Double Entry

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In Brief: we need to understand the underlying fallibility and subjectivity of accounts, and how the numbers blind us from what they fail to account for (e.g. environmental damage)… which is part of a broader trend of oversimplification which has us listen to what the “experts and numbers” say: GDP numbers, KPMG audit, S&P credit-rating, etc., to our detriment

  • crusades (11th century onwards) bring prosperity to the East-West conduit, Italy
  • fall of Constantinople -> rediscovery of Greek maths + popularization of Arabic numerals 
  • this^ + press + Pacioli -> spread of maths and double-entry accounting (DEA) as we know it
  • DEA made commerce super efficient and ‘transparent’ and allows…
  • … the later inventions of the joint stock and limited liability corporation, which help finance the infrastructure of the Industrial Revolution 
  • because better information -> better decision-making, national statistics and the conception of the GDP figure (ideas first pushed for by Kuznets and later developed by Keynes) and the method by which they are calculated – accounting -- become ubiquitous
  • accountancy firms pass the burden of exactitude onto management so in the end nobody’s really to blame: E&Y for Lehman Brothers and A. Andersen for Enron
    • conflict of interests: one floor of the firm is meant to audit while another gives advice on how to bypass rules and regulations, and flatter their financial statements
  • but while corporate accounting often misses the mark because its fundamentally subjective in key aspects such as asset valuation and costing, national accounting commits a worse crime: ignoring the elephant in the room: environmental damage 
    • because most natural resources are not considered assets, their (often irreversible) conversion into economically accountable goods, such as wood->timber is not recorded as capital depreciation
      • honeybee pollination activity is 60-100 times more valuable than the honey they produce

The Renaissance and the Age of Science were both catalyzed by the re-discovery of Greek mathematics and Hindu-Arabic arithmetic. Because the previous arithmetic system of Roman Numerals required the use of an abacus whose calculations were therefore never recorded, the commercial applications of Hindu-Arabic numerals and operations revolutionized the Western world where “wealth was seen as an obstacle to salvation” and education was monopolized by the Church. 

Jane Gleeson-White attributes this revival of the long-lost arts of mathematics to an Italian by the name of Pacioli -- an eminent thinker of his day by any standards and close friend of Da Vinci -- who in the 15th century exploited the recent invention of the press to publish books written in the vernacular of the people (i.e. Italian and not Latin), re-introducing maths in Summa and the concept of double-entry accounting (DEA) in De computis.

DEA allowed merchants to check at a glance whether their accounts were balanced or not, and involved the summation of merchandise accounts into a profit and loss account, the position of which was then either debited or credited to or from the capital account.

De computis, the first formalization of DEA (even referenced to by Tolstoy in Anne Karenina as “Italian book-keeping”) was revolutionary in its day but didn’t make mainstream waves until the nineteenth century and the advent of the joint stock, and later limited liability corporation. It then formalized the corporate machinations we today take for granted, the:

  • idea of income in the form of periodic dividends and not as self-contained ventures (i.e. the old payment-per-ship-voyage model)
  • differentiation between capital and income
  • concept of depreciation
  • establishment of auditing

More than one historian, the most prominent of whom is Sombart,  holds the contrarian opinion that the invention of DEA led to the rise of capitalism as we know it in that Marx used the definition of capital from DEA and thus the definition and concept of capitalism encapsulates the ideas in DEA… He even proposes that DEA led to the scientific revolution thanks to its subjecting of the world and the abstract to quantification and numbers… 

DEA was formative in the calculation of the first national economic statistics of the US by Kuznets, which was made necessary by the malaise and uncertainty surrounding the Great Depression and the 30’s, and subsequently commissioned by FDR and Hoover. Keynes brought the British government to the same understanding and reliable methods to calculate such stats were only made possible by his theoretical breakthroughs in developing a conceptual apparatus for understanding the working of an entire economy (GDP = C+I+G+(X-M)).

Helped by the creation of the World Bank and IMF, which made the gathering of national income statistics an essential task for every nation involved, accounting continued to rise to prominence through the 40s and 50s as these statistics became the key indicator of national success and government performance.

Yet accounting firms have proved again and again that they are unable to deliver the services they promise. an egregious problem that they mitigate with disclaimers like: “the application of accounting standards is subject to interpretation and professional judgement.” And while on one hand they are meant to create truthful analyses of a company’s financial situation, they are often paid to do the opposite: help their clients hide debts in complicated holding structures. 

And governments don’t do too much better with legislating effective regulation to prevent such accountancy mishaps for recurring.

Since Kuznets and Keynes, the modern world has developed a bit of a fetish for GDP. Markets jump at the release of new GDP figures and the production and release of new figures is a closely guarded process. But as RFK mentioned, GDP fails to account for many of the things that matter. It and the whole process of accounting need to be reviewed.