What is accounting?

If you have already attended some accounting classes or if you have spoken with someone who knows something about accounting, you will probably have a fairly good idea of what accounting is and what is used for. 

Accounting can be defined as ‘the process of identifying, measuring, and communicating eco-nomic information to permit informed judgements and decisions by users of the information’. A bit of a mouthful really, but what it means is that accounting involves deciding what amounts of money are, were, or will be involved in transactions (often buying and selling transactions) and then organising the information obtained and presenting it in a way that is useful for decision making.

Despite what some people think, accounting is not a branch of mathematics, although the man credited with writing the first book on the subject, Father Luca Pacioli (1445–1517), was a mathematician. He wrote on the topic ‘in order that the subjects of the most gracious Duke of Urbino [his sponsor or benefactor] may have complete instructions in the conduct of business’, and to ‘give the trader without delay information as to his assets and liabilities’. (‘Assets’ are things that you own; ‘liabilities’ are things that you owe.)

Accounting may not require a knowledge of mathematics but you do need to be able to add, subtract, multiply and divide – things you need to be able to do in your daily life anyway. Otherwise, you would not know how much money you had with you, how much you would have if you spent some of it, or whether the change you received was correct. So, let’s remove one big misconception some people have concerning accounting: you do not need to be good at arithmetic to be good at accounting, though you will find it easier to ‘do’ accounting if you are.

The history of accounting

Accounting began because people needed to:

• record business transactions,
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• know if they were being financially successful, and
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• know how much they owned and how much they owed.

It is known to have existed in one form or another since at least 3,500 BC (records exist which indicate its use at that time in Mesopotamia). There is also considerable evidence of accounting being practised in ancient times in Egypt, China, Greece, and Rome. In England, the ‘Pipe Roll’, the oldest surviving accounting record in the English language, contains an annual description of rents, fines and taxes due to the King of England, from 1130 to 1830.

However, it was only when Paciloi wrote about it in 1494 or, to be more precise, wrote about a branch of accounting called, ‘bookkeeping’ that accounting began to be standardised and recognised as a process or procedure.

No standard system for maintaining accounting records had been developed before this because the circumstances of the day did not make it practicable for anyone to do so – there was little point, for example, of anyone devising a formal system of accounting if the people who would be required to ‘do’ accounting did not know how to read or write.

One accounting scholar (A. C. Littleton) suggested that seven key ingredients which were required before a formal system could be developed existed when Pacioli wrote his treatise:

• Private property. The power to change ownership exists and there is a need to record the transaction.
• Capital. Wealth is productively employed such that transactions are sufficiently important to make their recording worthwhile and cost-effective.
• Commerce. The exchange of goods on a widespread level. The volume of transactions needs to be sufficiently high to motivate someone to devise a formal organised system that could be applied universally to record transactions.
• Credit. The present use of future goods. Cash transactions, where money is exchanged for goods, do not require that any details be recorded of who the customer or supplier was. The existence of a system of buying and selling on credit (i.e. paying later for goods and services purchased today) led to the need for a formal organised system that could be applied univer-sally to record credit transactions.
• Writing. A mechanism for making a permanent record in a common language. Writing had clearly been around for a long time prior to Pacioli but it was, nevertheless, an essential element required before accounting could be formalised.
• Money. There needs to be a common denominator for exchanges. So long as barter was used rather than payment with currency, there was no need for a bookkeeping system based upon transactions undertaken using a uniform set of monetary values.
• Arithmetic. As with writing, this has clearly been in existence far longer than accounting. Nevertheless, it is clearly the case that without an ability to perform simple arithmetic, there was no possibility that a formal organised system of accounting could be devised.

When accounting information was being recorded in the Middle Ages it sometimes simply took the form of a collection of invoices (which each show the details of a transaction) and receipts (which each confirm that a payment has been made) which were given to an accountant to calculate the profit or loss of the business up to some point in time. This practice persists to this day in many small businesses.

The accountant of the Middle Ages would be someone who had learnt how to convert the financial transaction data (i.e. the data recorded on invoices and receipts, etc.) into accounting information. Quite often, it would be the owner of the business who performed all the account-ing tasks. Otherwise, an employee would be given the job of maintaining the accounting records.

As businesses grew in size, so it became less common for the owner to personally maintain the accounting records and more usual for someone to be employed as an accounts clerk. Then, as companies began to dominate the business environment, managers became separated from owners – the owners of companies (shareholders) often have no involvement in the day-to-day running of the business. This led to a need for some monitoring of the managers. Auditing of the financial records by accountants became the norm and this, effectively, established the accounting profession.

The first national body of accountants, The Institute of Chartered Accountants of Scotland, was formed in Scotland in 1854 and other national bodies began to emerge gradually through-out the world, with the English Institute of Chartered Accountants being formed in 1880 and the first US national accounting body being formed in 1887.