Business: What’s It All About?
Purpose of a Business
 For profit
 Not-for-profit
Purpose of a Business
Simple Model of a Business
“The Firm”
INPUTS
Value
added
conversion
OUTPUTS
Acquisition/Payment Process
Sales/Collection Process
Capital, Financing
Property, Plant, Equipment
Raw Materials
Labour
Inventory
Goods & Services
Product or
Service
Nature of Business Operations
 Service business

Provides services for consumers.
 Merchandising business


Wholesale company--buys goods, adds value,
and sells them to other companies.
Retail company--buys goods, adds value, and
sells them to customers who consume them.
Nature of Business Operations
 Manufacturing

Makes the products it sells
 Financial Service

Deal in services related to money
What Do All Business have in
Common?
 All businesses have the
same goal: to add value or
provide value to
customers/clients.
 Typically they have three
processes:
 Acquiring
goods
 Conversion
 Selling the goods or
services
The three processes in common
 ACQUISITION/PAYMENT: acquiring goods
and services and paying for them.
 CONVERSION: the firm then does something
to add value by taking inputs and converting
them into outputs.
 SALES/COLLECTION: selling goods and
services and collecting payment for them.
The Process of Starting a Business
 Owners investment (Capital)
 Obtain additional financing if necessary
 Purchase necessary assets
 Add Value (Conversion)
 Sales (generate revenue)
 Collect money
 Repay any financing
Business Activities
 Business transactions are exchanges.
 Who “gets” what and who “gives” what in return are
separate transactions.
 The exchange occurs between the business entity
and usually an outside agent.
 The business gives something and then gets
something in return.
Resources, Events, and Agents
 Every business transaction is made up of three
components:



Resources are the things of economic value
exchanged.
Events are the actual giving and getting of the
resources.
Agents are the people who actually make the
exchange.
Exhibit 1-9 Steps and Documents in the
Acquisition/Payment Process
Exhibit 1-10 Steps and Documents in the
Sales/Collection Process
Who needs information about transactions?
A)
B)
C)
D)
E)
F)
G)
H)
Management
Regulatory agencies
Canada Customs and Revenue Agency
Creditors
Potential investors
Vendors (current and potential)
Customers
Employees
The Accounting Equation
Assets = Claims
Assets = Liabilities + Owner’s Equity

Asset: economic resources owned by the
business.
 Liability: obligations of the business to
creditors.
 Equity: owner’s claims to the assets.
Four Basic Financial Statements

Balance Sheet
Assets = Liabilities + Equity

Income Statement
Revenues - Expenses = Net income

Statement of Retained Earnings
Beginning RE + Net income - Dividends = Ending RE

Cash Flow Statement
Cash inflow - Cash outflow = Net cash flow
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 decision-making
inability to support change
Traditional Approaches: Financial Accounting
Orientation
 Dominance of traditional accounting as the primary
information provider leads to problems:

single view of business entity using the accounting/balance
sheet 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
The REA Approach to Business Modeling
Resources, Events, and Agents (REA) Model
 Developed in the ‘70's by Dr. Bill McCarthy of Michigan
State University
 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 is
a major change from the traditional double-entry
approach.

The REA or events perspective is increasingly seen as
necessary to meet changing information needs.
Resources, Events, and Agents (REA) 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 (REA) Model …
 The REA model is an alternative accounting
framework for modeling an organization’s

economic resources
economic events
economic agents, and

their interrelationships


 A variation of entity-relationship diagramming
(ERD) 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
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 (REA) Model …
 A variation of the entity-relationship diagramming
(ERD) is used in REA modeling.
 Basic ERD symbols:
entity
relationship
(optional)
attribute
(optional)
Advantages of the REA Model
 Using REA can lead to more efficient operations

helps managers identify non-value added activities that can
be eliminated



increased productivity via elimination of non-value added
activities generates excess capacity
storing both financial and nonfinancial data in the same
central database reduces multiple data collection, data
storage, and maintenance
detailed financial and nonfinancial business data supports a
wider range of management decisions

increased competitive advantage by providing more relevant,
timely, and accurate information to managers
Value Chain Analysis
 Competitive advantages from the REA approach can
be see via value chain analysis.



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.
Porter’s Value Chain
Revenue
Costs
Firm Infrastructure
Human resource management
Technology development
Procurement
Inbound
Operations
Logistics
Output
Logistics
Primary Activities
Marketing
& Sales
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 versus event-based.

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
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
 Organize the operating events identified in
sequence of occurrence
 Show each event as verb-object

This facilitates arranging them in order of occurrence.
 Note that the verb/event is represented from the
perspective of the organization, not the customer.
REA Example: Horizon Books …
Step 2: Place 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 (minimum-maximum
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)—rare
REA Example: Horizon Books …
Step 5: Completed REA model of sales process with cardinalities.
REA Model v. ERD
 The two methods have a lot in common, but there are
differences:






ERDs are more commonly found with traditional event-based
systems.
REA-modeling is used with event-oriented systems.
ERDs often use diamonds to show events, while REA model
always classifies events as a type of entity.
REA includes only operating events, while ERDs can capture
all three types of event.
REA facilitates placement of internal controls.
REA is more focused on business needs and, as a result,
often simpler.
ERD of Manufacturing
REA Model of Manufacturing, 1
REA Model of Manufacturing, 2
Developing an REA Model: Attributes and
User-Views
 The final step is to define the attributes associated
with the entities in the model.
 These are used to populate the database.
 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
Nonfinancial
Customer name Customer
address Customer
telephone number
Amount owed by customer
Value of total sales to date
Terms of trade offered
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