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«by Salama Salem May 2012 A thesis submitted in partial fulfillment of the requirements for a baccalaureate degree in Accounting Reviewed and approved ...»

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THE PAST, PRESENT, AND FUTURE OF ACCOUNTING:

ARE WE HEADED IN THE RIGHT DIRECTION?

by

Salama Salem

May 2012

A thesis

submitted in partial fulfillment

of the requirements

for a baccalaureate degree

in Accounting

Reviewed and approved by:

Andrew Pogogeff, CPA

Professor of Accounting

Thesis Supervisor

Submitted to

the Honors Program, Saint Peter's College

March 20, 2012 ii Abstract This study outlines the accounting profession and its progression throughout history in terms of methods, technology, fraud, and fraud prevention. The chapters are broken into early history, twentieth century, and twenty first century. The results show that, even though fraudulent activity has increased, all positive areas such as prevention technology, methods, and regulation have also increased to accommodate these mishaps and provide a better business environment.

ii

TABLE OF CONTENTS

Chapter 1

Introduction

Chapter 2

Early History

Double Entry Method

Pacioli

Cost Accounting

Standard Methods

Audit

Technology

Fraud

Chapter 3

CPA Exam

Ponzi Scheme

Securities Acts

Kreuger and Toll

McKesson and Robbins

Securities and Exchange Commission

First Business Computer

First Accounting Software

Chapter 4

Enron

Arthur Andersen

Sarbanes-Oxley Act of 2002

Forensic Accounting

Benford‟s Law

Conclusion

Works Cited

–  –  –

This study analyzes the direction of the accounting profession throughout history up until current events. One of the goals of this study is to appeal to students and all people of all different areas of study, not just accounting majors and professional accountants. The purpose of this study is to raise awareness of all the positive elements of the accounting profession and shed honest light on the negative aspects. The accounting profession has been often been portrayed negatively in the media due to exceptionally massive corporate scandals. However, the media does not often show the progress the accounting profession is making in general and also towards preventing and deterring these frauds as well. Shedding light on these important aspects is another goal of this study.

The next chapter, chapter two, discusses how different areas of early accounting developed. It was essential to include historical and geographical information pertaining to the development of accounting as a whole. Areas of accounting that are discussed are standard methods, cost accounting, auditing, and fraud. Early figures such as Pacioli and da Vinci are also discussed alongside their contributions to the accounting profession that still echo in business, technology, and mathematics today. Technology is also discussed a great deal as the invention of calculators and their many different variants and successors were vital to the progression of the accounting field.

The following chapter, chapter three, outlines the impact and progression of accounting in the twentieth century. The CPA exam is briefly discussed. Specific types of fraud, such as ponzi and pyramid schemes, are revealed and discussed. Subsequently, the Securities and Exchange Commission as well as the Securities Acts of 1933 and 1934 were introduced to address those frauds. In the realm of technology, the first business computer and first accounting software were touched on as the successors for the calculators.

The fourth and final chapter discusses the twenty first century accounting in the business world. Enron, Arthur Andersen, and Sarbanes-Oxley are all included in chapter four. Their impact on accounting regulation and the business world is discussed. The new and exciting field of Forensic Accounting is elaborated on. Benford‟s Law is also used to explain certain aspects of Fraud Prevention. Since this chapter contains much fairly recent information, a lot of sources are newspaper articles, such as The New York Times, as well as fairly recent scholarly journals.

–  –  –

During the 15th Century, Europe was exiting the Dark Ages and an era known as the Age of Discovery had started. This era brought about exploration, trade, conquest, and colonization between Europe and the continents of Africa, Asia, and America for many different reasons. (Weis and Tinius) In the area of trade, different systems of recording transactions were used. However, only one was prominent enough to still be used today. This system, which is believed to be the first written work of Accounting, was produced in the 15th Century by Franciscan friar, Luca Pacioli, now known as the father of accounting. His book is called “Summa de Arithmetica Geometria Proportioni et Proportionalita” or Everything About Arithmetic, Geometry and Proportion. Pacioli‟s “Summa” was widely read across Italy and was one of the first written works to be published on the Guttenberg Press. (Luca Pacioli: The Father of Accounting). It was the first written work to discuss the double entry accounting method, also known as the Venetian method (Sangster 432). This method was discussed in Summa with “such detail and clarity” that it became the standard accounting method since the book was published and remains as the foundation for today‟s accounting. (Weis and Tinius) Pacioli‟s writings emphasized legality and organization. He recommended procedures that would eliminate the possibility of fraud and keeping records in such a manner that would allow for them to be used in court. The first chapter of his book “would show how the merchant should keep his accounts and entries in an orderly way 'so that everything may readily be found in its place' - for otherwise there will be muddle and confusion, and no peace of mind.” (Yamey 375-376)

–  –  –





The double entry method is highly regarded throughout history as a great advancement in accounting method. German Economist and Sociologist Werner Sombart stated that the double entry method helps accountants depict assets as “money values which increase or grow less” instead of actual, individual products, which provides a better illustration for business. Sociologist James Aho goes as far as saying that the double entry method proves the “legitimacy” and “ethicality” of businesses whose functions could have been “morally suspect” or “even denounced by Church.” However, the comments were still detailed enough as to be able to identify a product or service, if needed. An entry written in 1512 by a silk merchant was so detailed that it provided enough information for an art historian to identify a painting that had an unknown painter. There have been quite a few instances of historians discovering information through early accounting ledgers. (Yamey 377, 379)

–  –  –

Pacioli, himself, was a friar with a passion for math and science that stemmed from his youth. At the age of sixteen, he decided to pursue a scholarly path involving mathematical and scientific theory. It is important to note that Pacioli works were written in Italian. Even though most scholarly work at the time was published in Latin, Italian publications meant that it was more practical to native common people and not just the educated. Pacioli emphasized practicality is his teachings. Pacioli “stressed the importance of putting theory to practical use, applying mathematical principles to business, and explaining ideas in common terms.” This was an underlying quality of Pacioli and was one of the reasons why his work was able to reach such a broad audience. (Weis and Tinius)

–  –  –

Cost accounting has also played a significant role throughout history. It is assumed that cost accounting started to develop in the late 15th century, during the reign of Henry VII in England. Fed up with restrictions, woolen manufacturers relocated their businesses to the countryside to escape the organized guild monopoly of the city.

However, these newly small businesses discovered that in order to succeed and survive, they needed to keep better track of their costs, something that was not necessary when they worked under the regulations of the monopoly. (Garner 385) As time passed, cost accounting became even more necessary. Fairly common complications were: having too much inventory at one time, payroll fraud/error, depreciation of equipment, cost adjustment for competition or slower seasons, evaluation of costs through monitoring all levels of production. However, early businesses still had the same general purposes as today, such as controlling the steps of productions and reducing waste of materials and labor. (Garner 387) One story of successful business, specifically involving accounting, comes from the 18th Century. Well-known potter, Josiah Wedgwood, noticed that his business was not operating as efficiently. Faced with a depression, he had to take it upon himself to save his business. He examined the records and found that his clerks were stealing money from him. Upon hiring a new clerk, they corrected inaccuracies and incorporated overhead costs and weekly reviews of their records. As businesses and laws became more complex, the need for professional accountants became apparent. In 1845, the first accounting firm opened in London. (How Technology Has Impacted Accounting)

–  –  –

Before computers became widespread, accounting was virtually all on paper. This would be done by a “bookkeeper” and was commonly known as bookkeeping.” Recording financial information would be done on a “General Journal” at first. This written record would be divided into columns. Each column contained an account that was used frequently and one column at the end would serve as a record for all the remaining accounts. Critical details such as amount, date, and comments were also recorded. At the end of the period, the totals were calculated. It was absolutely vital to make certain that all of the accounts zeroed out. This means that the total debits equaled the total credits in the account. If they did not, then the accounts must be reviewed and calculated again until the error is discovered. Even an error of a few cents was not to be overlooked because it was possible that those few cents could be the difference of multiple large errors. The bookkeeper would use a Trial Balance to balance the debits and credits. (Averkamp) The correct totals would then be written into a “General Ledger” and used to create Balance Sheets and Earning Statements. As the business grows, more journals are needed. Therefore, different journals were used for customers, employees, vendors, etc. Once these journals are zeroed out at the end of the period they can be posted to the General Ledger and also to a respective ledger of its own for more detailed records. (Zimmer)

–  –  –

Auditing, as defined by Columbia Electronic Encyclopedia, is the “examination and statement of accounts and of other documents connected with accounts by persons who have had no part in their preparation.” Auditor comes from the Latin word for “to hear” because auditors confirmed the validity of oral reports. The first known auditors were the spies of King Darius of ancient Persia. They would monitor the local Persian governors‟ actions. As the centuries went by, the auditors‟ role evolved from oral reports to verifying written documents. An important principle of auditing is Auditor Independence. Basically, an auditor should not have any bias toward the client. Bias, or even suspicion of bias, could greatly affect the validity of the audit. (Columbia Electronic Encyclopedia and McGraw Hill 1)

–  –  –

As accounting itself grew, the relevant technologies followed suit. A machine that could perform mathematical functions was needed. Wilhelm Schickard, a German scholar, was the first to design a device to calculate arithmetic tasks. It was at the request of astronomer Johann Kepler. Schickard built the machine for Kepler but it was destroyed in a fire before it was ever put to use. (CALCULATING MACHINES) Leonardo da Vinci also created a concept of a primitive version of a calculator which he called the “Codex Madrid.” This machine could theoretically be used to perform basic mathematical functions through its thirteen wheels (How Technology Has Impacted Accounting). Its design sketches were thought to be lost. They were found after da Vinci‟s death. Although the concepts involved were correct, the machine could not function efficiently if it were to be produced due to friction between the shafts and wheels. (Remoortel) It wasn‟t until 1642 that the first functioning calculator was created. Blaise Pascal, also credited for his accomplishments in mathematical theory and fluid power, invented the first mechanical calculator when he was a teenager. Although being a technological breakthrough, Pascal‟s calculator, also known as the “Pascaline,” did not sell very well.

Pascal was able to operate it and use it to perform addition and subtraction tasks to his liking. However, most people could not use the complicated device successfully as Pascal could. (Karwatka) Following the path set by Pascal, the Step Reckoner was invented in 1673 by Gottfried Wilhelm von Leibniz. This early calculator model could add and subtract just like the Pascaline. (Freiburger) It could also multiply, divide, and calculate square roots, which was something its predecessors could not. (Maxfield) The first commercially successful calculator model was the Arithmometer, invented in 1820. This large device could perform the all of the tasks that the Step Reckoner could, but was easier to use and reasonably affordable. (Palladino) It was popular during the Industrial Revolution and continued to sell for 90 years. (Freiberger) Another successful early calculator was the Comptometer. This was the first device to have keys that users would press to perform tasks, much like the calculators of today. Its mechanical register made adding and subtracting much less time consuming.



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