CHAPTER 1

THE STUDY OF ACCOUNTING

INFORMATION SYSTEMS

INTRODUCTION

You have been involved with accounting information systems most of your life. When you bought candy
as a child or textbooks as a college student,you entered into accounting transactions. If you Sold
lemonade in an earlier time, or sold back your textbooks in a more recent time, you engaged in other
types of accounting transactions. If you have received a bill from a department store or a monthly
statement from a credit card organization,You have received accounting Information.Information
systems that generate such information are called accounting information systems (AIs)We may be
involved with AIS's only as receivers of Information. On the other hand, we may employ them to a
greater degree and in a more formal manner. For instance we could keep careful records and prepare
financial statements. All transactions might be recorded on columnar paper (which we call our counting
books). From these recorded transactions we might draw up statements made Quarterly of yearly) that
(1) compare our against our expenses for the period and (2) reflect the status of what we own and what
we owe as of the end of the period. (As you know, these statements are called income statements and
balance sheets.) If we are interested in planning ahead, we might also prepare budgets To maintain
control over the accuracy of our bank accounts, we might prepare bark reconciliations when the bank
mails us our monthly bank statements.You may have encountered firsthand other AS than your own
Maybe you have worked during past summers for a business organization or an enterprise (which we
will henceforth call firm), or maybe you are currently working part-time fo ra fim. If so, you have likely
seen a more formal and complicated AIS than the one you may maintain for yourself. As you probably
suspect, all organizations not-for-profit Institutions as well as profit-oriented business firms must
maintains AIS. Our focus in this textbook will be on the AIs that pertain to business firms.Neverthless,
we should remember that every entity needs AI's. As we well see all AIS ranging from the most simple
to the most complex) exhibit the same essential features

REASONS FOR STUDYING ACCOUNTING INFORMATION SYSTEMS

1. As accountant, you will be closely involved with Als during your entire career. Not only will you be a
user of these AIs but you may possibly become developer of such systems. Furthermore, as an auditor
you will be expected to evaluate AIS.

2. Almost all business firms have computers as integral parts of their information systems. As
information has become more vital, the management of data and the preparation of needed reports
have become more complex and varied functions. You need to acquire the knowledge and skills that will
enable you to apply computer-based AlSs in effectively achieving these functions. Otherwise you are
likely to be much less productive in employing your accounting knowledge and skills
3. Modern-day information systems are also rapidly changing and improving there are incorporating
new developments from fields like the Internet and commerce, object technology, telecommunications,
and control. You should be aware of these developments and others that are just emerging, since they
will be increasingly common in the future with adequate knowledge and skills con-computer-based
information systems, you should be in a position to take advantage of the opportunities they ofter

THE IMPORTANCE OF INFORMATION TO MODERN ORGANIZATION

Information has been critical to individuals and organizations throughout recorded history. Since the
start of the agricultural and Industrial ages, accounting systems have provided part of the needed
information. During the agricultural age, farmers used rudimentary accounting systems to determine
their costs of producing cups for sale by comparing these costs against the revenues received in the
marketplace, they ascertained how much they profited or lost from each season's crop During the
industrial corporations manufactured or purchased ends for sale. Although the processes they
performed and the types of costs these incurred differed significantly from those encountered by
farmers they likewise compared their expenses against their revenues to measure each period's profit or
loss. Their accounting systems were somewhat more sophisticated, yet most of the systems employed
during the industrial age were still manually based and historically oriented We live in the information .
Today, the service sector has gained prominence in our economy. Modern business organizations
function in a vastly altered environment They must treat information as a valued resource in order to
prosper Much more information must be generated than the historical profit or loss incurred during
each accounting period. A steady stream of information is needed to enable firms to make sound
planning decisions and to control their operations. Firms that use information effectively can take
advantage of their opportunities and thousin.com on their competitors.

WHAT IS AN ACCOUNTING INFORMATION SYSTEM?

Although you may know a great deal about accounting perhaps this is your first opportunity to
comprehend this knowledge within the framework of Als we can begin by looking separately at the
terms accounting information and system "Then we can compile a definition and set of purposes for the
AS

ACCOUNTING

As you have learned from previous accounting courses, accounting has several facets.First, It is an
information system in its own right. That is,it employs various systemic operations to generate relevant
information. Among the operations that it encompasses Are (recording economic data (data collection
(2) maintaining stored data (data maintenance and (3) presenting quantitative information in financial
terms information generation). Figure I-portrays this set of operations within the accounting activity.
Second, accounting is the language of business, it provides the means by which the key affairs of a
business firm are expressed and summarized. Finally, accounting may be viewed as financial information
needed for the overall functioning of an entity such as a business firm) Certain key financial information
for instance, reflects the results of operations during accounting periods and the status of assets and
equities at the end of accounting periods. A variety of users, of whom some are within the entity and
some reside outside the entity use this information for various purposes

INFORMATION

In the broadest sense, information is intelligence that is meaningful and useful persons for whom it is
intended Information has value to firms and their manager as we have noted because it is necessary for
making sound decisions and in desired actions. Much of the information needed by firms is accounting
inform since it is particularly useful in meeting these needs. Accounting Information is output of AISs
and is financially oriented. Among the many examples of accounting information are income statements
provided to a firms managers an Accounts Receivables Aging Report sent to the firm's credit manager
and bills sent to a firm's customers. Information in the income statements may lead the managers to
make decisions concerning which expenses to reduce. An Accounts Receivable Aging Report may be
used by credit and collection managers to control the receipt of cash from credit sales. Bills mailed to
customers should induce them to pay the owed amounts by the stated due dates Usually, information is
derived from the processing of data. Data are the raw

facts and figures and even symbols that are together form the inputs to an informative system.Figure
1.1 shows the relationship of data and information by means of an input-pocessing-output or (IPO
diagram).That is, data become information through three stages.In the input(1),data of concern to a firm
arise from three sources exchange events, internal events and environmental elements.For instance a
sale an exchange may create such data as the quantity of product sold and the amount of the sale. Data

may also arise from events internal to the firm. For example, raw materials may be issued into
production and employees may expend hours of work on production jobs.Still other data may be
created by managers, as when they establish standard cost for elements of production such as direct
materials.Finally, data such as the interest rate changed on the credit card balances may be a factor of
the prime rate, an environmental event.When the data inputs are entered into an information system,
such as the AIS of a firm the processing stage takes place. Thus the quantity of product sold will be
multiplied by the unit price to determine the extended amount of sale.The processed data in the output
stage become information outputs,which are then communicated to the appropriate users.The
processed data pertaining to a sale,formally reflected on a bill or an invoice to the customer involved in
the sale.Aggregated sales transaction data provides a sales manager information about total sales of the
day.

SYSTEM

A system is a unified group of interacting arts that function together to achieve purpose.The world is
brimming with systems those that are natural and those made by humans. The Mississippi River and the
solar system are natural systems whereas a clock and a freeway network are human-made systems.
Each system has boundary that separates it from its environment Most systems are open in that the
accept inputs from their environments and provide outputs to the environments.Most are also tangible
in that they employ physical resources such as materials and personnel Figure 1-2 presents the basic
characteristics of a system

Because system are complex and numerous in the business as well as natural world, we will resist
the later in this chapter and in Chapter in particular we will be concerned with the fact that a system
contains interdependent parts that have system characteristics and are called subsystems.

Of the three terms accounting information and systems-perhaps the least familiar term is .. Most
accounting courses provide frameworks, such as financial reporting or taxation is usually not explained
within the context of accounting as an information system to cover this ground, we will focus on the
systems view of accounting.

ACCOUNTING INFORMATION SYSTEMS

The preceding descriptions of accounting information, and system enable us to develop a workable
definition of an AIS.An accounting information system sa unified structure within an entity, such as a
business firm that employs physical resources and other components to transform economic data into
accounting information with the purpose of satisfying the information needs of a variety of users.

FEATURES OF TYPICAL ACCOUNTING INFORMATION SYSTEMS

The above definition of an Als like all definitions, is rather vague and lifeless. To bring the concept of an
AIS to life, we will describe the features of AIs in a business firm Figure 1-3 provides a brief background
of this hypothetical but typical firm called Infoage Inc. Note that while the features / AlSs assume
somewhat differing appearances from organization to organization, All AIS have common
characteristics.The illustrative firm which build on the prior discussions of accounting information, and
system-emphasizes the purposes and users of information the.

INFOAGE, INC

Infoage, Inc. is a Seattle corporation with two revenue activities. Its principal activity is selling
microcomputers and accessories to small business and individuals. It also provides services related to
the selection and installation of microcomputer systems. George Freeman is the president, Diane
Varneys is the treasurer and controller. Mike Barker is the marketing manager. Jack Dyson is the
inventory manager.Jane Thomson is the systems services manager and Ralph Cannon is the office
manager. Roughly five dozen employees support these managers at the main office.In addition Infoage
has a warehouse and two retail outlets in the area.Each outlet is headed by an outlet manager who
supervise Eight employees.Sales are made on credit for cash. Services are billed at the end of an
engagement or periodically during extensive engagements. Each of the Managers in the has assigned
responsibilities that involve planning,control and directing operations.

The AIS/MIS maintained by Infoage is computerized in the main office, the warehouse and the outlets.
Ralph Cannon is responsible for its development and operation.While the computers in the main office
and in the warehouse are linked together into a peer-to peer network, they are not electronically
connected to the microcomputers in the outlets. Daily operations, such as purchasing merchandise for
resale are performed according to prescribed procedures. Most of the records and files are stored in the
computer system,although historical records and correspondence are kept in file cabinets The AIS/MIS
generates a variety of computer generated outputs, including sales and payroll reports.

Note End o chapter assignments may involve additional details about infoage.

FIGURE 1-3 An illustrative business firm and its AIS functions performed during transformation of data
into information, and the components/resources employed.

OBJECTIVES AND USERS OF AIS

The primary aim of any Als, as the definition notes, is to provide accounting information to a wide
variety of users. The users may be internal users, such as managers, or external users, such as
customers. Three specific objectives can be identified that will help achieve the primary aim. Each
objective is closely associated with specific categories of users of the AIS so both should be viewed
together.

First Objective: To Support the Day-to-Day Operations in order to operate from day to day, a firm
conducts a number of business events called transactions. Infoage Inc. is involved daily in receiving
computers and accessories at its warehouse next to the main office and in selling the merchandise.
Accounting transactions include events or transactions that represent exchanges having economic value.
The sale of computers by Infoage is an accounting transaction. Accounting transactions are formally
captured by the AIS for processing Most non-accounting transactions, such as placing a purchase order
for computers, lead to accounting transactions. For example, when the shipment of computers for
which Infoage had placed an order is received the accountant records an accounting transaction: an
increase in merchandise inventory (a debit to the account) and an increase in accounts payable (a credit
to the account). Thus certain non- transactions are also captured and processed by the AIS. Other nting
transactions and non-transactional data are handled by a related information system within the firm, as
we will see

Transaction processing consists of processing accounting, and non-accounting transactions through

key accounting records by means of procedures. As you have learned in earlier accounting courses,
accounting records consist primarily of journals (transaction files) and ledgers (master files); however,
they also include sourcing documents, registers, reference tables, and various other records. Transaction
processing is fairly standardized among firms for like transactions, such as credit sales.For instance, the
billing of customers by Infoage and by a service firm, such as a fim of architects and engineers, will have
similarities, since similar accounting records will be employed On the other hand, the details of the
procedures usually differ, depending on the system design. Also, although basic types of accounting
transactions tend to be reasonably common among firms, there are differences. Infoage requires the
basic set of accounting transactions typical to most merchandising firms sales of computers and services,
purchases of computers and peripherals, supplies, and services, receipts and disbursements of cash and
payroll disbursements to employees. The service firm needs all these transactions except those involving
products.

Transactions are processed by means of transaction processing systems (TPS) which are subsystems of
the AIS. Each TPS encompasses the steps for a particular type of transaction. In some cases, a TPS groups
the steps into an applications), a series of logical steps. Thus the TPS involving sales transactions for
Infoage is sub-divided into order taking, billing, accounts receivable posting, and so on. Later on you will
recognize this TPS also as a revenue cycle. Being subsystems, the TPSs of a firm are closely interrelated
Figure 1-4 shows the relationships among the TPSs used by Infoage's AIS.

Users of outputs from transaction processing systems range from managers an employees within the
affected firm to a variety of parties external to the firm. We respect to Infoage, the external users and
the information output documents or reports they receive include:
• Customers who receive sales invoices or bills.

• Suppliers who receive purchase orders and then (upon payment) checks

• Employees who receive paychecks.

.Banks that receive

(on request for bank
loans) financial
statements.

Second
Objective: To Support
Decision Making
by Internal Decision
Makers An equally
important purpose
is to provide
information for
decision making
Decisions must be
made
pertaining to
planning and controlling a firm's operations. This second objective is aided by activities that may be
broadly labeled as Information processing. For instance, Infoage uses its Als for a vital information
processing task:projecting expected revenues for the coming year. In doing so, the firm employs a
forecasting method (a type of decision model). With the expected revenue amount known, Infoage can
do necessary planning. The firm might, information system (MIS) as discussed later. Figure 1-5 diagrams
the relationship between information processing and transaction processing.

The managers of a firm are the primary decision makers who use the outputs from information
processing Infoage therefore contains several decision makers, Such as the president, the treasurer, and
the marketing manager. In sizable firms, certain key employees may also be involved in making
decisions. For instance, a cost accountant may need a report concerning the actual costs of producing a
component to aid her in recommending whether the production manager should buy or make the
component.
Third kind
Objective: To Fulfill
Obligations relating
to

Stewardship .Every firm must fulfill its legal obligations. Certain important obligations consist of
providing mandatory information to users who are external to the firm. Firms that are incorporated and
publicly owned have greater obligations, as do firms in regulated industries such as public utilities. They
may be required to provide information to stakeholders persons or firms having a stake in the welfare of
a firm. Stakeholders include owners creditors, labor unions, regulatory commissions, financial analysts,
industry associations, and even the general public. Though not a large firm. Infoage has owners called
stockholders, and thus it periodically issues financial statements to them. It also must provide payroll tax
withholding reports and income tax withholding reports to the appropriate government agencies

FUNCTIONS IN TRANSFORMING DATA INTO INFORMATION

Earlier we observed data being transformed into information during input, processing, and output
stages (see Figure 1-1). An effective AIS performs several key functions throughout these three stages.
Figure 1-6 shows these functions to be data collection, data maintenance, data management, data
control (including security and information generation. As the figure indicates, these functions are akin
to interrelated subsystems. Each function can in turn be subdivided into several steps.
 Data Collection .The data collection function (performed during the input stage)involves steps
such as capturing the transaction data, recording the data into forms and validating and editing the data
to ensure their accuracy and completeness. If the data elements are quantitative, they may also need to
be measured before recording If the transactions are captured at a point remote from the point where
they are to be processed, the data will need to be transmitted.Consider sales transactions made by
Infoage. When a customer places an order, a salesperson captures the facts concerning the credit sale at
one of the outlets. The salesperson records on a sales order form the pertinent data, such as the
customer's name and the desired products and quantities. Then the salesperson transmits the order to
the main office by fax machine. There a sales clerk validates the name and address of the customer by
reference to a file.

Data Maintenance The data maintenance function (performed during the processing stage) involves
steps like the following;

• Classifying, or assigning collected data to pre-established categories

• Transcribing or copying/reproducing the data onto another document or medium.

• Sorting, or arranging data elements according to one or more characteristics

• Batching, or gathering together groups of transactions of a similar nature.

• Merging, or combining two or more batches or files of data

• Calculating, or performing addition, subtraction multiplication and division

. Summarizing or aggregating quantitative data elements

.Comp aring, or
examining
items from
separate
batches or
files to find those
that

For example, a
clerk at Infoage
begins the
processing
of sales
transactions
by listing product codes next to descriptions in order to classify the product data.When the products
have been shipped to the costumers the key data are entered into the computer system. The computer
system then performs the following processing steps fo each sale, being guided by instructions called a
computer program: The quantities sold are multiplied by the unit sales prices to calculate the amount
owed by the customer for each product. The extended amounts are summed. The sales invoice is next
formatted into a record within the computer system.

At the end of each day, the computer program batches the invoice records and sort them by customer
numbers.Then, it summarizes the quantities of each product sold and lists the totals on a sales recap
record. Finally, the computer program compares todays totals with yesterday's totals and records each
increase or decrease .on an analysis record

Data Management. The data management function consists of three steps storing maintaining and
retrieving. Storing involves placing data in repositories called files or data bases Data must often be
stored for future reference; also, data that have been processed into information may be held
temporarily until needed by users.

Maintaining involves adjusting stored data to reflect newly occurring events, operations, or decisions.
Retrieving consists of accessing and extracting data, either for further processing or for reporting to
users.

In the case of sales transactions at Infoage, a clerk stores data concerning new customers in records
within the computer system. When sales have been made to customers, the customers' accounts in the
stored records are updated For instance a computer program adds the amount of a sale leg. $100) to
the previous balance in the customer's account le g. $900), thereby deriving the updated balance owed
by the customer leg. S1000) At the end of each month, a clerk accesses all of the customer records in
the computer system and retrieves the appropriate data to prepare needed information for managers

Data Control The data control function has two basic aims: (l) to safeguard and secure the firm's assets,
including data and (2) to ensure that the captured data are accurate and complete and processed
correctly. A variety of techniques and procedures are employed in an effective AIS to maintain adequate
control and security. One technique employed by Infoage is to validate input data by checking the sales
and other transaction data against reference records stored in the computer system. An other technique
is to require employees to enter passwords each time they turn of their microcomputers to begin
processing for the day.

Information Generation The information generation function includes such step as interpreting,
reporting and communicating information. It supports the output from both transaction processing and
information processing For instance, sales invoices are printed by Infoage each day, together with sales
summaries. In addition each month a computer program prepares an aging of account receivables
report, which analyzes. The invoices are mailed to customer whereas the other reports and analyzes are
communicated to the appropriate managers.

RESOURCES/COMPONENTS
Since an AIS is tangible, it requires physical resources and related components. We may classify these
resources and components as processor, data base, procedures,and input/output devices Control and
security devices could also be included, but they have been discussed under the control function. Not
included are the input data output information, and users. These components meet at the boundary of
the AIS, that is, they interface with the AIS.

Processor. The physical means by which data are transformed may be called processor. In Infoage the
processing function is essentially represented by the computer system. In Allen's basement
waterproofing firm, more of the processing is performed manually by the secretary and bookkeeper, so
they represent processors.Most firms today perform processing with a mixture of human and
automated processors. We should note, however, that processors are not solely represented by-
computers. They include such devices as typewriters and cash registers

Data Base -Broadly speaking, the data base consists of all stored data. Infoage is typical in that its data is
stored partly in a computer system and partly in such storage devices as file cabinets and desk drawers.
(We should note that in its narrow sense the term "data base" refers only to data stored in a computer
system)

Procedures -Particular sequences of steps performed within one or more of an AIS's functions are
known as procedures. They may be performed manually or by means of the instructions in computer
programs, as we have seen.

Input/Output Devices- Although the data and information are not resources to an Als, the physical
means of handling or storing them can be included. At infoage the data are initially stored on paper
forms or documents and then entered into the computer system via microcomputer keyboards.
Similarly, outputs are printed on copy forms by printers. For instance, Infoage prints paychecks on pre-
numbered blank-form stocks.

Miscellaneous Resources -An Als requires other resources that should be noted for instance, many
employees of a firm perform certain Als functions, such as recording data. Fixed assets may be needed
to house the system. Various supplies are needed,such as printer ribbons. Finally, funds must be
budgeted in order to maintain and develop an AIS

AIS's in the INFORMATION AGE

Most of the accounting information is generated from transactions. Transactions of firms have both
accounting and non-accounting attributes. For example, the delivery location and time of delivery may
be irrelevant to accounting, but the item codes and quantities delivered of each item are key accounting
inputs During the early days of computerization of AISs, accounting systems used to be isolated from
other information systems and served as operational support systems. Today, as more powerful,
flexible, economical, and user-friendly software and hardware have become available, the trend is
toward a logical arrangement where a single system can support both accounting and operational
needs. In sum, today's accounting systems are closely tied into and may even be fully integrated with
other information systems. A benefit of this trend is that accountants now have easy access to non-
accounting data, which may prove useful in the verification of accounting information.

Accountants can present a total comprehensive picture-called a Scorecard-more easily. thus providing
management with a complete dashboard measurements to control the firm's destiny. A downside of the
integrated system that accounting information, to the extent its access should be limited, needs to be
guarded from unauthorized access. Consequently,more sophisticated control and security measures will
need to be designed in integrated AISs

The AIS is not the only system within a firm that is concerned with data and information. In fact, the Ais
is a subsystem of a broader information system that encompasses all information generating activities.
Other component information system include the management information system, decision support
systems, experts systems, and executive information systems. In this section we shall survey these type
of Information systems, suggest relationships among them, and identify key subsystems.

Although our discussion will be brief, much additional coverage will be given the management
information system as well as to the AISs in following chapters and on the accompanying CD-ROM.

MANAGEMENT INFORMATION SYSTEM

As the name implies, the management Information system (MIS) serves the managers of the firm with
their information needs. It is as important to a firm's well-being as the AIS

Purpose and Scope .The sole purpose of an MIS is to aid the managers of a making decisions related to
their responsibilities. That is the MIS provides information needed to plan and control the activities of
the firm, ranging from organizing firm's personnel and setting policies to taking corrective actions when
raw materials are wasted. It spans all the managerial levels of fim, ranging from the president to the
lowest supervisor.The MIS employs all types of data, including non-transactiondata, it disseminates non-
financial as well as financial information.

MIS Subsystems Like most systems, the MIS contains subsystems. Perhaps the most useful set of
subsystems it incorporates is functional information systems.Since subsystems have all the
characteristics of systems, the terms "system and "subsystem are interchangeable A subsystem can also
be viewed as a system within a larger system Functional information systems are so named because
they support key organizational functions (to be discussed in Chapter 2). They interact with each other
by passing data and information among themselves. Although functional information systems vary
among different types of firms, four found in a manufacturing firm pertain to marketing, finance, human
resources, and production Figure lists examples of data captured by these subsystems and information
provided in managers.