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Accounting TheoryAccounting Theory

Topic : Accounting History Topic : Accounting History after Luca Pacioli after Luca Pacioli

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Accounting & CapitalismAccounting & CapitalismBeginning in the fifteenth century, Beginning in the fifteenth century, economic power began to shift from economic power began to shift from Italy to England. The economic Italy to England. The economic philosophy that prevailed from the philosophy that prevailed from the 1515thth to 17 to 17thth centuries is called centuries is called mercantilism. The mercantilist school mercantilism. The mercantilist school of thought created a system where of thought created a system where the central govt attempted to control the central govt attempted to control and regulate all the phases of and regulate all the phases of business activity.business activity.

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Accounting & CapitalismAccounting & Capitalism

There were rules for governing labor, There were rules for governing labor, methods of production, types and methods of production, types and quality of products, selling prices, quality of products, selling prices, methods of marketing etc. but such methods of marketing etc. but such rules were difficult to enforce.rules were difficult to enforce.

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By the late 18By the late 18thth century, a new principle century, a new principle concerning business became widely concerning business became widely accepted. The principle was that the accepted. The principle was that the economic initiative should come from economic initiative should come from individuals rather than from the govt. It is individuals rather than from the govt. It is difficult to say exactly when capitalism difficult to say exactly when capitalism emerged or when the industry revolution emerged or when the industry revolution started, bit the middle or the later part of started, bit the middle or the later part of the 18the 18thth century appears to be the safe century appears to be the safe assumptions. assumptions.

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CapitalismCapitalism

The focal point of capitalism is The focal point of capitalism is market which is self regulated by a market which is self regulated by a price mechanism made by operative price mechanism made by operative by supply and demand. Capitalism by supply and demand. Capitalism results in certain notion such as results in certain notion such as private property, money, private property, money, credit ,capital and profit become credit ,capital and profit become institutionalized that is they become institutionalized that is they become integral part of the economy. integral part of the economy.

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Capitalism and double entry systemCapitalism and double entry system

Double entry and capitalism are Double entry and capitalism are connected intimately as form and connected intimately as form and content. Double entry bookkeeping content. Double entry bookkeeping has proceeded from the same root of has proceeded from the same root of capitalism. capitalism.

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Sombart’s argumentsSombart’s argumentsTwo essential characteristics of Two essential characteristics of

capitalism according to Sombart are : capitalism according to Sombart are : 1)profit making 1)profit making 2)economic rationality.2)economic rationality. Economic rationality implies that Economic rationality implies that

participants choose resources in participants choose resources in relation to their goals, so that relation to their goals, so that maximum benefit are expected. maximum benefit are expected.

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Sombart’s argumentsSombart’s arguments

Sombart believed that double entry Sombart believed that double entry bookkeeping was one of the bookkeeping was one of the technological devices that propelled technological devices that propelled the development of capitalism. With the development of capitalism. With respect to profit making, Sombart respect to profit making, Sombart gave twofold answer: Firstly gave twofold answer: Firstly accounting is the way to determine accounting is the way to determine profit in capitalistic enterprise. profit in capitalistic enterprise.

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Cont….Cont….He gave the following two reasons why He gave the following two reasons why

double entry contributed to the growth of double entry contributed to the growth of business enterprise:business enterprise:

a)a) Double entry book keeping permitted the Double entry book keeping permitted the separation of owner and business itself separation of owner and business itself thus facilitating the growth of corporation thus facilitating the growth of corporation in capitalistic economyin capitalistic economy

b)b) Double entry book keeping represent Double entry book keeping represent the flow of capital through the business the flow of capital through the business entity i.e. capital –nominal account-profit entity i.e. capital –nominal account-profit and loss-capital. and loss-capital.

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Sombart’s argumentsSombart’s arguments

Secondly, accounting helped in Secondly, accounting helped in formulate the concept of capital formulate the concept of capital quantitatively. In double entry quantitatively. In double entry system, capital is easily defined and system, capital is easily defined and determined.determined.

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Sombart’s argumentsSombart’s argumentsOn the double entry effect on the economic On the double entry effect on the economic rationality Sombart offered 3 reasons:rationality Sombart offered 3 reasons:

a)a) From the business firm, production and From the business firm, production and consumption are reduced to calculation since consumption are reduced to calculation since only transaction that affect the entity are only transaction that affect the entity are recorded and expressed in monetarily.recorded and expressed in monetarily.

b)b) Double entry allows planning and control.Double entry allows planning and control.c)c) Double entry helped in construction of a Double entry helped in construction of a

conceptual framework by defining the assets, conceptual framework by defining the assets, liabilities, revenues , expenses and profit. liabilities, revenues , expenses and profit.

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Disagreement with SombartDisagreement with SombartYamey ,an economist objects to Sombart’s Yamey ,an economist objects to Sombart’s arguments. His points are:arguments. His points are:

a)a) Business firm 16Business firm 16thth to 18 to 18thth century did not keep century did not keep their account to have an accurate check of their account to have an accurate check of capital and profit, but simply as a ready record capital and profit, but simply as a ready record of transaction.of transaction.

b)b) His second point is that there is no need for a His second point is that there is no need for a double entry system to determine profit and double entry system to determine profit and capital, a single entry can do itcapital, a single entry can do it

c)c) Double entry can only assist the business firm Double entry can only assist the business firm to solve the routine problemto solve the routine problem

d)d) Accounting data can not help to select among Accounting data can not help to select among the alternate opportunities.the alternate opportunities.

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The UK The UK By the end of the 18By the end of the 18thth

century: century: The concept of Joint The concept of Joint Stock company was Stock company was

developed in England. developed in England.

Permanent existence;Permanent existence;Limited liability of Limited liability of shareholders;shareholders;Transferability of Transferability of shares. shares.

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The UKThe UK

Therefore, there was a need for the Therefore, there was a need for the development of audit profession and development of audit profession and govt regulation. govt regulation.

In 1844: The Companies Act: The In 1844: The Companies Act: The concept of audited B/S came but concept of audited B/S came but again dropped in 1900. again dropped in 1900.

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Professional accounting societiesProfessional accounting societies

The first professional body of The first professional body of accountant was formed in Scotland in accountant was formed in Scotland in 1853, the Society of Accountant in 1853, the Society of Accountant in Edinburgh. This was followed by Edinburgh. This was followed by other group in Glasgow(1855) and other group in Glasgow(1855) and Aberdeen(1867). Soon after the Aberdeen(1867). Soon after the establishment ,3 Scottish societies establishment ,3 Scottish societies decided to constitute a General decided to constitute a General Examining board and to adopt the Examining board and to adopt the designation of Chartered Accountant.designation of Chartered Accountant.

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Professional accounting societiesProfessional accounting societies

In 1870, the first English societies were In 1870, the first English societies were formed in Liverpool and London. formed in Liverpool and London. Three similar group were after Three similar group were after established. But , professional established. But , professional accountant decided to exclude the accountant decided to exclude the unqualified people. As a result these unqualified people. As a result these 5 organization formed The Institute 5 organization formed The Institute of Chartered Accountant in England of Chartered Accountant in England and Wales(ICAEW)and Wales(ICAEW)

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Cont…Cont…

To be a member of the institute one To be a member of the institute one has to pass a series of examination has to pass a series of examination and serve five years. and serve five years.

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Professional accounting societiesProfessional accounting societies

The concept of fair presentation of The concept of fair presentation of financial result and position is also of financial result and position is also of British origin. Professional accounting British origin. Professional accounting thinking and practice was developed thinking and practice was developed in UK and later exported Australia, in UK and later exported Australia, Canada , USA and other countries. Canada , USA and other countries.

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Professional accounting societiesProfessional accounting societies

The first professional organization to The first professional organization to be formed in North America was the be formed in North America was the Association of Accountant in Association of Accountant in Montreal, The Institute of Chartered Montreal, The Institute of Chartered Accountant of Ontario was Accountant of Ontario was established in 1883 followed by a established in 1883 followed by a Dominion Association of Chartered Dominion Association of Chartered Accountant. (renamed Canadian Accountant. (renamed Canadian institute of Chartered Accountant ) in institute of Chartered Accountant ) in 1902.1902.

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Professional accounting societiesProfessional accounting societies

The first professional accounting The first professional accounting origination in U.S The Institute of origination in U.S The Institute of Accountant and Bookkeepers was Accountant and Bookkeepers was founded in 1882. In 1886 the founded in 1882. In 1886 the American Association of Public American Association of Public accountant was established which accountant was established which became the AICPA became the AICPA

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The USAThe USADuring 20During 20thth century, the major development of century, the major development of financial accounting shifted to the USA.financial accounting shifted to the USA.

Stock market crash: 1929 : Great depression. Stock market crash: 1929 : Great depression.

As a result: SEC was created by the Securities As a result: SEC was created by the Securities Act of 1934: insisted a disclosure based Act of 1934: insisted a disclosure based regulatory structure. regulatory structure.

Famous monograph: Famous monograph: An Introduction to An Introduction to corporate accounting standards corporate accounting standards by Paton and by Paton and Littleton in 1940: put huge recognition on Littleton in 1940: put huge recognition on Historical cost accounting. Historical cost accounting.

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The USA The USA

Historical cost: still the primary basis Historical cost: still the primary basis of accounting. of accounting.

Recent development: Arguments on Recent development: Arguments on ‘fair value’- valuation of any asset or ‘fair value’- valuation of any asset or liability on the basis of its market liability on the basis of its market value, the discounted present value value, the discounted present value of its future receipts, or in some of its future receipts, or in some cases by means of a mathematical cases by means of a mathematical model. model.

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Authoritative bodiesAuthoritative bodies

The most powerful authoritative body The most powerful authoritative body is SEC created in 1934. it has is SEC created in 1934. it has jurisdiction among all the companies jurisdiction among all the companies to issue securities and listed in the to issue securities and listed in the stock exchange. stock exchange.

They have the legal power to They have the legal power to prescribe the accounting standard prescribe the accounting standard and procedure for these companies. and procedure for these companies.

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Accounting principlesAccounting principles

Though accountants labored long Though accountants labored long and hard to find these basic and hard to find these basic principles, little success were principles, little success were achieved. achieved.

Never agreed with ‘what accounting Never agreed with ‘what accounting principles are’ !!!!!!!!!!!principles are’ !!!!!!!!!!!

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Cont….Cont….FASB: FASB: Prior to FASB:Prior to FASB:The authoritative body in the private The authoritative body in the private

sector was Committee on Accounting sector was Committee on Accounting Procedure (CAP) which operated Procedure (CAP) which operated between 1938 and 1959 and the between 1938 and 1959 and the Accounting Principle Board (APB) Accounting Principle Board (APB) which operated between 1559 to which operated between 1559 to 1973.1973.

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Cont….Cont….The FASB was created by the The FASB was created by the recommendation of the AICPA sponsored recommendation of the AICPA sponsored study group because of the dissatisfaction study group because of the dissatisfaction of the APB. of the APB.

FASB has seven members who are FASB has seven members who are appointed by the trustees of the Financial appointed by the trustees of the Financial Accounting Foundation (FAF). The trustee Accounting Foundation (FAF). The trustee of FAF come from variety of different of FAF come from variety of different organization like: AICPA, AAA, NAA, organization like: AICPA, AAA, NAA,

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IASBIASB

The IASB, based in London, began The IASB, based in London, began operations in 2001. The IASB is operations in 2001. The IASB is committed to developing, in public committed to developing, in public interest, a single set of high quality, interest, a single set of high quality, global accounting standards that global accounting standards that require transparent and comparable require transparent and comparable information in general purpose F/Ss.information in general purpose F/Ss.

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An overview:An overview:The IASB co-operates with national accounting The IASB co-operates with national accounting standard-setters to achieve convergence in standard-setters to achieve convergence in accounting standards around the world.accounting standards around the world.The IASB is selected, overseen and funded by the The IASB is selected, overseen and funded by the IASC Foundation.IASC Foundation.Financial support is received from the major Financial support is received from the major accounting firms, private financial institutes and accounting firms, private financial institutes and industrial companies throughout the world, industrial companies throughout the world, central and development banks and other central and development banks and other international and professional organization.international and professional organization.

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Cont…Cont…The IASB consists of fourteen members The IASB consists of fourteen members (twelve full-time and two part-time) and (twelve full-time and two part-time) and has full discretion in developing and has full discretion in developing and perusing the technical agenda for setting perusing the technical agenda for setting accounting standards.accounting standards.The main qualification for membership of The main qualification for membership of the IASB are professional competence and the IASB are professional competence and practical experience.practical experience.The publication of a standard, exposure The publication of a standard, exposure draft, of final IFRIC Interpretation requires draft, of final IFRIC Interpretation requires approval by nine of the IASB’s fourteen approval by nine of the IASB’s fourteen members.members.

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Some other notable eventsSome other notable events

Stock market boom in 1990s and its Stock market boom in 1990s and its collapse in the early 20collapse in the early 20

‘ ‘hi-tech’ industries crash hi-tech’ industries crash

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Some other notable eventsSome other notable events

Numerous financial reporting Numerous financial reporting irregularities: Specially in terms of irregularities: Specially in terms of revenue recognition. revenue recognition.

Most notableMost notableEnron Enron

WorldCom Inc.WorldCom Inc.

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So…regulation became imperativeSo…regulation became imperativeMost notable Most notable Sarbanes Oxley Act: Passed Sarbanes Oxley Act: Passed by the US Congress in 2002………………by the US Congress in 2002………………

Target:Target:improving corporate governance improving corporate governance Tightening audit function. Tightening audit function.

Public Company Accounting Oversight Public Company Accounting Oversight Board (PCAOB):Board (PCAOB): Sets auditing standards Sets auditing standards and inspect and discipline auditors of public and inspect and discipline auditors of public companies. companies.

Introduction of audit committees.Introduction of audit committees.

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IFRSIFRS2005:2005:

New era:New era: Because, Because, the financial rules the financial rules for a worldwide capital market..for a worldwide capital market..

25 EU member states;25 EU member states;AustraliaAustraliaNZNZRussiaRussiaSouth AfricaSouth Africa

So, now, major guidelines are either:So, now, major guidelines are either:US GAAP US GAAP IFRS IFRS

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IFRSIFRSCanadian GAAP (very similar to US GAAP) will Canadian GAAP (very similar to US GAAP) will be eliminated and replaced by IFRS in 2011. be eliminated and replaced by IFRS in 2011.

China required that listed companies employ China required that listed companies employ IFRS beginning with 2007 financial reporting.IFRS beginning with 2007 financial reporting.

In 2007, the SEC dropped the former In 2007, the SEC dropped the former reconciliation requirement (to US GAAP) that reconciliation requirement (to US GAAP) that had long applied to foreign private had long applied to foreign private registrants reporting under fully complaint registrants reporting under fully complaint IFRS. IFRS.

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Norwalk Agreement Norwalk Agreement

In 2002.In 2002.

An agreement between FASB and IASB. An agreement between FASB and IASB.

Done for the ‘convergence’ of two sets Done for the ‘convergence’ of two sets of standards. of standards.

A number of revisions of either US GAAP A number of revisions of either US GAAP or IFRS have already taken place to or IFRS have already taken place to implement this commitment, with more implement this commitment, with more changes expected in the near future. changes expected in the near future.