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ACCOUNTING INFORMATION SYSTEM

(Acct-452)

Rift Valley University College


Center for Distance Education

Adama 2010
UNIT ONE

ACCOUNTING INFORMATION SYSTEM: OVERVIEW


Objectives
After studying this unit the reader should be able to:
explain what an accounting information system (AIS) is.
explain functions of AIS
explain sub systems of AIS
explain the difference between transactional processing system VS Enterprise
Resource Planning Systems

explain the different types of information systems.

identify factors attribute for good accounting information system


identify the difference between manual accounting procedure and computerized
accounting system

Introduction
A system is a set of two or more interrelated components that interact to achieve a goal.
Systems are almost always composed of smaller subsystems, each performing a specific
function important to and supportive of the larger system of which it is a part. For example,
the College of Business is a system composed of various departments, each of which is a
subsystem. Yet, at the same time, the college itself is a subsystem of the university.

1.1 What is an Accounting Information System?


An accounting information system (AIS) consists of people, procedures, and information
technology. Thus, an accounting information system (or simply an accounting system) may
be defined as the combination of personnel, records, and procedures that a business uses to
meet AIS its need for financial data.

1.2 Function of AIS


1

AIS perform three important functions in any organization


1 It collects and stores data about activities and transactions so that the organization can
review what has happened.
2

It processes data into information that is useful for making decision that enable
management to plan, execute, and control activities.

It provides adequate controls to safeguard the organizations assets, including its data.
These controls ensure that the data is available when needed and that it is accurate
and reliable.

1.3 Sub Systems of AIS


Most organizations engage in many similar and repetitive transactions. These transaction
types can be grouped into the five basic cycles, each of which constitutes a basic subsystem
in the AIS:
a. The expenditure cycle consists of the activities involved in buying and paying
for goods or services used by the organization.
b. The production cycle consists of the activities involved in converting raw
materials and labor into finished products. (Only manufacturing companies
have a production cycle; retail organizations buy finished goods for resale to
others.
c. The human resources/payroll cycle consists of the activities involved in hiring
and paying employees.(part of expenditure cycle)
d. The revenue cycle consists of the activities involved in selling goods or
services and collecting payment for those sales.
e. The financing cycle consisted of those activities involved in obtaining the
necessary funds to run the organization and in repaying creditors and
distributing profits to investors.
As shown in Figure 1.1, the basic activities in each of the five cycles can be described in
terms of a give-to-get relation. For example, the expenditure cycle entails giving up cash in
order to get goods and services. Similarly, the revenue cycle entails giving up goods and
services in order to get cash. Figure 1.1 also shows how the five cycles (or subsystems) of the

AIS are related to one another and how each feeds data to the general ledger and reporting
system that provides information to both internal and external users.
Financing Cycle
Funds
Get
Cash

Give
Cash

Funds

Funds
Expenditure Cycle

Human Resources Cycle


Get Cash

Get
Labor

Get
Cash

Data

Get
Goods

Data
Data
General Ledger & Reporting
System

Information
For both
Internal and
external users

Data
Labor

Data

Raw Materials

Production Cycle
pRP
Give
Labor

Get
Finished
Goods

Give raw
materials

Revenue Cycle
Get
Goods

Finished
Goods

Get
Cash

Figure 1.1 an AIS and Its Subsystem


Transaction processing system VS Enterprise Resource Planning Systems

Traditionally, the AIS have been referred to as a transaction processing system because it was
concerned only with financial data and accounting transaction. For example, when a purchase
is made the AIS will record a journal entry showing only the date of the purchase, a credit to
either cash or account payable and a debit to stock account. But other important information
about the purchase such as purchase order would be processed out side of the AIS. But the
existence of multiple systems creates a number of problems, often, the same data must be
captured and stored by more than one system, so it creates redundancy across systems and it
can also lead to discrepancies if the data is change in one system but not in others. In
addition, it is difficult to effectively integrate data from the various systems.
To resolve the above problems Enterprise resource planning system recently developed.
Enterprise recourse planning systems integrate all aspect of a companys operations with its
traditional AIS. Thus, when a purchase is made, the effect of transaction automatically flows
to all affected parts of the company. Inventory valuation, production schedule, and to other
affected area.

Self Check Exercise


1. What is accounting information system?
2. What are the functions of AIS?
3. Discuss about the subsystems of AIS.
4. Discuss the difference between Transactional processing system and Enterprise
recourse planning system
1.4 Why Study AIS?

1.4.1 The Study of AIS is Fundamental to Accounting


According to statement of financial accounting concepts No. 2, the primary objective of
accounting is to provide information useful to decision makers. Therefore, it is highly
recommended that the accounting education change commission recommended that the
accounting curriculum should emphasize that accounting is an information identification,
development, measurement, and communication process. The accounting education change

commission suggested that the accounting curriculum should be designed to provide students
with a solid understanding of three essential concepts:

The use of information in decision making

The nature, design, use, and implementation of an AIS

Financial information reporting

The other accounting course that you take (financial accounting, managerial accounting, tax
and audit) focus on your role as a preparer or reporter of information. In contrast AIS focuses
on understanding how the accounting system works: how to collect data about an
organizations activities and transactions; how to transform that data into information that
management can use to run the organization. Thus AIS course complements the other
accounting courses you will take.

1.4.2 The AIS Course Complements Other Systems Courses


There are many other systems courses that cover the design and implementation of
information systems, and that help you develop specialized skills in such areas as data bases
expert systems and telecommunications. The AIS course differs from these other information
system courses in its focus on accountability and control. These issues are important because
in most large business organizations the managers are not the owners. Instead, the owners
have entrusted management with assets and hold them accountable for their proper use.
Data and information are among an organizations most valuable assets. To see why, consider
what would happen if an organization lost all information about what its customers owed it or
if a list of its most profitable customers was obtained by a competitor. Clearly, the AIS must
include controls to ensure safety and availability of the organizations data. Controls are also
needed to ensure that the information produced from that data is both reliable and accurate.
These topics usually receive little attention in other system courses. Thus the AIS course
complements other system courses you may take.
Concerns about data reliability and security are relevant not only to accountants, but also to
all information systems professionals. More over, since typically the AIS is one of the largest
systems in most organizations, information systems professionals should have a basic

understanding of how it works. Thus the AIS course is an important part of the education of
information systems students.

Activity
1. What is the importance of studying AIS?
___________________________________________________________________________
___________________________________________________________________________
1.5 Types of Information System
1.5.1 Data Processing
Electronic data processing (EDP) is the use of computer technology to perform an
organizations transaction-oriented data processing. EDP is a fundamental accounting
information system application in every organization. As computer technology has become
commonplace, the term data processing (DP) has come to have the same meaning as EDP.

1.5.2 Management Information Systems


Management information system (MIS) describes information which supports managers to
make a decision. An MIS provides a wide variety of information beyond that which is
associated with DP in organizations. MIS recognizes that managers with in an organization
use and require information in decision-making, and that computer based information
systems can assist in providing information to mangers. Many organizations apply the MIS
concept to specific functional areas within the organization. Terms such as marketing
information system, manufacturing information system, human resource information system
and financial information system indicate the tailoring of MIS concept to the development of
specific information system to support decision making in a particular, well- defined
organization sub unit.

1.5.3 Decision Support Systems


In a decision support system (DSS), data are processed into a decision making format for
the end user. A DSS requires the use of decision models and specialized databases, and
differs significantly from DP system. A DSS is directed at serving ad hoc, specific, nonroutine information requests by management.
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1.5.4 Expert Systems


An expert system (ES) is knowledge based information system that uses its knowledge about
a specific application area to act as an expert consultant to end-users.

Activity
1. Describe the different computer based information systems?
2. What is the difference between DSS and ES?
1.6 Attributes of Good Accounting Information System

1.6.1 Overview
In designing and developing an efficient and effective accounting information system (or
simply referred to as an accounting system), it is important that certain basic principles be
followed. These principles or design features make accounting systems run efficiently. A
good and an effective system whether computerized or manual-includes the following
features: control, compatibility, flexibility, a favorable cost/benefit relationship, and useful
output.

1.6.2 Control
Managers need control over operations. Internal controls are the methods and procedures
used to authorize transactions and safeguard assets.

1.6.3 Compatibility
A compatible is one that works smoothly with the businesss operations, personnel, and
organizational structure. A compatible accounting information system conforms to the needs
of the business.

1.6.4 Flexibility
Organizations evolve. They develop new products, sell off unprofitable operations and
acquire new ones, and adjust employee pay scales. Changes in the business often call for
changes in accounting system. A well-designed system is flexible if it accommodates changes
without needing a complete overhaul.

1.6.5 Favorable Cost-Benefit Relationship

Achieving control, comparability, and flexibility costs money. These costs reduce a
companys net income, so managers often must settle for less than the perfect accounting
system. They strive for a system that offers maximum benefits at a minimum cost-that is, a
favorable cost/benefit relationship. As a matter of fact, a major consideration in developing
an accounting system is cost. The system must be cost effective; the benefit obtain from the
information must outweigh the cost of providing it. For example, the value of each
accounting report should be at least equal to the cost of producing it.

1.6.6 Useful output


To be successful, information must be understandable, relevant, reliable, timely, and accurate.
Designers of accounting systems must consider the needs and knowledge of the various users
so that the systems out put (reports and statements) will be useful. For example, sales
managers may need weekly reports of sales and factory supervisors may need daily reports of
production. Others with differing responsibilities (such as vice-president) may need such
reports only monthly or quarterly.

Activity
1

Discuss factors attribute for good accounting information system

1.7 Manual Accounting Procedures vs Computerized


Accounting System

1.7.1 Overview
Computerized accounting systems have replaced manual systems in many organizations-even
small businesses. In discussing the three stages of data processing- input, process and outputwe can observe the difference between a computerized accounting system and a manual
accounting system.

1.7.2 Manual vs. Computerized Accounting System


The relationship among the three stages of data processing is shown in Figure 1.2.
Input (Data)

Processing
(Accounting)

Output (Report)

Figure 1.3. The Three Stages of Data Processing


Inputs represent data from source documents, such as sales receipts, bank deposit slips, and
fax orders and other telecommunications. Inputs are usually grouped by type. For example, a
firm would enter cash-sale transactions separately from credit sales and purchase
transactions.
In manual accounting system, processing includes journalizing transactions, posting to the
accounts, and preparing the financial statements. A computerized system also processes but
without the intermediate steps (journal, ledger, and trial balance).
Outputs are the reports used for decision-making, including the financial statements (income
statement, balance sheet, and so on). Many companies make better decisions-and prospering
because of the reports produced by their accounting system. From computers viewpoint, a
trial balance is also a report. But a manual system would treat the trial balance as a
processing step leading to the statements. Figure 1.4 is an overview of computerized
accounting system.
Figure 1.3 Overview of a Computerized Accounting System

Computerized Accounting System


ACCOUNTING RECORDS
Journals
Ledgers
Other records

PERSONNEL
Input transactions, request reports, protect records

Accessed for
reports

Posted
INPUT

HARDWARE
Entered,
edited

Printed to
paper,
screen

OUTPUT

SOFTWARE
DATA

PROCESSING

REPORTS

1.7.3 Summary of the Accounting Cycle: Computerized and Manual


The following table summarizes the accounting cycle under both systems;
Computerized System

Manual System

Start with the account balances in the Same.


ledger at the beginning of the period.
Analyze and classify business transactions
by type. Access appropriate means for data

Analyze and journalize transactions as


they occur.

entry.
Computer automatically posts transactions

Post journal entries to the ledger accounts.

as a batch or when entered on-line.


The unadjusted balances are available
immediately after each posting.
The trial balance, if needed, can be
accessed as a report.
Enter and post the adjusting entries. Print

Compute the unadjusted balance in each


account at the end of the period.
Enter the trial balance on the work sheet,
and complete the work sheet.
Prepare

the

financial

statements.

the financial statements. Run automatic

Journalize and post the adjusting entries.

closing procedure after backing up the

Journalize and post the closing entries.

periods accounting records.


The next periods opening balances are

Prepare the post closing trial balance. This

created automatically as a result of

trial balance becomes step 1 for the next

closing.

period.

Figure 1.4 Comparisons of the Accounting Cycle in a Computerized and a Manual System

Activity 4

10

Compare and contrast manual accounting system VS computerized accounting system


by enumerating their advantages and disadvantages.
______________________________________________________________________
______________________________________________________________________
______________________________________________________________________

Answers to learning activities


Activity
1. Why study AIS?
In Statement of Financial Accounting Concepts No. 2, the FASB...

Defined accounting as an information system.

Stated that the primary objective of accounting is to provide information useful to


decision makers.

The Accounting Education Change Commission recommended that the accounting


curriculum should provide students with a solid understanding of three essential
concepts:
1. The use of information in decision making
2. The nature, design, use and implementation of an AIS
3. Financial information reporting
To understand how the accounting system works.
How to collect data about an organizations activities and transactions
How to transform that data into information that management can use to run
the organization
How to ensure the availability, reliability, and accuracy of that information
Auditors need to understand the systems that are used to produce a companys
financial statements.
Tax professionals need to understand enough about the clients AIS to be confident
that the information used for tax planning and compliance work is complete and
accurate.
One of the fastest growing types of consulting services entails the design, selection,
and implementation of new Accounting Information Systems.
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A survey conducted by the Institute of Management Accountants (IMA) indicates that


work relating to accounting systems was the single most important activity performed
by corporate accountants.

Activity
1. Describe the different computer based information systems?
o Electronic data processing (EDP) is the use of computer technology to perform an
organizations transaction-oriented data processing
o Management information system (MIS) describes the use of computer technology to
provide decision-oriented information to managers.
o In a decision support system (DSS), data are processed in to a decision making format
for the end user.
o An expert system (ES) is knowledge based information system that uses its
knowledge about a specific application area to act as an expert consultant to endusers.
2. What is the difference between DSS and ES?
The difference between the ES and DSS is that DSS assists a user in making the decision,
where as an ES makes the decision.

Activity
2

What are the accounting system principles? , Define them


1. Control. Managers need control over operations. Internal controls are the methods
and procedures used to authorize transactions and safeguard assets
2.

Compatibility. A compatible is one that works smoothly with the businesss


operations, personnel, and organizational structure. A compatible accounting
information system conforms to the needs of the business.

3.

Flexibility. An accounting system should be able to accommodate a variety of users


and changing information needs

4. Favorable cost benefit relationship. Organizations need to strive for a system that
offers maximum benefits at a minimum cost-that is, a favorable cost/benefit
relationship.

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5. Useful output. To be successful, information must be understandable, relevant,


reliable, timely, and accurate

Activity
1

Compare and contrast manual accounting system VS computerized accounting


system by enumerating their advantages and disadvantages.

In general, an accounting system includes the processes and procedures by which an


organizations financial information is received, registered, recorded, handled, processed,
stored, reported, and disposed of.
Manual accounting system is an accounting system that performs data processing manually.
(It will be cost effective only for small firms)
On the other hand, computerized accounting makes use of computers to handle raw data,
manipulate the data, and report the results quickly and accurately
Advantages of computerized accounting system include:
-

It enables to handle complex and large transactions easily;

It increases efficiency, accuracy, speed, and timeliness;

It reduces cost in relation to record keeping (cost per transaction

It handles large volume of data;

It enables efficient storage, computation, retrieval, and auditability;

Disadvantages of computerized accounting system include:


-

High initial cost investment to plan, install, test, and implement the computer system
properly;

Thus, it may not be cost-effective for small firms with lesser volume of data to
process

Initial implementation may be time taking;

It requires specialized skill;

Slow acceptance may there be by employees, clients, creditors, and auditors.

The advantages of computerized accounting will be the disadvantage for manual system
and vice versa.
Summary
13

An accounting information system is a collection of resources designed to transform data in


to information. This information is communicated to wide variety of decision makers. We use
the term accounting information system broadly to include transaction processing cycles, the
use of information technology and the development of information systems.
Most organizations experience similar types of economic events. These events generate
transactions that may be grouped according to four common cycles of business activities:
revenue cycle, expenditure cycle, production cycle, and financial cycle. An internal control
structure consists of the policies and procedures established to provide reasonable assurance
that specific organizational objectives will be achieved. Transaction cycles offer a systematic
framework for the analysis and design of information systems in that there is a similar
objective for each of various cycles. This objective is to be an integral part of an
organizations internal control structure.
The information system function is responsible for data processing. The organizational
structure and location of a large information system department with functional organization
were assumed and common functions within the department were discussed. Office
automation describes the use of electronic messages and documents; the use electronic data
interchange (EDI) computer integrated manufacturing (CIM) etc. organizational context.

Internal control process: a process designed to provide reasonable assurance regarding the
achievements of objectives in reliability of financial reporting, effectiveness and efficiency
of operations, and compliance with applicable laws and regulations.
Production cycle: events related to the transformation of resources into goods and services.
Revenue cycle: events related to the distribution of goods and services to other entities and
collection of related payments.

Transaction processing cycle: consists of one or more application systems.

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User-oriented: a philosophy of design that fosters a set of attitudes and an approach system
development that consciously considers organizational context.

CHAPTER TWO
BASIC FUNCTIONS AND ELEMENTS OF AN ACCOUNTING
SYSTEM

Objectives
After careful study of this section the reader must explain the over all components of an
accounting system.

Overview
An accounting system is comprised of accounting records (checkbooks, journals, ledgers,
etc.) and a series of processes and procedures assigned to staff, volunteers, and/or outside
professionals. The goals of the accounting system are to ensure that financial data and
economic transactions are properly entered into the accounting records and that financial
reports necessary for management are prepared accurately and in a timely fashion.

2.1 Components of an Accounting System


Traditionally, the accounting system includes the following components.
2.2.1 Chart of Accounts
The chart of accounts is a list of each item which the accounting system tracks. Accounts are
divided into five categories: Assets, Liabilities, capital, Revenues, and Expenses. Each
account is assigned an identifying number for use within the accounting system.

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2.2.2 General Ledger


The general ledger organizes information by account. The chart of accounts acts as the table
of contents to the general ledger. In a manual system, summary totals from all of the journals
are entered into the general ledger each month, which maintains a year-to-date balance for
each account.
In a computerized system, data is typically entered into the system only once. Once the entry
has been approved by the user, the software includes the information in all reports in which
the relevant account number appears. Many software packages allow the user to produce a
general ledger which shows each transaction included in the balance of each account.
For example:
Acct. No. 5105 Account Name: Office Supplies
Beginning Balance @ April 30: $1,535.26
Ck. No. 1443 John's Office Supplies 5/12 $347.40
Ck. No. 1451 Quality Paper Store

5/17

$32.89

Closing Balance @ May 31: $1,915.55

2.2.3 Journals and Subsidiary Journals


Journals, also called books of original entry, are used to systematically record all accounting
transactions before they are entered into the general ledger. Journals organize information
chronologically and by transaction type (receipts, disbursements, other). There are three
primary journals:

The Cash Disbursement Journal is a chronological record of checks that are


written, categorized using the chart of accounts.

The Cash Receipts Journal is a chronological record of all deposits that are made,
categorized using the chart of accounts.

The General Journal is a record of all transactions which do not pass through the
checkbook, including non-cash transactions (such as accrual entries and
depreciation) and corrections to previous journal entries.

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As organizations mature, and handle greater numbers of financial transactions, they may
develop subsidiary journals to break out certain kinds of activity from the primary journals
noted above. The most common examples of subsidiary journals include:

The Payroll Journal, which records all payroll-related transactions. This may be
useful as the number of payroll transaction s grows and becomes too large to handle
reasonably within the cash disbursements journal.

The Accounts Payable Journal and Accounts Receivable Journal track income and
expense accruals. These are useful for grouping income and/or expense accruals
which are too numerous to track effectively through the general journal. Some
accounting packages require you to set up all bills as accounts payable and all
revenue as accounts receivable, eliminating the cash disbursements and receipts
journals altogether.

The process of transferring information from the journals to the general ledger is called
posting. Computerized accounting systems often require users to post all income and expense
transactions through the accounts receivable and payable journals. Other automated systems
allow users to post to cash disbursements or receipts journals, but cannot produce detailed
financial information from these journals (such as a list of checks written presented in
numerical order.)
2.2.4 Checkbook
In very small organizations, the checkbook may serve as a combined ledger and journal.
Most financial transactions will pass through the checkbook, where receipts are deposited
and from which disbursements are made. Smaller organizations receiving few or no restricted
contributions find it easier to keep track of financial activity by running all of their financial
transactions through a single checking account. Very small organizations, with few deposits
and disbursements, may prepare reports directly from the checkbook after the balance has
been reconciled with the bank balance.

2.2.5 Accounting Procedures Manual

17

The accounting procedures manual is a record of the policies and procedures for handling
financial transactions. The manual can be a simple description of how financial functions are
handled (e.g., paying bills, depositing cash and transferring money between funds) and who
is responsible for what. The accounting procedures manual is also useful when there is a
changeover in financial management staff

2.2.6 The Accounting Cycle


The accounting cycle may be represented systematically as follows:
financial transactions -> analyze transaction -> record transaction in journals -> post journal
information to general ledger -> analyze general ledger account and make corrections ->
prepare financial statements from general ledger. The routine aspects of the accounting cycle
(recording transactions, posting, etc.) are generally done by bookkeepers or data entry clerks.
Accountants focus on the more analytical aspects of the accounting cycle (analyzing
transactions, preparing financial statements.) Many small organizations rely on a single
individual to perform all of these functions.

2.2.7 Maintaining the Integrity of an Accounting System


The key tasks for maintaining the integrity of an accounting system include the following.
A. Trial Balance
In a manual system all balances from the general ledger are tallied on a monthly basis to
make sure that debit balances equal credit balances. Once debits equal credits, financial
statements can be prepared using trial balance amounts. Computerized accounting systems
almost always produce a trial balance as a built-in report. Many software packages will not
allow you to post an entry to the general ledger until the debit and credit balances are equal.
B. Bank Reconciliation
Each month you will need to reconcile the balance in your checkbook with the balance in
your account according to your bank. This process has three basic steps:
I. Compare deposits and checks as they are recorded in the checkbook with those
reflected in the bank statement. Adjust any discrepancies.
II.

Adjust for bank charges or interest earned into the checkbook balance.

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III.

Subtract un-cashed checks from the bank s balance and add in checks you have
deposited which are not yet reflected in the bank's balance.

Activity 1
1. What are the basic components of an accounting system?
______________________________________________________________________
_______________________________________________________________.

Answer to Activity 1
1. What are the basic functions and components of an accounting system?
1

To collect and store data about the organizations business activities and transactions
efficiently and effectively:
Capture transaction data on source documents.
Record transaction data in journals, which present a chronological record of
what occurred.
Post data from journals to ledgers, which sort data by account type.

To provide management with information useful for decision making:


In manual systems, this information is provided in the form of reports that fall
into two main categories:

financial statements

managerial reports

To provide adequate internal controls:


Ensure that the information produced by the system is reliable.
Ensure that business activities are performed efficiently and in accordance
with managements objectives.
Safeguard organizational assets.

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UNIT THREE
REVENUE CYCLE AND CASH RECEIPT CYCLE
Objectives
After careful reading of this unit the reader must be able to:

describe the major features and operations in a sale order application system.

describe the major features and operations in an accounts receivable


application system.

draw a flow diagram (dfd) for sales order application system.

draw a flow diagram for accounts receivable application system.

describe the features and controls in cash receipts application system

draw a flow diagram that shows cash receipt application

describe a major functions in cash receipts application system

Introduction
Most enterprises, both for profit and not for profit, generate revenue through activities that
constitute their revenue cycle. The revenue cycle is the simplest form if the direct exchange
of finished goods or services is made on cash in a single transaction between a seller and a
buyer and is more complex when sales is processed on credit basis. Many days or weeks may

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pass between sales processing and the subsequent receipt of cash. This time lag splits the
revenue transactions into two phases:
1. the physical phase, involving the transfer of assets or services from seller to the buyer
2. the financial phase, involving the receipt of cash by the seller in payment of the
account receivable
Hence, the revenue cycle actually consists of two major subsystems (assuming sales on credit
basis):
1. the sales order processing system and
2. the account receivable system

.3.1 Sales Order Processing


A sales order application system comprises the procedures involved in accepting and
shipping customer orders and in preparing invoices that describe products services, and
assessment.
The sales order is the interface between the various function necessary to process a
customer order. These functions are sales order, credit, finished goods, shipping, billing,
accounts receivable, and general Ledger.

3.1.1 The Sales Department


The sales process begins in the sales department with the receipt of a customer order
indicating the type and quantity of merchandise being requested.
The sales order captures such vital information as the name and address of the customer
making the purchase; the customers account number; the name, number, and description of
the items sold; the quantities and unit prices of each item sold, and other financial
information such as taxes, discounts, and freight charges.
After processing sales order the sales department produces multiple copies of sales order to
distribute for credit authorizations, packing slips, stock release documents, shipping notices,
sales invoices, and ledger posting. In an actual system, the various sales order copies would
be numbered or color-coded to signify their purpose and distribution. After preparing the

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sales order, the sales clerk files one copy of it in the customer open order file for future
reference to facilitate communication with customer in their order status. To facilitate
customer inquiries, the open order file should organize and filed alphabetically by customer
name.

3.1.2 Credit Departments


A credit department is responsible to determine whether the customer is credit worthy or not
before the shipment of goods made. For regular customers, the credit check involves
determining that the total amount of credit granted does not exceed managements general or
specific authorization. For new customers, a credit check is necessary to establish the terms
of sale to the customer. The sales order function and credit valuation should be separated to
maintain good internal control system by separation of duties.
Once credit has been approved, the sales order function distributes the sales order set. One
copy of each sales order is forwarded to billing, allowing the billing function to anticipate the
receipt of matching shipping advices from the shipping function. One copy-usually called the
packing slip copy-is forwarded to shipping. This copy authorizes shipping to receive goods
from finished goods for shipping. Another copy-usually called the stock copy-is forwarded
to finished goods. This copy authorizes stores to release goods from its custody for shipment
to customers.
In some cases, a customers order may require that a production order be issued to produce
the goods, because the goods are not in stock. Such situations arise when the order is for a
special nonstick item or they are customized in their nature.

3.1.3 Finished Goods Department


The sales department sends the stock release (also called the picking ticket) copy of the sales
order to the warehouse. This document identifies which items of inventory must be located
and picked from the warehouse shelves. It also provides formal authorization for the
warehouse clerk to release custody of the specified assets. After picking the stock, the clerk
initials the stock release copy to indicate that the order is complete and accurate. Any out-ofstock items are noted on the stock release copy. One copy of the stock release travels with the
goods to the shipping department, and the other is filed in the warehouse to provide a record
of the transaction. Shipping should sign the stock copy to acknowledge receipt of the
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quantities noted thereon from finished goods. The clerk then adjusts the stock records to
reflect the reduction in inventory. The stock records are not the formal accounting records for
these assets. Charging the warehouse clerk with responsibility for asset custody and recordkeeping would be a weakness in internal control. The inventory accounting records are kept
in the inventory control department.

3.1.4 Shipping Department


Before the arrival of the goods and the stock release copy, the shipping department receives
the packing slip and shipping notice copies from the sales department. The packing slip
travels with the goods to the customer to describe the contents of the order. The shipping
notice informs the billing department that the customers order has been filled and shipped.
This document contains such pertinent facts as the date of shipment, items and quantities
shipped the carrier, and freight charges.
Upon receiving the goods from the warehouse, the shipping clerk reconciles the physical
items with the stock release documents, the packing slip, and the shipping notice to verify the
correctness of the order. This is an important step and the last opportunity to detect errors
before shipment. This shipping clerk packages the goods, attaches the packing slip to the
container, completes the shipping notice, and prepares a bill of lading. The bill of lading is a
formal contract between the seller and the shipping company (carrier) that transports the
goods to the customer. This document establishes legal ownership and responsibility for
assets in transit.
The shipping clerk transfers custody of the goods, the packing slip, and two copies of the bill
of lading to the carrier, then performs the following tasks:
1. Records the shipment in the shipping log
2. Sends the stock release document and the shipping notice to the billing department as
proof of shipment.
3. Files one copy each of the bill of lading and the shipping document.

3.1.5 Billing Department


Shipping forwards documentation of the shipment to the billing function.

This

documentation is termed the shipping advice and is usually the stock copy of the sales order
and a copy of the bill of lading. Billing pulls the related open order documentation, verifies
23

the order, then prepares the invoice by extending the charges for actual quantities shipped,
freight charges (if any) , and taxes (if any). Invoices are mailed to customers. Invoices are
recorded in the sales journal and posting copies are sent to accounts receivable. Sends the
shipping document to the sales department to close the open customer file. Periodically, a
journal voucher is prepared and forwarded to the general ledger function for posting to the
general ledger.
The sales journal is a special journal for recording sales transactions. Each sales invoice is
entered in the journal as a separate item. At the end of the period the clerk summarizes these
entries and prepares a journal voucher that is sent to the general ledger for posting.
Each journal voucher represents a general journal entry and identifies the general ledger
accounts affected. Current transactions, adjusting entries, and closing entries are all entered
into the general ledger.

3.1.6 Accounts Receivable Department


The accounts receivable department posts from the ledger copy of the sales order to the
customer accounts in the accounts receivable subsidiary ledger.
Each ledger copy of the sales order increases a customers account for the full amount of the
sale. After posting, the AR clerk files the ledger copy. Periodically, the clerk summarizes the
individual account balance into a single figure and sends this to the general ledger.

3.1.7 General Ledger Department


By the close of the processing period, the general ledger has received journal vouchers from
the billing and an account summary from the accounts receivable department.
The account summary independently provided by the accounts receivable department is used
to verify the internal accuracy of the overall process. By reconciling journal vouchers and
account summaries received from operating departments, the general ledger can detect many
types of errors.
The above-discussed functions in an organization's sales order application are clearly shown
on the following flow diagram.

24

A data flow diagram for sales order application system


8
Credit

Finished
Goods

Shipping

5
9

Customer

Sales order

6
Billing

11 A/R

10

13
12

G/L

Details
Customer
Data

Data flow key


1. Order
2. Sales order
3. Approved sales order
4. Shipping order
5. Packing slip
6. Billing memo
7. shipping advice
8. shipment
9. shipping advice
10. invoice
11. posting memo
12. journal voucher
13. Control total.

25

Activity 1
1. What is the difference between billing and accounts receivable function?
___________________________________________________________________________
___________________________________________________________________________
3.2 Transaction Flows in Account Receivable Systems

Overview
Accounts receivable represents that money owed by customers for merchandise sold or
services rendered. Since most of the sale in modern business made on credit, accounts
receivable often represents the majority of an organization's working capital. Accounts
receivable also maintains customer credit and payment history information, which is useful
in the overall administration of company credit policies. Account receivable systems includes
the followings.

3.2.1 Cash Receipts Department


The mail room under cash receipt department receives customers check along with a source
document called the remittance advice. The remittance advice is a portion of the original
invoice used to bill the customer. When payment is made, the customer tears off the
remittance advice portion and return it to the seller with the cash payment.
The cashier verifies the accuracy and completeness of the checks against the remittance
advice. After reconciling, the cashier records the cash receipts in the cash receipts journal.
Next, the clerk progress a bank deposit slip in triplicate showing the total amount of the days
receipts and forwards the checks and two copies of the deposit slip to the bank. Upon the
deposit of the funds, the bank teller validates the deposit slip and returns a copy to the
controller.
Customer remittance sips are then forwarded to account receivable for posting from cash
receipts department. Accounts receivable does not have access to the cash or checks that
accompany customer remittance.

26

3.2.2 Billing
Invoices, credit memos, and other invoice adjustments are routed to accounts receivable for
posting to the customer accounts. This maintains a separation of functions. Billing does not
have direct access to the accounts receivable records.

3.2.3 Accounts Receivable


A company is responsible for maintaining the subsidiary accounts receivable ledger. A
control account is maintained in the general ledger department. Debits and credits are posted
to the customer accounts from the posting media-remittance advices, invoices, and so onreceived from billing and cash receipts. This maintains separation of functions. Periodically,
customer statements are mailed directly to customers by the accounts receivable department.
Periodic processing also includes the preparation of an aged trial balance of the accounts
receivable subsidiary ledger for review by the credit department. Other types of customer
credit reports may be prepared based on the needs of the company. Such reports are often
prepared as a by-product of the processing required to send customers their statements.

3.2.4 Credit
Credit department functions in an accounts receivable application system include the
approval of sales returns and allowances and other adjustments to customer accounts, the
review and approval of the aged trial balance to ascertain customers creditworthiness, and
the initiation of write-off memos to charge accounts to bad-debt expense.

3.2.5 General Ledger


General ledger maintains the accounts receivable control account. Debits and credits are
posted to the accounts receivable control account from the journal vouchers/control totals
received from billing and cash receipts. These amounts are reconciled to the control totals
sent to the general ledger directly from accounts receivable, this reconciliation is an
important control in the accounts receivable application system.

3.2.6 Write-off of Accounts Receivable


The central feature in a write-off procedure is an analysis of past due accounts, usually done
with an aged trial balance. Numerous techniques are available to collect past due accounts
(e.g., follow-up letters, collection agencies), but some accounts are ultimately worthless. In
this case the credit manager initiates a write-off, which is approved by the treasure. On

27

approval, accounts receivable is authorized to write off the account. A copy of the
authorization is also sent to an independent third party (internal audit) for purposes of record
keeping. This is necessary because after the write-off, accounts receivable no longer has an
active record of the account. Note that internal audit confirms write-offs directly with the
customer to ensure that no collections have been made on written-off accounts. An employee
might intercept a customers payment on account and then arrange for the account to be
written off, so that the customer does not continue to be billed for the amount.
The above functions will be shown with a flow diagram below.
2

Cash receipts

G/L

Customer data

Customers
12

Accounts
receivable

Details

13
11

Receiving
8

Internal audit

9
7

14

Credit
manager

5
4

Billing

6
Treasurer

15

28

Data flow key


1. remittance advices
2. control total
3. sales return memo
4. sales return advice
5. credit memo
6. write off memo
7. write off advice
8. aged trial balance
9. journal voucher
10. control total
11. worthless account list
12. statements
13. total write offs
14. write off confirmation
15. write off memo

Activity 2
1. What is the role of credit department in the accounts receivable application system?
___________________________________________________________________________
___________________________________________________________________________
2. What is ageing analysis?

3.3 Cash Receipts Application System

Overview
This is an application system used to control the flow of information and documents
regarding cash receipts. Most of a companys cash receipts are generated though sales. Sales,
of course, may be made either for cash or on account. Although sales accounts are handled
through the companys billing and collection system, the end product of sales on account and
subsequent billings is the receipt of cash.

29

3.3.1 Cash Received on Account Application System


In order to have appropriate internal control on receipt of cash the company should separate
the followings functions.
A. Mailroom
Customer remittances on account are received in the mailroom. The mail is opened and the
checks and remittance advices are separated. Checks are restrictively endorsed and totaled. A
remittance list that documents the payments received is prepared. The remittance list is
balanced to the total of the checks received, and the agreement of these amounts is approved.
A copy of the remittance list and the remittance advices are forwarded to accounts receivable.
The checks and a control total are forwarded to cash receipts for deposit. A copy of the
remittance list and the control total are filed by date.
B. Cash Receipts
The basics objective in any cash receipts application is to minimize exposure to loss.
Procedures such as immediate deposit of receipts intact centralization of cash handling,
maintenance of minimal cash balances and immediate recording of cash transactions are
fundamental control techniques. Physical safeguards such as cash registers, vaults, immediate
endorsement of checks, and limited access to cash areas are generally necessary as well.
Checks received from the mailroom are combined with cash receipts, and a deposit slip is
prepared in three copies. The remittance slip and control total received from the mailroom are
balanced to the deposit slip, and the agreement of these amounts is approved. The remittance
list is then used to post the amount of the payments received from the mailroom into the cash
receipts journal. A journal voucher is prepared and forwarded to the general ledger. The
remittance list, control total, and a copy of the deposit slip are filed by date. The deposit is for
warded intact to the bank.
C. Accounts Receivable
The remittance advices are posted to the accounts receivable ledger. The postings to the
ledger are totaled. The control total is balanced to the remittance list. The agreement of these
amounts is approved. The remittance advices are sorted and filed by customer. The
remittance list and a copy of the control total of postings are filed by date. A copy of the
control total is forwarded to the general ledger.

30

D. General Ledger
The journal voucher from cash receipts and the control total received from accounts
receivable are compared. The amounts are then posted to the general ledger. The source of
posting the general ledger is the cashiers journal voucher notification of the amount of the
deposit of the payments received. This amount must agree with the total of items posted to
the accounts receivable ledger. The journal voucher and the control total are filed by date.
E. Bank
The bank accepts the deposit and validates a copy of the deposit slip. The validated copy
of the deposit slip is returned to Internet audit. The validated deposit slip is filed by date.
F. Internal Audit
Internal audit receives the periodic bank statement. Independent bank reconciliation is a
significant control in a cash-received on account application system.
To control incoming cash received through the mail, it is important that no one in the
mailroom (where the correspondence is opened), in the cashiers office (where the money
is summarized and a deposit prepared), or in the accounts receivable section (where the
assert reduction is recorded) has complete control over the transaction. In many systems,
the invoice or statement that is sent to a customer is prepared in such a way that the
portion with the name and address of the customer is returned with the payment. This is
common with telephone, utility, and department store invoices, and provides good
documentation for the payment
The source of posting the general ledger is the journal voucher notification issued by the
cashier indicating the amount of the deposit of cash receipts. This amount must agree
with the accumulated total of the items posted to the subsidiary receivable file. Validated
copies of the deposit slip go to the internal auditor, who uses them when reconciling the
ban account. The control of actual cash (as opposed to checks) received by mail relies
largely on direct supervision.

31

G. Remittance advice
Send to: FTR Corporation
Mauritius road, P. O. Box, 12445
Addis Ababa
Remittance advice
Date

costumes No

Amount paid

check No

____________________________________________________________
Please return the upper portion with your payment thank you
To: Selam- Saffron
Tanzania road
P. O. Box: 2542
Addis Ababa
Due data

Dat
a

customer No

Invoice No

Designatio
n

Amount clue

Amount
due.

Tank you for giving FTR corporation the chance to serve you
Previous balance
Payments
Credits
Late fees
Tax
Ending balance

3.3.2 Cash Sales Application System


32

The significant difference between a cash sales application system and cash received on
account application system is that there is no previous asset record (customer account
balance) in a cash sales system. The generation of initial documentation is thus the focal
point of the control system. Once a record has been prepared, cash sales are subject to
accounting control. The major feature of this system is the separation of the following
functions:
A. Finished Goods
The finished goods department has custody of the assets that are available for sale to
customers. Sales to customers are documented on sales orders. A sales order indicates the
amount due for the purchase as well as the inventory control numbers of the items being sold.
B. Cash Receipts
The customer takes a copy of the sales order to cash receipts. The cash receipts department
records the sale in a cash register or other secure device, accepts the customers payment, and
issues a sales receipt (two copies) to the customer. Number files the sales order. At the end of
the day, the daily cash summary is generated and includes a control total of the days cash
sales. One copy of this total is forwarded to the general ledger: the other copy is filed by date.
C. Billing
Sales orders are reviewed by reasonableness and posted to the sales journal. Any inventory
control information contained on sates could be processed at this point. A journal voucher is
prepared to summarize cash sales. The sales orders are filed by date. The journal voucher is
forwarded to general ledger.
D. General Ledger
The journal voucher from the billing department and the control total received from the cash
receipts department are compared. The amounts are then posted to the general ledger. Note
that the source of posting the general ledger is the journal voucher notification by billing
indicating the amount of sales orders received. This amount must agree with the total of the
cash received from customers by cash receipts. Finished goods do not release goods until the
customer returns from the cash receipts department with a sates receipt. The goods are
released with the sales receipt. A copy of the sales receipt is filed in the finished goods
department.
Data flow diagram- cash receipt application system
1

Stores

Billing
33

2
3
5

7
Cash
Receipts

Customer

G/L

12
13

14
9
Bank
Mailroom

10

A/R
Details

11
15

Customer
Data

Internal audit

Data flow key


1. cash sales
2. sales slip
3. sales slip
4. sales receipt
5. goods released
6. journal voucher
7. control total cash sales
8. mail receipts

9. checks
10. remittance advice
11.control total mail receipts
12. journal voucher
13. deposit
14. deposit slip
15. bank statement

Activity 3
1. What are the basic objectives in any cash receipts application?
___________________________________________________________________________
___________________________________________________________________________

Answers to learning activities


34

Learning activity 1
1. What is the distinction between billing and accounts receivable?
The distinction between billing and accounts receivable is important to maintain
separation of functions. Billing is responsible for invoicing individual sales transactions,
and accounts receivable maintains customer- accounts information and sends periodic
statements of account to customers. Billing does not have access to the financial records
(the receivable ledger), and the financial records are independent of the invoicing
operation.
Learning activity 2
1. What is the role of credit department in the accounts receivable application system?
Credit department functions in an accounts receivable application system include the
approval of sales returns and allowances and other adjustments to customer accounts, the
review and approval of the aged trial balance to ascertain customers creditworthiness, and
the initiation of write-off memos to charge accounts to bad-debt expense.
2. What is ageing analysis?
Ageing analysis involves the review of individual subsidiary account receivable, thereby
determining the number of day an account is past due from the due date. It usually involves
determining the age of the account and assigning the related probability of uncollectible.
Learning activity 3
1. What are the basic objectives in any cash receipts application?
The basics objective in any cash receipts application is to minimize exposure to loss.
Procedures such as immediate deposit of receipts intact centralization of cash handling,
maintenance of minimal cash balances and immediate recording of cash transactions are
fundamental control techniques. Physical safeguards such as cash registers, vaults, immediate
endorsement of checks, and limited access to cash areas are generally necessary as well.
Checks received from the mailroom are combined with cash receipts, and a deposit slip is
prepared in three copies. The remittance fist and control total received from the mailroom are
balanced to the deposit slip, and the agreement of these amounts is approved. The remittance
list is then used to post the amount of the payments received from the mailroom into the cash
receipts journal. A journal voucher is prepared and forwarded to the general ledger. The
remittance list, control total, and a copy of the deposit slip are filed by date. The deposit is for
warded intact to the bank.

35

Check Your Progress


1. Which of the following departments should mach shipping documents with open sales
orders and prepares daily sales summaries?
A. Billing
B. Sales order
C. Accounts receivable
D. Shipping
2. Which of the following departments should normally be responsible for the preparation
and journalizing of credit memos upon the receipt of approved sales return memos to
authorize a reduction in customers balances because of returned goods?
A. Receiving
B. Accounts receivable
C. Credit
D. Billing
3. Which document often accompanies merchandise shipped to a customer?
A. Picking list
B. Packing slip
C. Credit memo
D. Sales order
4. Which activity is part of the sakes order entry process?
A. Setting customer credit limits
B. Preparing a bill of lading
C. Checking customer credit
D. Approving sales returns
5. For good internal control credit memos should be approved by the
A. Credit manager
B. Sales manager
C. Billing manager
D. Treasurer

36

1. For adequate internal control, the department responsible for preparing checks for
signature should be
A. The department that signs the checks.
B. The accounts payable department
C. The purchasing department
D. The treasury department
2. In cash receipts application system, the remittance list is prepared in the mail room should
be directly forwarded to
A. Finished goods
B. Billing
C. Accounts receivable
D

General ledger

. In a cash receipts application system, the cash remittances received in the mail room should
be directly forwarded to
A. Cash receipts
B. Billing
C. Accounts receivable
D. General ledger

37

Summary

The sales process begins with a customer contacting the sales department. This initial
contact may be by telephone, mail, or in person. The sales department captures the
essential details of this event on a sales order. This information triggers a number of
tasks.

The first step in the sales process is to authorize the transaction by obtaining credit
approval for the customer.

When credit is approved, the sales information is released to the billing, warehouse,
and shipping processes.

The next step is to ship the merchandise, which should be done as soon after credit
approval as possible. If required to wait too long, the customer may cancel the order
and go elsewhere. The shipping process reconciles the products received from the
warehouse with the sales information that it received earlier. This reconciliation
ensures that the firm sends the correct goods to the customer. If an error has occurred,
such as the warehouse releasing the wrong products or quantities, the problem should
be detected at this point. Assuming all is well with the order; the goods will be packed
and shipped via common carrier to the customer. The shipping information is then
sent to the billing process.

The billing process compiles the relevant facts about the transaction (product prices,
handling charges, freight, taxes and discount terms) and bills the customer. The
billing department then transmits this information to the accounts receivable and
inventory control processes.

Accounts receivable receives the billing information and records this in the
customers account.

Likewise, inventory control uses information from billing to adjust the inventory
records to reflect a decrease in inventory.

Periodically (after each batch, daily, weekly, monthly, or so forth) the billing,
accounts receivable, and inventory control transmit summarized information to the
general ledger process. This includes: (1) the total of all sales from billing; (2) the
total increases to accounts receivable. From this information, the general ledger posts

38

to the control accounts affected by sales transactions during this period. In addition,
the general ledger process reconciles these independently compiled summaries to
identify record-keeping errors. For example, if billing had failed to bill a customer or
accounts receivable had recorded an incorrect amount, a discrepancy between their
summarized figures would be detected in the general ledger process.
Cash receipts are obtained from four major sources:
(1) Collection on accounts receivable and cash sales
(2) Conversion of other assets into cash
(3) Bank loans, bond issues and sales of stock
(4) Refunds from suppliers
Answers to Check your Progress Questions
1. A
2. D
3. B
4. E
5. A
6. B
7.

8.

39

UNIT FOUR
THE EXPENDITURE, RECOURCE MANEGEMENT AND
CASH DISBURSEMENT CYCLE
Objectives
After careful reading of this unit the reader must be able to:
-describe the major features and operations in a purchasing application system.
-describe the major features of and operations in resource management or payroll application
system.
-draw/understand a flow diagram for a purchasing application system
-draw/understand a flow diagram for Resource management or payroll application system.
-describe the major features and controls in cash disbursement
-draw/understand a flow diagram for cash disbursement application
-describe major functions in cash disbursement application system
Introduction
An organization's expenditure cycle includes the function required to acquire goods and
services that are utilized by the organization in conducting its operations. The expenditure
cycle includes the acquisition of goods for resale or use in production, the acquisition of
property and equipment and the acquisition of person service.
The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash
disbursement system and the applicable parts of the general ledger system.
Expenditure cycle Operations include:-

The preparation of purchase and recording of purchase order.

The receipt of goods and the recording of the cost of inventory.

The receipt of vendor invoices and the recording accounts payable.

The preparation of employee pay-checks and the recording of payroll activities.

The preparation and recording of cash disbursements, including payroll.

40

Purchasing
Accounts payable cash
disbursement system

General ledger
System

Expenditure
Cycle Inventory
System
Payroll system

The Over all Expenditure Cycle


4.1 System Definition and Functions in Purchase Application System

Overview
In some companies, all purchases of goods and services are channeled through and controlled
by centralized purchasing department. In others, the authority to place orders with vendors is
dispersed through out the company- a decentralized approach. Centralized purchasing may
yield increased quantity discounts stronger market position, better inventory control, buyer
specialization, and the like. Decentralized purchasing may also have some benefits because
of fast responsiveness of the purchaser and decentralized buyers may have greater knowledge
of the use and specifications of the desired goods and thereby maintain optimal inventory
levels. As in any organizational decision, the choice is largely one of management style and
philosophy.

41

4.1.1 System Definitions and Functions


The purchasing (p) /accounts payable (AP) / cash disbursement (CD) system is an interacting
structure of people, equipment, methods, and controls that is designed to accomplish the
following primary functions:First the P/AP/CD Systems handle the repetitive work routines of the departments listed by
capturing and recording data related to the day-to-day operations of those departments. The
recorded data then may be used to generate source documents (such as purchase orders and
receiving reports) and to produce internal and external reports.
Second the P/AP/CD system prepares a number of reports that support personnel at various
levels for different decisions will be used through out the paper:
Description of Information flows
1- Purchase requisition sent from inventory control department to purchasing
department.
2- Purchase requisitions from various other departments sent to purchasing department.
3- Purchase order sent to vendor.
4- Purchase order notification sent to various other departments or to inventory control
department.
5- Purchase order notification sent to receiving department.
6- Purchase order notification sent to accounts payable department.
7- Goods and Services received from vendor.
8- Receiving notification sent to accounts payable department.
9- Receiving notification sent to purchasing department.
10- Invoice received from vendor.
11- Approved voucher sent to cashier.
12- Accounts payable notification and inventory cost information sent to general ledger
system.
13- Check sent to vendor by cashier.
14- Paid voucher returned to accounts payable department.
15- Notification of the cash disbursement sent from cashier to general ledger system

42

The process associated with reordering inventory involve several important concept and
techniques, such as cyclical reordering, reorder point analysis, economic order quantity
(EOQ) analysis, and ABC analysis.
A purchase application system includes the five basic functions:
1/ Purchase requisition is prepared & approved.
2/ Purchase order issued.
3/ Materials received.
4/ Establish payable
5/ Checks are prepared.
1. Purchase requisition
A department which requires a material prepare a purchase requisition and send to a purchase
department.
2. Order Goods and Services
To place an order for goods and service the buyer first involve in vendor selection and then a
potential vendors will be evaluate with respect to such factors as unit price, quality, service,
promised delivery dates, terms, reliability, and amount purchased from the vendor to date.
3. Receive Goods and Services
When good arrive at the receiving department, it wills inspect and counted. This process
helps to insure that the right goods in a correct amount are received in acceptable condition
and nonconforming goods are rejected (returned) to the supplier. Notation of rejected goods
is added to the vendor service record in the vendor master file.
Once the condition of the goods has been approved the process of complete receiving report
by noting the quantity received on the approved purchase order receiving notification. Once
annotated with the quantity received the purchase order receiving notification become a
receiving report, which is the document used to record merchandize receipts.
As in the case of the receipt of goods, services received also should be documented properly.
Some organizations use an acceptance report to acknowledge formally the satisfactory

43

completion of a service contract. The acceptance report supports the payment due to the
vendor in the same way as the receiving report.
4. Establish Payable
The first step in establishing the payable involves validating the vendor invoice. This process
is triggered by receipt of the vendor invoice, a business document that notifies the purchaser
of an obligation to pay the vendor for goods or services that were ordered by and shipped to
the purchaser.
The process comprises a number of steps. First, the vendor invoice is compared against data
on a copy of the purchase order (Po accounts payable notification) to make sure that (1) the
purchase has been authorized and (2) invoices quantities, prices and terms conform to the
purchase order agreement. Next, the invoice is matched against the receiving report to
determine that the goods or services actually have been received and that goods have been
transferred to stores. Finally, the invoice is cheeked for accuracy of computed discounts,
extension, and total amount due.
If the data items do not agree, the invoice is rejected and follow up procedures are initiated.
If the data item agrees, the invoice is approved and the validated invoice is then used to
record the payable. Note that the vendor master file is also updated at this point to reflect
purchase history data.
A payable is recognized and recorded by simultaneously:

Creating a record on the accounts payable master file.

Updating the inventory master file for the cost of the item received.

Notifying the general ledger system of the amount of the payable that was recorded
( see the data flow "GL payable update")
5. Make Payment

The payment schedule adopted will depend on the availability of any favorable discounts for
prompt payment and on the organizations current cash position. Some companies will pay
multiple invoices with one check to minimize the cost of processing invoices. Most cash
managers will attempt to optimize cash balances to help achieve a fourth system goal. that is
to insure that the amount of cash.

44

Data flow diagram for purchase application system.


6
Receiving
7
5
Purchasing

Stores

10
4

11

A/P

Details

Vendor

Cash
Payment

13

12

Vender
Data
Data flow key
1. Requisition
2. Acknowledgement
3. Purchase order
4. Purchase advice
5. Receiving advice
6. Shipment
7. Receiving advice
8. Receiving report
9. Notice of receipt
10. Invoice
11. Approved invoice
12. Voucher package
13. Payment
45

4.1.2 Processing Non Invoiced Disbursements


Disbursements that are not typically supported by invoices such as, repayment of debt
obligation and interest and the like. In this case we may have a true voucher system and a
non voucher system. In a true voucher system the expenditure and payable recognize before
cash payment is made. But in a non-voucher system payable is not recognize before cash
payment is made.
The following diagram is a logical data flow diagram that shows the processing of noninvoiced payments under two different assumptions:
(1) A true voucher system is used in which all expenditures must be vouched that is,
formally approved for payments and recorded as a payable before they can be paid, and
(2) A non-voucher system is employed.

46

1/ assuming a true voucher system is used.

Payment

requiest
Originating
Department

Disburse
ment

Prepare

disbursement
voucher

GL

record
disbursement
voucher

General
ledger

Vouchers
Payable
Master File

GL cash
disburse
ment

Check

Payment notification

Prepare

Issue cheek

check

and
record
Payee
Payment

47

ash disbursement

transaction file

2/ assuming a non-voucher system is used.

48

Activity 1
1. Describe the major functions in purchase application system?
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Distinguish between accounts receiving and stores
___________________________________________________________________________
___________________________________________________________________________
4.2 Recourse Management or Payroll System

Overview
A payroll / personnel system involves all phases of payroll processing and personnel
reporting. The system provides a means of promptly and accurately paying employees,
generating the necessary payroll reports, and supplying management with the required
employee skills information. The processing should include a deduction for with holding
taxes, specialized deductions, government reporting, and internal personnel requirements. An
efficient system is necessary to establish and maintain good employer-employee
relationships.
4.2.1 System Function in Payroll Application Program
Two data flows enter the payroll system from departmental managers and supervisor's
attendance time records and job time records. Attendance time records shows the time period
that employees are in attendance at the job site and available for work. These records are
used to calculate the gross amount of each employees pay. Job time records on the other hand
reflect that start and stop times on specific jobs. Their purpose is to allow the distribution of
payroll costs to jobs in process (or to other accounts).
Attendance time records maintained near the entrance of the workplace and after take the
physical form of time sheets that are stamped as employees come and go. Job time records
are prepared at the worksite by employees entering the time each job is started and stopped.

49

"Reconcile hours worked" compares the total hours of each works as shown by at the
attendance time record with the hours reflected on the job time records for that employee.
The hours should agree. This reconciliation's is one of the payroll system control plans.

A. Personnel
The personnel office is responsible for placing people on the companys payroll, specifying
rates of pay, and authorizing all deductions from pay. All changes such as adding, or deleting
employees, changing pay rates, or changing levels of deductions from pay must be
authorized by the personnel office. The personnel function is distinct from time keeping and
from payroll preparation function.
B. Time keeping
The time keeping function is responsible for the preparation and control of time reports and
job time tickets. In manufacturing firm, an hourly employee typically clocks on and off of the
job. At the end of the period, the employee's time card or time report indicates the amount of
time that the employee was on the job and the time that he or she expects to receive pay for.
Time keeping is responsible for collecting and maintaining time cards and reconciling these
data to job time summary reports that are received from production.

C. Payroll
The payroll department is responsible for the actual computation and preparation of payroll.
Note that preparing payroll is independent of preparation of the input data on which pay is
based, the time reports and personnel data. Personnel data are received from the personnel
office; time reports are received from time keeping. The payroll register details the
computation of net pay (gross pay less deductions from pay). Pay checks are sent cash
payment for signature, review, and distributions. A copy of the payroll register is sent to
accounts payable to initiate the recording of a voucher for the payroll.

50

Data flow diagram for payroll application system (for manufacturing firm)
1

Personnel

Production

Payroll data

Time
Keeping

Payroll

Details

Payee
10

6
12
4

Cash
Payment

11

Bank

7
Cost
Distribution

A/P
14

13
8

G/L

Internal
audit

51

Data flow key


1. authorization

8. voucher

2. job time summary

9. journal voucher

3. job time cards

10. paychecks

4. job time report

11. voucher check

5. payroll register

12. canceled checks

6. paychecks

13. bank statement

7. voucher check

14. control total

Activity 2
1. Describe the major features of and operations in a payroll application system
________________________________________________________________________
________________________________________________________________________
4.3

Cash Disbursement Application System

Overview
Cash disbursements result primarily from payments to vendors (accounts payable) and
employees (payroll). The cash disbursement application system should separate the following
functions Objectives
4.3.1 Accounts Payable
The accounts payable department receives copies of the purchase requisition, purchase order
receiving report and vendor invoice. These documents are reviewed, certified as to
completeness, and assemble in a voucher package. The voucher package is filed by date.
Periodically the voucher package file is reviewed and voucher packages that are due are
pulled for payment. Accounts payable performs payment processing calculating the amount
due, discount (if any), and other such items. A voucher check is prepared for each voucher.
Voucher checks are posted to the voucher register. A total of these postings are prepared.
Voucher packages are posted to the accounts payable ledger. This posting is summarized on a
journal voucher and a distribution voucher. The voucher checks, voucher packages, and
control total are approved and forwarded to the cash disbursements department. The journal

52

voucher is forwarded to general ledger. The distribution voucher is forwarded to the


department managing the expense ledger.
4.3.2 Cash Disbursements
After the voucher checks and voucher packages are reviewed the checks are signed and the
voucher packages are canceled and filed by number. The voucher checks are then posted to a
check register. This posting is total and reconciled to the control total received from accounts
payable. Voucher checks are forwarded directly to the payees. The control total is forwarded
to general ledger.
4.3.3 Expense Ledger
The distribution voucher is posted to the expense ledger and/or inventory ledger as
appropriate. A distribution summary is prepared, reconciled to the distribution voucher, and
approved. The distribution voucher and a copy of the distribution report are filed by date. A
copy of the distribution summary is for warded to general ledger.
4.3.4 General Ledger
The distribution summary received from the expense ledger the journal voucher received
from accounts payable and the control total from cash disbursements are reconciled and the
totals are posted to the general ledger. The distribution summary received from the expense
ledger, the journal voucher received from the accounts payable department, and the control
total from the cash disbursements department are filed by date.
4.3.5 Internal audit
The canceled checks are received from the bank along with the bank statement. Independent
bank reconciliation is an important control in a cash disbursement application system.
4.3.6 Voucher Systems
A voucher system is essentially a review technique. A system in which every organizational
expenditure must be documented with an approved voucher. The real control over
disbursements is a final review of documents evidencing the entire transaction prior to the
authorization of payment. A voucher payable system, unlike the accounts payable system
encompasses all expenditures, including trade accounts, payroll capital expenditure, and so
on.

53

Data flow diagram for cash disbursement application system


3
Payment
data

A/P
2
1

Details
Payee

Expense
ledger

Cash
Disbursemen
t

4
5

6
G/L

Internal Audit

Data flow key


Data Flow Key
1. voucher check
2.distribution details
3.journal voucher
4. check
5. control total
6.control report
7. concealed checks
8. bank statement

54

Activity 3
1. Define an imp rest fund system
___________________________________________________________________________
___________________________________________________________________________

Answers to learning activities


Activity 1
1. Describe the major functions in purchase application system?
The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash
disbursement system and the applicable parts of the general ledger system.
Expenditure cycle Operations include:-

The preparation and recording of purchase orders.

The receipt of goods and the recording of the cost of inventory.

The receipt of vendor invoices and the recording accounts payable.

The preparation of employee pay-checks and the recording of payroll activities.

The preparation and recording of cash disbursements, including payroll.

2. Distinguish between receiving and stores


When good arrived at the receiving department, there is inspected and counted. This process
helps to insure that the right goods in a correct amount are received in acceptable condition.
Nonconforming goods are rejected (returned) to the supplier. Notation of rejected goods is
added to the vendor service record in the vendor master file.
Once the condition of the goods has been approved the process of complete receiving report
by noting the quantity received on the approved purchase order receiving notification. Once
annotated with the quantity received the purchase order receiving notification become a
receiving report, which is the document used to record merchandize receipts.
The stores department acknowledges receipt of the goods from receiving by signing the
receiving report and then forwarding the receiving report to accounts payable.

Activity 2
1. Describe the major features of and operations in a payroll application system
The HRM/payroll cycle is a recurring set of business activities and related data
processing operations associated with effectively managing the employee work force.

55

1. Update master payroll file


2. Update tax rates and deductions
3. Validate time and attendance data
4. Prepare payroll
5. Disburse payroll
6. Calculate employer-paid benefits and taxes
7. Disburse payroll taxes and other deductions

The first activity in the HRM/payroll cycle involves updating the payroll master file
to reflect payroll changes such as new hires, terminations, changes in pay rates, or
changes in discretionary withholdings.

It is important that all payroll changes are entered in a timely manner and are properly
reflected in the next pay period.

The second activity in the HRM/payroll cycle involves updating information about
tax rates and other withholdings.

These changes happen whenever updates about changes in tax rates and other payroll
deductions are received from various government units and insurance companies.

The third activity in the payroll cycle is to validate each employees time and
attendance data.

This information comes in various forms, depending on an employees status.

The fourth activity in the payroll cycle involves preparing payroll.

Data about the hours worked are provided by the department in which the employee
works.

Pay rate information is obtained from the payroll master file.

The person responsible for preparing paychecks cannot add new records to this file.

The fifth activity is actual disbursement of paychecks to employees.

Most employees are paid either by check or by direct deposit of the net pay amount
into the employees bank account.

The six activity is calculating tax and benefits. Some payroll taxes and employee
benefits are paid directly by the employer.

56

Federal and state laws require employers to contribute a specified percentage of each
employees gross pay to federal and state unemployment compensation insurance
funds.

Employers often contribute to health, disability, and insurance premiums.

The final activity in the payroll process involves paying the payroll tax liability and
the other voluntary deductions of each employee.

An organization must periodically prepare checks or use electronic transfer to pay the
various tax liabilities incurred.

Activity 3
1. Define an imp rest fund system
An imp rest fund is a fund maintained at a specified, predetermined amount. At all times, the
amount of cash on hand plus documented expenditures should equal the specified amount of
the tend, periodically, an impress fund is replenished: documented expenditures (petty cash
vouchers) are reviewed and approved, and a check is drawn to the fund or custodian of the
fund for the amount necessary to bring the fund back to its specified amount separate
checking accounts may be maintained for payroll and other expense categories such as
dividend payments.

Check Your Progress


1. In a purchase application system, which of the following departments should normally be
responsible for the preparation of the purchase order?
A. Cash disbursement

B. Purchasing
C. Accounts payable
D. Stores
2. In a purchase application system, which of the following departments should normally be
responsible for the preparation of the requisitions?
A.
B.
C.
D.

Cash disbursement
Purchasing
Receiving
Stores

57

3. In order to provide accountability for purchasing, copies of purchase requisitions should be


sent to
A. The vendor
B. Cash disbursement
C. Accounts payable
D. Receiving
4. In payroll application system, which of the following should be responsible for payroll
register?
A. Personnel department
B. Payroll department
C. Cash payment department
D. Time keeping department.
5. In a payroll application system, which of the following should be responsible for the
authorization of pay rates for employees?
A. Personnel department
B. Payroll department
C. Cash disbursement
D. Time keeping department
6. In cash disbursements application systems, the voucher package should be canceled by
A. Cash disbursement
B. Accounts payable
C. Expense ledger distribution
D. General ledger
7. Which of the following documents should normally be included in a voucher package?
A. Vendor invoice
B. Purchase order
C. Both A and B
D. Neither A nor B

58

Summary
The general P/AP/CD system entails several different files. The accounts payable master file
is a repository of all unpaid vendor invoices. In creating the records that compose typical
accounts payable master file information to be captured should be limited to data that lead to
accomplishing the goals of the system. The file designee should consider how the file would
be processed when the cash manager is deciding what payment to make. For example, the
manager may want to merge vender invoices so that the total amount due each vendor can be
accumulated. Alternatively, the manager might want to select specific invoices for payment.
Purchasing personnel when selecting an appropriate vendor usually accesses the vender
master file. During processing, vender data are retrieved to prepared purchase orders and to
issue payments. In addition to storing identification data the file is used by management to
evaluate vender performance and to make various ordering decisions.
The purchase order master file is a compilation of open purchase orders and includes the
status of each item on order. To keep track of a purchase, the purchasing department
generally creates a record in the purchase order, including information about the status of
each item on order. The order is closed only on receipt and acceptance of all goods detailed
on the order.
The other file appearing in the data flow diagrams are:
(a) The inventory master file. This file contains a record of each inventory item that is
stoked in the warehouse or is regularly ordered from a vendor. These records are used
to manage the inventory and to support the inventory in the general ledges.
(b) Recording report file. This is a transaction file of receiving report documents.
Physically, the reserving reports are often a duplicate copy of the purchase order
document. Therefore, a typical receiving report would comprise a heeder sectioncontaining the same information as a purchase order header-and one or more
receiving report lines-showing each item's identification card, description, quantity
ordered (unless the bylined copy was used), quantity received, and data received.

59

(c) Cash disbursements transaction file. the purchase of this file to show in chronological
sequence the details of each cash payment made. Accordingly each record in this file
normally would show the date the payment is recorded, vendor identification,
disbursement voucher number (if the voucher system is used), vendor invoice number
and gross invoice amount, cash discount taken on each invoice, net invoice amount,
check amount and check number.
The payroll system, as you might guess, has need for its own files. The employee/payroll
master file contains employee identification data as well as data used for the computation of
employee paychecks. Employee payroll records are keyed by an employee identification
code. The employee code can be designed so as to reflect certain employee attributes, such as
departments, factory and positions. Such code numbers can be used to provide management
with labor-cost distribution.
Cash payments are applied in four major ways:
(1) Payments on trade accounts payable and payrolls
(2) Investments in other assets
(3) Repayments of bank loans and bond issues
(4) Payments for operating expenses
Answers to Check Your Progress Questions
1. B. 2. D. 3. C. 4. B. 5. A. 6. A 7. c

60

UNIT FIVE
PRODUCTION CYCLE
Objectives
Careful study of this unit will enable the reader to:

describe the major features of a production control system.

describe the major features of a property accounting application system

Introduction
Production control, inventory control, inventory control, cost accounting are typical functions
in the production cycle of manufacturing firms. Few if any production-cycle activities exist
as separate functions in non manufacturing firms, but to same existent moat organization
hold some inventories and manage some type of production control are relevant to most
organizations. This section discusses accounting applications systems found in an
organizations production cycles. The central feature of the illustrated applications is the
segregation of duties to achieve organizational independence.
5.1 Production-Cycle Applications

Overview
This section provides an overview of the transaction flows necessary to support the function
of production control, inventory control, and cost accounting within a manufacturing firm.
5.1.1 Production Control
Cost accounting system focus on the management of manufacturing inventories: materials,
work-in process (WIP), and finished goods. Internal control over inventories and production
is based on separation of functions and basic records and documentation, such as production
orders, material requisition forms, and labor time cards. Protection of inventories from
physical theft involves security and access provisions as well as periodic physical counts and
tests against independent records.

61

5.1.2 File and Reports


Production control involves planning which products to produce and scheduling production
to make optimal use of resources. Basic production requirements are provided by the bill of
materials and master operations list. Detailed materials specifications for a product are
recorded on the bill of materials. The bill of materials lists all required parts and their
descriptions in subassembly order. The bill can be used as a ready reference for replacement
parts, as an aid in troubleshooting subassemblies, or as a parts list for the end user. By
distributing copies of bills to all affected departments, management can ensure uniform
access to accurate, up-to-date information at every operation, their sequencing, and their
related machine requirements are specified in the master operations list for a product. The bill
of materials and the master operation list are used extensively in the production control
function. In a standard cost system, the standard material and labor costs might be included
on the bill of materials and master operations list.
Determining what products to manufacture requires an integration of the demand for a
product, the product requirements, and the production resources available to the firm.
Resources available for production are communicated to the production control function
through inventory status reports and factor availability reports. A few material status report
details the material resource in inventory that are available for production. A factory
availability report communicates the availability of labor and machine resources. Demand
requirements for a product depend on whether it is custom-manufactured per customer order
or routinely manufactured for inventory. If the product is manufactured for inventory,
production requirements depend on a sales forecast, which may be sent to production control
from the sales or marketing department. Sales forecast must be related to the amount of a
product held in inventory. This information is provided in a finished goods status report,
which lists the quantities of products plan lists.
5.1.3 Transaction Flows
The production order serves as authorization for the production departments to make certain
products. Materials requisitions are issued for each production order to authorize the
inventory department to release materials to the production department. The items and
quantities shown on a materials requisition are determined from the specifications in the
products bill of materials requisition are determined from the specifications in the products
62

bill of materials. Note the flow of the materials requisition and production order in figure 1
the cost accounting function receives a copy of the production order directly from producer is
complete. In similar fashion, cost accounting receives copies of materials requisitions from
both the inventory control function and the production departments. This distribution of
documents implements an adequate segregation of duties and provides accountability for the
production departments.
Labor operations are recorded on job time cards. These cards are posted to production orders
and forwarded to the cost accounting department. The periodic reconciliation of time cards to
production labor reports is an important internal control function. This function was detailed
in the discussion of payroll processing in chapter 7.
Production status reports are periodically sent from the production department to the
production control function. A production status report details the work completed on
individual production orders as they move through the production process. It is used to
monitor the status of open production orders and to revise the departmental production
schedules as necessary.
The central document in the foregoing process is the production order. A copy of the
production order is sent to the cost accounting function to establish a WIP record for each
job.
5.1.4 Cost Accounting
The cost accounting department is responsible for maintaining a file of WIP cost records.
New records are added to this file upon receipt of new production orders. Initiated by
production control, materials costs are posted to this file from copies of materials requisition.
Direct labor costs are posted from job time tickets. Overhead costs are often applied on the
basis of direct labor hours or direct labor costs and, therefore, are posted at the same time as
labor costs. Cost accounting initiates a journal voucher reflecting each batch of job time
tickets posted that contains a debit to WIP and credits to payroll and manufacturing overhead.
This journal voucher is transmitted and posted to the general ledger.
As production orders are completed and goods are transferred to inventory, several
documents must be update. Productions control the production order from its file of open
production orders. Cost accounting closes the related WIP record , summarizes this activity,

63

and communicates a completed production cost summary to various managers. The finished
goods inventory records are updated to reflect the availability of the product.
Control of production efficiency requires comparisons of actual production with scheduled
production and an analysis of related variances. Production control also requires a
comparison and analysis of other factors, including budgeted cost versus actual cost for
individual production order and /or departments, and facility usage versus facility availability
by department. The control of inventory loss and the maintenance of optimal inventory levels
are also important to overall production control.
5.1.5 Inventory Control
The control of inventories is accomplished through a series of inventory records and reports
that provide such information as inventory use, inventory balances, and minimum and
maximum levels of stock. Recorder points and procedures are established. A reorder point is
the level of inventory at which it is desirable to order or produce additional items to avoid an
out-or-stock condition. The development of reorder points requires an analysis of product
demand, ordering or production lead time, inventory holding costs, and the costs associated
with an out-of-stock condition such as lost sales or inefficient use of production facilities.
Because inventory control aims at minimizing total inventory cost, an important decision to
be made is the size of each purchase order quantity, that is, the most economic order quantity
(EOQ). The reorder quantity must balance two system costs- total carrying costs and total
ordering costs. A formula for calculating the EOQ is

where
EOQ = economic order quantity (units)
R= requirements for the item this period (units)
S= purchasing cost per order
P= unit cost
I = inventory carrying cost per period, expressed as a percentage of the
period inventory value

64

Once the EOQ has been calculated, the timing of the order must be decided; that is, the
reorder point must be determined. If the order lead time and the inventory usage rate are
known, determining the reorder point is straightforward. Lead time is the time between
placing an order and the receipt of the goods. The inventory usage rate is the quantity of the
goods used over a period of time. The reorder point should be where the inventory level
reaches the number of units that would be consumed during the lead time. In a formula:
Reorder point = lead time x average inventory usage rate
Perpetual inventory records are the best source of the inventory information necessary to
calculate the EOQ. The units in the beginning inventory, on order, receipts, issues, and
balance on hand, should be included in these records. Appropriate control over inventories
requires periodic verification of items on hand. This can be done on a rotating basis when
perpetual inventory records exist, or it can be done with a periodic physical count.
An important part of inventory control is the evaluation of inventory turnover to determine
the age, condition, and status of stock. Special controls should be established to write down
obsolete and slow-moving inventory items and to compare the balance to an appropriately
established inventory level. A stock status report showing detailed use by period is especially
helpful in maintaining the inventory at a proper level and controlling slow-moving items.
Control over inventory includes methods of storing and handling. Items need to be classified
and properly identified so that they can be located appropriately and so that proper
verification and reporting are possible. The storage and handling of items must provide
security against embezzlement, protection against damage or spoilage, avoidance of
obsolescence, and assurance of proper control.
Inventory is a substantial investment. An inventory control system should provide status
reports on each active product so that the company can reasonably meet customer demands.
Because of the large number of inventory items and the variety of transactions affecting
them, it is difficult to keep inventory and production information up-to-date with manual
systems. A computerized inventory control system can result in a substantial reduction in
inventory investment.

These savings include a reduction in inventory without a

corresponding decrease in service, determination of economic order quantities and order

65

points, establishment of adequate safety stocks, and forecasts of future demand based on
current and past information. Usage records, turnover and obsolescence analyses, reorder
cult to generate in purely manual systems.
5.1.6 Just-in time (JIT) Production
Just-in time (JIT) production is a term used to describe a production system in which parts
are produced only as they are required in subsequent operations. JIT systems differ from
conventional productions systems in the inventories of Work In process, raw materials, and
finished goods are minimized or totally eliminated. The raw materials inventory, work in
process inventory, and finished goods inventory are shown within dash-line boxes to indicate
that they are eliminated to the extent possible in JIT production. The terms minimum
inventory production system (MIPS), material as needed (MAN), and zero inventory
productions system (ZIPS) also describe this concept of minimizing inventories.
Inventories serve as a buffer between different operations. Inventories are eliminated by
carefully analyzing operations to yield a constant production rate that will balance input and
output at the various stages of production. JIT production also emphasizes quality control.
Because inventories are minimized, defective production has to be corrected immediately if
the constant flow of production is to be sustained. Vendors guarantee timely delivery of
defect-free parts that may be placed immediately into production rather than first being
placed into raw materials inventory.
The financial benefits of JIT production system is primarily from the overall reduction in
inventory levels.

This reduces a firms total investment in inventories. Costs such as

handling and storing materials, obsolescence, storage space, and financing charges on total
inventory cost are reduced, perhaps significantly. Other benefits include possible lower labor
costs as operations are redesigned for constant-flow production, quantity discounts from
vendors who in return receive long-term contracts, and increased emphasis on quality
production and the corresponding reduction in the cost of waste and spoilage.

66

Activity 1
1. What is JIT production system?
________________________________________________________________________
________________________________________________________________________
2. Describe the EOQ formula.
________________________________________________________________________
________________________________________________________________________
5.2 Property Accounting Application
Overview
Property accounting applications concern an organizations fixed assets and investments. An
important element of effective internal control is the accurate and timely processing of
information relating to fixed assets and investments.

Such processing is accomplished

through the use of special accounting applications that provide for accounting, operational,
and management information needs (see Figure 3).
5.2.1 Fixed Assets
There are four objectives of fixed asset of investment accounting application:
1

Maintain adequate records that identify assists with description, cost, and physical
location.

Provide for appropriate deprecation and/or amortization calculations for book and tax
purposes.

Provide for reevaluation for insurance and replacement cost purposes.

Provide management with reports for planning and controlling the individual asset
items.

Fixed assets are tangible properties such as land, buildings, machinery, equipment, and
furniture that are used in the normal conduct of a business.

67

Property
Transactions

Reconciliation of discrepancies
Investments and fixed asset

Record in property legers

Periodic
Comparison

Property legers

Periodic processing

Depreciation
Calculation

Other management reports


Insurance &replacement costs

These items are relatively permanent and often represent a companys largest investment.
Transactions that change the amount of investment in fixed assets tend to occur infrequently
and usually involve relatively large amounts of money.
A company accumulates many assets over the life of the business, disposes of assets(by
retirement, sale, or other means), moves assets from one location to another, and match the
costs(other than land) to revenues by means of periodic depreciation charges over the
estimated useful life of the asset. To accomplish these tasks efficiently and to provide
adequate control, an automated system is frequently required.
Every organization, including those on a cash basis, should keep a ledger of fixed assets as an
aid to effective control. A fixed asset register is a systematic listing of an organizations fixed
assets. A separate section of the fixed asset register is usually kept for each major category of
asset. This categorization should be consistent with the general ledger account descriptions.
For example, an organization may have separate ledger accounts for buildings, furniture and

68

fixtures, and automobiles. There would be a separate section for each of these categories.
Assets themselves should be labeled with identifiers linked to the fixed-asset register.
When each asset is acquired, it should be tagged and entered in the fixed asset register. The
total dollar amount shown in the register should agree with the general ledger control
accounts. For this reason, entries must be made in the fixed-asset register not only to record
addition but also to asset sales or other dispositions.
Several entries must be made when an asset is disposed of. The first records the date of
disposal. The second entry removes the accumulated depreciation taken to date. A fixed-asset
register functions as a subsidiary ledger to the corresponding general ledger control accounts.
5.2.2 Investment
Investments, like fixed assets, require separate records; typically, an investment register is
used to provide accounting control over investments. As with all other assets, custody of
investment should be separate and distinct from record keeping. The investment register
should contain all relevant information, such as certificate number and the par value of
securities, to facilitate identification and control. All investment transaction should be duly
authorized and documented. A common control practice with respect to the physical handling
of investment securities is to require two people to be present when the firms safe deposit
box or other depositor is entered.
5.2.3 Internal Accounting Control Practices
The following questions suggest the internal accounting control procedures that would be
expected in a property application system.
A.

Do procedures require authorization by an official or committee for expenditures


(possibly over certain amounts) for
1. Capital assets?
2. Repairs and maintenance?

B. Are actual expenditures compared to budgets and additional approvals required if budget
authorization is exceeded?
C. Do written procedures exist that provide for distinguishing between capital additions and
repair and maintenance?

69

D. Do procedures require formal authorization for the sale retirement, or scrapping of capital
assets?
E. Are these records maintained by people other than those who are responsible for the
property?
F. Are the detailed records balanced at least annually with the general ledger controls?
G. Are the detailed record balanced at least annually with the general ledger controls?
H. Are physical inventories of property taken periodically under the super vision of
employees who are not responsible for the custody of recording of such properties?
I. Are periodic appraisals of property made for insurance purposes?
J. Are significant discrepancies between book records and physical inventories reported to
management?
K. With regard to small tools:
1. Are these physical safeguarded and is responsibility for them clearly defined?
2. Are they issued only upon written authorization?

Activity 2
1.

Describe the major features of a property accounting application system


________________________________________________________________________
________________________________________________________________________

Answers to activities
Learning activity 1
3. What is JIT production system?

Just-in time (JIT) production is a term used to describe a production system in which
parts are produced only as they are required in subsequent operations. JIT systems
differ from conventional productions systems in the inventories -

Raw materials Inventory


Work-in
Vendor
Operation
Process
1
Inventory

Operation
2

Finished goods Inventory

Customer

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Just- in Time (JIT) Production. of Work In process, raw materials, and finished
goods are minimized or totally eliminated. The raw materials inventory, work in
process inventory, and finished goods inventory are shown within dash-line boxes to
indicate that they are eliminated to the extent possible in JIT production. The terms
minimum inventory production system (MIPS), material as needed (MAN), and zero
inventory productions system (ZIPS) also describe this concept of minimizing
inventories.
4. Describe the EOQ formula

EOQ =
2xRxS
PxI

Where
EOQ = economic order quantity (units)
R= requirements for the item this period (units)
S= purchasing cost per order
P= unit cost
I = inventory carrying cost per period, expressed as a percentage of the
period inventory value

Learning activity 2
2. Describe the major features of a property accounting application system
One of the features of fixed asset includes its objectives;

Maintain adequate records that identify assists with description, cost, and
physical location.

Provide for appropriate deprecation and/or amortization calculations for


book and tax purposes.

Provide for reevaluation for insurance and replacement cost purposes.

Provide management with reports for planning and controlling the


individual asset items.

Check You Progress


1.

In a production control application system, which of the following documents serves as


authorization to release raw materials to the production department?
A. Production order

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B. Job time card


C. Journal voucher
D. Material requisition
2.

In a production control application system, which of the following departments should


receive copies of production orders?
A. Inventory control
B. Cost accounting
C. Purchasing
D. General ledger

3.

In a production control application system, which of the following documents serves as


authorizations to the production departments to make certain products?
A. Production order
B. Job time card
C. Material requisition
D. Journal voucher
4. Which of the following is a characteristic of (JIT) production?
A. Parts are produced only as they are required in subsequent
operations
B. A constant flow production rate
C. Both A and B
D. Neither A nor B
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One of the following is not a fixed asset?


A. Land
B. Building
C. Organization cost
D. Machinery

Summary
Production control, inventory control, and property accounting are typical production cycle
applications in manufacturing firms. A production control application system, plans and
schedules production and issues production orders to authorize production activities. Material
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requisition forms and job time cards are used to trace production costs to individual
production orders. A model production application control application system includes a
separation of the following functions: production control, the production departments,
inventory control, cost accounting and general ledger.
Inventory control is accomplished through a series of records and reports that provide
information concerning inventory use and inventory balances. Perpetual inventory records
are the best source of inventory information. The storage and handling of inventory items
must provide assurance of adequate control.
Property accounting applications concern an organizations fixed assets and investments.
Property accounting applications maintain records that identify an organizations fixed assets
and investments, provide for appropriate depreciation for financial and tax purposes, provide
information for insurance purposes, and provide information to management concerning use
and availability of an organizations fixed assets and investments.
Answers to Check Your Progress
1.

2.

3.

4.

5.

CHAPTER SIX
DEVELOPMENT OF AN ACCOUNTING INFORMATION
SYSTEM
Objectives
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After careful study of this unit, the reader must be able to

Explain the phases of accounting system development and the factors that do influence
its design.

Explain factors which influence the design of AIS

6.1 Overview
Good accounting systems do not just happen. They are carefully planned, designed, installed,
managed, and refined. Generally, developing an accounting system involves the following
four phases or stages:
6.1.1 Analysis
Analysis involves determining internal and external information needs, identifying
inefficiencies and bottlenecks in the current system, sources of information and the need for
controls, studying alternatives. If an existing system is being analyzed, its strengths and
weaknesses must be identified. The analyzed information will record in a series of data flow
diagrams and entity-relationship diagrams so that the system can be design.

6.1.2 Design
For a new system, forms and documents must be designed; methods and procedures selected
from alternatives; job descriptions prepared; controls integrated; reports formatted; and
equipment selected. Successful system design depends largely upon the capabilities of the
designer. Redesigning an existing system may involve only minor changes, a complete
overhaul, or replacement of a manual system by a computerized system.

6.1.3 Implementation
Whether a new accounting system is created or creating or an existing system is revised, the
plan and design must be implemented. New or revised documents, procedures, reports, and
processing equipment must be installed and made operational. Personnel must be hired,
trained, and closely supervised through a start-up or transition period. Implementation stage
is the stage when the theoretical design becomes a working, practical system.

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It is the users department that carries a major workload here. Whit out careful planning, the
result is always chaotic. This is a most crucial stage in the attainment of a new, successful
system and in providing user confidence in it.

6.1.4 Follow-up
After the system is up and running, it must be evaluated and monitored for weaknesses and
breakdowns. Also, its effectiveness and efficiency must be compared to the desired
organizational objectives and correction action must be taken if the actual result is deferred
from the planned.
Figure 1.2 highlights the relationship of these four phases in the life cycle of the
accounting system.

Analysis
Planning and identifying information needs and sources.

Follow-up

Design

aluating and monitoring, effectiveness and efficiency,& correcting any weaknesses


Creating forms, documents, procedures, job descriptions, & reports.

Implementation
Installing the system, training, personnel, and making the system wholly operational.

Figure 6.1 Phases in the development of an accounting system.


These phases, which represent the life cycle of an accounting system, suggest that few
systems remain the same forever. As experiences and knowledge are obtained, and as
technological and organizational changes occur, the accounting system may also have to
grow and changes.

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6.2 Factors Influencing Design of AIS


As shown in the figure below the development of IT organization culture and organization
strategy are among factors which influence the design of AIS
Figure 6.2 Factors Influencing Design of AIS

Organizational Culture

Strategy

AIS

Information
Technology

Figure 1.3 shows that new development in IT affects the design of AIS. Indeed, in the past
decade, IT has profoundly changed the way that accounting and many other business
activities are performed. Moreover, that impact is likely to continue in the future.
How to evaluate the costs and benefits of new IT developments requires developing a basic
understanding of corporate strategies and how IT developments can be used to implement
existing organizational strategies or create an opportunity to modify those strategies (note the
arrow from IT to strategies Figure 1.3).
Moreover, because an AIS functions with in the organization, it should be designed to reflect
the values of that organizational culture. The arrow between organizational culture and the
AIS is bidirectional. This reflects the fact that the AIS influence the organizational culture.
One way, it does so is, through choices on how, and to whom, it disseminates information.
For example, AIS that makes information easily accessible and widely available is likely to
increase pressures for more decentralization and autonomy.
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Activity 1
1. What are the phases of an accounting system development?
__________________________________________________________________________

Answer to Activity

Activity 1
1. What are the phases of an accounting system development?
1. Analysis. Analysis involves determining internal and external information needs,
identifying sources of information and the need for controls, studying alternatives. If
an existing system is being analyzed, its strengths and weaknesses must be identified
2.

Design. For a new system, forms and documents must be designed; methods and
procedures selected from alternatives; job descriptions prepared; controls integrated;
reports formatted; and equipment selected.

3. Implementation. Whether a new accounting system is created or creating or an


existing system is revised, the plan and design must be implemented. New or revised
documents, procedures, reports, and processing equipment must be installed and
made operational.
4. Follow-up. After the system is up and running, it must be evaluated and monitored for
weaknesses and breakdowns. Also, its effectiveness and efficiency must be compared
to designed and organizational objectives. Corrections in design or changes in
implementing may be necessary. Both internal and external audit procedures provide
feedback about the soundness of the system.

Summary
A system development project ordinarily consists of; system analysis, system design, and
implementation and evaluation phases. The system approach is a general procedure for the
administration of a system project. Its purpose is to assist in the orderly development of

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effective systems. A philosophy of user-oriented design fosters a set of attitudes and an


approach to systems development that consciously considers the organizational context.

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