Accounting Information Systems 10th ed chaps 1-4 PDF

The Information System: An Accountant’s Perspective FS nlike many other accounting subjects, such as inter- M@ Learning Objectives mediate ac...

The Information System: An Accountant’s Perspective FS nlike many other accounting subjects, such as inter- M@ Learning Objectives mediate accounting, accounting information systems After studying this chapter, you should: (AIS) lacks a well-defined body of knowledge. Recognize the primary information Much controversy exists among college faculty as to what flows within the business should and should not be covered in the AIS course. To environment. some extent, however, the controversy is being resolved through legislation. The Sarbanes-Oxley Act (SOX) of 2002 Understand the difference between established new corporate governance regulations and stan- accounting information systems and dards for public companies registered with the Securities and management information systems. Exchange Commission (SEC). This wide-sweeping legislation Understand the difference between impacts public companies, their management, and their audi- financial transactions and tors. Of particular importance to AIS students is the impact of nonfinancial transactions. SOX on internal control standards and related auditing pro- Know the principal features of the cedures. Although SOX does not define the entire content of general model for information the AIS course, it does identify critical areas of study that systems. need to be included. These topics and more are covered in Understand the organizational the chapters of this text. structure and functional areas ofa The purpose ofthis chapter is to place the subject of AIS in business. perspective for accountants. Toward this end, the chapter is divided into three major sections, each dealing with a different Be able to distinguish between external auditing, internal auditing, aspect of information systems. The first section explores the and advisory services as they relate to information environment of the firm. It identifies the types of information used in business, describes the flow of informa- accounting information systems. tion through an organization, and presents a framework for viewing AIS in relation to other information systems compo- nents. The section concludes with a review of the key elements of the general model for AIS. The second section of the chap- ter deals with the impact of organizational structure on AIS. Here we examine the business organization as a system of interrelated functions. Extensive attention is given to the IT and accounting segments, which play collaborative roles as the purveyors of financial information for the rest of the PIN IRS A Overview of Accounting Information Systems organization. The final section discusses the unique responsibility of accountants as domain experts in the design of AIS and as auditors of AIS. The Information Environment We begin the study of AIS with the recognition that information is a business resource. Like other business resources such as raw materials, capital, and labor, information is vital to the survival of the contemporary business organization. Every business day, vast quantities of information flow to decision makers and other users to meet a variety of internal needs. In addition, information flows out from the organization to external users, such as customers, suppliers, and stakeholders, who have an interest in the firm. Figure 1-1 presents an overview of these internal and external information flows. The pyramid in Figure 1-1 shows the business organization divided horizontally into several levels of activity. Business operations form the base of the pyramid. These activities consist of the product-oriented work of the organization, such as manufacturing, sales, distribution, bill- ing, and cash receipts. Above the base level, the organization is divided into three management tiers: operations management, middle management, and top management. Operations manage- ment is directly responsible for controlling day-to-day operations. Middle management is accountable for the short-term planning and coordination of activities necessary to accomplish organizational objectives. Top management is responsible for longer-term planning and setting organizational objectives. Every individual in the organization, from business operations to top management, needs information to accomplish his or her tasks. Notice in Figure 1-1 how information flows in two directions within the organization: horizontally and vertically. The horizontal flow supports operations-level tasks with highly detailed information about the many business transactions affecting the firm. This includes information about events such as the sale and shipment of goods, the use of labor and materials in the production process, and internal transfers of resources from one department to another. The vertical flow FIGURE 4-1 INTERNAL AND EXTERNAL FLows OF INFORMATION Top Stakeholders Management Middle. Management Operations Management Day-to-Day Operations Information  CoAeAC PA ERS | The Information System: An Accountant’s Perspective distributes information downward from senior managers to junior managers and operations personnel in the form of instructions, quotas, and budgets. In addition, summarized informa- tion pertaining to operations and other activities flows upward to managers at all levels. Man- agement uses this information to support its various planning and control functions. A third flow of information depicted in Figure 1-1 represents exchanges between the organiza- tion and users in the external environment. External users fall into two groups: trading partners and stakeholders. Exchanges with trading partners include customer sales and billing information, purchase information for suppliers, and inventory receipts information. Stakeholders are external entities with a direct or indirect interest in the firm. Stockholders, financial institutions, and gov- ernment agencies are examples of external stakeholders. Information exchanges with these groups include financial statements, tax returns, and stock transaction information. INFORMATION OBJECTIVES Specific information objectives will differ from firm to firm as specific user needs vary. Three fun- damental objectives are, however, common to all organizations: 1. To support the firm’s day-to-day operations. Operations personnel use information to assist them in the efficient and effective discharge of their daily tasks. 2. To support management decision making. Managers use information to assist them in planning and control decisions related to their areas of responsibility. 3. To support the stewardship function of management. Stewardship refers to managers’ responsibility to properly manage the resources of the firm and to report on their activities. External users receive stewardship information through traditional financial statements and other mandated reports. Internally, managers receive stewardship information from various responsibility reports. These objectives call for information sets that are diverse in their level of detail and nature. For example, managers cannot effectively employ the finely detailed information needed to support day-to-day operations. Management decision information tends to be highly summarized and ori- ented toward reporting on overall performance and trends rather than routine tasks. Similarly, accrual-based financial statement information, which is prepared for stakeholders, is unsuitable for most internal uses. The information needed to satisfy these diverse needs is the product of the information system. AN INFORMATION SYSTEMS FRAMEWORK The information system is the set of formal procedures by which data are collected, stored, pro- cessed into information, and distributed to users. Figure 1-2 shows the information system of a hypothetical manufacturing firm decomposed into its elemental subsystems. Notice that two broad classes of systems emerge from the decompo- sition: the AIS and the management information system (MIS). We will use this framework to identify the domain of AIS and distinguish it from MIS. Keep in mind that Figure 1-2 is a con- ceptual view; physical information systems are not typically organized into such discrete packages. More often, MIS and AIS functions are integrated within physical systems to achieve operational efficiency. The distinction between AIS and MIS centers on the concept of a transaction, as illustrated by Figure 1-3. The information system accepts inputs, called transactions, which are converted through various processes into output information that goes to users. Transactions fall into two classes: financial transactions and nonfinancial transactions. Before exploring this distinction, let’s first define the term transaction: A transaction is an event that affects or is of interest to the organization and is processed by its information system as a unit of work.  IP AN IR Til Overview of Accounting Information Systems 1-2 A FRAMEWORK FOR INFORMATION SYSTEMS Information System (IS) Accounting Management Information Information System (AIS) System (MIS) General Transaction Management Ledger/Financial Processing Reporting yale Marketing Distribution Ate z anagement Resource Reporting System System System oVeieme Systems Systems Systems (GL/FRS) (Ps) = (MRS) uh (Chapter 8) (Chapter 2) (Chapter 8) Expenditure Conversion Revenue Cycle Cycle Cycle (Chapters 5 & 6) (Chapter 7) (Chapter 4) Cost Sales Purchase Accounting Processing System System System Production Cash : Cash Disbursement ae Receipts System System System Payroll Processing System Fixed Asset System TRANSACTIONS PROCESSED BY THE INFORMATION SYSTEM Financial Transactions Information —-> | Information Eee System Nonfinancial Transactions  CURE AN TP UTE RE The Information System: An Accountant’s Perspective This definition encompasses both financial and nonfinancial events. Because financial transac- tions are of particular importance to the accountant’s understanding of information systems, we need a precise definition for this class of transaction: A financial transaction is an economic event that affects the assets and equities of the organiza- tion, is reflected in its accounts, and is measured in monetary terms. Sales of products to customers, purchases of inventory from vendors, and cash disbursements and receipts are examples of financial transactions. Every business organization is legally bound to correctly process these types of transactions. Nonfinancial transactions are events that do not meet the narrow definition of a financial trans- action. For example, adding a new supplier of raw materials to the list of valid suppliers is an event that may be processed by the enterprise’s information system as a transaction. Important as this information obviously is, it is not a financial transaction, and the firm has no legal obligation to process it correctly—or at all. Financial transactions and nonfinancial transactions are closely related and are often processed by the same physical system. For example, consider a financial portfolio management system that collects and tracks stock prices (nonfinancial transactions). When the stocks reach a threshold price, the system places an automatic buy or sell order (financial transaction). Buying high and selling low is bad for business, but it is not against the law. Therefore, no law requires company management to design optimal buy-and-sell rules into its system. Once the order is placed, how- ever, the processing of this financial transaction must comply with legal and professional guidelines. The Accounting Information System AIS subsystems process financial transactions and nonfinancial transactions that directly affect the processing of financial transactions. For example, changes to customers’ names and addresses are processed by the AIS to keep the customer file current. Although not technically financial transac- tions, these changes provide vital information for processing future sales to the customer. The AIS is composed of three major subsystems: (1) the transaction processing system (TPS), which supports daily business operations with numerous reports, documents, and messages for users throughout the organization; (2) the general ledger/financial reporting system (GL/FRS), which produces the traditional financial statements, such as the income statement, balance sheet, statement of cash flows, tax returns, and other reports required by law; and (3) the management reporting system (MRS), which provides internal management with special-purpose financial reports and information needed for decision making such as budgets, variance reports, and responsibility reports. We examine each of these subsystems in later sections of this chapter. The Management Information System Management often requires information that goes beyond the domain of AIS. As organizations grow in size and complexity, specialized functional areas emerge, requiring additional information for production planning and control, sales forecasting, inventory warehouse planning, market research, and so on. The MIS processes nonfinancial transactions that are not normally processed by traditional AIS. Table 1-1 gives examples of typical MIS applications related to functional areas of a firm. The Need to Distinguish between AIS and MIS SOX legislation requires that corporate management design and implement internal controls over the entire financial reporting process. This includes the FRS, the GLS, and the TPS that supply the data for financial reporting. SOX further requires that management certify these controls and that the external auditors express an opinion on control effectiveness. Because of the highly inte- grative nature of modern information systems, management and auditors need a conceptual view IPN IRAE ll Overview of Accounting Information Systems eal Exampces of MIS ApPLICATIONS IN FUNCTIONAL AREAS Function Examples of MIS Applications Finance Portfolio management systems Capital budgeting systems Marketing Market analysis New product development Product analysis Distribution Warehouse organization and scheduling Delivery scheduling Vehicle loading and allocation models Personnel Human resource management systems gw Job skill tracking system ao mw Employee benefits system of the information system that clearly distinguishes key processes and areas of risk and legal responsibility from other (nonlegally binding) aspects of the system. Without such a model, man- dated management and audit responsibilities under SOX may not be efficiently or adequately met. AIS SUBSYSTEMS We devote separate chapters to an in-depth study of each AIS subsystem depicted in Figure 1-2. At this point, we briefly outline the role of each subsystem. Transaction Processing System The TPS is central to the overall function of the information system. It converts economic events into financial transactions, records financial transactions in the accounting records (journals and ledgers), and distributes essential financial information to operations personnel to support their daily operations. The TPS deals with business events that occur frequently. In a given day, a firm may process thousands of transactions. To deal efficiently with such volume, similar types of transactions are grouped into transaction cycles. The TPS consists of three transaction cycles: the revenue cycle, the expenditure cycle, and the conversion cycle. Each cycle captures and processes different types of financial transactions. Chapter 2 of this text provides an overview of transaction processing. Chapters 4, 5, 6, and 7 examine in detail the revenue, expenditure, and conversion cycles. General Ledger/Financial Reporting Systems The GLS and the FRS are two closely related subsystems. Because of their operational interde- pendency, however, they are generally viewed as a single integrated system—the GL/FRS. The bulk of the input to the GL portion of the system comes from transaction cycle subsystems. Sum- maries of transaction activity are processed by the GLS to update the general ledger control accounts. Other, less common and infrequent, events such as stock transactions, mergers, and law- suit settlements, for which there may be no formal processing cycle in place, enter the GLS through alternate sources. The FRS measures the status of financial resources and the changes in those resources and communicates this information to external users, This type of reporting is called nondiscretionary reporting because the organization has few or no choices in the information it provides. Much of this information consists of traditional financial statements, tax returns, and other reports demanded by law.  (Cla AN TRAP TEARS Gl The Information System: An Accountant’s Perspective 9 Management Reporting System Managers must respond rapidly to many day-to-day business problems as well as plan and control their operations. The MRS provides the internal financial information needed to manage a busi- ness. Typical reports produced by the MRS include budgets, variance reports, cost-volume-profit analyses, and reports using current (rather than historical) cost data. This type of reporting is called discretionary reporting because the organization can choose what information to report and how to present it. A GENERAL MODEL FOR AIS Figure 1-4 presents the general model for AIS. This is a general model because it applies to all AIS, regardless of their underlying technologies. The model depicts the relationship between the key ele- ments that constitute an AIS application: end users, data sources, data collection, data processing, database management, information generation, and feedback. Each of these is discussed next. End Users End users fall into two general groups: external and internal. External users include creditors, stockholders, potential investors, regulatory agencies, tax authorities, suppliers, and customers. Internal users include management at all levels of the organization as well as operations personnel. In contrast to their more structured external reporting responsibilities, organizations have a great deal of latitude when it comes to internal reporting, which is driven by what best gets the job done. Internal reporting is, however, characterized by frequent changes in the information needs of internal users. This volatility poses a significant challenge to system designers who must balance the information requests and needs of internal users against legal, economic, internal control, and security issues. Frequent changes in information requirements necessitate information system changes, which, in turn, expose systems to material errors and, as we shall see later in this text, the potential for fraud. FIGURE 1-4 GENERAL MopeEL FOR ACCOUNTING INFORMATION SYSTEMS The External Environment The Information System — Database Management External Data Information External Data Sources of Processing Generation End Users Collection Data Feedback Internal Internal Sources End Users of Data The Business Organization Feedback PAN A Overview of Accounting Information Systems 1-4, we DATA VERSUS INFORMATION. Before discussing the data sources portion of Figure distinction between the terms data and informatio n. Data are facts, need to make an important (edited, summarize d, or refined) and have no direct effect on which may or may not be processed a user’s actions. By contrast, informatio n causes the user to take an action that he or she otherwise but could not, or would not, have taken. Information is often defined simply as processed data, this definition is inadequate. Information is determined by the effect it has on the user, not by its physical form. For example, a purchasing agent receives a daily report listing raw material inven- tory items that are at low levels. This report causes the agent to place orders for more inventories. The facts in this report have information content for the purchasing agent. This same report 1n the hands of the personnel manager, however, is a mere collection of facts, or data, causing no action and having no information content. In other words, one person’s information is another person’s data. Thus, information is not just a set of processed facts arranged in a formal report. Information triggers users to take actions that support their day-to-day business tasks, resolve conflicts, and plan for the future. We should note that action does not necessarily mean a physical act. For instance, a purchasing agent who receives a report showing that inventory levels are adequate will respond by ordering nothing. The agent’s actionto do nothing is a conscious decision, triggered by information and different from doing nothing because of being uninformed. The distinction between data and information has pervasive implications for the study of information systems. If output from the information system fails to cause users to act, the system serves no purpose. Data Sources Data sources are financial transactions that enter the information system from either internal or external sources. External financial transactions are the most common source of data. These are economic exchanges with other business entities and individuals outside the firm. Examples are the sale of goods and services, the purchase of inventory, the receipt of cash, and the disbursement of cash (including payroll). Internal financial transactions involve the exchange or movement of resources within the organization. Examples are the movement of raw materials into work- in-process (WIP), the application of labor and overhead to WIP, the transfer of WIP into finished goods inventory, and the depreciation of plant and equipment. Data Collection Data collection is the first operational stage in the information system. The objective is to ensure that event data entering the system are valid, complete, and free from material errors. In many respects, this is the most important stage in the system. Should transaction errors pass through data collection undetected, the system may process the errors and generate erroneous and unreli- able output. This, in turn, could lead to incorrect actions and poor decisions by the users. Two rules govern the design of data collection procedures: relevance and efficiency. The informa- tion system should capture only relevant data. A fundamental task of the system designer is to deter- mine what is and what is not relevant. He or she does so by analyzing the user’s needs. Only data that ultimately contribute to information (as defined previously) are relevant. The data collection stage should be designed to filter irrelevant facts from the system. Efficient data collection procedures are designed to collect data only once. These data can then be made available to multiple users. Capturing the same data more than once overloads facilities and leads to data redundancy, which causes inconsistencies among the redundant elements and reduces overall system effectiveness. Data Processing Once collected, data usually require processing to produce information. Data processing tasks range from simple to complex. Examples are mathematical algorithms (such as linear programming models) used for production scheduling applications, statistical techniques for sales forecasting, and posting and summarizing procedures used for accounting applications..  CLAS Pat Raw The Information System: An Accountant’s Perspective FIGURE 1-5 THE Data HiERARCHY Attributes, Records, and Files Attributes of Accounts Receivable Customer Account Number (Key) Accounts Customer Name — Receivable Customer Address Record Current Balance of Account Customer Credit Limit All Accounts Receivable Records Accounts Receivable Accounts 1 ve File Receivable Record Database Management The organization’s database is its physical repository for financial and nonfinancial data. We use the term database in the generic sense. The term could apply to a filing cabinet or a computer disk. Regardless of the database’s physical form, business data are organized in a logical hierarchy. The levels in the data hierarchy—data attribute, record, and file—are illustrated in Figure 1-5. DATA ATTRIBUTE. The data attribute is the most elemental piece of potentially useful data in the database. An attribute is a logical and relevant characteristic of an entity about which the firm captures data. The attributes shown in Figure 1-5 are logical because they all relate to a common entity—accounts receivable (AR). Each attribute is also relevant because it contributes to the information content of the entire set of attributes. As proof of this, the absence of any single rele- vant attribute diminishes or destroys the information content of the set. The addition of irrelevant or illogical attributes would not enhance the information content of the set. RECORD. A record is a complete set of attributes for a single occurrence within an entity class. For example, a particular customer’s name, address, and account balance is one occurrence (or record) within the AR class. To find a particular record within the database, we must be able to identify it uniquely. Therefore, every record in the database must be unique in at least one attribute.' This unique identifier attribute is called the primary key. Because no natural attribute (such as customer name) can guarantee uniqueness, we typically assign artificial keys to records. The key for the AR records in Figure 1-5 is the customer account number. This is the only unique identifier in this record class. The other attributes possess values that may also exist in other records. For instance, multiple customers may have the same name, sales amounts, credit limits, and balances. Using any one of these as a key to find a specific record would not work effi- ciently. These nonunique attributes are, however, often used as secondary keys for categorizing 1 When we get into more advanced topics, we will see how a combination of nonunique attributes can be used as a unique identifier. RUN IR TE I Overview of Accounting Information Systems of customers with data. For example, the account balance attribute can be used to prepare a list balances greater than $10,000. all the AR FILE. A file (or table) is a complete set of records of an identical class. For example, records of the organization constitute the AR file. Similarly, files are constructed for other classes is the of records such as inventory, accounts payable, and payroll. The organization’s database entire collection of such files. DATABASE MANAGEMENT TASKS. Database management involves three fundamental tasks: storage, retrieval, and deletion. The storage task assigns keys to new records and stores them in their proper location in the database. Retrieval is the task of locating and extracting an existing record from the database for processing. After processing is complete, the storage task restores the updated record to its place in the database. Deletion is the task of permanently removing obsolete or redundant records from the database. Information Generation Information generation is the process of compiling, arranging, formatting, and presenting informa- tion to users. Information can be an operational document such as a sales order, a structured report, or a message on a computer screen. Regardless of physical form, useful information has the following characteristics: relevance, timeliness, accuracy, completeness, and summarization. RELEVANCE. The contents of a report or document must serve a purpose. This could be to sup- port a manager’s decision or a clerk’s task. We have established that only data relevant to a user’s action have information content. Therefore, the information system should present only relevant data in its reports. Reports containing irrelevancies waste resources and may be counterproductive to the user. Irrelevancies detract attention from the true message of the report and may result in incorrect decisions or actions. TIMELINESS. The age of information is a critical factor in determining its usefulness. Informa- tion must be no older than the time frame of the action it supports. For example, if a manager makes decisions daily to purchase inventory from a supplier based on an inventory status report, then the information in the report should be no more than a day old. ACCURACY. Information must be free from material errors. Materiality is, however, a difficult concept to quantify. It has no absolute value; it is a problem-specific concept. This means that, in some cases, information must be perfectly accurate. In other instances, the level of accuracy may be lower. A material error exists when the amount of inaccuracy in information causes the user to make poor decisions or to fail to make necessary decisions. We sometimes must sacrifice absolute accuracy to obtain timely information. Often, perfect information is not available within the user’s decision time frame. Therefore, in providing information, system designers seek a balance between information that is as accurate as possible, yet timely enough to be useful. COMPLETENESS. No piece of information essential to a decision or task should be missing. For example, a report should provide all necessary calculations and present its message clearly and unambiguously. SUMMARIZATION. Information should be aggregated in accordance with the user’s needs. Lower-level managers tend to need information that is highly detailed. As information flows upward through the organization to top management, it becomes more summarized. Feedback Feedback is a form of output that is sent back to the system as a source of data. Feedback may be internal or external and is used to initiate or alter a process. For example, an inventory status  CC Jel AIP IPE IR 1 The Information System: An Accountant’s Perspective report signals the inventory control clerk that items of inventory have fallen to, or below, their minimum allowable levels. Internal feedback from this information will initiate the inventory ordering process to replenish the inventories. Similarly, external feedback about the level of uncol- lected customer accounts can be used to adjust the organization’s credit-granting policies. Organizational Structure and AIS In later chapters, we see how the design and/or audit of AIS require an understanding of the functional segments and activities that constitute an organization’s structure. Physical AIS comprise technologies of various types and configurations as well as people and tasks from across the organization. Indeed, the so-called AIS actually involve diverse accounting and nonaccounting activities and personnel. For example, the sales processing system, which is a subsystem of the revenue cycle (refer to Figure 1-2), includes the following organization functions: sales, credit, inventory control, warehousing, shipping, billing, accounts receivable, general ledger, and data processing. Figure 1-6 depicts these and other typical business functions for a hypothetical manufacturing firm. The shaded functions in Figure 1-6 (those associated with processing sales orders) emphasize the entity-wide impact of AIS. FUNCTIONAL SEGMENTATION Segmentation by business function is a common method of organizing a business entity. Functional segments derive from the flow of resources through the firm. For example, assume a manufacturing firm that employs the following resources: materials, labor, financial capital, and information. Table 1-2 shows the relationship between these resources and the functional segments that manage them. The segments and the functions within them will vary among organizations, depending on their size and lines of business. A public water company, for example, does not need to market its prod- uct and probably will have little in the way of advertising or market research functions. Also, a service organization with no inventories to manage will not need an inventory control function. The remainder of this section outlines the functional areas for the hypothetical firm represented in Figure 1-6. Materials Management The objective of materials management is to plan and control the materials inventory of the com- pany. A manufacturing firm must have sufficient inventories on hand to meet its production needs and yet avoid excessive inventory levels. Every dollar invested in inventory is a dollar that is not earning a return. Furthermore, idle inventory can become obsolete, lost, or stolen. Ideally, a firm would coordinate inventory arrivals from suppliers such that they move directly into the produc- tion process. As a practical matter, however, most organizations maintain safety stocks to carry them through the lead time between placing the order for inventory and its arrival. We see from Figure 1-6 that materials management has three sub-functions: 1. Purchasing is responsible for ordering inventory from vendors when inventory levels fall to their reorder points. The nature of this task varies among organizations. In some cases, pur- chasing requires no more than sending a purchase order to a designated vendor. In other cases, this task involves soliciting bids from a number of competing vendors. The nature of the business and the type of inventory determine the extent of the purchasing function. 2. Receiving is the task of accepting the inventory previously ordered by purchasing. Receiving activities include counting and checking the physical condition of these items. This is an organization’s first, and perhaps only, opportunity to detect incomplete deliveries and dam- aged merchandise before they move into the production process. 3. Stores takes physical custody of the inventory received and releases these resources into the production process as needed.  14 aunola of TIVNOILONN4 SVAYW 4O V Wul4y FANN TT I sseuisng uoneziuebic sjeuayey| UONEWIO}U} uononpold Hujeayey\ uonnquisig J@UUOSIOq Hununosoy juowebeuel\y ABojouyoey Buninsoey UONOWOY Bursnoyaien\ AJO\USAU] ejeqg JOyJUOD Huiseyoind Huunjoejnueyy juawabeuel\ Hulsseco0ld Bulnjeoey yoddns Hulsienpy Huiddiys \SOD swa}shS Hununosoy juaWdo|jsAeq pue ae soueusluley\| yorresey Sal0]S eseqeyeq Overview of Accounting Information Systems s}unoooy uoledjsiulwpy Huljasunog jusWasINgsiq ajqeAed YIOMION sjunoosoy uoessiulUpYy ajqeniaoey pexi4 sjessyjelouas Je6pe7q  (Cla AN IP IE Ie ARY Gl The Information System: An Accountant's Perspective FUNCTIONS FROM RESOURCES Resource Functional Segment Materials Materials Management Production Marketing Distribution Labor Personnel Financial Capital ————___-____________ Finance Information Accounting Information Technology Production Production activities occur in the conversion cycle in which raw materials, labor, and plant assets are used to create finished products. The specific activities are determined by the nature of the products being manufactured. In general, they fall into two broad classes: (1) primary manufactur- ing activities and (2) production support activities. Primary manufacturing activities shape and assemble raw materials into finished products. Production support activities ensure that primary manufacturing activities operate efficiently and effectively. These include, but are not limited to, the following types of activities: Production planning involves scheduling the flow of materials, labor, and machinery to efficiently meet production needs. This requires information about the status of sales orders, raw materials inventory, finished goods inventory, and machine and labor availability. Quality control monitors the manufacturing process at various points to ensure that the finished products meet the firm’s quality standards. Effective quality control detects problems early to facili- tate corrective action. Failure to do so may result in excessive waste of materials and labor. Maintenance keeps the firm’s machinery and other manufacturing facilities in running order. The manufacturing process relies on its plant and equipment and cannot tolerate breakdowns during peak production periods. Therefore, the key to maintenance is prevention—the scheduled removal of equipment from operations for cleaning, servicing, and repairs. Many manufacturers have elaborate preventive maintenance programs. To plan and coordinate these activities, mainte- nance engineers need extensive information about the history of equipment usage and future scheduled production. Marketing The marketplace needs to know about, and have access to, a firm’s products. The marketing func- tion deals with the strategic problems of product promotion, advertising, and market research. On an operational level, marketing performs such daily activities as sales order entry. Distribution Distribution is the activity of getting the product to the customer after the sale. This is a critical step since much can go wrong before the customer takes possession of the product. Incorrect ship- ments, damaged merchandise, or excessive lags between taking and filling of orders can result in customer dissatisfaction and lost sales. Ultimately, success depends on filling orders accurately in the warehouse, packaging goods correctly, and shipping them quickly to the customer. IPN IK TE Overview of Accounting Information Systems Personnel Competent and reliable employees are a valuable resource to a business. The objective of the per- sonnel function is to effectively manage this resource. A well-developed personnel function includes recruiting, training, continuing education, counseling, evaluating, labor relations, and compensation administration. Finance The finance function manages the financial resources of the firm through banking and treasury activities, portfolio management, credit evaluation, cash disbursements, and cash receipts. Because of the cyclical nature of business, many firms swing between positions of excess funds and cash deficits. In response to these cash flow patterns, financial planners seek lucrative investments in stocks and other assets, and low-cost lines of credit from banks. The finance function also admin- isters the daily flow of cash in and out of the firm. THE ACCOUNTING FUNCTION Accounting manages the financial information resource of the firm. In this regard, it plays two important roles in transaction processing. First, accounting captures and records the financial effects of the economic events that constitute the firm’s transactions. These include events such as the movement of raw materials from the warehouse into production, shipments of the finished products to customers, cash flows into the firm and deposits in the bank, the acquisition of inven- tory, and the discharge of financial obligations. Second, accounting distributes transaction infor- mation to operations personnel to coordinate many of their key tasks. The following accounting functions contribute directly to business operations: inventory control, cost accounting, payroll, accounts payable, accounts receivable, billing, fixed asset accounting, and the general ledger. We deal with each of these specifically in later chapters. For the moment, however, we need to maintain a broad view of accounting to understand its functional role in the organization. The Value of Information The value of information to a user is determined by its reliability. We saw earlier that the purpose of information is to lead the user to a desired action. For this to happen, information must possess certain attributes—relevance, accuracy, completeness, summarization, and timeliness. When these attributes are consistently present, information has reliability and provides value to the user. Unre- liable information has no value. At best, it is a waste of resources: at worst, it can lead to dysfunc- tional decisions. Consider the following example: A marketing manager signed a contract with a customer to supply a large quantity of product by a certain deadline. He made this decision based on information about finished goods inventory levels. Because of faulty record keeping, however, the information was incorrect. The actual inventory levels of the product were insufficient to meet the order, and the necessary quantities could not be manu- factured by the deadline. Failure to comply with the terms of the contract resulted in litigation.. This poor sales decision was a result of flawed information. Effective decisions require informa- tion that has a high degree of reliability. Accounting Independence Information reliability rests heavily on the concept of accounting independe nce. Simply stated, accounting activities must be separate and independent of the functional areas that manage and main- tain custody of physical resources. For example, accounting monitors and records the movement of raw materials into production and the sale of finished goods to customers. Accountin g authorizes pur- chases of raw materials and the disbursement of cash payments to vendors and employees. Accounting supports these functions with information but does not participate in the physical activities.  Cla AIP INE IR Il The Information System: An Accountant’s Perspective INFORMATION TECHNOLOGY Figure 1-6 depicts four information technology (IT) functions: (1) data processing, (2) systems develop- ment and maintenance, (3) database administration, and (4) network administration. Although an organization may have many additional IT functions, these four are included in this discussion because they hold specific internal control concerns for management and auditors, which we will investigate in detail in later chapters. In the following sections, we outline the key features of each of them. Data Processing The data processing function brings to bear IT personnel, computer hardware, application pro- grams (software), and corporate data to support user information needs through transaction pro- cessing and information reporting. Data processing configurations vary among different types of business entities. At one end of a continuum of options is the centralized data processing model and at the other end is the distributed data processing model. Many organizations employ a com- bination of centralized and distributed processing. CENTRALIZED DATA PROCESSING. Under the centralized data processing model, all data processing is performed by one or more large computers housed in a common data center that serves users throughout the organization. Figure 1-7 illustrates the centralized approach. End users process transactions from terminals in their respective departments, which are connected to the central computer and database. Because the computing resources (IT personnel, hardware, software, and data) are centrally located and accessible by all authorized users, the centralized data processing configuration lends itself to intra-organization communication and data sharing between user departments. DISTRIBUTED DATA PROCESSING. Figure 1-8 depicts the distributed data processing (DDP) model, in which users process their transactions locally. Under this configuration each user seg- ment possesses the IT personnel, facilities, hardware, software, and data they need to support FIGURE 1-7 CENTRALIZED DATA PROCESSING MODEL Data User Departments Processing Center User Departments i a ' ' ' ' i Transactions 1 ' Transactions User #1 User #2 S18P1O alls sales teh MON J2ap1O 4 Jawo}sno 104 no CHAPTER ee yeuinor we1bOld asea|ey ine : Bulyig pue 4901S SdK}0N —— ayepdy YVv Buiddiys PIO alld OSs payos @910AU| 4 dis Burjoed $,JOLUO}SND OSPBSI9Y Y9OIS asea|ey JequINN yuNoSDy 4001S wesbold Jawoysng Aq eli4 Adoo upas19 yoS Sdl0N JEPIO SBjBS LOS Adog sawoysno Buiddiys oll Adoo (v) peilps upaig Buiddiys 0} puss pue JEpsOC Sa|eS 40g aedald SP005 ld aledald Pue 18p1O pue ‘eonon Buiddiys JOWOISND sAIa@09y uBis ‘spood pue $]U@UNDOQ a|INU0IeY aseajay JEpP1O 4201S Jawosng aseajay 400} Adoo PHD dijg Burjoe d 20l}0N — Buiddiys asnoyalem Huisse0oig eyeq sees Buiddiys Reto Sal4 IWILNaNdaS HLIM ONISSAD0Ug HoLvg =:OL“ agunold 182 PAR ta Transaction Cycles and Business Processes the following several times per day. The main elements of the computer operations are reviewed in paragraphs. DATA ENTRY The process begins with the arrival of shipping notices from the shipping department. These docu- ments are copies of the sales orders that contain accurate information about the number of units shipped and information about the carrier. The shipping notices are arranged in batches that the data entry clerk converts to digital media to produce a transaction file of sales orders. This trans- action file will actually contain many separate batches of sales orders. Batch control totals are cal- culated for each batch on the file.’ EDIT RUN A batch system is composed of a series of program runs. In this example, the edit program is the first run, which validates transactions by testing each record for the existence of clerical or logical errors. Typical tests include field checks, limit tests, range tests, and price-times-quantity exten- sions.” Any detected-errors are removed from the batch and copied to a separate error file. Later, these are corrected by an authorized person and resubmitted for processing with the next day's business. The edit program recalculates the batch control totals to reflect changes due to the removal of error records. The edited transaction file is then passed to the next run in the process. SORT RUN At this point, the sales order transaction file is in no useful sequence. Recall from the Chapter 2 Appendix that a transaction file must be sorted in the same sequence as the master file it is updat- ing. In this example, the first master file to be updated is the accounts receivable file, whose primary key is ACCOUNT NUMBER. The first sort run in this system therefore rearranges the sales order file in order of customer ACCOUNT NUMBER, which is a secondary key in the transaction file. AR UPDATE AND BILLING RUN Now that the transaction file is sorted in the correct sequence, the AR master file can be updated. Figure 4-20 illustrates this process with some sample records. The AR update program sequen- tially matches the ACCOUNT NUMBER key in the first sales order transaction record with the corresponding record in the AR subsidiary master file. The program then recalculates the AR CURRENT BALANCE stored in the master file record by adding to it the INVOICE AMOUNT in the transaction record. This recalculated value, along with the other data fields in the master record, is written to a new master file. This process is repeated for the next sales order record and continues until all the transaction records are processed. Any master file records for which there is no corresponding sales order record is copied from the original file to the new mas- ter file. Thus, the update procedure actually creates a new AR subsidiary master file that incorpo- rates all the changes to customer accounts affected by the transaction records as well as those records that were unaffected by transactions. Also, the process leaves the original AR subsidiary master file complete and unchanged. This automatic backup feature is an advantage of sequential file processing. As part of the update process, each successfully processed (no errors) sales transaction is added to the sales journal file. At the end of the run, all the transactions are summarized, and an entry is made to the journal voucher file to reflect total sales and total increases to AR. Finally, the run prepares customer invoices, which are mailed to the customers. | Batch controls are designed to manage the flow of large numbers of records through the system. They consist of sum- mary figures pertaining to the number of records in the batch, total dollar amount of the batch, and a hash total of a nonfinancial field. See Chapter 3 for a detailed discussion. 2 Chapter 3 provides a complete discussion of computer application controls.  183 XX/ZL/Zk The Revenue Cycle COSI OUEW “UIIIY 0002 BZ Se (eo) Sot foo) Ke) COR LOE COni— = _L xX/Z/éL 0002 O02 "Ul@g “ISL OSE TNE x/6/eL OOO 008 ‘ZEN “IS UBIH b xX/9L/ZL 0002 COZ) “UII "PH JO/ARY 9z xxX/G/ZL OOSL O00 ‘Weg UC AejoIeg OLS xX/El/éL OOSt 009 S ule SE fom fe xx/8/Zk 000k C009) AUD “AS WI €ZL ssalppy WAN LOOV QAP Be Ro 4A aed) yur])eouejeg JuewAeYHuijjig| jusuNg pag} jseq] all4 Jalseyy aiqealsoey JuNODOY MEN Arepuodas Aay Aq Aey payos ajiqjo Je]sey| uojoesuesy Arewid 0} 9ll4 S XX/Z L/L OSL “UNIV JOE BZ 8 xxX/Z/éL O000G OO0Z ‘Uj@g ‘ISL OSB I xxX/6/CL OOO 008 ‘ZEN “IS UBIH 7 8 xxX/9lL/éL O00¢ O01 “UNIV ‘PH J0[AeL 92 b xxX/G/ZL OOSL OOO! “ule 4G AejoIeg OLS L xY/El/eL OOS 009 'S UIE GE sefuey9 I xx/8/EL OOOL OSE MO “IS Wid EZt junowy ssolppy Buiddiys apog 80d ayeq SO|OAU| WNN wny Jaweg sepic eed uanu dius} | | poy [WWI]; e0uR|eq ®) | | | JuawAeYHurjjig} juaUND WIAD] seq] B|qeAIsDeY ayepdy -spjel4 ys JUNODOY jeuIBLO Ja]Sey| Oll4 a|l4 UOOesUeI] Sales JEPsO SUIGUO WOUd SIIVS SLNNODSW JTSVAISZDIY 4O ALvad7j 0C-V aunold 184 PART II Transaction Cycles and Business Processes SORT AND INVENTORY UPDATE RUNS The procedures for the second sort and inventory update runs are similar to those previously described. The sort program sorts the sales order transaction file on the secondary key—INVENTORY NUM- BER. The inventory update program reduces the QUANTITY-ON-HAND field in the affected inven- tory records by the QUANTITY SOLD field in each sales order record. A new inventory master file is also created in the process. Figure 4-21 illustrates the process with some sample data. In addition, the program compares values of the QUANTITY-ON-HAND and the REOR- DER POINT fields to identify inventory items that need to be replenished. This information is sent to the purchasing department. Finally, a journal voucher is prepared to reflect cost of goods sold and the reduction in inventory. GENERAL LEDGER UPDATE RUN Under the sequential file approach, the general ledger master file is not updated after each batch of transactions. To do so would result in the recreation of the entire general ledger every time a batch of transactions (e.g., sales orders, cash receipts, purchases, and cash disbursements) is pro- cessed. Firms using sequential files typically employ separate end-of-day procedures to update the GL accounts. This technique is depicted in Figure 4-19. At the end of the day, the general ledger run accesses the journal voucher file. This file contains journal vouchers reflecting all of the transactions processed by the organization that day. The journal vouchers are sorted by GL account number and posted to the general ledger in a single run, and a new general ledger is created. The end-of-day procedures will also generate a number of management reports. These may include sales summaries, inventory status reports, general ledger change reports, transaction list- ings, journal voucher listings, and budget and performance reports. Quality management reports play a key role in helping management monitor operations to ensure that controls are in place and functioning properly. Batch Processing Using Direct Access Files Figure 4-22 illustrates a batch sales order system that employs direct access files. As with the previous example, the system employs manual procedures in the sales, credit, warehouse, and shipping depart- ments. The main elements of its computers operations are reviewed in the following paragraphs. KEYSTROKE The process begins with the arrival of batches of shipping notices from the shipping department. The data entry clerk converts the hard-copy shipping notices to digital form to produce a transac- tion file of sales orders. This process takes place several times throughout the day, resulting in a transaction file that contains many separate batches of records. For each batch stored on the file, the system automatically calculates batch control totals. EDIT RUN The edit program first validates all transaction records in the batch by performi ng clerical and logi- cal tests on the data. Detected errors are removed from the batch and copied to a separate error file (not shown in Figure 4-22), which are later corrected and resubmitted for processing with the next day’s business. The edit program recalculates the batch control totals to reflect any changes due to the removal of error records. The edited sales order file is then passed to the file update run. FILE UPDATE RUN Because direct access files are used in this system, the transac tion file does not need to be sorted before the update process. Also, note that the update process does not recreate new master files Figure 4-23 illustrates the direct access update process using sample data. 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