As one who was schooled in the art of double entry book-keeping I often say that the c.600 year old teachings of Pacioli are not going away any time soon. All modern accounting systems are based upon the principles he established.
What most people don’t know is the reason this arcane system was invented and became popular. It was for the prevention of fraud. It is a remarkably successful mechanism that often requires ne’er do well’s to go completely outside double entry with transactions that never hit the books. In short, Pacioli’s system has largely done a very good job of helping keep control and maintain governance over the transactions everyone understands.
But…it is almost completely useless at helping in running or managing the business. Various methods to overcome this have been tried out but all have flaws. Standard costing for example was built for a time when prices were relatively stable. Marginal costing assumes a clear delineation between fixed and variable cost. And all of that assumes you can analyze the right information in the first place.
The fundamental problem comes down to what’s known as the code block which in turn dictates the structure of the chart of accounts (COA.) Creating these mechanisms is one of the largest cost items in any systems implementation. They require extensive checking and rechecking before the system is installed. Why? Once the COA is established, it ends up being incredibly rigid and difficult to change.
Over the years, I’ve built hundreds of COAs, each designed to fulfill the needs of a particular industry or business. All of them have been deficient except in the smallest of business where the owner had a firm grasp of what was going on anyway.
There are numerous workaround, many of which default to some sort of ad-hoc analysis in a spreadsheet. Almost none of them systemically solve the problem of providing information that helps manage the business without breaking the integrity of the double entry system.
In the real world, this means that despite our having numerous new technologies that promise us better decision making, visualizations and access to untold riches in the form of unstructured data, we can NEVER truly manage the business except on an informed guesswork basis.
For example, marketing is run on a project basis – but the account structure will only have accounts for high level cost buckets:
None of these will tell you how much the program that was run in New York City on May 10th cost – so you can compare it to the number of leads generated and do educated business analysis. All that has to be done manually off-line.
In other words, the promise of ubiquitous data offering actionable insights can never be fully realized in the context of a governance driven framework.
Should we throw Pacioli out? Absolutely not. No-one has discovered a better way to help maintain a semblance of compliance than through his system of double entry. What else should we be thinking about?
That’s the subject of part 2 – coming tomorrow – where I draw upon ongoing conversations among colleagues around this vexing problem.
Disclosure: part of this is drawn from conversations with colleagues over email and other channels.