Chapter 2 Synopsis

Britain & the Industrial Revolution

The British Isles saw waves of conquerers throughout its history. William the Conquerer was the last in 1066. Britain had a fractured history for thousands of years, and typically was a backwater of Europe. It became part of the Roman Empire and achieved a reasonably high level of sophistication for about 400 years, but the collapse of Rome saw the island native Celtic population subject to invasion by Angles, Saxons, Danes and others. The Normal Conquest under William started the rise of Britain to become a major European kingdom. It had a number of great rulers, fought wars for France, Scotland, Wales, and Ireland, introduced Parliament, but trailed other European powers in wealth and culture and was somewhat late to the Renaissance. The Reformation came with the rule of (specifically the divorce of) Henry VIII. Much of the strife for the next 200-300 years was related to the struggle of religious factions, including the rise of the Industrial Revolution fueled by Dissenters. Britain had an industrial base, was a seafaring power, and had social and legal foundations that encouraged (or at least did not destroy) innovators and entrepreneurs.

There was something special about the Age of Elizabeth. Shakespeare was at his height, English adventurers were exploring the New World and raiding Spanish galleons, and joint stock companies were formed to exploit the opportunities of an expanding known world. The East India Company was given a royal charter as a joint stock company in 1600 with monopoly rights in Asia. Early voyages were successful and the East India Company became profitable and powerful and assisted British soldiers in the conquest of India for the British Empire.

Under the Stuart kings, the King James Bible was published and goldsmiths became bankers in London and lesser financial centers. The goldsmiths' safes were used to hold the monetary deposits of merchants and others, using gold notes as receipts. These receipts evolved into banknotes and these new bankers loaned money and performed other banking tasks. The Bank of England was founded as a joint stock company and became the central bank of Britain.

Much of Britain's wealth depended on the wool trade. The wool of British sheep was highly priced and sheep owners in the Cotswolds and other areas became rich. Instead of selling all wool to continental merchants, the domestic system of textile manufacturing developed. Small farmers did the spinning, cleaning, and weaving in their homes. About half the manufactured cloth was exported and a wealthy merchant class developed.

At this time manufacturing productivity levels were similar around the world and changed little over time. If Britain's productivity was 100 in 1750, then the rest of Europe was about 80 and the Third World perhaps 70. With the rise of the Industrial Revolution, Britain's productivity growth would average about two percent a year. This seemingly small rise resulted in Britain's productivity over 1,000 by 1900, when Britain was the world's industrial giant--although soon to be overtaken by the United States and Germany [Kennedy 1987].

The start of the Industrial Revolution was about 1750. Many inventions and organizations were in place well before that and setting a specific date is arbitrary. It proceeded at a glacial pace, no single event, no one individual, but a series of inventions, entrepreneurs, luck (both good and bad), and the development of new methods and institutions. It changed the world and how humans viewed the world. Even the modern concept of time was new, when people traveled to work and back homes for specific work hours.

Ironbridge

If a single location is needed for the birth of the Industrial Revolution, Ironbridge is a good candidate. It is located in a river valley west of Birmingham, has been converted into a series of museums mainly dedicated to the story of the Industrial Revolution, and has a spiffy bridge. Industry is long gone, to various manufacturing sites around Britain such as Birmingham, Coventry, and Manchester. Two hundred and fifty years ago, the iron furnaces were continously fired, with the Coalbrookshire Ironworks surrounded by forges and foundries, potteries and mines. To the west Blists Hill had coal and clay mines, brick and tile works as well as iron works. The working conditions were horrid and the place must have seemed like hell, especially at night.

Ironbridge, on the Severn River

Smelting of iron is done with carbon, by blowing heated air through a mixture of ore, coke, and limestone in a blast furnace to obtain cast or pig iron. The use of iron is ancient and iron began replacing bronze for tools and weapons about 1200 BC. Iron was being produced before the arrival of the Romans and large furnaces were in place for iron production by the late Middle Ages. Production declined when wood was outlawed for smelting. This problem was solved at Coalbrookshire by Abraham Darby (1678-1717), through the use of smetling iron with coke made of pit-coal.Darby established his Ironbridge site in 1709, since raw materials were plentiful here and the Severn River was one of the busiest in Europe for shipping goods. The ironworks expanded with the use of coal. Araham Darby II manufactured several cast iron cylinders for Newconen's steam engine and the first high-pressure steam boiler for Trevitchick's locomotive. It was Abraham III that actually built the bridge around 1780. By 1784 six "fire engines" (steam engines), eight blast furnaces, and none forges were in place--the largest iron works in the world.

Textiles

In Britain, textiles meant wool. Manufacturing relied on the domestic system based on piece rate. But progress based on innovative manufacturing equipment meant cotton, introduced from India by the East India Company. Initially, cotton cloth also used the domestic system, but manufacturing using cotton fibers could be mechanized and inventors introduced a series of new machines. The first was John Kay's flying shuttle for weaving in 1733 and James Hargreaves spinning jenny in the 1760s. Richard Arkwright patented the water frame in 1769, which used water power to spin yar and this was imporved by Samuel Crompton's "mule" a decade later. Edmund Cartwright mechanized weaving with the power loom in 1785. With rising demand for raw cotton, American Eli Whitley produced the cotton gin to remove cotton seed. The American South shifted to cotton production.

The factory system was invented for the textile industry. Arkwright built a cotton factory in the village of Cromford in 1771, funded by wealthy merchants. Power-driven machines required an army of laborers, working long hours at monotonous tasks in unsafe conditions for low wages. By 1800 most cotton manufacturing was done at factories. Cotton provided about half of Britain's exports well into the 19th century. By 1850 over 1900 factories were in the cotton industry with 330,000 workers, about 85% using steam and 15% using water power. A comparable number of factories produced other textiles.

The Steam Engine

Perhaps the greatest invention of the age was the steam engine, a commercial success when made operational by James Watt in 1769. Thomas Newcomen improved the steam engine, first invented in Holland, to use for drainage pumps in coal mines. Watt experimented with both the mechanics of Newcomen's engine and properties of steam. He found the engine inefficient and improved it by separating the steam condensation vessel from the cylinder and adding an air pump--which led to his 1769 patent. With partner Matthew Boulton, he began manufacturing steam engines and improving their quality and efficiency. By 1800 Boulton and Watts produced 500 steam engines. The oldest surviving steam engine, produced for the Birmingham Canal at Smethwick is now installed at the Birmingham Museum of Science and Industry.

Watt's steam engine

The first steam textile mill (1787) cost about £13,000, a single steam engine producing 30 horsepower about £1,500. These were most often financed through partnerships between entrepreneurs and rich merchants or landowners. Banks usually financed short-term trade credit to established companies. Once a factory was established, retained earnings were the most common source of capital. A few joint stock companies were formed, such as the Carron Company in the steel industry.

Wedgwood and the Importance of Cost Accounting

Josiah Wedgwood was the most famous potter in history and a key Industrial Revolution entrepreneur. At the time known for the craft of pottery, Wedgwood became a pottery manufacturer and a pinoeer both in production and cost accounting, Pottery includes all forms of ceramics, formed from various clay recipes and fired in a potter's oven. Wedgwood was a fourth generation potter and established his first partnership in 1754. He developed new products and became Her Masjesty's Potter with queensware. The years 1770-2 were financially difficult, when a depression hit. Demand dropped, inventories rose, and prices had to be cut.To make matter worse, clerks were embezzling funds, while ignoring debt payments and other paperwork.

Josiah Wedgwood by Joshua Reynolds

How could Wedgwood survive? He became a great cost accountant! He examined the business books in detail, discovered inefficient operations and the importance of overhead. He fould a history of embezzlement by his head clerk, when the accounts did not agree. A new clerk was installed and weekly accounting reviews implemented. Wedgwood was able to calculate detailed costs for materials and labor for each step of manufacturing for each product. Overhead costs were analyzed and allocated to specific products. He discovered tha costs to produce some products were considerably more than for others, with a corresponding effect on the prices that should be charged and profitability. The concepts of economies of scale and suck costs were discovered. The large percent of fixed costs of his factory suggested the importance of greater volume.

Based on the cost accounting analysis, the original high price policy for elite customers was changed. Prices could be charged differentially. Demand became the key to production and pricing policies. The market could be divided between high-price, high-quality, high-cost products for elite customers, while a mass market was developed with low-cost low-price pottery. Mechanization was part of the increasing output. He introduced an engine-turing lathe and in 1783 ordered a small fire (steam) engine. The cost system influenced wages paid and types of employees. Wedgwood survived, unlike most factories of the period who could not survive depressions.

Early Cost Accounting

Was Wedgwood typical of Industrial Revolution entrepreneurs? In some cases the answere is yes and for the same reason: survival. Entrepreneurs typically were factory innovators but seldom had accounting and finance skills. Accounts were kept, but accounting lagged the changes in mechanization, the factory system, and distribution. Capital markets were primitive, so financiers were unlikely sources for bailouts. As with Wedgwook, concern for accounting became crucial in times of difficulty, particularly the recurring depressions. Accounting was only beginning to become a profession in the 19th century, so entrepreneurs were usually on their own--some survived based on improved accounting techniques and information, many did not.

Fleischman and Parker (1991) evaluated the accounting records of 25 British manufacturers for the 1760-1850 period (which included Wedgwood). Of the 25, 13 were in textiles and 6 in iron--which included both Boulton and Watt and Darby. Both used relatively advanced accounting techniques, including cost control, overhead accounting, and standard costing. Carron Co., founded in 1759, was the first Scottish foundry to smelt iron with coke. Caroon was close to bankruptcy because of out-of-control costs, losses, and illiquidity. The survived by using cost estimates, monthly cost comparisons (per ton), performance measurement by department, revenue and expense by cost center, and overhead allocation (including depreciation). Because of fierce competition, cost evaluation was used to ascertain profitability. Based on this analysis, the firm withdrew from unprofitable line such as nail production and the anchor trade.

Transportation

Mass production required mass transportation to move raw materials to factories and finished goods to market. Water travel efficiently moved goods cheaply and was used by merchantilists around the world. Factory owners typically located plants near rivers or ports. As England became a global power, colonies served as sources of raw materials and ready markets for manufactured goods--handled through British merchants. Britain expanded transportation using first a canal system and then railroads, which became the primary means of mass transit in the 19th century.

Joint stock companies became common for canals and railroads, as well as waterworks and gasworks. Gas could be produced from coal and shortly after 1800, gas lamps were used in mills to replace candles. Frederick Winsor set about to light British cities with gas. This was accomplished by stock subscriptions beginning in 1806 to fund the massive utility to be called Gas Light and Coke Company. Within a few years all major British cities were illuminated with gas. Publicly funded utilities were on their way.

Wealthy merchants and industrialists saw the need for mass transportation, but these were expensive, took years to build, and required a vast infrastructure. They were too expensive for individuals to build. Since the government did not step in, capital markets expanded to meet the need. By 1773 meetings of brokers at Jonathan's coffeehouse developed into the London Stock Exchange.

The steam locomotive was something of a steam engine on its side. In 1802 Richard Trevethick (1771-1833) produced a high-pressure engine that he adopted into a railway locomotive. His first locomotive was built at Coalbrookdale in 1803, but he failed to attract investors. George Stephenson (1781-1848) built his first locomotive in 1814 and became the engineer to the Stockton and Darlington Railway, the first commercial railroad which started in 1825.

Locomotion, Stephenson's engine used at the Stockton & Darlington Railway

The Liverpool and Manchester Railway opened in 1830 and became the first public railroad on which all traffic was hauled by locomotive. About the same time, railroading started in the United States with the founding of the Baltimore and Ohio Railroad.

Roads expanded rapidly. The Londo and Greenwich Railway opened in 1838 and other London-based railroads soon after. From 1844-46 Parliament authorized over 400 railroads. Once started, a nationwide rail system soon became a reality. Industrialization was wa major beneficiary, with raw materials and finished good sent quickly and cheaply across the country and to major seaports.

Development of the Accounting Profession

At the start of the 19th century, evelen Londoners listed their occupation as "Accomptants". As industry, mass transportation and capital markets were established, the role of accountants expanded. Business regulation increased and taxes more heavily, promoting the need for professionals. The Bankruptcy Act of 1831 allowed accountants to be appointed "Official Assignees", the first government recognition of the new profession. A primary role became the preparation of accounts and the balance sheet of public companies. Bankrupt firms were especially likely to use their services, which increasingly served an audit function.

The British Companies Act of 1844 established the incorporation of business by a formal registration process and required annual appointement of auditors to examine the accounts and balance sheet of all public companies (the role of accountants under the British Companies Act would change substantially over the century). The Companies Act of 1862 required banks to be audited and established the practice of limited cash dividends to be paid only out of profits. By 1900, the audit was the central practice of accountants.

The earliest of the Big Six were started in mid-19th century London. William Deloitte oped a London firm in 1845.

William Deloitte

Samuel Price and Edwin Waterhouse formed their partnership in 1849. William Cooper started his firm in 1854, to be joined by his brothers in 1861. William Peat started in 1867. These men were active in establishing the Institue of Accounting in the 1870s and a royal charter was granted in 1880. With the Institute and professional requirements to become Chartered Accountants, the profession of accountants was firmly established.

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