Chapter 10 The REA Approach to Business Process

Chapter 10 The REA Approach to Business Process Modeling

Objectives for Chapter 10 • Limitations of traditional database system • Benefits of adopting an REA approach to information systems compared to a traditional approach • Implications of REA for the accounting profession • Steps involved in preparing an REA model of a business process • Importance of identifying the attributes of entity relations in relational database design • Differences between an REA model representation of a business process and an ER diagram representation

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 decisionmaking – inability to support change

Traditional Approaches: Financial Accounting Orientation • Dominance of accounting as the primary information provider leads to problems: – single view of business entity using the accounting model: Assets = Liabilities + Owners’ Equity – double-entry, debits and credits – high level of aggregation – ignoring non-financial data – inability to serve diverse enterprise-wide 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 – interrelationships • A variation of the Entity-Relationship diagramming 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 – these 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 • Developed in the ‘ 70's by Dr. Mc. Carthy (Michigan State University) from ER diagramming for accounting. • 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 represents a major change from the traditional double-entry approach. – The REA-events perspective will be increasingly seen as necessary to meet changing information needs in this information age.

Resources, Events, and Agents Model • A variation of the Entity-Relationship diagramming is used in REA modeling. ER-Diagram Symbols

Resources, Events, and Agents Model • A variation of the Entity-Relationship diagramming is used in REA modeling. ER-Diagram Symbols entity relationship attribute (optional)

Advantages of the REA Model • More efficient operations – It helps managers identify non-value added activities that can be eliminated. – Storage of both financial and nonfinancial data in the same central database reduces the need for multiple data. collection, data storage, and maintenance procedures – Storing financial and nonfinancial data about business events in detailed form permits the support of a wider range of management decisions. • Increased productivity via elimination of non-value added activities that will generate excess capacity • Competitive advantage by providing more relevant, timely, and accurate information

Value Chain Analysis • The competitive advantage benefits of adopting the REA approach are most clearly seen from the perspective of the value chain. – 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.

Revenue Costs Firm Infrastructure Human resource management Technology development Procurement Inbound Operations Logistics Output Logistics Primary Activities Marketing & Sales Margin Support Activities Porter’s Value Chain Service

Database Applications Phase 1 Flat Files Limitations: Redundant data; Anomalies Phase 2 Event-Driven Database Limitations: Loss of noneconomic information Phase 3 REA-Model Database Limitations: Not widely used; Requires detailed analysis

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 v. event-based. – i. e. , 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 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 Answer Query Make Sale Receive Payment Step 1: Identify operating events in Horizon Books’ sales model.

Developing an REA Model: Step 2 • The operating events identified now need to be organized in sequence of occurrence. • Notice how each event is shown as verbobject. – This facilitates arranging them in order of occurrence. • Note also that the verb is represented from the perspective of the organization, not the customer.

REA Example: Horizon Books Step 2: Place Horizon Books’ 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 (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)

REA Example: Horizon Books Step 5: Completed REA model of Horizon Books’ 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 REA model. • These are used to populate the database. • They are also used to create the various physical user-views needed in daily operations: – reports, documents, computer interfaces

Developing an REA Model: Attributes Using the customer as an example, these data include: Financial Customer name Customer address Customer telephone number Amount owed by customer Value of total sales to date Terms of trade offered Nonfinancial Customer credit rating Damaged goods record On-time payment record Customer volume record EDI access Internet access

Developing an REA Model: User-Views User-View #1 Past Due Accounts Name Amount James $500. 00 Henry $100. 00 … … User-View #2 Sales Report REA Database

REA Model v. ER-Diagram • The two methods have a lot in common, but there are differences: – ER-diagramming is more commonly found with traditional event-based systems. – REA-modeling is used with event-oriented systems. – ER-diagrams use diamonds to show events, while REA model classifies events as a type of entity. – REA includes only operating events, while ER-diagrams can capture all three types of event. – REA information facilitates placement of internal controls. – REA is simpler and more focused on business needs.

ERD Model of Manufacturing

REA Model of Manufacturing, 1

REA Model of Manufacturing, 2