The Evolution of Bookkeeping
Like most other business practices that we come across today, bookkeeping was very different a century ago than the way we see it today. The further back we went into history, the more difference we will come across in how accounting and bookkeeping were practiced by our ancestors. While the goals of bookkeeping remain the same, the process has changed enormously.
Just like our ancestors, we use bookkeeping with the following goals in mind:
- To have a better understanding of the inflow and outflow of cash in our business
- To be able to provide stakeholders with transparency in how money is spent or earned by the business
- To identify areas of expenses which can be cut down
- To identify solutions to increase cash inflow
- To make informed business decisions based on the organization’s financial standing
- To pay taxes to the authorities
- To pay dividends on profits
The processes utilized in achieving these goals have morphed from complicated handwritten notes and entries to automated accounting systems.
Keeping an account of bartered products
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The barter system was extremely complex. On the outside, it involved the basic exchange of one type of goods for another. But for a business owner, it was important to know how the products could be valued for a suitable exchange. At the end of the day, if the products were exchanged for something of lower value, it could translate into a loss for the trader.
Narratives of the exchange of products were written down by bookkeepers and stored as proof in the event of a dispute. Since transactions in the barter system could involve long periods of time, it was important to store the information in paper forming a written agreement. For example, a year’s worth of service at the farms could be exchanged for a bag of grains.
To make sure that both the parties held to their end of the agreement, it was important to have this agreement written down in the books. Since the process was long and arduous, rich businessmen would hire bookkeepers while small business owners would handle their own accounting work.
Introduction of currencies and bookkeeping
As the world transitioned into using currencies, traders would have to account for the money they spent and received. This was necessary in order to pay taxes, and it also helped them keep track of their business successfulness.
Many businessmen found the process of bookkeeping to be tiresome. Some did not prefer the mathematical calculation involved in accounting. So, they hired bookkeepers to maintain their business accounts. Rich business owners would have an in-house accountant while small business owners would visit a bookkeeper with their business transactions – receipts, bills, invoices, POs – and ask them to provide an accounting for these transactions.
These visits may happen as often as the trader or merchant would require his business accounts to validate their market value, to evaluate taxes or to pay debtors and follow up with people who owed money to their business.
These records were maintained in a single-entry system where all transactions were described in one column and the amount of money would be added to deducted in the second column. A third column was used to date every transaction.
A bookkeeper had to spend time reading every transaction to ensure that it was correctly entered. Since all debits and credits showed in a single line, differentiating between the two was time-consuming.
The Double Entry System Proposed by Luca Pacioli
Bookkeepers noticed the problems in a single entry system and started to look for ways to improve their accounting work. But this did not happen until the 15th century when an Italian monk, Luca Pacioli built the foundations for the double-entry system. He is also known as the Father of Accounting and Bookkeeping in Europe.
Pacioli describes the double-entry accounting system in his book Summa de arithmetica, geometria. Proportioni et proportionalita. The accounting cycle he describes in his books is very similar to the accounting practices of today. It includes journals, ledgers, balance sheets, and even trial balancing as a way of proving a balanced ledger.
So far, business owners used bookkeeping and accounting mostly for themselves and for partners or other stakeholders in the business. This information was not made public. It was considered crucial financial information which helped businesses plan the following financial year in a better way.
The Industrial Revolution and Bookkeeping
Supply chains became more complex when the industrial revolution changed how goods were manufactured and how they could be moved from one location to another with lesser effort. Businesses grew larger and corporations started distributing products through large and complex distribution networks. As more goods could be produced in a short time, those goods could be sold to a larger audience spread across different geographic locations.
Railway lines had been constructed in several countries, making it easier for goods to be distributed. Businesses now had to keep an account of their supply chain expenses, which would directly impact their profits and the price of the goods. Their accounting records became crucial in establishing the total cost of production and distribution of goods.
As corporations began to rise during the industrial revolution, people started investing in companies which they hoped would earn profits. These investments were mostly made on the basis of trustworthiness of businesses and the people behind the business. The financial health of a business was mostly evaluated by considering the financial health of its owners or board members. Accounting information about the business was not disclosed publicly. So investing in company stocks involved some amount of risk. This is one reason why investing in stocks was seen as a rich man’s sport.
To gain the trust of more people and make stock investments more feasible, companies started publishing their financials. Companies would publish their balance sheet, income flow, and cash flow statement to provide a transparent view to the public about their financial health. It drove investments for financially healthy companies and helped them prosper even more.
Accountants became the pillars on which investor relationships were built
This investment capital acquired from the shareholders made companies accountable to every shareholder. They had to make business decisions keeping the shareholders in mind. When the shareholders started to feel that businesses cannot be trusted completely for maintaining accuracy in the financial reports they shared with the public, the world saw the rise of accountants as key agents in maintaining transparency in a business’ financial transactions.
The accounting profession was recognized in 1896 in the USA. The title of Certified Public Accountant was awarded to those who passed state exams and had three years of experience in the field of accounting. By the mid-twentieth century, there were five big accounting firms which were recognized in the USA and Europe. These five companies were:
- Arthur Anderson
- Ernst & Young
Arthur Anderson lost its reputation in the Enron scandal. The energy company Enron had reported $100 billion in revenue through systematic accounting fraud. Arthur Anderson was the auditing company for Enron during this time. The company and its owner came under intense scrutiny after this scandal. As a result, the Big Five became Big Four. The rest of the four companies continue to be the top firms for accounts auditing.
Software products that automated bookkeeping
Computers had started making their way into companies and software products helped in automating many business processes. QuickBooks by Intuit was released in 1998 as accounting software that could help small businesses maintain their accounts with fewer hassles.
Several other accounting applications were introduced towards the end of the 20th century to support the growing demands of business owners who started embracing digitization of their accounting system. It also helped save significantly on hiring an accountant to manage their books. By making a one-time payment for the software, businesses could quickly and easily manage their accounts.
This is where bookkeeping stands today.
We are still utilizing the bookkeeping practices established by Luca Pacioli almost 500 years ago. But the process of bookkeeping has evolved and it has helped accountants complete their work with greater efficiency.
In recent years, Artificial Intelligence (AI) has been making it possible for data to be processed intelligently and for businesses to rely less on manual work. The same thing is applicable in the field of bookkeeping as well. AI can help businesses manage their accounts with higher efficiency and increased accuracy. While some people may see it as a concern for accountants, we feel that bookkeeping will remain a process that involves human intelligence too.
But the work done by accountants will reduce considerably when computers can make use of information fed into the system to track the flow of cash. This provides accountants with the option to work with higher precision since they will have more time to go through the records and check for errors. It will also help companies during audits since data trails can be easily maintained through the software system. Policies and regulations by regulating bodies can also be enforced through software programs, which makes it easy for businesses to operate in compliance with the necessary policies.
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