What is accounting?

Accounting is the recording of financial transactions plus storing, sorting, retrieving,

summarizing, and presenting the information in various reports and analyses. Accounting is also
a profession consisting of individuals having the formal education to carry out these tasks.

One part of accounting focuses on presenting the information in the form of general-
purpose financial statements(balance sheet, income statement, etc.) to people outside of the
company. These external reports must be prepared in accordance with generally
accepted accounting principles often referred to as GAAP or US GAAP. This part of accounting
is referred to as financial accounting.

Accounting also entails providing a company's management with the information it needs to
keep the business financially healthy. These analyses and reports are not distributed outside of
the company. Some of the information will originate from the recorded transactions but some of
the information will be estimates and projections based on various assumptions. Three examples
of internal analyses and reports are budgets, standards for controlling operations, and estimating
selling prices for quoting new jobs. This area of accounting is known as management accounting.

Another part of accounting involves compliance with government regulations pertaining to

income tax reporting.

Today much of the recording, storing, and sorting aspects of accounting have been automated as
a result of the advances in computer technology.


The Accounting Equation
 Financial Reporting Objectives
 Generally Accepted Accounting Principles
 Internal Control
 Introduction to Accounting
 Understanding Financial Statements
Analyzing and Recording Transactions

Adjustments and Financial Statements

Completion of the Accounting Cycle

Accounting for a Merchandising Company

Subsidiary Ledgers and Special Journals

Cash
Receivables

Inventory

Operating Assets

Related Topics:
Accounting Principles II

Economics

Principles of Management

18

Introduction to Accounting
Accounting is the language of business. It is the system of recording, summarizing,
and analyzing an economic entity's financial transactions. Effectively
communicating this information is key to the success of every business. Those who
rely on financial information include internal users, such as a company's managers
and employees, and external users, such as banks, investors, governmental
agencies, financial analysts, and labor unions. These users depend upon data
supplied by accountants to answer the following types of questions:

• Is the company profitable?

• Is there enough cash to meet payroll needs?
• How much debt does the company have?
• How does the company's net income compare to its budget?
• What is the balance owed by customers?
• Has the company consistently paid cash dividends?
• How much income does each division generate?
• Should the company invest money to expand?

Accountants must present an organization's financial information in clear, concise

reports that help make questions like these easy to answer. The most common
accounting reports are called financial statements.

Accounting Basics: Introduction

By Bob Schneider
By Bob Schneider

Accounting is a glorious but misunderstood field. The popular view is that it's
mostly mind-numbing number-crunching; it certainly has some of that, but it's
also a rich intellectual pursuit with an abundance of compelling and
controversial issues. Accountants are often stereotyped as soulless drones
laboring listlessly in the bowels of corporate bureaucracies. But many
accountants will tell you that it's people skills, not technical knowledge, that
are crucial to their success. And although it's often thought of as a discipline of
pinpoint exactitude with rigid rules, in practice accountants rely heavily on best
estimates and educated guesses that require careful judgment and strong
imagination.

Actually, stereotyping accounting and accountants, either positively or

negatively, is useless because accounting involves so many different
activities. The short-but-sweet description of accounting is "the language of
business." A more formal definition is offered by The American Accounting
Association: "The process of identifying, measuring and communicating
economic information to permit informed judgments and decisions by users of
the information."

However defined, accounting plays a vital role in facilitating all forms of

economic activity in the private, public and nonprofit sectors, in endeavors
ranging from coal mining to community theater to municipal finance.

Accounting Basics: History Of

Accounting
By Bob Schneider
By Bob Schneider
The name that looms largest in early accounting history is Luca Pacioli, who in
1494 first described the system of double-entry bookkeeping used by
Venetian merchants in his Summa de Arithmetica, Geometria, Proportioni et
Proportionalita. Of course, businesses and governments had been recording
business information long before the Venetians. But it was Pacioli who was
the first to describe the system
of debits and credits in journals and ledgers that is still the basis of today's
accounting systems.

The industrial revolution spurred the need for more advanced cost
accountingsystems, and the development of corporations created much larger
classes of external capital providers - shareowners and bondholders - who
were not part of the firm's management but had a vital interest in its results.
The rising public status of accountants helped to transform accounting into a
profession, first in the United Kingdom and then in the United States. In 1887,
thirty-one accountants joined together to create the American Association of
Public Accountants. The first standardized test for accountants was given a
decade later, and the first CPAs were licensed in 1896.

The Great Depression led to the creation of the Securities and Exchange
Commission (SEC) in 1934. Henceforth all publicly-traded companies had to
file periodic reports with the Commission to be certified by members of the
accounting profession. The American Institute of Certified Public
Accountants(AICPA) and its predecessors had responsibility for setting
accounting standards until 1973, when the Financial Accounting Standards
Board (FASB) was established. The industry thrived in the late 20th century,
as the large accounting firms expanded their services beyond the
traditional auditingfunction to many forms of consulting.

The Enron scandals in 2001, however, had broad repercussions for the
accounting industry. One of the top firms, Arthur Andersen, went out of
business and, under the Sarbanes-Oxley Act, accountants faced tougher
restrictions on their consulting engagements. One of the paradoxes of the
profession, however, is that accounting scandals generate more work for
accountants, and demand for their services continued to boom throughout the
early part of the 21st century. (For details on this and other scandals see, The
Biggest Stock Scams Of All Time.)

Accounting Basics: Branches Of

Accounting
By Bob Schneider
By Bob Schneider

Accounting can be divided into several areas of activity. These can certainly
overlap and they are often closely intertwined. But it's still useful to distinguish
them, not least because accounting professionals tend to organize
themselves around these various specialties.

Financial Accounting
Financial accounting is the periodic reporting of a company's financial position
and the results of operations to external parties through financial statements,
which ordinarily include the balance sheet (statement of financial
condition),income statement (the profit and loss statement, or P&L),
and statement of cash flows. A statement of changes in owners' equity is also
often prepared. Financial statements are relied upon by suppliers of capital -
e.g., shareholders, bondholders and banks - as well as customers, suppliers,
government agencies and policymakers. (To learn more on this read, What
You Need To Know About Financial Statements.)

There's little use in issuing financial statements if each company makes up its
own rules about what and how to report. When preparing statements,
American companies use U.S. Generally Accepted Accounting Principles, or
U.S. GAAP. The primary source of GAAP is the rules published by the FASB
and its predecessors; but GAAP also derives from the work done by the SEC
and the AICPA, as well standard industry practices. (For more on this
see, What is the difference between the IAS and GAAP?)

Management Accounting
Where financial accounting focuses on external users, management
accountingemphasizes the preparation and analysis of accounting information
within the organization. According to the Institute of Management
Accountants, it includes "…designing and evaluating business processes,
budgeting and forecasting, implementing and monitoring internal controls, and
analyzing, synthesizing and aggregating information…to help drive economic
value."

A primary concern of management accounting is the allocation of costs;

indeed, much of what now is considered management accounting used to be
called cost accounting. Although a seemingly mundane pursuit, how to
measure cost is critical, difficult and controversial. In recent years,
management accountants have developed new approaches like activity-based
costing (ABC) and target costing, but they continue to debate how best to
provide and use cost information for management decision-making.

Auditing
Auditing is the examination and verification of company accounts and the
firm's system of internal control. There is both external andinternal auditing.
External auditors are independent firms that inspect the accounts of an entity
and render an opinion on whether its statements conform to GAAP and
present fairly the financial position of the company and the results of
operations. In the U.S., four huge firms known as the Big Four -
PricewaterhouseCoopers, Deloitte Touche Tomatsu, Ernst & Young, and
KPMG - dominate the auditing of large corporations and institutions. The
group was traditionally known as the Big Eight, contracted to a Big Five
through mergers and was reduced to its present number in 2002 with the
meltdown of Arthur Andersen in the wake of the Enron scandals. (For further
information see, An Inside Look At Internal Auditors.)

The external auditor's primary obligation is to users of financial statements

outside the organization. The internal auditor's primary responsibility is to
company management. According to the Institute of Internal Auditors (IIA), the
internal auditor evaluates the risks the organization faces with respect to
governance, operations and information systems. Its mandate is to ensure (a)
effective and efficient operations; (b) the reliability and integrity of financial
and operational information; (c) safeguarding of assets; and (d) compliance
with laws, regulations and contracts.

Tax Accounting
Financial accounting is determined by rules that seek to best portray the
financial position and results of an entity. Tax accounting, in contrast, is based
on laws enacted through a highly political legislative process. In the U.S., tax
accounting involves the application of Internal Revenue Service rules at the
Federal level and state and city law for the payment of taxes at the local level.
Tax accountants help entities minimize their tax payments. Within the
corporation, they will also assist financial accountants with determining the
accounting for income taxes for financial reporting purposes.

Fund Accounting
Fund accountingis used for nonprofit entities, including governments and not-
for-profit corporations. Rather than seek to make a profit, governments and
nonprofits deploy resources to achieve objectives. It is standard practice to
distinguish between a general fund and special purpose funds. The general
fund is used for day-to-day operations, like paying employees or buying
supplies. Special funds are established for specific activities, like building a
new wing of a hospital.

Segregating resources this way helps the nonprofit maintain control of its
resources and measure its success in achieving its various missions.

The accounting rules for federal agencies are determined by the Federal
Accounting Standards Advisory Board, while at the state and local level the
Governmental Accounting Standards Board (GASB) has authority.

Forensic Accounting
Finally, forensic accounting is the use of accounting in legal matters, including
litigation support, investigation and dispute resolution. There are many kinds
of forensic accounting engagements: bankruptcy, matrimonial divorce,
falsifications and manipulations of accounts or inventories, and so
forth.Forensic accountants give investigate and analyze financial evidence,
give expert testimony in court and quantify damages.

Accounting Basics: The Basics

By Bob Schneider
By Bob Schneider

The Difference Between Accounting and Bookkeeping

Bookkeeping is an unglamorous but essential part of accounting. It is the
recording of all the economic activity of an organization - sales made, bills
paid, capital received - as individual transactions and summarizing them
periodically (annually, quarterly, even daily). Except in the smallest
organizations, these transactions are now recorded electronically; but before
computers they were recorded in actual books, thus bookkeeping.
 The accountants design the accounting systems the bookkeepers use. They
establish the internal controls to protect resources, apply the principles of
standards-setting organizations to the accounting records and prepare the
financial statements, management reports and tax returns based on that data.
The auditors that verify the accounting records and express an opinion on
financial statements are also accountants, as are management, tax
and forensic accounting specialists. (To learn more see, Accounting Not Just
For Nerds Anymore.)

Double-Entry Bookkeeping
The economic events of a business are recorded as transactions and applied
to the accounts (hence accounting). For example, the cash account tracks the
amount of cash on hand; the sales account records sales made. The chart of
accounts of even small companies has hundreds of accounts; large
companies have thousands.

The transactions are posted in journals, which were (and for some small
organizations, still are) actual books; nowadays, of course, the journals are
typically part of the accounting software. Each transaction includes the date,
the amount and a description.

For example, suppose you have a stationery store. On April 19, a

saleswoman for an antiques company visits you, and you buy a lamp for your
office for $250. A journal entry to record the transaction as a debit to the
Office Furniture account and a $250 credit to Accounts Payable could be
written as follows (Dr.is the abbreviation for debit, while Cr. is for credit):

Date Account Dr. Cr.

April 19 Office Furniture 250

 Accounts Payable 250

(Bought antique lamp; voucher #0016)

Each accounting transaction affects a minimum of two accounts, and there

must be at least one debit and one credit.

Keeping Good Accounting Records

Even a seemingly simple transaction like this one raises a host of accounting
issues.
Date:Suppose you had already agreed by phone to buy the lamp on April 15,
but the paperwork wasn't done until April 19. And the lamp wasn't delivered on
the 19th, but the 23rd. Or even as you bought it, you were thinking that you
didn't like it that much, and there's a strong chance you'll return it by the 30th,
when the sale becomes final. On which date - 15th, 19th, 23rd, or 30th - did
an economic event occur for which a transaction should be recorded?

Amount:The sales price is $250, but you get a 10% discount (to $225) if you
pay in 30 days; business is bad, though, so you may need the full 90 days to
pay. Similarly, however, you know the antique business is also lousy; even
though you agreed to pay $250, you can probably chisel another $50 off the
price if you threaten to return it. On the other hand, being in the stationery
business, you know one of your customers has been looking for a lamp like
that for a long time; he told you in February he'd pay $300 for one.

So what amounts should you record on April 19 (if indeed you record a
transaction on that date)? $250 or $225 or $200 or $300?

Accounts:You've debited the Office Furniture account. But actually you buy
and sell antiques frequently to your customers, and you're always ready to sell
the lamp if you get a good offer. Instead of an Office Furniture account used
forfixed assets, should the lamp be recorded in a Purchases account you use
forinventory? And if this was a big company, there might be dozens of office
furniture sub-accounts to choose from.

Accountants rely on various resources to answer such questions. There are

basic, time-honored accounting conventions: standards set forth by various
rules-making bodies, long-standing industry practices and, most important,
their own judgment honed through years of experience.

But the important point is that even the most basic accounting questions -
when did an economic event take place? What is the value of the transaction?
Which accounts are affected by the transaction? - can get very complex and
the right answers prove very elusive. There's no excuse for out-and-out
misrepresentation of company results and sloppy auditing that certainly
occurs. But the seeming precision of financial statements, no matter how
conscientiously prepared, is belied by the uncertainty and ambiguity of the
business activities they seek to represent.

Debits and Credits

We're accustomed to thinking of a "credit" as something "good" - our account
is credited when we get a refund; you get "extra credit" for being polite.
Meanwhile, a "debit" is something negative - a debit reduces our bank
balance; it's used to mean shortcoming or disadvantage.

In accounting, debit means one thing: left-hand side. Credit means one thing:
right-hand side. When you receive cash - a "good" thing - you increase the
Cash account by debiting it. When you use cash - a "bad" thing - you
decrease Cash by crediting it. On the other hand, when you make a sale,
which is nice, you credit the Sales account; when someone returns what you
sold, which is not nice, you debit sales.
"Good" and "bad" have nothing to do with debit and credit.

Debit = Left; Credit = Right. That's it. Period.

Accrual vs. Cash Basis Accounting

As we've seen, deciding when an economic event occurs and an accounting
transaction should be recorded is a matter of judgment. Accrual
accountinglooks to the economic reality of the business, rather than the actual
inflows and outflows of cash. (For more on this see, The Essentials of Cash
Flow.)

Although cash basis statements are simpler and make good sense for many
individual taxpayers and small businesses, it results in misleading financial
statements. Consider a Halloween costume maker: it conceives, produces
and sells costumes throughout the year, but gets paid for its costumes mostly
in October. If sales were recognized only when cash was received, October
would show an enormous profit while all other months would show losses.
Accrual accounting seeks to match the revenues earned during a period with
theexpenses incurred to generate them, regardless of when cash comes in or
goes out. (For details see, When should a company recognize revenues?)

Accounting Basics: The Accounting

Process
By Bob Schneider
By Bob Schneider

As implied earlier, today's electronic accounting systems tend to obscure the

traditional forms of the accounting cycle. Nevertheless, the same basic process
that bookkeepers and accountants used to perform by hand are present in
today's accounting software. Here are the steps in the accounting cycle:

(1) Identify the transaction from source documents, like purchase orders, loan
agreements, invoices, etc.

(2) Record the transaction as a journal entry (see the Double-Entry Bookkeeping
Section above).

(3) Post the entry in the individual accounts in ledgers. Traditionally, the accounts
have been represented as Ts, or so-called T-accounts, with debits on the left and
credits on the right.

(4) At the end of the reporting period (usually the end of the month), create a
preliminary trial balance of all the accounts by (a) netting all the debits and
credits in each account to calculate their balances and (b) totaling all the left-side
(i.e, debit) balances and right-side (i.e., credit) balances. The two columns should
be equal.

(5) Make additional adjusting entries that are not generated through specific
source documents. For example, depreciation expense is periodically recorded
for items like equipment to account for the use of the asset and the loss of its
value over time.

(6) Create an adjusted trial balance of the accounts. Once again, the left-side
and right-side entries - i.e. debits and credits - must total to the same amount.
(To learn more see, Fundamental Analysis: The Balance Sheet.)

(7) Combine the sums in the various accounts and present them in financial
statements created for both internal and external use.

(8) Close the books for the current month by recording the necessary reversing
 entries to start fresh in the new period (usually the next month).

Nearly all companies create end-of-year financial reports, and a new set of books
is begun each year. Depending on the nature of the company and its size,
financial reports can be prepared at much more frequent (even daily) intervals.
The SEC requires public companies to file financial reports on both a quarterly
and yearly basis.

1. Definition of accounting
What is accounting? People in the business world consider it to be quite important. When you plan to
invest in McDonald's stock, buy new equipment, or forecast future sales and expenditures, you almost
certainly use accounting information. Why? Because, accounting provides information for decision-
making in the business world.
Accounting is a service-based profession that provides reliable and relevant financial information useful
in making decisions.

Financial information may include sales, expenses, taxes and other figures.
There are three steps to preparing financial information:identification, recording and communication.
First, economic events are identified. A sale at a gas station, payment of taxes by a commercial
enterprise, or purchase of insurance are all examples of economic events.
Next, all economic events are recorded. Recording provides a history of a company's financial activities.
In this step, economic events are also classified and summarized.
Finally, information about classified and summarized economic events is communicated to interested
parties. Such communication may take several forms. One such form is a financial statement which you
will read about later in this tutorial.
2. Users of accounting information
There are two broad categories of interested parties, or accounting information users:
 external users
 internal users
External users are parties outside the reporting entity or company who are interested in the accounting
information.

Types of external users include:

 Investors (i.e., owners), who use accounting information to make buy, sell or keep decisions related to
shares, bonds, etc.
 Creditors (i.e., suppliers, banks), who utilize accounting information to make lending decisions.
 Taxing authorities (i.e., Internal Revenue Service), who need accounting information to determine a
company's tax liabilities.
 Customers, who may need accounting information to decide which products to buy from which
companies.
 Internal users are parties inside the reporting entity or company who are interested in accounting
information.

Types of internal users include:

 A company's senior and middle management, who use accounting information to run the business.
 Employees who use accounting information to determine a company's profitability and profit sharing.
Financial accounting provides information that is designed to satisfy the needs of external users. Such
reporting is usually done in the form of financial statements.
Managerial accounting provides information that is useful in running a company by internal users. Such
reporting is usually accomplished through custom-designed (or managerial) reports.

The illustration below shows relationships between the types of accounting and accounting information
users.
Illustration 1: Types of accounting and accounting information users

Luca Pacioli: The Father of Accounting*

In 1494, the first book on double-entry accounting was published. The author
was an Italian friar, Luca Pacioli. His impact on accounting was so great that five
centuries later, accountants from around the world gathered in the Italian village
of San Sepulcro to celebrate the anniversary of the book's publication.The first
accounting book actually was one of five sections in Pacioli's mathematics book
titled "Everything about Arithmetic, Geometry, and Proportions." This section
on accounting served as the world's only accounting textbook until well into the
16th century.
Since Pacioli was a Franciscan friar, he might be referred to simply as
Friar Luca. While Friar Luca is often called the "Father of Accounting,"
he did not invent the system. Instead, he simply described a method used by
merchants in Venice during the Italian Renaissance period. His system
included most of the accounting cycle as we know it today. For example, he
described the use journals and ledgers, and he warned that a person should
not go to sleep at night until the debits equalled the credits! His ledger
included assets (including receivables and inventories), liabilities, capital,
income, and expense accounts. Friar Luca demonstrated year-end closing
entries and proposed that a trial balance be used to prove a balanced
ledger. Also, his treatise alludes to a wide range of topics from accounting
ethics to cost accounting.

Pacioli was about 49 years old in 1494 - just two years after Columbus
discovered America - when he returned to Venice for the publication of his
fifth book, Summa de Arithmetica, Geometria, Proportioni et
Proportionalita (Everything About Arithmetic, Geometry and Proportion).
It was written as a digest and guide to existing mathematical knowledge,
and bookkeeping was only one of five topics covered. The Summa's 36
short chapters on bookkeeping, entitled De Computis et Scripturis (Of
Reckonings and Writings) were added "in order that the subjects of the
most gracious Duke of Urbino may have complete instructions in the
conduct of business," and to "give the trader without delay information as
to his assets and liabilities" (All quotes from the translation by J.B.
Geijsbeek, Ancient Double Entry Bookkeeping: Lucas Pacioli's Treatise,
1914).

Numerous tiny details of bookkeeping technique set forth by Pacioli were

followed in texts and the profession for at least the next four centuries, as
accounting historian Henry Rand Hatfield put it, "persisting like buttons
on our coat sleeves, long after their significance had disappeared." Perhaps
the best proof that Pacioli's work was considered potentially significant
even at the time of publication was the very fact that it was printed on
November 10, 1494. Guttenberg had just a quarter-century earlier invented
metal type, and it was still an extremely expensive proposition to print a
book.

Accounting practitioners in public accounting, industry, and not-for-profit

organizations, as well as investors, lending institutions, business firms, and
all other users for financial information are indebted to Luca Pacioli for his
monumental role in the development of accounting.
_____
The Father of Accounting: Luca Pacioli
The discipline and science of accounting is essential for the world economy to function well.
Without an accurate way to keep track of investments, expenditures, depreciation, and more,
there would be no way to understand the true financial picture of a company and no way to be
confident in its prospects. This would kill commerce, capital investment, and other transactions
that keep the economy running.

The history of accounting is more fascinating than many people probably imagine, and several
figures have made key contributions to the science. One of the most important people in the
history of accounting is Luca Pacioli, a Franciscan friar who lived during the fifteenth and
sixteenth centuries, and who is today known as the “Father of Accounting.” This resource will
provide a history of accounting and an overview of Pacioli’s contributions to the discipline.

History of Accounting

Most people are not likely to think of accounting when the topic of the “world’s oldest profession”
is raised, but many experts believe that accounting fits that description to a tee. From the start, it
was necessary for individuals to have a way to keep track of their business dealings even if they
were largely self-sufficient, merely growing their own food and taking care of their other needs.
As civilization progressed, ancient bookkeeping methods were developed. In the so-called
“Fertile Crescent,” ancient bookkeepers would use clay tokens of different shapes and sizes to
keep track of wealth. Each token could represent a different commodity — sheep, cattle, grain,
and so forth. New technologies and recording methods developed over time, and as money was
introduced to facilitate economic exchange, the token system was abandoned in the favor of
written accounts.

During the medieval period, Italian merchants began to involve themselves in trade with other
cities, first across the Mediterranean Sea and then in other parts of the world. The increasing
complexity of these trade relationships required better record keeping, and the system of
double-entry bookkeeping was invented. Luca Pacioli, an Italian Franciscan monk wrote Summa
de Arithmetica, Geometrica, Proportioni et Proportionalita in 1494, and it was the first full
description of this method of accounting.
During the Enlightenment and Industrial Revolution, Britain’s rise as the world’s chief economic
power meant that accounting methods would have to advance as well. Men such as Josiah
Wedgwood began implementing systems of cost accounting in their companies, and
professional accountants began offering their services in London. Such methods were carried
over to the United States, and large firms such as General Motors adopted these accounting
methods as well. Today, standardized accounting practices are in use across the globe, helping
companies around the world to stay afloat, attract investment, and keep the engine of the world
economy running.
The Life of Luca Pacioli

Luca Pacioli was born in 1445 in Tuscany, Italy, where he received an education in the ways of
medieval merchants and commerce. Over time, his interest in mathematics led him to become
an expert tutor in the subject, and he wrote a textbook on mathematics to help instruct his
students. During the years 1472–1475, Pacioli became a Franciscan friar, but he did not end his
tutoring career.

In 1494, Pacioli published his most famous work —Summa de Arithmetica, Geometria, Proportioni
et Proportionalita. In addition to providing instruction in standard mathematics, this work would
also describe double-entry bookkeeping completely for the very first time, which has earned for
him the title “father of accounting.” It was also the first textbook on algebra that was written in
the vernacular language of northern Italy. Eventually, Pacioli would travel to Milan, where he
became an associate of Leonardo da Vinci. Da Vinci actually learned a lot about mathematics
from Pacioli, and the knowledge he gained would help Da Vinci create some of the excellent
anatomical drawings for which he is known today.
Much of Pacioli’s work in mathematics was not original or unique, but his writings had a large
influence in Italy, allowing for information that was formerly the possession merely of the elite to
be disseminated among the general populace. Pacioli died in 1517, the same year that Martin
Luther’s 95 Theses in Germany would help spark the Protestant Reformation.

Friar Luca’s Contributions to Accounting

Pacioli did not actually invent double-entry bookkeeping, nor did ever claim to have done so. He
gave credit to one Bendetto Cotrugli for coming up with the system, as he relied on an
unpublished by Cotrugli for the portion of his work on accounting in his own Summa.
Nevertheless, Pacioli’s summation of the method was incredibly important for the history of
accounting, as it was one of the first descriptions of double-entry bookkeeping to be distributed
on a large-scale.
Double-entry bookkeeping allows for a company or individual to keep track of credits and debits
and thereby keep accounts in balance. Every financial transaction is recorded in two columns,
debits in the left and credits in the right, ensuring that the ways in which each transaction affects
every aspect of the company’s finances is properly recorded. For example, a company that
takes payment for a specific service will record a debit in the cash account and a credit in the
revenue account, allowing them to keep track of the real impact of the payment on the
company’s bottom line.

Double-entry bookkeeping itself may not sound all that exciting, but without it, most experts
would confess that the industrial revolution and growth of free-market capitalism could never
have happened. Luca’s description of double-entry bookkeeping ensured that the process would
become widely adopted across the Western world and would encourage the rise of Europe and
the United States as global powers.
Without the work of an otherwise obscure Franciscan friar in the fifteenth and sixteenth
centuries, the economy as we know it today could not exist. Pacioli’s description of double-entry
bookkeeping led to the rise of modern accounting, accurate record keeping, and the overall
growth of industry and trade. Understanding his role in accounting history is important for
understanding Western history and the way in which the economy functions today.

Luca Pacioli – The Father of Accounting

Life of Luca Pacioli

Luca Pacioli who was known as the father of accounting born in

1446 in Sansepolcro where he also received his earlier education known as abbaco education. The
knowledge he got was focused on knowledge required by merchants. While working as a tutor to the
three sons of merchant, he continued his own education in Venice in 1464 and during this time he
wrote his first book on accounting. Then he wrote a comprehensive abbaco textbook in vernacular
for his students who were studying from him during the period of 1477 and 1478. Then he started
teaching at the University level in Italy and he taught in numbers of Universities in Italy including
Perugia, holding the first chair in mathematics and contributing his knowledge to his students. In
1494, his first book on Summa de arithmetica, geometria and proportioni et proportionalita got the
publication in the city of Venice in Italy.

It was the time when he got huge reception for his work written on geometry, arithmetic and
mathematical proportions. Then in 1497, he got a invitation to resume his working in Milan from
Lodovico Sforza where he collaborated and transferred his ideas on mathematics and taught
mathematics to Leonardo da Vinci. When the Louis XII of France captured the city and drove their
patron out, it was the time when Pacioli and Leonardo had to leave the city of Milan in 1499. In 1517,
Pacioli died at the age of 70 in Sansepolcro where he spent most of his time at the final years of his
life.
Luca Pacioli’s Contribution to Accounting

The contribution of Luca pacioli in accounting was honored by accountants around the world who
gathered in San Sepulcro an Italian village to pay their huge tribute to his book published on double-
entry accounting. The first accounting book which was published in 1494 was based on five sections
in his mathematical book title in which he showed ‘Everything about Arithmetic, Geometry and
Proportions’. Until the 16th century, this book written on accounting served as the only textbook on
accounting around the world and due to this significant contribution, Luca Pacioli, was no doubt the
father of accounting. He did not invent the system but he described the method which was used by
merchants in Venice during the period of Italian Renaissance. The system he introduced in his book
of accounting was mostly the accounting cycle which is well-known in the modern world of
accounting. Luca Pacioli introduced the use of journals and ledgers in accounting systems and
warned that the accountant must not sleep until the debits are equaled to credits. The ledgers he
introduced were based on assets receivables and inventories, liabilities, capital, expenditure and
income accounts. Friar Luca also demonstrated the entries which the companies can use for their
yearend and he proposed the entry of trial balance for a balanced ledger. He also introduced wide
range of topics ranging from accounting ethics to cost accounting. His proposed accounting entries
and year end closing entries became so famous that they were widely used in industrial and financial
organizations in the modern world. Today, no organization can ignore his proposed journal and
ledger accounting system and then showing the balance of debits and credits to get the desired
results for the organizations. When he published his book on accounting, he was 49 years old in the
year 1494, returned to Venice for the famous publication of his fifth book on Geometria, Summa de
Arthmetica, Proportioni et Proportionalita. This book was written on Geometry, Everything about
Arithmetic and Proportions. In this book, he presented the guide to the already written mathematical
knowledge and bookkeeping was one of the most important accounting topics covered in this book.
He presented 36 short written chapters on bookkeeping in which he gave the necessary instructions
in the conduct of business and given the traders precious information on accounting without any
delay as to his assets and liabilities. Luca Pacioli also introduced numerous details about
bookkeeping techniques which were followed in texts and in professions for the next four centuries.
Then the accounting historian Henry Rand Hatfield argued that Pacioli’s work was potentially
significant even at the time of publication when it was first printed in November 10, 1494. Now his
underlined accounting principles are used by various accounting practitioners in industrial
accounting, public accounting, and accounting services for non-profit organizations. Accounting
techniques were proved to be very effective for investors, business firms, lending institutions, and all
the entire users of financial information are indebted to Luca Pacioli for his unbelievable and
monumental role in the development of accounting.
Luca Pacioli’s Legacy

Due to his double-entry bookkeeping system in accounting, organizations can follow the transactions
from one business to another which gave them right directions in financial growth. Organizations
become much familiar about yearend accounting entries to make the best records of their
expenditures and income in the form of yearend financial statements and income statements of the
organizations. The system introduced by Luca Pacioli was efficient and reliable in record keeping for
all types of businesses and organizations and it established the financial understanding through
global investment possibilities. Today, investors, shareholders, business firms and lending
institutions have appreciated and recognized his contributions as vital in the financial growth of
different businesses around the world. His accounting systems and double-entry bookkeeping record
systems are most widely used around the world in different manufacturing, industrial, services, and
hospitality organizations. No organization can survive without adopting his introduced record keeping
and double-entry accounting systems and system of accounting cycle which is most widely taught
and used in professionals’ organizations and accounts institutions. Luca Pacioli’s introduced
systems of accounting allowed people to record their investments and then attracting the
contributions of wealthy merchants into their businesses. Without the contribution of Luca Pacioli in
the field of accounting the trade with the new World and the Far East would have been slower and
even halted together. He gave way to the integration of ideas during the period of Renaissance in
Europe. At that time different fields were integrated to each other including art, science, business,
engineering and mathematics was central to the all parts of the fields. He established very strong
relationship and connection among various fields and the colleagues working with him during that
time. His double entry bookkeeping books on accounting are now published in different languages
such as German, English, Dutch and Italian helping people around the world to grasp knowledge in
the field of accounting and then serve in their respective fields thanks to Luca Pacioli who has given
us with such opportunities in the field of accounting.