Citation
Adapting the flow of resources concept to the business enterprise

Material Information

Title:
Adapting the flow of resources concept to the business enterprise
Creator:
Hines, Danny Ray, 1947- ( Dissertant )
Yu, Shih C. ( Thesis advisor )
Blodgett, Ralph J. ( Reviewer )
Stone, Williard E. ( Reviewer )
Place of Publication:
Gainesville, Fla.
Publisher:
University of Florida
Publication Date:
Copyright Date:
1975
Language:
English
Physical Description:
viii, 176 leaves. : illus. ; 28 cm.

Subjects

Subjects / Keywords:
Accountancy ( jstor )
Cash ( jstor )
Corporations ( jstor )
Financial accounting ( jstor )
Funds statements ( jstor )
Information resources ( jstor )
Information storage and retrieval systems ( jstor )
Input output ( jstor )
Systems theory ( jstor )
Working capital ( jstor )
Accounting thesis Ph. D
Dissertations, Academic -- Accounting -- UF
Financial statements ( lcsh )
Genre:
bibliography ( marcgt )
non-fiction ( marcgt )

Notes

Abstract:
The purpose of this study was to develop a resource flow matrix with particular emphasis on the changes in the economic position of the enterprise due to both financial and nonfinancial flows. As such, it serves as the basic link between the balance sheet and the income statement. The systems approach was the basic approach of the study. The initial step comprised an assessment of the nature and function of the funds statement. This was followed by an examination of the opinions of the American Institute of Certified Public Accountants on funds statements and various funds concepts. The second step of the study included a definition of the aims, constraints, and performance criteria which the resource flow matrix must satisfy. An attempt was then made to explore the meanings of "system," "information," "accounting," and the role of the accounting information system in the total organization system. A model of the accounting information system was developed in terms of the role of the accounting information system in the total management information system. It was concluded that a decision-making approach to theory verification is consistent with the frame of reference adopted. The study provided a mathematical basis for relating financial and nonfinancial flows. After an examination of the Leontief input-output model and the general form of the linear programming model, it was demonstrated that the decision models for the allocation of financial and productive resources are the same by relating the linear programming technique to financial planning and, therefore, to financial flows. The resource flow matrix was found to allow for comprehensive and concise presentation of the account interrelationships, as well as to provide the basis for development of the traditional financial statement. It was concluded that if there are advantages in utilizing the input-output reporting format for depicting productive flows, these same advantages apply to the depiction of total resource flows, financial as well as productive.
Thesis:
Thesis -- University of Florida.
Bibliography:
Bibliography: leaves 166-174.
General Note:
Typescript.
General Note:
Vita.
Statement of Responsibility:
by Danny Ray Hines.

Record Information

Source Institution:
University of Florida
Holding Location:
University of Florida
Rights Management:
Copyright [name of dissertation author]. Permission granted to the University of Florida to digitize, archive and distribute this item for non-profit research and educational purposes. Any reuse of this item in excess of fair use or other copyright exemptions requires permission of the copyright holder.
Resource Identifier:
000582327 ( AlephBibNum )
14101078 ( OCLC )
ADB0701 ( NOTIS )

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ADAPTING THE FLOW OF RESOURCES CONCEPT
TO THE BUSINESS ENTERPRISE









By





DANNY RAY HINES


A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL OF
THE UNIVERSITY OF FLORIDA
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE
DEGREE OF DOCTOR OF PHILOSOPHY


UNIVERSITY OF FLORIDA
1975















ACKNOWLEDGMENTS


Grateful appreciation is expressed to the members of

the Supervisory Committee--Dr. Shih C. Yu, Chairman, and Drs.

Williard E. Stone and Ralph H. Blodgett--for their helpful

guidance and constructive criticism.

Thanks are extended to R. Wileen Solt for editorial

suggestions and the preparation of the finished manuscript.
















TABLE OF CONTENTS



ACKNOWLEDGMENTS . . . . . . . . .. . . ii

LIST OF TABLES . . . . . . . . ... . . v

LIST OF FIGURES . . . . . . . . ... . .vi

ABSTRACT . . . . . . . . ... ...... vii

CHAPTER I. INTRODUCTION . . . . . . . .. 1
Statement of Purpose . . . ....... .. 2
Method of Analysis . . . . . . . . 2

CHAPTER II. FUNDS CONCEPTS AND FORMATS FOR FUNDS
STATEMENTS . . . . . . . . . 5
Antecedents to Funds Statement Perplexity . . 5
The American Institute of Certified Public
Accountants . . . . . ....... 12
The Issue Still Unresolved . . . . ... 33
Summary ................ .. .... 45

CHAPTER III. SYSTEMS AND FINANCIAL ACCOUNTING THEORY,
A FRAME OF REFERENCE . . . . .... 47
The Meaning of "System" . . . . . . 48
The Meaning of "Information" . . . . . 49
The Meaning of "Accounting" . . . . . .. .51
Development of a Model of the Accounting
Information System. . . . . . . .54
Motives and Developments Leading to General
Systems Theory . . . . . . . . .. 65
The Systems Approach . . . . . . ... 66
The Systems Approach--Not Unchallenged . . .. .69
Systems Theory Properties .... . . . . 71
Implications for Theory Construction and
Verification . . . . . . . . . 81
Summary . . . . . . . . . . . 86











CHAPTER IV. THE ESSENCE OF INPUT-OUTPUT . . .. .


The Use of Matrices for Allocation . . . .. 90
The Leontief Input-Output Models--
Static Version . . . . . . . .. 92
Linear Programming and Input-Output Analysis . 96
Input-Output Accounting--The Enterprise Level. . 106
Summary . . . . . . . . . . . 109

CHAPTER V. THE RESOURCE FLOW MATRIX . . . . .. .110

Linear Programming and Short-Term Financing. .. 110
Financial and Operating Flows Reconsidered . . 116
The Resource Flow Matrix . . ... .. ... 123
Summary . . . . . . . . ... .. . 127

CHAPTER VI. THE RESOURCE FLOW MATRIX AND THE
ACCOUNTING INFORMATION SYSTEM . . ... 129
The Goal-Process-Systems Complex . . . ... 129
The Resource Flow Matrix and the GPS Complex
of Accounting . . . . . . .... 138
The Resource Flow Matrix and Traditional
Financial Statements . . . . . .. .149
Summary . . . . . . . . . . .. 157

CHAPTER VII. SUMMARY AND CONCLUSIONS. . . . . ... 158

SELECTED BIBLIOGRAPHY ................. 166

BIOGRAPHICAL SKETCH . . . . . . . .... 175


90















LIST OF TABLES


Table

1 The SCFP Corporation, Comparative Statements of
Financial Position, December 31, 1972 and 1973 . 20

2 The SCFP Corporation, Income Statement, Year
Ending December 31, 1973 . . . . . ... 23

3 The SCFP Corporation, Statement of Retained
Earnings, Year Ending December 31, 1973 . . .. .24

4 The SCFP Corporation, Statement of Flow of Re-
sources, Year Ending December 31, 1973 ...... 26

5 The SCFP Corporation, Statement of Flow of Re-
sources, Year Ending December 31, 1973 ...... 28

6 The SCFP Corporation, Statement of Flow of Re-
sources, Year Ending December 31, 1973 ...... .30

7 The SCFP Corporation, Quick-Asset Flow Statement,
Year Ending December 31, 1973. . . . . ... 32

8 Working Capital Provided by Operations ...... 36

9 Working Capital Provided by Operations . . .. .. 37

10 Consolidated Statements of Changes in Financial
Position, Years Ending December 31, 1972 and 1971. 38

11 Illo Company, Analysis of Cash Flow from Opera-
tions, Year Ending December 31, 1972 . . ... 40

12 Illo Company, Statement of Changes in Financial
Position, Year Ending December 31, 1972. . . ... 41

13 Resource Flow Matrix . . . . . . ... 124

14 Resource Flow Matrix for the SCFP Corporation for
the Year Ending December 31, 1973. . . . ... 153













LIST OF FIGURES



Figure

1 Two Types of Flows of Resources and the Interrela-
tionships Which Need to Be Presented in a Funds
Statement . . . . . . . . . . . 10

2 Classifications of Transactions . . . ... .44

3 A Function Model of the Information Subsystem and
Its Role in the Total System . . . . .. 58

4 The Accounting System . . . . . . ... 64

5 The Verification Process . . . . . ... 85

6 A User View . . . . . . . .... . .120

7 The Relationship of the Income Statement to the
Balance Sheet . . . . . . . . ... 121

8 Relationship of the Statement of Changes in
Financial Position to the Balance Sheet . . .. .122

9 A Goal-Process-Systems Complex . . . ... 130

10 A Comparison of a Present State with a Desired
State . . . . . . . . ... . .133

11 The Role of Feedback in Controlling Movement
Toward a Stated Objective . . . .... .... 134

12 The Relationship of Feedback to Control in a
Closed System . . . .... . . .. 136

13 The Relationship of Feedback to Control in an
Open System . . . . . . . .... . .137

14 Patterns of Development in the Accounting System. 145









Abstract of Dissertation Presented to the Graduate Council
of the University of Florida in Partial Fulfillment
of the Requirements for the Degree of
Doctor of Philosophy



ADAPTING THE FLOW OF RESOURCES CONCEPT
TO THE BUSINESS ENTERPRISE



By

Danny Ray Hines
March, 1975



Chairperson: Shih C. Yu, Ph.D.
Major Department: Accounting


The purpose of this study was to develop a resource flow

matrix with particular emphasis on the changes in the economic

position of the enterprise due to both financial and nonfinancial

flows. As such, it serves as the basic link between the balance

sheet and the income statement.

The systems approach was the basic approach of the study.

The initial step comprised an assessment of the nature and func-

tion of the funds statement. This was followed by an examination

of the opinions of the American Institute of Certified Public

Accountants on funds statements and various funds concepts. The

second step of the study included a definition of the aims, con-

straints, and performance criteria which the resource flow matrix

must satisfy. An attempt was then made to explore the meanings









of "system," "information," "accounting," and the role of the

accounting information system in the total organization system.

A model of the accounting information system was developed in

terms of the role of the accounting information system in the

total management information system. It was concluded that a

decision-making approach to theory verification is consistent

with the frame of reference adopted.

The study provided a mathematical basis for relating

financial and nonfinancial flows. After an examination of the

Leontief input-output model and the general form of the linear

programming model, it was demonstrated that the decision models

for the allocation of financial and productive resources are

the same by relating the linear programming technique to finan-

cial planning and, therefore, to financial flows.

The resource flow matrix was found to allow for compre-

hensive and concise presentation of the account interrelation-

ships, as well as to provide the basis for development of the

traditional financial statement. It was concluded that if there

are advantages in utilizing the input-output reporting format for

depicting productive flows, these same advantages apply to the

depiction of total resource flows, financial as well as produc-

tive.


viii













CHAPTER I

INTRODUCTION



The income statement traditionally has been the principal

statement used by the accountant for reporting the flow of resources

of specific business enterprises. However, the income statement

is limited only to a disclosure of productive flows. In recogni-

tion of the need for a second flow statement, the American Insti-

tute of Certified Public Accountants issued Opinion No. 3 (1963)

and Opinion No. 19 (1971) on the necessity of the "funds" state-

ment and the "funds" concepts which should serve as the basis for

disclosure of resource flows.

Even after the issuance of two opinions by the American

Institute of Certified Public Accountants, much debate exists among

accountants as to the most useful concept and format for disclosure

of funds flows. The basic nature and function of the statement,

subtitled "Statement of Changes in Financial Position," in Opinion

No. 19, was to account for the operating and financial activities

of an enterprise during the operating period. A statement of this

nature is needed to reconcile the financial position of the enter-

prise at the beginning of the period with that at the end of the

period. Many writers are of the opinion that the statements of

changes in financial position found in the literature and in finan-









cial reports do not provide a report of the "total" resource flows

which have taken place between stock statement dates.

Do accountants presently provide a statement which dis-

closes all resource stock changes due to financial flows? Does a

statement prepared on a "working capital" or a "cash" basis, as

recommended in Opinion No. 19, serve as the basic link between re-

source stock accounts and nonfinancial flow accounts? These ques-

tions suggest the need for an investigation as to the proper concept

and statement format for disclosure of the changes in financial

position of the business entity.



Statement of Purpose


The purpose of this dissertation was to develop a resource

flow matrix which depicts the historical interrelationships between

the resources and sources of the resources of the business enter-

prise. A resource flow matrix so developed then provides a descrip-

tion of the changes in the financial position of the enterprise

due to both financial and nonfinancial flows. As such, it serves

as the basic link between the resource stock accounts and the non-

financial flow accounts.



Method of Analysis


The systems approach to problem solution comprised the

approach of this study. Recognizing that the use of systems con-







cepts in a research endeavor is not without controversy, considerable

discussion is provided in Chapter III on the systems approach.

The chapters are arranged so as to indicate first the rele-

vance of the study, then to provide a theoretical frame of reference

for development of the resource flow matrix, next to establish the

mathematical basis for development of the resource flow matrix, and,

finally, to discuss the relationship of the resource flow matrix to

the accounting information system. Several of the funds concepts

and formats for funds statements which have been suggested since the

construct "funds flows" was first employed are presented in Chapter

II. Support is provided in that chapter for further research on

funds concepts and formats for the funds statement. A frame of

reference for derivation of the resource flow matrix is developed

in Chapter III. In that chapter a model of the accounting informa-

tion system is developed, and the role of the accounting informa-

tion system in the entity is discussed. In a continuation of the

detail of the frame of reference, Chapter III includes, as indi-

cated above, a discussion of the systems approach to theory develop-

ment. In the last part of Chapter III, the implications of the model

and theory adopted for theory development and verification are pre-

sented. In Chapter IV the mathematical basis for relating finan-

cial and operating flows is deduced. Chapter V demonstrates that

the decision models for the allocation of financial and productive

flows are identical. It is this proof that is utilized to develop

the resource flow matrix. The relationship of the resource flow

matrix to the accounting information system is discussed in Chapter




.4



VI. A summary statement and conclusion are provided in the last

chapter, Chapter VII.













CHAPTER II

FUNDS CONCEPTS AND FORMATS FOR FUNDS STATEMENTS



In this chapter, several of the funds concepts and

formats for funds statements which have been developed since

the construct "funds flows" was first employed are considered.

The first part of the chapter provides a historical background

relevant to the current dissatisfaction with the "limited"

funds concepts utilized for financial-reporting purposes.

Next, the position of the American Institute of Certified

Public Accountants and the broader funds concepts which the

Institute's Accounting Principles Board could have utilized

at the time of publication of Opinion No. 19 (1971) are dis-

cussed. Support for further research on funds concepts and

formats for the funds statement is then provided.



Antecedents to Funds Statement Perplexity


The origin of the statement of changes in financial

position is usually credited to William Morse Cole. The 1908

edition of Cole's bookkeeping text, Accounts, Their Construc-

tion and Interpretation for Businessmen and Students of

Affairs, is usually cited as the date of the first funds state-

ment. Funds statements, however, have been dated prior to









1908. Thomas L. Greene presented a "Summary of Changes in the

Position of the Company" in his study of railroad financial

statements published in 1897 (106 ff.). Liability increases

and asset decreases were termed "sources of funds" by Greene.

He regarded asset increases and liability decreases as "uses

of funds." Rosen and De Coster observed in their "'Funds'

Statements: A Historical Perspective" that Cole was illustrat-

ing "only one of several types of 'supplementary' statements

that were being used in practice at the time. . All of these

reports are now called 'funds' statements" (1969, p. 125).

With regard to the term "funds," it may be noted that

H. A. Finney stated in 1925 that "it is not unlikely that the

term 'resources' is preferable" (p. 507). This observation is

especially noteworthy, since it is Finney who is credited with

the introduction of the term "funds" (1923). Finney led the

drive in the late 1910s and 1920s for limiting the concept

"funds" to a statement of the causes of changes in working capi-

tal (Rosen and De Coster, 1969, p. 128). Kafer and Zimmerman

noted that the equating of "funds" to "working capital" is a

widely accepted practice that has been attacked by various

authors. The final results of the attack, they observed, are

still indeterminate due to the recent demands for a widening,

as well as a reduction, of the scope of the term (1967, p.

96). It was Finney's position that the purpose of the funds

statement was to serve as an extension of the idea of compara-

tive balance sheets. In his view, a funds statement helped to









provide "a clear and comprehensive conception of the change

in the financial condition caused by the profits of .the

period, the dividend payments, and any financing programme

which may have taken place" (1923, p. 460).

Although, as noted above, accounting theorists ex-

pressed reasonable interest in the funds statement during

the period prior to 1925, Rosen and De Coster observed dis-

interest in the subject on the part of a majority of large

public companies of that period. Rosen and De Coster mailed

approximately 150 letters to large public companies operat-

ing prior to 1925 to ascertain whether or not a funds state-

ment was included in their reports of the time. Sixty

companies responded. Four used a type of funds statement.

One of the four grouped working-capital items together

(1969, p. 129). A lack of interest in the funds state-

ment is also noticed in the textbooks written from 1908 to

1955.

The importance and need for an understandable or-

ganization of the funds statement was recognized by A. C.

Littleton.


Management exercises a multiple stewardship,
financial as well as operating. . A du-
ty exists, therefore, to report on finances
as well as on operations. . Financial
transactions are important, and a report of
financial stewardship is very much needed.
. Unfortunately, however no clear cut
and orderly accounting statement for this pur-









pose has evolved. . It is doubtful if
an "application of funds statement" . .
fully answers] the need [because it] is
too complex in organization to be under-
standable. (1953, p. 80)


At the time of the publication of Littleton's monograph (1953),

there was a laxity, as before, in presenting a comprehensive

explanation of financial transactions. It was not until

after the American Institute of Certified Public Accountants'

Opinion No. 3 (1963) that one could begin to see significant

evidence of concern with the funds statement. Note the in-

crease from 25 to 207 companies presenting a funds statement

and the corresponding coverage by the auditor's report from

1958 to 1965 (Kafer and Zimmerman, 1967, p. 98).



Statement of Working Capital, Source, and Applica-
tion of Funds:

1958 1960 1965

Covered by auditor's
25 30 207
report

Not covered by audi-
tor's report

Total 185 208 458

n = 600 companies




It has been recognized for many years that enterprise

resources are of two major types--productive and financial. It

has also been recognized that information concerning the financ-








ing and investing activities of the business enterprise is

essential to financial-statement readers. Based on the above

observations, the American Institute of Certified Public Ac-

countants, in Opinion No. 19, stated the following:


When financial statements purporting to pre-
sent both financial position (balance sheet)
and results of operations (statement of in-
come and retained earnings) are issued, a
statement summarizing changes in financial
position should also be presented as a basic
financial statement for each period for which
an income statement is presented.
(1971, paragraph 7)


Many accounting writers have long recognized the need

for a funds statement. The diagram presented in Figure 1 was

offered by S. C. Yu as exhibiting the two types of flows of

resources and the interrelationships which need to be pre-

sented in a funds statement (1969, p. 573). In explaining his

diagram, Yu stated that "resources" denote a stock point--

a state position--from which flows begin and end. The ar-

rows denote continuous interplay between financial and pro-

ductive activities. It was Yu's observation that "implicitly,

the diagram tends to bridge the gap between the balance sheet

and the statements of income and retained earnings" (1969,

p. 572). Yu was calling for a total-resources funds con-

cept as opposed to the typical working-capital or cash con-

cept.

Considerable evidence is provided by Rosen and De Cos-

ter that liquidity has been the primary justification offered



























-Capital
Furnished by
Owners


Figure 1. Two Types of Flows of Resources and the Interrelationships Which Need to Be Presented
in a Funds Statement.


Productive
Activities









Revenue
Activities








for the adoption of the working-capital concept of funds. When

statements are used primarily as a basis for establishing credit,

one cannot question the importance of liquidity. Glenn L.

Johnson has presented several formulas for explaining changes

in working capital in terms of changes in noncurrent assets and

equities (1966). Harold J. Bierman, among other writers, em-

phasized that the primary information to be obtained from the

funds statement is "change in liquidity" (1960, p. 628). Noting

confusion on the part of the general public as to an under-

standing of the term "working capital," the American Institute

of Certified Public Accountants, in Opinion No. 19 (1971), re-

quired that an analysis of the changes in the components of

working capital accompany statements of changes in financial

position prepared on a working-capital basis. It was noted by

the Institute that the statement of financial position is no

longer a liquidity statement for borrowing purposes, but a

basic statement for information communication to many users.

At the extreme of the liquidity spectrum is the "literal-

cash" concept of funds. A funds statement prepared on this ba-

sis, as compared to the working-capital basis, corresponds to

a statement obtained from a set of books prepared on the cash

basis. The source-and-use-of-cash statement informs one of

where cash came from and how it was used.









The American Institute of Certified
Public Accountants


The significance of the statement of changes in finan-

cial position is the need for comprehensive information con-

cerning all of the financing and investing activities of the

enterprise. The items reported are intimately related to pro-

fit, since, to users and to managers, profit is the primary

source of continuing-cash and working-capital needs. This

statement is essential to fair reporting of the causes of

balance-sheet changes from period to period. The purpose of

the broad all-resources concept of the statement of changes

in financial position expressed in Opinion No. 19 (American

Institute of Certified Public Accountants, 1971), as opposed

to the earlier working-capital and cash concepts of funds

statements, is to provide the missing link in reporting on all

changes in financial position between two consecutive balance

sheets. The missing link comes from the fact that the income

statement reports changes as a result of operations, and the

statement of retained earnings reports only certain changes

in owner's equity. Neither statement, separately or jointly,

reports all changes in financial position between two consecu-

tive position statements.

In this section we will consider the American Institute

of Certified Public Accountants' Opinion No. 19, subtitled "Re-

porting Changes in Financial Position," and the broader funds

concepts available to the Institute at the time of Opinion No. 19.




13



opinion No. 19

The American Institute of Certified Public Accountants

was well aware of the varied conception of "funds" in practice

in its Opinion No. 19 (1971). Observing cash or its equivalent

and working capital as funds interpretations, the Institute

stated,


. a funds statement based on either the cash
or the working-capital concept of funds some-
times excludes certain financing and investing
activities because they do not directly affect
cash or working capital during the period. . .
To meet all of its objectives, a funds statement
should disclose separately the financing and
investing aspects of all significant transac-
tions that affect financial position during a
period. These transactions include acquisition
or disposal of property in exchange for debt or
equity securities and conversion of long-term
debt or preferred stock to common stock.
(paragraph 6)


In reference to this broadened concept of the funds

statement, the Institute recommended that the subtitle of the

statement be changed to "Statement of Changes of Financial

Position." The statement recommended by the Institute had the

following objectives:


1. To report on all of the financing and investing
activities of the enterprise.
2. To report on the generation and application of
funds (either on a working-capital or cash basis).
3. To complete the reporting of the causes of all
of the changes in financial position during the
period. (1971)









The Institute specified that the following criteria must

be met in presenting a statement of financial position:


1. The statement should be presented as a basic
financial statement for each period in which an
income statement is prepared.
2. The statement applies to all profit-oriented
business entities whether or not there is a
classification of assets and liabilities between
current and noncurrent.
3. The statement should be based on a broad concept
embracing all changes in financial position (not
limited to working capital or cash). All impor-
tant changes in financial position during the
period should be disclosed.
4. a. The statement should begin with the income
or loss before extraordinary items, if any, and
add back (or deduct) items recognized in de-
termining income (or loss) which did not use (or
provide) working capital or cash during the
period.
b. Alternatively, so as to not suggest that
adjustments to net income, such as depreciation,
generate working capital or cash, the statement
could begin with revenues that generated working
capital or cash during the period and deduct
operating expenses that required the outflow of
working capital or cash.
5. The items added back (or deducted) in 4a, above,
should be clearly presented to avoid the inter-
pretation that they provided funds.
6. The effects of extraordinary items should be re-
ported separately from the effects of normal
operating items.
7. The effects of all financing and investing acti-
vities, as well as working capital or cash,
should be individually disclosed.
8. If the format shows the flow of working capital
and two-year comparative balance sheets are pre-
sented, the detailed changes in working-capital
accounts nevertheless must be presented.
9. Working capital or cash provided (used) should be
appropriately described.









10. If the format shows the flow of cash, detailed
changes in other working-capital accounts should
be disclosed in the body of the statement.
11. Terms referring to cash should not be used un-
less all noncash items have been appropriately
adjusted.
12. There should be flexibility in form, content, and
terminology in the statement; flexibility should
be used to develop the presentation that is most
informative in the circumstances.
13. It is strongly recommended that isolated statis-
tics of working capital and cash, especially per
share amounts, not be presented. (1971)


The Institute stipulated the following with regard to

concept selection:


The statement summarizing changes in financial
position should be based on a broad concept em-
bracing all changes in financial position, and
. the title of the statement should reflect
this broad concept. The Board [Accounting Prin-
ciples Board of the American Institute of Certi-
fied Public Accountants] therefore recommends
that the title be "Statement of Changes in Fi-
nancial Position" (referred to below as "the
Statement"). The Statement of each reporting
entity should disclose all important aspects of
its financing and investing activities regard-
less of whether cash or other elements of work-
ing capital are directly affected. For example,
acquisitions of property and conversions of
long-term debt or preferred stock to common
stock should be appropriately reflected in the
Statement. (1971, paragraph 8)


Opinion No. 19 allows considerable variation in the re-

porting of the "limited" concepts of funds or "resources" re-

quired. It appears that the following recommendations of Perry

Masson in Accounting Research Study No. 2 (1961) could have been

more effectively utilized in at least limiting the variation









in the reporting concept and still allow flexibility in the

format of the funds-flows statement.


Accounting Research Study No. 2


Perry Masson advocated the all-financial-resources

funds concept in Accounting Research Study No. 2 (1961). He

indicated that all-financial resources comprised a different

and broad approach to the problem of interpreting the term

"funds." He conceived of all-financial resources as including

all assets, or financial resources, and not just those which

affect or flow through the working-capital accounts.


This conception of what is meant by "funds"
seems to us to be the most useful meaning of
the term. The narrower definitions, such as
"cash" or "working capital," have often led
to the omission from the statement of the
effect of transactions which do not directly
affect cash or working capital, but which,
nevertheless, are important items in the fi-
nancial administration of the business. Exam-
ples are the purchase of property in exchange
for shares of stock or bonds, gifts or subsidies,
exchanges of property, and the like. The in-
clusion of such transactions is sometimes jus-
tified by assuming intermediate steps, e.g., the
issue of bonds for cash and the purchase of
property with cash. This introduction of hypo-
thetical transactions could usually be unneces-
sary under the "all-financial resources" con-
cept since the changes in such items would
naturally fall into the scope and purpose of
the funds statement. . .
. The narrower concepts also tend to re-
strict the form in which the statement is pre-
pared and to introduce too high a degree of uni-
formity in the arrangement of the items. The
funds statement should be a flexible device,
designed to disclose and emphasize all signifi-
cant changes and transactions, whether they are








within or without the current asset and lia-
bility groups. Too often a single figure of
increase or decrease in working capital is
shown, when one of the most significant
changes may have been an increase or decrease
in inventories, receivables, or some other
current item. (1961, p. 54)


Other Concept Suggestions


In addition to the suggestion of Masson (1961), the

American Institute of Certified Public Accountants had available

to it many other concept suggestions in its preparation of

Opinion No. 19 (1971). In the following pages, some of those

concepts will be presented. All of the statements developed

will be based on the data of Tables I through 3, below. Table

4 indicates the kind of statement used by the Federal Reserve

Board prior to 1959. To some extent, Table 5 resembles the

format currently used by the Federal Reserve Board for its

flow-of-funds accounts. The format of Table 6 is an alterna-

tive to that presented in Table 5.

The general structure of Table 5 is as follows:


1. Statements of income and retained earnings--non-
financial flows.

2. Changes in balance-sheet accounts.
a. Real accounts--nonfinancial flows.
b. Financial assets--financial flows.
c. Liabilities--financial flows.


Note that this statement gives the effect of the nominal accounts

(the productive flow accounts in the accounting system) on the

real accounts. Also provided are changes within the position









statement accounts. The sum of the two provides total flows.

That is, the sum of the two provides an explanation of the

changes taking place from one stock position to another.

A format of the type in Table 6 allows concentration

in the financial and nonfinancial flows of funds. Information

is therefore provided as to how long-term investment was fi-

nanced. The basic structure of this statement is as follows:


Nonfinancial flows--operating and dividend transac-
tions:
Sources $295,480
Uses 275,245
Savings provided from operations 20,235

Financial flows:
Sources 54,225
Uses 53,850,
Net financial sources 375

Total available for capital formation 20,610
Less portion retained in current 5
assets nonfinanciall)
Capital formation 15,300
Capital formation (various) 15,300


Two of the more limited concepts of funds, in which the

emphasis is again on liquidity, are "cash and marketable securi-

ties" and "net quick assets." The cash-and-marketable-securities

concept is very close to that of "literal cash." It will be

considered in the next section of this chapter as we take.a look

at a sampling of thought subsequent to Opinion No. 19. Net

quick assets are composed of cash-and-demand deposits, secondary

cash reserves (government bonds, notes, etc.), and short-term









receivables less short-term payables. This concept excludes in-

ventories and prepaid items. An adjustment to net income for

change in inventories is therefore necessitated. A statement of

quick-asset flows based on George Staubus (1966) is presented in

Table 7. The statement format is Staubus'. Table 7 was pre-

pared using the data in Tables 1 through 3.

The quick-asset concept utilizing Staubus' format appears

very useful as a liquidity measure. A distinction is presented

between operating and financing activities. The issue resolu-

tion for the funds concept, however, still depends on whether

one is interested in cash, quick assets, working capital, and

so forth for liquidity or capital formation and net investment.

Can all be gained from the same statement or are several state-

ments required? In utilizing the net quick-asset concept, we

must distinguish between resource categories in order to pre-

pare the statement. Where is the line drawn between the "pools"

of credit and equity used for the various purposes? Does such

a distinction really matter? Would a total "source pool" and

a total "usage" concept be more descriptive of actual enter-

prise operations? Does the ability to be liquid in the short

term determine long-run success? Or, is the spending power of

the enterprise a function of total enterprise resources?











TABLE 1
THE SCFP CORPORATION, COMPARATIVE STATEMENTS OF FINANCIAL POSITION, DECEMBER 31, 1972 AND 1973



December 31 Net Change
1972 1973 Debit Credit

ASSETS

Current Assets
Cash $ 10,260 $ 18,350 $ 8,090
Marketable securities 2,000 2,000
Accounts receivable (net) 31,200 .48,700 17,500
Notes receivable 4,000 6,000 2,000
Accrued interest receivable 60 100 40
Inventories 19,000 24,000 5,000
Prepaid insurance 540 750 210
Office supplies 300 400 100

Sundry Assets
Long-term investments 44,000 48,000 4,000
Sinking fund 27,000 30,000 3,000

Fixed Assets
Land 21,000 33,000 12,000
Buildings (net) 144,000 138,000 $ 6,000
Furniture and fixtures (net) 11,300 13,500 2,200
Goodwill 10,000 10,000
Unamortized bond discount 660 600 60


TOTAL ASSETS


$323,320 $363,400









TABLE 1, continued:


December 31 Net Change
1972 1973 Debit Credit

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities
Accounts payable $ 17,400 $ 18,300 $ 900
Accrued wages and salaries 300 400 100
Accrued taxes payable 120 100 $ 20
Federal income taxes payable 16,200 20,425 4,225
Accrued interest payable 2,400 2,400

Long-Term Liabilities
Long-term notes payable 6,000 6,000
Sink fund bonds payable
(4%, due Oct. 31, 1982)

Stockholders' Equity
Capital stock--no par value;
stated value, $10; authorized,
20,000 shares; issued, 15,000 120,000 150,000 30,000
shares of which 300 shares
are in the treasury

Capital in Excess of Stated Value
From stock issuances 15,000 27,000 12,000
From treasury stock transactions 4,000 4,000
From stock dividends 2,400 2,400








TABLE 1, continued:


December 31 Net Change
1972 1973 Debit Credit

LIABILITIES AND STOCKHOLDERS' EQUITY, continued:

Retained Earnings
Appropriated
Reserve for sinking fund $ 25,000 $ 28,000 $ 3,000
Reserve for contingencies 3,000 $ 3,000
Unappropriated-- ---- 51,500 54,575 3,075
Deduct cost of treasury stock (4,200) 4,200
TOTAL EQUITIES $323,320 $363,400

TOTAL DEBITS AND CREDITS $69,360 $69,360











TABLE 2
THE SCFP CORPORATION, INCOME STATEMENT, YEAR ENDING DECEMBER 31, 1973




Net sales $288,000
Cost of goods sold 194,000
Gross profit on sales 94,000
Operating expenses
Advertising $ 8,500
Wages and salaries 30,500
Insurance 210
Office supplies 600
Bad debts 2,500
Property taxes 400
Depreciation--buildings 6,000
Depreciation--furniture and fixtures 1,100
Miscellaneous 1,200 51,010
Net operating income $ 42,990
Other income and expenses
Interest expenses 2,460
Interest income 320 2,140
Net income after other income and expenses $ 40,850
Income tax expense 20,425
NET INCOME AFTER INCOME TAX $ 20,425














TABLE 3
THE SCFP CORPORATION, STATEMENT OF RETAINED EARNINGS, YEAR ENDING DECEMBER 31, 1973




Retained earnings, December 31, 1972 $51,500
Net income for the year 20,425
Release of reserve for contingencies 3,000
TOTAL $74,925

Increase in reserve for sinking fund $ 3,000
Write-off of goodwill 10,000
Dividends 7,350 20,350
RETAINED EARNINGS, DECEMBER 31, 1973 $54,575

Additional Information
1. The company purchased $2,000 worth of marketable securities during the year.
2. The company wrote off $1,000 accounts receivable as uncollectable and recorded $2,500 estimated bad
debts at year end.
3. Insurance premiums paid during the year amounted to $420.
4. Purchases of $700 worth of office supplies were made.
5. The net change in the long-term investments account is the result of two separate transactions--addi-
tional purchases, $11,000, and sales with a total cost of $7,000 for $7,000.
6. The net change in the sinking-fund account reflects the annual requirement of deposit for the retire-
ment of sinking-fund bonds at maturity. Sinking-fund expenses and income are ignored for purposes of
illustration.
7. Additional land was acquired at a cost of $12,000.
8. Purchases of furniture and fixtures amounted to $3,300.
9. Goodwill was removed from the books by a charge to retained earnings.









TABLE 3, continued:




10. The applicable amount of bond discount amortization for the year is $60.
11. Actual payment of federal income taxes during the year amounted to $16,200, which apparently was the
amount of income taxes remaining unpaid at the end of 1972. Income taxes for 1973 amounted to
$20,425.
12. Three thousand shares of capital stock were issued, of which 430 shares were issued to retire the
long-term notes payable and the remainder sold for $36,000.
13. Reserve for sinking fund was increased by $3,000 and reserve for contingencies was eliminated.
14. The company acquired 300 shares of its own stock at a total cost of $4,200.
15. Dividends declared and paid during the year amounted to $7,350.











TABLE 4
THE SCFP CORPORATION, STATEMENT OF FLOW OF RESOURCES, YEAR ENDING DECEMBER 31, 1973




Sources

Nonfinancial flows
Net sales $288,000
Interest income 320
Depreciation 7,100
Amortization of bond discount 60
TOTAL PROVIDED FROM OPERATIONS 295,480
Financial flows
Increase in accounts payable $ 900
Increase in accrued wages and salaries 100
Increase in income taxes payable 4,225
TOTAL PROVIDED FROM CURRENT ACCOUNTS $5,225
Sales of long-term securities $ 7,000
Issuance of capital stock 42,000
TOTAL PROVIDED FROM NONCURRENT ACCOUNTS 49,000 54,225
TOTAL SOURCES OF RESOURCES $394,705


Uses

Nonfinancial flows
Cost of goods sold $194,000
Operating expenses 51,010
Interest expense 2,460









TABLE 4, continued:



Uses, continued:

Nonfinancial flows, continued:
Federal income taxes 20,425
Dividends 7,350
TOTAL USED IN OPERATIONS AND DIVIDENDS $275,245
Increase in inventories $5,000
Increase in office supplies 100
Increase in unexpired insurance 210
TOTAL USED IN OPERATION AND DIVIDENDS $5,310
Acquisition of plant and equipment 15,300 $ 20,610
TOTAL $295,855

Financial flows
Increase in cash $ 8,090
Increase in marketable securities 2,000
Increase in accounts receivable (net) 17,500
Increase in notes receivable 2,000
Increase in accrued interest receivable 40
Decrease in property taxes payable 20
TOTAL USED IN CURRENT ACCOUNTS $29,650
Acquisition of long-term securities $11,000
Addition to sinking fund 3,000
Decrease in long-term notes payable 6,000
Acquisition of treasury stock 4,200
TOTAL USED IN NONCURRENT ACCOUNTS 24,200 53,850


TOTAL USES OF RESOURCES


$349,705











TABLE 5
THE SCFP CORPORATION, STATEMENT OF FLOW OF RESOURCES, YEAR ENDING DECEMBER 31, 1973




Operating Transactions and Dividends--Nonfinancial Flows
Sources
Net sales $288,000
Interest income 320
Depreciation 7,100
Amortization of bond discount 60
TOTAL SOURCES $295,480
Uses
Cost of goods sold $194,000
Operating expense 51,010
Interest expense 2,460
Federal income taxes 20,425
Dividends 7,350
TOTAL USES 275,245
NET SAVING $ 20,235

Changes in Balance-Sheet Accounts
Nonfinancial flows--uses
Increase in inventories $ 5,000
Increase in office supplies 100
Increase in unexpired insurance 210
Acquisition of plant and equipment 15,300
TOTAL USES $20,610









TABLE 5, continued:



Changes in Balance-Sheet Accounts, continued:
Financial flows--sources
Increase in accounts payable $ 900
Increase in accrued wages and salaries 100
Increase in income taxes payable 4,225
Total provided from noncurrent accounts $5,225
Sales of long-term securities $ 7,000
Issuance of capital stock 42,000
Total provided from noncurrent accounts 49,000
TOTAL SOURCES $54,225

Financial flows--uses
Increase in cash 8,090
Increase in marketable securities 2,000
Increase in accounts receivable (net) 17,500
Increase in notes receivable 2,000
Increase in accrued interest receivable 40
Decrease in property taxes payable 20
Total used in current accounts $29,650
Acquisition of long-term securities $11,000
Addition to sinking fund 3,000
Decrease in long-term notes payable 6,000
Acquisition of treasury stock 4,200
Total use in noncurrent accounts $24,2Q0 53,850
NET FINANCIAL FLOWS 375a
NET INVESTMENT $20,235


aDeduction.











TABLE 6
THE SCFP CORPORATION, STATEfENT OF FLOW OF RESOURCES, YEAR ENDING DECEMBER 31, 1973




Nonfinancial Flows--Operating and Dividend Transactions
Sources
Net sales $288,000
Interest income 320
Depreciation 7,100
Amortization of bond discount 60
TOTAL SOURCES $295,480

Uses
Cost of goods sold $194,000
Operating expenses 51,010
Interest expense 2,460
Federal income taxes 20,425
Dividends 7,350 275,245
Savings provided from operations 20,235

Financial Flows
Sources
Increase in accounts payable $ 900
Increase in accrued wages and salaries 100
Increase in income taxes payable 4,225
Total provided from current accounts $5,225
Sales of long-term securities $ 7,000
Issuance of capital stock 42,000
Total provided from noncurrent accounts 49,000
TOTAL SOURCES $54,225









TABLE 6, continued:


Financial Flows, continued:
Uses
Increase in cash $ 8,090
Increase in marketable securities 2,000
Increase in accounts receivable 17,500
Increase in notes receivable 2,000
Increase in accrued interest receivable 40
Decrease in property taxes payable 20
Total used in current accounts $29,650
Acquisition of long-term securities $11,000
Addition to sinking fund 3,000
Decrease in long-term notes payable 6,000
Acquisition of treasury stock 4,200
Total used in noncurrent accounts $24,200 $53,850
Net financial sources $ 375
Total available for capital formation $20,610
Less portion retained in current assets nonfinanciall)
Increase in inventories 5,000
Increase in office supplies 100
Increase in unexpired insurance 210 5,310
Capital formation $15,300
Purchase of land $12,000
Purchase of furniture and fixtures 3,300











TABLE 7
THE SCFP CORPORATION, QUICK-ASSET FLOW STATEMENT, YEAR ENDING DECEMBER 31, 1973




Routine Operations
Inflows
Net sales $288,000
Interest income accrued 100 $288,100
Outflows
Purchases 199,000
Interest cost accrued 2,400
Income taxes for the year 20,425
Routine purchases of supplies and services 44,000 265,825
NET RECURRING QUICK-ASSET FLOW $22,275
Dividends paid 7,350
NET RECURRING QUICK ASSET FLOW RETAINED $14,925

Financing Transactions
Investment by owners and creditors
Long-term investment by owners (net) $37,800
Retirement of long-term debt and sinking-fund deposit 9,000 28,800
Uses
Net purchases of long-term securities 4,000
Purchases of plant and equipment and land 15,300 (19,300)
NET CHANGE IN QUICK ASSETS $24,425
NET QUICK-ASSET BALANCE JANUARY 1, 1973 9,100
NET QUICK-ASSET BALANCE DECEMBER 31, 1973 $33,525









The Issue Still Unresolved


As previously mentioned, Littleton (1953) expressed

doubt that an application of funds statement, due to its com-

plex organization, would fully satisfy the need of users for a

report on finances as well as operations. Yu (1969) called

for further thought toward the development of an understandable

funds statement. Now, in 1974, after two opinions by the Ameri-

can Institute of Certified Public Accountants' Accounting Prin-

ciples Board, the results of the attack in the late 1910s and

1920s on the concept "funds" is still indeterminable. There are

authors who today call for a limiting of the funds concept, as

well as demanding a widening of the concept employed.

An analysis of the manner in which corporations and the

accounting profession are complying with the requirements of

Opinion No. 19 (American Institute of Certified Public Accoun-

tants, 1971) indicates that the terminology and format selected

does not "fully answer the need" for an understandable funds

statement (Giese and Klammer, 1974). In a random sample of 10

percent of the 1971 "Fortune 500," Giese and Klammer found that

42 percent of the fifty firms used the term "funds" provided.

As discussed previously, this term has been used to mean every-

thing from literal cash, net quick assets, and working capital

to total resources. "Working capital provided" and "working

capital used" captions were utilized by 36 percent of the firms.

Only 10 percent of the firms used the recommended terminology--









"resources applied" and "resources used." Fifty percent of

their sample "did not clearly label items not currently requir-

ing working capital or cash as such" (1974, p. 57).

Giese and Klammer then proceeded to call for the cash

approach to the statement of changes in financial position using

the flow-through technique. They called for the cash approach

because cash was said to represent the only discretionary re-

source available to management. They stated that the alterna-

tive, working capital, was not an available liquid pool of re-

sources and therefore provided less information. The flow-

through technique, as set out for working capital in Table 9 and

as they recommended for cash in Table 12, with an accompanying

schedule in Table 11, was said to segregate the separate but

related inflows and outflows from operations.

Giese and Klammer recognized that the presentation for-

mat is critical for informative disclosure. They found that all

of the fifty firms in their sample used the add-back technique,

whether working-capital basis or cash basis, for items not re-

quiring current use of working capital or cash. They observed

that although the usual argument for the add-back technique is

simplicity, the typical statement in their survey had three or

four add-back items. Add-back items included depreciation, de-

pletion, amortization, deferred income taxes, equity in earnings

of unconsolidated subsidiaries, installment accounts due after

one year, losses on discontinued operations, and minority in-

terest. They presented a statement, Table 8, and asked how the









investor could be expected to understand why undistributed net

earnings of unconsolidated subsidiaries are subtracted from

operations or why the item "deferred income taxes" is an addi-

tion to "from operations" (1974, p. 58).

Of the five firms in the Giese and Klammer survey

which indicated they accounted for a change in cash, none computed

cash provided by operations as required in Opinion No. 19 (Ameri-

can Institute of Certified Public Accountants, 1971). The typi-

cal presentation used is shown in Table 10. Note that changes in

inventories, accounts receivable, and accounts payable are treat-

ed as nonoperational. Giese and Klammer indicated that this

type of statement "is a throwback to the discredited idea that

net income plus depreciation equals cash flow. . Operational

activities do include changes in current operational assets such

as accounts receivable and inventories" (1974, p. 60).

If the data in Tables 1 through 3 were structured in

the format suggested by Giese and Klammer, we would have a cash-

basis statement as allowed in Opinion No. 19. The only dif-

ference would be that financing and investing activities not

affecting cash would become part of resources applied and re-

sources provided in the Giese and Klammer statement. What can

be said of the Giese and Klammer recommendations? Some recom-

mendations for consideration of the clarity of the add-back and

flow-through formats are well received. The notion that in the

present environment the working-capital basis prepared using the

add-back technique creates confusion and errors in interpretation











TABLE 8
WORKING CAPITAL PROVIDED BY OPERATIONSa


1972 1973

Operations
Net income $18,990 $11,905

Add (Deduct)
Items not involving use of working capital:
Equity in earnings of related companies (2,255) (3,803)
Depreciation 10,225 8,921
Deferred income taxes 1,040 2,892

Working Capital
Provided by operations: $28,000 $19,915


alllustration of add-back format, working-capital approach.











TABLE 9
WORKING CAPITAL PROVIDED BY OPERATIONSa


Operations

Revenues
Less revenues not resulting in increase
in working capital
Equity in earnings of unconsolidated
companies (net of dividends)
Working-capital inflow from operations

Expenses
Less expenses not requiring current
outflow, working capital
Depreciation
Deferred income taxes

WORKING-CAPITAL OUTFLOW FROM OPERATIONS
WORKING CAPITAL PROVIDED BY OPERATIONS



alllustration of flow-through format.

SOURCE: Giese and Klammer, 1974, p. 59.


1972


1973


$769,314


$703,560


3,255


$766,059


$750,324



10,225
1,040


739,059
$ 27,000


3,803


$699,757


$691,655


8,921
2,892


679,842
$ 19,915











TABLE 10
CONSOLIDATED STATEMENTS OF CHANGES IN FINANCIAL POSITION, YEARS ENDING DECEMBER 31, 1972 AND 1971



1972 1971

Sources of Funds
From operations
Net earnings $34,806 $25,665
Adjustments for noncash items
Equity in undistributed net earnings (8,336) (4,013)
of 50%-owned foreign affiliates
Minority shareholders' equity in net earnings 1,282 1,317
Depreciation 16,859 14,242
Provision for possible losses on receivables 600 600
FUNDS PROVIDED FROM OPERATIONS 45,211 37,811

Borrowings
Notes payable to banks, due 1982 12,000
Notes payable to banks, short term 6,368
Long-term secured 1,171 591
Common stock sold under stock-option plans 1,292 1,072
Reduction in notes and accounts receivable 2,585 17,444
Increase in accounts payable, accrued expenses, 11,560 13,729
and income taxes, etc.

TOTAL SOURCES $80,187 $70,647








TABLE 10, continued:


1972 1971

Disposition of Funds
Reduction of debt
Fifty-three 4% notes payable to banks $16,555 $14,170
and insurance companies
Revolving credit 2,000 20,000
Debentures 4,200 2,188
Other 1,526 3,464
TOTAL REDUCTION OF DEBT $24,281 $39,822

Purchase of treasury stock 11,627
Cash dividends paid 3,009 2,251
Additions to plant and equipment, less
sales, retirements, etc., of $3,354,000 28,357 23,147
in 1972 and $7,083,000 in 1971
Increase in inventories 15,391 10,657
Increase (decrease) in other assets (15) 4,190
TOTAL $82,650 $80,067

Reduction in funds for the year (2,463) (9,420)
CASH AND MARKETABLE SECURITIES, BEGINNING OF YEAR 22,505 31,925

CASH AND MARKETABLE SECURITIES, END OF YEAR $20,042 $22,505











TABLE 11
ILLO COMPANY, ANALYSIS OF CASH FLOW FROM OPERATIONS, YEAR ENDING DECEMBER 31, 1972




Analysis of Revenue Flows
Revenue as reported on income statement $4,600,000
Less increase in accounts and notes
receivable that have no effect on 54,000
cash inflow
Net cash inflow from operations $4,546,000

Analysis of Expense Flows
Expenses as reported on income statement 4,530,000
Plus increase in inventory which 17,000
caused an increase in cash outflow
Less changes in items that have no
effect on cash outflow
Amortization of intangibles 10,000
Depreciation 52,000
Decrease in prepaid expenses 6,000
Increase in accounts payable 19,000
Increase in income tax 2,000
Increase in accrued liabilities 4,000
Increase in deferred income taxes 5,000
Net changes not requiring cash outflow 98,000

NET CASH OUTFLOW FROM OPERATIONS 4,449,000
NET CASH FLOW FROM OPERATIONS $ 97,000



aSchedule 1.











TABLE 12
ILLO COMPANY, STATEMENT OF CHANGES IN FINANCIAL POSITION, YEAR ENDING DECEMBER 31, 1972




Resources Provided
Cash from operations (Schedule 1) $ 97,000
Extraordinary gain from income statement $2,000
Book value of plant 6,000 8,000
Sale of investments 38,000
Increase in short-term notes payable 47,000
Increase in current portion of long-term debt 2,000
Increase in long-term debt 16,000
TOTAL RESOURCES PROVIDED $208,000


Resources Applied
Short-term investments $ 30,000
Plant and equipment investment 104,000
Payment of long-term debt 20,000
Treasury stock acquired 5,000
Dividends paid 40,000
Increase in cash 9,000
TOTAL RESOURCES APPLIED $208,000









which are resolved by the flow-through approach prepared on a

cash basis may require some deliberation. Their statement that

cash is the only single homogeneous resource completely dis-

cretionary to management requires some thought as to its

meaning. It is recognized that all resources are discretionary

over some period of time. Although it is accepted that changes

in current assets and current liabilities are related to operat-

ing, financial, and investing activities, a question presents

itself. Should current assets and current liabilities be con-

sidered operating flows or should they be set apart from operat-

ing activities? It appears that some current assets and current

liabilities are financial flows--just as it appears that inven-

tory changes are nonfinancial flows and part of the operating

cycle. Should all net uses (as determined from an analysis of

balance-sheet changes in Table 5) be considered investment? Or,

should some of these uses (increases in inventories) be con-

sidered operational? One might ask the following question: Is

the increase in inventories appropriate manageriallyy respon-

sible) only as a growth development of the company? If this

observation is correct, then an increase in inventories is new

investment (hoped to be permanent--that is, in maximization of

financial strength, the owners hope the company continues to

grow--does not shrink). If the increase in inventories is new

investment, then is this increase capital formation? When re-

sources available for capital formation are determined, should

the resources retained in current assets nonfinanciall) be









deducted as in Table 6. Is there an inconsistency in the state-

ment in Table 5 and the one in Table 6? What is the difference

in net investment and capital formation? Which statement pro-

vides the most information to the general user? It appears

that Giese and Klammer fail to distinguish between financial

and nonfinancial flows. Their statement does not fill the gap

between the position statement and the operating statement.

When their statement is read, confusion still exists as to the

resources provided from operations and the resources provided

from financial activities. Financial flows and nonfinancial

flows are not segregated in their statement. The investment

increase (decrease) and capital formation provided from opera-

tions is not distinguished from that provided from financial

activities.

In contrast to the more limiting concept of Giese and

Klammer, Buzby and Falk presented an expanded funds statement

(1974), calling for an integration of the cash and working-

capital definition of funds with the concept of changes in fi-

nancial position. Buzby and Falk's expanded funds statement

follows from Figure 2 presented below. Their expansion was

said to be based on "expressed needs of users for both a cash

flow and a change in working-capital analysis, as well as the

disclosure of other significant investing and financing trans-

actions" (1974, p. 57). It should be noted that their concept

is no different than those discussed earlier, but a presenta-

tion of three statements in one.











Transaction





Noncash





Affects Does Not
Working Affect
Capital Working Capital





Changes in
Financial
Position


Figure 2. Classifications of Transactions.









Summary


The first part of this chapter was concerned with an

acknowledgement of the importance of and the need for an under-

standable funds statement. This need has been recognized ever

since the late 1890s. Debate as to the inappropriateness of

the use of the term "funds!' dates from the writings of H. A.

Finney in 1925. A. C. Littleton (1953) pointed out that an

understandable application of funds statement was doubtful due

to its complex organization. Until around 1955, a general lack

of interest in the funds statement was noted. It was not until

after the American Institute of Certified Public Accountants'

Opinion No. 3 (1963) that one could begin to see significant

evidence of concern with the funds statement in'annual reports

of public companies. Increased concern with the term "funds"

and increased discussion of the need for a statement to fill the

gap between the balance sheet and the income statement culminated

with the American Institute of Certified Public Accountants'

Opinion No. 19 issued in 1971.

In that opinion the Institute recommended a broadened

concept of the funds statement. Instead of "funds," the term

"resources" was indicated as the desirable term. The Institute

stated that the objective of the statement is to report on all

of the financing and investing activities of the enterprise.

The report is to deal with the generation and application of

resources on either a working-capital or cash basis. The causes









of all changes in financial position during the period is to be

reported. The Institute further recommended that the title of

the statement be changed to "Statement of Changes in Financial

Position."

The statement of changes in financial position was found

to allow much latitude between minimum reporting and maximum re-

porting, cash or working-capital basis. Several authors felt

that there is an overemphasis on liquidity in the development

of the statement. Others felt that the resources concepts em-

ployed (cash and working capital) are not sufficiently broad to

describe fully the changes in financial position during the

accounting period. Some authors have even suggested multiple

statements. It appears that we do not yet have a statement

which answers the call for a statement reporting on total re-

source flows, financial as well as operating.













CHAPTER III

SYSTEMS AND FINANCIAL ACCOUNTING THEORY,
A FRAME OF REFERENCE



The purpose of this chapter is to provide a frame of

reference for development of the resource flow matrix. The

accounting information system is recognized as the principal

communication system producing the basis for decisions con-

cerning the flow of resources to and from the economic enter-

prise. It is therefore proposed that a study of the meaning

of "accounting," "information," and "system," and the role of

the accounting information system in the entity, will provide

the needed frame of reference. To state that accounting is

viewed as an information system appears to indicate that the

appropriate methodological framework for the study of account-

ing may be general systems theory. Therefore, after discussing

the accounting information system and its role in the entity,

the meaning of "general systems theory" as a methodological

approach will be considered. In the last section of the chap-

ter, the relationship of the model and theory adopted to the

processes of theory development and verification will be ex-

panded.









The Meaning of System


A well-recognized concept when considering the term

"system" is the idea of the whole which is made up of inter-

acting parts. Four of the most noted definitions of the term

"system" are the following:


A system is (1) something consisting of a set
(finite or infinite) of entities, (2) among
which a set of relations is specified so that
(3) deductions are possible from some rela-
tions to others or from the relations among
the entities to the behavior or the history
of the system. (Rapoport, n.d., p. 452)


A system is a complex of elements or compo-
nents directly or indirectly related in a
causal network such that at least some of
the components are related to some others
in a more or less stable way at some time.
(Buckley, 1968a, p. 493)


There are two essential characteristics of
systems, including (1) a set of elements
. [and] the relationships between and
among the elements and (2) the notion of
movement in unison in obedience to some
form of control. A system is defined as
some ongoing process of a set of elements,
each of which.are functionally and opera-
tionally united in the achievement of an
objective. (Optner, 1968)


A system is an assembly of procedures, pro-
cesses, methods, routines, or techniques
united by some form of regulated interaction
to form an organized whole.
(United States American Standards Institute)


The above definitions indicate that an information

system may be regarded as a related set of events, the aggre-









gate information potential these possess, and the means of

acquiring, storing, transforming, transmitting, controlling,

or otherwise processing such information. All of these pro-

cesses are related to, but distinct from, the external en-

vironment of the system.




The Meaning of "Information"


It is frequently stated that "information is the

negative of uncertainty" (Miller, 1965, p. 194; Pask, 1969,

p. 26; Shannon and Weaver, 1949, p. 7). However, this defi-

nition is quite unsatisfactory in describing what information

is. Consider the following historical antecedent of the

general term "information":


The Latin word informare, from which is
derived the word "information," signifies
to "put in form," to give a form or an as-
pect, to form, to create, but also to repre-
sent, present, create an idea or emotion.
It is possible to understand information in
general as whatever is put in form or in
order. Information signifies the placing
of several elements or parties, either ma-
terial or nonmaterial, into some form, in-
to some classed system that represents
classification of something. Under this
general form, information is also the class-
ification of symbols and of their relations
in a nexus like the "organization of the
organs and of the functions of a living
being or the organization of any social sys-
tem or any other community in general." In-
formation expresses the organization of a
system which is capable of mathematical de-
scription. It does not concern itself with the
matter of that system, but with the form which









can be the same for very different kinds of
matter (black marks of characters on paper,
neurons in the brain, ants in an ant nest,
etc.).
If mass is the measure of the effects of
gravitation and of the force inertia and
energy the measure of movement, "information
is, in the quantitative sense, the measure of
the organization of the material object."
It is evident that with the characteristics
of organization is linked not only the matter
but also its characteristics relative to
space, time, and movement. Matter, space,
time, movement, and organization are in mu-
tual connection. (Zeaman, 1962, p. 20)


It may therefore be said that information is something

in "form." The form of something is the essence of its being

and its reality. It is the means by which all systems relate

to their movement. The above is a point articulated by Wiener

after he considered the nature of information from the human

body down to the cell.


One thing at any rate is clear. The physi-
cal identity of an individual does not consist
in the matter of which it is made. Modern
methods of tagging the elements participating
in metabolism have shown a much higher turn-
over than was long thought possible, not only
of the body as a whole, but of each and every
component part of it. The "biological indi-
viduality of an organism seems to lie in a cer-
tain continuity of process and in the memory
by the organism of the effects of its past de-
velopment." This appears to hold also for its
mental development. In terms of the computing
machine, the individuality of the mind lies in
the retention of the earlier "taggings" and
memories, and in its continued development
along lines laid out. .
. the individuality of the body is that
of a flame rather than that of a stone, of a
"form" rather than a bit of "substances."
(Wiener, 1954, p. 99)









In a more familiar context to accountants, consider the

nature of information and information systems in distinguishing

between data and information. Gregory and Van Horn define

"data" as


. any facts that are a matter of direct ob-
servation. As used in business-data processing,
"data" means collections of signs or characters
generally arranged in some orderly way to make
up facts and figures. (1960, p. 335)


Information implies usefulness. Levin distinguishes be-

tween "data" and "information" as follows:


"Data" are facts or statistics, unrelated,
uninterpreted, and probably unused.
"Information" is knowledge derived from
the organization and analysis of data. In-
formation is data that are useful in achiev-
ing the objectives of the business.
(1956, p. 122)


An information system therefore has as its function

the transformation of data into information. In order to be

termed "information," the end product of the transformation

process must possess form and purpose.



The Meaning of "Accounting"


The following definition of "accounting" was given by

the American Institute of Certified Public Accountants in 1953:


Accounting is the art of recording, classi-
fying, and summarizing in a significant manner
and in terms of money, transactions, and events









which are, in part at least, of a financial
character and interpreting the results thereof.
(p. 9)


The function of accounting is stated in Accounting Re-

search Study No. 1 to be


S. (1) to measure the resources held by
specific entities, (2) to reflect the claims
against and the interest in those entities,
(3) to measure the changes in those resources,
claims, and interests, (4) to assign the
changes to specifiable periods of time, and
(5) to express the foregoing in terms of
money as a common denominator.
(Moonitz, 1961, p. 23)


The American Accounting Association's 1966 Committee to

Prepare a Statement of Basic Accounting Theory defined account-

ing as


the process of identifying, measuring, and
communicating economic information to per-
mit informed judgments and decisions by
users of the information. (1966, p. 1).


The Committee stated that the objectives of accounting

are to provide information for the following purposes:


1. Making decisions concerning the use of limited
resources, including the identification of cru-
cial decision areas and determination of objec-
tives and goals.
2. Effectively directing and controlling an organi-
zation's human and material resources.
3. Maintaining and reporting on the custodianship
of resources.
4. Facilitating social functions and controls.









In Chapter 3 of Accounting Principles Board Statement

No. 4, accounting is defined in the following terms:


Accounting is a service activity. Its
function is to provide quantitative information,
primarily financial in nature, about economic
entities that is intended to be useful in
making economic decisions--in making reasoned
choices among alternative courses of action.
Accounting includes several branches, for ex-
ample, financial accounting, managerial account-
ing, and governmental accounting.
Financial accounting for business enterpri-
ses is one branch of accounting. It provides,
within limitations described below, continued
history quantified in money terms of economic
resources and obligations of a business enter-
prise and of economic activities that change
those resources and obligations.
(American Institute of Certified
Public Accountants, 1970)


Financial accounting was indicated in Accounting Prin-

ciples Board Statement No. 4 as being shaped to a significant

extent by the environment, especially by:


1. The many uses and users which it serves.
2. The overall organization of economic activity
in society.
3. The nature of economic activity in individual
business enterprise.
4. The means of measuring economic activity.
(1970, paragraphs 40, 49)


The 1971 Committee on Information Systems of the Ameri-

can Accounting Association described the accounting information

system as


that portion of the formal information system
concerned with the measurement and prediction









of income, wealth, and other economic events
of the organization and its subparts or enti-
ties. (1971)


The accounting information system therefore has as

its function the acquiring, storing, transforming, trans-

mitting, or otherwise processing the data of the economic

events of a particular entity. The environment of the

accounting information system determines the form and pur-

pose of the transformation processes.



Development of a Model of the
Accounting Information System


This section of the chapter provides the development

of a model of the accounting information system. It is neces-

sary in providing a frame of reference for development of the

resource flow matrix to delineate the general accounting in-

formation system. In order to accomplish this objective, we

must first consider the role of the total management informa-

tion system in the organization, so that the role of the

accounting information system and its relationship to the

management information system and the organization will be

more easily understood.


The Management Information System


Karl Patrick believes that a management information sys-

tem "should come as close to being all things to all men in

the business as is economically and politically justifiable"









(1968, p. 10). Bertram A. Colbert (1967) and H. S. Gellman

(1968) have presented the following as representative of the

thinking of most writers as to the necessary characteristics

of a total management information system:


1. The full effect of a decision is considered in
advance by supplying complete, accurate, and
timely data.
2. Only necessary levels of detail are reported.
The problems associated with the use of incon-
sistent and incomplete data are eliminated from
the planning and decision-making processes by
providing a means for preparing and presenting
information in a uniform manner.
3. Data are presented in a form minimizing the
need for further investigation and interpreta-
tion. Common data and methods are utilized in
the preparations of long-range and short-term
plans.
4. Significant past relationships are identified,
structured, and quantified, and future relation-
ships are forecasted through the use of advanced
mathematical techniques in analyzing data.
5. Financial and production data are merged to help
measure performance, control costs, and facili-
tate planning with minimum processing of data.
6. The needs of all corporate units are recognized
so the requirements of each are met with a
minimum of duplication while serving the corpora-
tion as a whole (the suprasystem).
7. Personnel and data are utilized effectively in
order to obtain optimum speed and accuracy at
the lowest cost.
8. Flexibility and adaptability are provided.
(Colbert, 1967, p. 16; Gellman, 1968, p. 20)


As we consider this list of the necessary characteris-

tics of a total management information system, we must ask what

the position of accounting is in the information environment of


the total management system.









Role of the Accounting Information System
in the Total Management System


The information handling process in many firms has

undergone a change in the last two decades (American Account-

ing Association, 1971, p. 293). The following list of de-

velopments which have motivated the change was presented by

the 1971 Committee on Information Systems of the American

Accounting Association:



1. The advent of the general purpose digital
computer.

2. The adaptation of the scientific method to
the solution of management problems and,
accordingly, the establishment of rules
for a variety of disciplines, some of
which were traditionally found inside and
others outside the management area.

3. The development of mathematical methods to
the solution of management problems.

4. The formalization of information systems in
the operational areas. (1971, p. 293)



The Committee stated that the accountant, due to the new posi-

tion of accounting in the information environment, is now pri-

marily a user of information. The former data-accumulation

activities of the accountant are now said to receive only

limited attention. The Committee noted that it is now much

more difficult to draw boundaries around accounting due to the

involvement of the accounting function and the accounting infor-

mation system in a rapidly changing environment. In particular,









it is difficult to distinguish the role of the accounting in-

formation system in the firm's activities. It was also ob-

served that due to these involvements and evolvements, the

systems approach to information systems was implied. The

model presented in Figure 3 was suggested by the Committee

as a functional example of the information subsystem and its

role in the total system (American Accounting Association,

1971, p. 298).

Figure 3 parallels closely the definition of an in-

formation system as a related set of events, the aggregate

information potential these possess, and the means of

acquiring, storing, transforming, transmitting, controlling,

or otherwise processing such information. Figure 3 also

illustrates that all of these processes are related to, but

distinct from, the external environment of the system.




































External Sigls
Transmission










Decision
Makers




Goals


Figure 3. A Function Model of the Information Subsystem and Its
Role in the Total System.









John W. Buckley and Kevin N. Lightner present the

following diagram of accounting as the "hub of the management

information system" (1973, p. 25):


Personnel


Administration


Inventory
Control


11


Production


SEngineering


The accounting system is pictured in this diagram as

playing a principal role in managing the flow of economic data

in and among organizations. The accounting system is charged

with tying together the other subsystems in presenting a picture

of the total entity to both managers and external users. We must

ask, therefore, if there are any differences in accounting in-

formation criteria and those of management information systems.









Accounting Information Criteria and
Criteria of Management Information Systems

William Thomas Stevens identified purposes, perimeters,

and processes as the three dimensions of the management informa-

tion system in his doctoral dissertation (1970). Stevens sur-

veyed various statements concerning models of management infor-

mation systems in deriving the following concept which he indi-

cated as approximating the current state of the art:


A management information system is an organized
method of providing each manager with all the
evidence and only that evidence which he needs
or wants for decisions, when he needs or wants
it, and in a form which aids his understanding
and stimulates his action. (1970, p. 78)


According to Stevens, the dimension of perimeters con-

stitutes the criterion that distinguishes information from non-

information. After establishing the rationale of management in

its decision-making operations, Stevens found his concept to be

consistent with both the rationale of management accounting and

statements on management information systems. The perimeters

of accounting were the four basic standards of relevance, veri-

fiability, freedom from bias, and quantifiability as presented

in A Statement of Basic Accounting Theory (American Accounting

Association, 1966). Stevens proposed that the only major dif-

ferences between accounting information criteria and those of

management information systems is the criterion of quantifia-

bility. The quantifiability criterion interpreted "in its









broadest sense" (Stevens, 1970, p. 122) was found to be a

necessary attribute of both systems and as being comprehended

by his derived concept quoted above. Processes were stated

by Stevens to be the series of actions or operations which

are directed to an end. The processes identified by him were

planning, doing, and reviewing. The review element was taken

as being primarily the communication agent linking planning

with doing. Stevens concluded that when one takes full

account of the three dimensions of the management information

system, he has a complete concept.



A management information system is a means
of communication which combines the plan-
ning, doing, and reviewing elements of
the management process into an integrated
and coherent whole. It is designed to
provide each manager, whatever his status,
with all the relevant, verifiable, quan-
tifiable, and unbiased evidence he will
use for making decisions. This informa-
tion is to be presented to him in such a
way as to stimulate behavior that will
lead to the attainment of the goals
established for the entire management pro-
cess. (1970, p. 185)



It appears that the boundaries separating the account-

ing system and the total management information system are in-

creasingly indistinct. However, if the accounting information

system has concepts problems, and characteristics which are

distinguishable from those of other systems, it is necessary

to delineate the boundaries of these two systems.









A Model of the Accounting Information System


In Chapter 1 of Accounting Principles Board Statement

No. 4 (American Institute of Certified Public Accountants,

1970), the Board sought to identify and organize concepts

that, for the most part, were currently accepted. In setting

out the characteristics of the accounting system, we will

rely on the proposals in that statement. A systems depiction

of the accounting system as described by the Board is pre-

sented in Figure 4.

The model presented in Figure 4 satisfies the defini-

tion of the accounting information system set out on page 54,

above, and the role of the accounting information system in

the total management system as discussed previously. Based

on this model, it seems that general systems theory is an

appropriate methodological framework for development of the

resource flow matrix.

The remainder of this chapter is devoted to a discus-

sion of the implications of general systems theory for theory

development and verification.

























Figure 4. The Accounting System.

















4t USER
ECONOMIC Input Transformation 1 __ Transformation 2 Output, WANTS
EVENTS Boundary Journalize Posting Boundary AND
[ NEEDS


FEEDBACK

Exception Control Comparative Interpretive
Reports


Input Boundary--qualitative objectives, i.e., usefulness criterion: relevance, understandability, verifia-
bility, neutrality, timeliness, comparability, completeness. Transformation 1, Journalize--dollars and
cents, account titles, debit and credit. Transformation 2, Posting--sorting, aggregation. Output Bound-
ary-accounting entity, going concern, measurement of economic resources and obligations, time periods,
measurement in terms of money, accrual, exchange price, approximation, judgment, general-purpose financial
statement, fundamentally related financial statement, substance over form, materiality.


GENERAL OBJECTIVES
Goal of system. To present reliable financial information about enterprise resources and
obligations, economic progress, and other changes in resources and obligations. To pre-
sent information helpful in estimating earnings potential and to present other financial
information needed by users, particularly owners and creditors. 0









Motives and Developments Leading to
General Systems Theory


In considering the term "system," a query comes to mind

as to how this idea came to stimulate the quest for a general

systems theory. Ludwig Von Bertalanffy identified several mo-

tives which lead to the postulation of a general systems theory

(1968, 91 ff.). It was Von Bertalanffy's position that, until

recently, the field of science as a nomothetic endeavor was

practically identical with theoretical physics. The consequence

was the postulate of reductionism. As it turned out, the enti-

ties of concern to physics--atoms, elementary particles, and the

like--are much more ambiguous than originally thought. Rather

than metaphysical building blocks of the universe, Von Ber-

talanffy points out, the entities of concern to physics are com-

plicated conceptual models which were invented to take account

of certain phenomena of observation. Also, due to the maturing

of the biological, behavioral, and social sciences, and to new

technologies, a generalization of scientific concepts and models

which are beyond the traditional system of physics has become

necessary. The new conceptual models are described by Von Ber-

talanffy as transcending the conventional departments of science.

These expanded constructs are seen as being applicable to phenom-

ena in various fields.

Von Bertalanffy enumerated the following seven develop-

ments intended to meet the needs of a general theory of systems:









1. Cybernetics, based upon the principle of feedback
or circular causal trains providing mechanisms
for goal-seeking and self-controlling behavior.
2. Information theory, introducing the concept of
information as a quantity measurable by an ex-
pression isomorphic to negative entropy in
physics, and developing the principles of its
transmission.
3. Game-theory analyzing, in a novel mathematical
framework, rational competition between two or
more antagonists for maximum gain and minimum
loss.
4. Decision theory, similarly analyzing rational
choices, within human organizations, based upon
examination of a given situation and its possible
outcomes.
5. Topology, or relational mathematics, including
nonmetrical fields such as network and graph
theory.
6. Factor analysis, i.e., isolation, by way of
mathematical analysis, of factors in multi-
variable phenomena in psychology and other fields.
7. General systems theory in the narrower sense
(G.S.T.), trying to derive, from a general defi-
nition of "system" as a complex of interacting
components, concepts characteristic of organized
wholes such as interaction, sum, mechanization,
centralization, competition, finality, etc., and
to apply them to concrete phenomena.
(1968, p. 90)



The Systems Approach


It was Von Bertalanffy's position that as problems become

more complex and as the solutions to these problems involve hetero-

geneous disciplines, the "systems approach" becomes necessary. C.

West Churchman, probably one of the most recognized writers on

systems thinking, presents the following five basic considera-

tions which he feels must be remembered in putting systems think-


ing to use:










1. The total system objectives and, more specifically,
the performance measures of the whole system.
2. The system's environment--the fixed constraints.
3. The resources of the system.
4. The components of the system, their activities,
goals, and measures of performance.
5. The management of the system.
(Churchman, 1968)


Based on Churchman's considerations and the work of Jo-

seph E. McGrath, Peter G. Nordlie, and W. S. Vaughan, Jr. (Optner,

1973, pp. 73-86), as well as many other writers on the topic of

systems research, it may be stated that any systems research prob-

lem has at least three aspects.


1. The system itself must be defined as well as its
parts.
2. The performance of the system in relation to its
purposes or objectives must be assessed.
3. The system's environment--the medium in which it
is embedded and in which it operates--must be un-
derstood.


The four basic stages of a research problem may be viewed as:


1. Delineation of system performance requirements.
2. Derivation of relevant variables leading to opti-
mal performance.
3. Development and integration of the system.
4. Evaluation of system performance in terms of
the requirements.


The collection of information in systems research there-

fore involves two aspects. First, knowledge must be gathered or

generated about the variables relevant to the problem and the









range of variation of those variables. Second, knowledge must

be gathered or generated about the covariation of two or more

variables and the restrictions which are set on the combinations

of values of relevant variables that can actually occur as the

system operates.

Churchman's five considerations, in conjunction with the

stages of a research problem and the collection of information

in systems research enumerated above, lead to the following

detail of the systems approach to solution of a given problem.


1. A statement of the problem.
2. An assessment of the relevance of the problem.
3. A defining of the aims, constraints, and per-
formance criteria of the solution to the problem.
4. Determination of the structure of the existing
system.
5. Determination of the defective elements in the
existing system which hinder the attainment of
an assigned objective.
6. Assessment of the relative importance of the out-
puts of the system as determined by the criteria.
7. Determination of the structure necessary for a
choice of alternatives.
8. Determination of the solution-finding process.
9. Selection of alternatives with a view to solution
finding.
10. Construction of a model to choose among alterna-
tives. '
11. Realization of the solution.
12. Evaluation of the consistency of the solution with
original objectives and constraints.
13. Evaluation of the results stemming from the reali-
zation of the solution.


The systems approach to problem solution, as enumerated









above, is the approach to be followed in this study. All but

Steps 8 through 13 will have been substantially completed by

the end of the present chapter. Steps 8, 9, and 10 will have

been completed by the end of Chapter IV. The concern of the

remainder of the study will be Steps 11 through 13.



The Systems Approach--Not Unchallenged


We must recognize that the use of systems theory in a

research endeavor is not without controversy. Systems theory

dates from about 1940. In that year Howard Aiken proved that

chains of cause and effect, with each effect becoming the next

cause, could be extended to an unlimited length. The harnessing

of feedback in the 1930s allowed for the controlling and under-

standing of unlimited regenerative cause-and-effect actions.

The subsequent development of information theory provided a

technique by which large numbers of causes and effects could

be counted. Systems analysis was the subject of heated discus-

sions in the early 1950s. Mixed opinions were expressed, and

still are, as to the efficacy of systems analysis in its problem-

solving role. The ability to evaluate alternatives in a consis-

tent, unarbitrary manner emerged as a principal objective of

systems analysis. Criteria selection received increased em-

phasis due to writings of the 1950s and early 1960s. In the

mid-1950s the use of systems concepts in research became more

articulated. At that time, classification, definition, and









other organizational attempts to bring the systems approach into

research were well under way (Laszlo, 1972a).

The study of interacting parts may, of course be traced

back as far as Newton. Kant pointed out that in organic bodies,

the whole, although built up of parts, seems to determine the

relations of the parts to one another and to itself. In con-

scious, purposive activity, Kant observed, the end brought to

pass by certain means also determines the means employed to

accomplish it. Hegel, in observing cause and effect, asked if

any way may be found both of avoiding the difficulties of "in-

finite regress" and "infinite progress" and of synthesizing effi-

cient and final causation on a concept that would embrace and

harmonize them both (Laszlo, 1972a).

Some qualifications as to the newness of the idea of a

great synthesis to provide for the unity of science must also be

recognized. Commenting on the hierarchy of synthesis, Hegel

observed that the "skeleton" of the hierarchy is constructed

of a series of superimposed ascending triads in which seemingly

antagonistic concepts revealed in experience by the "understand-

ing" are reconciled and combined. These syntheses were said to

be derived from one another by logical implication and from a

logical hierarchy, culminating in the "all-embracing, all-

reconciling absolute idea" (Laszlo, 1972a). The attempt of the

logical positivist to provide the means for a unity of all

knowledge was not without extensive criticism. Many philoso-

phers, for instance Bertrand Russell, have said that if we go all








the way, we will be dealing with total knowledge. To deal with

total knowledge, these writers have said, is humanly impossible.

It is recognized that general systems theory is not the

only approach to the building of a sound empirical theory. It

was chosen because the accounting information system, as defined

in the preceding pages, is a system and therefore should lend

itself to systems analysis



Systems Theory Properties


With the above caveats in mind, it is necessary in pro-

viding the frame of reference for the remainder of this study

to discuss the properties of a general theory of systems.

Ervin Laszlo (1972a) explicit mapped four systems prop-

erties which he ascertained as being applicable throughout the

range of phenomena of organized complexity. In Introduction to

Systems Philosophy: Toward a New Paradigm of Contemporary

Thought (1972a), he presented the case for a systematic and con-

structive inquiry into natural phenomena on the assumption of

"general order in nature." This assumption, which he clearly

labeled as an assumption, was said to follow from the following

presuppositions: (1) The world exists and (2) The world is, at

least in some respects, intelligibly ordered (open to rational

inquiry).

According to Laszlo, if we assume that reality is merely

mapped by models and not determined by them, then the models pro-









vide properties of the common underlying core of events. The

task of general systems theory is to uncover that core. Since

a direct communion cannot be experienced with objective reality,

the objectives of general systems theory can only be accomplished

through the existing models. However, more than analysis of

existing models is required. Analysis requires supplementing by

synthesis. Laszlo saw the task as being the evolving of the

conceptual categories within which the findings of the special

sciences would gain new significance by yielding general laws

and principles of organization. He set about the task by con-

ceiving of the units of scientific investigation as systems with

certain invariant properties.

The invariant properties Laszlo spoke of were said to

serve to define the behavior of the systems in their environments.

It was his position that natural systems are characterized by the

measurable nonrandom regularity of the coactions of their com-

ponents. These conceptually discovered invariances are differen-

tial equations stating functional relationships between variables.

Intrasystematic and intersystematic hierarchies determine the

particular transformations of this invariance. Each subsystem,

sub-subsystem, and so forth, is indicated by Laszlo's hypothesis

to be capable of conceptualization. Such conceptualization

yields a system manifesting the postulated invariances. The

postulated invariances exist in the coaction of the system's

parts as well as in its total system coaction with systems in

their surroundings. Mapping invariances by means of "creatively









postulated general systems constructs" overcomes the difficulties

entailed by asking "how does it work" or attempting to examine

systems from the viewpoint of the primitive parts. He said that

analysis to discover which mechanisms "make it tick" is "reduc-

tional in intent, if not necessarily in result" (1972a). He

cited the prevalent belief in the fallacy of reducing societal

phenomena to interactions between biological individuals as one

of the instances of frustration of this type of endeavor. Laszlo

observed that attempting the explanation of an organized system

from the viewpoint of primitive parts leads to simplified laws

applying to the whole.


In the face of much difficulties in interrelating
the constraints arising in organized wholes with
the degrees of freedom permitted by deterministic
laws for the parts, the present approach seeks
invariant system properties as a set of constant
and universal constraints. Rather than denying
that such constraints exist in addition to the
known law of physics or looking at them as irre-
ducible emergent laws of organized entities at
their own level of organization, we assume that
they are formative constants of nature--properties
of all "natural systems." These . are not
observable below a given level of organization,
i.e., they are "system properties" or "laws of
organization" . so the laws defining the
constraints at higher levels of organization do
not simply emerge when that level has been
reached, but should be assumed to be present
all along, though not in observable or measurable
capacity. (1972a, p. 33)


Laszlo is concerning himself, as a philosopher, with in-

variant properties of natural systems. He says that these in-

variant properties are universal constraints which become effect-









ively observable at particular levels of organization. The

invariant properties are "thereafter manifest in diverse trans-

formations corresponding to the various levels of the micro-

hierarchy" (1972a). His task, therefore, was to postulate the

commonality underlying the manifest behavior of organized enti-

ties as a set of invariant properties of natural systems. These

invariant properties are seen to be "general laws of natural or-

ganization cutting across disciplinary boundaries and applying

to organized entities in the microhierarchy at each of its many

levels" (1972a).

The theory explored by Laszlo was as follows:


R = F(a,e,y,6),


where a, 0, y, and 6 are independent variables having the joint

function R ("natural system"). The independent variable a was

termed the "systematic state property." The variables 6 and y

represented "System-Cybernetics I and II," respectively. The last

of Laszlo's postulated invariances, 6, represented the holon

property. We will consider the systematic state property first.


Systematic State Property--R = F(a)

This first postulate concerns the calculation of the com-

plexes of elements composing a system. It was stated by Laszlo

as follows:


An "ordered whole" is a nonsummative system in
which a number of constant constraints are im-









proved by fixed forces, yielding a structure
with mathematically calculable parameters.
(1972a)


In further expansion of this property, Laszlo cites Von

Bertalanffy's discussion of three ways in which complexes of ele-

ments can be calculated.


1. Complexes of elements can be calculated according
to the number of elements,
2. According to the species of the elements,
3. And according to the relatives of the elements.
(Von Bertalanffy, 1968, Chapter 3)


The following illustration was presented by Von Bertalanffy

to clarify calculation of complexes of elements. Note that a and

b symbolize various complexes.


(1) a 0 0 0 0 b 0 0 0 0 0

(2) a 0 0 0 0 b 0 0 0 6

(3) a 0-0-0-0 b 0--0
I I
0_0


In Cases 1 and 2, one may understand the sum of elements

considered in isolation. In case 3 one must know both the ele-

ments and the relations between them. Cases 1 and 2 exhibit "sum-

mative" characteristics. Case 3 exhibits a "constitutive" com-

plex. In a summative complex, characteristics of the elements

are the same within and outside the complex. To understand a

complex whose characteristics are dependent on the specific re-

lations within the complex, one must know not only the parts,




76



but also the relations.

As an example of a nonsummative complex of interdepen-

dent elements, consider "Pareto's law" of the distribution of

income within a nation.



1= bQ2


where Q = number of individuals gaining a certain income, Q

amount of the income, and b and are constants. More generally,

a nonsummative complex of interdependent elements takes the form


dO1
d-- = F(Q1 2' 2 On)


dQ2
-d-F= F 2(QI' Q2 ... Q )


dQ
dF = n(l 2'. n)



The above system of simultaneous differential equations

specifies that a change in the measure of any Q affects all other

Q's. An equation governing a change in any one part is different

in form from the equation governing change in the whole. If it

is assumed that Equation 1 can be developed into Taylor's series,

Equation 2, and if one lets the coefficients of the variables

Q. (j i) become zero, the nonsummative complex degenerates to

Equation 3 and is now a summative complex.









dQ1
-dt- alQ1 + a12Q2 + .+ (2)



dQ
dt= aili + ailli + aillli + .. (3)



In Equation 3 a change in each element depends only upon the ele-

ment itself, that is,


dQ
1 2
dt allQ1 + 111 1



dQ2
dt a 21 2 + a2112 +



dQ
dt= nln+ anll +



Each element in the system is considered independent of

others. The variation in the total complex is the sum of the

variations of the elements. The functional behavior of the whole

in constitutive complexes is determined by the law-bound regu-

larities exhibited by the interdependent elements. Laszlo empha-

sized that the construct "ordered wholeness" is not identical with

the mystical interpretation of the principle--"a whole more than

the sum of its parts"--but is an acceptable and indeed an often-

used construct in natural, anthropological, and social scientific

literature.









System-Cybernetics I--R = F(B)

System-Cybernetics I is the second of the independent

variables in Laszlo's theory. Laszlo used the term "cybernetics"

as the study of processes interrelating systems with inputs and

outputs and "this structural, dynamic structure 'system.'" He

recognized that the foci of attention in any description inter-

relating input-output functional analysis with internal-state

descriptions become the central processes whereby the input is

channeled through the system resulting in the modification of

part or all of its existing parameters. System-Cybernetics I

refers to the study of self-stabilizing controls operating by

error-reducing negative feedback. R = F(y), which will later be

discussed as System-Cybernetics II, refers to the importance of

error (or "deviation") amplifying control processes which func-

tion by means of positive feedback.

System-Cybernetics I concerns the concept of adaptive

self-stabilization. Le Chatelier's principle, which has been

adopted in many fields, states that every system in chemical

equilibrium undergoes, upon variation of one of the factors of

the equilibrium, a transformation in such direction that, if

it had produced itself, would have led to a variation of opposite

sign to the factor under consideration (1888). This principle

is the essence of Laszlo's System-Cybernetics I. Compensation

for changing conditions in the environment is made through

coordinated changes in the system's internal variables. Ordered









wholes of interdependent parts, governed by fixed internal con-

straints and exposed to externally introduced perturbations,

conserve a relative invariance of their total complex compared

with a more variant fluctuation of their courting components.

Systems with calculable fixed forces (ordered wholes) tend to

return to stationary states following perturbations in their

environments. Systems of this kind reorganize their flows to

eliminate or buffer out the perturbations.


System-Cybernetics II--R = F(y)


In his discussion of System-Cybernetics II, Laszlo pointed

out that systems with calculable fixed forces (ordered wholes)

reorganize their fixed forces and acquire new parameters in

their stationary states when subjected to the action of a physi-

cal constant in their environment. Laszlo stated that


We start with the fact that natural systems in
general go to ordered steady states. Now
most of a natural system's states are rela-
tively unstable. So in going from any state to
one of the steady ones, the system is going
from a larger number of states to a smaller.
In this way, it is performing a selection, in
the purely objective sense that it rejects some
states by leaving them, retains some other
states by sticking to it. Thus, as every de-
terminate natural system goes to its steady
state, so does it select. (1972, p. 43)


Therefore, each new steady state is "more resistant"

to the original perturbation than the former steady state. The

notion is expressed that, given a sufficiently isolated system-

environment complex, the system will organize itself as a func-





80


tion of maximal resistance to the forces acting on it in its en-

vironment. Systems will complexity in response to inputs from

the environment. As systems evolve from the relatively simple

to the relatively more complex, one observes the merging of some

characteristics, the differentiating of other characteristics,

and the development of partially-autonomous subsystems in a

hierarchical sequence.


External ___ Internal = Adaptive
Forcing Constraints Self-Organization


However, Laszlo pointed out that adaptation is not synony-

mous with structural stability. An adapted system was stated to

be resistant to the kind of forcing which elicited the process

of self-organization; it was not stated to be more resistant to

all factors in its general environment. Laszlo further stated

that the opposite is more generally the case, yielding a more

improbable and, therefore, unstable system due to the increased

complexity of structure. The system's intrinsically unstable

structure is balanced by a wider range of self-stabilizatory func-

tions. One may conceptualize the development of systems in an

environment in which forces are constantly operative as alternat-

ing stabilization around the parameters of existing fixed forces

with reorganization of the fixed forces as a function of in-

creasing resistance to perturbation forces in the environment.

When it becomes difficult to understand the detached mechanism

whereby a change was induced in a particular system considered









in isolation, it may be necessary to consider the next higher

suprasystem.


Holon Property--R = F(6)

The last property presented by Laszlo concerned the ver-

tical ordering of natural phenomena. It was stated in this postu-

late that from the viewpoint of a system of level n, there is an

"intrasystematic hierarchy" of its structure-function constitu-

tion. This intrasystematic hierarchy is made up of the hierarchi-

cally-ordered series ((a c b) c c) c n. The system of level n

is also part of an "intersystematic hierarchy." The intersystema-

tic hierarchy consists of the structure-functional wholes con-

stituted by the systems environmental coordinations with other'

systems such that ((n c x) c y) c z.

The four systems properties identified above serve to

define the nature of all systems. The consideration at this

point is the implication of the adopted concept of the account-

ing information system and its role in the organization for

theory development and verification from a systems point of view.



Implications for Theory Construction and Verification


An acquaintance with decision theory, measurement theory,

and communication theory is necessary for information evaluation.

The basic objective of the information system is that of pro-

viding the necessary input for the user's decision mode. The

objective of a decision is to solve a problem--to evaluate alter-









natives in attempting to select the best alternative. Evalua-

tion involves comparison to some standard and comparison among

alternatives. Comparison necessitates measurement. The outputs

of the information system (expression of measurements) are not

information to a decision maker unless he understands their

necessity and reliability. Communication is therefore the

dominating factor in structuring the information system.

Communication is the connecting and integrating link

among the systems network. According to Alfred Kuhn, the pur-

pose of communication is to influence behavior (1963, p. 18).

William C. Scott agrees with Kuhn, but further states that the

purpose of communication is to prompt actions which lead to the

effective accomplishment of goals (1962, p. 173). As stated

previously, the accounting information system is the principal

communication system furnishing the fuel for decisions regulat-

ing the flow of resources to and from business organizations.

It therefore appears that we have the basis for a deci-

sion-making approach to theory verification. The outputs of the

accounting information system must be verified through the deci-

sion models in which they are used (Sterling, 1970). Richard

Mattessich has stated that the decision-making problem aims

toward the center of the accounting discipline (1964, p. 14).

Thomas H. Williams and Charles H. Griffin observed that essen-

tially accounting practice is an analytical mechanism seeking

to expose the essence of quantified data. "It is an instrument

of decision making" (Williams and Griffin, 1964, p. 47). The









belief that the study of accounting should be related to the

nature and objectives of business decisions was expressed by

Paul E. Fertig, Donald G. Istvan, and Homer J. Mottice (1965, p.

v). Raymond J. Chambers observed that "accounting is concerned

with the provision of some of the facts on the basis of which

one may act knowledgeably given one's ends or purposes" (1966,

p. 15). Another indication of support for the decision-making

approach to verification comes from Robert H. Roy and James H.

MacNeil's Horizons for a Profession (1967, p. 12).

However, in considering the verification process, it

must be remembered that a theory of empirical science may be

divided into two parts--the formal system which is composed of

abstract symbols and syntactical rules for manipulation of those

symbols and an interpretation of the formal system which connects

certain symbols to observations by semantical rules (American

Accounting Association, 1971b, p. 57). The propositions in the

formal system are analytic. As we have indicated, these ana-

lytical properties must be reenforced by synthesis. The propo-

sitions of the interpreted theory are to be empirically tested.

As indicated by the American Accounting Association (1971b),

the semantical rules connecting the theory plane and the observa-

tion plane are themselves connected with two different kinds of

observations--inputs and outputs. To complete a theory, the

kinds of observations and the measurement rules must be specific.

These constitute the empirical input to the formal system. The

syntactical rules specify the manipulations of those inputs.








The formal system is said to be verified if the expected occu-

rences (the outputs) are observed in enough cases. Figure 5

illustrates the above (American Accounting Association, 1971b,

p. 58).

Accounting terms such as "depreciation expense," "income,"

"working capital," and so on, are analytic terms. They are cal-

culated from certain inputs and are not subject to separate mea-

surement. The American Accounting Association (1971b) also indi-

cated that it is rather the entire theory plane that is subject

to confirmation. Verification of the theory plane brings us back

to the decision-making approach to theory development. Decision

theory outputs refer to the plane of observation. The choice

among competing measurement models for use in a given decision

model must be made on the basis of the one yielding the most effi-

cient achievement of the stated goals. The decision model speci-

fies the properties to be measured. The function of accounting

is to measure those properties specified by the decision model.

The decision model therefore provides us with a definition of

relevance.













THEORY PLANE





















OBSERVATION PLANE


Syntactical
Inpu Manipulations Outputs
S(Relation of
Signs to Signs)


Figure 5. The Verification Process.









Summary


The purpose of this chapter was to provide a frame of

reference for consideration of the aims, constraints, criteria,

and structure of the dissertation as we move toward develop-

ment of the resource flow matrix. In the first section of the

chapter, the meaning of "system," "information," "accounting,"

and the role of the accounting information system in the organi-

zation was discussed.

The idea of the whole and a whole made up of interacting

parts seemed to run through the definitions of system considered.

These definitions were found to indicate that an information

system is a related set of events, the aggregate information

potential these possess, and the means of acquiring, storing,

transforming, transmitting, controlling, or otherwise processing

such information. All of these processes were found to be related

to, but distinct from, the external environment of the system.

An information system was therefore determined to have as its

function the transformation of data into information. It was

determined that in order to be termed "information," the end

product of the transformation process must possess form and

purpose. The accounting information system was found to have

as its function the acquiring, storing, transforming, trans-

mitting, or otherwise processing the data of economic events of

a particular entity. The environment of the accounting informa-

tion system was stated to determine the form and purpose of the

transformation processes.









The next section of the chapter provided for the develop-

ment of a model of the accounting information system. First, the

role of the total information system in the organization was

considered. Then, the role of the accounting information system

in the total management system was discussed. The model pre-

sented of the information subsystem and its role in the total

system were found to parallel closely the definition of an in-

formation system. The accounting system was pictured as playing

a principal role in managing the flow of economic data in and

among organizations. There were found to be no differences in

accounting information criteria and criteria of management in-

formation systems. However, it was determined that the account-

ing information system does have concepts, problems, and charac-

teristics distinguishing it from other systems. A model was

developed which satisfies the definition of the accounting in-

formation system and the role of the accounting information sys-

tem in the total management system.

Based on this model, it appeared that general systems

theory is the appropriate methodological framework for develop-

ment of the resource flow matrix. The remainder of the chapter

was therefore devoted to a discussion of the implications of

general systems theory for theory development and verification.

The motives and developments leading to a general systems theory

were then presented to place the theory in proper perspective.

Systems thinking was interpreted as suggesting the systems

approach to complex problems. The detail of systems methodology









led to the development of thirteen facets in the systems approach

to problem solution. After observing that the systems approach

to theory development is neither new nor noncontroversial, four

systems properties were identified as defining the nature of all

systems.

The four systems properties were indicated asdetermining

a theory R = F(a,8,y,6). The independent variable a was termed

the "systematic state property." The variables 8 and y repre-

sented System-Cybernetics I and II, respectively. The holon

property was represented by the variable 6. It was determined

that an ordered whole is a nonsummative system in which a number

of constant constraints are improved by fixed forces yielding a

structure with mathematically calculable parameters. System-

Cybernetics I refers to the study of self-stabilizing controls

which operate by error-reducing negative feedback. System-Cyber-

netics II refers to the importance of deviation-amplifying con-

trol processes which function by means of positive feedback.

The holon postulate concerns the vertical ordering of phenomena.

The basis for a decision-making approach to theory veri-

fication was then developed. It was stated that a theory of

empirical science may be divided into two parts. One part was

presented as the formal system which is composed of abstract

symbols and syntactical rules for manipulation of those symbols.

The other concerns the connection of those symbols to observa-

tions. The validity of the theory was stated to depend on its

effect on the decisions of the user. If it does not affect the




89



decisions of the user in the proper manner, then it is not infor-

mation and, hence, should not be a part of the output of the

accounting information system.













CHAPTER IV

THE ESSENCE OF INPUT-OUTPUT



This chapter provides the mathematical basis for relat-

ing financial and operating flows. The relationship of simul-

taneous equations to the accounting information system and sys-

tems analysis in general will be provided first. We will then

demonstrate that the solution of the Leontief input-output model

and the general form of the linear programming model is identi-

cal. (This proof will provide the basis for development of the

resource flow matrix.) A brief note of the extent of discus-

sion of utilization of input-output accounting at the enterprise

level will then be presented.



The Use of Matrices for Allocation


The utilization of simultaneous equations is common to

most reciprocal-allocation areas of accounting. Simultaneous

equations are involved because of the allocation of interacting

effects indicating the presence of a whole other than the simple

sum of its parts. An observation of a constellation of interrela-

ted variables is observation of the "systematic state property."

Functional behavior of the whole is determined by "law-bound" regu-

larities exhibited by interdependent elements. It is assumed









that the law-bound regularities refer to the interrelations

existing at a given state of equilibrium--that is, the variables

in the model are simultaneously in a state of rest. A situation

therefore exists which necessitates the tools of "static" or

"equilibrium" analysis.

In a model of static analysis, variables necessary only

to the system level (holon property) for the purpose at hand are

selected. Had the model been enlarged to include additional

variables (subsystems), a more complex model would be necessary,

and the equilibrium state applying to the smaller model would

not apply. After the relevant variables have been selected, the

state of rest for the system's components detailed follows from

the compatability of each component with every other component.

If such compatability were not the case, no equilibrium would

exist. The defining of an equilibrium exists in referencing

Laszlo's System-Cybernetics I and II. The state of rest involved

is based on the balancing of the internal forces of the model

while the external forces are assumed to be fixed. An environ-

mental change causes a counterbalancing change within the system.

Changes cause complexity as the system moves toward a new state

of equilibrium. If no changes are experienced in external forces,

equilibrium will perpetuate itself.

The solution of a function, such as quantity demanded

and quantity supplied considered in an isolated market, is ele-

mentary. Solve this equation by finding price where quantity

demanded and quantity supplied are a function of price alone.









But consider a model in which several interdependent commodi-

ties are simultaneously considered, and the solution becomes

somewhat more complex. An adjustment in the quantity of one

commodity would call for adjustments in all others. One might

picture cost allocation in a company with several interrelated

service centers. An adjustment in the amount of service from

one department calls for adjustments in all others. Does

an adjustment in investment in one activity call for adjust-

ment in other activities? Or does a firm not consider the

interacting effects of multiple investments? In seeking the

optimal expression of operating activities, should not opti-

mal financial resource usage also be considered? As more

variables and more equations enter a model, the system of

equations will become larger and more complicated. The use

of matrix algebra is a method suitable for handling large

systems of simultaneous equations. Through the use of

matrix algebra, a way is provided for testing the existence

of solutions by evaluation of a determinant.





The Leontief Input-Output Models--Static Version



The question of concern in the static version of Leon-

tief's input-output analysis is the level of output of each of

the n industries in an economy in order that production will

just be sufficient to satisfy the total demand for that product.