Chapter 2

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

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

 Scott and Susan recognize that they need

qualified accounting help and have hired a
full-time accountant, Ashton Fleming.

 Ashton is responsible for creating an

accounting information system (AIS).
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 What questions does Ashton ask himself?
 How am I going to organize things?
 Where do I start?
 What information does S&S need in order to operate
effectively?
 How can that information be provided?

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

 How do I organize all the data that will be

collected?

 How should I design the AIS so that the information

provided is reliable and accurate?

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

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Types of information needed for decisions:
 Some is 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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( The revenue cycle: involves activities of selling
goods or services and collecting payment for those
sales.
s The expenditure cycle: involves activities of buying
and paying for goods or services used by the
organization.
o The human resources/payroll cycle: involves
activities of hiring and paying employees.

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ð The production cycle: involves activities converting
raw materials and labor into finished goods.
d 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 Expenditure Human
Cycle Cycle Resources

General Ledger & Reporting System

Production Revenue
Cycle 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 Function

Sales order Take customer order.

Delivery ticket Deliver or ship order

Remittance advice Receive cash.

Deposit slip Deposit cash receipts.

Credit memo Adjust customer accounts

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 EXPENDITURE CYCLE
Source Document Function

Purchase requisition Request items.

Purchase order Order items.

Receiving report Receive items.
Check Pay for items.

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 HUMAN RESOURCES CYCLE
Source Document Function

W4 forms Collect employee

withholding data.

Time cards Record time worked

by employees.

Job time tickets Record time spent

on specific jobs.

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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 isn’t there.
• Subsidiary ledger

The subsidiary ledgers contain the detail accounts

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

e.g.
–accounts receivable
–inventory
–accounts payable
Relationship between General and Subsidiary
ledger
Relationship between General and Subsidiary ledger
• Subsidiary ledger

Advantages:
1 Shows transactions affecting one customer or one
creditor in a single 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.
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 Other problems with budget:
 Budgeting can also be dysfunctional in that
the focus can be redirected to creating
acceptable numbers instead of achieving
organizational objectives.

 Does this mean organizations shouldn’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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 h What are some of the problems that might
occur when management focuses only on
profit measure based reports? (what areas
of the business might suffer as a result?)

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

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

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

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

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  Improperly prepared journal entries
 Unposted journal entries
 Debits not equal to credits
 Subsidiary not equal to general ledger
control accounts
 Inappropriate access to the general ledger
 Poor audit trail
 Lost or damaged data
 Account balances that are wrong because of
unauthorized or incorrect journal vouchers
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  Pre-numbered and well-designed journal vouchers
 Validating data on journal vouchers
 Correcting detected errors before the data are posted
to the general ledger
 Compiling standardized adjusted
journal entries
 Pre-computing batch control totals

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

 Summing the amounts posted to the general ledger

accounts and then comparing the posted totals to
the pre-computed batch control totals

 Establishing and maintaining an adequate audit trail

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

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

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

 Allows instant communication with all sub-

systems of an organization

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