Redefining the Ontology of Accounting

Published on 15 January 2012 Computing

Accounting is more than 7,000 years old. This discipline helps us to plan, execute and assess business transactions. It is also the universal language of business.

In particular, double-entry accounting (also known as double-entry bookkeeping) system has been used for about the last five centuries as a framework to record business transactions. We can then consolidate these transactions and report summaries through standardized documents such as ledgers, balance sheets, income statements, etc.

However, we are living in the age of information technology. And the way we perform accounting still looks like it is pre-computer age.

Can we do any better now?

In the following, I will briefly explain my concerns. Then, a relatively recent and exciting ontological approach to accounting follows.

Before proceeding, please note that I am a programmer, not an accountant. However, I do hands-on accounting and develop accounting systems.

Problem 1: What happened to my data?

Firstly, the information resulting from the accounting process is quite opaque. The typical accounting process tends to concentrate mostly on the preparation of summary of transactional data for statutory filing which presents a top-level view of business operations.

Furthermore, there is not much emphasis on the very continuum of business execution; there are significant cut-off times such as end of month, quarter or year. In conclusion, there is some information loss both in quantity and quality due to the primary focus on the summary of the data.

There is nothing wrong with summarizing per se. What I am trying to say is that the target audience of such summaries is merely external.

Problem 2: Computers to Replace Processes, Not Tools

Secondly, I am more concerned with the technical aspects of accounting. Let’s look at the etymology of accountant (from Wikipedia as of 2012-01-15):

The word “Accountant” is derived from the French word Compter, which took its origin from the Latin word Computare.

If it is about computation, we have a better understanding of computational models and methodologies compared to 500 years ago. If this sounds like a bold claim, check this out: Algebraic Models For Accounting Systems. It even talks about monoids which can characterize certain accounting systems with special properties. The term monoid can be dated back to the early 1930s, but not any earlier.

As far as I understand, there is not much of a difference between the pre-computer age and now in how we perform accounting except that we are using portable calculators instead of pen and paper, and personal computers instead of Facit.

A Better Way

Why am I concerned with accounting?

I have been involved in designing and implementing e-commerce and financial portfolio management systems. I think that accounting in general could have served as a more solid basis for our data modeling. Every time we prototyped around this idea, we failed and ended up having two separate systems: one based on an operational data model and another one based on an accounting data model.

However, around 2010, we met a different approach: Resources - Events - Agents (REA). We used some concepts from REA in our e-commerce application. Later in 2014, we used a watered-down version of it to build our portfolio and fund management system.

I can tell that it was a wise choice, and it still seems very promising.

REA Wikipedia article gives a relatively good overview of REA. However, I would recommend Model-Driven Design Using Business Patterns by Pavel Hruby.

In essence, REA defines an ontology of business events occurring among agents as resources being exchanged during a business transaction or converted during a manufacturing process.

REA Entity Diagram

Besides these entities, the core of the ontology also includes the commitments of agents to events. Furthermore, “Model-Driven Design Using Business Patterns” shows how REA ontology can be extended via policies (and various other patterns) to incorporate complex business processes, capture more granular information about business transactions, and derive reports directly from first-hand data.

As for the last point above: One surprising result of using REA is that conventional accounting is a natural consequence of working with business transactions: You fold them and get your insights, and some of these insights are already what we use the double-entry accounting system for.

REA comes with one more surprise egg: Using REA, accounting systems can very easily be implemented from an independent, third-party perspective, i.e. if you have access to business transactions for multiple entities, one system can handle accounting for all these entities in full integrity.

Is REA ready? From an academic perspective, probably yes. Yet, we cannot find practices, let alone the best ones, publicly. There is no reference implementation, either. Yet, do not be discouraged: learn more about REA and play with it to assess its merits.