Accounting Information System

Chapter One
Accounting Information systems: An Overview
Learning Objectives:
 Explain what an accounting information system (AIS) is.
 Describe the basic functions AIS performs.
 Discuss why studying the design and management of AIS is important.
 Explain the role played by the AIS in a company’s value chain.
 Discuss ways that the AIS can add value to a business.
 Describe the basic strategies and strategic positions that a business can adopt.
 Contrast the basic strategies and strategic positions that a business can adopt.

1.1. Introduction
A system is a set of two or more interrelated components to achieve a goal. Systems are almost
always composed of smaller subsystems, each performing a specific function important to and
supportive of the larger system for which it is a part.

An accounting information system is a collection of resources such as people and equipment

designed to transform financial data into information. The information is communicated to a wide
variety of decision makers. AIS perform this transformation whether they are essentially manual
or computerized.

Organizations depend on information systems in order to stay competitive. Information is just as

much as a resource as plant and equipment. Productivity, which is crucial to staying competitive,
can be increased through better information systems. Accounting as an information system
identifies, collects, processes and communicates economic information about an entity to a wide
variety of people.

AIS consist of five components:

1. The people who operate the system and perform various functions.
2. The procedures both manual and automated involved in collecting, processing, and storing
data about organization’s activities.
3. The data about the organization’s transactions
4. The software used to process the organization’s data
5. The information technology infrastructure including computers, peripheral devices, and
network communication devices.

The five components together enable AIS to fulfill three important functions in any organization.
1. It collects and stores data about activities and transactions.

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2. It processes data into information that is useful for making decisions.
3. It provides adequate controls to safeguard the organization’s assets including its data, to
ensure that the data are available when needed and are accurate and reliable.

1.2. Information Systems

The term information system suggests the use of computer technology in an organization to
provide information to users. A computer based information system is a collection of computer
hardware and software designed to transform data into useful information. There are several
types of computer based information systems. These include the following:
1. Electronic Data Processing (EDP) - is the use of computer technology to perform an
organization’s transaction oriented data processing. EDP is a fundamental accounting
information system application in every organization. As computer technology has become
commonplace, the term data processing has come to have the same meaning as EDP.
2. Management Information Systems (MIS) - describes the use of computer technology to
provide decision-oriented information to managers. MIS provides a wide variety of information
beyond that which is associated with data processing in organizations. It recognizes that
managers within organizations use and require information in decision-making, and that
computer based information systems can assist in providing information to managers.

Functional MIS Systems- many organizations apply the MIS concept to specific functional
areas within the organization. This indicates the tailoring of MIS concept to the development
of specific information systems to support decision-making in a particular well-defined
organization subunit.
a. Marketing Information System- is an MIS that provides information to be used by a
marketing function. Much of the information is obtained from the organization’s
accounting information system. Examples are sales summaries and cost information. Other
information must be gathered from the organization’s environment. Examples of
environmental information would include customer preference data, customer profiles,
and information on competitor’s products.
b. Manufacturing Information System- is an MIS that provides information to be used by
the manufacturing function. Much of the information is obtained from the organization’s
accounting information system. Examples are inventory summaries and cost information.
Other information must be gathered from the organization’s environment. Examples of
environmental information would include raw materials data, potential new vendor
profiles, and information on new manufacturing techniques.
c. Human Resource Information System- is an MIS that provides information to be used
by the human resource (personnel) function. Much of the information is obtained from the
organization’s accounting information system. Examples are wage and payroll tax
summaries and benefit information. Other information must be gathered from the

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organization’s environment. Examples of environmental information would include
government regulation data, and general labor market information.
d. Financial Information System- is an MIS that provides information to be used by the
finance function. Much of the information is provided by the organization’s accounting
information system. Examples are cash flow summaries and payment information. Other
information must be gathered from the organization’s environment. Examples of
environmental information would include interest rate data, lender profiles, and
information on credit markets.
3. Decision Support Systems (DSS) - provide data processed into a decision making format
for the end user. A DSS requires the use of decision models and specialized databases, and
differs significantly from a DP system. A DSS is designed for specific types of decisions for
specific users. It is directed at serving specific non-routine information requests by mangers. A
familiar example is the use of spreadsheet software to perform what if analysis of operating or
budgeted data such as sales forecasts by marketing personnel.
4. Expert Systems (ES) – are knowledge based information systems that use the knowledge
about a specific application area to act as an expert consultant to end-users. Like DSSs an ES
requires the use of decision models and specialized databases. Unlike DSSs an ES is also
requires the development of a knowledge base- the special knowledge that an expert
possesses in a decision area and an inference engine- the process by which the expert makes a
decision. An ES attempts to replicate the decisions that would be made by an expert, human
decision maker in the same decision situation. An ES differs from DSS in that the DSS assists
the user in making a decision, whereas an ES makes the decision.
5. Executive Information System (EIS) – is a system tailored to the strategic information
needs of top-level management. Much of the information used by top-level management
comes from sources other than an organization’s information systems. Examples are
meetings, memos, television, periodicals, and social activities. But some information must be
processed by the organization’s information systems. An EIS provides top-level management
with easy access to selective information that has been processed by the organization’s
information systems. This selective information concerns the key success factors that top-
level management has identified as being critical to the organization’s success. Actual versus
projected market share for product groups and budget versus actual profit and loss data for
divisions might be key success factors for top-level executive.
6. Accounting Information System (AIS):-is a computer-based system designed to
transform accounting data into information. However, AIS is used broadly to include
transaction processing cycles, the use of information technology and the development of
information systems.

1.3. Why Study the AIS?

Effective AIS is essential to the organization’s long run success.

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1. It enables monitoring the events that occur and how well an organization works.
2. It also tracks the effect of various events on the resources that the organization controls.
3. Information about the agents who participate in the events is used to assign responsibility
for actions taken.

In statement of financial accounting concepts No. 2, the Financial Accounting Standard Board
(FASB) defined accounting as an information system. It also stated that the primary objective of
accounting is to provide information that is useful to decision makers. Therefore, it is not surprising
that the accounting education change commission recommended that the accounting curriculum
should emphasize that accounting is an information identification, development, and
measurement and communication process.

The AIS course focuses on understanding how the accounting system works i.e. how to collect
data about the organization’s activities and transactions; how to transform that data into
information that management can use to run the organization; and how to ensure the availability,
reliability and accuracy of that information. Hence, it complements the other accounting courses.

The AIS course fits into both the accounting and information system curricula. Study of AIS
fundamental to accounting because change shall be incorporated in the accounting curricula. The
commission suggested that the accounting curriculum should be designed to provide students
with a solid understanding of three essential concepts:
1. The use of information in decision making
2. The nature, design, use and implementation of an AIS
3. Financial information reporting

The other accounting course that you take (Financial Accounting, Managerial Accounting, Tax and
Audit) focus on your role as a reporter of information. Thus, studying about the design and
management of AIS is important because of the following reasons.
1. To understand how the accounting system works.
 How to collect data about an organization’s activities and transactions
 How to transform that data into information that management can use to run the
organization
 How to ensure the availability, reliability, and accuracy of that information
2. Auditors need to understand the systems that are used to produce a company’s financial
statements.
3. Tax professionals need to understand enough about the client’s AIS to be confident that the
information used for tax planning and compliance work is complete and accurate.
4. One of the fastest growing types of consulting services entails the design, selection, and
implementation of new Accounting Information Systems.

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5. A survey conducted by the Institute of Management Accountants (IMA) indicates that work
relating to accounting systems was the single most important activity performed by
corporate accountants.

There are many other systems courses that cover the design and implementation of information
systems and which help develop specialized skills in such areas as databases, expert systems, and
telecommunications. The AIS course differs from these other information systems courses in its
focus on accountability and control. These issues are important because in most large
organizations, the managers are not owners. Instead, the owners have entrusted the
management with assets (including data and information) and hold them accountable for their
proper use. Hence, the AIS course complements the other systems course.

1.4. Factors Influencing the Design of AIS

There are three basic factors influence the design of AIS:

1. Information technology (IT)
2. Organization’s/ Business strategy
3. Organizational culture

Organizational
Strategy
Culture

AIS

Information
Technology

Fig 1.1 Factors influencing the design of Accounting Information System

IT is profoundly changing the way that accounting and many other business activities are
performed. It is also essential to know the costs and benefits of new IT developments. This
requires developing basic understanding of business strategies and how IT can be used to
implement those strategies as well as how new developments in IT create an opportunity to
modify those strategies.

Moreover, because the AIS functions within an organization, it should be designed to reflect the
values of that organizational culture. The design of AIS also influences the organizational culture
by controlling the flow of information within the organization. For example, an AIS that makes

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information easily accessible and widely available is likely to increase pressures for more
decentralized and autonomy.

New developments in IT also affect the design of AIS. Because an AIS functions within an
organization, it should be designed to reflect the values of that organizational culture. In addition
to directly affecting the way that organizations carry out their value chain activities, IT such as the
Internet can also affect significantly both strategy and strategic positioning. For example, it
dramatically cuts costs, thereby helping companies to implement a low cost strategy.

1.5. Basic Activities of Accountants

There are 10 most important activities performed by accountants

1. Accounting systems and financial reporting
2. Long-term strategic planning
3. Managing the accounting and finance function
4. Internal Consulting
5. Short-term budgeting
6. Financial and economic analyses
7. Process improvement
8. Computer systems and operations
9. Performance evaluation
10. Customer and product profitability analyses

1.6. The Role of the AIS in the Value Chain

The objective of most organizations is to provide value to their customers. This requires
performing a number of different activities. These activities are conceptualized as forming a value
chain. A business will be profitable if the value it creates is greater than the cost of producing its
products or services.

An organization’s value chain consists of nine interrelated activities that collectively describe
everything it does. The five primary activities consist of the activities performed in order to create,
market, and deliver products and services to customers and also to provide post-sales services
and support. They directly provide value to its customers. These are:
1. Inbound logistics- consists of receiving, storing, and distributing the materials that are inputs
used by the organization to create the services and products that it sells.
2. Operations- activities that transform inputs into final products or services.
3. Outbound logistics- are the activities involved in distributing finished products or services to
customers.
4. Marketing and sales- refers to the activities involved in helping customers to buy the
organization’s products or services.

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5. Service- activities that provide post sale support to customers. Examples are repairs and
maintenance services.

1. Firm Infrastructure
2. Human Resources
3. Technology
4. Purchasing

1. Inbound 2. Operations 3. Outbound 4. Marketing 5. Services

Logistics Logistics & sales

Fig 1. 2 The Value Chain

Organizations also perform a number of other support activities that enable the five primary
activities to be performed efficiently and effectively. Those support activities can be grouped into
four categories:

1. Firm Infrastructure- refers to the accounting, finance, legal support, and general administrative
activities that are necessary for any organization to function. The AIS is part of the firm
infrastructure.
2. Human resources- activities that include recruiting, hiring, training, and providing employee
benefits and compensation.
3. Technology- activities that improve a product or service. Examples include research and
development, improvements in information technology, web site development, and product
design.
4. Purchasing- includes all the activities involving in procuring raw materials, supplies, machinery,
and the buildings used to carry out the primary activities.

It shall be recalled that systems are often composed of subsystems. Thus, each step in an
organization’s value chain is itself a system consisting of a set of activities. For example, the sales
and marketing step includes such activities as market research, calling on customers, order
processing, and credit approval. In addition, an organization’s value chain is itself a part of a larger
system.

The value chain concept can be extended by recognizing that organizations must interact with
suppliers, distributors, and customers. An organization’s value chain and the value chains of its
suppliers, distributors, and customers collectively form a value system.

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1.7. How Can AIS Add Value to an Organization?

The value chain model shows that the AIS is support activity. Thus, AIS can add value to the
organization by providing accurate and timely information so that the five primary value chain
activities can be performed more effectively and efficiently. Well-designed AIS can do this by:
1. Improving the quality and reducing the cost of products and services- an AIS for example can
monitor machinery so that operators are notified immediately when the process falls outside
acceptable quality limits. This helps not only maintain product quality but also reduces the
amount of wasted materials and the costs of having to rework anything.
2. Improving efficiency- well designed AIS can help improve the efficiency of operations by
providing more timely information. For example, a just in time manufacturing approach
requires constant, accurate, up to date information about raw materials inventories and their
costs.
3. Improved decision making- an AIS can improve decision making by providing accurate
information in a timely manner.
4. Sharing of knowledge- a well-designed AIS can make it easier to share knowledge and
expertise, perhaps thereby improving operations and even providing a competitive
advantage.

Well designed AIS can also help an organization profit by improving the efficiency and
effectiveness of its supply chain. For example, allowing customers to directly access the
company’s inventory and sales order entry systems can reduce the cost of sales and marketing
activities. Moreover, if such access reduces customers’ costs and time of ordering, both sales and
customer retention rates may increase.

1.8. Data and Information

Data refers to any and all of the facts that are collected, stored, and processed by an information
system. Three kinds of data need to be collected for any activity. These are:
1. Facts about the event itself,
2. The resources affected by the event, and
3. The agents who participated in that event. Consider selling process as an example.

Data need to be collected about the sale event itself (such as date of sale, total amount etc), data
about the resources being sold (identity of the goods or services), and data about the agents who
participated in the sale event (the identity of the customer and the salesperson). Once data have
been collected, the AIS will transform the facts so that they will be used to make decisions. Thus
information is data that have been organized and processed to provide meaning. The following
diagram depicts the characteristics of Useful Information

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Relevant Timely

Reliable Understandable

Complete Verifiable

Fig 1.3 Characteristics of Useful Information

1.9. Decision Making

There are different models of decision-making and problem solving process. All those models
depict that decision-making is a complex, multi-step activity. Decision making involves the
following steps:
1. Identify the problem
2. Select a method for solving the problem
3. Collect data needed to execute the decision
4. Interpret the outputs of the model.
5. Evaluate the merits of each alternative
6. Choose and execute the preferred solution

The AIS can provide assistance in all phases of decision-making. Different decision models and
analytical tools can be provided to users. Query languages can facilitate the gathering of relevant
data upon which to make the decision. Various tools such as graphical interfaces can help the
decision maker interpret the results of a decision model and evaluate and choose among
alternative course of action. Finally the AIS can provide feedback on the results of actions.

The degree to which AIS can support decision-making depends, however, on the type of decision
being made. Decisions may be categorized either in terms of the degree of structure or by their
scope.

1.9.1. Decision Structure

Decisions vary in terms of the degree they are structured. Decisions are classified into three in this
regard.
1. Structured decisions- are repetitive, routine, and understood well enough that they can be
delegated to lower level employees in the organization. For example, the decision about
extending credit to established customers require only knowledge about the customer’s credit
limit and current balance. Structured decisions can often be automated.

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2. Semi structured decisions- are characterized by incomplete rules for making the decisions and
the need for subjective assessments and judgments to supplement formal data analysis.
Setting a marketing budget for a new product is a typical example. Although such decisions
can’t be fully automated, they are often supported by computer based decision aids.
3. Unstructured decisions - are nonrecurring and non-routine decisions. For example, choosing
the cover of a magazine, hiring senior management, and selecting basic research projects to
be undertaken. No framework or model exists to solve such problems. Instead, they require
considerable judgment and intuition. Nevertheless, unstructured decisions can be supported
by computer based decision aids that facilitate gathering information from diverse sources.

1.9.2. . Decision Scope

Decisions vary in terms of the scope of their effect. This will include:
1. Operational control- concerns the effective and efficient performance of specific tasks.
Decisions relating to inventory management and extending credit are examples of
operational control activities.
2. Management control- concerns the effective and efficient use of resources for accomplishing
organizational objectives. Budgeting, developing human resource practices and deciding on
research projects and product improvements are examples of management control
activities.
3. Strategic planning- concerns the establishing of organizational objectives and policies for
accomplishing those objectives. Setting financial and accounting policies, developing new
product lines, and acquiring new businesses are examples of strategic planning decisions.

There exists a correspondence between a manager’s level in an organization and his decision
making responsibilities.

1. Top management-unstructured and semi structured decisions, involving strategic decisions.

2. Middle managers-deal with semi structured decisions, involving management control.
3. Lower level supervisors and employees- face semi structured or structured decisions
involving operational control.

1.10. Value of Information for Decision Making

The value of information is the benefit produced by the information minus the cost of producing
it. The information produced by well-designed AIS can improve decision making in several ways:

1. Identifies situations requiring management action. For example, a cost report with a large
variance might stimulate management to investigate and if necessary take corrective action.
2. Reducing uncertainty, accounting information provides a basis for choosing among
alternative actions. For example, accounting information is often used to set prices and
determine credit policies.

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3. Information about the results of previous decisions provides valuable feedback that can be
used to improve future decisions.

Nevertheless, although more information is often better, this is only true to a point. There are
limits to the amount of information that the human mind can effectively absorb and process.
Information overload occurs when those limits are passed. Information overload is costly because
decision-making quality declines while the costs of providing that information increase. Thus,
information overload reduces the value of information. Consequently, information system
designers must consider how advances in IT can help decision makers more effectively filter and
condense information thereby avoiding information overload.

Moreover, it is important to recognize that there are costs associated with producing information.
Those costs include the time and resources spent in colleting, processing, and storing data as well
as the time and resources used in distributing the resulting information to decision makers. There
are also many opportunities to invest in additional IT to improve the overall performance of the
AIS. Most organization, however, do not have unlimited resources to invest in improving their
information systems. Therefore, another important decision involving identifying which potential
AIS improvements are likely to yield the greatest return. Making this decision wisely requires that
accountants and information system professionals

1.11. AIS and Corporate Strategy.

There are two basic strategies that companies can follow:
1. A product differentiation strategy entails adding some features or services to a product that
are not provided by competitors. Doing so allows a company to charge a premium price to
its customers.
2. A low cost strategy entails striving to be the most efficient producer of a product or a
service.
Sometimes companies can succeed in both producing a better product than competitors and in
doing at costs below its industry average. Usually, however, companies must choose between the
two basic strategies. If they concentrate on being the lowest cost producers, they will have to
forego some value added features that might differentiate their product. If they focus on product
differentiation, they most likely will not have the lowest costs in the industry. Thus a business
strategy involves making choices.

The choice of a business strategy involves the selection of a specific strategic position they shall
adopt. There are three strategic positions.

1. Variety based strategic position involves producing or providing a subset of the industry’s
products or services.

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2. Need based strategic position involve trying to serve most or all of the needs of a particular
group of customers. This entails first identifying a target market.
3. Access based strategic position involves serving a subset of customers who differ from other
customers in terms of factors such as geographic locations or size, which creates different
requirements for serving those customers.

The above strategic positions are not mutually exclusive and indeed often overlap. For example, a
company may adopt elements of all the three. Choosing a strategic position is important because
it enables the company to focus its efforts; otherwise, it risks trying to be everything to
everybody.

1.12. The Future of AIS

An organization’s AIS play an important role in helping it adopt and maintain a strategic position.
Achieving a close fit among activities requires that data be collected about each activity. It is also
important that the information system collect and integrate both financial and non-financial data
about the organization’s activities. The Internet makes strategy more important than ever.
Traditionally, the AIS was used as transaction processing system because it was concerned about
financial data. To handle non-financial data, other systems were used leading to redundancy and
problem in updating data.

Enterprise resource planning (ERP) systems-integrate all aspects of a company’s operations with
traditional AIS. They are designed to overcome these problems as they integrate all aspects of a
company’s operations with its traditional AIS. For example, when a sales order is entered by the
sales force, the effect of the transaction automatically flows to all affected parts of the company.
Inventory is updated, production schedules are adjusted, and purchase orders of raw materials
and supplies are initiated. More over, important non-financial data such as the time of sale are
collected and stored in the same system.

A key feature of ERP systems is the integration of financial with other non-financial operating
data. The value of such integration is to suggest that there may be strategic benefits to more
closely linking traditionally separate functions of information systems and accounting, and many
organizations are beginning to combine these two functions.

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