By Phin Upham
Prior to the technique the Accounting 101 students learn as “double bookkeeping,” people didn’t do a great job of accounting for potential losses. Barter exchanges focused on the trade of one good for another, and typically failed to take into account costs for materials or time spent performing an activity. The journey to double-entry bookkeeping began with the recognition that companies needed to make note of what they were losing if they wanted a true picture of their financial outlook.
Single-Entry Bookkeeping and Pacioli
The process of single-entry bookkeeping relied on an entry for every kind of transaction, like a credit or a debit, line by line. The end result was a ledger full of transactions, but not very well organized. It became very difficult to track balances during days where sales were high, and the entries themselves weren’t providing very helpful data.
This was one of many mathematical and scientific problems that 15th century Italian monks were working on. One of those monks was Luca Pacioli, who created a method to track both credits and debits in order to form a truer picture of one’s finances. Double entry accounting makes it possible for owners to see where a loss may have occurred. The entry notes the cost of the product, and notes the money exchanged for that product. The idea was to have the totals balance out at the end, or it would be simpler to see where a loss occurred.
The system uses the same approach as the golden rules of accounting: where equity is equivalent to the difference between assets and liabilities.
About the Author: Phin Upham is an investor at a family office/ hedgefund, where he focuses on special situation illiquid investing. Before this position, Phin Upham was working at Morgan Stanley in the Media and Telecom group. You may contact Phin on his Phin Upham website or Twitter page.