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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 Cos 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 students business
methods and commercial correspondence and Australian elementary bookkeeping
represent examples of the shift towards professional education and accreditation in the
accountancy profession.Double 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 enterprises 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 companys 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
Dr Profit and Loss

With the increase in the amount of provision


for bad debts

Cr Provision for Bad Debts


Decrease in provision
Dr Provision for Bad Debts

With the decrease in the amount of 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.

45,000

1,000

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.

31

Balance c/f
($40,000*10%)

4,000

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:
Bad Debt Expense
Allowance for Doubtful Accounts

Debit
100,000

Credit
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:
Allowance for Doubtful Accounts
Accounts Receivable

Debit
40,000

Credit
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:
Accounts Receivable
Allowance for Doubtful Accounts

Debit
15,000

Credit
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.