Foundations of accounting

1. Foundations of accounting ONTOBRAS-2013 The industrial application of ontology: Driven by a foundational ontology A paradigm shift case study

2. Topics • Background • Themes • Background • New foundations • Original foundations • Why Pacioli? • A ‘true and fair’ representation

3. Themes Themes to bear in mind

4. Themes to bear in mind • Paradigm Shift • Shift in information technology • A nice example of how a shift in technology creates an opportunity for a new conceptual structure

5. Background History

6. History • Epilogue to book: Business Objects (Partridge 1996) • See §2 – The accounting paradigm’s debit and credit pattern, §3 – Accounting’s ledger hierarchy, and §4 – Developing a new object-oriented accounting paradigm • This drew upon almost a decade of commercial work re-engineering enterprise systems using the BORO methodology • A new foundation for accounting (Partridge 2002) • LOA Technical Report 23/02 - A new foundation for accounting: Steps towards the development of a reference ontology for accounting LOA - LADSEB-CNR, Padova, Italy, December 2002. Abstract: This paper firstly reviews the need for a radical shift in the foundations and framework of accounting’s conceptual scheme. It, secondly, proposes that the foundations of the new scheme should be a reference ontology. It outlines a process – ontological analysis – for building this and illustrates how it will work with some examples • Shifting the ontological foundations of accounting’s conceptual scheme (Partridge 2003) • Paper presented at the Sixth European Conference on Accounting Information Systems, Seville, Spain, 1 April 2003. Abstract: The purpose of this paper is to establish the nature of the need for a new accounting conceptual scheme and provide the framework for taking a managed approach to this change. This paper firstly reviews the nature of the need for a radical shift in the foundations and framework of accounting’s conceptual scheme. It touches upon how the existing uses of ontological analysis within accounting information systems research do not address this need. It then outlines how a more philosophical approach to ontological analysis provides a process for starting the shift in the foundation. And illustrates how the process will work with some examples

7. New foundations

8. New foundations; not a new idea • Some early references • Goetz, B. E. (1939). "What's wrong with accounting." Advanced Management (Fall): pp. 151-57 • Schmalenbach, E. (1948). PretialeWirtschaftslenkung, Band 2: PretialeLenkung des Betriebes. Bremen, Dorn

9. Modern initiatives • There are two modern ontological analysis initiatives within accounting information systems • Wand/Weber • Wand and Weber (1989) An Ontological Evaluation of Systems Analysis and Design Methods • The Wand/Weber initiative explicitly draws upon the work of Mario Bunge (Bunge1974). Its focus is on the needs of conceptual modelling and is not directed towards a specific model of accounting • McCarthy/Geerts • McCarthy (1982) The REA Accounting Model • The McCarthy/Geerts initiative has developed a specific model of accounting called (in (McCarthy 1982)) the ‘REA Accounting Model’ • Geertsand McCarthy (2002) An Ontological Analysis of the Primitives of the Extended-REA Enterprise Information Architecture say on p.2 • “many scholars consider it [their REA model] a more solid foundation for the enterprise information systems of the future than the traditional double-entry framework it attempts to supplant” • Similar points are made in Walker and Denna (1997) Arrivederci, Pacioli? A new accounting system is emerging. and Andros, et al. (1992) Reengineer your accounting, the IBM way

10. The original foundations

11. Accounting - bookkeeping • Based upon old information technology • The emergence of accounting (and its conceptual scheme) is closely associated with the emergence of writing (an early information technology) • Historians tell us that writing developed in Ancient Mesopotamia millennia ago to help people manage the accounts of the developing city-states. (e.g. Nissen, et al. (1993) Archaic bookkeeping)

12. The current accounting conceptual scheme • The current accounting conceptual scheme has its roots in a more recent development. The introduction of printing in the late fifteenth century prompted a number of books on accounting – describing various different systems • It also prompted Europe’s standardisation on the one of these most suited to the then current technology – the system described in the chapter Particularis De Computis Et Scripturis (Details of Accounting and Recording) in the book Summa de Arithmetica, Geometria, Proportioni et Proportionalita by Pacioli printed in 1494) • The system is one that, as Pacioli noted, had been used by Venice merchants for hundreds of years. So printing was not a key factor in its development – just in the standardisation upon it

13. A paper and ink system • The influence of paper and ink technology is plain in the book’s text. For example, in Chapter 2, Pacioliwrites • “The businessman must then prepare his Inventory in the following way: First of all, he must write on a sheet of paper or in a separate book …” • Further on he says: • “In the left margin, next to the [journal] entry place the page numbers where the debit and credit entries are to be found, the debit above the credit below. Immediately enter the debit and credit account in the index, each under its own letter. Cash will be placed under the letter C as follows ‘Cash, page 1’. Place Capital also under C, ‘Capital of my own, page 2’. In this way, continue entering in the Index all the debit and credit accounts under their respective letters, in alphabetic order. When this is done the accounts can easily be located in the Ledger.”

14. The competition • In the first 50 years of printing, there were a significant number of books on accounting, each describing different schemes • Pacioli’s scheme became the standard • This is despite the fact that many of the other competing schemes had features that were missing from Pacioli’s

15. Example of a different scheme • One such scheme is (Manzoni 1534) who notes that • “the four principal things appertaining to buying, selling, receiving, paying, exchanging, lending and gifts are • The one who gives • The one who receives • The thing given • The thing received”

16. Difference between the schemes • The Manzoni scheme differs from the Pacioli scheme in a couple of important ways • Firstly is recognised the non-monetary element of the transaction • Secondly, it explicitly recognises the proprietor, which is implicit in Pacioli’s • Littleton (Accounting evolution to 1900 (1933)) noted (on p.51) a Manzoni-type approach was better • “The simple logic of the early Italian manner became much obscured when the conscious inclusion of the proprietor in every transaction fell into neglect.”

17. Why Pacioli?

18. Why Pacioli? • Why the Venetian method? • Why did the Venetian merchants prefer their approach • Information technology • It was simpler and easier to implement on paper and ink systems • Manzoni’s scheme may be a “fairer and truer” reflection of the transaction, but it was more difficult to implement

19. Depreciation • At the time, the lack of precision in recording the transaction did not cause problems • However, as accounting became more widespread and tightly controlled a problem revealed itself: depreciation • When goods were held in stock for a time, their value could go down. However, they were recorded in the Pacioli-based system at book cost. Keeping track of this began to emerge as a problem in the 18th century • Additional systems of valuation and depreciation were developed to handle this

20. A ‘true and fair’ representation

21. Mr Smith buys a car

22. A “true and fair” picture

23. A model-based view

24. Aristotle’s causes view Aristotle used "cause" (in Greek, aition) to mean "an explanation for how a thing came about“ So, the idea is, that if you can identify the causes you are giving an explanation

25. Summary

26. Summary • The structure of the current accounting scheme reflects its roots in paper and ink technology • The structure was simplified to facilitate implementation in that technology • As a new technology has emerged, the original requirement is now redundant • An opportunity for improvement has emerged • A top ontology provides a mechanism to flesh out that opportunity

27. Questions