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Can Double-Entry Bookkeeping Save the World?

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Jane Gleeson-White’s bestselling Double Entry: How the Merchants of Venice Created Modern Finance is firmly entrenched as the leading primer to accounting history. This extremely popular and well-written book begins by arguing that accounting was the world’s first communications technology. The first accounting system dates from 7000 BC and the first complex accounting systems date from 3500 BC. The earliest accounting systems were not kept in writing, but with tokens shaped to resemble specific property. The early accountants realized that, rather than making tokens, they could simply draw the tokens’ shapes on tablets. Thus, accountants invented writing to record private property.

Gleeson-White traces the early history of accounting to the pivotal invention of double-entry bookkeeping in northern Italy around 1300 AD. She argues Roman numerals stunted the development of accounting. Double-entry bookkeeping could only emerge after 1200 when Fibonacci (1170–1249) popularized in Europe the Hindu-Arabic numerals and arithmetic we all use today. For the author, the “economic boom” of the crusades and the popularization of Hindu-Arabic numerals in Europe explains the invention of double-entry in Italy around 1300.

The book’s main character is Luca Pacioli (1446–1517), a Franciscan monk and mathematician born near Florence. Although he did not invent the approach, Pacioli published the first systematic treatise on double-entry bookkeeping in 1494. Pacioli’s famous 27-page accounting treatise makes him the father of double-entry accounting. Gleeson-White justifiably devotes a significant portion of the book to the life of Pacioli and his famous treatise.

After treating Pacioli, the author briefly traces the movement and development of double-entry bookkeeping across Europe and into the New World. She argues that the concept of capitalism came from double-entry bookkeeping. She then explains how her “economic hero,” John Maynard Keynes, used the double-entry method to develop national income accounting. She criticizes the role of accounting in recent accounting frauds and financial crises. Finally, Gleeson-White ends the book by arguing double-entry bookkeeping is destroying the planet and a new form of “green accounting” is desperately needed to save the earth.

Unfortunately, Double Entry is a highly problematic primer to accounting history. It must be stressed that the author has an extremely dim view of accounting. For example, “[accounting] tools cannot be trusted to convey the true state of the business at all. ... [Accounting] numbers are arbitrary, illusory.” Again, “accounting measures are fundamentally arbitrary and go largely unchallenged.” The book’s polemical tone makes for an unbalanced primer.

The Function of Profit and Loss

Gleeson-White cannot explain the real social or historical significance of accounting because she displays no understanding of the social function of profit and loss. In the free market, businesses can only maximize profit by maximizing consumer satisfaction. Consumption is the purpose of all production, and it is impossible to earn profits by producing goods that no one wants to consume. Moreover, businesses that consistently fail to satisfy consumers suffer consistent losses until they are forced out of business. Thus, the profit-loss mechanism drives profit maximizing business to the maximum possible satisfaction of consumers. In short, the profit maximizing goal creates a true harmony of interests between business and consumers. Accountants and double-entry bookkeeping serve as an indispensable social function because they crystalize profit and loss and thereby facilitate the maximum satisfaction of consumers. All this is lost on the author, so readers cannot grasp the overwhelming importance of accounting. 

Gleeson-White is incorrect to claim that accounting is “arbitrary, illusory.” Wealth maximizing businesses have an enormous incentive to produce the highest quality accounting information possible. False, or “arbitrary, illusory” accounting leads to poor decision making, consumer dissatisfaction, wealth destruction, and eventual business failure. On the other hand, high quality accounting facilitates good decision making, enhanced consumer satisfaction, and the accumulation of wealth. The profit-loss mechanism weeds out businesses with arbitrary accounting and creates a tendency toward meaningful, high quality accounting.

Fundamentally, Gleeson-White’s polemic is a revolt against nature’s limits on accounting. She forgets that there is no such thing as perfection in this world, and double-entry accounting has limits just like any other indispensable tool. Ludwig von Mises notes four limits of accounting. First, double-entry bookkeeping cannot exist without money. Second, double-entry only applies to scarce goods that are bought and sold with money. Third, double-entry bookkeeping can only exist under capitalism and cannot exist under socialism. In other words, financial accounting requires private property, and where there is no private property there can be no financial accounting. Fourth, government intervention in money and banking is capable of systematically falsifying bookkeeping. Gleeson-White ignores all these limits.

Blaming Accounting for the Faults of Interventionism

For example, financial crises always involve universal, systemic accounting failures. But can we blame accounting? No. Government intervention in money and banking systematically falsifies accounting. First, accounting is conducted with money. Inflation destroys the value of money and with it the value of accounting information. Second, central bank policy falsifies the interest rate. The interest rate is the universal price that affects the accounting value of every noncurrent asset and liability. Consequently, falsification of the interest rate must cause a universal falsification of accounting information. We must blame the central bank for the systematic accounting failures experienced during financial crises, not accounting. Similarly, it is illegitimate to blame accounting for corporate fraud like Gleeson-White. Clearly we must blame the scoundrels who abuse accounting, not the science of accounting itself.

Gleeson-White attacks the auditing profession and naïvely suggests auditing should be taken over by government regulators. However, even perfect auditing cannot prevent business failures. Auditors can test accounting records, but they cannot coerce businesses into satisfying consumers and earning profits. And neither can a regulator. Furthermore, auditors have the most powerful financial incentive to audit thoroughly and honestly, for if they do not, they will lose clients and income. Regulators lack this powerful incentive. Finally, the greatest threat to quality accounting is a regulator, i.e., the central bank. Auditors cannot detect and correct the accounting distortions caused by central banking. And neither can a regulator. It is unjust to blame auditors for the unavoidable systemic accounting failures caused by central banking.

Gleeson-White insists her hero, Keynes, “applied the principles of double-entry bookkeeping to construct his whole-economy framework.” She never mentions that Keynes despised accounting and accountants. Furthermore, Keynes’s framework is not double-entry accounting because it does not possess “the six essential features of double-entry bookkeeping.” Now, the author is correct that “GDP is deeply flawed.” But since national income accounting is not double-entry bookkeeping, her attack on GDP has nothing to do with accounting.

Benefits Only Obtained Through Private Property

Gleeson-White further argues accounting destroys the planet by causing the overexploitation of natural resources. Her conservationist arguments evince no knowledge of economics. The free market has a remarkable built-in mechanism that leads to the optimal mix of consumption and conservation. Business is inherently concerned about the future of natural resources because the present value of a business depends on its future cash flows. The price system regulates the conservation of natural resources by communicating changes in supply and demand through the present value of projects. A business that overexploits natural resources will impair future cash flows and reduce the present value of the business. In short, double-entry bookkeeping is a system of green accounting that leads to the optimal amount of conservation.

The utopian system of green accounting Gleeson-White demands is impossible. As noted, double-entry can only exist when there is private property in scarce goods. Parts of the environment she wants to “value” with green accounting are not valued as scarce resources and therefore have no accounting value. These parts of the environment would have already been appropriated if they were valued as scarce goods. The green accounting value assigned to unappropriated parts of the environment must be arbitrary. Now it is true many natural resources cannot be appropriated because governments restrict ownership of the oceans, air, forests, rivers, and wilderness. But this means these scarce resources cannot produce revenues and thus free cash flows. This makes it impossible to calculate the present value, so the green accounting value of government controlled natural resources must be arbitrary. Government is the great force preventing double-entry accounting from regulating the conservation of natural resources.

Contrary to Gleeson-White, the main obstacle to conservation is the modern-day communism in oceans, air, forests, rivers, and wilderness. Communism in natural resources always leads to the tragedy of the commons. And as Murray Rothbard wrote, “every instance of ‘overuse’ and destruction of a natural resource has been caused, not by private property rights in natural resources, but by government.” We do not need to replace double-entry accounting with more government and arbitrary green accounting. We need to universalize the principle of private property so we can apply double-entry bookkeeping to the environment.


Contact Edward W. Fuller

Edward Fuller, MBA, is a graduate of the Leavey School of Business.

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Image of Luca Pacioli via Wikipedia