Chapter 10 The REA Approach to Business Process Modeling Accounting Information Systems, 5 th edition James A. Hall COPYRIGHT © 2007 Thomson South-Western,

Chapter 10The REA Approach to Business

Process Modeling

Accounting Information Systems, 5th edition

James A. Hall

COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo,

and South-Western are trademarks used herein under license

Objectives for Chapter 10• Limitations of traditional database systems • Benefits of an REA approach to information

systems• Implications of REA for the accounting • Steps in preparing an REA model of a business

process• Importance of identifying the attributes of

entity relations in relational database design• Differences between REA model

representations and ER diagram representations

Traditional Approaches:User-View Orientation

• When data-modeling and IS design is too oriented toward the user’s views, problems arise:– multiple information systems– duplication of data– restricted user-view leads to poor decision-

making– inability to support change

Traditional Approaches:Financial Accounting Orientation

• Dominance of traditional accounting as the primary information provider leads to problems:– single view of business entity using the

accounting/balance sheet model:

– double-entry, debits and credits– high level of aggregation– ignoring non-financial data

– inability to serve diverse enterprise-wide needs

Assets = Liabilities + Owners’ EquityAssets = Liabilities + Owners’ Equity

Resources, Events, and Agents Model

• Developed in the ‘70's by Dr. McCarthy (Michigan State) • The definition of events is broad enough to encompass both

operational and accounting transactions. – Expands the scope and usefulness of AIS by making it capable of

providing both financial and nonfinancial information.

• Data for each event is stored in disaggregated form. – Outputs are subsequently produced by assembling the required data

from the various records.

• Many firms have not adopted the REA model since it is a major change from the traditional double-entry approach. – The REA or events perspective is increasingly seen as necessary to

meet changing information needs.

Resources, Events, and Agents Model

• An approach to database design meant to overcome problems with traditional approaches:– formalized data modeling and design of IS – use of centralized database – use of relational database structure– collects detailed financial and non-financial data– supports accounting and non-accounting analysis– supports multiple user views– supports enterprise-wide planning

Resources, Events, and Agents Model

• The REA model is an alternative accounting framework for modeling an organization’s – economic resources – economic events– economic agents, and – their interrelationships

• A variation of entity-relationship diagramming (ERD) is used to model these relationships.

Resources in the REA Model• Economic resources are the assets of the

company.– able to generate revenue– objects that are scarce and under the control of the

organization– can be tangible or intangible

• Does not include some traditional accounting assets:– for example, Accounts Receivables– artifacts that can be generated from other primary data

Events in the REA Model• Economic events are phenomena that effect

changes in resources.– a source of detailed data in the REA approach to

databases

• Three classes of events:– operating events--what happens– information events--what is recorded– decision/management events--what is done as a

result

• Only operating events are included in the REA model.

Agents in the REA Model• Can be individuals or departments• Can participate in events• Can affect resources

– have discretionary power to use or dispose of resources

• Can be inside or outside the organization– clerks– production workers– customers– suppliers, vendors– departments, teams

Resources, Events, and Agents Model

• A variation of the entity-relationship diagramming (ERD) is used in REA modeling.

• Basic ERD symbols:

entity relationship

(optional)

attribute

(optional)

Advantages of the REA Model

• Using REA can lead to more efficient operations– helps managers identify non-value added activities that

can be eliminated• increased productivity via elimination of non-value added activities

generates excess capacity

– storing both financial and nonfinancial data in the same central database reduces multiple data collection, data storage, and maintenance

– detailed financial and nonfinancial business data supports a wider range of management decisions

• increased competitive advantage by providing more relevant, timely, and accurate information to managers

Value Chain Analysis

• Competitive advantages from the REA approach can be see via value chain analysis. – Value chain analysis distinguishes between

primary activities (create value) and support activities (assist performing primary activities).

– REA provides a model for identifying and differentiating between these activities.

– Prioritizing Strategy: Focus on primary activities; eliminate or outsource support activities.

Porter’s Value ChainRevenue

Costs

Firm Infrastructure

Human resource managementTechnology development

Procurement

Inbound Logistics

OperationsOutput

LogisticsMarketing

& SalesService

Sup

port

Act

ivit

ies

Primary Activities

Margin

Phase 1Flat Files

Phase 2Event-Driven Database

Phase 3REA-ModelDatabase

Limitations:Redundant data;Anomalies

Limitations:Loss of non-economic information

Limitations:Not widely used;Requires detailed analysis

Database Applications

Database Sales Order Entry/Cash Receipts System

Database Purchases/Cash Disbursement System

Limitations of Transaction-Based Systems

• Event: a single business activity within a business process which involves resources and agents

• Traditional event-based database systems tend to focus exclusively on economic events.– loss of non-economic/non-financial information

• REA is event-oriented versus event-based.– includes non-economic and economic event

information

Developing an REA Model: Overview

• Before developing the REA model, identify events and classify as:

Operating events--activities that produce goods and services

Information events--activities associated with recording, maintaining, and reporting information

Decision/Management events--activities that lead to decisions being taken

• REA model uses only operating events.

REA Example: Horizon BooksHorizon Books is a bookstore in downtown Philadelphia. It carries an inventory of approximately 5,000 books. Customers come in and browse the shelves, select their books, and take them to one of three cashiers positioned in different parts of the store. One of the cashiers is situated at an information desk where customers can discover whether a particular book is in stock, place orders for books not currently available in the bookstore, and collect and pay for books previously ordered. The cashier at the information desk has a book database that is consulted for every query. There are no credit sales. All customers pay for their purchases at the time of purchase.

Developing an REA Model: Step 1

• Identify the operating events that are to be included in the model

• These are the events that support the strategic objectives of the organization and about which we need to gather information.

REA Example: Horizon Books

Step 1: Identify operating events in Horizon Books’ sales model

Answer Query Make

Sale

ReceivePayment

Developing an REA Model: Step 2

• Organize the operating events identified in sequence of occurrence

• Show each event is shown as verb-object – This facilitates arranging them in order of

occurrence. • Note that the verb/event is represented

from the perspective of the organization, not the customer.

REA Example: Horizon Books

Step 2: Place operating events in sequence

Developing an REA Model: Step 3

• Identify the resources and agents involved in each operating event

• This is most easily done by answering who, what, and where questions about each event. – Who was involved? – What was involved? – Where did it take place?

REA Example: Horizon Books

Step 3: Identify resources and agents associated with events

Developing an REA Model: Step 4

• Identify the links between the resources, events, and agents

• Start from each event and connect it to the resources and agents that are involved in the event

• Draw a line connecting events that are logically related

REA Example: Horizon Books

Step 4: Establish Horizon Books’ sales process relationships.

Developing an REA Model: Step 5

• Assign the record associations or cardinalities of all the entity relationships

• Five forms of associations (minimum-maximum cardinalities) are used when constructing the REA model:– zero-to-one (0,1) – zero-to-many (0,M) – one-to-one (1,1) – one-to-many (1,M) – many-to-many (M,M)—rare

REA Example: Horizon Books

Step 5: Completed REA model of sales process with cardinalities.

Developing an REA Model: Attributes and User-Views

• The final step is to define the attributes associated with the entities in the model.

• These are used to populate the database.

• Also used to create the various physical user-views needed in daily operations:– reports, documents, computer interfaces

Developing an REA Model: Attributes

Financial Customer name Customer address Customer telephone numberAmount owed by customerValue of total sales to dateTerms of trade offered

NonfinancialCustomer credit ratingDamaged goods recordOn-time payment recordCustomer volume recordEDI accessInternet access

Using the customer as an example, these data include:

Developing an REA Model: User-Views

User-View #1

Past Due AccountsName AmountJames $500.00Henry $100.00 … …

Sales Report

User-View #2

REA Database

REA Model v. ERD• The two methods have a lot in common, but there

are differences:– ERDs are more commonly found with traditional event-

based systems.– REA-modeling is used with event-oriented systems.– ERDs often use diamonds to show events, while REA

model always classifies events as a type of entity.– REA includes only operating events, while ERDs can

capture all three types of event.– REA facilitates placement of internal controls. – REA is more focused on business needs and, as a

result, often simpler.

ERD of Manufacturing

REA Model of Manufacturing, 1

REA Model of Manufacturing, 2