2.2 First developments and implementation of accounting standards in Europe and in the United States

Accounting can be described as storytelling of a company’s business transactions through the books of accounts, also as a discipline that seeks to provide information about a business entity1, to facilitate the accountability of management to the company’s stakeholders and as “the systematic recording of financial and economic transactions and other events”.2 The main events that marked the history of accounting “throw(s) a light on economic and business history generally, and may help us better predict what is on the horizon as the pace of global business evolution escalates”.3 The origins of accounting were traced back in 3600BC when trade started in Mesopotamia, now Iraq. J. R. Edwards (1989) divides the development of accounting in four periods: the pre-capitalist period between 4000 BC and 1000 AD; the commercial capitalism between the years 1000-1760; the industrial capitalism between the years 1760-1830 and the financial capitalism between 1830 to date. Bookkeeping in Mesopotamia and Babylonia was then made in stone and clay tablets. It was developed in parallel to writing.4 At this point, bookkeeping was mainly meant to meet Government and business’ needs.5 Later in Lydia (the ancient kingdom of West Asia Minor), in 700 BC, coined money was invented. Afterwards, the practice of coining money spread to other Mediterranean countries, as Greece, where accounting was further developed.6 Bookkeeping became easier7as transactions could then be expressed in financial terms.8As extensively acknowledged in the literature (among others, Littleton, 1933; Peregallo, 1938; Brown 1968; Wolk, H.I., Francis, J.R., & Tearney, M.G., 1986; J. R. Edwards, 1989; Alexander, 2002; Marshall, Mc Manus & Fiele, 2004; Véron 2007, Soll, 2014)9 financial accounting practices developed between the 13th and 14th centuries in Italy, in the cities of Florence, Genoa and Venice. In these cities, around the year 1300, evolved the decisive and innovative event of the double-entry bookkeeping method of registering financial operations, still known today. According to this method every financial event is entered twice, as a debit and as a credit, in a company’s accounting books, to calculate profit and loss, and to balance assets and liabilities. By 1390 the double-entry method was in full operation within and outside Florence, in Italy.10 In 1494 a Franciscan Friar called Luca Pacioli described the double-entry method in his book “Summa de Arithmetica, Geometria, Proportioni et Proportionalita” published in Venice.1112The creation of the double- entry bookkeeping method marked the start of modern accounting13 and modern capitalism.14The history of modern accounting is “part of the necessary information management machinery required by successful modern nation-states”.15 To this date, the double-entry method allows companies to keep track of their business. It is based on this basic model of accounting that a balance sheet is produced, having survived several financial crises.16 Eventually, this practice developed and it contributed to the development of capitalism.17 In the 20th century, Max Weber, a German political economist, believed in the importance of average people having knowledge of the double-entry bookkeeping for the success of capitalism.18 One may say that it has been a successful model so far and the precedent of the present accounting practice.

From the publishing of the double-entry method in 1494 until the industrial revolution in the 18th century and in the 19th century when professional accounting bodies started to emerge in the United Kingdom (UK), there was a period of stagnation, both in the evolution of business and accounting practices.19 It was called the “age of stagnation”.20Accounting practices originated without regulation and tended to accompany business practices. After the “age of stagnation” business practices increased and became more complex, and accountants were then challenged to deal with a higher demand for information.21 The first companies, as the Dutch East India Company, already since the year 1602 have been preparing financial statements registering their costs and profits. The double-entry method started to be used in the Netherlands in the beginning of 1500s and it was widely used, from the lower society class including prostitutes, to the highest social ranking, the Prince of Orange.22 Already in this period accounting fraud was known to be possible, Luca Pacioli described in his book that Venetian traders kept one accounting book to show to customers and another one to show to suppliers.23

In the UK, for example, although it was used since the sixteenth century, it was only in the end of the eighteenth century that the double-entry method became fully operational. The slow use of the double-entry method until then is thought to be due to the lack of business demand.24

In the 19th century companies began to publish their financial statements, with or without a legal requirement. The fact that companies published their financial statements without a legal requirement shows the shift towards the publication of financial statements. At this point balance sheets changed from serving as internal accounting documents to information for prospective shareholders, creditors, and the public as a whole. The publication of financial statements led to the development of specific industry’ regulations as well as the need for some standardization of accounting. However, due to the nature and scale of their business activities, only certain industries as railway companies in 1868, gas companies in 1871 and electric lighting companies in 1882, were the object of accounting legislation.25 The reasoning behind these industry standardization was to protect investors, improve comparability and disclosure. At first, accounting was done in the exclusive interest of the shareholders and later as corporations grew, it became also in the interest of markets and of investors.26 The growth of corporations led them to look beyond their own national business market, as this one was no longer enough to feed their trading objectives. With international trade growing, corporations were making business transactions with corporations operating in different countries.27 Therefore, investors were attracted to invest in foreign companies. Since accounting requirements were developed in national company law the challenge was to accurately evaluate a corporation’s performance and compare it against its competitors. Corporations were then reporting their business transactions using diverse approaches and methods.

By the mid-19th century accountancy takes form as an organized profession, local accounting firms emerge and around the 1890s the first accounting courses were introduced at universities.28 The ancestors of the Big Four accounting firms originated between 1840 and 1870.29 “By 1900, six of the firms that would become “The Big Eight” had been founded”.30 In the 19th century the laissez-faire was dominant and companies were free to develop their business activities.31 These companies were able to choose the most suitable accounting principles and policies to their activities and they reported in a discretionary way to investors.32 The harmonization of accounting standards on a national level came as a result of the growing mobility of capital and with the introduction of stock exchanges.33 Although transparency was higher, it was still common practice to keep crucial financial information away from public capital markets and this only changed after the great financial crash in 1929.34 The times followed by World War I were of prosperity and optimism. The stock market rapidly rose and reached what the economist Irving Fisher called a “high plateau”. The excessive confidence and speculation led to economic and financial imbalances and in result, in 1929, the US stock market collapsed, followed by a great financial depression.