Chapter 2

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1 Explain the three basic functions performed by an accounting information system (AIS).

2 Describe the documents and procedures used in an AIS to collect and process transaction data.

3 Discuss the types of information that can be provided by an AIS.

4 Describe the basic internal control objectives of an AIS and explain how they are accomplished.

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The grand opening of S&S is two weeks away.

Scott and Susan recognize that they need qualified accounting help and have hired a full-time accountant, Ashton Fleming.

Ashton is responsible for creating an accounting information system (AIS).

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What questions does Ashton ask himself? How am I going to organize things? Where do I start? What information does S&S need in order

to operate effectively? How can that information be provided?

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How am I going to collect and process data about all the types of transactions that S&S will engage in?

How do I organize all the data that will be collected?

How should I design the AIS so that the information provided is reliable and accurate?

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Businesses engage in a variety of activities, including:

Acquiring capital Buying buildings and equipment Hiring and training employees Purchasing inventory Doing advertising and marketing Selling goods or services Collecting payment from customers Paying employees Paying taxes Paying vendors

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Types of information needed for decisions:Some is financialSome is nonfinancialSome comes from internal sourcesSome comes from external sources

An effective AIS needs to be able to integrate information of different types and from different sources.

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To collect and store data about the organization’s business activities and transactions efficiently and effectively

To provide management with information useful for decision making

To provide adequate internal controls

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A transaction is: An agreement between two entities to

exchange goods or services; OR Any other event that can be measured

in economic terms by an organization.

EXAMPLES: Sell goods to customers Depreciate equipment

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The transaction cycle is a process:

Begins with capturing data about a transaction

Ends with an information output, such as financial statements

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Many business activities are paired in give-get exchanges

The basic exchanges can be grouped into five major transaction cycles. Revenue cycle Expenditure cycle Production cycle Human resources/payroll cycle Financing cycle

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1. The revenue cycle: involves activities of selling goods or services and collecting payment for those sales.

2. The expenditure cycle: involves activities of buying and paying for goods or services used by the organization.

3. The human resources/payroll cycle: involves activities of hiring and paying employees.

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4. The production cycle: involves activities converting raw materials and labor into finished goods.

5. The financing cycle: involves activities of obtaining necessary funds to run the organization, repay creditors, and distribute profits to investors.

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Thousands of transactions can occur within any of these cycles.

But there are relatively few types of transactions in a cycle.

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ExpenditureCycle

HumanResources

ProductionCycle

RevenueCycle

FinancingCycle

General Ledger & Reporting System

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The data processing cycle consists of four steps:

1. Data input2. Data storage3. Data processing4. Information Output

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The trigger for data input is usually business activity. Data must be collected about:

1. Each event of interest2. The resources affected by each event3. The agents who participate in each

event

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Historically, most businesses used paper source documents to collect data and then transferred that data into a computer.

Today, most data are recorded directly through data entry screens.

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Control over data collection is improved by: prenumbering each source

document and using turnaround documents

having the system automatically assign a sequential number to each new transaction

employing source data automation

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Source Document Function

Sales order Take customer order.

Delivery ticket Deliver or ship order

Remittance advice Receive cash.

Deposit slip Deposit cash receipts.

Credit memo Adjust customer accounts

REVENUE CYCLE

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Source Document Function

Check Pay for items.

Purchase order Order items.

Purchase requisition Request items.

Receiving report Receive items.

EXPENDITURE CYCLE

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HUMAN RESOURCES CYCLE

W4 forms Collect employeewithholding data.

Time cards Record time worked by employees.

Job time tickets Record time spent on specific jobs.

Source Document Function

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GENERAL LEDGER AND REPORTING SYSTEM

Journal voucher Record entry posted togeneral ledger.

Source Document Function

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• Ledger• General ledger• Subsidiary ledger• Coding techniques• Chart of Accounts• Journals• Audit trails

• Ledger

A ledger is a file used to store cumulativeinformation about resources and agents. Wetypically use the word ledger to describe the setof t-accounts. The t-account is where we keeptrack of the beginning balance, increases,decreases, and ending balance for each asset,liability, owners’ equity, revenue, expense, gain,loss, and dividend account.

• Ledger – example:

• General Ledger

The general ledger is the summary levelinformation for all accounts. Detail information isnot kept in this account.

Example: Suppose XYZ Co. has three customers. Anthony Adams owes XYZ $100. Bill Brown owes $200. And Cory Campbell owes XYZ $300. The balance in accounts receivable in the general ledger will be $600, but you will not be able to tell how much individual customersowe by looking at that account. The detail isn’t there.

• Subsidiary ledger

The subsidiary ledgers contain the detail accounts associated with the related general ledger account. The accounts receivable subsidiary ledger will contain three separate t-accounts— one for Anthony Adams, one for Bill Brown, and one for Cory Campbell.

e.g. –accounts receivable–inventory–accounts payable

Relationship between General and Subsidiary ledger

Relationship between General and Subsidiary ledger

• Subsidiary ledger

Advantages:1 Shows transactions affecting one customer or one creditor in a single account2 Frees the general ledger of excessive details3 Helps locate errors in individual accounts4 Reduces the number of accounts in one ledger and by using control accounts5 Division of labor in posting

One employee posts to the general ledger Another employee posts to the subsidiary ledger

• Coding techniques

Coding is a method of systematically assigning numbers orletters to data items to help classify and organize them. There are many types of codes including:– Sequence codes– Block codes– Group codes

•Chart of Accounts

The chart of accounts is a list of all general ledger accounts used by an organization. It is important that the chart of accounts contains sufficient detail to meet the information needs of the organization.

•Journals

In manual systems and some accounting packages, thefirst place that transactions are entered is the journal.

A journal entry is made for each transaction showing the accounts and amounts to be debited and credited.

-General journal-Specialized journal

•JournalsExample

•Audit trails

• Provides a means to check the accuracy and validity of ledger postings. (e.g. page 38)

• An audit trail exists when there is sufficient documentation to allow the tracing of a transaction from beginning to end or from the end back to the beginning.

• The inclusion of posting references and document numbers enable the tracing of transactions through the

journals and ledgers and therefore facilitate the audit trail.

Batch processing is the periodic updating of the data stored about resources and agents

On-line, real-time processing is the immediate updating as each transaction occurs

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FieldRecordData ValueFileDatabase

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The second function of the AIS is to provide management with information useful for decision making.

The information an AIS provides falls into two main categories: Financial Statements Managerial Reports

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Output can serve a variety of purposes: Financial statements can be provided to

both external and internal parties. Some outputs are specifically for

internal use:▪ For planning purposes▪ For management of day-to-day operations▪ For control purposes▪ For evaluation purposes

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Management Functions

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Management Functions

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Problem Structure

•The problem structure reflects how well the decision maker understands the problem.

•Elements of problem structure:•data•procedures•objectives

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Problem Structure

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Managerial reports Report objectives - reports must have value

or information content They should:

reduce the level of uncertainty associated with a problem facing the decision maker

influence the behavior of the decision maker in a positive way

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Managerial reports Goal congruence:

A carefully structured management reporting system and compensation schemes help to appropriately assign authority and responsibility.

If compensation measures are not carefully designed, managers may be tempted to engage in actions not optimal for the organization in the long-run.

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Managerial reports Important to choose what to

measure for your problem.

You get what you measure

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Example:An instructor wants to improve

student performanceHe decides to encourage better

attendance by grading students on attendance (i.e., measuring it).

What is the result?

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Example:Result:Better student attendance

The improved attendance may or may not improve learning outcomes.

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Example:Result: Students may be getting better grades when

attendance is measured, but not learning more. Some students may in fact reduce their

studying because they believe they can use the attendance score to boost their grade. This behavior would be a dysfunctional result of the measurement.

What would be a better method?

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Other inappropriate performance measure examples:

The use of price variance to evaluate a purchasing agent can affect the quality of the items purchased.

The use of quotas (such as units produced) to evaluate a supervisor can affect quality control, material usage efficiency, labor relations, and plant maintenance.

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The AIS must also be able to provide managers with detailed operational information about the organization’s performance.

Two important types of managerial reports are– budget– performance reports

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What is a budget?A budget is the formal expression of

goals in financial terms.One of the most common types of

budget is a cash budget.

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What is a performance report?A performance report lists the

budgeted and actual amounts of revenues and expenses and also shows the variances, or differences, between these two amounts.

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Magic Co. Monthly Performance Report Budget Actual VarianceSales $32,400 $31,500 ($900)Cost of Goods 12,000 14,000 (2,000)Gross Margin $20,400 $17,500 ($2,900)Other Expenses 9,000 7,000 2,000Operating Income $11,400 $10,500 ($900)

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Be careful using budget reports Budgets can cause dysfunctional behavior. Example:

In order to stay within budget, the IT Department did not buy a security package for its system.

A hacker broke in and devastated some of their data files.

Critical security measures were foregone in order to meet budgetary goals.

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Other problems with budget: Budgeting can also be dysfunctional in

that the focus can be redirected to creating acceptable numbers instead of achieving organizational objectives.

Does this mean organizations shouldn’tbudget?

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1) Some people say that accountants should focus on producing financial statements (e.g. balance sheet) and leave the design and production of managerial reports (e.g. performance reports) to information systems specialists.What are the advantages and disadvantages of following this advice?

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2) What are some of the problems that might occur when management focuses only on profit measure based reports? (what areas of the business might suffer as a result?)

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The third function of an AIS is to provide adequate internal controls to accomplish three basic objectives:

1 Ensure that the information is reliable.

2 Ensure that business activities are performed efficiently.

3 Safeguard organizational assets.

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What are two important methods for accomplishing these objectives?

1 Provide for adequate documentation of all business activities.

2 Design the AIS for effective segregation of duties.

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Documentation allows management to verify that assigned responsibilities were completed correctly.

What did Ashton encounter while working as an auditor that gave him a firsthand glimpse of the types of problems that can arise from inadequate documentation?– failure to bill for repair work

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Segregation of duties refers to dividing responsibility for different portions of a transaction among several people.

What functions should be performed by different people?– authorizing transactions– recording transactions– maintaining custody of assets

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Improperly prepared journal entries Unposted journal entries Debits not equal to credits Subsidiary not equal to general ledger

control accounts Inappropriate access to the general

ledger Poor audit trail Lost or damaged data Account balances that are wrong because

of unauthorized or incorrect journal vouchers

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Pre-numbered and well-designed journal vouchers

Validating data on journal vouchers Correcting detected errors before the data

are posted to the general ledger Compiling standardized adjusted

journal entries Pre-computing batch control totals

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Posting journal entries to the general ledger accounts with a variety of program checks performed before and after posting

Summing the amounts posted to the general ledger accounts and then comparing the posted totals to the pre-computed batch control totals

Establishing and maintaining an adequate audit trail

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Preparing frequent trial balances, with any differences between total debits and credits being investigated

Maintaining a log or file of journal vouchers by number and periodically checking to make certain that the sequence of numbers is complete

Printing period-end listings and change reports for review by accountants before the financial statements are prepared

Reviewing financial reports and other outputs for correctness and reasonableness

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Enterprise resource planning (ERP) systems are designed to integrate all aspects of a company’s operations (including both financial and non-financial information) with the traditional functions of an AIS.

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Objectives of the software To ensure full security by introducing

adequate controls, checks and balances and also by maintaining audit Trails.

To minimize data redundancy by eliminating duplicate entries.

To enable the organizations to provide its customers a more value added service.

To create a flexible system so that future needs and changes in the business flow can be easily incorporated

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AdvantagesSecurity and control features

Allows instant communication with all sub-systems of an organization

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Disadvantages Customization of the ERP software is limited. Once a system is established, switching

costs are very high Resistance in sharing sensitive internal

information between departments can reduce the effectiveness of the software.

ERP Systems centralize the data in one place, example customer , financial data. This can increase the risk of loss of sensitive info, if there is any security breach

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