I wrote the following article in 1994 while working on my Masters degree. In conjunction with writing this paper, we were required to make a presentation to our faculty and peers. The paper and presentation were the entire basis for our grade. Accountants are typically conservative and professional. I took a big chance with my presentation and showed up in a T-shirt, shorts, and flip-flops to make my point. I held up a hammer and said that as accountants, we try to cut wood with a hammer. We hold on to traditions and methods that needed to be changed and improved but are too afraid to try new things.
My gamble paid off. I received an A for both my presentation and my paper.
Many accounting practices are based on methods that are outdated. The double entry accounting system was designed to “account” for financial activity; not to predict it. To report to tax agencies and other organizations on financial status. Corporations and investors today attempt to use this data to predict the future. Although it can provide clues to the future, I believe it’s a lot like driving a car while looking through the rear view mirror. You can’t drive by using the past to predict the mountains, weather, and curves ahead. Why not use predictive data to predict the future? Why not look out the front window while driving the car? Better yet, why not reference a road map detailing the road ahead?
“Budgets,” you say? Budgets? Don’t make me laugh! I’ve worked for an Accounting Firm. I’ve worked for Corporations. I’ve seen how budgets work and how they can be manipulated. I’ve seen how they are often not based on sound financial data but rather a best guess. Or worse, an optimistic projection by a management team trying to increase stock value. A budget is a subjective, speculative, unregulated financial document. Governmental/Nonprofit accounting (fund accounting) does a better job, but still could be improved on. The budget is a separate living entity separate from the financial reports. But what if it wasn’t? I think it would have been impossible years ago, too much paperwork. But then years ago, so was detailed job costing. Too often the costs far outweighed the benefits to produce such reports. Now, however, we use computers, and it is possible.
The past few years I have been thinking more in terms of personal finances, rather the corporate accounting. Programs like Quicken and Money are great for tracking when and where your money goes, but I am continually disappointed on the weak budget functions included in the software. The budget shouldn’t be independent of the historical data. Intertwine it with the core financial data. Imagine financial software that encompassed not only the past and present but also the future. Your current financial status is in the middle of information stretching in both directions. Every purchase you have made or might make has an immediately visible impact. Want to purchase that big screen TV, punch it in to your software and watch how your whole future is adjusted. The base mentality of the home finance packages is that the financial information ends at the present. It doesn’t. Forecasting and budgeting functions fall short. Tie it all together and it becomes more accurate and useful.
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Triple-Entry Accounting Methods
May 24, 1994
Accounting practices today are based on the double-entry method. There have been many proposals by various accountants to expand this into a triple-entry accounting system. Why should the accounting profession consider changing? This paper will discuss this question by looking at how the double-entry system has developed, and what weaknesses it possess that could be strengthen by incorporating a triple-entry method.
History of Double-Entry Accounting
There is evidence that even during the Mesopotamian era, a fairly complex accounting of possessions, purchases, and expenditures existed on tablets. Extensive accounting methods also existed in Greece since the fifth century B.C. The middle ages had developed a fairly advance system of accounting just before the introduction of double entry accounting. Accounting practices today are derived from these early systems.
There are many influences from the developers of early accounting that extend into our practices today. One of these practice is the avoidance of negative numbers.
Through the use of debits and credits, accountants avoid the use of negative numbers. There are several reasons for this, such as control and ease of use for accountants who did not have the benefits of computers and calculators. Perhaps, however, the initial introduction of the debit and credit was not linked to such reasons.
According to various mathematicians, it wasn’t until the first century A.D. that negative numbers were even recognized. The Chinese became the first to use negative numbers by using red rods for positive numbers, and black rods for negative numbers. Evidence suggests that negative numbers appeared first in accounting rather than mathematics.
According to Yuji Ijiri, a advocate of triple-entry accounting, the avoidance of negative numbers and thus the development of the debit/credit is one reason the progression of the double-entry accounting did not develop into a triple-entry method, as will be discussed later.
Before the development of double-entry accounting, accountants relied on a chart of balance sheet accounts to record financial transactions. This creates a system that is very difficult to examine for accountability. Consider the extreme problems such a system would pose today. Companies would publish Balance sheets without Income Statements. There would be no way for investors to examine the changes in equity. The development of double-entry accounting opened the realm of accounting into a whole new world, and a whole new chart of accounts.
The practice of double-entry accounting has existed for Centuries. “The first to write on double-entry was probably Benedetto Cortrugli, [who] finished his book on the 25th of August, 1458.” Accountants today use these same basic 500 year old techniques. Why haven’t accountants experienced the industrial revolution in technology and ideas that has effected the rest of the world? Are these century old ideas so perfect and flawless that there is not a need for change? Perhaps the publications of hundreds of documents daily on financial laws, ideas, and theories by various private, regulatory, and governmental agencies signifies the flaws and weaknesses of these age old practices.
One flaw in current accounting practices is that financial statements attempt to predict the future though historical data. When double-entry was developed, it was the need for this historical data to account for the change in equity that sparked the progression of single-entry accounting into a double-entry system. The historical records of transactions are an important part of any entity, however, this method was developed for the purpose of accounting for transactions; not predicting them. Accountants today are attempting to use a very powerful and efficient tool for a purpose in which it was not designed. By attempting to alter this tool into completely different element, it has been damaged and the original purpose hampered. Accountants are trying to both drive nails and cut wood with a saw.
What then is the solution? Accountants surely must recognize many of the flaws in the current practices. Is it time for accounting to evolve into another form? What characteristics would this new form possess? What problems would it solve, and what new problems would it create? Primitive accounting developed from single to double entry, and there have been many proposals and ideas suggesting that it is now time to progress to triple-entry accounting.
Triple Entry Accounting
There are many ideas on a triple entry accounting system. Some computer software claims to use a triple or quintuple entry method. These software packages allow the user to record information about a transaction in numerous different fields. The software can track more than just an income and asset account in each transaction. Each transaction can also be assigned a region code, item number, salesman ID, or any other code needed to organize transactions. Although these packages do allow multiple entries past the double-entry, they are merely just repeating a double entry. Each of the different multiple entries relates back to one account, and they are not inter-related. This is basically an extensive double-entry job or customer costing accounting method.
Other accountants have proposed expanding the double-entry to include triple-entry for income tax purposes. This again is not a true triple-entry, but multiple double entries using a different chart of accounts. Many problems exist with this proposal, such as depreciation. After an in-depth examination of the income tax idea, it becomes easier to just keep two different sets of books.
Perhaps a simple analysis of the progression of accounting will answer the question of what the triple-entry method should accomplish. When it was important to merely track asset balances, single-entry accounting evolved. When accountability for assets became important, accountants developed the double-entry method. Today, accountants are trying to use historical data to predict the future. Why not use predictive data to predict the future? Historical data is relevant and important, and was developed for a meaningful purpose. Predictive data, however, is also important. Accounting does not just include where you are and where you’ve been, but also where your going. Is it time to evolve into a triple-entry method that will aid in predicting the future? Does the jump to triple-entry accounting complete the accounting cycle? One accountant who believes this is the next step is Yuji Ijiri, author of Momentum Accounting and Triple-Entry Bookkeeping.
A summary of what Yuji believes can be illustrated in the following analogy. The profits of a company are like a motor trip. Sometimes the car is driving forwards, sometimes backwards, and sometimes sitting still. The Balance sheet tells the precise location of the vehicle. The Income statement tells how fast the vehicle is traveling. The speed of the vehicle describes to investors information that can be used to estimate the future only as long as the vehicle travels the same speed. The question of whether the car is accelerating or decelerating can only be determined by using past information to estimate. What if the new triple-entry method allowed for the calculation of acceleration, or the momentum of the company, as Yuji defines it. Consider the relationship of the basic accounting equation:
Owners Equity = Assets – Liabilities
Yuji points out that owners equity, or capital accounts, are “in essence subaccounts of retained earnings, [and] are thus oriented toward describing the past.” On the other side of the equation, the difference between assets and liabilities describe the present situation of the enterprise. Consider this modification of the above equation:
Present = Past
The present state of an entity is represented by past transactions. By extending the equation another step a representation of a triple accounting system as proposed by Yuji is defined:
Past = Present = Future
Under this equation, each of the three different aspects inter-related with each other aspect. Yuji modifies this equations to use the following terms:
Capital = Wealth = Budget
A common relation must exist between all three aspects of the equation, and the new accounts and reports created by the new category must indicate the current and future momentum of the entity. The development of these relationships and purposes becomes the impediment in developing the triple-entry system.
The actual journal entries and methods to account for a triple-entry accounting system are very complex and would require an extensive writing. An overview how journal entries might be made and how financial statements might be effected will be presented. These methods are not flawless, and are presented to stimulate ideas and the development of such a system.
A new chart of accounts would be created through the creation of the triple-entry method. The debit/credit would either be discontinued, or a debit/credit/trebit method employed. The predictive side of the equation, the budget, would allow for a more accurate representation of future transactions. According to Yuji, accounting entities have a momentum of income producing abilities, meaning that the business has incurred events that generate the flow of future incomes. One example of this is rent collections. If a company rents out apartments, the inflow if revenue after the initial startup continues indefinitely. Another example is the hiring of a new employee. This puts into momentum the outflow of cash for an indefinite period. Yuji proposes a method of triple-entry accounting to account for such examples.
Actual journal entries proposed by Yuji are complicated. In fact, of the two publications by Yuji in a three year period, his proposed method of making journal entries changed.
By following the number trail, a basic understanding of how Yuji proposes this system can be seen. For more information about this method, Yuji has published several books on triple-entry accounting.
Financial Statements, as proposed by Yuji, would contain much more information that current statements. Because the triple-entry method incorporates the future into the statements, the momentum of the business is recorded in reference to future transactions. Yuji also incorporates the term “impulse accounting” in describing the relationship of changing momentum within a company.
The benefits of the triple entry financial statements over current financial statements is that they give the reader the numbers necessary to estimate future earnings based on present and future transactions, not historical data. Using the car analogy, these statements tell the reader how fast the car is going and how fast the car is accelerating or decelerating based on the road conditions ahead of the vehicle. The three aspects of accounting; present, past, and future, have all been integrated to give the complete financial picture.
The Budget accounts show exactly where the financial statements are or will be effected. They also show not only how fast the company is accelerating or decelerating, but also the difference in these numbers when compared to prior and future periods. This change in acceleration, or impulse as Yuji defines, shows how much the company is improving from period to period, and where the changes are occurring.
On the financial statement presented, Rental revenue is currently effecting income by $30/month. The impulse of $18/month in rental revenue this month explains an increase in the momentum of rental revenue this month by $18/month. For instance, a car accelerating at 12mph began accelerating at 30mph, an increase of 18mph.
These methods are complicated and not free from problems and errors. Yuji acknowledges that there are many fallacies in this procedure, but also points out may strengths. One of the obvious strengths in this method is the integration of future transactions into the financial statements. This enables investors to use predictive data to make predictions.
Drawbacks on this method include the complexity of the transactions, and the fact that an entire profession would have to adapt and modify a practice that is firmly engraved by generations practice. There are many other points that could be discussed on this proposal, and there are several books containing these arguments. This paper serves as an introduction to the triple-entry accounting method.
In conclusion, I believe that the current accounting policies are using a powerful double-entry accounting method improperly. I believe it was designed for recording past transactions for accountability reasons. Accountants today are trying to use historical data to predict the future. It is possible to develop a system that uses predictive data to predict the future, although a completely successful method has not yet been proposed. Accountants should keep these ideas in mind throughout their professions, and perhaps someday enough ideas will be gathered that will enable the development of such a system.
There are also other topics that we have discussed in the classroom that should be addressed when designing a new system, such as valuation. Accounting is much too complicated for a simple answer. By discussing new ideas and thoughts, more answers are given. Someday, we may have a more complete picture of the accounting cycle.
Hotch, Ripley, “Money Matters; accounting software; evaluation,” Nation’s Business, July 1990, Vol. 78, No. 7, Pg. 40.
Ijiri, Yuji, Studies in Accounting Research #18, “Triple-Entry Bookkeeping and Income Momentum,” (American Accounting Association, 1982.
Ijiri, Yuji, Studies in Accounting Research #31, “Momentum
Accounting and Triple-Entry Bookkeeping: Exploring the
Dynamic Structure of Accounting Measurements,” (American
Accounting Association, 1989).