Bean Counters

The Triumph of the Accountants and How They Broke Capitalism

Richard Brooks

• Publisher: Atlantic Books
• Year: 2018
• ISBN:
  9781786490308
• Topic: Business
• Subtopic: Accounting
• Index: Business

'A devastating exposé.' Mail on Sunday They helped cause the 2008 financial crash.
They created a global tax avoidance industry.
They lurk behind the scenes at every level of government... The world's 'Big Four' accountancy firms - PwC, Deloitte, Ernst & Young, and KPMG - have become a gilded elite. Up in the high six figures, an average partner salary rivals that of a Premier League footballer. But how has the seemingly humdrum profession of accountancy got to this level? And what is the price we pay for their excesses?Leading investigative journalist Richard Brooks charts the profession's rise to global influence and offers a gripping exposé of the accountancy industry. From underpinning global tax avoidance to corrupting world football, Bean Counters reveals how the accountants have used their central role in the economy to sell management consultancy services that send billions in fees its way. A compelling history informed by numerous insider interviews, this is essential reading for anyone interested in how our economy works and the future of accountancy.

PART I

FROM THE TIGRIS TO WALL STREET

A Noble Profession’s Ignoble History

1

MERCHANTS AND MAYHEM

THE BIRTH OF MODERN ACCOUNTING AND THE SEEDS OF ITS CORRUPTION

Leonardo Fibonacci is now almost exclusively associated with his eponymous sequence in which each number is the sum of the previous two (1, 1, 2, 3, 5, 8 and so on). But the son of a wealthy twelfth-century merchant from Pisa did more than define a numerical progression; he also helped to transform the world of commerce and thus the course of Western civilization.

Fibonacci was schooled among Arab mathematicians in one of the city-state’s trading enclaves on the North African coast and travelled extensively around Egypt, Byzantium and southern Europe. There he studied not just the classical Greek disciplines, such as geometry, that his European contemporaries learned. He also mastered the Arabic number system that had already revolutionized mathematics, science and astronomy.

When the 32-year-old Fibonacci published his great treatise Liber Abaci (The Book of Calculation) in 1202, the Arabic method that we use today, with its ‘place value’ system for units, tens, etc., wasn’t entirely unknown in Europe. But it was his Liber that brought it into the abbaco schools of Venice, Florence and Pisa as they churned out successive generations of merchants. It was both textbook and business manual, covering geometry and algebra (an Arabic term for completion or balance), alongside techniques for such matters as allocating money among business partners. A chapter explaining principles that have been boring schoolchildren ever since, ‘On the Addition and Subtraction of Numbers with Fractions’, was followed directly by one on ‘Finding the Value of Merchandise by the Principal Method’.¹ Crucially, wrote one accounting historian, Fibonacci ‘demonstrated the superiority of Arabic numbers by presenting accounts in which Roman numerals in the text were contrasted with Arabic figures in columns on the right’.² Just as science and maths would become more practicable using the Arabic numbering method rather than the cumbersome Roman one (try subtracting VDI from MMCDXLIX or dividing CDLXXV by XIX),³ so would accounting. From counting stock and cash to more complex tasks like computing investment returns, the new numbers were eminently superior.

The era of measurement ushered in by Fibonacci transformed medieval northern Italy. It laid the foundations, sometimes literally, for Renaissance art and architecture. But nowhere were the new methods to prove more revolutionary than in commerce, where they made possible an ingenious new way of accounting called double-entry bookkeeping.⁴ As economist Werner Sombart would later write of the method’s origins: ‘Double-entry bookkeeping was born out of the same spirits as the systems of Galileo and Newton, as the theories of modern physics and chemistry’; it ‘discloses to us the cosmos of the economic world’.⁵

First used by Florentine merchants at the end of the thirteenth century, the system allows not just for the recording of a transaction; it simultaneously registers its financial consequences and thus automatically keeps a tab on the things that matter: sales and purchases, debtors and creditors, and so on. The state of an enterprise – its profits, its assets, its debts and much else – can be readily judged. The golden rule of double-entry bookkeeping is that every transaction is recorded by debiting one account, or ledger, and crediting another. That’s the ‘double-entry’. When, for example, a business sells something for cash, its bookkeeper records a sale through a credit to the ‘sales account’ and an increase in its cash through a debit to the ‘cash account’. (Somewhat counter-intuitively, assets of the business are recorded as debit balances and liabilities as credits.) If the sale is made not for cash but for settlement later on, there will be a credit to the sales and a debit to the account of the particular debtor (someone who owes the business money, derived from the Latin for ‘to owe’, debere). When the customer pays the bill, his account is credited – netting it to zero – and the cash account debited. Again, matching credit and debit entries. The sums of debits and credits are thus always identical and, in the absence of errors, the books ‘balance’. And while the process is now highly automated, the rules remain essentially unaltered many hundreds of years after they were devised. When the publisher of this book, for example, sells a copy to a bookshop, the publisher’s entries will be to credit its sales ledger and debit an account in the name of the bookshop (which would become its debtor). When the bookshop pays the bill, the publisher’s entries are to credit the ‘bookshop account’ – reducing it to zero – and debit the ‘cash at bank’ account, reflecting the publisher’s increased bank balance.

When the accounts are reckoned at any particular point, such as the end of a year, the sales and expenses ledgers would be closed with balancing entries in a profit-and-loss account. So if sales were worth 100 florins in the year, there would be credits in the sales account totalling this amount. It would be closed for the year by a debit of 100 and a corresponding credit in the profit-and-loss account. If in the same year there were purchases costing 60 florins – debits in the purchases account totalling this amount – it would be closed with a credit of 60 and a corresponding debit in the profit-and-loss account of 60. The profit-and-loss account would then have a credit balance of 40 florins. As a final step, this account would be closed with a debit to the profit-and-loss account of 40 and a corresponding credit would be made to the proprietor’s ‘capital’ account. This is effectively what the business owes him and is therefore a liability in the balance sheet. The balance sheet then ‘balances’ because there would have been an identical increase in the business’s net assets. In the example here, if all sales and purchases had been for cash, there would be 40 florins more cash in the business at the end of the year.

Double-entry bookkeeping represented a huge advance on previous accounting methods. Without a handle on matters like an enterprise’s assets and liabilities, it was impossible to divide the spoils of a business among partners or shareholders rationally, to gauge the credit-worthiness and viability of a business or to decide how much employees can be paid. All such assessments are fundamental to investment and trading and thus to a functioning market economy. Some consider the Roman period to have been a commercial flop for this reason. In the words of one scholar, ‘the Romans’ failure to develop double-entry accounting served as a structural flaw which deprived them of the impetus for economic rationalism and profit-seeking behavior’.⁶

There was more of a demand for reliable accounting in late-medieval and early-Renaissance northern Italy. The mercantile ethos of the city-states was at odds with the Church’s distaste, bordering on hostility, for the business of making money. New patterns of society and improved agricultural productivity had increased wealth and expanded commercial opportunities. But with these came exploitation, turning the Church’s attention to sins associated with money. The Third Lateran Council in Venice in 1179, for example, determined that ‘usurers’ who lent money at interest should be excommunicated. In this climate, any merchant concerned for his reputation, not to mention his afterlife, was at pains to show the worthiness of his commercial success. Accounting presented the possibility of doing so, superficially at least. Double-entry bookkeeping in particular resonated with the tradition in Christianity and more ancient belief systems of balancing rights and wrongs.

The new accounting method was of special interest to those plying the morally dubious trade of financing the merchants. Their activities really amounted to moneylending for profit but were structured to evade the Church’s strictures. Under ‘bills of exchange’, these merchant bankers would advance money to a trader in his home city. Then, once he had sold his merchandise abroad, he would repay the debt to the banker’s agent in the foreign land in local currency. The exchange rates would be set to give the banker a profit. A Florentine merchant might borrow 100 florins, worth say £40, at home and be required to repay £45 in London three months later. What was in substance interest had been transformed into something that wasn’t. But still a cloud of suspicion as dark as a priest’s cassock hung over the activity, and the least the financiers could do was account properly.

One man with more need than most for accounting’s commercial and exculpatory qualities was fourteenth-century merchant Francesco di Marco Datini, a Tuscan who made a fortune from bills of exchange and dealing in everything from cloth to weapons. Rigorous accounting was essential both commercially and, perhaps even more importantly, to assuage Datini’s conscience. As his biographer noted, he ‘was preoccupied by the thought that his very skill in making profit was sin’.⁷ From around 1380, Datini operated a full double-entry bookkeeping system. The main account books, the libri grande that consolidated the contemporaneous notes of his transactions into double-entry accounts, explain his diligence. Each carried one of two headings: ‘In the Name of the Holy Trinity and of all the Saints and Angels of Paradise’, or sometimes simply ‘In the Name of God and Profit’.⁸

For the merchants and their bankers seeking wealth and piety, double-entry bookkeeping offered security and a certain salvation. But, one family was to discover, only if it was done properly.

RENAISSANCE MEN

In 1397, Giovanni di Bicci de Medici, a 37-year-old banker, returned from Rome to his home town of Florence and established a bank that would survive for just short of one hundred years.

Maintaining a branch in Rome to take deposits from the Vatican, the Medici Bank offered the full suite of early-Renaissance banking services and quickly became one of the leading banchi grossi of Italy. It lent extensively using bills of exchange, took interests in trading ventures and handled the savings of the leaders of the Catholic Church (cleverly evading the ban on usury by turning interest into discrezione, or optional payments that – it just so happened – would invariably be paid). It sent tithes, taxes and indulgences across Europe to Rome. And as much to earn public acceptance as anything else, it diversified into trading, notably in the woollen industry operating from the Cotswolds in England. ‘To deal in exchange and in merchandise with the help of God and good fortune’, ran the mission statement.

The key to the Medici rise was to combine scale and attention to detail, whether at home in Florence or in branches that by the middle of the fifteenth century stretched from London to Venice. In Giovanni’s son Cosimo, the architect of the bank’s achievements from his succession in 1420 until his death in 1464, the Medici had the right leader. As well as being a control freak who had spies in every corner of Florence, Cosimo understood the value of good accounting.

He needed to. Banking depended on assiduously applied double-entry bookkeeping. Bills of exchange, the bread-and-butter of the business, paid slim margins. A default on one could wipe out the gains on many times the number that were honoured. Keeping close tabs on borrowers, spreading risk and not over-exposing the bank to more suspect customers was therefore critical. Distant branches were partnerships between a Medici Bank holding company and local managers in a federated structure that would work only if the results of the branches were fairly shared. The profits needed to be properly measured.

Double-entry bookkeeping met these specifications ideally. It wasn’t merely a means of accounting for the Medici business. It was central to actually doing it. In his book The Reckoning – Financial Accountability and the Making and Breaking of Nations, historian Jacob Soll goes so far as to say: ‘The Great Masters of the Medici Bank used accounting to create a financial machine that allowed them to dominate their age, both culturally and politically, like no family before them.’⁹

This was the achievement of Cosimo and his trusted general manager and chief accountant from 1435, Giovanni Benci, who had begun his career as an office boy at the Rome branch twenty-five years earlier. He had risen through the Geneva branch to become Cosimo’s most trusted adviser, earning the nickname ministro, or minister. In the words of leading Medici historian Raymond de Roover: ‘It was during the years of Benci’s management that the Medici Bank witnessed its greatest expansion and reached the peak of its earning capacity.’ Crucially, Benci was ‘thoroughly familiar with double-entry bookkeeping’.¹⁰ Under his searching accounting regime, Medici branches were required to close their ledgers and balance their accounts every year. The books would then be sent to Florence for the annual ‘audit’ (a word originating in the more feudal traditions of landowners ‘listening’ to managers read out their estate accounts). The ledgers were statements of great detail, with balance sheets identifying the amounts owed by each customer, or debtor, and thus containing hundreds of items that the accountants back in Florence could check. Their chief concerns were, firstly, to identify debts that might go bad – perhaps because the debtors were already behind with payments – and, secondly, to spot indulgent lending to the wrong customers. Defaults had done for a number of fourteenth-century Florentine financial powerhouses,¹¹ and Cosimo was not going to let the Medici go the same way. The double-entry system allowed his auditors to pick out doubtful debts and track their history through the branch’s records. If they weren’t happy, they would summon the branch manager to Florence for a grilling from Cosimo and Benci. The result was controlled success in a manner that later bankers would have done well to emulate.

DEATH OF AN ACCOUNTANT

Cosimo had, however, become over-dependent on Giovanni Benci. When the accountant died in 1455, he was not replaced for three years. During this period it emerged that Benci had been the sole signatory on the Medici Bank holding company’s partnership agreements with all its local...