REA-based Cost & Financial Accounting Model: Integrated Resource-Based Cost and Financial Accounting

Abstract

Cost accounting is not cost accounting. There are different conceptualizations of cost accounting. E.g., in traditional cost accounting direct cost are traced directly and indirect (overhead) costs are allocated indirectly via cost pools to the cost objects. In Activity-Based Cost (ABC) accounting the indirect costs are related to activities and from there they are allocated to the cost objects. Flexible standard-cost accounting traces direct costs and allocates indirect costs via input standards for the resources applied in the activities to the finished products. The same holds true for the financial accounting domain as there also exist different conceptualizations. The traditional financial accounting is purely based upon monetary terms. In the Resource Event Agent (REA)-based accounting transactional information related to the exchange and conversion of resources is collected. The REA-based financial accounting is grounded in the Asset Liability Equity (ALE) accounting equation to fulfill the legal financial accounting requirements. Still missing is an accounting model that aligns resource-based cost and financial accounting in a single comprehensive domain model. In this article this integration problem will be solved by establishing the 'REA-based cost & financial accounting model' that seamlessly incorporates the resource-based accounting approaches for the cost and financial accounting domains.

Keywords

• eol>ABC accounting
• RCD-ABC accounting
• ALE accounting
• flexible standard-cost accounting
• REA-based cost & financial accounting

1. Introduction

The primary research objective of this article is the establishment of a comprehensive accounting system that integrates the resource-based financial and cost accounting domains. For achieving this objective the ‘REA-based financial accounting model’ is specified first. This financial accounting model has its origin in McCarthy’s seminal ‘Resource Event Agent (REA) accounting model’ [ 1 ] and its subsequent extension by McCarthy/Geerts [ 2 ] into the ‘REA business ontology’ to incorporate a policy infrastructure next to the accounting infrastructure. For assuring its financial accounting compliance and for having a compact representation, the modifications by Schwaiger [ 3 ] and the modeling of Fischer-Pauzenberger/Schwaiger [ 4 ] are applied for specifying the REA-based financial accounting model. By integrating the ‘Resource Consumption Driven (RCD)-ABC accounting’ into it, the ‘REA-based cost & financial accounting model’ is derived. This conceputal model seamlessly integrates the resource-based cost and financial accounting domains and hence, it solves the integration problem. As conceptual model [ 5 ] it contains the key concepts of the cost & financial accounting domains and as such it defines the language spoken in that domain in a formal modeling language. The benefits of the integrated domain model relate to a potential enhancement of the understanding of the integration problem and its solution in existing ERP and Production Control systems. But beyond that, it might inspire the development of new ERP and Production Control systems [ 6 ] that are grounded on the integrated resource-based approach from the very beginning.

This article is structured as follows. The next section specifies the ‘REA-based financial accounting model’. After that concepts of flexible standard-cost accounting and its relations to the different variants of the ABC accounting are investigated. Next the ‘REA-based cost and financial accounting model’ is derived by integrating the key accounting concepts that underlie the flexible standard-cost accounting in form of the RCD-ABC accounting into the REA-based financial accounting model. In the final section the paper is concluded.

2. REA-based Financial Accounting Model: Specification

The ‘REA accounting model’ was developed McCarthy [ 1 ] as ‘a generalized framework for accounting systems in a shared data environment’. It conceptualized the economic logic of double entry bookkeeping in the entity-relationship modeling language without having to refer to the accounting concepts like ‘debit’, ‘credit’ and ‘account’. Instead, the REA accounting model focuses on the conceptual key concepts of ‘economic resource’, ‘economic event’ and ‘economic agent’ as well as their relationships that link the underlying ‘stock flows’ of resources among the agents according to the ‘duality principle’. The REA accounting model was extended by McCarthy/Geerts [ 2 ] to include next to the REA-related ‘accounting infrastructure’ an additional ‘policy infrastructure’. At the policy level additional key concepts for capturing future related ‘business policies’ and ‘schedulings’ [ 7 ] like ‘commitment’, ‘economic contract’ and ‘economic agreement’ are included as well as their relationships to each other and to the elements in the accounting infrastructure.

Figure 2 shows the ‘REA©-based ALE accounting model’ [ 4 ] which is a condensed version of the REA-based ALE accounting model where the ‘©’ sign stands for ‘(C)’, i.e. commitment. Now the accounting transaction and its accompanying value restriction is incorporated in the ‘balanced duality’ relationship. The contractual foundation of all types of accounting transactions is captured in the ‘balanced reciprocity’ relationship among all debit and credit commitments contracted in each transaction. Figure 3 shows the REA©-based ALE accounting model in its generic version which neglects the ‘business location’ concept as it is not important later of. The ‘economic claim’ is now explicitly shown as sub-type of the economic resource among the other ALE sub-types. The cardinalities are eliminated as they are not needed later on and ‘economic contract’ is simplified to ‘contract’ as the adverb is not needed. The model provides the key structure of the ‘REA-based financial accounting model’ and accordingly it is called like this. Only one refinement is added that is discussed next.

Concerning the concept balanced duality Guarino et al. make an important observation. “Besides the duality relation, a further ontological constraint that links an increment event and its dual decrement is the fact that they are both part of the same economic exchange event. This was indeed the choice made in a former paper by Schwaiger […], which was unfortunately changed in the OntoREA version. We believe that putting explicitly this mereological constraint in the model is important to avoid undesired interpretations (note that in the original REA model no constraints are put on the duality relation).” [8, p. 96]. The deficiency of not explicitly showing the mereological constraint is solved in Figure 4 by indicating the connection of the balanced duality to the accounting transaction and showing its parts in form of debit and credit events that are constraint by the value restriction so that they balance in total. In this representation the balanced duality is the ‘holonym’ of its ‘meronyms’ in form of debit and credit events. “Instances of IsPartOf are also called meronymic relationships (from the Greek word méros, which means ‘part’). If P is part of W, then we say that P is a meronym of W and that W is a holonym of P. In conceptual modeling, these relationships are usually called aggregations or compositions, although these terms have unfortunately become overloaded with a diversity of meanings and we shall not use them here.” [9, p. 142].

3. Conceptualizations of Cost Accounting: RCD-ABC Accounting

Specification

There are different conceptualizations of cost accounting [ 10 ] that can be considered for being integrated into the REA-based financial accounting model. The traditional cost accounting [ 11 ] is a ‘2-stage allocation’ system as the indirect (overhead) costs are allocated in the first step to cost pools and in the second step to the cost objects. Direct costs are traced directly to the cost objects. The traditional Activity-Based Cost (ABC) accounting [ 12 ] also is a 2-stage allocation system. In this system the indirect costs are allocated to activities in the first step and in the second step the activity costs are allocated to the cost objects. The ABC accounting has the advantage of allowing a more accurate cost allocation compared to the traditional volume-based approach, but this happens at the expense of a huged data requirement concerning the information needed for determining the activity costs [10, p. 16].

Kaplan/Anderson [ 13, 14 ] recognized and solved this shortcoming of the traditional ABC accounting by introducing the Time Driven (TD)-ABC accounting. “The basis for the new approach (TD-ABC) is highlighted in an early cost management article, where Robin Cooper articulated the difference between transactional and “effort” cost drivers. Transactional cost drivers count the number of times an activity is performed.” [13, p. 6]. “An alternative approach for estimating an ABC model, which we call ‘time-driven activity-based costing’, addresses all the above limitations. It is simpler, less costly, and faster to implement, and allows cost driver rates to be based on the practical capacity of the resources supplied.” [13, p. 5]. “The essence of activity-based costing and activitybased management is the measurement and management of the organization’s capacity. For this purpose, ABC systems require two estimates: 1. The unit cost of supplying capacity, and 2. The consumption of capacity (unit times) by the activities the organization performs for products, services, and customers.” [13, p. 6].

“In retrospect, we wish that the evolution of ABC in the 1980s had taken a different path so that this method could have been implemented at the outset. But the underlying theory for ABC had not been developed when it was first introduced in the mid-1980s so the elegance and conceptual clarity of this new approach were not obvious at the time.” [13, p. 5].

Focusing upon the consumptions of capacity resources in the activities shows two important properties of TD-ABC accounting, firstly, it actually is a Resource Consumption Driven (RCD)-ABC and secondly, it can be extended to also include materials and other directly consumed resources. Seeing and extending TD-ABC in that way gives exactly the scope covered by the flexible standardcost accounting. “One of the main features of ‘flexible standard costing’ [15, p. 306, fn 6] lies in its production theoretic foundation which reflects a company as a complex input-output system. This theory is based on Leontief’s work and has been generalized for quite arbitrary production functions... This foundation is widely used both for tracing direct costs to products and for allocating indirect costs.” [15, p. 306]. “In Germany flexible standard costing finally found a better theoretical basis in the production theory... The production theory... was developed to study the input-output relations of a business enterprise in great detail... The main characteristic of this theory is that there are two different input-output relations in a firm – direct relations between output and input of direct materials and direct labour, and indirect relations. In cases of indirect relations the input depends on the number of elementary work units of cost centres wanted, the intensity or speed of production and the technical features of the assets used. Thus flexible standard costing has a theoretical basis for direct and indirect costs which, by referring to work units, is similar to activity-based costing.” [16, p. 265].

Accordingly, the theoretical basis of the flexible standard-cost accounting consists of 1. allocating indirect costs via unit-input for the resources ‘applied’ in the activities to cost objects in a 1-stage allocation system and 2. tracing direct costs to the cost objects.

Concerning the applied resources it distinguishes between (direct) material resources that are ‘consumed’ in the activities and capacity resources like personnel and equipment that are ‘used’ in the activities. Hence, the flexible standard-cost accounting is based upon a Resource ‘Consumption’ Driven (RCD)-ABC accounting foundation. Its RCD basis extends the time-driven foundation of the TD-ABC accounting as not only unit-time is considered for effect cost drivers but also volume-based unit-inputs like e.g. for the unit-input of material resources in pieces, kilogram, litre etc. Figure 5 shows in the left panel the activity’s input-output relation that is modeled in Leontief’s input-output analysis via ‘production coefficients’, i.e. the unit-inputs into Leontief’s production function. In the right panel of Figure 5 the input-output relation of the production activity is shown for the inputresources in form of the capacity resources ‘personnel’ (PERS) and ‘equipment’ (EQIP) as well as for the materials resources (MAT). For producing the output, the capacity resources are used and the materials resources are consumed. The inputs for all resources are quantified by their unit-inputs, i.e. production coefficients. These coefficients are actual values when they are transactionally collected. When they are used for planning and control purposes like in the flexible standard cost accounting, the coefficients are standard values. The usage of standard production coefficients for cost management control purposes is the reason why this budgetary cost management control system is called ‘flexible standard-cost accounting’.

Using the production coefficients from the flexible standard-cost accounting the unit-costs, i.e. cost per unit of output of each resource applied in the activity are calculated simply by multiplying the production coefficient, i.e. the RCD-quantity with the price of the input-resource, i.e. the RCDprice. This ‘unit-cost accounting metric’ is formalized in equation (1) where the production coefficient (ProCo) specifies the unit-input of the resource and the RCD-price is the input-resource’s cost rate (CRate). Due to its RCD foundation, this metric is called ‘RCD-ABC (accounting) metric’ and the theoretical basis of the flexible standard-cost accounting is called ‘RCD-ABC accounting’. (1) (2)

ABC acty ,res , fP= ⏟ProCoacty ,res , fP⋅⏟CRateacty ,res , fP [res.input /unit ]

[ price/res.unit ] where ABC … activity-based cost ProCo … production coefficient (unit-input) CRate … cost rate acty … activity res … resource fP … finished product where FPC

FPC fP=∑ ∑ ABC acty ,res , fP

acty res … finished product cost As can be seen by the sub-indices, the RCD-ABC metric in equation (1) calculates the cost for the finished product (fP) with respect to the applied activity (acty) and the employed input resource (res) in form of consumed materials as well as used capacity resources.

For calculating the finished product’s total cost (FPC) the costs of all its attributable activities (acty) and input-resources (res) have to be summed up as is shown in equation (2). There the important extension from the TD-ABC accounting to the RCD-ABC accounting clearly shows by covering not only the indirect costs of capacity resources via time-driven production coefficients but also via volume-driven production coefficients. Furthermore, also direct costs, i.e. materials and others like direct costs of labour, are simultaneously covered in equation (2) in an activity-based way via their corresponding production coefficients in the different production activities.

4. REA-Based Financial Accounting Model: Integrating RCD-ABC

Accounting

Now, the RCD-ABC accounting is integrated into the REA-based financial accounting model. For doing this, the traditional distinction of a transaction into its two sub-types, i.e. ‘economic exchange’ activity and ‘conversion’ activity is important. The RCD-ABC accounting relates to a conversion activity where input-resources are converted into an output in form of finished products. In the language of the REA-based accounting domain the task of modeling an activity “that creates new products or services or adds value to the existing ones as conversion of some economic resources to others” is formulated by Hruby [ 17 ] as follows. “During the conversion, the enterprise uses or consumes economic resources in order to produce the resource of the same or another kind.  Each conversion consists of at least one increment economic event that increases the value of the resource by modifying its features, and at least of one decrement economic event that decreases the value of a resource by modifying its features. The increments and decrements in the conversion process typically occurs over a period of time.  Each increment event is related to exactly one economic resource by a relationship called produce.

The produce relationship means that the economic event creates a new economic resource or modifies some features of an existingresource. Each decrement event is related to exactly one economic resource either by a use or by a consume relationship. The consume relationship means that the economic resource does not exist after the decrement event (the resource is consumed). The use relationship means that the economic resource still exists after the decrement event, but some of its features have been modified.  In order to keep track of which resources have been used or consumed in order to produce others, the increment and decrement economic events are related by the conversion duality relationship, or in short, conversion. The conversion duality is an n-ary relationship; in the application model there can be many increment and many decrement events related by a single conversion duality.” [17, p. 41].

Hruby uses the increment/decrement notations from the REA accounting model and the REA business ontology model, what does not cause any problem as in the conversion activity no financial instruments are involved. The ‘conversion duality’ concept is defined as holonym with meronymic parts in form of increment and decrement events that are related to resources. Concerning the inputresources the distinction is made between ‘consumed’ resources that do not exist after the conversion, i.e. the material resources, and the ‘used’ resources that still exist afterwards, i.e. the capacity resources. Accordingly, conversion duality incorporates the concept of production coefficient from the RCD-ABC accounting. By also considering the value constraint between the decrement and increment events from the conversion duality also the financial accounting requirement is fulfilled that the cost of the output, i.e. the finished product is equal to the cost of all its input-resourses needed for producing it.

Building on Hruby’s argumentation, the RCD-ABC accounting and its associated unit-cost RCDABC accounting metric can be integrated into the REA-based financial accounting model as shown in Figure 6. The integration starts with explicitly distinguishing the different types of input-resources. For ensuring practical relevancy the categorization ISO/IEC’s ‘Enterprise Control System Integration’ (ECSI) standard [ 6 ] is taken for that purpose as this standard provides a precise definition of the language spoken in the ‘Enterprise Resource Planning (ERP) and Production Control’ (short: ‘ERP-Control’) domain.

Figure 6 shows the explicit inclusion of the ECSI standardized types of input-resources in form of ‘material’ and the capacity resources in form of ‘equipment’ and ‘personnel’. For addressing the context of conversion activities, the balanced duality now covers conversion activities as well. In these activities materials are the input-resources that are consumed whereas the capacity resources in form of personnel and equipment are used. The output of the conversion activity is the finished product. For satisfying the value constraint all involved debit (incr./decr.) and credit (decr./incr.) events have to be balanced in monetary terms.

The required balancing of the conversion activity’s debit and credit events relates to the unit-cost RCD-ABC accounting metric in equation (1). In this metric the finished product’s cost (FPC) is calculated by multiplying the production coefficients, i.e. the RCD-quantities with the corresponding cost rates of the input-resources, i.e. the RCD-prices and by summing up according to equation (2) the resulting terms over all activities and input-resources needed for the finished product. Figure 7 shows the relevant excerpt from the REA-based cost & financial accounting model where the production coefficients (ProCo) are explicitly inserted in the input-resources material, personnel and equipment. These coefficients are used in equation (1) to calculate the activity-based costs for each activity and applied resource which are aggregated via equation (2) to derive the finished product cost (FPC) by summing up the costs of all attributable activities and the thereby consumed material resources as well as used capacity resources in form of equipment and personnel. Comparing Figure 6 and Figure 7 shows an important feature needed for integrating the REA-based cost accounting into the REA-based financial ALE accounting, i.e. the need for the generic debit/credit notation for events. In the REA-based cost & financial accounting model inFigure 6 the debit and credit events are generically defined so that they can be associated to events concerning changes in the balance sheet as well as in the income statement. In contrast to that, in the integrated REA-based cost accounting model in Figure 7 the credit events correspond to resource inputs, i.e. resource decrements and the debit events to the output, i.e. resource increments which are the finished products of the conversion activities. The assignment to debit and credit events carries the financial ALE accounting semantics of conversion activities. Debit events represent decrements of assets whereas credit events represent increments of assets. Hence, ‘resource-based cost accounting’ as well as conversion activities correspond to an ‘accounting exchange on the asset side’ [3, p. 569].

5. Conclusion

The primary research objective of this article is the establishment of a comprehensive accounting system that seamlessly integrates resource-based financial and cost accounting domains. This integration problem was solved by starting with the specification of the REA-based financial accounting model. Next, different cost accounting conceptualizations were investigated. There the flexible standard-cost accounting showed especially beneficial and its theoretical basis in form of the production coefficients and their related RCD-ABC accounting metric in equation (1) were identified as the core concepts of the RCD-ABC accounting which was used to model conversion activities along Hruby’s definitions.

The final result is the ‘REA-based cost & GHG accounting model’ – shown in Figure 7 – that specifies the conversion activity as input-output relation where input-resources are converted into outputs in form the finished products. Important to note is that this input-output relation is not restricted to the company’s production domain but instead it can be applied to any activity in the company. So, the production coefficient based RCD-ABC accounting metric can also be applied for cost accounting in the logistics domain where time is not the most important cost driver, but weight of the transported products and the transport distances are more relevant. Furthermore, also to service activities the metric can be applied where the consumption of materials is a neglectable cost driver or is missing at all.

The two metrics for calculating the activity-based costs (ABC) in equation (1) and for calculating the finished product cost (FPC) in equation (2) already indicates a typical multi-level aggregation structure for the production domain. Such multi-level production systems also are at the core of ERPControl systems [ 6 ] where the multi-level aggregation structure of materials is specified in the Billof-Material (BOM) and the multi-level aggregation structure of the activities is specified in the Routing. Hence, the REA-based cost & financial accounting model should not only enhance the understanding of the problem of integrating cost and financial ALE accounting in general, but also in the specific context of ERP-Control systems. The context of ERP-Control systems covers the integration in already existing systems as well as the establishment of new ERP-Control systems that are grounded in the integrated resource-based accounting from the very beginning.

Finally, it is interesting to note that for the near future it can be expected that the scope of the REA-based cost and financial ALE accounting will be extended for integrating ‘GHG emission accounting’ as well. A promising approach that combines cost and environmental accounting was developed by Emblemsvåg/Bras [ 18, 19 ]. Such an expansion to a ‘REA-based cost & GHG & financial accounting model’ not only gives a common understanding of the often very differently conceptualized domains of cost, GHG emission and financial ALE accounting. But also, current and potential future providers of ERP-Control systems should benefit by having a domain-driven [ 20 ] conceptual model specified in the formal UML language that they can use for designing and implementing such comprehensively aligned systems, e.g. by using the domain engineering methodology [ 21 ].

The author(s) have not employed any Generative AI tools.

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