LBSAC3145 ADVANCED ACCOUNTING THEORY & PRACTICE

TUTORIAL ONE

The history of accounting demonstrates that it was responsible for the rise of
capitalism. Critically consider this assertion.

Reading:

Belkaoui, A.R. (2004) Accounting Theory, Chapter 1, Thomson Learning

Mathews, M.R. (1996) Accounting Theory & Development, Chapter 2, Thomas

Nelson.

Winjum, J. (1971), ‘Accounting and the Rise of Capitalism: An Accountant’s View,

Journal of Accounting Research, Vol. 9, (2), pp333-350

Yamey, B.S. (1964), ‘Accounting and the Rise of Capitalism: Further Notes on a
Theme of Sombart’, Journal of Accounting Research, Vol. 2, (2), pp.117-135

( Winjum & Yamey articles available electronically)

Introduction
The statement above makes reference tangentially to the Sombart thesis. In his major
work, Der Moderne Kapitalismus, Sombart asserts that capitalism and double-entry
bookkeeping are intimately inter-connected. In a section of the book which covered
the development of double- entry bookkeeping, he identified a number of stages:
1. The first appearance of accounts. They brought order to the “inextricable
confusion” of merchant’s records, which previously had no purpose other than
to prevent oversights, and took the form of basic notes with no underlying
system. According to Sombart, the first accounts were developed.
2. Development of DEB : each entry is recorded in two accounts, as a debit in
one, as a credit in the other. This is the fundamental principle of DEB.
Through this system, an enterprise’s accounts are inextricably linked, tightly
bound together like a “bundle of sticks”. Sombart thought this stage was
linked in the second half of the fourteenth century. In particular, he mentioned
the accounts of the city of Genoa, which were kept under a double entry
system from as early as 1340.
3. A third stage came about with the introduction of the capital account and a
profit & loss account – keeping track of every movement through the
company’s capital cycle, quantifying it and recording it in writing.
4. 1608 is taken as the year it was first proposed to close annual accounts and
establish a balance sheet within a DEB system.
5. Final stage considered by Sombart saw stocktaking in closing procedures – the
link between establishing the balance sheet and this non-accounting procedure

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 does not appear to have been realised until very late on. – in his opinion, it
went unnoticed throughout the early capitalism period.

Sombart was obviously far from ignorant of accounting history and considered that
DEB underwent an improvement process throughout the early capitalism period. He
believed that in the early capitalistic period, its economic principles were still
struggling for recognition. As capitalism developed and profits were rationally
pursued, scientific, mechanistic technology (of which DEB was a part) was widely
applied.

Sombart highlighted various aspects of the significance of a systematic accounting

system in the development of capitalism:

1. Keeping accounts encouraged order and clarity, which Sombart believes are
necessary for successful development of a capitalist system. Accounting
brought mathematical order to business.
2. The idea of accumulation also developed thanks to DEB – has only one
objective: to increase the value of a sum measured in a purely quantitative
manner. DEB obliterates consideration of the nature of goods and products,
the principle of satisfying demand is forgotten, all that matters is the idea of
accumulation – no other approach is possible, just values which appreciate or
depreciate. The concept of capital was created essentially from this point of
view since it can be defined as the capacity for accumulation as assessed
through DEB
3. DEB created a system of concepts which we use to understand the world of
the capitalistic economy. For instance the concept of capital – without DEB it
would not have come into being – the capacity for accumulation as assessed
through DEB. Also, the concept of production cost, non-production cost. If
DEB highlights the notion of capital and its accumulation then it also
engenders the notion of the capitalistic enterprise as an organisation designed
to increase the value of a given capital. This reveals the creative contribution
of DEB to the arrival of the capitalistic enterprise.
4. Finally, Sombart stresses DEB’s contribution to the separation of the business
and its owner. The capitalistic enterprise must be considered as the
organisation of production in such a way as to free each undertaking from its
owner. The company becomes autonomous and stands apart from the
businessman. The company is a separate entity and is a channel for capital
which has been constructed by integration into the accounting system and the
owner acts almost like a creditor supplying capital.

So, Sombart asserted that the system of double entry was an active catalyst in the
economic expansion that occurred in Europe, both as an instrument for the ordering of
economic data and in its role in transforming attitudes toward economic life. An
important component of the Sombart thesis is that in a capitalist economy, the firm is
continually trying to enlarge its capital through successive periods of profitable
operations.
Accounting provides analytical data which explains the various aspects of operations
which influenced the resulting increase or decrease in net capital, revealing an
analysis of positive & negative factors involved in the production of a net increase in

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the capital of the enterprise. Only double entry had the potential to provide relevant
data on individual activities and a comprehensive report on overall enterprise progress
and status.

Issues to consider

Economic Rationalism and Decision-making

Producers need relevant economic data for the rational appraisal of past managerial
decisions and the planning of future operations. Yamey (1964) who has commented
on this issue several times and can be considered to be Sombart’s most hostile
commentator, questions the relevance of income and capital calculations for decision-
making purposes, he recognises that they can be important for overall control of an
entity’s affairs. In the view of Winjum (1964), Yamey appears to underestimate the
role of accounting data in the decision-making process and concentrates almost
exclusively on the entrepreneur’s ability to anticipate future price movements through
market analysis – ignoring the role that past enterprise experience plays in the
predictive process. He stated that accounting data can only ever concern the past
while decisions relate to the future, therefore accounts can only have a very small role
to play in decision making. In Winjum’s (1971) view, prior experience will provide a
starting point for future estimates. Winjum vehemently disagrees with Yamey on this
point. He believes that the past has contributed to forming the business owner’s
judgement and market knowledge, and this helps him/her to anticipate events in a
more realistic way. Management can appraise previous decisions so that past
mistakes and errors can be analysed – internal review of decision-making- dependent
to some extent on accounting data.

Yamey does admit that if double entry was of material assistance in helping the
businessmen of the medieval period to allocate their resources among the alternatives
under consideration, “then a major part of the Sombart thesis would be established
and it would be appropriate to credit the invention of double entry with substantial
economic consequences”. The crucial question is whether the information contained
within the venture accounts of the merchants of the time would have served this
purpose. Yamey does not believe that it would – he believes that it played a minor
part in building up the capitalist system. He states that in a continuing enterprise,
knowledge of total or aggregated profitability or rate of return on capital is not
relevant to current decisions which are concerned with changes in the use of part of
the resources at the firm’s disposal. Whatever value there may be in calculations of
total profit or of total capital, in Yamey’s view, it is clear that they can be made
independently of double entry bookkeeping. This is the case of course – the inventory
method (accounting equation).

Double entry cannot contain the materials necessary for a complete inventory of
assets and liabilities. In the accounts we have data as to cost of acquisition, but not
current values. If current values are taken into account and incorporated in the
calculation of profits, then suitable entries have to be made in the income statement to
reflect profits and losses on the revaluation of assets. The income statement is no
longer an independent check on the calculation of profit, but equally dependent on the
results of external inventory taking.

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Yet in an analysis of the books kept by merchants in the 16th and 17th centuries there is
evidence that they understood the accounting techniques involved in accounting for
the performance of their various ventures, and were strongly motivated by the desire
for profits. There was enough detail in the accounting ledgers for the calculation of
profit or loss on each venture, market or commodity. So, perhaps not every merchant
took up the opportunity to exploit the contribution that double entry could make to the
rational pursuit of profits, some clearly did. A merchant called John Johnson who
Winjum (1964) describes as having a complete set of accounts. These accounts
revealed the original cost of his merchandise, plus any additional expenditures for
freight, commissions and other charges. Sales were recorded and the profit or loss on
each venture was calculated upon its completion. The use of an integrated system of
interrelated accounts contributed to a systemisation of the merchant’s business affairs.
Order and systematic organisation were necessary for prosperity and the source of
order was double entry bookkeeping. It created order out of chaos, it brought
information together from scattered memoranda which prior to this had formed the
basis of the merchant’s records, so that he/she did not know the state of their finances.
Merchants appeared to rely on the systematic and integrating qualities of double
entry.

Calculation of total profit and total capital

Did double entry records facilitate and encourage the regular calculation of total profit
and capital. Yamey asserts that amongst English records of the time, there is little to
establish that double entry system went together with a regular balancing and
preparation of summary accounts. The construction of rudimentary balance sheets
was generally less regular and much less frequent than might be expected. A general
impression gained, is that closing of accounts and the balancing of accounts were just
as concerned with narrow bookkeeping purposes such as the accuracy of the ledger &
tidying up the ledger as with the calculation of total profit and the new capital figure.
Regular annual closings of the accounts became common practice relatively late in
history – during the second half of the twentieth century.

Yamey believes that the assertion that double entry was responsible for the separation
of the firm from the owners was invalid. The lack of validity was apparent from the
fact that partnership concerns were in operation before the invention of double entry
and many partnerships have operated without the system since its invention. There is
no evidence that these arrangements caused difficulties between individual proprietors
of between them and the firm. Also, joint stock companies functioned for long periods
without the double entry system e.g. the Dutch East India Company, Sun Fire
Insurance Office of London, Capital & Counties bank in England.

Yet Winjum emphasises that DEB did permit the separation of ownership and
management and thereby promoted the growth of the large joint stock company. By
permitting a distinction between personal and business assets and made possible the
autonomous existence of the enterprise. He states that the oldest surviving records in
DEB, those from Genoa in 1340, reveal just such a separation. This indicates that
people were aware of this opportunity from the earliest days, although it was not used
by most merchants, who had no need for it.

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The double entry system, though it calls for a capital account in the owners name,
does not enforce the rigorous separation of business assets and activities from
personal assets and activities.

In many sole proprietorships, household expenditures went through the business

books as well as the business expenses. The double entry system does little more than
provide a framework into which accounting data can be fitted and within which the
data can be arranged, grouped or re-grouped.

Yamey poses the question: did information revealed in the ledgers improve the ability
of business people to place resources where returns could be maximised? Where there
is a choice of options which are familiar to the business from past experience,
accounting records can provide information as to the likely results from choosing one
option over another, but this will depend on the stability of costs and prices over the
relevant period – where costs and prices not stable, the a/c records provide little or no
guidance. So , he concludes that accounting records played no more than a minor part
in accentuating the pursuit of profit by enabling the business person to select more
successfully from the opportunities open to him/her. This is not meant as a criticism
of double entry, it just an observation on the limited possibilities of the system.
If some of the claims made by Sombart are to be considred valid, business decision-
making would have been rendered more mechanistic and less risky and to that extent,
the capitalist entrepreneur would have had a less significant role in the development
of capitalism.

Yamey quotes the work of Professor Brachey who in his study of double entry
accounting records in early 19th century Baltimore, found that they aided in dealing
with routine problems of business management, rather than in the resolution of
entrepreneurial decisions. Therefore, the superiority of double entry should not be
exaggerated. A system of single entry with accounts for debtors, creditors and cash,
would provide a large part of the information necessary for decision-making.

Will also mention here the work of Lemarchand (1992, 1993, 19941) who put forward
new arguments against Sombart. He found that DEB was not the only accounting
model used by capitalist enterprises at least up to the 19th century. Lemarchand states
that two types of accounting co-existed: a DEB system inherited from merchants’
records and a “financial” system derived from the accounting practices of landowners,
who in the 19th century were also mine-owners and that these two systems were only
combined into a single DEB system in France at least, in the 19th century. Again, we
find the idea that the various capitalist actors had other calculation and valuation
methods open to them, not just DEB, and that they used these methods, just as they
could calculate capital and profit by the inventory method.

Accounts in “finance” operated on the basis of lists of expenses and income, but with
no balance sheet or capital account. Although it would be possible to calculate profit,
it would not be possible to relate the profit to investments or capital.

Of course we have not mentioned the “elephant in the room”, and that is Karl Marx.
Although he does not refer to accounting in great deal in his writings, it is possible to
1
Lemarchand, Y. (1994), ‘Double entry versus charge and discharge accounting in 18th century
France’. Accounting and Business History, Vol. 4 (1), 119-145

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relate his analysis of capital accumulation to the accounting practices of his time – the
19th century. The capitalist is forever throwing new capital into circulation with the
aim of increasing wealth formed by the total capital in action. What form does this
capital take? Money or merchandise? Value requires an independent form, by means
of which its identity can be asserted. Money forms the starting point and the
conclusion of every valuation process. This representation of capital corresponds very
closely to that given by balance sheets formed from the process of DEB. Other
aspects of Marx’s theory appear to correspond perfectly to 19 th century accounting
theory and as Bryer (1994) stresses, it is possible to derive from Marx a set of
accounting principles that are clear and consistent with the accounting practices of his
own time. He was well aware of the debate about the valuation of fixed assets and that
accounting choices have a direct impact on profit calculation and the determination of
potential dividends. Yet nowhere does Marx imply or state that accounting was
responsible for the rise of capitalism – he appears to imply that accounting facilitated
the rise of capitalism.

To conclude, we can say that there is something in each of these views. Whilst it is
possible to act in an entrepreneurial way without the benefits of double entry, the fact
is that it does promote order. It can provide information re past profitability which can
be a guide to the future. It certainly helped in the whole process of the development of
capitalism, it facilitated the rise of capitalism but it is overstating the case that it was
responsible for the rise of capitalism. However, we should acknowledge that the fact
that it still exists today, is a testament to its utility and longevity.