Accounting for Valueflows and Regeneration Reimagined

Professor William McCarthy teaches accounting and information systems at Michigan State University and is the innovator of a new way of accounting called Resources-Events-Agents (REA). 

In this exclusive interview, Professor McCarthy talks about how traditional accounting systems have a hard time keeping track of value flows and supporting practices that help the environment. 

He says that the double-entry bookkeeping method, which started in Venice in the 1400s, makes it harder to understand the real economy and work towards sustainability. 

So as companies face challenges with modern supply chains and the need for more sustainable economies, Professor McCarthy's work on REA offers an interesting take on the future of accounting.

Let’s dive in. 

For hundreds of years, accountants have used a method called double-entry bookkeeping. This method was first used by merchants in Venice, Italy, in the 1400s. They used math and wrote things down on paper to keep track of their business deals.

But Professor McCarthy says this old way of accounting doesn't work well anymore. It doesn't show the whole story of what's really happening in the economy. When something happens, like when two companies trade goods, traditional accounting quickly turns it into simple numbers and accounts, stripping away the context and rich data of the transaction. It doesn't keep all the important details.

This makes it hard for companies to understand their supply chains and how their actions impact the environment. The old accounting method is like telling a story but leaving out key parts. And Professor McCarthy thinks it’s time for change. 

Professor McCarthy has a different idea. He calls it Resources-Events-Agents, or REA for short. REA is like a new language for accounting that focuses on telling the whole economic story. "We often characterize REA as economic storytelling," Professor McCarthy explains.

In REA, instead of just writing down numbers, accountants keep track of all the important stuff. They look at the resources being traded, the events happening, and the people or companies involved. It's like writing a detailed story that doesn't leave anything out. "I found a new way of [telling economic stories] using Entity Relationship modeling, and later other things, that was called R E A, because “R” means the two resources that they were going to swap; “A” means to two agents who are at arm's length with each other; and “E” very simply means the process of sending things across this way." Professor McCarthy explains.

With REA, it's easier to see how things are connected. For example, if a company sells something, REA would keep track of what was sold, who bought it, and how it affects things like inventory and contracts. This gives a clearer picture of the economy. Imagine a visual story… "You have a customer called Charlie who will make a sale of inventory. And we put an object into the system, and it's described as a sale or shipment," Professor McCarthy elaborates.

Professor McCarthy says REA is like building a big, detailed map of how a company works. This map can help companies make better decisions and understand their impact on the world around them.

REA accounting could be a game-changer for companies trying to be more sustainable and regenerative. By tracking the flow of resources, events, and agents across a supply chain, REA provides a more comprehensive picture of a company’s environmental and social impact. "The best example I've seen of the supply chain example is Lynn Foster's examples for an apple pie," Professor McCarthy says, referring to a case study on the Valueflows website.

Traditional accounting makes it hard to see how business actions affect the environment, discounting “externalities”. But REA keeps track of important details that show the full impact.

Additionally, professor McCarthy believes that REA accounting is becoming increasingly important as customers and regulators demand more information about how products are made. People want detailed information about the origin and processing of the products they buy, from the farming and dyeing of cotton to the processing of olive oil. They want assurances about the absence of certain chemicals in the soil and the testing done at various stages of production.

It’s this demand for transparency driven by a growing awareness of the social and environmental impacts of business that has customers shifting to companies which are optimizing for sustainability rather than profit.

In response to these concerns, we are seeing changes in regulations, particularly in the EU and North America, that require companies to provide more detailed information about their supply chains. REA accounting is well-suited to meet these requirements because it allows for the flow of contextualized data, not just numbers on ledgers.  

However, changing accounting systems is not easy. "The biggest barrier to all of my work for years has been computational viability," Professor McCarthy admits. But with new technologies and a shift in mindset, REA could help companies tell a richer story of their impact on the world.

Despite the challenges, Professor McCarthy sees hope for the future of accounting innovation. He believes that new technologies, like Holochain, could help make REA accounting more viable.

In many ways, Holochain is an ideal technology for REA accounting because of how it leverages decentralized data storage — making it affordable and easy for smaller players in a supply chain to participate.

Professor McCarthy believes that small, innovative groups could lead the way in changing accounting. These nimble, environmentally and socially aware organizations might be able to make a real impact.

However, he also acknowledges the challenges ahead, particularly from large, established players in the accounting software industry. These companies may be resistant to change and could even try to acquire innovative startups to maintain their dominance.

As the accounting profession faces a choice between evolution and obsolescence, the work of visionaries like Professor McCarthy and the potential of new technologies like Holochain offer a glimpse of a more regenerative and sustainable future. The path forward may not be easy, but the stakes are too high to cling to the status quo.

Originally published on the Holochain Blog on May 15, 2024.