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The Accounting System As an Information Function
Author(s): John E. Butterworth

Source: Journal of Accounting Research , Spring, 1972, Vol. 10, No. 1 (Spring, 1972), pp.
1-27
Published by: Wiley on behalf of Accounting Research Center, Booth School of
Business, University of Chicago
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The Accounting System as an
Information Function
JOHN E. BUTTERWORTH*
The Information Dilemma
Often, there is the implication that a natural distinction exists between

information and the action which it is expected to elicit. Bedford and
Onsi, for example, define accounting information in the following way:'
To an accountant, information is the fundamental material upon which intelligent
action is based. It has the connotation of significant data.
Similarly, the American Accounting Association, in proposing standards
for accounting information, gives primacy to the standard of relevance,
and states :2
For information to meet the standard of relevance, it must bear upon or be usefully
associated with the action it is designed to facilitate or the result it is desired to
produce.
Again the distinction is drawn, but is it really so clear? Consider, for ex-
ample, the standard cost system in a manufacturing firm. This system
supplies information which is useful for some decision-making purposes.
But, underlying each standard input cost is an implied decision about the
kind and amount of resource to be used and the nature of the market in
which it is to be purchased. Behind each input/output relationship is an
implied decision regarding the technical conditions under which the process
should operate and the rate at which employees should work. In order to
obtain solutions to one set of problems-those for which the output of a
* Associate Professor, University of British Columbia.

1 Norton M. Bedford and Mohamed Onsi, "Measuring the Value of Information-
An Information Theory Approach," Management Services (Jan.-Feb., 1966), pp.
15-22.
2 American Accounting Association, A Statement of Basic Accounting Theory (AAA,
1966), p. 9.

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2 JOURNAL OF ACCOUNTING RESEARCH, SPRING, 1972
standard cost system will be considered useful-we must assume the

solution of many others. Often, our assumptions turn out to be wrong.
The dilemma is universal and is central to the problem of information
system design.
We must recognize, therefore, that the distinction between information
and action is certainly not a natural one. It appears to be motivated
mainly by the need to reduce the complexity of real systems to dimensions
which are computationally feasible. I intend to show that the distinction
between information and decision is based upon the need to suppress
portions of the decision-making process in considering some specific prob-
lem. But this in turn creates its own decision problems since in designing
an information system we must determine which decision elements shall
remain explicit and which can be considered invariant with respect to the
problem in hand. As a result, the study of an information problem becomes
the study of a decision problem. The choice of a particular information
system, which is itself a decision problem at another level, therefore implies
the use of a particular class of decision models. Conversely, the choice of a
decision model implies the use of a special class of information systems
yielding the parameters of that decision model. Unfortunately, we notice
the tendency of specialists who are concerned with these two classes of
problems to ignore their interdependence. In a very real sense, the problems
of the management scientist are also the problems of the information
specialist.
Since the distinction between information and action is the consequence
of a deliberate choice, we should naturally like to make that choice in the
best possible way. The choice involves a tradeoff between an enlargement
of the decision problem, which increases the demands placed upon the
decision-makers to understand and to compute, and a contraction of the
problem boundaries with a consequent reduction of the range of alterna-
tives that can be applied to the task in hand. In general, the evaluation of
alternative information structures requires a clear specification of the
unstated decision problem,3 but the procedure is often computationally
impractical. The purpose of this paper is to show that certain useful results
hold even in the absence of a clearly specified decision rule. These results
are particularly applicable to the accounting system design problem.
I begin by characterizing the structure of the double-entry accounting
system in a way which stresses the special properties that prove useful in
comparing alternative systems.
The Accounting System
The basic relationship of accounting systems can be represented in a

form that emphasizes the simultaneous effect upon the whole system and
I For a discussion, see Demski, Feltham, Horngren, Jaedicke and Sprouse, Cost
Concepts and Implementation Criteria (An Interim Report) (New York: AICPA,
1969), p. 43.

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ACCOUNTING AS AN INFORMATION FUNCTION 3
disregards the step-by-step computational techniques normally used to

implement them. This representation makes possible, under certain very
general conditions, the ranking of alternative systems according to their
value to the firm. In addition, it simplifies the conceptual task of inte-
grating the operational accounting model with the formal decision models,
which is necessary for a complete characterization of the overall information
problem.
With these ends in mind, it is convenient to regard the accounting
system as a function over the space of states of the world:4
b = a (xx, . Xk- X XX) (1)

where bk is the vector of account balances at the start of the kth period,
the list of dollar amounts which reflect the status of the accounting system
at some point in time, and the accounting function 0 expresses the relation-
ship between the history of states of the world' and those account balances.
Each state of the world xt, xt e Xt, is a vector of immense (possibly infinite)
dimensions, containing all potential knowledge about events occurring in
the ith interval of time. The notion is left purposely vague since it will
be necessary to define the relevant coordinates when some specific applica-
tion is considered. The state of the world xt is an abstract device which
enables us to conceive the existence of knowledge to which we have no
access and have no means of observing directly.
For notational convenience, define ok = (x0, x1, *-, x1k-), xk E Xk, so
that ;k represents all knowledge existing prior to the current period. Thus
(1) may be rewritten:
bk 0( xk). (2)
The accounting functio

aggregation function a and a measurement function r. Thus, by writing
0 (k, aXk) = 0 -(k12 k- 1), T(Xk)I (3)

we can separate the accounting process very naturally into the initial
assignment of money values to events (the determination of transaction
amounts) and the aggregation of those transaction amounts into individual
account balances. The transaction amounts for the kth period are given
by the relationship:
tk r(xk) (4)
where tk is the vector

tion of the measurement rules to the current state vector during the kth
period.
4The convention is adopted of using Greek letters to represent functions, small

Roman letters-values of functions, and Roman capitals-sets or operators.
A term used here in its broadest sense, as in the literature of information eco-
nomics. See for example, J. Marschak, "Problems in Information Economics" in
Management Controls, ed. Charles P. Bonini, Robert K. Jaedicke, and Harvey M.
Wagner (New York: McGraw-Hill, 1964).

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4 JOHN E. BUTTERWORTH
Balance
sheet
Assets boEquities
= bi = 12
Cash Inventory Fixed Liabilities Stockholders'

L= bs assets = b e
(net) N
+ =b9
Accounts Retained Capital

L~~~~~~~payable earnings stock
(5) b b5 .
Income Dividends
b~~~l. b=112
Sales Cost of Depreciation

= b13 Sales = bi5
FIG. 1. The Graph of a Simple Double-Entry Accounting Aggregation System
For the time being, we shall be concerned only with the properties of
the aggregation function o-, since these are common to all double-ent
accounting systems. Although the examples given are double-entry account-
ing examples, very little will be said initially about the measurement rule
r whose properties are also important in the specification of the double-
entry accounting system.
The structure of the aggregation system o- will be illustrated by reference
to the specific and much simplified accounting system6 given in Figure 1.
In this illustration, we may consider the accounts as the nodes of a
graph, and the notion of an account has been interpreted liberally to include
all those monetary quantities which are systematically aggregated, whether
or not they might be represented by actual ledger accounts. Thus assets
is included as an account, even though it is ordinarily the total of the
balance sheet asset column, and may not be separately determined until
the balance sheet is prepared, The illustration falls naturally into a tree-like
structure, as does any other accounting system.
Suppose now that the graph of Figure 1 is augmented by the dotted arc
labelled (5). With this addition, a unique loop is created in the graph, which
6 For a more rigorous graph theoretic treatment, see John E. Butterworth, "Ac-
counting Systems and Management Decision: An Analysis of the Role of Informa-
tion in the Management Decision Process" (unpublished Ph.D. dissertation, Uni-
versity of California, Berkeley, 1967), pp. 28-66.

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includes the accounts Inventory, Assets, Balance sheet, Equities, Lia-

bilities, and Accounts payable. Clearly, one may associate this loop with
the transaction, "purchase inventory on credit," and the accounts it
includes are all those, and only those, affected by this class of transaction.
If a simple flow convention is now adopted, the graph provides a geometric
interpretation of the classification properties of the double-entry system.
For this purpose, the transaction "purchase inventory on credit" is regarded
as a money flow whose direction parallels the physical flow of goods from
accounts payable to inventory and thence around the other accounts in
the loop described. The amount of this flow is added to all accounts where
the direction of flow is toward the balance sheet account (inventory, assets)
and subtracted from those accounts where the flow is away from the balance
sheet account (accounts payable, liabilities, equities). Thus a flow amount
of, say, $1,000 will result in a positive balance of $1,000 in the account
Inventory and Assets, and a negative balance in Accounts payable, Lia-
bilities, and Equities. The positive and negative balances may be regarded
as exactly equivalent to debit and credit balances respectively and when so
interpreted reflect the effect upon all the accounts of the system of the
transaction described. The effect of any other transaction upon the accounts
of the system may be determined in a similar manner, and in every case
the accounts affected may be identified by reference to the loop created by
addition of an arc between the relevant primary accounts.
Not surprisingly, the geometric model described has its algebraic counter-
part. A transaction of type i may be represented by a column vector sj
whose components are ones, minus ones, and zeros, each corresponding to
an account of the system. For a given transaction, the number one is
assigned to all accounts through which there are flows toward the balance
sheet account, the number minus one to all accounts to which there are
flows away from the balance sheet, and zero to all others. Thus for the
transaction "purchase inventory on credit" we have:
-1
-1
0
0
0
0
S5= 1.
0
-1
0
0
0
0
0-i

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The balance sheet account (bo) has been omitted since we know that
the balance of this account is always zero. For all other accounts, the
component indicating the transaction effect appears in a position which
corresponds to the account balance vector index shown in Figure 1.
Suppose we now extend the example by adding several other transactions
and describing them in a similar way. In order to simplify the illustration,
the number of transactions permitted is limited to these eight:
(1) Sell capital stock for cash
(2) Pay dividends
(3) Sell merchandise for cash
(4) Dispose of inventory
(5) Buy inventory or credit
(6) Pay accounts payable
(7) Acquire fixed assets for cash
(8) Depreciate fixed assets.
The arcs relating to transactions other than (5) are not shown in Figure
1 since the graph which results from adding the eight transactions is not
planar. Consequently, they cannot be represented clearly. But the relation-
ships of the graph can be equivalently and compactly represented by the
system matrix S, in which each column sj indicates the effect of a transac-
tion of type j upon the 15 accounts of the system. The complete system
matrix is shown in Table 1.
The entries in each column have been interpreted as indicating the
effect upon each account in the system of a particular class of transaction.
TABLE 1
S
The Matrix Representation of a Simple Double-Entry Accounting Aggregation System
Transaction
Account
1 2 3 4 5 6 7 8
bi =Assets 1 -1 1 -1 1 -1 0 -1
b2 =Equities -1 1 -1 1 -1 1 0 1
= Liabilities 0 0 0 0 -1 1 0 0
bN = Stockholders' equity -1 1 -1 1 0 0 0 1
b= Retained earnings 0 1 -1 1 0 0 0 1
b6 Income 0 0 -1 1 0 0 0 1
b7 =Cash 1 -1 1 0 0 -1 -1 0
b8= Inventory 0 0 0 -1 1 0 0 0
b= -Fixed assets 0 0 0 0 0 0 1 -1
bio= Accounts payable 0 0 0 0 -1 1 0 0
b11= Capital stocks -1 0 0 0 0 0 0 0
bl2= Dividends 0 1 0 0 0 0 0 0
b13= Sales 0 0 -1 0 0 0 0 0
b14= Cost of sales 0 0 0 1 0 0 0 0
bid= Depreciation 0 0 0 0 0 0 0 1

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Similarly, the rows of the matrix represent the effects of each class of
transaction on a particular account.7 All those rows relating to accounts
whose balances are the sum of other accounts are simple vector sums of
the other rows in S which correspond to the accounts summed. Thus, if
the ith row of S is denoted by st:
1 7 8 9
8 = 8 + 8 + 8
s2= 810 + 811 + 812 + 813 + 8

8 10
S = 8S
4 =11 + 8 + 1 + 11+ 6
and so on. Of course we can obtain the same equalities by substituti

Si in the above.
The examples will now be extended to show the effect of simultaneous
flows in all the eight loops of the system. Suppose the accounts have zero
balances initially, and the following transactions occur in the first period:
(1) Issue capital stock = ti = $5,000

(2) Pay dividend = t2 = 200
(3) Sell merchandise = t3= 2,500
(4) Dispose of inventory (C.G.S.) = 4 = 2,000
(5) Buy inventory = t6= 3,000
(6) Pay accounts payable = t6= 1,000
(7) Buy fixed assets = t7= 3,000
(8) Depreciate fixed assets = t8= 100
5000-
200
2500
so that t= 2000
3000
1000
3000
100
The system matrix S may be used to derive the account balances from
the transactions by using the relationship:
bk+1 = Stk (5)
a special form of (3) obtained by substituting (4) into (3) and recognizing
that the initial balances are zero. Using (5) to determine b2 we have:
7The matrix representation of the primary accounts is contained in rows 7-15 of

the matrix S, below the dotted line in Table 1. It is a node-arc incidence matrix,
identical to that described by Ijiri in his Management Goals and Accounting for Con-
trol (Chicago: Rand McNally, 1965), p. 93, and hence has exactly two nonzero entries
in each of its columns, a one and a minus one.

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1 -1 1 -1 1 -1 0 -1F p7200
-1 1 -1 1 -1 1 0 1 -7200
0 0 0 0 -1 1 0 0 -2000
-1 1-1 1 0 0 0 1 at -5200
0 1 -1 1 0 0 0 1 -2500
0 0 -1 1 0 0 0 1 2500 -400
2 1 - 1 1 0 0 - 1 -1 0 2000 - 31000
0 0 0 -1 1 0 0 0 3000000
0 0 0 0 0 0 1 -1 1002900
0 0 0 0 -1 1 0 0 1000 -2000
-1 0 0 0 0 0 0 0 3000 -5000
0 1 0 0 0 0 0 0L10200
0 0 -1 0 0 0 0 0 -2500
0 0 0 1 0 0 0 0 2000
LO0 0 0 0 0 0 0 1 L 100-i
and b2 summarizes the effect of the transactions upon the accounting

system S. The elements of b2 may be rearranged in the more conventional
financial statement form shown in Table 2.
One additional algebraic step is required in order to prevent the accumu-
lation of unwanted balances in the so-called nominal accounts at the start
TABLE 2
Illustrative Financial Statements

Balance Sheet
Assets Equities
Cash $3300 Liabilities:

Inventory 1000 Accounts Payable $2000
Fixed assets 2900 Total Liabilities $2000
Stockholders' Equity:
Capital Stock $5000
Retained Earnings 200
Total Stockholder's Equity 5200
Total Assets $7200 Total Equity $7200
Statement of Income and Retained Earnings
Sales revenue $2,500

Less operating expenses:
Cost of sales $2000
Depreciation 100 $2,100
Net income $400

Dividends paid $200
Net to retained earnings $200

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of each period. First, define the matrix E, which is merely an identity

matrix with zeros on the diagonal in all those rows which relate to the
noncumulative, or nominal, accounts. For the accounts of Table 1, for
example, rows 6, 12, 13, 14, and 15 of E would contain only zeros. Then,
substitute E in (3), which gives:
f = o[b-1' tk]
Ebk-1 + Stk.
If we now apply (6) recursively, noting that EE * E = E we get
k-1
bk+l = ES ( t) + St, (7)
which indicates, as expected, that the balance of all accounts at any time
is the sum of all transaction flows since the initial period.
To illustrate (6), suppose that the earlier example is extended for a
second accounting period, and let
01
500
4000
t = 2500
3000
3500
0
100_
so that
it 0 0 0 0 0 0 0 0 0 0 0 0 0 0l 7200-1
0 1 0 0 0 0 0 0 0 0 0 0 0 0 0 -7200
0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 -2000
0 0 0 1 0 0 0 0 0 0 0 0 0 0 0 -5200
0 0 0 0 1 0 0 0 0 0 0 0 0 0 0 -200
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -400
0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 3300
b3=? ? ? ? 00 0 0 1 0 0 ? ? 00 1000
0 0 0 0 0 0 0 0 1 0 0 0 0 0 0 2900
0 0 0 0 0 0 0 0 0 1 0 0 0 0 0 -2000
0 0 0 0 0 0 0 0 0 0 1 0 0 0 0 -5000
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 200
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 -2500
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2000
0 0 0 0 0 0 0 0 0 0 0 0 0 0 L 100._

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- 1 -1 1 -1 1 -1 0 -1'
-1 1 -1 1 -1 1 0 1
0 0 0 0 -1 1 0 0
-1 1 -1 1 0 0 0 1 0
0 1 -1 1 0 0 0 1 50
0 0 -1 1 0 0 0 1 500
1 -1 1 0 0 -1 -1 0
+ 0 0 0-1 1 0 0
0 0 0 0 0 0 1 -1 3500
0 0 0 0 -1 1 0 0 3500
-1 0 0 0 0 0 0 0 0
0 1 0 0 0 0 0 0 100-
0 0 -1 0 0 0 0 0
0 0 0 1 0 0 0 0
LO 0 0 0 0 0 0 1 0
7200+ 400 r 7600

-7200 -400 -7600
-2000 500 -1500
-5200 -900 -6100
-200 -900 -1100
0 -1400 -1400
3300 0 3300
- 1000 + 500 1500
2900 - 100 2800
-2000 500 - 1500
-5000 0 -5000
0 500 500
0 -4000 -4000
0 2500 2500
0 100 L 100
Again, all the amounts required for the preparation of financial statements
are available in the vector b3, though these will not be reproduced.
It has already been pointed out that the rows of S indicate the effects
upon a particular account of each class of transaction. If we are interested
in the causes of changes in any specific account, the flows which comprise
the account balance change may be separately determined by itemizing
the operation of vector multiplication. For example, a cash flow statement
may be constructed by utilizing row seven of Table 1 to indicate the several
transaction flow effects upon the cash account.8
Typically, the system matrix S has many linearly dependent rows which
result from the aggregative properties of the accounting system. Even
8 A funds flow statement may be constructed in a similar manner, but a fictitious
funds "account" must be created for the purpose by adding those rows which repre-
sent working capital accounts.

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the submatrix of primary accounts possesses at least one dependent row,

since it is always an incidence matrix. One property of such a matrix is
that any row is the negative sum of all other rows. Therefore the rank of
the matrix S cannot be greater than the number of primary accounts less
one, a property which follows from the need in the double-entry accounting
system to use two accounts to record one transaction. This implies that, in
any system in which we have a set of independent transactions, we may
omit any account and deduce the balance from the remaining data.
Many interesting parallels can be drawn between the operations with
which we are familiar in double-entry bookkeeping and those which are
suggested by the network model proposed. However, the usefulness of such
a model can only be justified if it extends, rather than parallels, the under-
standing we already possess of the operational characteristics of traditional
accounting systems. In the following section, the properties described will
be related to certain information value concepts.
A Model of Information Value
The accountant faces the recurring problem of designing an accounting

system for a given entity or of making changes in an existing system in
the expectation that some overall benefit may be gained. In such cases, he
-would like an assurance that the expected benefits will exceed the costs.
Though cost estimates may ordinarily be made with a reasonable degree
of reliability, the evaluation of the expected benefits raises very serious
difficulties. Even the notion of information benefit, or value, is vague and
must be made precise before any statements can be made about the relative
usefulness of alternative accounting systems. For this purpose, we specialize
the information economic theory of Marschak9 and Radner'0 to the ac-
counting information function11 and assume that the costs and benefits of
a proposed change may be separately evaluated. Since our concern is with
a measure of benefits, the cost determinative model will not be recognized
explicitly.
Suppose, then, that the benefits earned by a firm in the kth period of its
history are given by the real valued payoff function
r = co (k, ak, xk) (8)
where ak is a vector describing the decisions made during the period, an

element of the set of all possible decisions Ak, and k and X are as defined
earlier. Thus, the payoff or benefit is a function of the past state history
I Marschak, op. cit.

10 R. Radner, "The Evaluation of Information in Organizations," Proceedings
of the Fourth University Symposium on Probability and Statistics (University of
California Press, I961), pp. 491-530.
11 For a more general discussion, see Gerald A. Feltham, "The Value of Informa-
tion," The Accounting Review, XLIII (October, 1968), 684-96.

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(i), current decisions (ak), and the future state (xk), whose occurrence
must obviously be dependent upon the past history and action chosen.
This relationship is recognized by a probability distribution VI' whic
dependent upon tk and ak, i.e.
Pr[xk I xk ak] = V(xk I #, ak). (9)

Suppose (without loss of generality) that the information about past
history is limited to that provided by the accounting system-that is, by
the accounting information function 0 (#) = 0 (x k1, xkl). Let the functi
aAk represent the decision rule, so that the decisions chosen in the current
period are given by:
a= = ak (b ([]) (10)
when ak e Ak, the set of feasible decisions in the current period.

Since the periodic return has been postulated to be a function of a past
history which cannot be directly observed, it follows that the periodic
return must itself be determined randomly. Thus, if information about past
events is limited to that provided by 0, it is convenient to redefine the
periodic return in terms of bk, or
- (bk, ak, bk+l) Zo w(Xk, ak, xk)Pr(.|+l bk, bk+) (11)
where Pr ("kl I Vk, bk+1) represents the probability that a specific past
history is described by a given set of account values. The accounting
system may therefore be regarded as a noisy channel, in the sense descr
by Shannon and Weaver.'2
Using (11), the value of a given accounting system and decision rule, as
a function of the current state of knowledge summarized by bk, is given by
the recursive relationship:
Uk(6, a; bk) = E [C (bk, ak (bk); bk+1)

bk+l (12)
+ lUk+i (0, a; bk+l)]0(bk+l I bk ak)
for k = 1, 2, * n; k Xek, the set of all feasible alternative histories,

U,+1 (0, a; b"+') 0, OA is a discount factor, and the distribution 4
ending balances is derived from the relationships:
12 The analogy will not be pursued here since the mathematical theory of com-
munication originated by Shannon and Weaver defines information quantity in a
manner which is related only coincidentally to its value in use, with which we are
concerned. See Claude E. Shannon, and Warren Weaver, The Mathematical Theory
of Communication (Urbana: University of Illinois Press, 1949). The problems of this
well-developed branch of probability theory form a subproblem of the information
economic concepts of Marschak and Radner.

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Cj[bk+l I bk, ak] = > Pr[tk+l bk l I bk, ak]
= E Pr[Jgk+| b, ak]Prtbk+l I x*+l]

:gk+l (13)
= X Pr[#
*fk+1
= Z Pr[xk |x a ]-Pr[nk I bk]p r[bk~l l Xk+]

$gk+l
For our purposes Prfbk I tk] is assumed to be one or zero. In other words,
we hypothesize a special form of noisy channel in which a given sequence
of events results in a uniquely determined set of account balances. But
the reverse is not true, since the same observed value may be generated
by numerous alternative histories. This functional form appears to accord
well with the observed properties of accounting systems for which rules
may be specified in sufficient detail to insure a unique result for a given
sequence of financial events. Unfortunately, the inability to reverse this
process poses a problem which is fundamental in the design of any account-
ing system. Though we should like to design systems in such a way that
the state representation summarized by the output vector of the system
is associated with a unique system history, there are computational barriers
which make such a representation infeasible. Accordingly, we can only
insure that, in a sense still to be made precise, the output of the system
will enable us to distinguish between prior histories which may have a
quite different economic significance. This problem is the primary concern
of the remainder of the paper.
The value of a given pair of information and decision rules was defined
in (13). The value computation implied in this definition does not yield
directly the value of the information system, which is dependent upon the
choice of a decision rule. In these circumstances, it is rational to choose the
best available decision rule. Therefore, the value of the information system
at the start of the kth period, given bk, is defined as
Vk (60; b) = max { Uk(O, a; b )}

a
= max { [ Ec(bk, ak, bk+) + 3Vk+l (0; bk+l) 1 (bk+l | bk, ak) (14)
ak bk+1
for k = 1, 2, *,n; x eXk, and V.+

Note that the function a is now defined implicitly
optimal ak with the state description bk. Thus the number of alternative
actions can be no greater than the number of state descriptions. Un-
fortunately, the evaluation of (14) in any even remotely realistic situation
raises problems of formulation and computation which are, in general,
insurmountable.-3 Nevertheless, it is still possible to draw useful con-
13 The recursive relationship of (14) may be observed to be an adaptive control
process and therefore implies some form of optimal estimation procedure. For a

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clusions about the comparative value of information structures, and, in

particular, to derive the condition under which we can assert that the
value of one system is at least as great as another, i.e., that Y/ (0'; b/) >
Vk(6; bk) for two distinct systems 0' and 0.
The Comparative Value of Alternative Accounting Systems
As suggested earlier, the ability to distinguish between significantly

different prior histories Jk would be desirable. In order to clarify the notion
we need to partition the set XIC into the subsets of all possible histories x*.
A partition of Xk is a collection of subsets of Xk which is mutually exclusive
and exhaustive and contains no empty subsets. More precisely, define z
IZi, Z2 X Zm} as a partition of Xk which must satisfy:
(a) zi n zf =z for all i # j
(b) Z1 U Z2 U ... U Zm = X' (15)
(c) zi % 4 for all i.
We are especially concerned with the partition which is implied by a

given accounting information function 0. Let z (0) represent this partition,
where
Z (0) ={Zbk}
and (16)
Zbk - I bk = I sk)
In other words, the subset Zbk contains all those alternative histories which
will result in the same final output value bk; in functional language the
image of bk in Xk. It is clear then that the specification of the subsets
corresponds to the specification of the function 0, and that there is a one-to-
one correspondence between 0 and the associated partition z(0). Conse-
quently, the problem of designing an information system, i.e., specifying
0, is technically equivalent to that of selecting an appropriate partition
14
Z.
With this in mind, we define a relationship between partitions. We will

say that a partition z' is at least as fine as z if, and only if, for all zj'f z' there
exists a zj e z such that zi' C zj. Thus, every subset of z' is contained in some
discussion see Richard Bellman, Adaptive Control Processes: A Guided Tour (Prince-
ton University Press, 1961), especially chap. XVI.
In order to avoid unnecessary notational complexity, perfect implementation is
assumed, and no distinction has been made between decision and action. The restric-
tion is not necessary for the results which follow, and a may, alternatively, be taken
to be a stochastic function.
14 There are obvious limitations upon human comprehension and other behavioral
constraints which make it necessary to qualify this statement. In the technical
sense, however, the actual form of the information signal is immaterial since it is
used only to identify the relevant subset of the statespace.

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subset of z. Conversely, under the same conditions, we say that z is at least

as coarse as z'. If, in addition, we have z' 5 z, then z' is said to be finer than z,
and z coarser than z'. This relationship induces only a partial ordering over
the partitions of Xk since if the given condition is not satisfied, there is then
no relationship defined between z and z'. Because of the unique association
between z (0) and 0, we may speak equivalently of the relationship between
0' and 0, and say, for example, that 0' is at least as fine as 0 when the corre-
sponding partitions z' and z satisfy the condition given above.
The usefulness of this concept lies in the correspondence that exists
between the gross value of information systems as defined in (14), before
deducting costs of operations, and their fineness. For it is true that any
information system 0' which is at least as fine as another, say 0, must be at
least as valuable as 0, regardless of the form of the payoff function co or the
nature of the outcome probability distribution 6.16
A simple example will illustrate why this should be so. Indeed, upon
reflection the result is so obvious that it scarcely requires proof. Suppose
that the accounting system 0 is the one used in the example given earlier,
in which the output of the system is the vector of 15 balances for the given
accounts. Suppose further that the inventory account balance represents
the value of inventory stored in two separate warehouses. If we now add
two additional accounts representing the amounts stored in each of the two
warehouses, whose totals sum to b8, we create a new accounting informa-
tion system, say 0, which is finer than the original system 0, and hence at
least as valuable. To see why this should be so, note the obvious fact that,
using 0, the same decisions may be made as with 0, since the same total
inventory balance is known. But since the individual balances are also
known, an additional set of decisions becomes available which is potentially
(though not necessarily) more valuable.
More generally, the relationship can be illustrated by reference to the
definition of information values given in (14). Denote by bk the output of 0,
which is assumed to be finer than 0. Expressing the return co in terms of b,
we have:
Vk(6; bk) = maxt b [c(t, ak gk+1)

ak~ ~~~A~ Ak Ae A;
+ tVk+l(O; bk)I4(gk+l |b , tg)Pr(bk I bk)
fork =1,2, ..,n;e (17)
- max{fE[Uk(O, a; Ak) } bk]}-
On the other hand, for 0, we obtain:
15 For an elaboration of this idea see J. Marschak, "Remarks on the Economics

of Information," Contributions to Scientific Research in Management, p. 86 (Western
Data Processing Center, University of California, Los Angeles, 1959). Again, we should
point out that there may be psychological barriers which inhibit the realization of
the potential technical benefits of the finer system.

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Vk (b; bk) = > max { Z [, (b& akb )ul)

t6k ak kil
+ I3Vk+I(O; bk)I,(Ak+I I aG, Ak)}pr(Ak j ik)
for k = ly, 2, ... , n; X~kE S,

- E[max{Uk(O, a; b k)} | b].
a
In the first case, we may observe only bk and subsequently choose an

appropriate course of action. In the second case, however, many more
alternative actions become available to us as a result of the ability to
observe each of the many bk which may be summarized by a single bk. As
a result, we arrive at the inequality: 16
E[max{Uk(O, a; b )} I b ] > max{E[Uk(O, a; bk) | bk}. (19)

et CZ
We are naturally interested in the magnitude of the above difference,

since this represents the incremental value of the alternative information
structure. An evaluation of the difference is obviously equivalent in diffi-
culty to the solution of (14), but bounding methods are useful here, and
one such result is given later.
The value ordering properties of systems exhibiting the finer/coarser
relationship are also of interest since the relationship occurs so very fre-
quently in accounting systems. As seen earlier, it appears when an account
of an existing system is analyzed or factored into subsidiary accounts,
which is a process of refinement continually carried out as accounting
systems are modified. One of the first tasks in the design of accounting
systems is the selection of a level of fineness appropriate to the task in hand,
as represented by the set of primary accounts.'7 More generally, the tree-
like structure of accounting systems illustrated in Figure 1 provides an
ordering of system value. At the apex of the tree is the balance sheet account
which yields no information since we know the balance of this account is
always zero. If we truncate the tree at the accounts Assets and Equities,
we add information which, obviously, has potentially greater value. As
subclasses of Assets and Equities are added, still more alternative systems
with potentially greater value are created, presumably at the expense of a
more complex processing system with a correspondingly higher operating
cost. This systematic branching must eventually terminate, hopefully
close to the point at which the marginal benefits gained are equalled by the
added cost.
In the evaluation of marginal benefit, it is obvious that the form of the
16 For a general proof of this relationship in the one-period case see Avriel and
Williams, "The Value of Information and Stochastic Programming," Operations
Research, 18 (Sept.-Oct., 1970), 948.
17 A problem equivalent to the definition of elementary tasks discussed in, for
example, chap. 1 of James C. Emery, Organizational Planning and Control Systems
(New York: Macmillan, 1969).

129.78.139.29 on Sat, 19 Sep 2020 12:04:40 UTC
return function w must be an important factor. It is suggested that

of this return function is a proper starting point for the system
problem, and some further value properties may be directly derived
In particular, the information system 0 is called payoff adequate if,
if, for each output value b0 and alternative decision a", the expect
= Zz C(X, a', x') 'i (x' I rk, ak) yields precisely the same valu
XkE Zbk . Under this condition, it is clear that a further refinement of
contribute additional information value. If 0 and 0 are both payoff ad
the inequality (19) becomes an equality, as can be seen from the
of the computation implied.
Further the system 0 is called payoff relevant if it is the coarsest possible
payoff adequate structure. Marschak has shown that one, and only one,
such structure exists.'8 In addition, the payoff relevant partition may be
derived directly from the payoff function, in the same way that the parti-
tion associated with a given information system was defined in (16).
Denote the payoff-relevant partition by z (cw), where:
z (c) = {ziak}
and (20)
,ak= {x | = > C(Sk a, x') . (Xk I tk' a*)}
One approach to the system design problem is to attempt to determine

z (w) since this is optimal in the sense that no more valuable system can be
found. However, the cost of constructing such a system is, in general,
prohibitive, and we may still be concerned with the problem of comparing
less than adequate systems. It is useful therefore to consider a system
adequate with respect to another if it yields the same value. It is easily
seen that a sufficient condition for 0 to be adequate (in this sense) with
respect to 0 is provided when the expected return Ak+ CW(b', a +I).
b(gk+| a', &') is identical for all a', and all values of &' such that:
{X I & = &(X )} C {X I = @(v)} for some b,

or (21)
zA C z
The abov
example
with the
each war
distingui
yields no
respect t
18 J. Mar
metrica, 3

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But suppose instead that 0 is not adequate with respect to 0. In other

words, potential gains exist which may result in a greater value for 9. In
this case, we can determine an upper bound on the magnitude of the
inequality Vk (0; bk) ? Vk (0; bk) for 0 finer than 0. It is clear that, i
period, the amount lost by failing to distinguish between events which may
result in a significantly different economic outcome cannot be greater than
the difference between the largest and smallest possible outcome values.
More precisely, define the set of indistinguishable balances Bk by:
B= b | 2 I : Ze for some V (22)

and let 6 (b) represent the largest possible difference in peri
a given state description bkV where (bk) is given by:
= k max 9{ 2 c:(& ,a',bk+) (+b b I a ) }

O(Ak k O(A,+l Ak (23)
A mii { . a, . ) | ba) }
For a specific value of bk, (23) gives the maximum
which can be incurred because of inability to observe tk directly. The re-
turn associated with a combination of the most unfortunate unobservable
outcome and the worst action choice is subtracted from the returns from
the best possible outcome and action pair. With future values of bk un-
known, and its distribution difficult to determine, the largest difference
which can be incurred in any period, say d* is:
d* = max IS (bk) . (24)

bA;
Since the return in each period is discounted by the factor iB, the discounted
sum of the maximum amount d*, summed over the remaining n - k pe-
riods, must provide (ignoring system cost differences) an upper bound on
the incremental value of 0. Thus we arrive at the inequality:"9
0 < Vk(0; bk) - Vk(O; bk) < d* [(1 a ] * (25)
We have established that sufficient conditions for the above difference to

be zero are satisfied by systems 0 and 0, 8 finer than 0, when both are payoff
adequate, or when 0 is adequate with respect to 0. Roughly speaking, the
right-hand bound suggests that when an incremental change to a finer
system is considered, the maximum benefit which might be obtained is
limited by the discounted sum of the largest uncontrollable difference in
the return function. Notice, too, that the computation of this bound does
not depend upon knowledge of the decision rules. Rather, the computation
is dependent only upon knowledge of the payoff function co and its expected
value for a given decision and starting state description bk. In addition, if
the return function is linear in bk+l, the only knowledge required about the
19 E d*() =d*EP = d* d*(1 T

in~k Low 1-

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ACCOUNTING AS AN INFORMATION FUNCTION 19^
future is the ability to predict the expected value of b"', which can
be used to determine the return as a function of that one value for each
decision. Therefore, the bound provides an upper limit which is quite
easily estimated in any real situation in which it may be difficult to specify
the decision problem more fully, and impossible to obtain evidence for the
probability distribution of t"+' without first carrying out the very refine-
ment of 0 which we are trying to evaluate. In these situations, linear cost
approximations are very frequently encountered. But the generality of
application entails some sacrifices of usefulness, since the penalty is com-
puted without regard to the probability of occurrence of catastrophic
misfortune or to the ability to avoid misfortunes by appropriate action
choice. Clearly, more useful results may be obtained if more specific condi-
tions are assumed.
The following example may help to clarify some of the concepts which
have been developed.
An Example
Consider the simple retail distribution network illustrated in Figure 2..

A retail firm has branches at two remote locations. The two branches se
goods at retail, while the central office purchases the one commodity
marketed and ships it to the two retail branches. There is inventory capacity
at all three points, and units ordered by the central office at the beginning;
of a period are delivered at the end of that period, being available for
shipment to the branches during the following period. In the third period,
it is available for sale by the branch, and amounts sold become receivable,
Branch 1 Sell Branch I Collect Branch 1

inventory - receivables cash
=rtentry = p -X5 b4 -b2
a2/
, __~~~~~~~~~~~~~_
Central Central Withdraw

inventory Cash
6~ =bi a4
Branch 2 B
inventory receinrables S cash
= b=P2X6. = r bs~b
Purchase =
FIG. 2. A Retail Distribution System

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being collected in the fourth period, with the cash transmitted to the
central office during the fifth and last of the five-period cycle. The cash
may be withdrawn or retained to meet future purchases.
The problem for the firm is to maximize the discounted return from its
inventory and cash management policy when holding costs attach to the
balances of cash and inventory, and these costs are different in each of the
three units. For simplicity, it is assumed that the receivables earn interest
at a rate equal to. the holding cost. All holding costs are functions of the
ending balances of the previous period. No shortage penalties are incurred
other than those generated by the lost sales revenue. All decisions are
made at the beginning of a period and are executed during a period. The
decision vector ak for any period is defined as follows:
a, = quantity of new merchandise ordered
a2 = quantity shipped from central office to branch 1
a3 = quantity shipped from central office to branch 2
a4 = amount of cash withdrawn.
The state of the world xk is defined by:
Xi - a,
X2 = a2
X3 = a3
X4 = a4
a = quantity demanded at branch 1 (a random variable)

x6 = quantity demanded at branch 2 (a random variable).
Balance sheet
Assets Equities
Cash at Investment at A/R at 1, Owners'

1,2,3 1,2,3 = b13 2=b14 equity
Cash at Cash at Inventory Inventory A/R at A/R at

1 ,2 3 = bi at l,2 at 3 1 = b4 2 = 6
b= o b12 =
Cash at C[ash at Inventory Inventory

1 = b2 ]2 = bs atI2
=67 = bs
(b15 and b16 omitted)
FIG. 3. The Accounting System Structure for the Retail Distribution System

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Demand at the two retail points is known only up to a probability distribu-

tion / (xa, x6) = -/A (xs) - / (x6), which assumes independence.
Several alternative information structures will be examined, but for the
sake of continuity these will be defined in terms of a single payoff adequate
structure-payoff adequate, that is, with respect to the specific class of cost
function to be defined. Figure 3 illustrates the network form of such a
structure.
Next, the transaction measurement function r(xk) is defined:
t= =f (xi) = cost of cash purchases
t2 = ClX2 = amount shipped to branch 1
t3 = cIx3 = amount shipped to branch 2
t4 X4 = a4 = cash withdrawn
t- ciX5 = cost of goods sold by branch 1
t6= p1X = amount of sales at branch 1
t7= C2X6 = cost of goods sold by branch 2
t8 P2X6 = amount of sales at branch 2
= = cash transferred from 1 to 3
t9o b = cash transferred from 2 to 3
til = b4k1 = cash collections at branch 1
=2 = b5 = cash collections at branch 2
where f (xi) = co + cixi and c0 is the fixed order cost, cl the unit purch
price. The definition assumes that inventory is adequate to meet demand.
Otherwise, of course, the amount sold is limited to that available. The
matrix representative of the aggregation function a is shown in Table 3.
TABLE 3
Matrix Representation of the Aggregation Function a
Transaction
Account
1 2 3 4 5 6 7 8 9 10 11 12
Cash at3 1 -1 0 0 -1 0 0 0 0 1 1 0 0
Cash at 1 2 0 0 0 0 0 0 0 0 -1 0 1 0
Cashat2 3 0 0 0 0 0 0 0 0 0 -1 0 1
A/R at 1 4 0 0 0 0 0 1 0 0 0 0 -1 0
A/R at 2 5 0 0 0 0 0 0 0 1 0 0 0 -l
Inv. at 3 6 1 -1 -1 0 0 0 0 0 0 0 0 0
Inv. at 1 7 0 1 0 0 -1 0 0 0 0 0 0 0
Inv.at2 8 0 0 1 0 0 0 -1 0 0 0 0 0
Owners' equity 9 0 0 0 1 1 -1 1 -1 0 0 0 0
Cash at 1, 2 10 0 0 0 0 0 0 0 0 -1 -1 I I
Cash at 1, 2, 3 11 -1 0 0 -1 0 0 0 0 0 0 1 1
Inv.atl,2 12 0 1 1 0 -1 0 -1 0 0 0 0 0
Inv. atl,2,3 13 1 0 0 0 -1 0 -1 0 0 0 0 0
A/R 14 0 0 0 0 0 1 0 1 0 0 -1 -1
Branch 1 equityl5 0 1 0 0 -1 1 0 0 -1 0 0 0
Branch 2 equity 16 0 0 1 0 0 0 -1 1 0 -1 0 0

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The problem for the firm may now be formulated, assuming only that
the costs of holding for cash g (- ), and for inventory h (- ) are functions of
the balances at the three points. That does not suggest, of course, that the
cost of holding inventory at (say) retail branch 1 is necessarily the same
as the cost at retail branch 2, or the cost for the central office. The problem
may be stated:
Vk (O; bk) = max { b+i [bk |t -f (a,) - g (bi, b2, b3k )

ak
h(b6k, b7k, b8k) + fVk+l(O; bk+l)]ck(b+ | b', ak) } (26)
for k = 1, 2, , n; Vn+, (; bk) O, and tke 4k.
Since all income accounts have been omitted, the transformation from bk
to bk+l is given by (5). Using the definitions of r (xk) above, this may be
expanded to read:
rf(xi)
ClXi
CiX3
bk+1 = bk + S P1X . (27)

C1X6
b2k
bak
Lb5
In the above equation, only t5, t6, t7, and t8 are random, with all other
transactions determined by current decisions or previous balances.
We now consider the effects of alternative cost structures and informa-
tion structures upon the information value Vk. First, assume that the
functions g(-) and h(.) have certain alternative separability properties.
Define the cost structures:
C, _fg(b, b2, b3) = gi(bi) + g2(b2) + g3(b3)

1 h(b6, b7, b8) = hi(b6) + h2(b7) = h3(b8)
C= g(bi, b2, b3) = gi(bi) + 92(b2 + b3)

{h(b6, b7, b8) = hi(b6) + h2(b7 + b8) (28)
C= Jg(bi, b2, b3) = gi(b1 + b2) + g3(b3)

3 h(b6, bN, b8) = hi (b6 + bN) + h3(b8)
C = fg(bi, b2, b3) = gi(bi + b2 + b)

h(b6, bN, b8) = hi (b6 + b7 + b8).
In the first case, the cost relationships are different in each unit. In the

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second, branch 2 and central office costs are additive. In the third, the
costs in the two branches are additive; and in the last, the holding and
shortage costs are functions of the total amounts held only. Finally, define
four alternative accounting systems 0 by:
jb2~ b6 Fblll _ b61

01= 0~2 =bio 03= b131 04- b5(29)
Lii L~b12 4J4
L:b, ] b~ Lb;0,
The first function corresponds to complete information, since the value of
all accounts which can be significant are known. The second, 02, assumes
that only the totals of cash, inventory and receivables, at the two retail
points are known. The third, 03, assumes that only the aggregate of cash,
inventory, and receivables is known, that no information is available as to
where the balances are held. 04 yields only the amount of branch equity-
the sum of cash, inventory, and receivables at each branch.
It is obvious that 0i is payoff adequate for all cost structures C. But it is
payoff relevant only for C, for in the other three cases there does exist a
payoff adequate accounting structure which is coarser, yet yields the same
(n - k) period return. In fact, all possible pairs, (Ci, Oi) may be classified
either as payoff relevant (r), payoff adequate (a), or not payoff adequate
(0). The classification is shown in Table 4. There is, therefore, a payoff
relevant accounting system for all cost structures but C3. No accounting
system has been provided which satisfies the need to distinguish the balance
at branch 2 without distinguishing the balances at the other two points.
However, 04 iS not adequate with respect to any given cost structure since
it fails to distinguish between inventory and cash at the retail point.
The payoff adequate or relevant systems shown above are optimal in
the value sense, again ignoring cost. But other relationships between sys-
tems may be derived, because there is a coarser/finer relation linking the
systems 01, 02, and 03. 01 is finer than 02 and 04, and 02 is finer than 03.
The implicit value orderings, disregarding, cost, with the data of Table 4,
yield the following inequalities, in which Vk* denotes the optimal (n - k)
period return:
TABLE 4
The Payoff Adequacy of Alternative Cost/lInform
01 02 0i 04
C, r 0 0 0
C2 a 0 0 0
C3 a r 0 0
C4 a a r 0

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Vk* = Vk (Cl, 01) 2 Vk (Cl, 62) 2 Vk (Cl , 03)

Vk* = Vk (C2, 01) 2 Vk (C2, 02) 2 Vk (C2 , 03)
Vk* = Vk (C3, 01) = Vk (C3, 02) 2 Vk (C3, 03)
Vk* = Vk (C4, 01) = Vk (C4, 02) = Vk (C4, 03) (30)
Vk* = Vk (Ct 01) 2 Vk (Cit 04) for i = 1,2, , 4.
Note that the inequalities above were derived without any concern for
the relative likelihood of future events, or the manner in which decisions
are made. They depend only upon knowledge of the coarseness/fineness
relationship between alternative information structures, and upon the
ability to identify the significant variables in the return function. It has
already been pointed out that the first requirement is always readily
observable in accounting systems, and the second is a prerequisite first
step in any analysis of system operations. Hence, the ability to rank order
alternative systems with this most primitive data allows the rational
elimination of alternatives at a very early stage in the analysis.
No further conclusions may be drawn about the relative values of the
system without more specific knowledge about, at least, the nature of the
assumed cost function. Suppose, for example, that system 02 is in use, and
the substitution of 06 is considered, under the cost conditions C1. Suppose
further that the capacity of each of the two warehouses is limited to
$100,000 value of inventory, and that the storage and holding costs are
linear:
g(b1, b2, b3) = .08b, + .09b2 + .07b3
h(b6, b7, b8) = .09b6 + .11b7 + .08b8.
The cash and inventory costs may be considered separately. The cash
balances affected are those of the two branches which are the receivables
of the preceding period. No decisions are involved and the costs are a
function of the beginning balances only. For any aggregate cash balances
bio, the smallest cost must be incurred when the balance is all in branch 1
the largest when the reverse is the case. Clearly, the maximum difference
d*(blo) may occur when the aggregate balance is $100,000, which is the
maximum possible sales at either branch in any one period, because of the
$100,000 warehouse capacity. Then d*(blo) = (.09 - .07) 100,000 = $2,000.
Similarly, the maximum difference in the holding and storage costs
h(b6, b7, b8) may occur when $100,000 warehouse capacity is utilized, so
that d*(b2) = (0.11 - .08) 100,000 = $3,000. Then, in this case, d*-
d*(blo) + d*(bn) = $5,000. If the horizon is limited to ten periods, so that
n = 10, and ,B = 0.9, then we obtain:
0 < Vj(0; b k) - Vj(0; b k) < 5000 .9(1 - (0.9)10) = $29,310.

0.1
The amount of $29,310 determined above may then be compared with the

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immediate outlay for information processing equipment, plus the present

value of the future stream of costs associated with the use of that equip-
ment. If the amount so determined exceeds $29,310, it is then certain that
the system should not be used. Thus, many more alternatives may be
eliminated with a minimum of computational effort, so that more extensive
analysis may be restricted to a rationally selected subgroup of potentially
more valuable systems.
Summary
The accounting system has been presented as a functional relationship

between the set of observable events and the descriptive measures of those
events which we refer to as accounting information. A model of information
value which assumed independence of costs was used to show the close
interdependence of the information and decision functions. It was seen
that the range of alternatives available to the decision-maker was sys-
tematically narrowed as the information structure lost its capacity to
discriminate between events, with a consequent suppression of decision
relationships. Although the choices must still be made, the process by
which they are determined is no longer explicit.
The relative value of alternative systems was characterized in terms of
the properties of finer and coarser structures, properties which are found
universally in the accounting system with its typical aggregative hierarchy
of accounts. Some conditions were developed under which comparisons
could be made between alternative systems, and bounds were established
for the incremental value of a proposed change.
The suggested method of evaluation provides a practical means of
analyzing the properties of large scale real systems. Consider, for example,20
the problem of a bank operations manager whose existing information
system must provide, amongst other information, the amounts payable on
demand to each client, computed at regular, usually daily, intervals.
Though the amounts of individual daily deposits and checks are also
recorded, this is not sufficient to determine the amount available to the
bank for remunerative investment from a given depositor on a given day.
The amount so available depends upon both the rate at which new deposits
are made and the banks upon which the checks included in deposits are
drawn, for there may be a delay of up to three days before many checks can
be collected through the Federal Reserve system. Thus, if a bank allows
credit to a customer for his deposit on the day of deposit, it is possible for
the usable balance to be negative, even though the amount computed
conventionally may show a substantial nominal balance. In such cases,
20 The example given here is based on a research project supported by a contract
between the Johns Hopkins University and the First National Bank of Maryland,
Baltimore, Md., which was directed by the author. It focuses on only one aspect of
that study, in which a modified information system and linear programming model
of bank operations were simultaneously constructed.

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the bank must provide funds in order to support the transaction velocity
of the account. Clearly, the bank payoff function is affected by information
not available in most banks, since its collection raises many technical
difficulties.
In this situation, the information system design may consider numerous
alternative aggregative schemes based on an initial breakdown of deposit
amounts into their collection periods. If bj represents the balances of the
jth demand depositor, then bj = Zt=0 bjt, when bjt is the (unobservable)
amount collectable t days from today for the jth depositor. The aggregative
schemes have the general form brit = jet ijt, in which collectability is
assessed by depositor class according to some predetermined classification
scheme, and Ji is the index set of depositors in the ith class. Measurement
of bj, may be expensive since it entails essentially a quadrupling of the
number of deposit accounts, which in even a moderately sized commercial
bank may imply an increase of the order of 300,000 in the number of ac-
counts.
Coarseness/fineness relationships may be used to construct hierarchies
of aggregation which break down, for example, commercial depositors into
industrial, wholesale, retail and other categories. Industrial users may be
classified by their product, geographic location, size, and so on. At each
level of aggregation, there are potential gains which may be estimated by
using stratified random sampling to estimate Pr[bjit I biu]. The ability to
sample in this way allows the substitution of more useful potential value
estimates than the quite general method proposed above, which is not
dependent upon the availability of such data, but may initially guide the
choice of sampling scheme. With the sample data, it becomes possible to
set confidence limits for the amounts in each collection class, which can
then be used to estimate the maximum potential gain from their measure-
ment.
The concepts of information value were applied to the accounting system
structure because of its special and well-defined form, unique in the gen-
erality and breadth of its use. These concepts are, naturally, not limited to
the accounting system, and extension to (for example) the measurement of
physical quantities of service flows will suggest itself. It was pointed out
that the management scientist should also be aware of the problems de-
scribed, which complement those with which he is more directly concerned.
One frequently observes the use of decision models which imply an informa-
tion source that is too coarse for the problem in hand. Witness the demand
for the "measurement" of such opportunity costs as inventory holding
and shortage costs, which, properly, can be determined only by an explicit
statement of the optimization problem that yields the cost of the best
alternative to the possession or sale of inventory.
In the same vein, it might be suggested that many controversies in
financial accounting have arisen because the choice of any specific oppor-

129.78.139.29 on Sat, 19 Sep 2020 12:04:40 UTC
tunity cost as generally useful to the reports of all firms can always be
refuted by appealing to specific counterexamples for which that opportunity
is clearly not optimal. Again, the use of such costs is obtained only at the
expense of the suppression of these problems. It seems inevitable that, in
the future, the accountant must begin to take more explicit cognizance of
the decision processes which utilize the output of the accounting system.

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The Accounting System As an Information Function

Author(s): John E. Butterworth

Stable URL: https://www.jstor.org/stable/2490216

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The Information Dilemma

Often, there is the implication that a natural distinction exists between

* Associate Professor, University of British Columbia.

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standard cost system will be considered useful-we must assume the

The Accounting System

The basic relationship of accounting systems can be represented in a

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disregards the step-by-step computational techniques normally used to

b = a (xx, . Xk- X XX) (1)

The accounting functio

0 (k, aXk) = 0 -(k12 k- 1), T(Xk)I (3)

where tk is the vector

4The convention is adopted of using Greek letters to represent functions, small

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Cash Inventory Fixed Liabilities Stockholders'

Accounts Retained Capital

Sales Cost of Depreciation

FIG. 1. The Graph of a Simple Double-Entry Accounting Aggregation System

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includes the accounts Inventory, Assets, Balance sheet, Equities, Lia-

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The Matrix Representation of a Simple Double-Entry Accounting Aggregation System

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s2= 810 + 811 + 812 + 813 + 8

and so on. Of course we can obtain the same equalities by substituti

(1) Issue capital stock = ti = $5,000

bk+1 = Stk (5)

7The matrix representation of the primary accounts is contained in rows 7-15 of

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and b2 summarizes the effect of the transactions upon the accounting

Illustrative Financial Statements

Cash $3300 Liabilities:

Total Stockholder's Equity 5200

Total Assets $7200 Total Equity $7200

Statement of Income and Retained Earnings

Sales revenue $2,500

Net income $400

Net to retained earnings $200

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of each period. First, define the matrix E, which is merely an identity

If we now apply (6) recursively, noting that EE * E = E we get

bk+l = ES ( t) + St, (7)

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7200+ 400 r 7600

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the submatrix of primary accounts possesses at least one dependent row,

A Model of Information Value

The accountant faces the recurring problem of designing an accounting

r = co (k, ak, xk) (8)

where ak is a vector describing the decisions made during the period, an

I Marschak, op. cit.

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Pr[xk I xk ak] = V(xk I #, ak). (9)

when ak e Ak, the set of feasible decisions in the current period.

- (bk, ak, bk+l) Zo w(Xk, ak, xk)Pr(.|+l bk, bk+) (11)

Uk(6, a; bk) = E [C (bk, ak (bk); bk+1)

+ lUk+i (0, a; bk+l)]0(bk+l I bk ak)

for k = 1, 2, * n; k Xek, the set of all feasible alternative histories,

19 E d() =dEP = d* d*(1 T