Accounting in the Middle Ages

I am not an accountant, but some years ago I read a history of early accounting ¹. What struck me was that the metaphor that led to double entry book keeping was balance, and that from an outsider's point of view, it was hard to find profit.

All in all, for double entry book keeping, three new ways of thinking must emerge, one of which is balance. A second is that humans can create entities separate from themselves, to create golems, as it were. A third is that humans think of time as linear.

In the Middle Ages, an enterprise started when a few people took a chance to support it. Perhaps, also a usurer would loan it money. The difference between the investors and the usurer is that the usurer was supposed to be paid regardless of the success of the venture, but only a fixed amount. The investors might lose — pirates or a government might seize a cargo, or a storm destroy it — or they might gain hugely.

The venture was seen as an entity separate from those who put money into it. This was a key notion. In particular, the owners are not the entity. Another key notion was balance; that idea was possible because no one yet thought in negative numbers.

A venture possesses assets, such as the ship to carry the goods, the gold to buy the silk, or the silk itself (or, more prosaically, the silver to purchase the grain). The people who put money into it are either the investors or the usurers. Investors own equity; the usurers are a liability.

Thus, the basic accounting equation:

the assets of an enterprise have the same value as
the money put in by usurers and investors.

Or, in modern and for most people, more boring, language;

    assets = liability + equity

An increase in liabilities means a bigger loan from a usurer who trusts that he will be paid back. The usurer is a creditor, a word that comes from the Latin, `trusts'.

An increase in equity means a bigger investment from an owner.

Before the invention of negative numbers, the value of the enterprise was seen as a positive number. Consequently, an increase in what the business owned, an increase in it liabilities or equity, was seen as an increase in assets.

And indeed, the more put into the business, the more are its assets. People could understand that the value of an enterprise equaled what it owes. The amount owed was a definite debt. The amount received was also definite. Indeed, if everyone was honest, the two had to equal.

The metaphor is like that of an old fashioned balance scale: on the right hand side is put the weight of the liabilities and equity, all definite. On the left hand side is put the weight of assets; also definite. Unless someone steals, the two must balance.

Moreover, balance continues on a smaller scale. During a venture, it looks as if the overall total of assets for an enterprise does not change. The composition changes, but if there is no theft, balance remains.

Suppose you exchange gold for silk. The amount of fixed assets increases. The venture gains a load of silk. The amount you must pay the seller also increases (from nothing to the value of the shipment). The values of both balance.

In modern thought, we would say that as a result of your payment, the value of cash decreases, which is a negative number. At the same time, the value of your cargo increases by a positive amount. And the absolute value of the negative number is equal to the absolute value of the positive number. This way of thinking also works, but it is more abstract than the notion of a definite debt balancing a definite gain.

Suppose your voyage is a success. You come home and sell your silk. Now the amount of gold you have increases; but its value equals the value of the silk you must give your buyers. Another balance.

Dissolve the venture: everyone receives his money, including the usurer. What is left over goes to the equity investors. The exact value of the enterprise is divided up among those who are owed money from it. Nothing is stolen. Again a balance.

Everything balances. A careless Medieval thinker, more used to brigands and predatory barons who steal, may well wonder how profit comes from balance? To understand how profit and loss occur, you must think over time. This is a third key notion. Not only must you think of what you pay for the silk here and now, but you must learn what the merchant paid months ago, and what it cost to ship it.

Put another way, rather than think of time as circular, or a spiral, a round of seasons, months, and religious celebrations, you must think of time as linear.

You must think of the Christmas last year as being very different from the Christmas of this year, even though both are similar religious celebrations of the birth of your savior. (And which is more important for you, being saved for ever and ever, or a little silk?)

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