Pack your bags and come on an adventure with me. We’re time travelling to 15th century Venice to meet Luca Pacioli, a Franciscan monk who was later dubbed ‘The Father of Accounting’. In his fifth book, known simply as The Summa, he writes that every merchant needs three things: sufficient cash or credit, good bookkeepers and an accounting system to view the business affairs at a glance.
He discusses the creation of three books: the memorandum, the journal and the ledger–except these had a different meaning back then.
The memorandum is the book where all transactions are recorded in the currency in which they are conducted; at the time when they are conducted. It is prepared in a chronological order and is essentially a narrative of the business’ economic activities. In 15th century Venice, the memorandum was necessary because invoices, bank statements and other official record-keeping documents had not yet been born.
The second book, the journal; is one that all students of accounting will be familiar with. Except in the days of Pacioli, it was the merchant’s private book; and it was where he would record the business activities in chronological order in only one currency.
The final book, the ledger is–again, is one that all students of accounting will know. It is an alphabetic listing of all the business accounts along with a running balance of each particular account.
In Pacioli’s day, financial statements were never discussed. Why? Because financial statements, even till today, are prepared to communicate the results of the business to interested users. Businesses that were tightly controlled by owners had no need for these financial statements. Nevertheless, Pacioli did recommend doing a yearly ‘balancing’ to determine the ‘failure’ or ‘success’ of the business as well as to determine if there were any errors.
It was during Pacioli’s time that two important concepts emerged: the monetary unit concept as well as the periodicity concept.
The monetary unit concept is simple to modern eyes. It asserts that money will now be the common unit of measurement for economic activity. This concept was a crucial development in economic thought as we no longer had to record the number of cows, sheep, crops and so on. We could instead just reflect the monetary value of the produce or products we were intending to sell.
Prior to this system, merchants had to keep complicated lists of all the items available for sale–except they could not be defined by a common denominator.
The periodicity concept, on the other hand, then insisted that we assess the success or failure of our enterprise at regular intervals. It was due to this key development at this particular point in history that income became the key measurement tool through which we determined whether our businesses had succeeded or failed.
In modern terminology, we call this cash basis accounting. Even till today, small businesses and sole proprietors use cash basis accounting
Regardless of the size or scale of your venture, there are four basic principles which underly accounting as a discipline. The creation of a business entity, the belief and faith in the entity as a growing concern, a common monetary unit for measurement as well as periodicity.
By the Industrial Revolution, however, the accounting system would change. Not necessarily in its entirety, but it would have to grow even more complex to account for the advent of manufacturing.