The Foundation of the Business Process Model - Economic Exchanges

1. The Foundation of the Business Process Model - Economic Exchanges • Economic Exchange – Two related economic events where we acquire one resource in exchange for another • Economic exchanges are important because they involve the most fundamental events where value is added in the business. Therefore, the first part of this course will focus on these events only. • Examples: give cash, get inventory; give inventory, get cash; get cash from investor, give dividend to investor; borrow money from bank, give money to bank; give cash, get building; give cash, get services

2. Components of an Economic Exchange • Two related events • Each event is associated with a resource – one event increases resources (get), the other decreases or uses resources (give); get and give may, and usually do, involve different resources • Each event usually involves one internal agent and one external agent; in an exchange, generally the same external agent is associated with both events • Goal is to understand what the events, resources and agents are, and the nature of the relationships between them

3. An REA Model of an Economic Exchange William E. McCarthy* Michigan State University (These slides may be copied as long as original source is cited) *http://www.msu.edu/user/mccarth4/

4. Cookie-Monster (the customer) and Elmo (the entrepreneur) meet in the (real or virtual) marketplace, thus setting the stage for an Economic Exchange

5. Economic Resource Economic Event Economic Agent duality Economic Exchange Pattern R E A Source: W. E. McCarthy “The REA Accounting Model: A Generalized Framework for Accounting Systems in a Shared Data Environment,”The Accounting Review, July 1982, pp 554-78. W.E. McCarthy “The REA Modeling Approach to Teaching Accounting Information Systems,” Issues in Accounting Education, November 2003, pp. 427-41. (source of following slides)

6. Cookie-Monster (the customer) and Elmo (the entrepreneur) engage in a SHIPMENT (transfer of Cookie Inventory)

7. Economic Resource Economic Resource Economic Agent Economic Agent Economic Agent Economic Agent Economic Event stock-flow stock-flow inside participation outside participation outside participation duality COOKIES ELMO SALE cookie monster Give Take Economic Event inside participation REA model of cookie sale from entrepreneur’s (ELMO) perspective

8. Economic Resource Economic Resource Economic Agent Economic Agent Economic Agent Economic Agent Economic Event stock-flow stock-flow outside participation outside participation inside participation duality COOKIES ELMO SALE cookie monster Give Take cookie monster Economic Event CASH RECEIPT inside participation ELMO CASH REA model of cookie sale from entrepreneur’s (ELMO) perspective

9. Economic Resource Economic Resource Cookies Salesperson Cashier Economic Agent Economic Agent Economic Agent Economic Agent Economic Event stock-flow stock-flow Sale outside participation outside participation inside participation Customer Customer Give Take Economic Event Cash Receipt inside participation duality Cash more general exchange model from the entrepreneur’s (ELMO’s) internal perspective

10. COOKIES COOKIES-stockflow-SALE SALE-duality-CASH_RECEIPT SALE Partial Database for Elmo’s Cookie Business Why is this invoice amount $14.75 ?? How is customer paying for this ???

11. business process business process business process labor cash cash cookies Acquisition Cycle Conversion Cycle Revenue Cycle cookie ingredients value chain A business process is a set of activities that takes one or more kinds of input and creates an output that is of greater value to the customer (Hammer and Champy) A value chain is a purposeful network of business processes aimed at assembling the individual components of a final product (i.e., its portfolio of attributes) of value to the customer (Porter and Geerts/McCarthy) Part of ELMO’sValue Chain for Providing Cookies

12. Semantic infrastructure of system matches extended REA pattern Enterprise Information Systems Basic Accounting Systems Counting artifacts e-collaboration systems Enterprise Systems classification structure is from David, McCarthy & Sommer, Communications of the ACM, May 2003, pp. 65-9.

13. Different perspectives on REA modeling needed for enterprise modeling (value chains) and collaboration space (supply chains) • Enterprise modeling (as evidenced in normal ERP systems) is done from the perspective of one company or entrepreneur. Business processes are viewed as components of a single value chain. A single exchange (like the sale of a product for money) would be modeled twice, once in the enterprise system of each trading partner. • Collaboration space modeling (as evidenced in ebXML or ISO Open-edi) is done from a perspective independent of each trading partner. A single exchange is modeled once in independent terms that can be then mapped into internal enterprise system components. Supply chains are networks of business processes that alternate internal transformations and external exchanges (definition due to Bob Haugen). • REA modeling works in both cases and the independent to trading partner mapping is absolutely straightforward and completely defined.

14. Illustration of Perspective: Trading Partner vs. Independent Enterprise Independent view of Inter-enterprise events Enterprise Business Process Business Process Business Process Business Process Business Process Business Process Business Process Business Process Business Process Enterprise Trading Partner view of Inter-enterprise events (upstream vendors and downstream customers) Blue arrows represent flow of goods, services, and cash between different companies; green arrows represent flows within companies Used for collaboration space modeling SOURCE: Adapted from ISO 15944-4, K. Morita

15. Economic Resource Economic Resource Economic Agent Economic Agent Economic Agent Economic Agent Economic Event stock-flow stock-flow duality COOKIES from ELMO SHIPMENT cookie monster to initiating transfer responding transfer to ELMO Economic Event PAYMENT from cookie monster CASH REA model of cookie sale from independent (collaboration space) perspective

16. Identifying Economic Exchanges The Merchant of Venice receives funding from outside investors. His goal is to purchase silk in China and sell it to the wealthy people in Italy. To accomplish this goal, he first purchases a boat. Next he hires a deck hand to captain the ship to China and back. While in China, the manager negotiates with silk sellers and purchases silk. When the return trip is completed, the Merchant of Venice pays the deck hand, and sells the silk. After retaining a portion of the proceeds for himself, the remaining proceeds from the venture are distributed among the investors according to the amount of their original investment.

17. Merchant of Venice – Economic Exchanges • Get cash from investor, give cash (principal plus return) to investor • Give cash to silk merchant, get silk from merchant • Give silk to wealthy people, get cash from wealthy people • Give cash to ship builder, get ship from ship builder • Give cash to deck hands, get service from deck hands • Give cash to merchant, get services from merchant

18. Entity: events, resources or agents Describes the Relationship between entities ER Diagrams • REA/Business Process – Show the events, resources and agents in a business process and relationships between them • Data Model –Show the key entities to store data about (tables) and relationships between them which must be captured (primary/foreign key relationships and M:M tables) ER DIAGRAMS ARE NOT FLOWCHARTS!!!!!!

19. Basic REA Template for an Economic Exchange Resource Increasing Event Internal Agent get by from External Agent for to Resource Decreasing Event Internal Agent give by

20. Basic REA Template for an Economic Exchange -- Revenue Inventory Goods Delivery Shipping Clerk give by to Customer for from Cash Cash Receipt Cash Rects Clerk get by

21. Timing of Events • Generally, ERD’s are drawn with the events listed from top to bottom in the order they take place • For revenue, the two events making up the exchange may occur • At the same time (a cash sale) • With the delivery first (a sale on account) • With the cash receipt first (customer prepays or makes a deposit)

22. Basic REA Template for an Economic Exchange – Expenditure Inventory Goods Receipt Receiving Clerk get by from Vendor for to Cash Cash Payment Cash Pmts. Clerk give by

23. REA Data Modeling • Step 1: Identify Events -- Store information about events we want to plan, execute or evaluate; list these down the center of the ER • Step 2: Identify Resources Influenced by Events -- Resources are often assets of the business that we wish to track information about; List these to the left of the events on the ER. • Step 3: Identify Agents Involved in Events -- Usually one internal agent and one external agent. List these to the right of the events on the ER.

24. REA Data Modeling, continued • Step 4: Identify Attributes of Events, Resources and Agents -- Selection of attributes determines what information we later have to make reports, etc. • Step 5: Identify Relationships between Events, Resources and Agents -- Words in the box are unimportant, but you may want to use the basic terminology used in the templates

25. Identifying Attributes • Eventually, we will become much more exacting about the attributes stored when we create database tables. For now, attributes help to understand what is being modeled • For events, think of all of the things that would be on the paper document used to capture information about the event • For resources and agents, this is their master file information

26. Basic REA Template for an Economic Exchange – Revenue Inventory Goods Delivery Shipping Clerk give by to Customer for from Cash Cash Receipt Cash Rects Clerk get by

27. Attributes - Revenue • Goods Delivery – Date, Dock shipped from, customer, items shipped, qty. • Cash Receipts – Date, Place received, customer, amount received • Inventory – Item Number, description, qty on hand • Cash – Account/Drawer Number, Bank/Location, Description, Balance • Customer – Customer Number, Name, Address, Contact, Credit Limit, Balance • Shipping Clerks, Cash Receipts Clerks – Employee Number, Name, Address, Department

28. More on Attributes – Inventory • Inventory items can be either • generic inventory items – ones that we always keep in stock where we keep a catalog of the items we sell; The data table for generic inventory items is basically a listing of the items in our catalog and QOH • unique inventory items – custom made items that will each have a unique identifier (think job order costing). The data table for unique inventory items is a listing of all of the individual items (or groups of identical items called jobs) produced • YOU SHOULD ALWAYS ASSUME GENERIC INVENTORY ITEMS, UNLESS IT IS SPECIFICALLY STATED OTHERWISE

29. More On Attributes – Cash • The cash resource represents cash on hand or in the bank. The data table storing information about cash looks like one of the following • For cash on hand – A listing of all of the cash drawers in all of our stores and the amount of cash that should be in each one • For cash in the bank – A listing of all of our bank accounts, the bank and the balance

30. Basic REA Template for an Economic Exchange – Expenditure Inventory Goods Receipt Receiving Clerk get by from Vendor for to Cash Cash Payment Cash Pmts. Clerk give by

31. Attributes - Expenditure • Goods Receipt – Date, Dock where received, vendor, items received, qty. • Cash Payments – Date, Cash Account Number, Vendor, amount paid • Inventory – Item Number, description, qty on hand • Cash – Account/Drawer Number, Bank/Location, Description, Balance • Vendor – Vendor Number, Name, Address, Contact, Credit Limit, Balance • Receiving Clerks, Cash Payments Clerks – Employee Number, name, Address, Department

32. Basic REA Template for an Economic Exchange – Payroll Employee Service Get Employee Service Time Ticket Production Supervisor get by from Employee for to Cash Cash Payment Payroll Clerk give by

33. REA Data Modeling, Continued • Step 6: Cardinality and Optionality -- For each entity pair there are really TWO DIFFERENT relationships • Focus on a single example of one of the two entities • Cardinality -- How many instances the entity on the other side of the relationship can be associated with that single entity? • Optionality -- At ANY possible point in time, does a relationship have to exist between the entity and the one on the other side, or is it simply possible for a relationship to exist? • Reevaluate, starting with a single example of the other entity in the relationship

34. Cardinality and Optionality Example Cash Payment Vendor sent to • Single Payment • How many vendors associated with single payment? • Only one (no crows feet) • Does payment always have to have a vendor? • Yes (vertical line) • Notice where this symbol goes

35. Cardinality and Optionality Example Cash Payment Vendor sent to • Single Vendor • How many payments associated with single Vendor? • Can be many (crows feet) • Does Vendor always have to have a payment? • No – goods received, no payments yet (circle) • Notice where this symbol goes

36. Basic REA Template for an Economic Exchange -- Conversion Finished Goods Inventory Manufacture Goods (Production Order) Production Supervisor get by for for for Production Supervisor by Issue RM (Materials Requisition) Raw Materials Inventory Storeroom Clerk give from Production Supervisor Production Supervisor by by Use Machines (machine Log) Use Employee Service (Time Ticket) Machine Time Machine Operator Employee Service Employee give from give from

37. Attributes - Conversion • Manufacture Goods/Production Order – Date, factory number, supervisor, item to produce, qty. • Use Raw Materials/Materials Requisition -- Date, Storeroom Clerk, Production Employee, Items Issues, Production Order, Qty Issued • Use Employee Service/Time Ticket – Date Employee, Production Order, Hours Worked, Job Code • Use Machine Time/Machine Log – Date, Machine Operator, Machine, Hours used, Production Order • Employee Service – Job Code, Description, Capacity • Machine Time – Machine Number, Machine Use, Capacity • FG/RM Inventory – Item Number, description, qty on hand • Production Supervisor, Storeroom Clerk, Employees, Machine Operators – Employee Number, name, Address, Department, YTD earnings

38. Conversion Key Points • There is NO CASH INVOLVED, but Economic Exchange Still Exists – Get Finished Goods, Give up employee service, machine time, raw materials • The Economic Exchange is within the organization • Because all events are internal, there may not be two agents for each event; Most often, the ones deleted would be the production supervisor (authorizer) in the ‘use machine time’ and ‘use employee service’ events • Often, all of these events are recorded using a single document (i.e. a record of a good being assembled; called a job cost sheet); the process illustrated here would be used in a large manufacturing operation • The Manufacture Goods event can take place over a course of time (several hours, days or weeks). We may record sub-events – i.e. start production, complete production

39. Simultaneous Production and Consumption • Definition – When a single resource is received or created at the same time it is used or delivered. • Simultaneous production and consumption takes place with all services. Unlike goods where there is one event where we get the good (goods receipt) and a separate one where we give it (shipment), for services, give and get occur simultaneously because services cannot be stored • Because of simultaneous production and consumption, the Give Employee Service pattern for conversion is the same as the Get Employee service template shown for payroll, except it says “GIVE” rather than “GET” • These are really the same event because we simultaneously get (produce) and give (consume) the employee’s service. • Despite the fact that they are the same event, sometimes, the event is recorded two different times, once to pay payroll (the get) and separately to track it for job costing purposes (the give); A better design is to record the event only once, on the time ticket, and use the data for both payroll and job costing (as we will assume)

40. Ontological Extensions to the REA Model (Geerts and McCarthy) • Type images for basic objects allows specification of policies and controls plus abstract specification of negotiation components • Commitment images for economic events allows specification of contracts and agreements • State machine model allows specification and ordering of business events as collaboration space messaging and/or internal workflow • Aggregation of binary collaborations allows mediated collaboration with third parties SOURCE: Geerts and McCarthy, The Ontological Foundations of REA Enterprise Information Systems, 2003.

41. Business Transaction governs Agreement Economic Event Type Economic Resource Type typifies establish specifies specifies Business Role involves Economic Commitment specifies qualifies reciprocal fulfills reserves typifies Regulator Economic Resource Economic Event stockflow Economic Agent from to constrains duality Economic Contract Partner Third Party requires Bilateral Collaboration Mediated Collaboration participates ISO Open-edi Ontology Collaboration Model SOURCE: Adapted from ISO 15944-4, W.E. McCarthy