Bookkeeping in the Middle Ages

Modern accounting took root in the medieval world between the years 1200 and 1500 because circumstances surrounding commerce, capital and credit at this time provided the necessary condition for bookkeeping to emerge. Historical evidence in the form of accounting records attest to this. The fact that modern accounting emerged during the Middle Ages is highly significant for several reasons. First, modern accounting differentiates itself from most branches of professional activities in that one of its major techniques goes back as far as the 14th century. Secondly, the emergence of bookkeeping attests to the dynamic economic activity of the Middle Ages. It is therefore of the essence of accounting that it be used in an environment where active trade exists. It would not make sense for example for accounting to be used in a manorial economy in which people produced for subsistence and operated a barter economy. Scholars have done extensive research on medieval business records which show that the double-entry system of bookkeeping originated in Italy. According to these studies, it would seem that double-entry did not originate in one particular place but that it developed gradually and almost simultaneously in several Italian trading centres. Although no definite date can be given, what is certain is that double-entry system of bookkeeping originated between 1250 and 1350. The earliest records available so far date back to 1157 consisting of a few figures jotted down on three scraps of paper. These were inserted in the cartulary of the Genoese notary, Giovanni Scriba whose records included a number of partnership contracts mostly for the purpose of overseas trade. Italian merchants known to have dominated the trade of the Mediterranean devised these arrangements known as the commenda and the societas maris. Both involved co-operation between a travelling partner and an investing partner who stayed on land. The accounts in question were related to the winding up of three successive temporary partnerships between two Genoese merchants for the years 1156 to 1158. The first two ventures were a commenda. All the capital was contributed by the investing partner and the profits made at the end of the voyage were divided according to the rules of the commenda: three-fourths to the investor and one-fourth to the traveller. The third partnership was a combination of both the commenda and the societas maris contracts. Under the societas maris contract, the investing partner put twice the amount invested by the travelling partner and profits were to be shared equally between the partners.

Historical evidence also shows that much of accounting practice as it is today can be traced to business organisation in the past. Accounting is historical by nature: its essence is to express in quantitative form business transactions which happened in the past. Accounting is not a priori to business activity. Since trade rests on the exchange of goods and services, the duality which forms the basis of double-entry book-keeping is deeply rooted in the nature of business. It is therefore not surprising that the merchants would eventually hit upon a system founded on an equation between debits and credits. Prior to the 12th century, trade was minimal in Western Europe. People lived in manors which were isolated settlements and surrounded by wilderness. Within the manor, trade was minimal arising from the small weekly markets amongst the peasants or on the occasion of a travellers presence seeking shelter in the manor. Between manors little economic interactions occurred. The high risk of travelling outside the manor made it far more efficient to adjust to economic needs by moving people when necessary, rather than by moving goods regularly; hence the individual settlements were fairly selfsufficient and isolated. The itinerant medieval merchant had little incentive to trade as he was constantly exposed to the danger of losing his stock of goods to road bandits. After the 12th century however, a number of factors converged that worked as incentives for trade. Population increase was the main factor which accounts for economic growth during this period. As population grew, people left the manors in search for new lands to cultivate within the protection of a new lord. As new settlements filled spaces between adjacent manors, vast areas of wilderness gradually disappeared leaving less space for brigands to hide. More areas were brought under the protection of the lords and their vassals and as peace and security prevailed, commerce increased. Artisans and craftsmen were attracted to these central places as demand for their services increased. Some areas such as Flanders depended on the trading of its cloth to furnish the population with basic foodstuffs such as cereals and wine. The revival of trade and commerce in the eleventh and twelfth century led not only to the proliferation of towns but also to a number of secondary institutional arrangements designed to reduce market imperfections such as the establishment of fair. The fair was essentially a primitive organized market where sellers, gathered in one place during a specified period of time, could attract buyers. The Champagne Fairs, for instance, established in the 12th and 13th centuries served as a meeting ground for Northern and Southern Europe. These fairs provided a stimulus for trade as it simplified the financial dealings between merchants, enabling them to have access to prices and thus reducing the costly individual search for market information. They also played an important role in the development of a capital market by developing effective credit instruments. For instance, an instrument similar to a bill of exchange was devised which permitted a merchant to enter into a transaction without the need of using metallic money thus eliminating the risk which the merchant incurs in securing and transporting it. The fourteenth and the fifteenth centuries were perhaps the most brilliant and progressive period in the history of accounting.

The balancing of books was not the primary objective of medieval accounting but the use of accounting as a tool of management or control. Italian merchants made a start by developing the rudiments of cost accounting, by introducing reserves and other modes of adjustments such as accruals and deferred items, and by giving attention to the audit of balance sheets. One of these Italians was Francesco di Marco Datini, the famous Pratese merchant- banker. By 1395, Datini was at the helm of a firm with headquarters in Prato, and branches in Florence, Pisa, Genoa, Avignon, Barcelona, Valencia and Palma de Mallorca. He also had representatives in London. He established a bank in Prato (1398) and was a partner in a shop there producing woollen cloth (1384-1400). The Datini records show that by 1390 the double-entry system was already in use most of these branches abroad and at his main office in Florence. For purposes of control, branch managers were expected to send a copy of the balance sheet regularly to headquarters, and several of such copies are still preserved in Prato. These copies reveal that the books were kept according to the most exacting standards of double-entry. It is of interest to note that as early as 14th century, a number of accounting principles which are at the basis of current accounting practice were already in use. The recognition of accruals, depreciation, reserves and provision for unpaid charges were among the entries made in the profit and loss statements. Even before 1400 entries appear for accruals, for fees in arrears or assets and for unpaid wages or liability. The same can be said of the accounting policies related to inventory valuation. For instance the historical cost concept in inventory valuation was applied. Inventories were usually priced at cost, but if goods are damaged, inventory was valued below cost. In an entry in 1412 the inventory was priced below cost because as the notation said, the vineyard was ruined. In 1406, the Profits on Goods Account showed a loss item of 14 fl. because utensils deteriorated during the year. Apart from these, the Datini company also kept rudimentary cost accounting records related to the manufacturing establishment in Prato which contain interesting examples of job accounting with allocation of burden and indirect labour cost. According to Littleton, there are no other similar records available until 1817 in France in a textbook by Payen and in 1818 in England through a text by Cronheim. Apart from Datini, an extensive fragment of a ledger belonging to Averardo di Francesco de Medici gives valuable information about the business activity of one of the most important banks in the fifteenth century. The Medici material is valuable for the use they made of balance sheets for purposes of management and control. The Medici Bank is an example of a holding company except that it was a combination of partnerships rather than of corporations or joint stock companies. At the peak of its prosperity it had five branches in Italy, four beyond Alps. Besides the bank, the Medici controlled three manufacturing establishments in Florence itself: two woollen shops and one silk shop. Each of the branches and the shops was an autonomous partnership or separate entity which had its own capital, its own partners and books. However the Medici had a controlling interest, at least fifty percent of the capital in all of them. Strict control was exercised over the branches and regular audits were made.

The partnership agreements required the branch managers to close and balance their books each year on March 24, or more often, if required by the senior partners, the Medici. A copy of the balance sheet was sent every year to the headquarters in Florence, accompanied by a report of the branch manager. At headquarters, the balance sheets were audited. The audit consisted in going over the journal and balance sheet, item by item, in order to detect ageing or slow accounts. Bad debts were then as they are now a danger to the solvency of merchant bankers. Excessive loans granted to a single individual or firm, overdue items or large advances were also checked and the branch manager was asked for an explanation. In some instances, each receivable listed in the balance sheet is accompanied by a comment as to the prospects of its recovery. From time to time the managers were called to report at the Florence headquarters. Window-dressing techniques were already existing then and discovered. There were cases in which the managers tried to make the balance sheet look better than they really were. The internal control procedures of the firm however had one weakness: the branches were not visited frequently by inspectors or travelling auditors. Someone was sent to adjust matters only after trouble had already developed which was usually too late. In general, there was too much confidence placed in the branch managers and this move perhaps was a major factor in the downfall of the Medici Bank. Apart from the need for internal control, balance sheets were also used for taxation purposes in the fifteenth century. In 1427 a new tax known as the catasto was introduced, a hybrid between an income and a property tax. The law required each taxpayer to file a return listing all his property and to submit a copy of the latest balance sheet of any business firm which he held a share. Several balance sheets of Medici were found annexed to their catasto reports for 1427 and 1433. However the tax became unpopular with the business men. They objected to its inquisitive nature and to allowing tax commissioners, whom they suspected to be their competitors, pry into their affairs. In 1458, the catasto on business investments was abolished due to rampant fraud: the merchants seemed to have managed then as it is now- to evade taxes by concealing their profits and tampering with their records. Nevertheless, the practice of using accounting information for taxation purposes was revived in modern times and continues up to this date.