Chapter 6 - Accounting System Design

Chapter 6 – Accounting System Design
Chapter Outline
• Principle of Accounting Systems
• Accounting System Installation and Revision
• Internal Control
• Guidelines to Strong Internal Control
• Special Journals and Subsidiary Ledgers
1 By Animaw Yayeh (BSc, BA & MBA) 11/17/2017

Principle of Accounting Systems
 The way in which management is given the information for
use in conducting the affairs of the business and reporting to
owners, creditors, and other interested parties is called the
Accounting System.
 It includes the entire network of communications used by a
business organization to provide needed information.
 The accounting information system collects and
processes transaction data and communicates financial
information to decision makers.

Principle of Accounting Systems Cont’d …
 It includes not only each of the steps in the accounting cycle
but also the documents that provide evidence of the
transactions, and the records, trial balances, worksheets, and
financial statements that result.
 An accounting system may be either manual or
computerized.
 Most businesses these days use some sort of computerized
accounting system, whether it is an off-the-shelf system for
small businesses, like ACCPAC, QuickBooks or
Peachtree, or a more complex custom-made system.

 Because of the difference in businesses, the number of transactions
to be processed and in the uses made of accounting data, accounting
systems will vary from business to business.
 There are broad principles of accounting system;
 Cost-Effectiveness – the accounting system must be tailored to
meet the specific needs of each business. The value of the system
produced should be at least equal to the cost of producing it. No
matter how detailed or the information may be; it should not be
produced if it costs more than the benefits received by those who
use it.
 Flexibility - the characteristics of the modern business to consider
change. The accounting system must adapt to the constantly
changing environment.
 The accounting system should accommodate a variety of
users and changing information needs.
 The system should be sufficiently flexible to meet the
resulting changes in the demands made upon it.
 Adequate Internal Control – The accounting
information system must provide the information needed by
management in reporting to owners, creditors, and other
interested parties. Besides the system should aid management
in directing operations. The detailed policies and procedures
used to direct operations and provide reasonable assurance
that the entity’s objectives are called internal Control.

 Effective Reporting – users of the information provided
by the accounting system rely on various reports for relevant
information presented in an understandable manner. When
these reports are prepared, the requirements and knowledge
of the user should be recognized.
 Adaptation to Organizational Structure – No two
organizations are structured alike, the accounting system
should be tailored to the organizational structures of each
business. The line of authority and responsibility will affect
the information requirements of each business.

Accounting System Installation and Revision
 A complete knowledge is important for an accounting system
before designing and installation the system.
 As a business grows and changes, its accounting system also
changes in a three-step process.
 There are three-step process in accounting system:
Step 1. Analyze system as per user information needs.
Step 2. Design the system to meet the user needs.
Step 3. Implement the system.

Accounting System Installation and Revision Cont’d …
 System Analysis – the goal of system analysis is to determine
information needs, the series of such information, and the
deficiencies in procedures and data processing methods
presently used.
 The system analysis begins with a review of the organization
structure and the job descriptions of the personnel affected.
 This review is followed by the study of the forms, records,
procedures, processing methods, and records used by the
enterprise.

 System Design - the designing of an accounting system
involves changes (minor to major) in the existing system. It
may be a revision of a particular form and related procedures
and processing methods, or it may be a revision of the entire
system.
 The system designers must have a general knowledge of the
qualities of different kind of data processing equipment and
the ability to evaluate alternatives.
 The successful systems design depends to a large extent upon
the creativity, imagination, and general capabilities of the
designer, observance of the broad principles previously
discussed is necessary.

 System Implementation – The final phase of the creation
or revision of an accounting system is to carryout or
implement the proposals.
 New or revised forms, records, procedures, and equipment
must be installed and that are no more useful must be
withdrawn.
 All personnel responsible for operating the system must
carefully be;
 Trained
 Closely supervised
Until satisfactory efficiency is achieved.
Internal Control
 Internal control is defined as the procedures and processes
used by a company to:
1. Safeguard its assets.
2. Process information accurately.
3. Ensure compliance with laws and regulations.
 Internal control is a process designed by a company to
establish the reliability of the accounting records and financial
a mechanisms in accordance - with generally accepted
accounting principles (GAAP) and to ensure that the
company's assets are protected.

Internal Control Cont’d …
 Internal control is the process designed to
 ensure reliable financial reporting,
 effective and efficient operations, and
 compliance with applicable laws and regulations.
 Safeguarding assets against theft an unauthorized use,
acquisition, or disposal is also part of internal control.
 Internal controls are the policies and procedures that protect
assets from misuse, ensure that business information is
accurate, and ensure that laws and regulations are being
followed.

Guidelines to Strong Internal Control
 The internal control structure consists of the policies and
procedures established to provide reasonable assurance that the
enterprise’s goals and objectives will be achieved.
 The internal control structure varies according to the size and type
of business enterprise.
 In a small business few control policies and procedures are
necessary.
 As the number of employees and the complexities of an enterprise
increase, it becomes more difficult for management to maintain
control over all phases of operations.
 As firm grows, management needs to delegate authority and to
place more reliance on the control structure in order to achieve
adherence to enterprise goals and objectives.
Guidelines to Strong Internal Control
 Internal control consists of all the related methods and
measures adopted within an organization
 to safeguard assets,
 enhance the reliability of accounting records,
 increase efficiency of operations, and
 ensure compliance with laws and regulations.

Guidelines to Strong Internal Control Cont’d …
 Good internal controls will:
 help align the performance of the organisation with the
overall objectives
 encourage good management
 ensure proper financial reporting
 safeguard assets
 deter and detect fraud and error
 reduce exposure to risks

 Internal control systems have five primary
components.
 The components/elements of internal control are;
 A control environment.
 Risk assessment.
 Control procedure/activities.
 Information and communication.
 Monitoring.

Internal control systems components Cont’d …
1. A control environment – represents an overall attitude toward
and awareness of the importance of control by both management
and other employees.
 Factors influencing the control environment of an enterprise
include
 management’s philosophy and operation style - includes the
management’s attitude concerning controls (routinely
violated controls by top management are unimportant for the
lower employees),
 the organizational structure of the enterprise, and
 the personnel policies and practices – include the hiring,
training, evaluation, promotion and compensation of
employees.
Internal control systems components Cont’d …
 Control environment is the responsibility of top
management to make it clear that the organization values
integrity and that unethical activity will not be tolerated.
 This component is often referred to as the “tone at the
top.”

2. Risk Assessment - involves identifies areas in which risks of loss
of assets or inaccuracies in accounting records are high so that
adequate controls can be implemented. Among the greater risks in
a retail store are that employees may steal cash and customers may
steal goods.
 Companies must identify and analyze the various factors that
create risk for the business and must determine how to manage
these risks.
 Internal control should provide for an assessment of the risks the
organization faces from both external and internal sources.
 A precondition to risk assessment is the establishment of clear,
consistent objectives.

3. Internal control procedures/activities - help ensure that
management’s directives are carried out. The control activities
should be effective and efficient in accordance with the
organization’s control objectives.
 Control procedure/activities are the policies, procedures,
techniques, and mechanisms that enforce management’s directives.
 The six principles of control procedures/activities are as follows.
 Establishment of responsibility - Control is most effective when
only one person is responsible for a given task.
 Segregation of duties
 Documentation procedures
 Physical controls
 Independent internal verification
 Human resource controls
 Establishing responsibility often requires limiting access only
to authorized personnel, and then identifying those personnel.
 Segregation of duties is indispensable in an internal control
system.There are
 two common applications of this principle:
1. Different individuals should be responsible for related
activities.
2. The responsibility for record-keeping for an asset should be
separate from the physical custody of that asset.
 The rationale for segregation of duties is this: The work of one
employee should, without a duplication of effort, provide a
reliable basis for evaluating the work of another employee
 Making one individual responsible for related activities
increases the potential for errors and irregularities.
 Companies should establish procedures for
documents.
 whenever possible, companies should use pre-
numbered documents, and all documents should be
accounted for.
 Physical controls relate to the safeguarding of assets
and enhance the accuracy and reliability of the
accounting records.
 To obtain maximum benefit from independent internal
verification:
1. Companies should verify records periodically or on a surprise
basis.
2. An employee who is independent of the personnel
responsible for the information should make the verification.
3. Discrepancies and exceptions should be reported to a
management level that can take appropriate corrective
action.
 Independent internal verification is especially useful in
comparing recorded accountability with existing assets.

Limitations of Internal Control
 Internal controls cannot ensure success.
 Bad decisions
 Poor managers
 Unethical behavior
 Collusion
 Override of controls
 Competition
 Companies generally design their systems of internal control to
provide reasonable assurance of proper safeguarding of assets
and reliability of the accounting records.
 The concept of reasonable assurance rests on the premise that the
costs of establishing control procedures should not exceed their
expected benefit.
Special Journals and Subsidiary Ledgers
 The accounting information system collects and processes
transaction data and communicates financial information to
decision-makers.
 An accounting system may be either manual or
computerized.
 Manual accounting systems perform each of the steps in the
accounting cycle by hand.
 Many small businesses eventually replace their manual accounting
system with a computerized general ledger accounting
system.
 General ledger accounting systems are software programs
that integrate the various accounting functions related to sales,
purchases, receivables, payables, cash receipts and
disbursements, and payroll.

Special Journals and Subsidiary Ledgers Cont’d …
 Computerized systems have a number of advantages over
manual systems.
1. the company typically enters data only once in a
computerized system.
2. because the computer does most steps automatically, it
eliminates many errors resulting from human
intervention in a manual system, such as errors in
posting or preparation of financial statements.
3. provides information up-to the-minute.

 When there are a small number of transactions, the journal
entries were then posted individually to the accounts in the
ledger in which such a system is simple to use and easy to
understand.
 However, when a business has a large number of similar
transactions, using an all-purpose journal is inefficient and
impractical.
 In such cases, subsidiary ledgers and special journals are
useful.

 Special Journals - designed to be used for recording a single
kind of transaction that occurs frequently.
 The format and number of special journals that a business uses
depends on the nature of the business.
 A business that gives credit might use a special journal designed
for recording only revenue from services provided on credit.
 If a transaction cannot be recorded in a special journal, the
company records it in the general journal.
 Transactions that cannot be entered in a special journal,
including correcting, adjusting, and closing entries are recorded
in a General Journal.

 The four types of special journals are
 Sales Journal - Used for all sales of merchandise on
account
 Cash Receipts Journal - Used for All cash received
(including cash sales)
 Purchases Journal - Used for all purchases of
merchandise on account
 Cash Payments Journal - Used for all cash paid (including
cash purchases)
 The types of transactions that occur frequently in a company
determine what special journals the company uses.

 A subsidiary ledger is a group of accounts with a common
characteristic (for example, all accounts receivable). It is an
addition to and an expansion of the general ledger.
 Companies use subsidiary ledgers to keep track of individual
balances. The subsidiary ledger frees the general ledger from the
details of individual balances.
 Two common subsidiary ledgers are:
1. The accounts receivable (or customers’) subsidiary ledger,
which collects transaction data of individual customers.
2. The accounts payable (or creditors’) subsidiary ledger,
which collects transaction data of individual creditors.

 A general ledger account summarizes the detailed data from a
subsidiary ledger.

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Chapter 6 – Accounting System Design

1 By Animaw Yayeh (BSc, BA & MBA) 11/17/2017

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