Accounting and management 101, part 1

Books on accounting typically consists of endless pages of definitions and things that has to be memorized. Important yes, but it might be more motivating and fun to have a histrorical, critical and personal introduction. An approach in which we learn about the problems for which the distinction and terms was introduced before we have to memorize it. An approach in which we mention the people behind the ideas to make it more interesting. An approach in which we invite to debate by presenting conflicting views and encourage critical thinking instead of mindnumbing memorization. Now, hard work is still needed and we will have to memorize things, but it becomes much easier and fun to do this when we understand the need, when we can connect the ideas to persons and problems and when we have to think about weaknesses.

Take the case of double accounting. The historical background was the increasing size of trade, banking and companies in Rennaisanse Italy. An individual person or small trader knew how much money he had. The number of transactions was small enough that a simple system, or even no formal system, was needed. However, when a company becomes larger, you need a method to make sure that you keep track of money going in and out. Not only do you need a system for that, you would like to have a system that makes it easy to discover mistakens. Did we recive the goods we ordered and have we paid the bill?

Double accounting was an answer to this problem. It was first described, but not really invented, by a Franciscan friar, Luca Pacioli, in a book from 1492. The title of the book is a bit ambitious - "Everything about Arithmetic, Geometry, and Proportions." Not exactly a humble title, but maybe he was primary Italian and only secondary a friar. In any case, the point is that every transaction is listed twice because it represents something that comes in (credit) as well as something that goes out (debit). So, if you buy a new ship, your fixed asset account is credited with the value of the ship, but the price of the ship is a debit to the cash asset account.

Luca Pacioli

So what, you might complain. Why should we go through the tedious work of recording every transaction twice - as debit and credit in different accounts? Isn't this a waste of time? It may be if you are running a very small business, but if you are in charge of a larger company you need a method of accounting that reduces the chance of making accounting errors. To see this imagine you run a business and suddenly one day discover that you have enough cash to buy a new castle. Sounds good, but it would be a very bad idea if the reason you had so much cash was that you had forgotten some that some of it was income from merchandise that you had yet to pay. Such a mistake might be easy to make if the number of transactions is large, and doube accounting reduces this problem because it forces you to keep track of both credit and debit. It is a device to detect errors. Every day you check whether debits and credits sum to zero. Buying a ship increases fixed assets, but reduce cash assets (or increase liabilities if it is to be paid later). There is always a balance. If not, a mistake has been made, and error is detected, and you have to double check your accounts. As Pacioli argued:  A good merchant should not go to sleep at night until the debits equalled the credits!

There is of course, much more to accounting that this story, but it illustrates some main ideas. Accounting is not an end in itself. It is a tool to be used to make good decisions. Can I afford to make this investment? How much money do I have? How much of it is in liquid assets? Which investment will give the highest expected return? How much does the various steps in the production process cost and is it possible to cut some of the costs?

The usefulness ot accounting, and the purpose of learning it, depends on the extent it is able to answer these and other questions that we have. This means that it is not a fixed set of rules to be memorized, but someting that can be improved and criticised. This makes the theory of accunting much more interesting and creative area than most people believe - and introductions to the field should reflect this instead of just the dull stuff.