ACCOUNTING MEASUREMENT AND
METHODOLOGICAL CHARACTERISTICS OF ACCOUNTING DYNAMICS
Saburo Kameyama Department of Commerce Chuo University
742 Higashinakano Hachioji, Tokyo, Japan
Takahiro Kojima Senshu University
Akira Uchino Yokohama College of Commerce
Kinya Machida Asahi University
ABSTRACT
Accounting Dynamics is a methodology for modeling and simulation of
accounting using System Dynamics. Our reasons for presenting Account-
ing Dynamics are as follows.
a) Accounting is a primitive quantification of social processes com-
posed of everyday transactions between economic entities.
b) Therefore, accounting models, which consist of such transaction
data, have their actual counterparts in the real economic world.
c) On the other hand, accounting measurement (including double entry
bookkeeping) is very adaptable to the System Dynamics observations.
d) So that, Accounting Dynamics modeling and simulation seem to be
very effective tools for depicting, analyzing, predicting and improv-
ing the actual state of resource allocation in social systems.
We believe there is no other system that measures each and every
routine transaction as completely as business accounting. Further-
more, in most System Dynamics research on social systems, e.g., the
System Dynamics National Model, it is emphasized that there is no
macrostructure, other than the aggregation of many microstructures
If the national economy’s behavior results from its microstructure, a
realistic and reliable model of that microstructure will be an indis-
pensable premise for building a National Model. The accounting Dyna-
mics model will provide such a macrostructural building block at the
business level or at the upper social level.
In our presentation, we analyze accounting measurement and identify
the methodological characteristics of Accounting Dynamics. Accounting
measurement has axiomatic rules (primarily represented by double en-
try) and institutional constraints. Traditionally, accounting meas~
urement is periodic (discrete) and lacks the feedback concept. We
introduce the feedback concept into the accounting model and present
generic Accounting Dynamics models in some detail.
THE IMPLICATIONS OF ACCOUNTING MEASUREMENT
Accounting is the most primitive quantification of social process.
Accounting measurement has special implications derived from the quan-
tification of the very nature of social process which is distinct from
the physical or natural process. There are at least three fundamental
requirements for accounting measurement.
The first is a monetary unit as a measurement scale. Monetary scale
is a common denominator used to evaluate all human activities. By
using the monetary scale, accounting makes it possible to quantify all
human interactions. But the value of a monetary unit itself is the
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product of many interacting social forces and varies in its substan-
tial purchasing power depending upon the historical date of transac-
tion. However, it may be said that accounting measurement has a
dimensional consistency at all times.
The second requirement is the unique measurement form of double entry
bookkeeping. The quantity of every transaction is measured by apply-
ing a monetary unit and then recording the same amount in the debtor
and creditor columns of the corresponding accounts. This procedure is
generally called journalizing. The sum of all debtor accounts and of
all creditor accounts belonging to an entity are always equal. Here
two classes of accounts are identified. One is the balance sheet
account and the other is the income statement account. Balance sheet
accounts represent assets on the debtor side and equities on the
creditor side. Equities mean the legal ownership right for assets.
Income statement accounts represent expenses on the debtor side and
revenues on the creditor side. Expenses and revenues mean subtraction
from and addition to assets and have respectively corresponding in-
fluences to equities. Balance sheet accounts are very much like level
variables and income statement accounts are rate variables in System
Dynamics.
The third requirement refers to accountability. In our society, deci-
sions about resource use and disposition are largely made by a steward
or agent represented by a manager personally separated from the legal
owner of that resource. Accountability means the social obligation of
such a steward reporting his economic performance or how he used his
resources to the equity owner. Eventually the object of accounting
measurement is accountability in this context. Thus it can be said
that accounting measurement is not a mere valuation of goods or ser-
vices isolated from social context but confirms a human relationship
involving the charge and discharge of accountability through perform-
ance evaluation of measurement. At. the beginning of every accounting
period, accountability is charged on the debtor side of the balance
sheet account as the sum of various assets, and at the end of the
period, accountability is discharged on the creditor side, emphasizing
especially the profit figure earned during the period. Income state-
ment accounts, the total of asset inflow and outflow resulting from
the profit seeking activities of management, present a causal explana-
tion of net asset increase (profit) or decrease (loss).
The data passing the above three requirements qualify as accounting
information. The network of accounting information, as a whole,
virtually controls the resource allocation in social systems. In the
network, accounting information communicates accountability, that is,
the economic performance of management, and influences the decisions
of investors (institutional or public). As a result, in the hands of
a competent management, more economic resources are accumulated, in
other words, more accountabilities are charged. For the total optimi-
zation of resource allocation processes through the accounting net-
work, there are many working rules for accounting measurement which
are called generally accepted accounting principles or simply account-
ing rules.
This is only a rough picture of the everyday function of accounting in
our society. But there lie numerous problems inside and outside
accountancy. The main reason for these problems is that most accoun-
ting rules originate in daily practices and are not established scien-
tific tests. Nobody, so far, has been able to see the whole picture
of the accounting function. For example, there is an accounting rule
concerning the historical cost basis in assets valuation which is one
of the most influential rules at presént. According to this rule, all
assets, in principle, are recorded at acquisition price under the date
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of the acquisition. This price is called the historical cost of
asset, because its value originates in historical fact of acquisi-
tion, and thereafter is kept constant, through the manufacturing stage
until the time of product sale (in the case of raw materials). Here,
it is obvious that the matching of revenue with expense (a major
accounting principle) has very a curious result in an economic sense,
because revenue and expense are respectively measured at different
nominal monetary values originating from their transaction dates.
Furthermore, it is also obvious that the total book value of assets
is a mixture of a wide variety of assets measured at different nominal
monetary values. It is not a representation of the substantial eco-
nomic value of a business entity but a mere summation of the histori-
cal cost of assets. This gap between the.book value and the substan-
tial market value are revealed, for instance, at merger and acquisi-
tion. These and other troublesome problems involved in business
accounting are rarely taken up for scientific discussion. It is very
important to make clear the actual state of resource allocation con-
trolled by an accounting information network.
INTRODUCTION OF THE FEEDBACK CONCEPT INTO THE ACCOUNTING MODEL
To understand the real condition of resource allocation, it is desir-
able to model and simulate the social system in terms of accounting.
This is the basic view point of Accounting Dynamics. Accounting
Dynamics depends on System Dynamics for modeling and simulation meth~
odology. But Accounting Dynamics also has special methodological
issues derived from accounting measurement. In this section, we
discuss this problem.
One of the most important problems in developing Accounting Dynamics
methodology is the introduction of the feedback concept into the ac—
counting model. The feedback concept naturally premises a continuous
time concept. But traditionally, the accounting discipline has no
continuous time concept, only a discrete time period concept. The
accounting period is one of the basic conventions of modern accounting
theory. Periodical income determination of a business entity for
performance evaluation is the main objective of accounting measurement
and it is attained by the matching of revenues realized during a
specific period with expenses accrued during that period. But, as
stated above, this periodical matching of revenue with expense has
only nominal meaning. All accounting variables, including revenue
and expense are, in the real sense of the word, not variables but
legally confirmed amounts. They reflect social human relationships
but have no time-varying nature. In this context, accounting measure-
ment is essentially discrete.
Thus, in order to introduce the feedback concept into the accounting
model, it is necessary first to describe the accounting variable as a
function of continuous time, even though it is a constant. Tradition-
al accounting formulas are as follows
A=L+C or C#A-L (1)
E+P=R or P=R-E (2)
Asset Li: Liability C : Equity capital
Expense R : Revenue PP: Profit
As generally known, formula (1) is called the balance sheet equation
and (2) the income statement equation. Each variable is then restated
as a time function with the elements of subaccount in parenthesis.
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Akar» Xag 7 Kan 3 1)
LQXqy ) Xygr 0 Ry bt)
R(Xpy o> Xppg is ' Xpp 5 td
E(¥g, ¢ Bey 8? Koy 2 8D
Totally differentiating (1), we get
ac = y-BA. at -y 26 at (’)
Oke
here, dC (increment of Equity.Capital) means P, so that
dc=P=R-E (2°)
Equations (1’) and (2’) respectively are only conversions of equations
(1) and (2) in terms of differentiation. But it should be noted that
the former equations are of different order from the latter. Espe-
cially, it should be emphasized that by their nature, the terms R, E
and P are in a different order than A, L, and C. This is essential
to the understanding of the transformation of accounting variables
into variables of a time-varying nature. Consequently, if equation
(1) represents the opening balance of a specific accounting period,
and (2) represents economic performance during that period, then the
closing balance are:
L
azu+e+(@-—Bat or aztec+((y2h yeh 03
j fot. 3%) ,
This is an exact representation of the relationship between equation
(1) and (2).
Desired
‘Achiovemonts
Delays
Decision
Moking Transformation
Process Process
Information
Channels
t
Delays
Noise
Bios
Figure 1. Control System Structure
of Organization (Roberts, 1978)
115
The next step in introducing the feedback concept into the accounting
model is depicting the closed network of accounting information that
communicates the charge and discharge relationships within accounta-
bility. The accounting feedback loop model is not different from that
of the control loop of organization in general, except its concepts
are represented by accounting terms. Roberts(1987) presented a typical
diagram of the control system structure of organizations as shown in
figure 1.
Roberts points out four characteristics of the diagram that are note-
worthy. We discuss the same points from an accounting perspective.
First, Roberts says that the transformation of decision into results
takes place through a complex process, which includes a basic struc-
ture of organizational, human, and market relationships. He says this
structure is sometimes not apparent because of its numerous sources of
noise or random behavior and due to its often lengthy time delays
between cause and effect. It should be noted first that the feedback
loop around the decision transformation process in figure 1 is applica-
ble to various levels of social systems. At the national economy
industrial, corporate, divisional, departmental, and even at indivi-
dual personnel levels, there will be a feedback loop just as in figure
1. In the Accounting Dynamics approach, the decision transformation
process represents the accountability center at each level and legally
confirms charge and discharge human relationships. But, as we stated
above, there are a lot of problems in the accounting measurement of
performance evaluation. However, in the Accounting Dynamics model, it
is obvious that the process should not be a black box, because it
represents a legal credit and debt human relationship. Further, it is
clear that the decision transformation process depicted in the rectan-
gle, namely, as a level variable, fits nicely into the notion of a
balance sheet, even though it consists of only one account
The second aspect to be noted in the diagram, Roberts says, is the
distinction between the achievements that are apparent and those that
are real. As long as the accounting information channel, then time
delay is the only problem in the communication process. If any biases
exist, most of them are socially accepted and originate in the ac-
counting measurement process itself. Time delays are derived from the
monthly closing of the books in cost accounting and the yearly closing
in financial accounting.
The third feature of the diagram is the decision process as a response
to the gap between the objectives of the organization and its apparent
progress toward those objectives. As Roberts says, such goalseeking
behavior is present in all organizations. They are also common obser-
vations in the budgetary control process of management accounting.
Finally, Roberts points out that the fourth characteristic of figure 1
is the continuous feedback path of the decision-results-measurement—
evaluation-decision, and he emphasizes that it is vital to treat each
element of this feedback path properly and to recognize its continuous
nature. Roberts’s emphasis ought to apply to Accounting Dynamics.
BUILDING THE ACCOUNTING DYNAMICS MODEL
In order to simulate the real state of resource allocation in the
social system, the quantification process of accounting, that is, the
accounting mechanism of processing daily transaction data, must be
built into the model. The Accounting Dynamics model can be conceived
at the corporate, urban, national, and higher levels in social sys—
tems. However, as a first step, we have developed the prototype model
116
at the corporate level and discussed technical problems actually
encountered in building it.
In building the AD corporate model, we have referred to the System
Dynamics Corporate Model by Lyneis(1980). Lyneis’s model includes a
lot of important factors such as the structure of inventory and the
production system; forecasting in decision making; interactions with
suppliers, labor, customers and competitors; and evaluating and con-
trolling financial performances. Many interesting dynamic behaviors
are analyzed in Lyneis’s model. For example, capacity expansion
financial constraints and professional resource expansions. We ap-
preciate Lyneis’s model, but we take a somewhat different approach to
the Accounting model.
We chose a company listed on the first section of the Tokyo Stock
Exchange for our study. The main activities of the company are the
manufacture of concrete piles and pipes, and steel frames and con-
struction work. It is capitalized at 1,200 million Yen ($8 million),
has gross sales of about 20,000 million Yen ($133 million), and
employs 800 people. The company produces on order, and the production
process is relatively simple. The financial performance of the
company shows gradual decline as is seen in the trend of gross sales
The problems have been mainly caused by general economic crises,
especially the so-called structural crises in process industry, and
have resulted in operational losses
\ AD SECTOR oN ow
he Managenent Polley Financial Constraints
a |
ACCOUNTING SECTOR
a
Capital Equipment proaudtton
hea
_— SS
ENVIRONMENT SECTOR as -~
gr ~ 4° \ PRODUCT MARKET
UABOR MARKET MATERIALS MARKET
v 7
N
Figure 2. Overview of the Accounting Dynamics
Corporate Model, Type II
17
As a prototype of the AD corporate model, we have developed two models
(type 1 and type 2) of the company. Type 1 overviews the physical and
accounting structures of the company and portrays its basic behavior
and critical issues. The model also shows one possible approach to
coping with actual problems. Type 2 covers the physical and account-
ing structures of the company in more detail.
Figure 2 is an overview of type 2. There are four main sectors. The
first one is the AD sector, which is controlled. by management policy
or feedback from financial constraints. So far the model does not
include the management subsector, and management policy performs manu-
ally by changing the initial conditions or rebuilding a part of the
model. The second sector is accounting sector which includes subsec~
tors of revenues, expenses, cost accounting, B/S, P/L, and financial
index. The first three subsectors represent auxiliary variables. B/S
and P/L subsectors are made by level variables and rate variables,
which are induced from the above two auxiliary variables. The finan-
cial index subsector calculates and shows the financial indexes. One
purpose of AD modeling and simulation is to test accounting princi-
ples. We can choose any accounting rule in the accounting sector
For example, we can change cost accounting rules by restructuring them
in the accounting sector. The third sector is the physical sector.
There are four product subsectors as well as labor and capital equip-
ment subsectors in the physical sector. But because of the similarity
between piles and pipes, we assume them to form one production subsec-
tor. The basic structure of a production subsector is similar to
Lyneis’s model. The fourth sector is called the environment sector
because it mainly describes external variables and initial values. It
includes the product market and other subsectors. Labor and materials
market subsectors do not yet exist.
This model thus includes many factors occurring in the internal and
external environments. Using this model, we have tried to analyze the
causal relationships between the critical problems of the company.
We have to recognize that there are many problems in order to realize
the full implications of the concept of Accounting Dynamics. However,
as far as its methodological aspects are concerned, we have made clear
considerable Accounting Dynamics issues and have created a prototype
of the AD corporate model.
CONCLUSION
We believe that the Accounting Dynamics model is the most typical
System Dynamics application model to social systems for following
three reasons. First, the Accounting Dynamics approach is very much
like the relativist view of scientific theory (Barlas and Carpenter,
1978). As discussed above, the accounting quantification of the
social process is a confirmation of human relationships, which commu-
nicates charge and discharge of accountability. That is to say,
accounting measurement is, in its very nature, conversational and not
confrontational. Accounting data represents not an objective and
absolute truth, but a mere trade-off amount of transactions among
interested parties. Second, a validation of the Accounting Dynamics
model is naturally built on confidence among interested parties.
Building confidence is the most important criteria of System Dynamics
model validation (Forrester and Senge, 1980). Because of its legal
aspect, accounting measurement has various social constraints in the
quantification process. These constraints are called generally ac-
counting principles or accounting rules. "Generally accepted" is the
only justification for accounting. So far, institutionalism has deep-
118
ly influenced accounting theory. But, now, accounting principles have
to be reformed based on a more appropriate causal explanation of the
resource allocation process, the endorsed new methodology of social
science. Third, Accounting Dynamics model is a theory of economic
resource allocation in social systems. Accounting, as we emphasized,
measures every day transactions in our society almost exhaustively.
Based on such accounting data, the Accounting Dynamics model has
explanatory power about resource allocation process. The simulation
model, which captures the resource allocation process operationally
will become one of the most powerful theories of social science.
REFERENCES
Barlas Y. and Carpenter S.(1987) A Fundamental Philosophy of Science
Question and Validation of System Dynamics Models, in Quifan Wang and
Robert Eberlein (eds.), Proceedings of The 1987 International Confer-
ence of The System Dynamics Society, Shanghai, China, pp.896-914.
Forrester J.W. and Senge P.M.(1980) Tests for Building Confidence in
System Dynamics Models, in A.A. Legasto, Jr., J.W. Forrester, J.M.
Lyneis(eds.), SYSTEM DYNAMICS, Studies in the Management Sciences
Volume 14, North-Holland Publishing Co., pp.209-228.
Lyneis, J.M.,(1980) Corporate Planning and Policy Design -- A System
Dynamics Approach, The MIT Press.
Robert E.B.(1978) Design of Management Control Systems, in E.B.
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