1.

The History of Accounting

14thCentury

The history of accounting dates back to ancient civilisations, however the birth of

double-entry bookkeeping in the 14th century is seen as being the beginning of the

modern accounting period.

The Renaissance period in Italy (14th to 16th century) saw many major developments

in accounting practice. At this time, Arabic numerals were first used to keep records

of business transactions in place of Roman numerals, and record keeping developed

on a large scale. In 1494 Luca Pacioli, a Franciscan friar, published the Summa de

Artihmetica, Geometria, Proportioni et Proportionalita. In it were 36 chapters on

bookkeeping in which Pacioli described double-entry bookkeeping and other

commerce-related concepts. Double entry bookkeeping is a system in which a debit

and credit entry is entered for each transaction : “Every debit has its credit – every

amount that is charged to on account must be placed to the credit of another”.

Although Pacioli did not invent double-entry bookkeeping, he is credited with being

the first person to widely disseminate this knowledge, and the principles published in

his Summa remain largely unchanged to this day. Developments that came later

included the splitting of records into different books “suited to the nature of the

business carried on, each [book] containing such transactions as exclusively apply to

its title”, for example cash books for recording money received and payed, and

invoice books for recording goods purchased and sold. Variations in bookkeeping also

developed between different industries & professions (e.g. Shipping, newspapers and

printing).
17thCentury

Colonial expansion in the 17th century and demand for foreign goods saw the rise of

‘chartered companies’, the first corporations. The scale of these endeavors required

large investment, the reward for investors being that assets were divided between

stock holders at the end of each voyage. However this was not always possible, with

permanently invested capital required to support future voyages. Bookkeeping had to

develop to keep track of the assets and profits of many distinct trading ventures at

different stages of completion.

In 1657, the company ruled that stock was to be valued, and four years later the

governor of the company stated that “future distributions would consist of the profits

earned (dividends) and not “divisions” as in the past”.

This was a big progression towards the modern conditions under which corporations

operate and was the first large-scale example of stock exchange, investment and

corporate finance. These accounting practices continued to develop through the next

centuries. Many guides for investors and accountants were written during this

development period. Examples include Stock Exchange Accounts; with an appendix

of forms which details stock exchange bookkeeping, Haight and Freese Co’s Guide to

Investors which lists the stock prices for various companies between 1890-1900 and A

Corporate Venture which states that “unless the stockholder in a corporation knows

the ropes they may be pulled to his disadvantage”.

The Phonopore Company Limited certificate is an example of a shares certificate

from 1893 indicating that William Robert Pullman Esquire was the holder of 120

shares in the Phonopore Company, valued at £1 each.

18thCentury

During the Industrial Revolution, methods were required which could be used to track

costs related to large scale production in factory-manufacturing operations. Josiah

Wedgwood, the founder of famous pottery manufacturer Wedgwood is considered by

many to be a pioneer in cost accountancy. After examining business accounts, Josiah

Wedgwood discovered that his head clerk had been embezzling from the company

and so after hiring a new clerk he implemented weekly account reviews to keep track

of his finances. These reviews allowed him to calculate detailed costs for materials

and labour, leading to the discovery of overhead costs and economies of scale.

19thCentury

The early evolution of accounting was dominated by advances in bookkeeping

practice. There are numerous books chronicling this progression. The century

following the industrial revolution saw great progress from the “method of

systematically recording [financial] exchanges into a means of giving business

management an effective control over its affairs”.

1816 - John Croaker, a bank clerk from England, was caught and charged with

embezzling from the bank and was sent to the colony of New South Wales. Upon

arrival he was granted an immediate ticket of leave and began working as a clerk in

the justiciary and set himself up as a commodities dealer. At this time, the first Bank

of New South Wales opened, and John Croaker helped to establish their bookkeeping

practices, instigating double-entry bookkeeping for the first time in Australia.

1854 - On the 6th of July 1854, a petition was signed by forty-nine accountants in

Glasgow asking Queen Victoria for the grant of a Royal Charter. Thus the formal

accounting profession emerged in Scotland with the formation of Edinburgh Society

and Glasgow Institute of Accountants. The title ‘Chartered Accountant’ was decided
upon and adopted for members of the Society, and was soon adopted by the Glasgow

Institute and the later formed Aberdeen Society. However the Institute of Chartered

Accountants of Scotland was not formed until the three societies merged in 1951.

1880 - In 1880, the Institute of Chartered Accountants in England and Wales was

formed, bringing together members from a number of individual accounting

organisations. The newly formed institute developed standards of conduct and

examinations for admission.

Books such as Book-keeping exercise for accountant students, The student’s business

methods and commercial correspondence and Australian elementary bookkeeping

represent examples of the shift towards professional education and accreditation in the

accountancy [Link] Entry Bookkeeping for technical classes and schools

gives examples of civil service examination papers for accountants from this period.

1887 - During the rapid growth of American industry in the 1800s, many Scottish and

British accountants travelled to the United States to audit and keep track of British

investments in the country. A number of these professionals remained in the US and

are thought to have begun the practice of accountancy in America. In 1887 the

American Association of Public Accountants was formed.

20thCentury

On the 19th of June 1928, a Royal Charter was granted by George the Fifth,

establishing The Institute of Chartered Accountants in Australia upon recognition that

the “profession of Public Accountants in the said Commonwealth [Australia] is

practiced by a considerable number of persons and the duties and functions of such

public accountants are of great and growing importance in respect of their

employment in the capacities of Liquidators acting in the winding up of Companies

and of Receivers under Decrees and Trustees in Bankruptcy or Insolvency,

arrangements with creditors and in various positions of trust under the Courts of

Justice in the said Commonwealth of Australia, and also in the auditing and

certification of the accounts of Public Companies and other business, and various

other kindred matters, in all of which a technical knowledge of the duties imposed is

of essential importance.”
Objective of accounting may differ from business to business depending upon

their specific requirements. However, the following are the general objectives of

accounting.

i) To keeping systematic record:

It is very difficult to remember all the business transactions that take place.

Accounting serves this purpose of record keeping by promptly recording all the

business transactions in the books of account.

ii) To ascertain the results of the operation:

Accounting helps in ascertaining result i.e., profit earned or loss suffered in business

during a particular period. For this purpose, a business entity prepares either a Trading

and Profit and Loss account or an Income and Expenditure account which shows the

profit or loss of the business by matching the items of revenue and expenditure of the

some period.

iii) To ascertain the financial position of the business:

In addition to profit, a businessman must know his financial position i.e., availability

of cash, position of assets and liabilities etc. This helps the businessman to know his

financial strength. Financial statements are barometers of health of a business entity.

iv) To portray the liquidity position:

Financial reporting should provide information about how an enterprise obtains and

spends cash, about its borrowing and repayment of borrowing, about its capital

transactions, cash dividends and other distributions of resources by the enterprise to

owners and about other factors that may affect an enterprise’s liquidity and solvency.

v) To protect business properties:

Accounting provides up to date information about the various assets that the firm

possesses and the liabilities the firm owes, so that nobody can claim a payment which

is not due to him.

vi) To facilitate rational decision –making:

Accounting records and financial statements provide financial information which help

the business in making rational decisions about the steps to be taken in respect of

various aspects of business.

vii) To satisfy the requirements of law:

Entities such as companies, societies, public trusts are compulsorily required to

maintain accounts as per the law governing their operations such as the Companies

Act, Societies Act, and Public Trust Act etc. Maintenance of accounts is also

compulsory under the Sales Tax Act and Income Tax Act
2. Provision for doubtful debts

The provision of doubtful debts also as known as allowance for doubtful accounts, is

a balance sheet account that reduces the reported amount of accounts receivable. (A

change to the balance in the allowance for doubtful accounts also affects bad debt

expense on the income statement.) Providing an allowance for doubtful accounts

presents a more realistic picture of how much of the accounts receivable will be

turning to cash. After all, a company selling products (or services) on credit to

thousands of customers will likely have a few customers who will not be able to pay

the full amount they owe to the company.

Accounting for the Provision for Doubtful Accounts

If a company is using the accrual basis of accounting, it should record an allowance

for doubtful accounts, since it provides an estimate of future bad debts that improves

the accuracy of the company’s financial statements. Also, by recording the allowance

for doubtful accounts at the same time it records a sale, a company is properly

matching the projected bad debt expense against the related sale in the same period,
Accounting entries

Increase in provision With the increase in the amount of provision

for bad debts

Dr Profit and Loss

Cr Provision for Bad Debts

Decrease in provision With the decrease in the amount of provision

for bad debts

Dr Provision for Bad Debts

Cr Profit and Loss

Increase in provision for bad debts

Example

A firm decided to make a provision for bad debts at 10% of the debtors’ accounts
which totalled $50,000 on 31 December 1994.

On 31 December 1995, the debtors accounts totalled $60,000. The firm maintained
the provision at 10% of its total debtors.
Provision for
1994 1994
Dec Bad
$ 31 Balance c/d
Debts
Dec
$ 31 Profit and loss
5,000 5,000
($50,000
Profit and* 10%)
Loss Account for the year
1994 (Extract)
ended 31 December
Gross profit $ $
X
Less: Expenses
Increase in provision for bad debt 5,000
Balance Sheet as at 31 December
Current Assets 1994
(Extract)
Debtors 50,000
Less: provision for bad5,000
debt
45,000

Provision for
1994 1994
Bad
Dec$ 31 Balance c/d Debts
Dec
$ 31 Profit and loss
5,000 5,000
1995($50,000 * 10%) 1995
Dec 31 Balance c/f Jan 1 Balance b/d 5,000
Dec 31 Profit and Loss 6,000 1,000
($60,000*10%) 6,000
6,000
Profit and Loss Account for the year
1994 1995
ended 31 December (Extract)
Gross profit $ $ $ $
X X
Less: Expenses
Increase in provision for bad debt 1,000
5,000
Balance Sheet as at 31 December (Extract)
Current Assets 1994 1995
Debtors 50,000 60,000
5,000 6,000
Less: provision for bad45,000
debt 54,000

Decrease in Provision for bad debts

Example

The debtors’ accounts on 31 December 1996 totalled $40,000. The firm decided to
maintain the provision at 10% of the total debtors.

Provision for
1994 1994
Dec Bad
$ 31 Balance c/d Debts
Dec
$ 31 Profit and loss
5,000 5,000
1995($50,000 * 10%) 1995
Dec 31 Balance c/f Jan 1 Balance b/d 5,000
Dec 31 Profit and Loss 6,000 1,000
6,000
($60,000*10%) 6,000
1996 1996
Dec 31 Profit
$ and Loss Jan 1 Bal$ b/f
2,000 6,000
Balance c/f
($40,000*10%) 4,000
6,0 6,0
00 00
Profit and Loss Account for the year
1994 1995
ended 31 December 1996
(Extract)
Gross profit $ $ $ $ $ $
X X X
Add: Decrease
Less: Expenses in provision for bad debts
Increase in provision for bad debt 1,000
2,000 5,000

Balance Sheet as at 31 December

Current Assets 1994 1995 1996
(Extract)
50,00060,000 40,000
Debtors
5,000 6,000 4,000
Less: provision for bad debt
45,00054,000 36,000

For example, a company records $10,000,000 of sales to several hundred customers,

and projects (based on historical experience) that it will incur 1% of this amount as
bad debts, though it does not know exactly which customers will default. It records
the 1% of projected bad debts as a $100,000 debit to the Bad Debt Expense account
and a $100,000 credit to the Allowance for Doubtful Accounts. The Bad Debt
Expense is charged to expense right away, and the Allowance for Doubtful Accounts
becomes a reserve account that offsets the account receivable of $10,000,000 (for a
net receivable outstanding of $9,900,000). The entry is:

Debit Credit
Bad Debt Expense 100,000
Allowance for Doubtful Accounts 100,000

Later, several customers default on payments totaling $40,000. Accordingly, the

company credits the accounts receivable account by $40,000 to reduce the amount of
outstanding accounts receivable, and debits the Allowance for Doubtful Accounts by
$40,000. This entry reduces the balance in the allowance account to $60,000. The
entry does not impact earnings in the current period. The entry is:

Debit Credit
Allowance for Doubtful Accounts 40,000
Accounts Receivable 40,000

A few months later, a collection agency succeeds in collecting $15,000 of the funds
that the company had already written off. The company can now reverse part of the
previous entry, thereby increasing the balances of both accounts receivable and the
allowance for doubtful accounts. The entry is:

Debit Credit
Accounts Receivable 15,000
Allowance for Doubtful Accounts 15,000
4. Financial Statements

Financial statements are a collection of reports about an organization's financial

results, condition, and cash flows. They are useful for the following reasons:

 To determine the ability of a business to generate cash, and the sources and

uses of that cash.

 To determine whether a business has the capability to pay back its debts.

 To track financial results on a trend line to spot any looming profitability

issues.

 To derive financial ratios from the statements that can indicate the condition of

the business.

 To investigate the details of certain business transactions, as outlined in the

disclosures that accompany the statements.

The standard contents of a set of financial statements are:

 Balance sheet: Shows the entity's assets, liabilities, and stockholders' equity as

of the report date.

 Income statement: hows the results of the entity's operations and financial

activities for the reporting period.

 Statement of cash flow: Shows changes in the entity's cash flows during the

reporting period. Which classified into three categories: operating cash flows,

investing cash flow, financing cash flow

 Statement of Stockholders' Equity: This statement displays how equity

changes from the beginning of an accounting period to the end.