The REA-invention of Double Entry Bookkeeping - Moving Accounting Back to the Center of Enterprise Information Architectures by prof. William E. McCarthy

Thank you for inviting Bill & me

across

The REA-invention of Double Entry Bookkeeping:

Moving Accounting Back to the Center

of Enterprise Information

Architectures

&

In the spirit of Ghent

The Ghent Altarpiece (Het Lams Gods)

Let’s go back a few years to ?

In the year 1432

• Gutenberg’s printing press was impending, and the advanced use of Hindu-Arabic numbers was becoming prevalent in Europe. Technological Imperative

• Copernicus and Columbus had not yet been born, but it was the dawn of the Renaissance and the Age of Discovery. Increasing trade ventures were causing “a blizzard of transactions” that needed accurate and reliable documentation and stewardship. Commercial Imperative

• Where was accounting (enterprise information systems) in the 1400s?

– Accounting had been around in various locales for 3,000 years already in the form of tokens, clay jars, and sticks. There are even claims that accounting caused the invention of writing.

– Counting artifacts preceded van Eyck by thousands of years.

– In Italy, double-entry accounting had already started in the 1300s (reached Bruges soon thereafter) .

– Double-entry spread faster once books were available detailing its operation. Technological Imperative

In his Summa in 1494, Luca Pacioli codified the Venetian method of bookkeeping which had

evolved to deal with the blizzard of commercial transactions at the dawn of the Renaissance and

the Age of Exploration. Trading ventures he mentions include those with the cities of Antwerp

and Bruges.

Luca Pacioli – “Father” of Accounting

• Debit – from Italian

“debito” -- owed to the

proprietor

• Credit – from Italian

“credito” – owed from the

proprietor

• BOOKS:

– Memorandum

– Journal (L)

– Ledger (G)

Accounting systems through the ages

Enterprise Economic Activities (Events) Principal

(reality)

Surrogates (accounting

system)

notched

stick

Agrarian Age

“ transactional

memory external

to the parties of

the exchange”



(reality)

Surrogates (accounting

system)

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age

Luca Pacioli & double-entry

accounting (1494) spread

throughout Europe and

beyond. Engineered

accounting artifacts

facilitated this change and

evolution.

notched

stick

Agrarian Age

“ transactional

memory external

to the parties of

the exchange”

Path-Creation Design

Double-Entry Accounting

Recording and Counting

Technologies.

Systematic Accuracy and

Reliability

LEGEND

Path-Creation Change

Path-Dependent Change

Innovation: Creation of New

Artifacts (Technological Imperative)

Changing Business

Models and Expectations (Commercial Imperative)

Accounts, Journals

and Ledgers

Semantic Web

Technologies

Technological Imperative

Commercial Imperative

Path-Dependent

Design

Documentation and

Stewardship

Counting & Calculating Methods

Narrative descriptions and

single-entry records

Hindu-Arabic Numerals and

Arithmetic Advances

SOURCE: Geerts & McCarthy

Fast forward to the last 50 years

(1962 – 2012)

• Technological Imperatives:

– Computers, advanced tracking technologies,

markup languages, database semantics, etc.

• Commercial Imperatives:

– Efficiency, multidimensionality,

comprehensiveness, interoperability, etc.



Surrogates

jar

notched

stick

Agrarian Age

source

document

computer

files and

General

Ledger

Financial

statements

Industrial Age

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age

“ transactional

memory external to

the parties of the

exchange”



Surrogates

jar

notched

stick

Agrarian Age

source

document

computer

files and

General

Ledger

Financial

statements

Industrial Age

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age

“ transactional

memory external to

the parties of the

exchange”



Surrogates

jar

notched

stick

Agrarian Age

source

document

computer

files and

General

Ledger

Financial

statements

Industrial Age

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age

“ transactional

memory external to

the parties of the

exchange”

What happens to modern

computer systems when you

“pave these cow-paths” ??



Surrogates

jar

notched

stick

Agrarian Age

source

document

computer

files and

General

Ledger

Financial

statements

Industrial Age

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age

“ transactional

memory external to

the parties of the

exchange”

X

What’s wrong with the traditional accounting system? (why not pave the cowpaths ??)

• Its dimensions are limited (need multidimensional focus)

• Its classification schemes (CoA) are not always appropriate (need

more semantic focus on modeling of reality)

• Its aggregation level is too high and predetermined (determined by

closing, adjusting, and costing procedures)

• Its degree of integration with other systems is limited (need links with

types, commitments, and other data from supply chain, production,

marketing, human resources, etc.)

Source

document

M/Files and

general ledger

Financial

Statements

Accounting engineering artifacts

gone bad

• Crazy code block expansions

• Period costing & matching

• Absorption costing

• Activity-based accounting (G/L

centered)

• LIFO, SoYD

• Grundrechnung ?

Inventory $$$$$

account balance

Inventory Inventory

Type Color $$$$$

account-code balance

Inventory Inventory

Type Size Distribution

Channel Color --- $$$$$

account-code balance

Sales-

person Customer

FOR EXAMPLE: ACCOUNT-CODING of

ECONOMIC PHENOMENA

see Vandenbosscheeter and Wortmann

(REA Workshop 2006)

double-entry accounting

Enterprise economic

phenomena

double entry sludge




Technologies.


Reliability

LEGEND





Changing Business


Accounts, Journals

and Ledgers



Path-Dependent

Design

Documentation and

Stewardship


Automated Reasoning




Arithmetic Advances

Database Technologies

Computers Semantic Web

Technologies

Markup Languages

Advanced Tracking

Technologies

Multidimensionality and Integration Independent

Interoperability

Transaction and Master Files (GL)

XBRL GL

Efficiency

Temporal and

Granular Comprehensiveness

Facet-Coded

Accounts

Digital Single Entry

Activity-Based Costing


Enterprise Economic Activities Principal

jar

notched stick

Agrarian Age

source document

computer files and General Ledger

Financial statements

Industrial Age

memorandum

Journal .

A/ Rec …. Sales…

Ledger .

ooo

Mercantile Age

Surrogates

“ transactional

memory external to

the parties of the

exchange”

going beyond the bookkeeping to

natural language descriptions

Accounting Systems Evolution


Surrogates

jar

notched

stick

Agrarian Age

source

document

computer

files and

General

Ledger

Financial

statements

Industrial Age

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age

Economic storytelling

with semantic models of

value creation by firms

Financial

Reporting

View

Other

Views of

Enterprise

Event-chains

Enterprise Systems

Age

“ transactional

memory external

to the parties of

the exchange”

Cookie-Monster (the customer) and Elmo (the entrepreneur) meet in the (real or virtual) marketplace, thus setting the

stage for an Economic Exchange

Cookie-Monster and Elmo engage in a SALE (transfer of Cookie Inventory)

Cookie-Monster and Elmo engage in a PAYMENT (transfer of Cash)

accounts-receivable

1.00

sales

1.00

cash

1.00

1.00

cost-of-goods-sold

.80

inventory

.80

ELMO sold cookie

COOKIE-MONSTER

ELMO received cash

COOKIE-MONSTER

Economic Resource

insideParticipate

stock-flow

Economic Agent

Economic Agent

Economic Event

outsideParticipate

Economic Resource

insideParticipate

stock-flow

Economic Agent

Economic Agent

Economic Event

outsideParticipate

insideParticipate

stock-flow

Economic Agent

Economic Agent

Economic Resource

Economic Event

duality

Modeling requited transactions with REA patterns

outsideParticipate

Economic Resource

Economic Event

Economic Agent

Economic Agent

stock-flow

outsideParticipate

insideParticipate

<<Economic Agent>>

Customer

customerNumber

customerName

discountPerCent

receivableBalance

updateReceivableBalance()

Stockflow

lineItemQuantity

lineItemPrice

0..* 1..1

<<Economic Resource>>

Cookies

productNumber

description

currentUnitPrice

unitCost

calculateUnitCost()

<<Economic Event>>

Sale

invoiceNumber

numberOfLineItems

saleAmount

discountedAmount

costOfGoodsSold

calculateNumberOfLineItems()

calculateSaleAmount()

calculateDiscountedAmount()

calculateCostOfGoodsSold()

WholesaleCustomer

mainWarehouseCity

tellAboutSelf()

RetailCustomer

statusCategoryCode

statusCategoryName

tellAboutSelf()

outsideParticipate

1..*

0..*

1..1

1..1

Product# Description Price Cost

P-1 Chocolate Chip

1.05 .90

P-2 Chocolate 1.00 .80

P-3 Peanut Butter

.95 .78

P-4 Pecan 1.10 .94

Invoice#

Payment Timestamp

Amount Applied

I-1 2JUL0830 14.75

I-2 3JUL0800 2.00

I-2 5JUL0800 18.00

I-3 8JUL1145 6.00

I-4 8JUL1200 1.00

C-999 E-1234 3JUL 10.95 I-3

C-987 E-1234 5JUL 1.00 I-4

C-888 E-1234 2JUL 20.00 I-2

C-987 E-1234 1JUL 14.75 I-1

Buyer# Seller#

Date

Sale Amount

Invoice#

Product# Invoice# Quantity

P-2 I-1 5

P-3 I-1 10

P-2 I-2 20

P-4 I-3 9

P-1 I-3 1

P-2 I-4 1

COOKIE

SALE

COOKIE-stockflow-SALE

SALE-duality-CASH_RECEIPT

An accounting database

Cost

11.80

16.00

9.36

.80

Product# Description Price Cost

P-1 Chocolate Chip

1.05 .90

P-2

Chocolate 1.00 .80

P-3

Peanut Butter

.95

.78

P-4 Pecan 1.10 .94

Invoice#

Payment Timestamp

Amount Applied

I-1 2JUL0830 14.75

I-2 3JUL0800 2.00

I-2 5JUL0800 18.00

I-3 8JUL1145 6.00

I-4 8JUL1200 1.00

C-999 E-1234 3JUL 10.95 I-3

C-987 E-1234 5JUL 1.00 I-4

C-888 E-1234 2JUL 20.00 I-2

C-987 E-1234 1JUL 14.75 I-1

Buyer# Seller#

Date

Sale Amount

Invoice#

Product# Invoice# Quantity

P-2 I-1 10

P-3 I-1 5

P-2 I-2 20

P-4 I-3 9

P-1 I-3 1

P-2 I-4 1

COOKIES

SALE

COOKIES-stockflow-SALE

SALE-duality-PAYMENT

Cost

11.80

16.00

9.36

.80

Story of why this invoice amount to $14.75 ??

Adding temporal and granular expansion, process phases,

and business events to REA

Business

Process governs

Economic

Agent to-participate

from-participate Economic

Event

Economic

Resource

stock-flow

duality

Economic

Event Type

Economic

Agent Type

specifies

specifies

typify

typify

policy

bundles

Business

Event

Business

Process

Phases

workflow Value/Supply

Chain

networked

Economic

Agreement

Economic

Commitment

fulfills

Economic

Resource

Type

specifies

reciprocal typify

policy

38

Accept Customer Contact

Assess Customer Needs

Check Car File & Choose

Assess Insurance Options & Credit

Fill in Contract

Customer Pays

Find Car & Provide Keys

Return Car

Update Files

Check Out Car

Payroll

Process

Cash

Acquisition

Process

Cash

Labor

Labor

Maintenance

Process

Cash

Labor

Labor

Car

Car

Revenue

Process

Cash

Maintained Car

Labor Labor

Exchange

Customer

Car Maintained Car

Labor

Cash

Revenue

Rental

Contract

Rental

Agent

Customer

Cash

Receipt Cash

Cashier

REA – 3-level architecture

Economic

Event

Economic

Resource Economic

Agent

stockflow fromParticipation

toParticipation

Economic

Commitment reciprocal

fulfill

duality

Resource

Type

typifiy specify

Event Type

Agent Type

specify

specify

typify

typify

participate

policy

policy

policy

trigger

responsibility

component

Resource Event Agent

In philosophy and computer science, an ontology is a formal

representation of a set of concepts within a domain and the

relationships between those concepts. It is used to reason about the

properties of that domain, and may be used to define the domain

(Wikipedia).

Ontology Summit 2011

Communique

Fundamentally, ontology is about reaching agreements on what things mean and putting it in machine-processible

form. In an enterprise, this represents a radically different way to express meaning. The usual way is for meaning to be scattered throughout the organization in people’s heads, in email, in no-longer maintained requirements

documents, in conceptual models, etc. … Ontology both forces and enables an organization to be clear about

what things mean and in doing so, gets everyone on the same page. Equally important, formally representing meaning enables automated inference which helps to

reduce unnecessary complexity, improve reliability and increase agility.

Business

Process

Business

Process

Business

Process

Enterprise #1

Business

Process

Business

Process

Business

Process

Enterprise #3

Enterprise #2

Business

Process

Business

Process

Business

Process

Collaboration Space Perspective: Trading Partner vs. Independent

Independent view of

Inter-enterprise events

Trading Partner view of

Inter-enterprise events

(upstream vendors and

downstream customers)

Dotted arrows represent flow of goods, services, and cash between

different companies; solid arrows represent flows within companies

SOURCE: Adapted from ISO/IEC 15944, 2007

Buyer Seller

Third Party

Collaboration Space

Value Exchange

Japan expert contribution to 15944-4, 9 May 2002, Seoul Korea

Accounting Systems Evolution


Surrogates

jar

notched

stick

Agrarian Age

source

document

computer

files and

General

Ledger

Financial

statements

Industrial Age

memorandum

Journal .

A/ Rec ….

Sales…

Ledger .

ooo

Mercantile Age




Financial

Reporting

View

Other

Views of

Enterprise

Event-chains

Enterprise Systems

Age


of interoperable

communities of firms

Semantic Web

Age

Collaboration

Space

“ transactional

memory external

to the parties of

the exchange”

Economic

Event

Economic

Resource

Economic

Agent

stock-flow from

to

Economic

Agreement

Economic

Commitment

Economic

Claim

materializes

settles

fulfills

establish

duality

Economic

Resource

Type

typify specifies

Economic

Event Type

Economic

Agent Type

specifies

specifies

typify

typify

reciprocal

Business

Process governs

Business

Event

Business

Process

Phases

workflow

aggregate

Independent view of

exchange events

Trading Partner view of exchanges Trading Partner view of conversions

1. Planning—Identification-Negotiation-

Actualization-Post-actualization phases

2. inside/outside participate

3. inflow/outflow stockFlow

4. 1-to-1, 1-to-n, n-to1, m-to-n duality

5. other

1. Planning—Negotiation-Actualization-

Post-actualization phases

2. inside only participate

3. use--produce stockFlow

4. n-to-1 dualities

5. other

REA

ontology

REA

enterprise

ontology

(Coase)

meronymic

0..* 1..1

PK

receive

duality

provide

0 ..*

stockflow

{incomplete, disjoint}

«EventType» ExpeditionType

- expeditionTypeName PK - expedExpectedTimeLength - standardUndiscountedSlotFee - expeditionTypeCapacity

«EconomicResource» SupplyItem

- supplyItemTypeNumber PK - supplyItemPrice - supplyItemQOH-

«EconomicResourceType» SupplyItemCategory

- supplyItemCategoryName PK - monthlySaleAmountOfSIC

«EconomicAgentType» EmployeeType

- employeeType PK - startingWageForEmpType - countOfEmployeesForType

«EconomicEvent» Expedition

- expeditionNumber PK - slotsFilledForScheduleExped - actualDuration - scheduledExpeditionDate

«EconomicEvent» ExpeditionTicket

- ticketNumber PK - discountedSlotCharge - total$AmountOfSupplyItems - countOfSlotsOnThisTicket

«EconomicResourceType» AircraftType

- aircraftTypeName PK - aircraftSeatingCapacity - aircraftFuelCapacity

«EconomicResource» Aircraft

- aircraftEngineNumber PK - dateAircraftManufactured - aircraftName CK -

«EconomicAgent» Employee

- employeeNumber PK - employeeName

«EconomicAgent» ExpeditionWorker

- employeeNumber PK

«EconomicAgent» Guide

- employeeNumber PK - dateQualifiedAsAGuide

«EconomicAgent» BookingAgent

- employeeNumber PK - bookingAgentCommRate

«EconomicAgent» Pilot

- employeeNumber PK - dateOfInitialPilotLicense

«EconomicAgentGroup» People

- peopleName PK - approximatePopulation

«EconomicAgent» Client

- clientNumber PK - clientName

«EconomicEvent» Payment

- remittanceAdvceNum PK - $AmountOfRemitAdvice - clientCheckNumber

«BusinessLocation» Location

- locationName PK - locationMapCoords CK

distance

- distanceBetween policy-sequence

- sequenceOfLocationOnTour

policy- qualifies

- hoursFlown

stockFlow

- quantityOfItemOnThisTicket

policy-count

- countOfEmployeeType

«EconomicResource» Cash

- cashAccountNumber PK - cashAccountBalance receive

provide

participate stockflow

participate

participate

policy

policy

typify

typify

typify

0 ..*

0 ..*

0 ..*

site

0 ..*

0 ..*

0 ..*

0 ..*

0 ..* 0 ..*

0 ..*

0 ..*

0 ..*

1..1

0 ..*

0 ..* 0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

1..*

1..*

1..*

0 ..*

0 ..*

0 ..*

0 ..*

0 ..*

1..1

1..1

0..1

1..1

1..1

1..1

1..1

0..1 0 ..*

0 ..*

lead

group group

0 ..* 0 ..*

0..1 0..1

0 ..*

typify

0..1

start finish

Typed REA model for exchange business process

- manufacturingRunNumber PK - actualTotalT&MCost - toDateRunLaborCost - toDateRunMaterialCost - actualQuantityProduced

«EconomicEvent» Manufacturing Run

-operationTypeName PK

-standardSequence

«EventType»

Operation Type

- employeeTypeName PK

- startingWage

«AgentType»

Employee Type

- scheduledOperationNumber PK

- scheduledSequence

«EconomicCommitment»

Scheduled Manufacturing Operation

quantityOfRawMaterialPerUnit

policyBM

- scheduledMinutes

specify1

- minutes

participate

- minutesUsed

used

- laborMinutesPerUnit

policyOL

-standardUnitCost -qOH

«EconomicResourceType»

Raw Material Type

-rawMaterialCatalogNumber PK

- minutesNeededPerUnit

policyTM

-dateAcquired

«EconomicResource»

Raw Material

-rawMaterialTagNumber PK

-quantityOwned


Tool-Machine Type

-toolMachineTypeDescription PK

-standardUnitCost

-qOH


Medical Equipment Type

-medicalEquipmentCatalogNumber PK

-standardGramWeight

-dateAcquired

«EconomicResource»

Tool-Machine

-toolMachineNumber PK

-totalMinUsedSinceAcquis

- scheduledMinutes

specify

- scheduledQuantity

specify

- productionOrderNumber PK - budgetedTotalLaborCost - budgetedTotalMaterialCost

- projectedQuantityProduced

«EconomicCommitment»

Scheduled Manufacturing Run

- budgetedTotalTool&MachineCost

- quantityUsed

used

- minutes

participate

- minutes

participate

- initiationTimestamp PK

- actualDuration

«EconomicEvent»

Manufacturing Operation

- actualSequence

duality

participate

specify

produce

participate

typify

policyBM

fulfill

1..1

1..*

-medicalEquipTagNumber PK

-actualGramWeight

«EconomicResource» Medical Equipment

- employeeNumber PK

- employeeName

«EconomicAgent» Employee

- wage - dateHired

- employeeNumber PK

«EconomicAgent» Machinist

- employeeNumber PK

«EconomicAgent» Assembler

- employeeNumber PK

«EconomicAgent» Electrician

- employeeNumber PK

«EconomicAgent» Scheduler

- employeeNumber PK

«EconomicAgent» Supervisor

reciprocal

fulfill

typify

typify

typify

consume

participate

specify specify

1..1

1..1

1..1

1..1

1..1

0..*

0..*

0..* 0..*

0..*

0..*

0..*

0..*

0..* 0..*

0..*

0..1

0..1

0..1

0..1

0..1 0..1

1..*

1..*

1..* 1..*

1..*

1..*

1..*

{complete, disjoint}

0..*

0..*

0..*

0..*

0..*

0..*

0..*

1..1

1..1

1..1

1..1

1..*

1..*

1..*

0..*

0..*

0..*

0..*

0..* 1..1

1..1

0..*

1..*

1..*

typify

1..1

0..*

conversion

business process




Technologies.


Reliability

LEGEND





Changing Business


Accounts, Journals

and Ledgers



Path-Dependent

Design

Documentation and

Stewardship


Automated Reasoning




Arithmetic Advances


Computers Semantic Web

Technologies

Markup Languages

Advanced Tracking

Technologies

Multidimensionality and Integration Independent

Interoperability


XBRL GL

Efficiency

Temporal and


Facet-Coded

Accounts






Enterprise Value Chain


Technologies.


Reliability

LEGEND





Changing Business


Accounts, Journals

and Ledgers

Multidimensionality and Integration


Independent Interoperability

Computers

Integrated Repository with Minimal General

Ledger

Semantic Web

Technologies


XBRL GL



Path-Dependent

Design

Documentation and

Stewardship Efficiency

Temporal and


REA Accounting

Model


Facet-Coded

Accounts

Automated Reasoning

REA Enterprise Ontology




Integrated Value Chain,

Business Process, and

WorkFlow Descriptions


Arithmetic Advances

Markup Languages


Advanced Tracking

Technologies


Positive REA (study what is)

Enterprise Economic Activities

jar

notched stick

Agrarian Age

source document

computer files and General Ledger

Financial statements

Industrial Age

memorandum

Journal . A/ Rec …. Sales…

Ledger .

ooo

Mercantile Age




Financial Reporting

View

Other Views of Enterprise Event-chains

Enterprise Systems Age


of interoperable

communities of firms

Semantic Web Age

Normative REA (beyond prototypes)

Fully-implemented,

REA-directed,

enterprise system Accumulation of

engineering

expertise &

implementation

experience

Standards work with ebXML,

UN-CEFACT (UMM module)

and ISO Open-edi (accounting

& economic ontology)

Hoping for the REA “golden spike” where the

positive (ecologically rational) and the normative

(rationally designed) meet

Where are we today in technology?

Where are will we be in 15 years?

REA monograph – proposed outline

1. The original REA model

a. REAs & accounting ontology

b. the switch to an independent view

2. Granular expansions

a. Up to Value Chains and Value Systems (supply chains) and down to

workflow (state machine)

b. Fit to Theory of the Firm (Coase) – same pattern

i. Exchanges

ii. Conversions

c. The economic component structures of resources (Lancaster) and agents

(need to identify an economic source)

3. Temporal expansions

a. What could be or should be (types, standards, budgets)

b. What is planned or scheduled (commitments and contracts)

c. Business Process phases – Tie workflow to state changes and business

events

4. Needed expansions

a. Claims – tied to Financial Instrument Business Ontology

b. Materialization of account balances

c. Internal controls – Tie to scripts for integrity constraints

5. Future directions and open issues

a. Evaluative (positive)

i. Behavioral

ii. Railway spike (where normative and positive meet in actual

practice)

b. Design (normative)

c. Tie to other accounting work – XBRL-FR and IMA managerial roadmap

An Expanded Vision for Accounting

double-entry accounting

Enterprise economic

phenomena

REA-engineered accounting

systems

Any questions

??

The REA-invention of Double Entry Bookkeeping:

Moving Accounting Back to the Center

of Enterprise Information

Architectures



Enterprise Value Chain


Technologies.


Reliability

LEGEND





Changing Business


Accounts, Journals

and Ledgers

Multidimensionality and Integration


Independent Interoperability

Computers

Integrated Repository with Minimal General

Ledger

Semantic Web

Technologies


XBRL GL



Path-Dependent

Design

Documentation and

Stewardship Efficiency

Temporal and


REA Accounting

Model


Facet-Coded

Accounts

Automated Reasoning

REA Enterprise Ontology




Integrated Value Chain,

Business Process, and

WorkFlow Descriptions


Arithmetic Advances

Markup Languages


Advanced Tracking

Technologies
