Chapter 2

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Explain the three basic functions performed by an accounting information system (AIS). Describe the documents and procedures used in an AIS to collect and process transaction data. Discuss the types of information that can be provided by an AIS. Describe the basic internal control objectives of an AIS and explain how they are accomplished.

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The grand opening of S&S is two weeks away. Scott and Susan recognize that they need qualified accounting help and have hired a full-time accountant, Ashton Fleming. Ashton is responsible for creating an accounting information system (AIS).

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What questions does Ashton ask himself?

ow am I going to organize things?  Where do I start?  What information does S&S need in order to operate effectively?  How can that information be provided?


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 How am I going to collect and process data about

all the types of transactions that S&S will engage in?

 How do I organize all the data that will be

collected?
 How should I design the AIS so that the information

provided is reliable and accurate?

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Businesses engage in a variety of activities, including: Acquiring capital Buying buildings and equipment Hiring and training employees Purchasing inventory Doing advertising and marketing Selling goods or services Collecting payment from customers Paying employees Paying taxes Paying vendors

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Types of information needed for decisions: Some is financial Some is nonfinancial Some comes from internal sources Some comes from external sources An effective AIS needs to be able to integrate information of different types and from different sources.
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To collect and store data about the organization s business activities and transactions efficiently and effectively To provide management with information useful for decision making To provide adequate internal controls

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A transaction is: An agreement between two entities to exchange goods or services; OR Any other event that can be measured in economic terms by an organization. EXAMPLES: Sell goods to customers Depreciate equipment
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The transaction cycle is a process:

Begins with capturing data about a transaction Ends with an information output, such as financial statements

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Many business activities are paired in give-get exchanges The basic exchanges can be grouped into five major transaction cycles.
 Revenue cycle  Expenditure cycle  Production cycle  Human resources/payroll cycle  Financing cycle

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2.

3.

The revenue cycle: involves activities of selling goods or services and collecting payment for those sales. The expenditure cycle: involves activities of buying and paying for goods or services used by the organization. The human resources/payroll cycle: involves activities of hiring and paying employees.

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4. 5.

The production cycle: involves activities converting raw materials and labor into finished goods. The financing cycle: involves activities of obtaining necessary funds to run the organization, repay creditors, and distribute profits to investors.

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Thousands of transactions can occur within any of these cycles.

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

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Financing Cycle

Expenditure Cycle

Human Resources

General Ledger & Reporting System

Production Cycle

Revenue Cycle

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The data processing cycle consists of four steps:

1. Data input 2. Data storage 3. Data processing 4. Information Output

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The trigger for data input is usually business activity. Data must be collected about:
1. Each event of interest 2. The resources affected by each event 3. The agents who participate in each event

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Historically, most businesses used paper source documents to collect data and then transferred that data into a computer. Today, most data are recorded directly through data entry screens.

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Control over data collection is improved by:

 prenumbering each source document

and using turnaround documents  having the system automatically assign a sequential number to each new transaction  employing source data automation
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REVENUE CYCLE
Source Document Sales order Delivery ticket Remittance advice Deposit slip Credit memo Function Take customer order. Deliver or ship order Receive cash. Deposit cash receipts. Adjust customer accounts

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EXPENDITURE CYCLE
Source Document Purchase requisition Purchase order Receiving report Check Function Request items. Order items. Receive items. Pay for items.

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HUMAN RESOURCES CYCLE

Source Document Function

W4 forms Time cards

Collect employee withholding data. Record time worked by employees. Record time spent on specific jobs.

Job time tickets

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GENERAL LEDGER AND REPORTING SYSTEM

Source Document Function

Journal voucher

Record entry posted to general ledger.

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

 Ledger
A ledger is a file used to store cumulative information about resources and agents. We typically use the word ledger to describe the set of t-accounts. The t-account is where we keep track of the beginning balance, increases, decreases, and ending balance for each asset, liability, owners equity, revenue, expense, gain, loss, and dividend account.

 Ledger example:

 General Ledger
The general ledger is the summary level information for all accounts. Detail information is not kept in this account. Example: Suppose XYZ Co. has three customers. Anthony Adams owes XYZ $100. Bill Brown owes $200. And Cory Campbell owes XYZ $300. The balance in accounts receivable in the general ledger will be $600, but you will not be able to tell how much individual customers owe by looking at that account. The detail isnt there.

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

Relationship between General and Subsidiary ledger

Relationship between General and Subsidiary ledger

 Subsidiary ledger
Advantages: 1 Shows transactions affecting one customer or one creditor in a single account 2 Frees the general ledger of excessive details 3 Helps locate errors in individual accounts 4 Reduces the number of accounts in one ledger and by using control accounts 5 Division of labor in posting One employee posts to the general ledger Another employee posts to the subsidiary ledger

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

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

Journals
In manual systems and some accounting packages, the first place that transactions are entered is the journal. A journal entry is made for each transaction showing the accounts and amounts to be debited and credited. -General journal -Specialized journal

Journals
Example

Audit trails
Provides a means to check the accuracy and validity of ledger postings. (e.g. page 38) An audit trail exists when there is sufficient documentation to allow the tracing of a transaction from beginning to end or from the end back to the beginning. The inclusion of posting references and document numbers enable the tracing of transactions through the journals and ledgers and therefore facilitate the audit trail.

Batch processing is the periodic updating of the data stored about resources and agents On-line, real-time processing is the immediate updating as each transaction occurs

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Field Record Data Value File Database

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The second function of the AIS is to provide management with information useful for decision making. The information an AIS provides falls into two main categories:
 Financial Statements  Managerial Reports

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Output can serve a variety of purposes:

 Financial statements can be provided to both

external and internal parties.  Some outputs are specifically for internal use:
For planning purposes For management of day-to-day operations For control purposes For evaluation purposes

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Management Functions

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Management Functions

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Problem Structure The problem structure reflects how well the decision maker understands the problem. Elements of problem structure: data procedures objectives

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Problem Structure

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Managerial reports

Report objectives - reports must have value or information content They should:
 reduce the level of uncertainty associated with a

problem facing the decision maker  influence the behavior of the decision maker in a positive way

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Managerial reports

Goal congruence:
 A carefully structured management reporting system and

compensation schemes help to appropriately assign authority and responsibility.  If compensation measures are not carefully designed, managers may be tempted to engage in actions not optimal for the organization in the long-run.

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Managerial reports Important to choose what to measure for your problem.

You get what you measure

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Example: An instructor wants to improve student performance He decides to encourage better attendance by grading students on attendance (i.e., measuring it). What is the result?

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Example: Result: Better student attendance

The improved attendance may or may not improve learning outcomes.

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Example: Result:

Students may be getting better grades when attendance is measured, but not learning more. Some students may in fact reduce their studying because they believe they can use the attendance score to boost their grade. This behavior would be a dysfunctional result of the measurement.

What would be a better method?

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Other inappropriate performance measure examples:

 The use of price variance to evaluate a purchasing

agent can affect the quality of the items purchased.  The use of quotas (such as units produced) to evaluate a supervisor can affect quality control, material usage efficiency, labor relations, and plant maintenance.
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The AIS must also be able to provide managers with detailed operational information about the organization s performance. Two important types of managerial reports are
budget performance reports

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What is a budget?

A budget is the formal expression of goals in financial terms. One of the most common types of budget is a cash budget.

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What is a performance report?

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

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

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Be careful using budget reports

Budgets can cause dysfunctional behavior. Example:

 In order to stay within budget, the IT Department

did not buy a security package for its system.  A hacker broke in and devastated some of their data files.  Critical security measures were foregone in order to meet budgetary goals.  The resulting costs far outweighed the savings. 2/10/2012

Other problems with budget:

Budgeting can also be dysfunctional in that the focus can be redirected to creating acceptable numbers instead of achieving organizational objectives. Does this mean organizations shouldn t budget?

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1)

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

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2)

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

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The third function of an AIS is to provide adequate internal controls to accomplish three basic objectives: Ensure that the information is reliable. Ensure that business activities are performed efficiently. Safeguard organizational assets.

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What are two important methods for accomplishing these objectives? Provide for adequate documentation of all business activities. Design the AIS for effective segregation of duties.

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Documentation allows management to verify that assigned responsibilities were completed correctly. What did Ashton encounter while working as an auditor that gave him a firsthand glimpse of the types of problems that can arise from inadequate documentation?
failure to bill for repair work

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Segregation of duties refers to dividing responsibility for different portions of a transaction among several people. What functions should be performed by different people?
authorizing transactions recording transactions maintaining custody of assets

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Improperly prepared journal entries Unposted journal entries Debits not equal to credits Subsidiary not equal to general ledger control accounts Inappropriate access to the general ledger Poor audit trail Lost or damaged data Account balances that are wrong because of unauthorized or incorrect journal vouchers

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Pre-numbered and well-designed journal vouchers Validating data on journal vouchers Correcting detected errors before the data are posted to the general ledger Compiling standardized adjusted journal entries Pre-computing batch control totals

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Posting journal entries to the general ledger accounts with a variety of program checks performed before and after posting Summing the amounts posted to the general ledger accounts and then comparing the posted totals to the pre-computed batch control totals Establishing and maintaining an adequate audit trail

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Preparing frequent trial balances, with any differences between total debits and credits being investigated Maintaining a log or file of journal vouchers by number and periodically checking to make certain that the sequence of numbers is complete Printing period-end listings and change reports for review by accountants before the financial statements are prepared Reviewing financial reports and other outputs for correctness and reasonableness

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

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Objectives of the software

To ensure full security by introducing adequate controls, checks and balances and also by maintaining audit Trails. To minimize data redundancy by eliminating duplicate entries. To enable the organizations to provide its customers a more value added service. To create a flexible system so that future needs and changes in the business flow can be easily incorporated

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Advantages Security and control features

Allows instant communication with all subsystems of an organization

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Disadvantages Customization of the ERP software is limited. Once a system is established, switching costs are very high Resistance in sharing sensitive internal information between departments can reduce the effectiveness of the software. ERP Systems centralize the data in one place, example customer , financial data. This can increase the risk of loss of sensitive info, if there is any security breach
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