Accountancy

Accountancy
Key concepts
Accountant Bookkeeping Trial balance General ledger Debits and credits Cost of goods sold Double-entry system Standard practices Cash and accrual basis GAAP / IFRS
Financial statements
Balance sheet Income statement Cash flow statement Equity Retained earnings
Auditing
Financial audit GAAS Internal audit Sarbanes-Oxley Act Big Four auditors
Fields of accounting
Cost • Financial • Forensic Fund • Management • Tax
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Accountancy or accounting is the art of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management.^[1]

Such financial information is primarily used by managers, lenders, investors, tax authorities, regulators, and other decision makers to make resource allocation decisions between and within companies, organizations, and public agencies. It involves the process of recording, verifying, and reporting of the value of assets, liabilities, income, and expenses in the books of account (ledger) to which debit and credit entries (recognizing transactions) are chronologically posted to record changes in value (see bookkeeping). Accounting has also been defined by the AICPA as "The art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof."^[2]

Etymology

The word "Accountant" is derived from the French word "Compter" which took its origin from the Latin word "Computare". The word was formerly written in English as "Accomptant", but in process of time the word, which was always pronounced by dropping the "p", became gradually changed both in pronunciation and in orthography to its present form."^[3]

History

Early history

During the period 8000-3700 BCE, the Fertile Crescent witnessed the spread of small settlements supported by agricultural surplus. Tokens, shaped into simple geometric forms such as cones or spheres, were used for stewardship purposes in relation to identifying and securing this surplus, and are examples of accounts which refereed to lists of personal property.^[4] Some of them bore markings in the form of incised lines and impressed dots. Neolithic community leaders collected the surplus at regular intervals in the form of a share of the farmers’ flocks and harvests. In turn, the accumulated communal goods were redistributed to those who could not support themselves, but the greatest part was earmarked for the performance of religous rituals and festivals. In 7000 BCE, there were only some 10 token shapes because the system exclusively recorded agricultural goods, each representing one of the farm products levied at the time, such as grain, oil and domesticated animals.The number of token shapes increased to about 350 around 3500 BCE, when urban workshops started contributing to the redistribution economy. Some of the new tokens, stood for raw materials such as wool and metal, and others for finished products among which textiles, garments, jewelry, bread, beer and honey.^[5]

The annual balance sheet of a Sumerian state-owned farm, drawn up by the scribe responsible for artisans: detailed account of materials and workdays for a basketry workshop. Cuneiform script in clay, ca. 2040 BCE. Department of Oriental Antiquities, Louvre.

The true cognitive significance of the token system was to foster the manipulation of data. Compared to oral information passed on from one individual to the other, tokens were extra-somatic, that is outside the human mind. As a result, the Neolithic accountants were no longer the passive recipients of someone else’s knowledge, but they took an active part in encoding and decoding data. The token system substituted miniature counters for the real goods which eliminated their bulk and weight and allowed dealing with them in abstraction by. As a result, heavy baskets of grains and animals difficult to control could be easily counted and recounted. The accountants could add, subtract, multiply and divide by manually moving and removing counters.^[6]

The Mesopotamian civilization emerged during the period 3700-2900 BCE amid the development of technological innovations such as the plough, sailing boats and copper metal working. Clay tablets with pictographic characters appeared in this period to record commercial transactions performed by the temples. Such records preceded the earliest found examples of cuneiform writing in the form of abstract signs incised in clay tablets which were written in Sumerian by 2900 BCE in Jemdet Nasr. Therefore “token envelop accounting” not only preceded the written word but constituted the major impetus in the creation of writing and abstract counting. ^[7] During the Sumerian period, token envelop accounting was replaced by flat clay tablets impressed by tokens which that merely transfered symbols. Such documents were kept by scribes, who were carefully trained to aquire the necessary literary and arithmetic skills and were held responsible for documenting financial transactions. ^[8]

Simple accounting is mentioned in the Christian Bible (New Testament) in the Book of Matthew, in the Parable of the Talents.^[9] The Islamic Quran also mentions simple accounting for trade and credit arrangements.^[10]

In the twelfth century AD, the Arab writer, Ibn Taymiyyah, mentioned in his book Hisba (literally, "verification" or "calculation") detailed accounting systems used by Muslims as early as in the mid-seventh century AD These accounting practices were influenced by the Roman and the Persian civilizations that Muslims interacted with. The most detailed example Ibn Taymiyyah provides of a complex governmental accounting system is the Divan of Umar, the second Caliph of Islam, in which all revenues and disbursements were recorded. The Divan of Umar has been described in detail by various Islamic historians and was used by Muslim rulers in the Middle East with modifications and enhancements until the fall of the Ottoman Empire.

The development of mathematics and accounting were intertwined during the Renaissance. Mathematics was in the midst of a period of significant development in the late 15th century. Hindu-Arabic numerals and algebra were introduced to Europe from Arab mathematics at the end of the 10th century by the Benedictine monk Gerbert of Aurillac, but it was only after Leonardo Pisano (also known as Fibonacci) put commercial arithmetic, Hindu-Arabic numerals, and the rules of algebra together in his Liber Abaci in 1202 that Hindu-Arabic numerals became widely used in Italy.^[11]

Luca Pacioli and double-entry bookkeeping

A double-entry bookkeeping system is defined as any bookkeeping system in which there was a debit and credit entry for each transaction, or for which the majority of transactions were intended to be of this form.^[12] Luca Pacioli wrote a 27-page treatise on bookkeeping that contained the first known published work on that topic, and is said to have laid the foundation for double-entry bookkeeping as it is practiced today.^[13]

Pacioli's portrait, a painting by Jacopo de' Barbari, 1495, (Museo di Capodimonte).^[14]

Pacioli's "Summa de Arithmetica, Geometria, Proportioni et Proportionalità" (trans. "Review of Arithmetic, Geometry, Ratio and Proportion") was first printed and published in Venice in 1494. It included a 27-page treatise on bookkeeping, "Particularis de Computis et Scripturis" (trans. "Details of Accounting and Recording"). It was written primarily for, and sold mainly to, merchants who used the book as a reference text, as a source of pleasure from the mathematical puzzles it contained, and to aid the education of their sons. It represents the first known printed treatise on bookkeeping; and it is widely believed to be the forerunner of modern bookkeeping practice. In Summa Arithmetica, Pacioli introduced symbols for plus and minus for the first time in a printed book, symbols that became standard notation in Italian Renaissance mathematics. Summa Arithmetica was also the first known book printed in Italy to contain algebra.^[15]

According to Pacioli, accounting is an ad hoc ordering system devised by the merchant. Its regular use provides the merchant with continued information about his business, and allows him to evaluate how things are going and to act accordingly. Pacioli recommends the Venetian method of double-entry bookkeeping above all others. Three major books of account are at the direct basis of this system: the memoriale ( trans. memorandum), the giornale (journal), and the quaderno (ledger). The ledger is considered as the central one and is accompanied by an alphabetical index.^[16]

The nature of double-entry can be grasped by recognising that this system of bookkeeping did not simply record the things merchants traded so that they could keep track of assets or calculate profits and losses; instead as a system of writing, double-entry produced effects that exceeded transcription and calculation. One of its social effects was to proclaim the honesty of merchants as a group; one of its episoemolical effects was to make its formal precision based on a rule bound system of arithmetic seem to guarantee the accuracy of the details it recorded. Even though the information recorded in the books of account was not necessarily accurate, the combination of the double entry system's precision and the normalizing effect that precision tended to create the impression that books of account were not only precise, but accurate as well. Instead of gaining prestige from numbers, double entry bookkeeping helped confer cultural authority on numbers.^[17]

Post-Pacioli

The spread of the Italian accounting rules over the rest of Europe and thence further afield, was the result of treatises, some of them strongly based on Pacioli's work, describing and explaining the system and its practice. The "Quaderno doppio" (trans. Double-entry Ledger, Venice, 1534) of Domenico Manzoni da Oderzo was one of the first reproductions of Pacioli's "Particularis de Computis et Scripturis". This work, important because of elaborate examples, was very popular and widespread among merchants: it enjoyed no less than seven editions between 1534 and 1574. Other books that are directly or indirectly based on Pacioli's work are Hugh Oldcastle's "A Profitable Treatyce called the Instrument or Boke to learne to knowe the good order of the kepyng of the famous reconynge called in Latyn, Dare and Habere, and in Englyshe, Debitor and Creditor" (London, 1543), a translation of Pacioli's treatise, and Wolfgang Schweicker's "Zwifach Buchhalten" (trans. Double-entry bookkeeping, Neurenberg, 1549), a translation of the "Quaderno doppio".^[18]

A short book of instructions was also published in 1588 by John Mellis of Southwark, England, in which he says, "I am but the renuer and reviver of an ancient old copies printed here in London the 14 of August 1543: collected, published, made, and set forth by one Hugh Oldcastle, Schoolmaster, who, as reappeared by his treatise, then taught Arithmetics, and this booke in Saint Ollaves parish in Marko Lane." Mellis refers to the fact that the principle of accounts he explains (which is a simple system of double entry) is "after the former of Venice".

A book described as The Merchants Mirrour, or directions for the perfect ordering and keeping of his accounts formed by way of Debtor and Creditor, after the (so termed) Italian manner, by Richard Dafforne, accountant, published in 1635, contains many references to early books on the science of accountancy. In a chapter in this book, headed "Opinion of Book-keeping's Antiquity," the author states, on the authority of another writer, that the form of book-keeping referred to had then been in use in Italy about two hundred years, "but that the same, or one in many parts very like this, was used in the time of Julius Caesar, and in Rome long before." He gives quotations of Latin book-keeping terms in use in ancient times, and refers to "ex Oratione Ciceronis pro Roscio Comaedo"; and he adds:

"That the one side of their booke was used for Debitor, the other for Creditor, is manifest in a certain place, Naturalis Historiae Plinii, lib. 2, cap. 7, where hee, speaking of Fortune, saith thus:

Huic Omnia Expensa.

Huic Omnia Feruntur accepta et in tota Ratione mortalium sola.

Utramque Paginam facit."

An early Dutch writer appears to have suggested that double-entry book-keeping was even in existence among the Greeks, pointing to scientific accountancy having been invented in remote times.

There were several editions of Richard Dafforne's book — the second edition in 1636, the third in 1656, and another in 1684. The book is a very complete treatise on scientific accountancy, beautifully prepared and containing elaborate explanations. The numerous editions tend to prove that the science was highly appreciated in the 17th century. From this time on, there has been a continuous supply of literature on the subject, many of the authors styling themselves accountants and teachers of the art, and thus proving that the professional accountant was then known and employed.

Types of accounting

• Financial accounting is "a major branch of accounting involving the collection, recording and extraction of financial information, and the summary of it in the form of a periodic profit and loss account, a balance sheet and a cash flow statement in accordance with legal, professional, and capital market requirements".^[19]
• Management accounting is another branch of accounting performed within an organization to provide information only accessible to its decision-makers.
• Open-book accounting is an accounting principle that aims to improve accounting transparency of organizations.
• Tax accounting is the accounting needed to comply with jurisdictional tax regulations.
• Accounting scholarship is the academic discipline that studies the theory of accountancy.

The related, but separate financial audit comprises internal audit and external audit. External audit — carried out by independent auditors — examines the financial statements and accounting records in order to express an opinion as to the truth and fairness and adherence to Generally Accepted Accounting Principles (GAAP). Commonly used GAAP include the US Financial Accounting Standards Board (FASB), which issues FASB Pronouncements including Statements of Accounting Standards, and the International Accounting Standards Board (IASB), which issues International Financial Reporting Standards (IFRS). Many other countries have instituted local standards resulting in a local country GAAP. Internal audit aims at providing information for management usage, and is typically carried out by employees.

Accounting scandals

The year 2001 witnessed a series of financial information frauds involving Enron Corporation, auditing firm Arthur Andersen, the telecommunications company WorldCom, Qwest and Sunbeam, among other well-known corporations. These problems highlighted the need to review the effectiveness of accounting standards, auditing regulations and corporate governance principles. In some cases, management manipulated the figures shown in financial reports to indicate a better economic performance. In others, tax and regulatory incentives encouraged over-leveraging of companies and decisions to bear extraordinary and unjustified risk.^[20]

The Enron scandal deeply influenced the development of new regulations to improve the reliability of financial reporting, and increased public awareness about the importance of having accounting standards that show the financial reality of companies and the objectivity and independence of auditing firms.^[20]

In addition to being the largest bankruptcy reorganization in American history, the Enron scandal undoubtedly is the biggest audit failure.^[21] The scandal caused the dissolution of Arthur Andersen, which at the time was one of the five largest accounting firms in the world. It involved a financial scandal of Enron Corporation and their auditors Arthur Andersen, which was revealed in late 2001. After a series of revelations involving irregular accounting procedures conducted throughout the 1990s, Enron filed for Chapter 11 bankruptcy protection in December 2001.^[22]

One consequence of these events was the passage of Sarbanes-Oxley Act in 2002, as a result of the first admissions of fraudulent behavior made by Enron. The act significantly raises criminal penalties for securities fraud, for destroying, altering or fabricating records in federal investigations or any scheme or attempt to defraud shareholders.^[23]

Notes and references

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