History of Accounting - Essay Example

History of Accounting History of Accounting Introduction Accounting is the practice that entails the knowledge body largely concerned with methods used to record transactions, keep financial records, carry out internal audits, analyze and report financial information and advice on taxation matters (Needles & Powers, 2013). Generally, accounting presents a systematic process that identifies and measures, records, interprets, classifies, verifies, summarizes, and communicates financial information. Differently from most modern professions, the history of accounting is often discussed from the perspectives of one influential event, which is the invention and spreading of the processes of bookkeeping that entails double entry (Oldroyd & Dobie, 2008). Agreeably, governments and businesses had much earlier been recording their business information, but Luca Pacioli was the first person who described the credits and debits system in ledgers and journals, which still forms the basis of modern accounting systems. Ancient governments and businesses used accounting as a measure of the results of their economic activities and to convey such information to users who included regulators, management, creditors and investors. This paper will trace the field and practice of accounting to its creation and discuss what caused its creation while exploring why governments started creating rules and laws to govern the field. Further, it will compare and contrast the laws of accounting from different governments and identify the major changes that have taken place in the field over the last 10 years. Overview Modern accounting is made up of several subfields that include financial accounting, taxation, management accounting, accounting information systems and auditing (Needles & Powers, 2013). Although these subfields also existed in ancient accounting, they were not in a form of togetherness that significantly represented double entry until the medieval ages, when they became significantly strong fields. Financial accounting focuses on the maintenance of financial capital either in constant units of purchasing power or nominal monetary units. Its key role is to report the financial information of an organization to external users. In that sense, financial accounting measures and records the transactions of an organization and prepares financial statements. Tax accounting entails preparing, analyzing and presenting payments of tax and tax returns, which are done by organizations recognized as corporations, partnerships, sole proprietorships as well as individuals (Needles & Powers, 2013). Management accounting is focused on measuring, analyzing and reporting information that managers can use to arrive at decisions that target meeting the organization’s objectives. Reports from management accounting are future-oriented like, for example, budgets. Accounting management systems are components of organizational information systems that are exclusively used to process quantitative data. Auditing is concerned with verifying assertions regarding payoffs. Its practice is based on examining and evaluating an organization’s financial statements without bias. All these aspects of accounting developed alongside the increased need to keep records of growing business transactions. History Writing may be as old as civilization, but systematically manipulating symbols and number as is done in arithmetic was not a characteristic of the ancient civilization. From a broad perspective, accounting can be said to have developed from the need of financial reporting and records of accounting have been traced and linked to the ancient civilizations of Mesopotamia and they date back to over 7,000 years (Alexander, 2002). Scribes were the Mesopotamian equivalents of modern day accountants and although their duties are similar, those of the scribes were more extensive. Apart from recording transactions, the scribes also bore the responsibility of ensuring the compliance of the agreements with the details of the code of requirements that guided commercial transactions. Evidence of accounting practices can also be traced back to ancient Iran as well as the auditing systems that the Babylonians and Egyptians developed (Alexander, 2002). These records list expenditures, goods traded and goods receive. These facts are further related to the development of taxation as seen in the trading activities carried out by temples. Ancient bookkeeping was developed in the 14th century and the process was driven by seven key factors that included private property, capital, commerce, credit, writing, money and arithmetic. Critics of the contributions of Luca Pacioli in the field of accounting assert that viewing its history from his perspective is generally overlooking its long evolution that occurred in the ancient and medieval ages. However, his views are also a significant compilation and summary of the profession as it was practiced by governments and businesses long before the Venetian merchants (Alexander, 2002). The field may be stereotyped as mainly being made up of the practice of mind-numbing analysis of numbers but, although there is some truth to it, it also portrays an abundance of the intellectual pursuit of controversial and compelling issues. Viewed from the 14th century perspective, especially in Greece and Rome, private property necessitated the advent of the power of changing ownership (Oldroyd & Dobie, 2008). Essentially, this also gave rise to bookkeeping as a means of recording facts related to property and its associated rights. The investment of capital was also recorded as the productive employment of wealth that led to commerce and, by extension, necessitated credit. With the growth of commerce, both geographically and in volumes, organized systems of recording transactions became necessary and eventually replaced the inefficient methods of keeping records that were in place. Then, as credit was increasingly being developed as a representation of using future goods and capital in the present, the need to record the transactions to be refered to while claiming compensation grew as well (Oldroyd & Dobie, 2008). This practice was significantly aided by the development of writing, which was initially viewed as a mechanism intended to compensate the limits of the human memory by creating permanent records in a common language. Ideally, this is also one of the objectives of modern practices of accounting. In ancient Egypt, governmental accounting was developed similar to the ways it was done in Mesopotamia. Instead of clay tablets, papyrus was used to facilitate the easy storage of more detailed records. These were used to keep extensive records by the royal storehouse networks and further facilitated the recording of tax payment. Bookkeepers in ancient Egypt kept detailed storehouse records, which were further subjected to elaborate systems of verification that were further developments of auditing. However, even with the storage of such important records, ancient Egyptian accountants took centuries to progress beyond simply making lists as a form of accounting. This lack of development was mainly caused by the absence of coined money and illiteracy (Oldroyd & Dobie, 2008). The one thousand years that separate the publication of the work of Pacioli, Summa, and the fall of the Roman Empire is viewed as a period of stagnation in accounting. Further, medieval accounting practices conducted outside of Italy are not always included in historical histories. However, as shown by studies, principles of conservatism and stewardship were founded of medieval agency accounting. The conditions that fueled the rapid and great advances in the accounting technology during the Renaissance were created in the medieval era. The accounting practice in the Roman Empire was characterized and set by the era’s centralized legal policies. On the other hand, the bookkeeping of medieval times was restricted and centered on the dedicated feudal manor establishments. The manor and exchequer systems made it necessary to have a number of authoritative delegations over property to actual users and holders from the owners. Ideally, the key function of the medieval era’s accounting was to enable owners of property and the government to monitor those in subordinate segments of economic and social pyramid (Alexander, 2002). Accounting Laws and Governments Before the 1930s, corporations were not compelled by laws or regulations to ensure that their financial statements are audited (Needles & Powers, 2013). Different governments started creating and instituting laws to govern accounting practices at different times. The creation of the laws was a push by regulators and politicians to have a common set of accounting standards in the country that were representative of high qualities of practice and ethics. For proper governance and auditing, it was imperative for a country to commit to common rules of accounting. Essentially, comparable accounting throughout the country means markets become more efficient as investors are able to compare companies from different areas of the country. This only becomes possible if the governments set high standards and quality of accounting in the form of laws and regulations. The modern form of the accounting practice as carried out by chartered accountants has its origins in the 19th century Scotland. In 1854, Queen Victoria was petitioned for a Royal Charter by Glasgow’s Institute of Accountants. By that time, the Industrial Revolution in Britain was at a high and London became the world’s financial center. As the limited liability companies grew alongside large scale logistics and manufacturing, so did the need for proficiency in accounting, which led to the introduction of company laws. In the US, the American Association of Public Accountants was formed in 1887 as the first national society of accounting. In 1896, New York became the first state to pass the law that recognized the qualification refered to as the Certified Public Accountant. This marked the emergence of accounting as an accredited profession in the nation as it appears today. Later, the General Accounting Office was established in 1921 by the Budget and Accounting Act (Needles & Powers, 2013). Its main role was to examine matters related to receipt, disbursement and use of public funds from the government perspective and report its findings and recommendations to the president and Congress. Further, it also meant that the president would for the first time start submitting the federal government’s annual budget to Congress. The budget was intended for the consolidation of the spending agencies both in the legislative and executive arms of the government. After they settled in the US in the last two decades of the 19th century, chartered accountants from England and Scotland provided reports on British interests. Here, they did most of the early auditing tasks. Later in 1913, after the Constitution’s sixteenth amendment was approved, the first Revenue Act was passed by Congress. The significance of this was that most corporations had not been previously keeping accounting records adequately. However, it was appreciated by company executives after realizing that recording depreciation was important as it was deductible for the purposes of tax. Pressure to establish common accounting standards further mounted after the 1929 crash of the stock market. It was felt by many that misleading and insufficient information from financial statements resulted in inflated stock prices, which eventually led to the crash and depression. For the sake of restoring investor confidence, the Securities Act of 1933 and the Securities Exchange Act of 1934 were created. While the first Act provides requirements for accounting and disclosure for initial securities offerings, the second one is applicable to secondary transactions. It stipulates requirements for reporting for organizations that trade their securities publicly either through over-the-counter markets or organized stock exchanges. Through the Securities Exchange Act, the Securities and Exchange Commission (SEC) was created. Although the SEC, which is a body appointed by the government, has since delegated to the private sector the principal standard-setting responsibility, it still retains the primary authority to set standards. Most of these standards and the processes of setting them relate to laws and regulations that govern how information is measured and reported in organizations oriented with making profit. However, the creation of the Governmental Accounting Standards Board (GASB) in 1984 was for the development of accounting standards targeting governmental units. These targeted units included cities and states. Operating under the Governmental Accounting Standards Advisory Council and the Financial Accounting Foundation, it is a non political and independent organization. It is dedicated to establishing and developing rules for local and state governments to report consistently transparent and clear financial information to their constituents. It is also one of the two bodies responsible for establishing generally accepted accounting principles (GAAP). GASB is charged with the jurisdiction over governmental institutions’ financial reporting while the Financial Accounting Standards Board (FASB) is responsible for establishing accounting rules for the private sector. New Laws and their Impacts In 2001, the SFAS 142 Goodwill and Other Intangible Assets Act was issued by FASB (Needles & Powers, 2013). For the first time over a period of more than 30 years, this Act changed the way goodwill is treated by accounting in major ways. The changes were implemented at the same time that FASB also issued SFAS 141 Business Combinations that essentially abolished the method of pooling-of-interests for business combination accounting. The pooling-of-interests entirely avoided the issue of goodwill. However, when transitioning to the SFAS 142, one third of 100 companies analyzed were able to write off over 30% of their goodwill and annual their combined annual profits were reported to increase by $20 billion. However, such magnitudes of changes present difficulties to financial statement users by causing data time series discontinuities (Needles & Powers, 2013). Previous practice called for goodwill that was recorded after an acquisition to be amortized through a period not exceeding 40 years. Essentially, two significant changes were made by the new law on goodwill. First, it brought to an end the amortization of any goodwill, irrespective of its date of origin. That means that from, then, goodwill was regarded as an asset that did not bear reduction for intermittent amortization. Secondly, organizations started being required to evaluate goodwill at least once a year for impairment. In the event that goodwill is found to be impaired, the carrying amount is also reduced, which leads to the recognition of impairment loss. Although the accounting laws differ between the American and British accounting systems, there are also many similarities. The British system also adopted a new law on goodwill like the American system whereby instead of capitalizing and amortizing goodwill, organizations can write it off directly against reserves (Needles & Powers, 2013). Both systems have laws governing the minimum requirement of being audited. In Britain, all companies are compelled by the Companies Act to appoint qualified and independent auditors. However, those reporting below £1 million in turnover are exempted from auditing. On the other hand, the American system requires companies with more than $5 million and 500 shareholders to have their financial statements subjected to an audit. However, viewing differences between the two systems, the British system begins SFAS statements with post-tax profit. In that sense, tax does not appear as one of the uses of cash. The British system measures tangible assets initially at cost Changes in Accounting Caused by the Enron and Arthur Anderson Scandals Even before Enron and Arthur Andersen fell, there were various safety measures instituted to safeguard the public sector and investors in general. They included the Generally Accepted Auditing Standards (GAAS), the Generally Accepted Accounting Principles (GAAP) and the Statements on Auditing Standards (SAS) and they were, necessarily, improved after the fraud (Sifuna, 2012). The executives at these two firms may not have had the intention of impacting positively on the accounting industry. However, their actions forced the industry to react in ways that brought changes that have actually been beneficial by leaving the accounting industry and the economy stronger. Enron was a Texas-based energy and utility giant that used Arthur and Andersen as their auditors and accountants. Revealed in 2001, the Enron Scandal led to the Enron Corporation filing for bankruptcy and the Arthur Andersen being dissolved. The complex financial statements presented in regards to Enron largely confused analysts and shareholders. Further, the unethical practices and complex business model necessitated the use of accounting limitations that modified and misrepresented the balance sheet and earnings in order to imply favorable earnings. Both Enron and Arthur Andersen took advantage of investors, the government and general public to increase personal wealth as much and as quickly as possible. However, these events facilitated positive changes in the accounting industry bought forward by the American Institute of Certified Public Accountants (AICPA), the government, government agencies and interested accounting groups. Effective from January 2002, the changes by AICPA addressed the need of retaining recorded policies of accounting firms (Sifuna, 2012). Auditors were since then required to consider specific factors in their attempts to determine the extent and nature of documentation for specific procedures and audit areas. They were further required to document every decision that was deemed to be of considerable significance. In particular, these changes are seen to be directly linked to the fact that no fraud was indicated by Arthur Andresen in presenting the audit report of Enron yet the fraud existed. These changes have facilitated the exposure of deception ad fraud even though they mean more work for auditors (Sifuna, 2012). Generally, companies in the accounting industry have been compelled to become more proactive in their auditing roles, with the significant result that public confidence in businesses and auditors has been restored. Indeed, many organizations hired new auditors for the sake of rechecking past audits upon the revelation of the contributions of Arthur Andersen towards aiding the Enron fraud. Viewed from the aspect of the Enron and Arthur Andresen perspective, the accounting industry may probably never be perfect, but effects of the changes occasioned by the fraud destined to result in ethical practice (Sifuna, 2012). Conclusion Accounting has been seen to entail an organization’s recording of transactions, keeping financial records, conducting internal audits, analyzing the reports and advising on matters concerned with taxation. Aspects of modern accounting that have been traced back to ancient practices include financial accounting, taxation, management accounting, accounting information systems and auditing, even though they only significantly developed in the medieval ages. Accounting may have generally developed from the necessity of storing records (or bookkeeping), but the practice of bookkeeping has now become a key element of accounting. Governments started creating laws to govern accounting mainly to have a common set of rules throughout the country. This facilitated effective auditing and the ability of investors to compare different companies from different parts of the country. The accounting profession as it appears today in the US emerged towards the close of the 19th century. In modern terms, accounting has seen changes brought to the industry by various stakeholders after some specific frauds were revealed. In particular, the Enron and Arthur Andersen Fraud uncovered auditing loopholes that led to the revision of the rules of practice, which has proved to be beneficial to the modern practice of accounting. References Alexander, J. (2002). History of accounting. New York: Association of Chartered Accountants in the United States. Needles, B., & Powers, M. (2013). Principles of financial accounting. New York: Cengage Learning. Oldroyd, D., & Dobie, A. (2008). Themes in the history of bookkeeping. London: Routledge. Sifuna, A. (2012). Disclose or abstain: The prohibition of insider trading on trial. Journal of International Banking Law and Regulation, 27(9), 103-117. Read More