Ais Chap 1 7 PDF

CHAPTER 1 Information Requirements; Information in
The Information System: An Accountant’s Business

Perspective • Each user group has unique information
requirements.
The Information Environment • The higher the level of the organization, the
• Accounting information systems (AIS) are greater the need for more aggregated
specialized subset of information systems that information and less need for detail.
processes financial transactions. • Information is a business resource that:
• It identifies, collects, processes, and o needs to be appropriately managed
communicates economic information about a firm o is vital to survival of contemporary
using a wide variety of technologies. businesses
• It captures and records the financial effects of the
firm’s transactions. What is a System?
• It distributes transaction information to • A group of interrelated multiple components or
operations personnel to coordinate many key subsystems that serve a common purpose
tasks. • System or subsystem?
o processes financial transactions; e.g., o A system is called a subsystem when it is
sale of goods viewed as a component of a larger
o processes nonfinancial transactions that system.
directly affect the processing of financial o A subsystem is considered a system
transactions; e.g., addition of newly when it is the focus of attention.
approved vendors
• Information flows are the flows of information System Decomposition versus System
into and out of an organization. Interdependency
• Trading partners is a category of external user, • System Decomposition
including customer sales and billing information, o the process of dividing the system into
smaller subsystem parts
purchase information for suppliers, and inventory
• System Interdependency
receipts information.
o distinct parts are not self-contained
• Stakeholders are entities either inside or
o they are reliant upon the functioning of
outside an organization that have a direct or
the other parts of the system
indirect interest in the firm.
o all distinct parts must be functioning or
the system will fail
INFORMATION OBJECTIVES
• Three fundamental objectives that are common
to all organizations:
o To support the firm’s day-to-day
operations.
o To support management decision
making.
o To support the stewardship function of
management
AN INFORMATION SYSTEMS FRAMEWORK

• The information system is the set of formal
procedures by which data are collected,
Internal Information Flows processed into information, and distributed to
• Horizontal flows of information used primarily at users.
the operations level to capture transaction and • A management information system (MIS) is
operations data a system that processes nonfinancial transactions
• Vertical flows of information not normally processed by traditional accounting
o downward flows — instructions, quotas, information systems (e.g. tracking job skills of
and budgets employees)
o upward flows — aggregated transaction • A transaction is event that affects or is of
and operations data interest to the organization and is processed by
its information system as a unit of work.
• A financial transaction is an economic event
that affects the assets and equities of the
organization, is measured in financial terms, and The Management Information System
is reflected in the accounts of the firm (e.g. The Need to Distinguish between AIS and MIS
purchase of goods)
• Nonfinancial transactions are event that do Examples of MIS Applications in Functional Areas
not meet the narrow definition of a financial
transaction; other events (e.g. preparation of
purchase order)
A Framework for Information Systems
AIS SUBSYSTEMS
• Transaction Processing System
o Converts economic events into financial
transactions.
o Records financial transactions in the
accounting records.
o Distributes essential financial information
to support operations.
• General Ledger/Financial Reporting Systems
o Takes information from the TPS and
other input.
o updates general ledger control accounts.
o handles nondiscretionary reporting
requirements.
o Nondiscretionary reporting is a type
of reporting in which the organization has
few or no choices mation consists of
Transactions Processed by the Information traditional financial statements, tax
Systems returns, and other legal documents.
• Management Reporting System
o provides the internal information needed
to manage a business and handles
discretionary reporting.
o Discretionary reporting is a type of
reporting in which the organization can
choose what information to report and
how to present it.
The Accounting Information System
• The transaction processing system (TPS) is A GENERAL MODEL FOR AIS
an activity composed of three major
• The general model for AIS is a model that
subsystems—the revenue cycle, the expenditure
describes all information systems, regardless of
cycle, and the conversion cycle; supports daily
their technological architecture.
business operations
• The general ledger/financial reporting End Users
system (GL/FRS) is a system that produces
• End users are users for whom the system is
traditional financial statements, such as income
built.
statements, balance sheets, statements of cash o External users include creditors,
flows, tax returns, and other reports required by stockholders, potential investors,
law. regulatory agencies, tax authorities,
• The management reporting system (MRS) is suppliers, and customers.
a system that provides the internal financial o Internal users include management at
information needed to manage a business; all levels of the organization as well as
produces special-purpose reports for internal use operations personnel.
DATA VERSUS INFORMATION o Efficient collection procedures designed
• Data are facts, which may or may not be to collect data only once (EFFICIENCY)
processed (edited, summarized, or refined) and Data Processing
which have no direct effect on the user. • once collected, data usually require processing to
• Information causes the user to take anction produce information; tasks range from simple to
that he or she otherwise could not, or would not, complex (summarizing to sales forecasting using
have taken. statistical techniques)
Database Management
General Model for Accounting Information • Database is a physical repository for financial
Systems data. Term could apply to a filing cabinet or
computer disk.
Levels of Data Hierarchy

• Data Attribute
o the most elemental piece of potentially
useful data in the database.
• Record
o is a complete set of attributes for a single
occurrence within an entity class.
• File (or Table)
o is a complete set of records of an
identical class.
Database Management Tasks

Data Sources • Database management involves three
• Data sources are financial transactions that fundamental tasks: storage, retrieval and
enter the information system from either internal deletion.
or external sources. • Database management system is a special
o External financial transactions are the software system that is programmed to know
most common source of data for most which data elements each user is authorized to
organizations. access.
▪ E.g., sale of goods and services,
purchase of inventory, receipt of The Data Hierarchy
cash, and disbursement of cash
(including payroll)
o Internal financial transactions involve the
exchange or movement of resources
within the organization.
▪ E.g., movement of raw materials
into work-in-process (WIP),
application of labor and
overhead to WIP, transfer of WIP
into finished goods inventory,
and depreciation of equipment
Transforming the Data into Information

• Functions for transforming data into information
according to the general AIS model:
1. Data Collection Information Generation
2. Data Processing • Information generation is the process of
3. Data Management compiling, arranging, formatting, and presenting
4. Information Generation information to users.
o Relevance: Content must serve a
purpose.
Data Collection
o Timeliness: No older than time frame of
• Data collection is the first operational stage in
supported action.
the information system.
o Accuracy: Free from material errors.
o Objective is to ensure data are valid,
o Completeness: All essential information
complete and free from material errors.
is present.
o Only relevant data should be captured
(RELEVANCE)
o Summarization: Aggregated for the Functions From Resources
user’s needs.
• Feedback is a form of output that is sent back
to the system as a source of data.
Organizational Structure and AIS

• Physical AIS comprise technologies of various
types and configurations as well as people and
tasks from across the organization.
• The structure of an organization helps to allocate
o responsibility THE ACCOUNTING FUNCTION
o authority • Accounting manages the financial resource of the
o accountability firm:
• Segmenting by business function is a very o Captures and records transactions.
common method of organizing o Distributes transaction information to
• The sales processing system, which is a operations personnel.
subsystem of the revenue cycle, includes the • The Value of Information
following organization functions: sales, credit, o Reliability is the property of information
inventory control, warehousing, shipping, billing, that makes it useful to users.
accounts receivable, general ledger, and data o To be reliable, information must possess
processing. the following attributes - relevance,
accuracy, completeness, summarization
FUNCTIONAL SEGMENTATION and timeliness.
• Segments are functional units of a business o Unreliable information has no value.
organization.
• Materials Management THE ACCOUNTING FUNCTION
o Purchasing • Accounting Independence
o Receiving o It is required by information to be reliable
o Stores o Independence is the separation of the
• Production record-keeping function of accounting
o Production planning involves scheduling from the functional areas that have
the flow of materials, labor, and custody of physical resources.
machinery to efficiently meet production o Supports these functions with
needs. information but does not participate in
o Quality control monitors the the physical activities.
manufacturing process at various points o Decisions makers in these functions
to ensure that the finished products meet require that such vital information be
the firm’s quality standards. supplied by an independent source to
o Maintenance keeps the firm’s machinery ensure its integrity.
and other manufacturing facilities in
running order. INFORMATION TECHNOLOGY
• Marketing, Distribution, Personnel, Finance, • Centralized data processing is a model under
Accounting, Computer Services/Information which all data processing is performed by one or
Technology more large computers, housed at a central site,
that serve users throughout the organization.
Functional Areas of a Firm o It lends itself to intra-organization
communication and data sharing.
• Distributed data processing (DDP) is
reorganizing the IT function into small
information processing units (IPUs) that are
distributed to end users and placed under their
control.
o Users process transactions locally with
each user segment possessing IT needs
to support their operations.
o Users function independently and tend
not to share data and information.
Centralized Data Processing Model o Enterprise resource planning (ERP)
is a system assembled of prefabricated
software components.
Systems Maintenance
• It involves changes in the system as user needs
changes and evolve.
• It may be trivial or significant.
• Between 80% - 90% of system’s total cost may
be incurred because of maintenance activities.
Database Administration
• Centrally organized companies with shared data
use database administration to ensure security
and integrity.
Organization of IT Function in a Centralized Network Administration

System • A network is a collection of interconnected
computers and communications devices that
allows users to communicate access data and
applications, and share information and
resources.
• Network administration is being responsible
for the effective functioning of the software and
hardware that constitute the organization’s
network.
o This involves configuring, implementing,
and maintaining network equipment.
Distributed Data Processing Model
• Primary Areas of Centralized Data Processing:

Database administration, Data processing,
Systems development, Systems Maintenance
Systems Development and Maintenance

Systems Development
• It is the process organizations use to acquired
information systems. Information systems can be
purchased or built from scratch.
• Commercial software is pre-coded software
that a user purchases from a software vendor.
o It is available for general accounting and
industry specific applications.
o Commercial software packages are
sometimes called turnkey systems
because they often can be implemented
by the user with little or no modification.
o Turnkey systems are completely
finished and tested systems that are
ready for implementation.
• Custom software is software built to individual
specifications.
o Custom systems are expensive than
commercial packages.
o Creating custom software requires an in-
house team of qualified individuals.
• Systems development life cycle is the Organization of IT Function in a Centralized
software development process. System
• is a software distribution model in which service
providers host applications for client
organizations over a private network or the
Internet.
Infrastructure as a service (IaaS)

• is the provision of computing power and disk
space to client firms who access it from desktop
PCs.
• The client firm can configure the infrastructure for
storage, networks, and other computing needs,
including running operating systems and data
processing applications.
Potential Advantages of DDP
Platform as a service (PaaS)
1. Cost reductions in hardware and data entry tasks
2. Improved cost control responsibility • enables client firms to develop and deploy onto
the cloud infrastructure consumer-generated
3. Improved user satisfaction since control is closer
applications using facilities provided by the PaaS
to the user level
vendor.
4. Back-up of data can be improved through the use
of multiple data storage sites
The Role of Accountants in AIS
• Accountants are involved in both the design and
Potential Disadvantages of DDP
the audit of AIS.
1. Loss of control
• Accountants play a prominent role on systems
2. Mismanagement of company resources
development teams as domain experts,
3. Hardware and software incompatibility
responsible for many aspects of the conceptual
4. Redundant tasks and data
system including specifying rules, reporting
5. Consolidating tasks usually segregated
requirements and internal control objectives.
6. Difficulty attracting qualified personnel
• The IT professionals on the team are responsible
7. Lack of standards
for the physical system, including data storage.
Outsourcing the IT Function
ACCOUNTANTS AS SYSTEM DESIGNERS
• Due to the highly technical, dynamically changing
• Conceptual system is the production of several
and expense of IT, many executives look to IT
alternative designs for a new system.
Outsourcing.
• Physical system is the medium and method for
• Organization sells IT resources and leases back
capturing and presenting the information.
IT services.
• Data storage is an efficient information system
that captures and stores data only once and
IT Outsourcing
makes this single source available to all users who
• is contracting with a third-party vendor to take
need it.
over the costs, risks, and responsibilities
associated with maintaining an effective
ACCOUNTANTS AS SYSTEM AUDITORS
corporate IT function, including management of
• Accountants perform audits which typically
IT assets and staff and delivery of IT services
involve the AIS.
such as data entry, data center operations,
o External audit is an independent
applications development, applications
attestation and opinion (audit report)
maintenance, and network management.
regarding financial statement
presentation.
Cloud computing
o Requires auditors (independent CPAs) to
• is a location-independent computing variant of IT test internal controls and perform
outsourcing whereby shared data centers deliver substantive tests of data.
hosted IT services over the Internet. These o Critical element is auditor
services fall into three categories: software as a independence, which means the
service (SaaS), infrastructure as a service (IaaS), auditor is free from factors that might
and platform as a service (PaaS). influence the audit report.
• Auditor is an expert who expresses an opinion
Software as a service (SaaS) about the fairness of a company’s financial
statements.
• Attest function is an independent auditor’s The Role of the Audit Committee
responsibility to opine as to the fair presentation • Audit committees serves an independent “check
of a client firm’s financial statement. and balance” for internal audit functions and a
• Substantive tests are tests that determine liaison with external auditors.
whether database contents fairly reflect the • This is usually composed of three people who
organization’s transactions. should be outsiders (not associated with the
• Assurance service is broader in scope than families of executive management nor former
traditional attestation audit officers, etc.), one of which must be a “financial
expert”.
Attest Service Versus Advisory Services
• Tests of controls are tests that establish Designer/Auditor Duality
whether internal controls are functioning • Designer – knowledge of functions, tasks and
properly. controls in the system
• IT auditing is the review of the computer-based • Auditor – knowledge of audit issues and concerns
components of an organization. The audit is often (e.g. audit risk, audit objectives, etc.)
performed as part of a broader financial audit. • Accountants must be able to clearly convey their
• IT auditors evaluate IT, often as part of external needs to the systems professionals who design
audit the system.
• The accountant should actively participate
Sarbanes-Oxley Act of 2002 in systems development projects to ensure
• Prior to SOX, accounting firms were permitted to appropriate systems design.
provide both advisory and attest services to
clients.
o SOX legislation restricts non-audit
services that auditors may provide and
prohibits auditors from providing these
services:
o Other accounting services including
bookkeeping, financial information
systems design and implementation,
appraisal or valuation, actuarial, and
internal audit outsourcing.
o Management or human resources, broker
or dealer, investment adviser, or
investment banking services.
o Legal services and expert services
unrelated to the audit.
o Any other service that the Board
determines, by regulation, is
impermissible.
o
Internal Audits
• Internal auditing is the appraisal function
housed within the organization to examine and
evaluate activities.
External Versus Internal Auditors

• External auditors attest to the fairness of financial
statements and represent outsiders and internal
auditors provide in-house IS and IT appraisal
services and represent the interests of the
organization.
Fraud Audits
• These have increased in popularity as a corporate
governance tool. These may be initiated by
managers to investigate employees or the board
to investigate management.
CHAPTER 2 Accounting Records
Introduction to Transaction Processing • Accounting records are documents, journals or
ledgers used in transaction cycles.
AN OVERVIEW OF TRANSACTION PROCESSING
• The most common financial transactions are MANUAL SYSTEMS
economic exchanges with external parties. • Documents
• These include the sale of goods or services, the • Source documents are documents that
purchase of inventory, the discharge of financial capture and formalize transaction data
obligations, and the receipt of cash on account needed for processing by their respective
from customers. transaction cycles.
• Financial transactions are common business • Product documents are documents
events that occur regularly. that result from transaction processing.
• Turnaround documents are product
TRANSACTION CYCLES documents of one system that become
• The Expenditure Cycle source documents for another system.
o The expenditure cycle is the
acquisition of materials, property, and Creation of a Source Document
labor in exchange for cash (cash
transactions). Time lag between
components due to credit relationship
with suppliers (credit transactions)
o physical component (acquisition of
goods)
o financial component (cash
disbursements to the supplier)
• The Conversion Cycle
o The conversion cycle provides value
added through its products or services
(conversion cycle).
o The production system (planning,
scheduling, and control of the physical A Product Document
product through the manufacturing
process)
o The cost accounting system
(monitors the flow of cost information
related to production)
• The Revenue Cycle
o The revenue cycle receives revenue
from outside sources
o Time lag between components due to
credit relationship with customers (credit
transactions).
o It is the cycle composed of sales order
processing and cash receipts.
Relationship Between Transaction Cycles

A Turnaround Document
• A journal is a record of a chronological entry. Relationship between the Subsidiary Ledger and
o Special journals are used to record the General Ledger
specific classes of transactions that occur
in high frequency.
o A register is often used to denote
certain types of special journals.
▪ For example, the payroll journal
is often called the payroll
register.
o General journal is used to record
nonrecurring, infrequent, and dissimilar
transactions.
o Journal vouchers replaces the
traditional general journal.
▪ These are also used for
accounting journal entries into
an accounting system for the
purposes of making corrections
or adjustments to the accounting
data.
▪ For control purposes, all JVs
should be approved by the
appropriate designated
authority.
• A ledger is a book of accounts that reflects the THE AUDIT TRAIL
financial effects of the firm’s transactions after • An audit trail is a set of accounting records that
they are posted from the various journals. trace transactions from their source documents to
o GENERAL LEDGERS contain account the financial statements.
information in highly summarized control • An audit trail is of utmost importance in the
accounts. conduct of a financial audit.
o SUBSIDIARY LEDGERS contain details • The external auditor’s responsibility involves, in
for each 0f the individual accounts that
part, the review of selected accounts and
constitute a particular control account.
transactions to determine their validity, accuracy,
• Together the accounting records provide an
and completeness.
audit trail for tracing account balances
contained in the financial statements back to the
DIGITAL ACCOUNTING RECORDS
source documents and events that created them.
• Modern accounting systems store data in four
o Important in the conduct of a financial
types of digital computer files:
audit.
o A master file contains account data.
o A transaction file is a temporary file
Sales Order Recorded in a Sales Journal
that holds transaction records that will be
used to change or update data in a
master file.
o A reference file is a file that stores the
data used as standards for processing
transactions.
o An archive file is a file that contains
records of past transactions that are
Flow of Information from the Economic Event to
retained for future reference. It forms an
the General Ledger
important part of the audit trail.
• The Digital Audit Trail
o These are less observable than those
between hard-copy documents, but they
still exist.
Digital Accounting Records in a Computer-Based user files affected by a change in status;
System may result in decisions based on
outdated information.
• Task-Data Dependency
o Task-data dependency is a user’s
inability to obtain additional information
as his or her needs change. This is the
effect of user’s information set
constrained by the data user possess and
controls
• Flat Files Limit Data Integration
o Files structured in the view of the primary
user (single user view model), may not
be useful to other users, thus preventing
data integration (e.g. accounting data
according to standards); Separate files
are difficult to integrate across multiple
users; options
File Structures
• Digital file structures and storage techniques vary
widely among transaction processing systems.
• Some structures are effective at processing all
records in large master files.
• Some file structures are better for directly
locating and processing a single record in a large
file.
• The legacy systems are large mainframe
systems implemented in the late 1960s through
the 1980s.
THE DATABASE MODEL
• The database model is a symbolic model of the
THE FLAT-FILE MODEL
structure of, and the associations between, an
• The flat-file model is an environment in which
organization’s data entities.
individual data files are not related to other files.
• The database management system (DBMS)
• There are three significant problems in the flat-
is a software system that controls access to the
file environment: data storage, data updating,
data resource.
and currency of information.
• The most striking difference between the
• Data Capture and Storage
database model and the flat-file model is the
o Data storage is an efficient information
pooling of data into a common database that all
system that captures and stores data
organizational users share.
only once and makes this single source
available to all users who need it.
Database Model
Organizations must incur the costs of
multiple collection and storage
procedures.
• Data Updating
o Data updating is the periodic updating of
data stored in the files of an organization.
Changes or additions must be performed
multiple times which adds significantly to
the task and cost of data management.
• Currency of Information
o Currency of information is a problem
associated with the flat-file model
because of its failure to update all the
Documentation Techniques Data Flow Diagram of Purchases System
• Visual images convey vital system information
more effectively and efficiently than words.
• Accountants use system documentation
routinely, as both systems designers and
auditors.
• Five basic documentation techniques are: data
flow diagrams, entity relationship diagrams,
system flowcharts, program flowcharts, and
record layout diagrams.
DATA FLOW DIAGRAMS AND ENTITY

RELATIONSHIP DIAGRAMS
• Data Flow Diagrams
• The data flow diagram (DFD) is the
use of a set of symbols in a diagram to
represent the processes, data sources,
data flows, and process sequences of a
current or proposed system. Relationship between ER Diagrams and DFDs
• It is used extensively by systems analysts • DFDs and ER diagrams document different
to represent the logical elements of the system aspects but are related.
system but does not depict the physical • DFDs model systems processes and ER diagrams
system model system data.
• Entity Relationship Diagrams • Each data store in a DFD is represented as an
• An entity relationship (ER) diagram is entity in a corresponding ER diagram (e.g.
a documentation technique used to diagram 2-17)
represent the relationship among data
entities in a system. Entity Relationships Diagram Symbols
• Cardinality (degree of relationship is
the numeric mapping between entities
such as one-to-one (1:1), one-to-many
(1:M), and many-to-many (M:M).
• A data model is the blueprint for what
ultimately will become the physical
database.
Data Flow Diagram Symbol Set
Data Model
SYSTEM FLOWCHARTS
• System flowchart
o It is used to show (graphical
representation) of the physical
relationship between the key elements—
input sources, programs, and output
products—of computer systems or
departments, manual activities, Program Flowchart Symbols
computer programs, hard-copy and
digital accounting records.
o Also describe the physical computer
media being employed.
o Shows the processing of a single
transaction only.
• Flowcharting Manual Activities
o Lay out the physical area of activity.
o Transcribe the written facts into visual RECORD LAYOUT DIAGRAMS
format. • Record layout diagrams are used to reveal the
• Flowcharting Computer Processes internal structure of the records that constitute a
o Transcribe the written facts into visual file or database table. The layout diagram usually
format. shows the name, data type, and length of each
attribute (or field) in the record.
Symbol Set for Representing Manual Procedures • Detailed data structure information is needed for
such tasks as identifying certain types of system
failures, analyzing error reports, and designing
tests of computer logic for debugging and
auditing purposes.
Record Layout Diagram for Customer File
Transaction Processing Models

• Alternative transaction processing models fall
Symbol Set for Representing Computer Processes broadly into two types: (1) batch processing and
(2) real-time processing.
• Batch processing involves gathering transactions
into groups or batches, resulting into time lag,
and then processing the entire batch as a single
event.
• Real-time processing systems process individual
transactions continuously as they occur.
• Many systems incorporate both real-time and
batch processing features.
Characteristic Differences between Batch and

PROGRAM FLOWCHARTS Real-Time Processing
• A program flowchart is a diagram providing a
detailed description of the sequential and logical
operations of the program.
• Every program represented in a system flowchart
should have a supporting program flowchart that
describes its logic.
• The connector lines between the symbols
establish the logical order of execution.
DIFFERENCES BETWEEN BATCH AND REAL-TIME

SYSTEMS
• Information Time Frame
o Batch systems are systems that
assemble transactions into groups for
processing.
o Real-time systems are systems that • Deadlock or “wait” is a state that occurs
process transactions individually at the between sites when data are locked by multiple
moment the economic event occurs. sites that are waiting for the removal of the locks
• Resources from the other sites.
o Generally fewer required with a batch •
system. Batch Processing with Real-Time Data Collection
• Operational Efficiency
o Batch processing of noncritical accounts
eliminates unnecessary activities at
critical points in the process.
• Efficiency versus Effectiveness
o Designer must consider the trade-off
between efficiency and effectiveness.
UPDATING MASTER FILES FROM TRANSACTIONS

• Updating a master file record involves changing
the value of one or more of its variable fields to
reflect the effects of a transaction (batch and
real-time).
• Master file backup procedures - standard
procedures to maintain file integrity in the event
that:
o An update program error corrupts the
master file being updated.
o Undetected transaction errors result in
corrupted balances.
o A disaster physically destroys current
master files.
• If the current master file becomes corrupted or is
destroyed, corporate IT professionals can retrieve
the most current backed-up file from the REAL-TIME PROCESSING
archives. • Real-time systems process the entire transaction
as it occurs.
Record Structures for Sales, Inventory, and • Real-time processing is well suited to systems
Accounting Receivable Files that process lower transaction volumes and those
that do not share common records.
• Terminals at distributed sites throughout the
organization are used for receiving, processing,
and sending information on the status of current
transactions.
Real-Time Processing of Sales Orders
BATCH PROCESSING USING REAL-TIME DATA

COLLECTION
• A popular data processing approach, particularly
for large operations, is to digitally capture and
process aspects of the transaction at the source
as they occur, and process other aspects of the
transaction in batch mode.
Data Coding Schemes o ADVANTAGES – allow insertion of new
• Data coding involves creating simple numeric or code within a block
alphabetic codes to represent complex economic o DISADVANTAGES – information content
phenomena that facilitate efficient data of the code is not apparent
processing. • Group Codes
o Group codes are used to represent
A SYSTEM WITHOUT CODES complex items or events involving two or
• Business organizations process large volumes of more pieces of related data.
transactions that are similar in their basic o For example, a coding scheme for
attributes. tracking sales might be 04-09-476214-
• Uncoded entry takes a great deal of recording 99, meaning:
space, is time-consuming to record, and is o ADVANTAGES
obviously prone to many types of errors. ▪ Facilitates representation of
large amounts of diverse data.
A SYSTEM WITH CODES ▪ Allows complex data to be
• Advantages of data coding in AIS are: logically represented.
o Concisely representing large amounts of ▪ Permits detailed analysis and
complex information that would reporting.
otherwise be unmanageable. o DISADVANTAGES
o Providing a means of accountability over ▪ Overuse which can increase
the completeness of the transactions costs and linking of unrelated
processed. data.
o Identifying unique transactions and • Alphabetic Codes
accounts within a file. o Alphabetic codes are alphabetic
o Supporting the audit function by characters assigned sequentially.
providing an effective audit trail. o These are used for many of the same
purposes as numeric codes.
Data Coding Scheme (E.g. Chart of Accounts) o These may use sequential, block or group
coding techniques.
o ADVANTAGES: Alphanumeric codes
are codes that allow the use of pure
alphabetic characters embedded within
numeric codes. These dramatically
increase the capacity to represent large
numbers of items.
o DISADVANTAGES: It is difficult to
rationalize the meaning of the codes and
they tend to be difficult for users to sort.
• Mnemonic Codes
o Mnemonic codes are alphabetic
characters in the form of acronyms and
other combinations that convey meaning.
o Common application is the two code
NUMERIC AND ALPHABETIC CODING SCHEMES
state abbreviations or college course
• Sequential Codes
coding (in combination with numeric
o Sequential codes are codes that
codes).
represent items in some sequential order
o ADVANTAGES: Codes convey a high
(ascending or descending).
degree of information.
o ADVANTAGES – support reconciliation of
o DISADVANTAGES: Limited ability to
batch transactions
represent items within a class.
o DISADVANTAGES – carry no information
beyond their order; difficult to change
• Block Codes
o A numeric block code is a coding
scheme that assigns ranges of values to
specific attributes such as account
classifications.
o A chart of accounts is a listing of an
organization’s accounts showing the
account number and name.
Chapter 2
Introduction
to
Transaction
Processing
Accounting Information
Systems 9e
James A. Hall
© 2015 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in
whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
• A financial transaction is an economic event that affects the
assets and equities of the firm, is reflected in its accounts, and
is measured in monetary terms.
• 3 transaction cycles: the expenditure cycle, the conversion

cycle and the revenue cycle. Every business:
– Incurs expenditures in exchange for resources (expenditure
cycle).
– Provides value added through its products or services
(conversion cycle).
– Receives revenue from outside sources (revenue cycle).
© 2015 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 2
•.
• Expenditure Cycle: Time lag between components due to
credit relationship with suppliers.
– physical component (acquisition of goods)
– financial component (cash disbursements to the supplier)
• Conversion Cycle:
– the production system (planning, scheduling, and control of the
physical product through the manufacturing process)
– the cost accounting system (monitors the flow of cost information
related to production)
• Revenue Cycle: Time lag between components due to credit
relationship with customers.
– physical component (sales order processing)
– financial component (cash receipts)
DISCUSS THE FLOW OF CASH THROUGH THE TRANSACTION
CYLES. INCLUDE THE RELEVANT SUBSYSTEMS AND ANY
TIME LAGS THAY MAY OCCUR
• Cash flows into the firm from sales made to

customers. The sales order processing subsystem of
the revenue cycle captures the intent of customers to
exchange cash for services or goods manufactured.
Typically sales are made on credit. The cash receipts
subsystem of the revenue cycle captures the actual
receipt of cash. Depending on the credit terms and
promptness of payment by the customer, the lag
between the sales order processing subsystem and
the cash receipts subsystem may be days, weeks, or
months.
• The cash inflow allows the organization to purchase

raw materials, pay workers, and buy capital assets
necessary to manufacture the product (or to provide
services). The raw materials requirements are
determined by the production planning subsystem of
the conversion cycle. These requirements trigger
orders being placed through the purchases/accounts
payable subsystem of the expenditure cycle. For
credit sales, the cash is ultimately released once the
goods are received (or services are performed) and an
invoice has been received.
• The lag between receiving goods and disbursement

of cash may be days or weeks. Cash is also disbursed
to employees, typically after services are rendered by
the employees. The lag is usually no more than one-
half a month for salaried employees and as short as
one-half a week for hourly wage earners. The payroll
subsystem of the expenditure system captures these
disbursements to employees.
EXPLAIN WHETHER THE COST ACCOUNTING SYSTEMS
PRIMARILY SUPPORTS INTERNAL OR EXTERNAL REPORTING
• Initially, the cost accounting system was used for the

valuation of inventory and cost of goods sold
reported to external users; however, the valuable use
of cost accounting data for budgeting, cost control,
performance reporting, and management decision
making have proved to be crucial internal support.
DISCUSS THE ROLE OF THE CONVERSION CYCLE FOR
SERVICE AND RETAILING ENTITIES
• The conversion cycle activities for service and
retailing entities include planning the items to
purchase or the services to produce, planning the
workforce to accomplish the necessary tasks
(extremely crucial in service entities), and directing
the workforce in performing the service or selling the
good.
CAN A TURNAROUND DOCUMENT CONTAIN INFORMATION
THAT IS SUBSEQUENTLY USED AS A SOURCE DOCUMENT
• Yes. For example, the remittance advice of a bill that

is returned with the payment serves as a source
document for the cash receipts transaction
processing system. Thus, the product document
becomes a source document.
WOULD THE WRITING DOWN OF OBSOLETE INVENTORY BE
RECORDED IN A SPECIAL JOURNAL OR THE GENERAL
JOURNAL
• Thistype of transaction is recorded in the general

journal since it is nonrecurring, infrequent, and not
similar to other types of transactions.
ARE BOTH REGISTERS AND SPECIAL JOURNALS
NECESSARY
• Sometimes the terms are used interchangeably, such
as the sales journal is sometimes called the sales
register. The term journal is appropriate when the
information needs to be ultimately posted to the
general ledger. Registers may be used to keep logs of
information that may support, but do not specifically
get posted to the general ledger, such as a raw
materials receipts register or a shipping log.
DISCUSS THE RELATIONSHIP BETWEEN BLANCE IN AP GL
CONTROL ACCCOUNT AND WHAT IS FOUND IN THE AP SL
ACCOUNT
• The balance in the general ledger is considered a
control account. This amount is an aggregated
number representing the total amount owed to
creditors listed in the accounts payable journal. The
accounts payable subsidiary ledger details the exact
amount owed to each creditor. The sum of the
amounts owed to each creditor listed in the accounts
payable journal should equal the corresponding
control total in the general ledger. Thus, the accounts
payable subsidiary ledger is a detailed breakdown of
the summary control total of accounts payable in the
general ledger.
WHAT ROLE DOES THE AUDIT TRAIL PLAY IN THE TASK
OF CONFIRMATION
• Confirmation is most typically used for confirming the
accounts receivable account as reported on the
balance sheet. The audit trail is used to trace from the
general ledger accounts receivable control account to
the subsidiary account, and then to specific customer
accounts. A sample of the customer accounts is then
selected for confirmation.
EXPLAIN THE MAGNETIC AUDIT TRAIL FUNCTIONS
• In theory, the digital audit trail functions the same as
a manual audit trail. In practice, the steps are slightly
different. The archive file that consists solely of valid
transactions is the file to which the accounts
receivable subsidiary account balances and
transactions are traced. The customers still need to
be contacted for confirmation.
ARE LARGE BATCH SIZES PREFERABLE TO SMALL
BATCH SIZES
• Small batches have the advantage of fewer
transactions to sort through for error detection, but
they are not processed as efficiently. Further,
computing facilities and constraints might dictate
whether multiple small batches may be processed
throughout the day or whether a single large batch is
processed at night when the computing facilities have
excess capacity. (Multiple small batches may still be
processed in the evening.)
DISCUSS WHY AN UNDERSTANDING OF THE LEGACY
SYSTEM TECHNOLOGIES IS OF SOME IMPORTANCE TO
AUDITORS
• Not all modern organizations use entirely modern

information systems. Some firms employ legacy
systems for certain aspects of their data processing.
When legacy systems are used to process financially
significant transactions, auditors need to know how
to evaluate and test them.
IF AN ORGANIZATION PROCESSES LARGE NUMBERS OF
TRANSACTION THAT USE COMMON DATA RECORDS, WHAT
TYPE OF SYSTEM WOULD WORK BEST ALL ELSE BEING =
• Large-scale systems that process high volumes of

transactions often use real-time data collection and
batch updating. Master file records that are unique to
a transaction, such as customer accounts and
individual inventory records, can be updated in real
time without causing operational delays. Common
accounts should be updated in batch mode. Real-time
processing is better suited to systems that process
lower transaction volumes and those that do not
share common records.
IF AN ORGANIZATION PROCESSES TRANSACTIONS THAT
HAVE INDEPENDENT DATA NEEDS WHAT TYPE OF SYSYEM
WOULD WORK BEST ALL ELSE BEING =
• Real-time processing is better suited to systems that

process lower transaction volumes and those that do
not share common records.
WHAT IS THE MOST STRIKING DIFFERENCE BETWEEN
THE DATABASE MODEL AND OEN FLAT FILE MODEL
• The most striking difference between the database
model and the flat-file model is the pooling of data
into a common database that all organizational users
share.
WHAT IS MEANT BY THE TERM SINGLE USER VIEW AS IT
APPLIES TO FLAT FILES AND WHY IS THIS A PROBLEM
• The flat-file approach is a single-view model. Files are

structured, formatted, and arranged to suit the
specific needs of the owner or primary user of the
data. Such structuring, however, may exclude data
needed by other users, thus preventing successful
integration of data across the organization. For
example, because the accounting function is the
primary user of accounting data, these data are often
captured, formatted, and stored to accommodate
financial reporting and generally accepted accounting
principles(GAAP).
WHAT IS MEANT BY THE TERM SINGLE USER VIEW AS IT
APPLIES TO FLAT FILES AND WHY IS THIS A PROBLEM
• Thisstructure, however, may be useless to the

organization’s other (nonaccounting) users of
accounting data such as the marketing, finance,
production, and engineering functions. These users
are presented with three options: (1) do not use
accounting data to support decisions, (2) manipulate
and massage the existing data structure to suit their
unique needs, or (3) obtain additional private sets of
the data and incur the costs and operational
problems associated with data redundancy.
EXPLAIN THE SIMILARITY AND DIFFERENCE BETWEEN DATA
UPDATE AND INFORMATION CURRENCY PROBLEMS
ASSOCIATED WITH FLAT FILES
• The data update problem in a flat-file model occurs

because organizations have a great deal of data
stored in files that require periodic updating to reflect
changes. For example, a change to a customer’s
name or address must be reflected in the appropriate
master files. When users keep separate files, all
changes must be made separately for each user. This
adds significantly to the task and the cost of data
management.
EXPLAIN THE SIMILARITY AND DIFFERENCE BETWEEN DATA
UPDATE AND INFORMATION CURRENCY PROBLEMS
ASSOCIATED WITH FLAT FILES
• Information currency problems occur because user

failing to update all the user files affected by a change
in status. If update information is not properly
disseminated, the change will not be reflected in
some users’ data, resulting in decisions based on
outdated information.
DISCUSS SOME OF THE PROBLEMS ASSOCIATED WITH
GENERAL LEDGER SYSTEMS THAT DO NOT HAVE DATA
CODING SCHEMES
• Uncoded data takes a great deal of recording space, is

time-consuming to record and is prone to many types
of errors. Consider a firm that manufactures bicycles
and carries in its inventory reflector lights. The lights
come in six sizes, 2 colors, and 4 different grades of
material. Thus, 48 different varieties of reflector light
are held (6x2x4). Every time lights are purchased, the
description would need to be included rather than a
code. For example if 100 units of one type of reflector
light were purchased, and 200 units of another were
purchased from Collins Manufacturer in Roanoke,
Virginia, the journal entry would be:
CODING SCHEMES
• Inventory-2”, yellow, metal reflector light 75

• Inventory-3”, orange, plastic reflector light 120
• A/P-Collins Mnf-Roanoke, VA 195
CODING SCHEMES
• Some problems this approach may produce are 1. the

sales staff will have a more tedious job in writing up
orders, and more errors may occur (i.e. what if they
forget to write the color or material type?), 2. the
warehouse personnel will have a more difficult time
locating and picking the goods for shipment, and
again more errors may occur, and 3. the accounting
personnel will also have a more tedious job posting to
the subsidiary ledgers and errors may occur.
SHOULD AN AUDITOR WISHING TO ASESS THE ADEQUACY
OF SEPARATION FUNCTIONS EXAMINE DATA FLOW
DIAGRAM OR SYSTEM FLOWCHART
• The auditor should examine the system flowchart

since it clearly depicts the separation of functions and
illustrates who is responsible for performing specific
processing steps. The dataflow diagram illustrates the
logical system and is too general since many different
physical designs may be applicable.
INDICATE WHETHER A SEQUENTIAL, BLOCK, ALPHABETIC OR
MNE-MENIC CODE WOULD BE MOST APPROPRIATE
• a. state codes—alphabetic code, i.e. PA, this method

is appropriate because it corresponds with the postal
services abbreviation and is meaningful to humans.
• b.check number—numeric, sequential. This method
allows the checks to be examined to determine if any
are missing.
• c. chart of accounts—block coding since this method
allows a whole class of items to be restricted to a
specific range. i.e. assets 100-199, liabilities 200-299,
equity accounts, 300-399.
• d. inventory item number—alpha-numeric. The numeric

portion allows the items to be easily sorted and found.
The alphabetic portion allows more combinations to be
made with fewer digits or characters. i.e. 2000A, 2000B,
2000C could represent virtually the same inventory item
but in three different sizes.
• e. bin number (inv warehouse location)—group codes
since certain digits may be used to represent which
warehouse, certain digits may be used to represent floor,
certain digits may be used to represent rows, certain
digits may be used to represent bins. i.e. 211225 could
represent warehouse 2, floor 1, row 12, and bin #25.
• f.sales order number—numeric, sequential. This

method allows the sales orders to be examined to
determine if any are missing.
• g. vendor code—alpha-numeric. The alphabetic
portion allows more meaningful codes to be used and
found. The numeric portion allows different firms
with similar names to be distinguished. i.e. ALPH01,
ALPH02 WHERE ALPH01 is the vendor code for
Alphahydraulics and ALPH02 is the vendor code for
Alpha Trucking Services. Once the name of the
company is known, finding the vendor code is much
easier than if only numbers are used.
• h.invoice number—numeric, sequential. This

method allows the invoices to be examined
sequentially. Gaps in the sequence may signify
missing invoices.
• i. customer number—same as for vendor code. alpha-
numeric
CHAPTER 3 This includes details about software as well as
Ethics, Fraud, and Internal Control hardware and concerns about networks
connecting computers as well as computers
Ethical Issues in Business themselves.
• Ethical standards are derived from societal mores 3 Levels of Computer Ethics
and deep-rooted personal beliefs about issues of 1. Pop – exposure to stories about computer
right and wrong that are not universally agreed technology on popular media;
upon. 2. Para – having real interest in computer ethics;
• Ethics are the principles of conduct that acquiring skill and level in the field (e.g. for
individuals use in making choices that guide their systems professional and AIS students);
behaviour in situations involving the concepts of 3. Theoretical – for multidisciplinary researchers;
right and wrong. applying theories of other fields (e.g. philo, socio,
• Often, we confuse ethical issues with legal issues. psych) to computer science
• A new problem or just a new twist on an old
BUSINESS ETHICS problem?
• Business ethics involves answering two • Privacy
questions: o Privacy is full control of what and how
o How do managers decide what is right in much information about an individual is
conducting business? available to others and to whom it is
o Once recognized, how do managers available.
achieve what is right? • Ownership
• Making Ethical Decisions o The creation and maintenance of shared
o Businesses having conflicting databases make it necessary to protect
responsibilities to employees, people from the potential misuse of data.
shareholders, customers and the public. o It is the state or fact of exclusive rights
o Ethical responsibility is the and control over property, which may be
responsibility of organization managers an object, land/real estate, intellectual
to seek a balance between the risks and property, or some other kind of property.
benefits to their constituents that result
from their decisions. • Security (Accuracy and Confidentiality)
• PROPORTIONALITY - The benefit from a o Computer security is an attempt to
decision must outweigh the risks and no avoid such undesirable events as a loss
alternative should provide greater or same of confidentiality or data integrity.
benefit with less risk. • Ownership of Property
o What can an individual or organization
own?
• Equity in Access
o related to economic status, culture and
safety.
• Environmental Issues
o e.g. papers from trees
• Artificial Intelligence
o e.g. responsibility of decision making by
expert systems
• Unemployment and Displacement
o e.g. employers responsible in retraining
displaced employees due to
computerization?
• Misuse of Computers
o e.g. copying software, used personally
SARBANES-OXLEY ACT AND ETHICAL ISSUES

• Sarbanes-Oxley Act (SOX) is the most
significant federal securities law, with provisions
COMPUTER ETHICS designed to deal with specific problems relating
• Computer ethics is the analysis of the nature to capital markets, corporate governance, and
and social impact of computer technology and the the auditing profession.
corresponding formulation and justification of • It requires public companies to disclose to the
policies for the ethical use of such technology. SEC if they have a code of ethics that applies to
the CEO, CFO and controller. If a company does • Employee fraud is the performance fraud by
not have a code, it must explain why. non-management employee generally designed
to directly convert cash or other assets to the
Section 406—Code of Ethics for Senior Financial employee’s personal benefit.
Officers • Management fraud is the performance fraud
• CONFLICTS OF INTEREST - Procedures for that often uses deceptive practices to inflate
dealing with conflicts of interest (not necessarily earnings or to forestall the recognition of either
preventing, provide trainings) insolvency or a decline in earnings. It does not
• FULL AND FAIR DISCLOSURES - To ensure involve direct theft and is more harmful as it
candid, open, truthful disclosures (not complex usually involves material misstatements of
and misleading accounting techniques) financial data.
• LEGAL COMPLIANCE - Requiring employees to o Perpetrated at levels of management
follow applicable laws, rules and regulations. above internal control structures.
• INTERNAL REPORTING OF CODE o Frequently involves exaggerated financial
VIOLATIONS - A mechanism to permit prompt statement results.
internal reporting of ethical violations (whistle o Misappropriation of assets often
blowers) shrouded in complex transactions
• ACCOUNTABILITY - Taking appropriate actions involving related third parties.
when code violations occur (audit committee in-
charge). THE FRAUD TRIANGLE
• The fraud triangle is a triad of factors
Fraud and Accountants associated with management and employee
• The passage of SOX has had a tremendous fraud:
impact on the external auditor’s responsibilities o situational pressure (includes personal or
for fraud detection during a financial audit. job-related stresses that could coerce an
• The Statement on Auditing Standards (SAS) individual to act dishonestly);
No. 99 is the current authoritative document that o opportunity (involves direct access to
defines fraud as an intentional act that results in assets and/ or access to information that
a material misstatement in financial statements. controls assets); and
• The objective of SAS 99 is to seamlessly blend the o ethics (pertains to one’s character and
auditor’s consideration of fraud into all phases of degree of moral opposition to acts of
the audit process. dishonesty).
DEFINITIONS OF FRAUD
• Fraud is the false representation of a material
fact made by one party to another party, with the
intent to deceive and induce the other party to
justifiably rely on the material fact to his or her
detriment.
• Act must meet five conditions:
o False representation: false statement
or disclosure.
o Material fact: fact must be substantial
factor in inducing someone to act.
o Intent to deceive: must exist or
knowledge that statement is false.
o Justifiable reliance:
misrepresentation must have been a
substantial factor relied on.
o Injury or loss: must have been
sustained by the victim.
• Fraud in business has a more specialized FINANCIAL LOSSES FROM FRAUD
meaning: • A recent study suggests fraud losses equal 5% of
o Intentional deception, asset revenue.
misappropriation or financial data • The actual cost of fraud is, however, difficult to
manipulation to the advantage of the quantify for a number of reasons:
perpetrator. o Not all fraud is detected.
o White collar crime, defalcation, o Of that detected, not all is reported.
embezzlement and irregularities. o In many fraud cases, incomplete
information is gathered.
o Information is not properly distributed to
management or law enforcement
authorities.
o Too often, business organizations decide
to take no civil or criminal action against
the perpetrator(s) of fraud. • Fraud Losses by Age
• In addition to the direct economic loss to the o Older employees tend to occupy higher-
organization, indirect costs—including reduced ranking positions and therefore generally
productivity, the cost of legal action, increased have greater access to company assets.
unemployment, and business disruption due to
investigation of the fraud—need to be
considered.
• Collusion in the commission of a fraud is difficult
to prevent and detect.
Distribution of Losses
• Fraud Losses by Education

o Generally, those with more education
occupy higher positions in their
organizations and therefore have greater
access to company funds and other
assets.
THE PERPETRATORS OF FRAUDS
• Fraud Losses by Position within the Organization
o Individuals in the highest positions within
an organization are beyond the internal
control structure and have the greatest
access to company funds and assets.
Conclusions to Be Drawn
• Opportunity factor, other than situational
pressure and ethics, explains much of the
financial loss differential
• Those in higher position – with greatest access to
the assets
• Position – those with highest position are above
• Fraud Losses and the Collusion Effect the internal control
o One reason for segregating occupational • Gender – more men occupy the higher corporate
duties is to deny potential perpetrators positions
the opportunity they need to commit • Age – older employees occupy higher positions
fraud. • Education – those with higher education occupy
o When individuals in critical positions higher positions
collude, they create opportunities to • Collusion – it creates opportunities for greater
control or gain access to assets that access to assets that otherwise would not exist
otherwise would not exist.
FRAUD SCHEMES
Fraudulent Statements
• Fraudulent statements are statements
associated with management fraud.
• In this class of fraud scheme, the financial
• Fraud Losses by Gender statement misrepresentation must itself bring
o Women are not fundamentally more direct or indirect financial benefit to the
honest than men, but men occupy high perpetrator.
corporate positions in greater numbers THE UNDERLYING PROBLEMS
than women. • Lack of Auditor Independence: Audit firms also
o This affords men greater access to engaged by their clients to perform non-
assets. accounting activities.
• Lack of Director Independence: Many board of o most common fraud schemes involve
directors are comprised of directors who are not some type of asset misappropriation
independent. (almost 90% according to ACFE study).
• Questionable Executive Compensation Schemes: • Skimming involves skimming cash from an
Stock options as compensation result in strategies organization before it is recorded on the
aimed at driving up stock prices at the expense organization’s books and records.
of the firm’s long-term health. o Another example is mail room fraud,
o In extreme cases financial statement in which an employee opening the mail
misrepresentation has been used to steals a customer’s check and destroys
achieve stock prices needed to exercise the associated remittance advice.
options • Cash larceny is theft of cash receipts from an
• Inappropriate Accounting Practices: Common organization after those receipts have been
characteristic to many financial statement fraud recorded in the organization’s books and records.
schemes. o Lapping is the use of customer checks,
• SOX establishes a framework for oversight and received in payment of their accounts, to
regulation of public companies. Principal reforms conceal cash previously stolen by an
pertain to: employee.
o Creation of the Public Company • Billing schemes, also known as vendor fraud,
Accounting Oversight Board are schemes under which an employee causes
(PCAOB) to set standards, inspect firms, the employer to issue a payment to a false
conduct investigations and take regulator supplier or vendor by submitting invoices for
actions. fictitious goods/services, inflated invoices, or
o Auditor independence: More separation invoices for personal purchases.
between a firm’s attestation and non- o A shell company is establishing a false
auditing activities. vendor on the company’s books, and
o Corporate governance and responsibility: then making false purchase orders,
Audit committee members must be receiving reports, and invoices in the
independent and committee must hire name of the vendor and submitting them
and oversee the external auditors. to the accounting system, creating the
o Issuer and management disclosure: illusion of a legitimate transaction. The
Increased requirements. system ultimately issues a check to the
o Fraud and criminal penalties: New false vendor.
penalties for destroying or tampering o A pass-through fraud is similar to shell
with documents, securities fraud, and company fraud except that a transaction
taking actions against whistleblowers. actually takes place. The perpetrator
Corruption creates a false vendor and issues
• Corruption involves an executive, a manager, or purchase orders to it for inventory or
an employee of the organization in collusion with supplies. The false vendor purchases the
an outsider. needed inventory from a legitimate
• Bribery involves giving, offering, soliciting, or vendor, charges the victim company a
receiving things of value to influence an official in much higher than market price for the
the performance of his or her lawful duties. items, and pockets the difference.
• An illegal gratuity involves giving, receiving, o A pay-and-return is a scheme under
offering, or soliciting something of value because which a clerk with check writing authority
of an official act that has been taken. Similar to a pays a vendor twice for the same
bribe, but after the fact. products (inventory or supplies) received
• A conflict of interest is an outline of procedures and then intercepts and cashes the
for dealing with actual or apparent conflicts of overpayment returned by the vendor.
interest between personal and professional • Check tampering involves forging, or changing
relationships. in some material way, a check that was written to
• Economic extortion is the use (or threat) of a legitimate payee.
force (including economic sanctions) by an • Payroll fraud is the distribution of fraudulent
individual or organization to obtain something of paychecks to existent and/or nonexistent
value. employees.
o The item of value could be a financial or • Expense reimbursement fraud involves
economic asset, information, or claiming reimbursement of fictitious or inflated
cooperation to obtain a favorable business expenses.
decision on some matter under review. • Thefts of cash is the direct theft of cash on hand
• Asset Misappropriation in the organization.
• Noncash fraud is the theft or misuse of non- The Preventive-Detective-Corrective Internal
cash assets (e.g., inventory, confidential Control Model
information). • Preventive controls are passive techniques
• Computer fraud involves theft, misuse, or designed to reduce the frequency of occurrence
misappropriation of assets by altering computer- of undesirable events by forcing compliance with
readable records and files, or by altering the logic prescribed or desired actions. Preventing errors
of computer software; the illegal use of and fraud is more cost-effective than detecting
computer-readable information; or the intentional and correcting them.
destruction of computer software or hardware. • Detective controls are devices, techniques, and
Losses from Asset Misappropriation Schemes procedures designed to identify and expose
undesirable events that elude preventive
controls.
• Corrective controls are actions taken to
reverse the effects of errors detected.
Internal Control Shield
Losses from Fraud by Scheme Type
INTERNAL CONTROL CONCEPTS AND

TECHNIQUES
• The internal control system is a set of policies
a firm employs to safeguard the firm’s assets,
ensure accurate and reliable accounting records
and information, promote efficiency, and
measure compliance with established policies.
• Modifying Assumptions (inherent to the control
objectives; guide designers and auditors of
internal controls)
o Management responsibility is the
concept under which the responsibility
for the establishment and maintenance
of a system of internal control falls to Preventive, Detective, and Corrective Controls
management.
o Reasonable assurance is an assurance
provided by the internal control system
that the four broad objectives of internal
control are met in a cost-effective
manner. Cost of achieving objectives
should not outweigh the benefits.
• METHODS OF DATA PROCESSING. Control
techniques vary with different types of
technology.
• LIMITATIONS. These include (1) possibility of
error, (2) circumvention, (3) management
override and (4) changing conditions.
Control Weaknesses and Risks

• Control weaknesses increase the firm’s risk to
financial loss or injury from the threats.
• Statement on Auditing Standards (SAS) No. actions are taken to deal with the
109 is the current authoritative document for organization’s risks.
specifying internal control objectives and o IT CONTROLS: General controls are
techniques. It is based on the COSO framework. controls that pertain to entity-wide
• SOX and Internal Control: concerns such as controls over the data
o Public company management center, organization databases, systems
responsibilities are codified in Sections development, and program maintenance.
302 and 404 of SOX: Application controls are controls that
o Section 302 requires management to ensure the integrity of specific systems.
certify organization’s internal controls on o PHYSICAL CONTROLS relate to human
a quarterly and annual basis. activities.
o Section 404 requires management to o Transaction authorization is a
assess internal control effectiveness. procedure to ensure that employees
o Committee of Sponsoring process only valid transactions within the
Organizations of the Treadway scope of their authority.
Commission (COSO) is a joint initiative o Segregation of duties is the separation
of five private sector organizations and is of employee duties to minimize
dedicated to providing thought incompatible functions. These include
leadership through the development of separating: (1) transaction authorization
frameworks and guidance on enterprise and processing, (2) asset custody and
risk management, internal control, and record-keeping, (3) tasks so that
fraud deterrence. successful fraud must require collusion.
o Supervision is a control activity
COSO internal control framework five involving the critical oversight of
components: employees. It is a compensating control
• The Control Environment in organizations too small for sufficient
o The control environment is the segregation of duties.
foundation of internal control. o The accounting records of an
o It sets the tone for the organization and organization consist of documents,
influences control awareness. journals, or ledgers used in transaction
o SAS 109 requires auditors obtain cycles. These capture economic essence
sufficient knowledge to assess attitudes and provide an audit trail.
and awareness of the management, o Access controls are controls that
board and owners regarding internal ensure that only authorized personnel
controls. have access to the firm’s assets.
o As a minimum, board should adopt the
provisions of SOX. Segregation of Duties Objectives
• Risk Assessment
o Risk assessment is the identification,
analysis, and management of risks
relevant to financial reporting.
• Information and Communication
o The quality of information the AIS
generates impacts management’s ability
to take actions and make decisions.
o An effective accounting information
system records all valid transactions and
provides timely and accurate information.
• Monitoring
o Monitoring is the process by which the
quality of internal control design and o Verification procedures are
operation can be assessed. independent checks of the accounting
o This can be done thru separate system to identify errors and
procedures (e.g. internal audits) or misrepresentations.
ongoing activities (e.g. computer o These differ from supervision – these
modules, management reports) happen after the fact by an individual not
• Control Activities directly involved in the transaction or task
o Control activities are the policies and being verified. Supervision happens
procedures to ensure that appropriate
during the activity by a superior directly • Hash total is a control technique that uses
responsible for the task. nonfinancial data to keep track of the records in
o Management can assess (1) individual a batch.
performance, (2) system integrity and (3)
data correctness. Batch Control Record
o Includes:
• Reconciling batch totals during
transaction processing.
• Comparing physical assets with
accounting records.
• Reconciling subsidiary accounts
with control accounts.
• Reviewing management reports
that summarize business Run-to-Run Controls
activities.
IT APPLICATION CONTROLS
• are associated with applications.
Input controls are programmed procedures, often

called edits, that perform tests on transaction data to
ensure that they are free from errors.
• CHECK DIGIT: A check digit is a method for
detecting data coding errors in which a control
digit is added to the code when it is originally
designed to allow the integrity of the code to be
established during subsequent processing.
o It allows integrity to be established
during processing and helps prevent two
common errors:
o Transcription errors are the type of
errors that can corrupt a data code and
cause processing errors.
o Transposition errors are errors that
occur when digits are transposed.
• MISSING DATA CHECK identifies blank or • Audit trail controls ensures that every
incomplete input fields. transaction can be traced through each stage of
• NUMERIC-ALPHABETIC CHECK identifies data in processing from its economic source to its
the wrong form. presentation in financial statements.
• LIMIT CHECK identify fields that exceed • Every transaction the system processes, including
authorized limits. automatic ones, should be recorded on a
• RANGE CHECK verify that all amounts fall within transaction log.
an acceptable range. o TRANSACTION LOGS – serve as journals;
• REASONABLENESS CHECK verify that amounts contain only successful transactions
that have based limit and range checks are o LOG OF AUTOMATIC TRANSACTIONS –
reasonable.* log or audit trail of internally generated
• VALIDITY CHECK compare actual fields against transactions (system triggered).
acceptable values.
Transaction Log to Preserve the Audit Trail
Processing Controls are programmed procedures to
ensure an application’s logic is functioning properly.
• Batch controls is an effective method of
managing high volumes of transaction data
through a system.
o The objective is to reconcile system
output with original input.
• Run-to-run controls are controls that use
batch figures to monitor the batch as it moves
from one programmed procedure to another.
Backup Procedures for Batch Systems Using Direct Access
MASTERFILE BACK-UP CONTROLS AND GFS Files
BACKUP TECHNIQUE
• Master File Backup Controls may be viewed as
either a general control or an application control.
o The grandfather-father-son (GFS) is
a back-up technique employed by
systems that use sequential master files
(whether tape or disk). It is an integral
part of the master file update process.
o The systems designer determines the
number of backup master files needed
for each application. Two factors
influence this decision: (1) the financial
significance of the system and (2) the BACKUP OF MASTER FILES IN A REAL-TIME
degree of file activity. SYSTEM
• Real-time systems pose a more difficult problem
Grandfather-Father-Son Approach because transactions are being processed
continuously.
• Backup procedures are therefore scheduled at
pre-specified intervals throughout the day (e.g.,
every 15 minutes).
Backup Procedures for Real-Time Processing System
BACKUP PROCESS IN BATCH SYSTEM USING Output controls are procedures to ensure output is not
DIRECT ACCESS FILES lost, misdirected or corrupted and that privacy is not
• Each record in a direct access file is assigned a violated.
unique disk location or address that is determined • Can cause disruption, financial loss and litigation.
by its primary key value.
• The destructive update approach leaves no Controlling Hard-Copy Output
backup copy of the original master file. It requires • OUTPUT SPOOLING: Spooling is directing an
a special recovery program if data is destroyed or application’s output to a magnetic disk file rather
corrupted. than to the printer directly because output data
in output devices can become backlogged
Destructive Update Approach (bottleneck). Proper access and backup
procedures must be in place to protect these
output (spool) files.
• PRINT PROGRAM CONTROLS should be designed
to prevent unauthorized copies and employee
browsing of sensitive data.
• SENSITIVE COMPUTER WASTE should be
shredded for protection.
• REPORT DISTRIBUTION must be controlled.*
• END-USER should examine reports for
correctness, report errors and maintain report
security.
Controlling Digital Output
• Can be directed to the user’s computer screen or
printer
• Threat: interception, disruption, destruction,
corruption of output message
• Two types: a) exposures from equipment failure,
b) exposures from subversive threats
Stages in the Output Process

THE REVENUE
CYCLE
ERECE, MATULA, RAMOS and TALION
CA51019 AIS
UST Alfredo M. Velayo College of Accountancy
University of Santo Tomas
O u rna vO u c her
File (Gene raI J ouma I)
Rec eJ va b Ie
Reco rds
Le dg er
men to ry
Rio rds
RecOr•d s g*urc ho •e
Reed u is it Ion F lie
Inven tory
SuDs d la ry L eo g er
th Ipp ng L oq
The Conceptual System: Sales Order Procedures
• Receive order.
• Begins with receipt of customer order which is transcribed into a formal
sales order which is placed in the customer order file for future reference.
May take days or weeks.
• Check credit.
• Before processing order, creditworthiness must be established.
• Pick goods.
• The stock release or picking ticket provides authorization to warehouse
personnel to release goods which are sent to shipping along with the
verified stock release.
• Warehouse employees adjust stock records to reflect inventory reduction
and prepares back-order records if insufficient goods.
• Ship goods.
• Shipping department uses the packing slip and shipping notice to reconcile
goods received from the warehouse.
• Goods are packaged, bill of lading is prepared, goods are given to carrier,
and shipment is recorded in the shipping log.
• Bill customer.
• Done after shipment by sending a completed sales invoice.
• Billing record-keeping includes recording the sale in the sales journal.
• The sales journal is a special journal used for recording completed sales
transactions. Entries are summarized in a sales journal voucher used to
update the GL control account.
Number
JOLir nal Vo\ iCher
b:lto
Account Annum
N\imbe r OCOunl Name DR CR
E xplnnation . .. . .. .” . ,.
Approved @ PDSlO-d
• Update inventory records.

• The inventory control function updates inventory subsidiary ledger
accounts from the stock release document information.
• Update accounts receivable records.
• Customer records in the accounts receivable (AR) subsidiary ledger
updated from the sales order ledger copy.
• Post to general ledger.
• General ledger function uses journal vouchers to update control accounts.
Perpetual Inventory Record — Item # .•o.iii?
Item Units Units Qnty on Reorder Qnty on Purch Vendor Standard Total Inxen
Description Date Received Sold Hand Point EOQ Order Order # Number Cost Cost
Name: a/a«»x/Aggs/y Account Number /J33
Addfess: qoé3’/
Date Explanalion
Payment Sale Ascount Available
Number (CR) (DR) Balance Limit Credit
/0/7 600.00
The Conceptual System: Sales Return Procedures
• Prepare return slip.

• Customer records in the accounts receivable (AR) subsidiary ledger
updated from the sales order ledger copy.
• Prepare credit memo.
• If clerk has authorization, sent directly to billing function.
• Approve credit memo.
• Credit manager evaluates and return the approved credit memo to the
sales department.
• Update sales journal.
• Update inventory and AR records.
• Update general ledger
Tcstal
The Conceptual System: Cash Receipts Procedures
• Open mail and prepare remittance list.

• Remittance advice is a turnaround document.
• Record and deposit checks.
• After reconciling, employee records check in the cash receipts journal and
prepares a bank deposit slip.
• Update accounts receivable records.
• Update general ledger.
• Reconcile cash receipts and deposits.
• Employee not involved in cash receipts process reconciles receipts by
comparing (1) a copy of the prelist, (2) deposit slips and (3) related journal
vouchers.
Physical Systems
• Physical accounting information systems combine technology and human
activity.
• Smaller businesses tend to rely less on technology, whereas larger
companies tend to employ advanced technologies.
• Nature of the mix employed in a system impacts the internal controls
needed to control the system.
• Computers in basic technology revenue systems are independent.
• Information between departments is communicated via hard-copy
documents.
• Maintaining physical files of source documents is critical to the audit trail.
Physical Systems: Basic Sales Order Processing
• Begins with a customer placing an order.
• Sales department captures details on a sales order form.
• Credit department verifies credit and approves order.
• Warehouse sends inventory to shipping and records inventory reduction.
• Shipping reconciles order, prepares bill of lading, ships items, records
transaction and sends stock release to billing.
• Billing department bills customer and updates sales journal.
• AR and inventory clerks update subsidiary ledgers.
• Journal vouchers and summaries are periodically sent to GL for
reconciliation and posting.
AR UuDsi<Siary File
Curre nl
AcJ cJ rC•S:s Bnla nce CrashI Li rz it Bil Iin cj Oute
LJIll L C•r D:c ie'
2aIes O rcJer
Account
Amount
Number
Inventory
Mu m be r
Oes cr lation zoo
0
Sut>sicliary File
Physical Systems: Basic Cash Receipts Processes
• Checks and remittance advices received in mail room.
• Clerk reconciles items, endorses checks, prepares remittance list and sends
checks and list copy to cash receipts department.
• Remittance advices and list copy sent to AR.
• Cash receipts clerk records checks in cash receipts journal, prepares deposit slip
and sends checks to bank.
• Periodically a journal voucher is sent to GL department.
• AR updates customer balances and sends summary to GL.
• GL clerk reconciles amounts and posts to control accounts.
• Controller clerk performs periodic bank reconciliations.
Physical Systems: Advanced Technology
• Advanced technologies allow integration of accounting with other business
systems through a common information system.
• Objective is to improve performance and reduce costs.
• Can significantly alter and simplify the revenue cycle.
• Remittance advices and list copy sent to AR.
• With an integrated sales order processing system many functions are
performed automatically to the center computer system.
• These labor intensive activities increase operating costs and contribute to
human error.
• Technology reduces costs and errors, increasing efficiency.
Mail Room Computer Operations Controller Ofiice
C heck
Cash
Receipts
Fteconoand
Dr os%Ch cV
Check
Pm6ame
Li6T
Physical Systems: Integrated Cash Receipts
• Checks and remittance advices received in mail room.
• Clerk reconciles items, endorses checks, prepares remittance list and sends
checks, remittance advices and list to cash receipts.
• Cash receipts clerk reconciles checks and creates a record in the cash receipts
journal for each remittance advice, and prepares deposit slip.
• Member of security group deposits checks in bank.
• System automatically closes sales invoice, posts to GL, and prepares and
distributes various management reports.
• Controller clerk periodically reconciles remittance lists, deposit slips, cash
receipts journal and GL cash account.
"° TABLE
4-1 Sur•sWARY Or RevEHtJe CYCLe RtssS wbéo C< HTROLS
Risk Ph sical Co I I fT Control
Sales to t‹n-creclitwont y Tr nnsac tion AtithnrlZUt1Ori — creclit check Automnteñ creclit check
customers Segreg‹ction of duties — separate credit nnd sales
functions
Shipping wrorig iten1w'quai1tities Independent verification — Shipping Department Scanner tech nolagy
reco‹xiIes shi ›n1ent with order Automated iriventory orderirig
lnaccu ate fecord ker*pul g Transaction authorization — renliUnnce list Input data edits
Acco« nting ecorrts — audit trail documents. journals , Auton›alert posting to
accounts. ‹end files accounts
li1depe.i1dent verification — shipping. billing. and GL File baCkup
M›sapproprintiot› of assets Transaction authorization - - retzliftance list Mult›level security to achieve

Supervision — illail room segregation of Pr ties
Access control — warehouse security, dnily deposits of
cash. night deposit box. locked safes
Segregation of duties - caste receipts. general ledger.
AR function. wareho‹›se. inventory records
Un‹cuthorizerl access to dnta Access control — source cloctimeizts, jo meals, ledgers Password control
Segregabon of duties — sub legers. GL. nsset Multilevel security to prevent
custody unauthorized acce ss to data
Physical Systems: Risks and Internal Controls
• Primary risks associated with revenue cycle transactions:
• Undetected data input errors:
• IT controls include data checks and check digit edits to help prevent errors.
• Selling to un-creditworthy customers:
• Physical controls include proper transaction authorization, including a
segregation of duties between transaction authorization and transaction
processing.
• IT controls include automatic credit checking.
• Shipping incorrect items or quantities:
• Physical controls include independent verification.
• IT controls include scanner technology and automated ordering.
• Inaccurately recording transactions in journals and accounts.
• Physical controls include transaction authorization, accounting records,
prenumbered documents, special journals, subsidiary ledgers, general
ledger control accounts, files and independent verification:
• Shipping department reconciles goods being shipped against packing
slip to ensure customer is receiving correct items and quantity.
• Billing function reconciles original sales order with shipping notice to
ensure bills are correct and sales are recorded properly.
• GL function reconciles journal vouchers and summary reports prepared
independently in different functional areas before posting to control
accounts.
• IT controls include automated postings and file backups.
• Misappropriation of cash receipts and inventory.
• Physical controls include transaction authorization, supervision (especially
in the mail room), access controls and segregation of duties:
• Cash receipts function should be separate from the AR function.
• Cash receipts clerk should not have access to GL cash.
• Personnel with physical custody of inventory should not update records.
• IT controls include multilevel security.
• Unauthorized access to accounting records and reports.
• Motives include attempt to create a fraud, data theft and malicious acts.
• Physical controls include access controls and segregation of duties such that
the perpetration of a fraud requires collusion.
• IT controls include passwords and multilevel security.
Physical Systems: Multilevel Security
• Employs programmed techniques that permit simultaneous access to a central

system by many users with different access privileges.
• Users are prevented from obtaining information for which they lack
authorization.
• Two common multilevel security methods:
• Access control list (ACL) method assigns privileges directly to individuals
which is burdensome in large organizations.
• Role-based access control (RBAC) creates standard tasks called roles that
are assigned specific privileges.
• Once a role is created, individuals are assigned to it.
• Easy to add or delete roles as job responsibilities change.
Physical Systems: Point-of-Sale (POS) Systems
• POS systems used extensively in retail establishments.
• Customers pick items from shelves and take them to a cashier.
• Clerk scans the Universal product code (UPC) of items.
• Price and description retrieved from inventory file.
• Inventory levels are updated and reordered as needed.
• System automatically calculates taxes, discounts and total.
• Non-cash payments are approved via online connection.
• At shift end, money and receipts reconciled to the internal cash register tape
with cash over and shorts accounts for.
• Cash receipts clerk prepares deposit slip for total daily cash receipts and batch
program posts entry to the GL.
Physical Systems: POS Control Issues
• Authorization:
• Clerk should match customer signature with credit card.
• Supervision:
• Surveillance cameras and floor security help prevent shoplifting and
employee theft.
• Access Control:
• Separate cash drawers, locked showcases and magnetic tags attached to
merchandise help control theft.
• Accounting records:
• Only supervisors should access internal cash register tapes.
• Independent verification:
• Cash drawers should be reconciled to internal register tapes.
Physical Systems: Reengineering
• Electronic data interchange (EDI) expedites transactions.
• Customer’s computer automatically orders inventory as needed.
• Seller processes order with little or no human involvement.
• Binding terms specified in a trading partner agreement.
• Control problems include ensuring only valid transactions are processed
and that accounting records are not compromised.
• Doing business on the Internet involves both business-to-business (B2B) and
business-to-consumer (B2C) transactions.
• Opens the door to thousands of business partners without formal trading
agreements.
• Risks include threats from computer hackers, viruses and transaction fraud.
Chapter 5
The
Expenditure
Cycle
Part 1:
Purchases and
Cash
Disbursements
Procedures
Systems 9e
James A. Hall
Objectives for Chapter 5
• Recognize the fundamental tasks that constitute the

purchases and cash disbursement process.
• Identify functional areas involved in purchases and cash
disbursements and trace the flow of these transactions.
• Specify documents, journals, and accounts that provide audit
trails, promote the maintenance of records, and support
internal decision making and financial reporting.
• Understand risks associated with purchase and cash
disbursements activities and controls that reduce these risks.
• Be aware of operational features and control implications of
technology used in purchases and cash disbursement systems.
© 2015 Cengage Learning. All rights reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 2
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
The Conceptual System
• Purchase processing procedures:

– Monitor inventory records, prepare purchase order. receive goods,
update inventory records, set up accounts payable.
• Vouchers payable system:
– Alternate to AP procedures that uses cash disbursement vouchers
and maintains a voucher register, providing improved control over
cash disbursements. Vouchers payable file equivalent to AP file.
– GL function posts journal voucher data.
• Cash disbursement system:
– Identify liabilities due, prepare cash disbursements, update AP
record and post to general ledger.
Physical Systems
• Basic Technology Expenditure Cycle:
– Computers tend to be independent PCs.
– Information between departments is communicated via hard-
copy documents.
– Maintaining physical files of source documents is critical to the
audit trail.
• In the following flowcharts note that, in many departments,
after an individual completes his or her assigned task,
documents are filed as evidence task was performed.
Physical Systems: Basic Purchases Processing
• Begins when inventory clerk prints purchase requisitions by
accessing the purchase requisition file.
– File created when inventory dropped to reorder point.
• Purchasing department receives the purchase requisition.
– Adds record to the digital open purchase order file.
– PO copies to vendor, inventory control, AP and receiving (blind).
• Receiving reconciles goods with packing slip and blind PO.
– Report to storeroom and purchasing department, files hard copy.
• AP reconciles invoice, purchase order and receiving report.
– Records transaction in the purchases journal.
• Gender ledger department receives journal voucher from AP
and account summary from inventory control.
Physical Systems: Basic Cash Disbursements System
• AP clerk reviews AP packet in open AP file, identifies items
due, and sends documents to cash disbursements.
• Cash disbursements reviews documents, prepares three-part
check and records pertinent data in the check register.
– Check and supporting documents sent for signature and mailing.
– AP packet and check copy returned to AP.
– Files check copy and sends summary journal voucher to GL.
• AP department removes the liability and sends AP summary
to GL department.
• GL department posts to the general ledger control accounts
and files the documents.
Physical Systems: Integrated Purchases Processing
• Departmental activity lower than basic technology system.
• Purchases computer application reads purchase requisition
file for reorders, prepares and sends PO, updates records.
• Receiving reconciles goods with packing slip and blind PO.
– Record added to receiving report file and PO closed.
– Inventory and GL control accounts automatically updated.
• AP clerk receives invoice, adds record to vendor file and files
hard-copy.
– System automatically links vendor invoice, PO and receiving
report, reconciles documents and creates virtual AP packet.
– AP clerk reviews virtual packet and if no discrepancies are found,
system automatically approves payment.
Physical Systems: Integrated Cash Disbursements
• Each day the DUE DATE fields of vendor invoices are
scanned for items due to be paid.
• Checks are automatically printed, signed, and distributed to
the mail room for mailing.
– Large checks receive additional signatures before mailing.
• Payments automatically recorded in check register file.
• Vendor invoices are closed.
• General ledger AP control and cash accounts updated.
• Reports transmitted to AP and cash disbursements
departments for management review and filing.
Expenditure Cycle Risks and Internal Controls
• Risk of unauthorized inventory purchases.
– Physical Controls: Transaction authorization
– IT Controls: Automated purchase approval
• Risk of receiving incorrect items, quantities or damaged
goods.
– Physical Controls: Independent verification and supervision
– IT Controls: Scanner technology
• Risk of inaccurately recording transactions.
– Physical controls: Transaction authorization, accounting records
and independent verification.
– IT controls: Input data edits, error messages, automated
postings, and file backups.
Expenditure Cycle Risks and Internal Controls
• Risk of misappropriation of cash and inventory.

– Physical Controls: Supervision, independent verification, segregation
of duties – inventory control from inventory warehouse and accounts
payable from cash disbursements.
– IT Controls: Automated three-way match and payment approval and
multilevel security.
• Risk of unauthorized access to accounting records and reports.
– Physical Controls: Access controls and segregation of duties.
– IT Controls: Password control and multilevel security.
Reengineering Using EDI
• Key element of success in the implementation of a trading
partner agreement to eliminate discrepancies that require
human involvement to resolve.
• Some organizations have eliminated the receiving function.
– Objective is to send goods directly to production which avoids
delays and associated handling costs.
– Accounting and auditing issues:
• How to account for inventory receipts with no receiving function and
report?
• Accounting for scrap in the production process.
• Unique risks that need to be recognized and controlled.

– Includes ensuring only valid transactions are processed and risk of
unauthorized access to accounting records.
Chapter 6
The
Expenditure
Cycle
Part 2:
Payroll
Processing
and Fixed
Asset
Procedures
Systems 9e
James A. Hall
• Recognize fundamental tasks of the payroll and fixed asset

processes.
• Identify functional depts. of payroll and fixed asset activities
and the flow of transactions through the organization.
• Specify the documents, journals, and accounts that provide
audit trails, promote record maintenance, and support
internal decision making, and financial reporting.
• Understand risks associated with payroll and fixed asset
activities and recognize controls that reduce these risks.
• Be aware of operational features and the control implications
of technology used in payroll and fixed asset systems.
Conceptual Payroll System
• Personnel dept. prepares personnel action forms to:
– Activate new employees, change pay rates, deductions and job
classifications.
• Production employees fill out two forms:
– Job tickets account for the time spent on each job. Cost
accounting uses these tickets to allocate charges to WIP.
– Time cards are used to capture the total time worked each pay
period for payroll calculations.
• After cost accounting allocates labor costs to the WIP
accounts, charges are summarized in a labor distribution
summary and forwarded to GL function.
Conceptual Payroll System
• Payroll dept. receives pay rate and withholding data from the
personnel dept. and hours-worked from production.
– Prepares payroll register, enters information into employee
payroll records, prepares paychecks and sends them to distribute
paycheck function, files time cards, personnel action forms and
payroll register copy
• Distribute paychecks.
• Prepare accounts payable.
• Prepare cash disbursement.
– Prepares a single check for entire payroll and deposits it in the
payroll imprest account which is used only for payroll. Copy sent
to AP and journal voucher prepared and sent to the GL function.
Update General Ledger
• GL function receives labor distribution summary,
disbursement voucher and journal voucher. GL clerk
makes entry which must have equal debits and credits:
Basic Technology Payroll System
Basic Technology Payroll System
• Personnel action and time and attendance information
initiate the payroll process.
• Payroll department reconciles information, calculates payroll
and sends paychecks to paymaster for distribution to
employees.
• Cost accounting receives information regarding time spent
on each job for posting to the WIP subsidiary ledger.
• AP receives payroll register and authorizes cash
disbursements to deposit a check into the bank imprest
account from which payroll is drawn.
• GL department reconciles summary information and updates
accounts.
Advanced Technology Payroll System
Advanced Technology Payroll System
• Larger organizations often integrate payroll processing
within the human resource management (HRM) system
which captures a wide range of personnel related data.
– Human resource clerks enter data in employee records in real time.
– Cost accounting enters job cost data in real time to create the
labor usage file.
– Biometric time clocks verify employee identify.
– Magnetic swipe ID cards work like credit cards and identify time
worked.
– Proximity cards use readers to record time worked.
– Mobile remote devices allow employees to clock in using hand-
held devices or web browsers.
– Data processing is done in batches at the end of the work period.
Advanced Technology Payroll System – Data Processing
• Labor costs distributed to WIP, overhead and expense
accounts.
• Online labor distribution file is created.
• Payroll is calculated and an online payroll register is created.
• Employee record files are updated.
• Paychecks are prepared, signed and distributed.
• Funds to cover payroll are transferred to the payroll imprest
account and the transfer is recorded.
• Digital journal vouchers are entered and system
automatically updates the GL.
Payroll System Risks and Internal Controls: Risk of
Inaccurately Recording Transactions
• Risks include:
– Incorrectly calculated time and attendance data, unrecorded or
incorrectly recorded Wages Payable, and inaccurate postings.
• Physical Controls - Accounting Records:
– Control objective is to maintain audit trail for payroll records.
– Time cards, job tickets and disbursement vouchers.
– Journal info from labor distribution summary and payroll register.
– Subsidiary and GL accounts.
• Physical Controls – Independent Verification:
– Supervisor verification of time cards and attendance.
– AP clerk verification of payroll register accuracy.
– GL department reconciliation of labor distribution summary and
payroll disbursement voucher.
Inaccurately Recording Transactions
• IT Controls - Data Input Edits:
– Verify the integrity of transaction data.
– Include: missing data checks, numeric-alphabetic data tests, tests
for invalid data values and check digits.
• IT Controls – Error Messages and File Backup:
– Any mismatch when posting time card or personnel action data to
an employee record should produce an error message.
– Backup procedures should be in place to reduce risk of data loss.
• IT Controls – Automated Posting to Accounts:
– Record keeping functions are automated in advanced technology
systems.
– Eliminating the human element reduces potential for error and
significantly improves efficiency.
Misappropriate of Cash through Payroll Fraud
• Two general forms:

– Paying nonexistent employee by submitting fictitious timecards or
the overpayment of employee.
• Physical Controls – Transaction Authorization:
– Personnel action form helps payroll keep employee records current.
• Physical Controls – Segregation of Duties:
– Timekeeping and personnel functions should be separated.
– Because payroll has both asset custody (paychecks) and record-
keeping responsibility (employee payroll records), assign AP the
responsibility of reviewing payroll register and approving payment.
– Use an independent paymaster to distribute checks to help verify
the existence of employees.
Misappropriate of Cash through Payroll Fraud
• Physical Controls – Supervision:

– Supervisor should observe timekeeping and reconcile time cards
with actual attendance.
• Physical Controls – Access Control:
– Prevent improper access to accounting records.
• IT Controls – Input Controls:
– Limit tests to detect excessive hours reported per period.
– Biometric scanners, swipe cards, and PINs help ensure that
individuals clocking in are valid employees.
– Automated tests to validate timecards against up-to-date
employee files.
– Paycheck direct deposit.
Unauthorized Access to Payroll Records and
Confidential Employee Data
• Motives include:
– Malicious acts such as corrupting or deleting payroll data.
– Theft of confidential information such as Social Security Numbers,
pay rates and other personal data.
– Attempts to perpetrate a payroll fraud..
• IT Controls:
– Password protected payroll files.
– Multilevel security techniques limit access to HR, accounts payable,
cash disbursements, cost accounting and general ledger.
The Conceptual Fixed Asset System
• Fixed assets are the property, plant and equipment used
in the operation of a business.
• Fixed asset system processes transactions pertaining to
acquisition, maintenance and disposal of assets.
• Specific objectives:
– Process fixed asset acquisition as needed and in accordance
with formal management approval and procedures.
– Maintain adequate account records of asset acquisition, cost,
description, and physical location in the organization.
– Maintain accurate depreciation records.
– Provide management with needed information.
– Record retirement and disposal of assets.
Asset Acquisition, Maintenance and Disposal
• Asset acquisition begins when manager determines asset
needs to be replaced or a new fixed asset is warranted.
• Asset maintenance involves adjusting FAS subsidiary
account balances as assets depreciate.
– Depreciation calculations are internal transactions that the FAS
system bases upon a depreciation schedule.
– Physical improvements must also be recorded to increase the
subsidiary account balance and depreciation schedule.
• At the end of an asset’s useful life (or earlier), asset must be
removed from FAS subsidiary ledger (asset disposal).
– Disposals require disposal request forms and disposal reports as
source documents as well as proper approval.
Acquisition Procedures
• Process begins when the fixed asset accounting clerk
receives a receiving report and a cash disbursement voucher.
– Clerk creates a record of the asset in the FAS ledger and the system
automatically updates the GL and prepares journal vouchers and
reports including depreciation schedules.
Asset Maintenance and Disposal
• Computerized FAS automatically:
– calculates current period’s depreciation.
– updates accumulated depreciation and book-value fields in the
subsidiary records.
– posts total depreciation to the affected GL accounts.
– records depreciation transactions.
• When an asset record is deleted from the FAS, the system:
– posts an adjusting entry to the fixed asset control account in the GL.
– records losses or gains associated with the disposal.
– prepares a journal voucher.
Fixed Asset System Risks and Controls
• Authorization controls should be formal and explicit.
– Written request and independent approval for high-value items.
• Supervision controls are an important element in the physical
security of fixed assets.
– Ensure assets are used in accordance with organizational policies and
that they are not taken home for personal use unless authorized.
• Independent verification controls should be used by internal
auditors to test for reasonableness of fixed asset acquisitions
and approvals.
– Verify location, condition, and fair value of fixed asset against the
fixed asset records in the subsidiary ledger.
– Check programming logic for automatic calculations (depreciation).
THE EXPENDITURE CYCLE PART 2:
PAYROLL PROCESSING AND FIXED
ASSET PROCEDURES
ERECE, MATULA, RAMOS and TALION

CA51019 AIS
UST Alfredo M. Velayo College of Accountancy
University of Santo Tomas
OBJECTIVES FOR MODULE 6
• Recognize fundamental tasks of the payroll and fixed asset processes.
• Identify functional depts. of payroll and fixed asset activities and the flow of
transactions through the organization.
• Specify the documents, journals, and accounts that provide audit trails,
promote record maintenance, and support internal decision making, and
financial reporting.
• Understand risks associated with payroll and fixed asset activities and recognize
controls that reduce these risks.
• Be aware of operational features and the control implications of technology
used in payroll and fixed asset systems.
CONCEPTUAL PAYROLL SYSTEM
• Personnel dept. prepares personnel action forms to:
• Activate new employees, change pay rates, deductions and job
classifications.
• Production employees fill out two forms:
• Job tickets account for the time spent on each job. Cost accounting uses
these tickets to allocate charges to WIP.
• Time cards are used to capture the total time worked each pay period for
payroll calculations.
• After cost accounting allocates labor costs to the WIP accounts, charges are
summarized in a labor distribution summary and forwarded to GL function.
CONCEPTUAL PAYROLL SYSTEM
• Payroll dept. receives pay rate and withholding data from the personnel dept.
and hours-worked from production.
• Prepares payroll register, enters information into employee payroll
records, prepares paychecks and sends them to distribute paycheck
function, files time cards, personnel action forms and payroll register copy
• Distribute paychecks.
• Prepare accounts payable.
• Prepare cash disbursement.
• Prepares a single check for entire payroll and deposits it in the payroll
imprest account which is used only for payroll. Copy sent to AP and journal
voucher prepared and sent to the GL function.
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UPDATE GENERAL LEDGER
• GL function receives labor distribution summary, disbursement voucher and
journal voucher. GL clerk makes entry which must have equal debits and
credits:
BASIC TECHNOLOGY PAYROLL SYSTEM
BASIC TECHNOLOGY PAYROLL SYSTEM
• Personnel action and time and attendance information initiate the payroll
process.
• Payroll department reconciles information, calculates payroll and sends
paychecks to paymaster for distribution to employees.
• Cost accounting receives information regarding time spent on each job for
posting to the WIP subsidiary ledger.
• AP receives payroll register and authorizes cash disbursements to deposit a
check into the bank imprest account from which payroll is drawn.
• GL department reconciles summary information and updates accounts.
ADVANCE TECHNOLOGY PAYROLL SYSTEM
ADVANCE TECHNOLOGY PAYROLL SYSTEM
• Larger organizations often integrate payroll processing within the human
resource management (HRM) system which captures a wide range of
personnel related data.
• Human resource clerks enter data in employee records in real time.
• Cost accounting enters job cost data in real time to create the labor usage
file.
• Biometric time clocks verify employee identify.
• Magnetic swipe ID cards work like credit cards and identify time worked.
• Proximity cards use readers to record time worked.
• Mobile remote devices allow employees to clock in using hand-held
devices or web browsers.
• Data processing is done in batches at the end of the work period.
ADVANCE TECHNOLOGY PAYROLL SYSTEM –
DATA PROCESSING
• Labor costs distributed to WIP, overhead and expense accounts.
• Online labor distribution file is created.
• Payroll is calculated and an online payroll register is created.
• Employee record files are updated.
• Paychecks are prepared, signed and distributed.
• Funds to cover payroll are transferred to the payroll imprest
account and the transfer is recorded.
• Digital journal vouchers are entered and system automatically
updates the GL.
PAYROLL SYSTEM RISKS AND INTERNAL CONTROLS:
RISK OF INACCURATELY RCODING TRANSACTIONS
• Risks include:
• Incorrectly calculated time and attendance data, unrecorded or incorrectly recorded
Wages Payable, and inaccurate postings.
• Physical Controls - Accounting Records:
• Control objective is to maintain audit trail for payroll records.
• Time cards, job tickets and disbursement vouchers.
• Journal info from labor distribution summary and payroll register.
• Subsidiary and GL accounts.
• Physical Controls – Independent Verification:
• Supervisor verification of time cards and attendance.
• AP clerk verification of payroll register accuracy.
• GL department reconciliation of labor distribution summary and payroll disbursement
voucher.
PAYROLL SYSTEM RISKS AND INTERNAL CONTROLS:
RISK OF INACCURATELY RCODING TRANSACTIONS
• IT Controls - Data Input Edits:
• Verify the integrity of transaction data.
• Include: missing data checks, numeric-alphabetic data tests, tests for invalid data
values and check digits.
• IT Controls – Error Messages and File Backup:
• Any mismatch when posting time card or personnel action data to an employee record
should produce an error message.
• Backup procedures should be in place to reduce risk of data loss.
• IT Controls – Automated Posting to Accounts:
• Record keeping functions are automated in advanced technology systems.
• Eliminating the human element reduces potential for error and significantly improves
efficiency.
PAYROL SYSTEM RISKS AND INTERNAL CONTROLS: RISK OF
MISAAPROPRIATE OF CASH THROUGH PAYROLL FRAUD
• Two general forms:
• Paying nonexistent employee by submitting fictitious timecards or the overpayment of
employee.
• Physical Controls – Transaction Authorization:
• Personnel action form helps payroll keep employee records current.
• Physical Controls – Segregation of Duties:
• Timekeeping and personnel functions should be separated.
• Because payroll has both asset custody (paychecks) and record-keeping responsibility
(employee payroll records), assign AP the responsibility of reviewing payroll register
and approving payment.
• Use an independent paymaster to distribute checks to help verify the existence of
employees.
PAYROL SYSTEM RISKS AND INTERNAL CONTROLS: RISK OF
MISAAPROPRIATE OF CASH THROUGH PAYROLL FRAUD
• Physical Controls – Supervision:
• Supervisor should observe timekeeping and reconcile time cards with actual
attendance.
• Physical Controls – Access Control:
• Prevent improper access to accounting records.
• IT Controls – Input Controls:

• Limit tests to detect excessive hours reported per period.
• Biometric scanners, swipe cards, and PINs help ensure that individuals
clocking in are valid employees.
• Automated tests to validate timecards against up-to-date employee files.
• Paycheck direct deposit.
PAYROLL SYSTEM RISKS AND INTERNAL CONTROLS: RISK OF
UNATHORIZED ACCESS TO PAYROLL RECORDS AND CONFIDENTIAL
EMPLOYEE DATA
• Motives include:
• Malicious acts such as corrupting or deleting payroll data.
• Theft of confidential information such as Social Security Numbers, pay rates
and other personal data.
• Attempts to perpetrate a payroll fraud..
• IT Controls:
• Password protected payroll files.
• Multilevel security techniques limit access to HR, accounts payable, cash
disbursements, cost accounting and general ledger.
TABL E
6-1
Risk Physical Control IT COfltFOl
Inaccurately recording Accounting records—audit Vail document, Input data edits

transaction journals, accounts, and files Error Messages
File backup
AutomQed posting to account
Misappropriation of Cash Transaction authorization—personnel action form Limit tests, biometric scanners, validation
through payroll fraud Segregation of duties—Time keeping, personnel, controls, direct deposit
AP, cash disbursements, paymauer Multilevel SecuriN to provide segregation
Supervision— time-keeping process of duties
Access control over source documents, journals,
ledgers
Unauthorized access to Password control _

Payroll data Multilevel security to prevent unauthorized j=
access to daa
THE CONCEPTUAL FIXED ASSET SYSTEM
• Fixed assets are the property, plant and equipment used in the operation of a
business.
• Fixed asset system processes transactions pertaining to acquisition,
maintenance and disposal of assets.
• Specific objectives:
• Process fixed asset acquisition as needed and in accordance with formal management
approval and procedures.
• Maintain adequate account records of asset acquisition, cost, description, and physical
location in the organization.
• Maintain accurate depreciation records.
• Provide management with needed information.
• Record retirement and disposal of assets.
ASSET ACQUISITION, MAINTENANCE AND
DISPOSAL
• Asset acquisition begins when manager determines asset needs to be replaced
or a new fixed asset is warranted.
• Asset maintenance involves adjusting FAS subsidiary account balances as
assets depreciate.
• Depreciation calculations are internal transactions that the FAS system bases upon a
depreciation schedule.
• Physical improvements must also be recorded to increase the subsidiary account
balance and depreciation schedule.
• At the end of an asset’s useful life (or earlier), asset must be removed from FAS
subsidiary ledger (asset disposal).
• Disposals require disposal request forms and disposal reports as source documents as
well as proper approval.
ACQUISITION PROCEDURES
• Process begins when the fixed asset accounting clerk receives a receiving
report and a cash disbursement voucher.
• Clerk creates a record of the asset in the FAS ledger and the system automatically
updates the GL and prepares journal vouchers and reports including depreciation
schedules.
ASSET MANAGEMENT AND DISPOSAL
• Computerized FAS automatically:
• calculates current period’s depreciation.
• updates accumulated depreciation and book-value fields in the subsidiary
records.
• posts total depreciation to the affected GL accounts.
• records depreciation transactions.
• When an asset record is deleted from the FAS, the system:

• posts an adjusting entry to the fixed asset control account in the GL.
• records losses or gains associated with the disposal.
• prepares a journal voucher.
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FIXED ASSET SYSTEM RISKS AND CONTROLS
• Authorization controls should be formal and explicit.
• Written request and independent approval for high-value items.
• Supervision controls are an important element in the physical security of fixed
assets.
• Ensure assets are used in accordance with organizational policies and that they are not
taken home for personal use unless authorized.
• Independent verification controls should be used by internal auditors to test
for reasonableness of fixed asset acquisitions and approvals.
• Verify location, condition, and fair value of fixed asset against the fixed asset records
in the subsidiary ledger.
• Check programming logic for automatic calculations (depreciation).
Chapter 7
The
Conversion
Cycle
Systems 9e
James A. Hall
• Understand basic elements and procedures encompassing a traditional
production process.
• Understand data flows and procedures in a traditional cost accounting
system.
• Be familiar with accounting controls in a traditional environment.
• Understand principles, operating features, and technologies of lean
manufacturing.
• Understand shortcomings of traditional accounting methods in the
world-class environment.
• Know key features of activity-based costing and value stream
accounting.
• Be familiar with information systems associated with lean
manufacturing and world-class companies.
2
3
The Conversion Cycle in a Traditional Manufacturing
Environment
• Transforms input resources such as raw materials, labor, and
overhead into finished products or services for sale
• Consists of both physical and informational activities related
to manufacturing products for sale.
• One of the following production methods is used:
– Continuous processing creates a homogeneous product through a
series of standard procedures.
– Made-to-order processing involves fabrication of discrete products in
accordance with customer specifications.
– Batch processing produces batches of discrete products.
5
• The production schedule is the formal plan
and authorization to begin production.
6
• The bill of materials (BOM) specifies the type
and quantity of RM and subassemblies used for
each unit of a finished product.
7
• A route sheet shows the production path that a
particular batch follows during manufacturing.
8
• The work order uses the BOM and route sheets to
specify the materials and production for each batch.
9
• A move ticket records work done in each work center
and authorizes movement from one center to another.
10
• A materials requisition authorizes storekeeper to
release materials into the production process.
11
12
Batch Production Activities
• Production planning and control:
– Specifying materials and operations requirements.
– Production scheduling.
• Material and operations requirements:
– Requirement is the difference between what is needed for the
batch and what is available in the RM inventory.
– Purchase requisitions created for additional RM needs.
• Production scheduling:
– Master schedule coordinates productions of different batches.
– Produces work orders, move tickets, and material requisitions for
each batch with copies of work orders sent to cost accounting.
13
Batch Production Activities
• Work centers and storekeeping:
– Production begins when workers obtain raw materials.
– When task completed move ticket authorizes batch to proceed to
next work center with copy sent to production planning.
– Finished products sent to FG warehouse and copy of work order
sent to inventory control to update FG inventory records.
– Work center supervisors send employee time cards and job tickets
to payroll and cost accounting.
• Inventory control:
– Provides production planning and control with status reports on
finished goods and raw materials inventory.
– Continual updates of raw materials inventory.
– Records completed production by updating FG inventory records.
14
EOQ Inventory Model
• Objective of inventory control is to minimize total inventory
cost while ensuring adequate inventories to meet demand.
– When and how much inventory should be purchased?
• Economic order quantity (EOQ) model based on
assumptions that may not reflect economic reality:
– Demand is constant and known with certainty.
– Ordering lead time is known and constant.
– All inventories in the order arrive at the same time.
– Total yearly cost of placing orders decreases as order quantities
increase.
– Carrying costs increase as quantity of inventory orders increases.
– No quantity discounts so purchase price is constant.
15
• Objective of EOQ is to reduce total inventory costs. Figure
7.10 shows relationship between costs and order quantity.
16
• Assumptions of the EOQ model produce the saw-
toothed inventory usage pattern illustrated below.
17
• When parameters are subject to variation, additional
inventory units (safety stock) are added to the reorder
point to avoid stock-out events.
18
Cost Accounting Activities
• Record the financial effects of the physical events
occurring in the production process.
• Begins when the production planning and control
department sends the work order to cost accounting.
• Cost accounting clerk creates a new cost record for the
batch and files in WIP file.
• The records are updated as materials and labor are used.
– Deviations from standards are recorded to produce variances.
• Receipt of last move ticket signals completion of
production and transfer for WIP to FG inventory.
– WIP account is closed, journal vouchers are recorded and sent to
the GL department for posting to the control accounts.
19
20
21
22
Controls in the Traditional Environment
• Transaction authorizations:
– Production planning and control authorize the production
activity via a formal work order.
– Move tickets signed by supervisors authorize batch activities and
product movement through work centers.
– Materials requisitions and excess material requisitions authorize
storekeeper to release materials to work centers.
• Segregation of duties:
– Separation of transaction authorization and processing.
– Separation of record keeping from asset custody.
• Inventorycontrol records separate from storerooms and warehouses.
• Cost accounting separate from production work centers.
• GL separate from subsidiary accounting records.
23
• Supervision:
– Work center supervisors oversee RM usage to ensure all released
materials are used in production and waste is minimized.
– Employee time cards and job tickets are checked for accuracy.
• Direct access to assets:
– Limited access to sensitive areas.
– Quantities in excess of standards require approval.
• Indirect access to assets:
– Control over critical source documents, including the use of pre-
numbered documents.
24
• Accounting records:
– Objective is to establish an audit trail for each transaction.
• Independent verification:
– Cost accounting reconciles material and labor usage with
standards and investigates variances.
– GL dept. verifies movement from WIP to FG by reconciling
journal vouchers from cost accounting and inventory
subsidiary ledgers from inventory control .
– Internal and external auditors periodically verify the raw
materials and FGs inventories through a physical count.
25
What is a World-Class Company?
• Maintains strategic agility, able to turn on a dime, aware of

customer needs and not resistant to paradigm change.
• Motivates and treats employees like appreciating assets with
decisions pushed to the lowest level of the organization.
• Profitably meets customer needs and continually delights
them.
• Customer satisfaction philosophy permeates all activities.
• Manufacturers follow a philosophy of lean manufacturing.
26
Principles of Lean Manufacturing
• Evolved from Toyota Production System (TPS) which is
based on the just-in-time (JIT) production model.
– Goal is improved efficiency and effectiveness in every area.
• Pull processing involves pulling products from consumer end
(demand) rather than pushing from production end (supply).
• Perfect quality (zero inventory defects) is required for pull
processing success.
• Waste minimization requires activities that do not add value
or maximize the use of scarce resources be eliminated.
– Involves financial, human, inventory and fixed assets.
27
Principles of Lean Manufacturing
• Inventory reduction is the hallmark of lean manufacturing.
– Inventories cost money, camouflage production problems and can
precipitate overproduction.
• Production flexibility strives to reduce setup time to a
minimum, allowing for the production of a greater diversity of
products quickly, without sacrificing efficiency.
• Established supplier relations are mandatory as late
deliveries, defective raw materials, or incorrect orders will shut
down production due to lack of inventory reserves.
• Team attitude requires each employee to be vigilant of
problems that threaten the continuous flow of production line.
28
Techniques and Technologies that Promote Lean
Manufacturing
• Physical reorganization of production facilities:

– Simplified facility arrangement shortens the physical distance
between activities reduces setup and processing time, handling
costs and inventories.
• Automation of the manufacturing process:
– By replacing labor with automation, firm can reduce waste,
improve efficiency, increase quality and improve flexibility.
– Traditional manufacturing consists of a range of different
machines each controlled by a single operator.
– Islands of technology is an environment where automation
exists in islands of computer numerical controlled machines
that perform multiple operations with little human involvement.
29
30
31
32
Manufacturing
• Computer-integrated manufacturing (CIM) is a completely
automated environment with the objective of eliminating
non-value added activities.
• Automated storage and retrieval systems (AS/RS) are
computer-controlled conveyor systems that carry materials to
the shop floor and finished products to the warehouse.
– Reduced errors, improved inventory control, lower storage costs.
• Robotics uses robots to perform specific actions over and
over with a high degree of precision.
– Also used in hazardous environment or for performing dangerous
and accident-prone monotonous tasks.
33
Manufacturing
• Computer-aided design (CAD) is used to design better
products faster.
– Increases productivity and accuracy and allows firms to be more
responsive to market demand.
– Shortens time between initial and final design.
– Advanced systems design product and process simultaneously.
• Computer-aided manufacturing (CAM) is the use of
computers to assist the manufacturing process.
– Output of the CAD system is fed to the CAM system.
– Benefits include improved process productivity, cost and time
estimates, process monitoring and quality, and decreased setup and
labor costs.
34
35
Value Stream Mapping
• Essential activities add value; nonessential activities do not
and should be eliminated.
• Company’s value stream includes all steps essential to
producing a product.
• Companies pursuing lean manufacturing use a value stream
map (VSM) to identify business process aspects that are
wasteful and should be eliminated.
– Works best in focused, high-volume processes which benefit from
reducing repetitive processes by even small amounts of time.
– Less effective in low-volume processes in which employees
frequently switch between multiple tasks.
36
37
Accounting in a Lean Manufacturing Environment
• Lean manufacturing requires new accounting methods and

information.
• Shows what matters to customers (quality and service).
• Identifies profitable products and customers.
• Identifies opportunities for operation and product
improvement.
• Encourages adoption of value-added activities and processes
and identifies those that do not add value.
• Efficiently supports multiple users with both financial and
non-financial information.
38
What’s Wrong with Traditional Accounting
Information?
• Inaccurate cost allocations occur because overhead is
assumed to be directly related to direct labor.
– Automation changes the relationship between direct labor, direct
materials, and overhead costs which becomes more significant.
– Using standard costs leads to distortions in a lean environment.
• Promotes non-lean behavior due to incentives to produce

large inventories and conceal waste in overhead allocations.
• Time lags as standard cost data are historic in nature.
– After-the-fact info is too late to be useful in a lean environment.
• Financial orientation is not always suitable for evaluations
pertaining to functionality and improvements.
39
Activity Based Costing (ABC)
• Method that allocates costs to facilitate planning and
control by assigning costs to activities and cost objects.
– Activities describe work performed in a firm.
– Cost objects are the reasons for performing activities.
• Assumes that activities cause costs and that products
(and other cost objects) create a demand for activities.
• First step is to determine the cost of an activity and an
appropriate activity driver that measures consumption.
– ABC uses multiple activity drivers, whereas traditional
accounting has only one, e.g. machine or labor hours.
40
41
Advantages and Disadvantages of ABC
• Advantages:
– More accurate costing of products/services, customers, and
distribution channels.
– Identifying the most and least profitable products and customers.
– Accurately tracking costs of activities and processes.
– Equipping managers to drive continuous improvements.
– Facilitating better marketing mix.
– Identifying waste and non-value-added activities.
• Disadvantages:
– Too time-consuming and complicated to be practical.
– Promotes complex bureaucracies in conflict with lean manufacturing
philosophy of process simplification and waste elimination.
42
Value Stream Accounting
• Captures costs by value stream rather than by department
or activity making it simpler than ABC accounting.
• Value streams cut across functional and departmental lines
and includes non-manufacturing costs.
• Essential aspect is defining the product family.
• Makes no distinction between direct and indirect costs.
– Raw materials based on purchases and all employee labor costs
of employees in the value stream are included.
• Typically only allocated cost is a charge for the facility
– Overhead costs which cannot be controlled are not allocated.
43
44
45
Information Systems that Support Lean
Manufacturing
• Materials Requirement Planning (MRP) is an automated
production planning and control system used to support
inventory management.
• Ensures adequate raw materials for production process.
• Maintains the lowest possible level of inventory on hand.
• Produce production and purchasing schedules and other
information needed to control production.
46
47
Information Systems that Support Lean
Manufacturing
• Manufacturing Resource Planning (MRP II) is an extension
of MRP that has evolved beyond inventory management.
– Coordinates a wide range of manufacturing activities.
– Benefits include improved customer service and cash flow, reduced
inventory, increase productivity, help in achieving long-term goals
and managing change and production flexibility.
• Enterprise Resource Planning (ERP) Systems are software
suites that integrate the entire organization into one system
connected to a single common database.
– An electronic data interchange (EDI) communication link allows
firm to interact with customers and suppliers via Internet or direct
connection.
48
49

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CHAPTER 1 Information Requirements; Information in

The Information System: An Accountant’s Business

AN INFORMATION SYSTEMS FRAMEWORK

A Framework for Information Systems

Levels of Data Hierarchy

Database Management Tasks

Transforming the Data into Information

Organizational Structure and AIS

Organization of IT Function in a Centralized Network Administration

Distributed Data Processing Model

• Primary Areas of Centralized Data Processing:

Systems Development and Maintenance

Infrastructure as a service (IaaS)

External Versus Internal Auditors

Relationship Between Transaction Cycles

DATA FLOW DIAGRAMS AND ENTITY

Data Flow Diagram Symbol Set

Record Layout Diagram for Customer File

Transaction Processing Models

Characteristic Differences between Batch and

DIFFERENCES BETWEEN BATCH AND REAL-TIME

UPDATING MASTER FILES FROM TRANSACTIONS

Real-Time Processing of Sales Orders

BATCH PROCESSING USING REAL-TIME DATA

• 3 transaction cycles: the expenditure cycle, the conversion

• Cash flows into the firm from sales made to

• The cash inflow allows the organization to purchase

• The lag between receiving goods and disbursement

• Initially, the cost accounting system was used for the

• Yes. For example, the remittance advice of a bill that

• Thistype of transaction is recorded in the general

• Not all modern organizations use entirely modern

• Large-scale systems that process high volumes of

• Real-time processing is better suited to systems that

• The flat-file approach is a single-view model. Files are

• Thisstructure, however, may be useless to the

• The data update problem in a flat-file model occurs

• Information currency problems occur because user

• Uncoded data takes a great deal of recording space, is

• Inventory-2”, yellow, metal reflector light 75

• Some problems this approach may produce are 1. the

• The auditor should examine the system flowchart

• a. state codes—alphabetic code, i.e. PA, this method

• d. inventory item number—alpha-numeric. The numeric

• f.sales order number—numeric, sequential. This

• h.invoice number—numeric, sequential. This

SARBANES-OXLEY ACT AND ETHICAL ISSUES

• Fraud Losses by Education

Internal Control Shield

Losses from Fraud by Scheme Type

INTERNAL CONTROL CONCEPTS AND

Control Weaknesses and Risks

Input controls are programmed procedures, often

Backup Procedures for Real-Time Processing System

Stages in the Output Process

• Update inventory records.

• Prepare return slip.

• Open mail and prepare remittance list.

Oes cr lation zoo

4-1 Sur•sWARY Or RevEHtJe CYCLe RtssS wbéo C< HTROLS

Risk Ph sical Co I I fT Control

M›sapproprintiot› of assets Transaction authorization - - retzliftance list Mult›level security to achieve

• Employs programmed techniques that permit simultaneous access to a central