts of someone was actually more complicated than it sounds. 

The man who created a system to solve the problems presented by Islamic estate accounting was Muhammad ibn Musa al-Khwarizmi. If you remember back to a previous episode, al-Khwarizmi is the father of algebra. He also formalized the decimal numbering system and brought in the idea of zero from India.

….all in the name of accounting. 

The Tang dynasty in China developed paper money, which required much more accounting than did money based on precious metals. They kept meticulous records in paper books. The entire Mandarin class in China, who were the imperial civil servants, had recordkeeping as a major part of their job. You could literally say they were the first bookkeepers. 

One of the interesting things about accounting is that it appears to have spread quite a bit between different cultures. As it was inexorably associated with trade, traders would share notes with each other as they went from port to port. 

There was an innovation that had been around for centuries in various forms, but it took a long time to become formalized. It was probably the most revolutionary technology in the history of accounting and laid the foundation for all modern business and economics. 

Double. Entry. Bookkeeping. 

Double-entry bookkeeping had been around for a long time in various forms. Elements of it can be found in ancient Greece, Rome, China, India, and Egypt. It was also used by European Jews, Italian traders, and by al-Khwarizmi. 

The principal behind double-entry bookkeeping is that every transaction is entered twice in different accounts in a ledger. Usually credits and debits, or assets and liabilities. 

Let’s say for example that a company takes out a $100,000 loan. They get $100,000 in cash which is a debit, and they take on $100,000 in debt, which is a credit. 

If you then take $10,000 to buy furniture, your cash is credited $10,000, and your furniture assets are debited $10,000. 

Every business transaction is entered twice in this system, and each side of the ledger has to equal the other. By requiring two entries for each transaction, it greatly eliminates the possibility of errors. 

This is why it is called “balancing the books”.

The person who has been dubbed the founder of modern accounting is an Italian by the name of Luca Pacioli. Pacioli didn’t invent double entry bookkeeping. As I mentioned, it has been used in various forms around the world for centuries. 

Pacioli wrote a book called Summa de arithmetica, geometria in 1494. It was a general mathematics textbook designed to cover everything about the subject at that time. 

In it, he devoted 27 pages to accounting and the double entry bookkeeping system.  His book was used as the primary accounting textbook for almost a hundred years. 

The system he put down in writing is basically the same one that is used around the world today. 

The rise of formal accounting was a big reason behind the rise of joint-stock companies like the Dutch East India company which arose soon after. 

Accountants, however, didn’t become their own distinct profession until the 19th century. The first organization of accountants was formed in Glasgow, Scotland. They petitioned Queen Victoria to get their own royal charter so they could be distinct from lawyers.

Accountants eventually became a profession with certification similar to doctors and lawyers. In 1887, the American Institute of Certified Public Accountants was established in the United States. 

The genesis of this episode came from a course I took my freshman year in college a long time ago. We were required to take a course in basic financial accounting as part of getting an economics major.

I came away from the course with two things. The first was an appreciation for accounting and how important it was. Years later when I ran my own business, that one-semester course proved to be invaluable.

The second thing I came away with was the knowledge that I never wanted to be an accountant. 

Accounting isn’t just data entry. It actually requires creativity and problem-solving, and I don’t just mean in a way to cheat on taxes. 

I’ll end with one example that always stuck with me and was something I never really thought about. 

Let’s suppose you are a company that has a storage tank for fuel. You put fuel into the tank, and then you take fuel out of the tank.

The price of fuel is always changing so every time you put fuel into the tank it might be a totally different price. 

When you take fuel out, how do you measure the cost of the fuel when everything that was put in was at a different price and everything is mixed together? 

Your first reaction might be just average everything together. That certainly is an option and it is called the weighted-average method.

However, this can be very difficult to calculate if different-priced fuel is constantly going in and out. Depending on the business, every time you took fuel out, it might be a different average. 

Taking an average isn’t the only way to solve the problem, however. Another option is called First In, First Out, or FIFO. Let’s say the price of the first 100 liters of fuel you put in the tank cost $1 a liter, then the first 100 liters taken out would all be given a cost of $1 a liter. Under this system, it doesn’t matter when you take it out or how much was put in before you took it out. 

The other option is Last in, First Out, or LIFO. This is just the opposite. Under this method, the cost of the most recent fuel put in is deducted first. 

There is no right way to decide what method to use. You just need to pick whatever makes the most sense for your company and stick with it. 

There are many, many other cases in accounting for things like categorizing assets or how you calculate depreciation. On top of all that, there are laws, professional standards, and ethical issues which need to be considered. 

So, even though accounting is often thought of as a boring profession, it is extremely important and it involves more creativity and problem solving than most people realize. 

Also, it has been a part of human civilization for as long as there has been civilization, and it was in no small part responsible for civilization’s rise.