Along time ago, food was available free to humans; so was land, water and air. With “progress”, we had to pay for what we earlier could take free from the environment. First, it was food that we paid for, soon followed by land and water. It now looks only a matter of time before we pay money for the air we breathe. We can reverse this trend if we want to, and reverse it soon. But for this, we need a second revolution in accounting.
Illustration: Jayachandran/ Mint
Luca Pacioli, in 1494, flagged off the first accounting revolution. He documented the practice of double-entry bookkeeping. This coincided with the birth of the European Renaissance. Around the same time, Martin Luther and John Calvin promoted the value system of diligence and dedication to hard, unremitting work as a path to salvation. This value system applied in economic pursuit seeded the idea of a materialistic world as an end in itself. The double-entry bookkeeping system honed it to finesse by computing its profit and loss.
By accounting for both the legs of exchange in commercial transactions, double-entry bookkeeping enabled the development and growth of two distinct aspects in the economy. The first, a credit-based economy and the second, commercial transactions with longer gestation period. Credit transactions could now be accounted with the same ease as cash transactions. To a large mass of people, this allowed consumption in anticipation of income. Now, the economy was no longer limited by income in the hands of its consumers. The only limit was production, and efforts were made to push this barrier too. Transactions with longer gestation period permitted producers to experiment with larger investments, resulting in economies of scale that transformed human life.
Berkeley economist J. Bradford Delong estimates that during the hunter-gatherer era, per capita income was $90. It took 18,000 years for this to double to $180 by AD 1750. But in the last 250 years, per capita income multiplied manifold to reach $6,600. About 97% of the “consumption” in human history was in the last 0.01% of the time. It was not only the increase in per capita income that contributed to this consumption spree, but also the growing human population. From about a billion in 1800, our population crossed six billion.
In this frenzy, the opening idea of Pacioli’s treatise on double-entry bookkeeping is worth revisiting. The original idea, “The end or purpose of every business man being to make lawful, and fair enough profit to keep himself substantially”, was distorted. This somewhere down the line became “the objective of business is profit”, dropping the two critical adjectives attached to profit —lawful and fair. Income in the absence of these two adjectives can and does become a liability.
Pacioli had identified three prerequisites for a good businessman. The first was cash or any other substantial power; this is what today we call creditworthiness. The other two prerequisites were a good accountant, and prompt and accurate recording. In his words, “it would be impossible to conduct business without due order of recording, for without rest, merchants would always be in great mental trouble.”
If we need to reverse the current trend to get away from “great mental trouble” and enjoy the free and pure—air, water and food—we need to get back to the second and third prerequisites identified by Pacioli— good accounting, and prompt and accurate recording.
As the need was to measure performance at shorter intervals, the first accounting revolution emphasized income accounting and profit. Economic progress in the last three centuries has not only reduced the world to a global village, but also compressed millennia measured by consumption into centuries, if not decades. This compression requires us to look at time horizons measured by consumption and take stock of not just income and profit, but wealth too.
Wealth is etymologically derived from the old English word weal, which means “well-being or welfare”. We need to account for our “well-being and welfare”. Income reflects an element of the past, while “well-being and welfare” has a “present-continuous” feel. The second revolution in accounting is the movement from accounting for income to accounting for wealth.
The first accounting revolution started with microenterprises or commercial firms before it moved to accounting for national economies. Today, the language of national income accounting—gross national product, per capita income, savings rate and investment flows—is common language. This reflects the fact that both macroeconomies and microenterprises have become points of debate and deliberation among the people.
An interesting feature of the 21st century is large microenterprise. Large commercial firms exceed the size of small and medium economies. In fact, an interesting study by Anderson and Cavanagh in 2000 found 51 of the 100 largest economic entities in the world to be corporate entities, with national economies accounting for only the balance 49.
Appropriately, considering the urgency, the “second accounting revolution” has begun with both the macro and microentities. Called by various names—green accounting, sustainability accounting, ecological and environment accounting, triple bottom line, among others—all these reflect the basic change in accounting for “wealth” and not just income or profit. Wealth in its full spectrum is not just financial asset. At an individual level, wealth includes physiological and psychological well-being; and at the societal level—both social and ecological health.
So, what is this new accounting system?
(The second part of this article will be published on Friday.)
Shankar Jaganathan is a consultant with Wipro Ltd. He is the author of a soon-to-be-published book on the history of corporate disclosure from 1553 to 2007. Comment at firstname.lastname@example.org