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CORE CONCEPTS OF Accounting Information Systems Twelfth Edition Mark G. Simkin, Ph.D. Professor Department of Accounting and Information Systems University of Nevada Jacob M. Rose, Ph.D...
CORE CONCEPTS OF Accounting Information Systems Twelfth Edition Mark G. Simkin, Ph.D. Professor Department of Accounting and Information Systems University of Nevada Jacob M. Rose, Ph.D. Professor Department of Accounting and Finance University of New Hampshire Carolyn Strand Norman, Ph.D., CPA Professor Department of Accounting Virginia Commonwealth University JOHN WILEY & SONS, INC. VICE PRESIDENT & PUBLISHER George Hoffman SENIOR ACQUISITIONS EDITOR Michael McDonald PROJECT EDITOR Brian Kamins ASSOCIATE EDITOR Sarah Vernon SENIOR EDITORIAL ASSISTANT Jacqueline Kepping PRODUCTION MANAGER Dorothy Sinclair PRODUCTION EDITOR Erin Bascom MARKETING MANAGER Karolina Zarychta CREATIVE DIRECTOR Harry Nolan SENIOR DESIGNER Wendy Lai PRODUCTION MANAGEMENT SERVICES Laserwords Maine SENIOR ILLUSTRATION EDITOR Anna Melhorn PHOTO EDITOR Elle Wagner MEDIA EDITOR Greg Chaput COVER PHOTO Maciej Frolow/Brand X/Getty Images, Inc. 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These copies are licensed and may not be sold or transferred to a third party. Upon completion of the review period, please return the evaluation copy to Wiley. Return instructions and a free of charge return shipping label are available at www.wiley.com/go/returnlabel. If you have chosen to adopt this textbook for use in your course, please accept this book as your complimentary desk copy. Outside of the United States, please contact your local representative. Library of Congress Cataloging-in-Publication Data Simkin, Mark G. Core concepts of accounting information systems/Mark G. Simkin, Carolyn Strand Norman, Jake Rose.—12th ed. p. cm. Rev. ed. of: Core concepts of accounting information systems/Nancy A. Bagranoff, Mark G. Simkin, Carolyn Strand Norman. 11th ed. c2010. Includes index. ISBN 978-1-118-02230-6 (pbk.) 1. Accounting–Data processing. 2. Information storage and retrieval systems–Accounting. I. Norman, Carolyn Strand. II. Rose, Jake. III. Bagranoff, Nancy A. Core concepts of accounting information systems. IV. Title. HF5679.M62 2012 657.0285– dc23 2011029036 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 In memory of my father, Edward R. Simkin (Mark G. Simkin) Chase your big dreams! (Jacob M. Rose) Thank you to my students—you’re the best! (Carolyn S. Norman) ABOUT THE AUTHORS Mark G. Simkin received his A.B. degree from Brandeis University and his MBA and Ph.D. degrees from the Graduate School of Business at the University of California, Berkeley. Before assuming his present position of professor in the Department of Accounting and Information Systems, University of Nevada, Professor Simkin taught in the Department of Decision Sciences at the University of Hawaii. He has also taught at California State Uni- versity, Hayward, and the Japan America Institute of Decision Sciences, Honolulu; worked as a research analyst at the Institute of Business and Economic Research at the University of California, Berkeley; programmed computers at IBM’s Industrial Development—Finance Headquarters in White Plains, New York; and acted as a computer consultant to business companies in California, Hawaii, and Nevada. Dr. Simkin is the author of more than 100 articles that have been published in such journals as Decision Sciences, JASA, The Journal of Accountancy, Communications of the ACM, Interfaces, The Review of Business and Economic Research, Decision Sciences Journal of Innovative Education, Information Systems Control Journal, and the Journal of Bank Research. Jacob M. Rose received his B.B.A degree, M.S. degree in accounting and Ph.D. in accounting from Texas A&M University and he passed the CPA exam in the state of Texas. Dr. Rose holds the position of professor at the University of New Hampshire, where he is the director of the Master of Science in Accounting Program. He previously taught at Southern Illinois University, Montana State University, the University of Tennessee, Bryant University, and the University of Oklahoma, and he was an auditor with Deloitte and Touche, LLP. Professor Rose has been recognized as the top instructor in accounting at multiple universities, and he has developed several accounting systems courses at the graduate and undergraduate levels. He is also a prolific researcher, publishing in journals such as The Accounting Review; Accounting, Organizations and Society; Behavioral Research in Accounting; Journal of Information Systems; International Journal of Accounting Information Systems; Journal of Management Studies; and Accounting Horizons. Professor Rose has been recognized as the top business researcher at three universities, and he received the Notable Contribution to the Information Systems Literature Award, which is the highest research award given by the Information Systems Section of the American Accounting Association. Carolyn Strand Norman received her B.S. and M.S.I.A. degrees from Purdue University and her Ph.D. from Texas A&M University. Dr. Norman is a Certified Public Accountant (licensed in Virginia) and also a retired Lieutenant Colonel from the United States Air Force. At the Pentagon, she developed compensation and entitlements legislation, work- ing frequently with House and Senate staffers. Prior to assuming her current position, Dr. Norman taught at Seattle Pacific University where she co-authored the book, XBRL Essentials with Charles Hoffman, and was selected as Scholar of the Year for the School of Business and Economics. Dr. Norman has published more than 50 articles in journals such as The Accounting Review; Accounting, Organizations and Society; Behavioral Research in Accounting; Journal of Accounting and Public Policy; Journal of Information Sys- tems; Advances in Accounting Behavioral Research; Issues in Accounting Education; and Journal of Accounting Education. She is currently the Interim Chair of the Accounting Department at Virginia Commonwealth University. iv PREFACE Information technologies affect every aspect of accounting, and as technologies advance, so does our accounting profession! For example, accountants no longer spend much of their day footing ledgers and making hand calculations. Today, accountants use the many helpful functions in spreadsheet software and update or change calculations instantly. And increasingly, the Internet continues to change the way accountants work. Because most accounting systems are computerized, accountants must understand software and information systems to turn data into financial information and develop and evaluate internal controls. Business and auditing failures continue to force the profession to emphasize internal controls and to rethink the state of assurance services. As a result, the subject of accounting information systems (AIS) continues to be a vital component of the accounting profession. The purpose of this book is to help students understand basic AIS concepts. Exactly what comprises these AIS concepts is subject to some interpretation, and is certainly changing over time, but most accounting professionals believe that it is the knowledge that accountants need for understanding and using information technologies and for knowing how an accounting information system gathers and transforms data into useful decision- making information. In this edition of our textbook, we include the core concepts of Accounting Information Systems indicated by chapter in the table below. The book is flexible enough that instructors may choose to cover the chapters in any order. ACCOUNTING INFORMATION SYSTEMS COURSE CONTENT AREA COVERAGE AIS Applications 7, 8, 15 Auditing 12 Database Concepts 3, 4, 5 Internal Control 9, 10, 11 Management of Information Systems 1, 2, 13 Management Use of Information 1, 6, 7, 8, 14, 15 Systems Development Work 13 Technology of Information Systems All chapters Use of Systems Technology All chapters About This Book The content of AIS courses continues to vary widely from school to school. Some schools use their AIS courses to teach accounting students how to use computers. In other colleges and universities, the course focuses on business processes and data modeling. Yet other courses emphasize transaction processing and accounting as a communication system and have little to do with the technical aspects of how underlying accounting data are processed or stored. Given the variety of objectives for an AIS course and the different ways that instructors teach it, we developed a textbook that attempts to cover the core concepts of AIS. In writing the text, we assumed that students have completed basic courses in financial and managerial accounting and have a basic knowledge of computer hardware and software concepts. The text is designed for a one-semester course in AIS and may be used at the community college, baccalaureate, or graduate level. v vi Preface Our hope is that individual instructors will use this book as a foundation for an AIS course, building around it to meet their individual course objectives. Thus, we expect that many instructors will supplement this textbook with other books, cases, software, or readings. The arrangement of the chapters permits flexibility in the instructor’s subject matter coverage. Certain chapters may be omitted if students have covered specific topics in prior courses. Part One introduces students to the subject of AIS. In the first chapter, we lay the basic foundation for the remainder of the text and set the stage for students to think about the pervasiveness of technology that is common to organizations and the impact technology has on the accounting profession. This chapter also includes a section on careers in AIS that is designed to introduce students to the career paths that combine accounting with the study of information systems. Students taking the AIS course may or may not have had an earlier course in information technology. Chapter 2 allows those who did not have such a course to learn about the latest technologies and emphasizes their use in accounting. For students who have had earlier courses in computers and/or information systems, this chapter serves as a review but might also contain new technologies that students have not studied in other courses. Part Two discusses data modeling and databases. Chapter 3 begins our coverage by discussing database concepts in general, describing how to design database tables and relationships, and discussing how databases promote efficient storage of the data needed to support business decisions. This chapter also responds to increasing instructor interest in teaching the REA approach to data modeling. Chapter 4 describes how to use the latest version of Microsoft Access to create databases and extract data from databases. Chapter 5 continues the discussion of how to use Microsoft Access to develop database forms and reports. Chapters 4 and 5 are more ‘‘how to’’ than the other chapters in the book, and they allow the instructor to guide students with hands-on experience in using software to implement the database concepts they have learned. Part Three begins with Chapter 6 and a discussion of systems documentation, a matter of critical importance to the success of an AIS and also to an understanding of an information system. This chapter describes the various tools that accountants can use to document an AIS for their own and others’ understanding of information flows. Business processes and software solutions for improving those processes are gaining in importance in today’s businesses. Chapters 7 and 8 discuss several core business processes and highlight a number of Business Process Management (BPM) solutions that are currently available in the marketplace. Instructors who focus on transaction cycles in their AIS courses may choose to use supplemental pedagogical tools, such as software and practice sets, to cover this material in more depth. Part Four is an overview of internal controls and the potential consequences of missing, weak, or poorly developed controls. Although the subject of internal control appears repeatedly throughout the book, we examine this subject in depth in Chapters 9 and 10. These two chapters introduce students to internal controls that are necessary at each level of the organization. Chapter 11 focuses on computer crime, ethics, and privacy to help students understand the need for internal controls. The last section of the book examines special topics in AIS. Chapter 12 introduces the topic of auditing in an IT environment. Information technology auditing is an increasingly important field and represents a great career opportunity for students who understand both accounting and IT. Recognizing that some students in AIS courses may have completed courses in management information systems (MIS) and thus are already familiar with systems development topics, the emphasis in Chapter 13 is on the accountant’s role in Preface vii designing, developing, implementing, and maintaining a system. Although we integrated Internet technology throughout this book, its influence on accounting information systems is so great that we devoted a special chapter to it. Chapter 14 provides a basic overview of Internet concepts, discusses financial reporting on the Internet including an expanded section on XBRL, explores the accounting components of e-business, and covers the issues of privacy and security. Finally, in Chapter 15, we discuss accounting and enterprise software, and the chapter provides advice related to AIS selection. Special Features This edition of our book uses a large number of special features to enhance the coverage of chapter material as well as to help students understand chapter concepts. Thus, each chapter begins with an outline and a list of learning objectives that emphasize the important subject matter of the chapter. This edition of the book also includes many new real-world Cases-in-Point, which are woven into the text material and illustrate a particular concept or procedure. Each chapter also includes a more detailed real-world case as an end-of-chapter AlS-at-Work feature. Each chapter ends with a summary and a list of key terms. To help students understand the material in each chapter, this edition also includes multiple-choice questions for self- review with answers and three types of end-of-chapter exercises: discussion questions, problems, and cases. This wide variety of review material enables students to examine many different aspects of each chapter’s subject matter and also enables instructors to vary the exercises they use each semester. The end-of-chapter materials also include references and other resources that allow interested students to explore the chapter material in greater depth. In addition, instructors may wish to assign one or a number of articles listed in each chapter reference section to supplement chapter discussions. These articles are also an important resource for instructors to encourage students to begin reading professional journals. We include articles from Strategic Finance, The Journal of Accountancy, and The Internal Auditor, which represent the journals of three important accounting professional organizations. There are two major supplements to this textbook. One is an instructor’s manual containing suggested answers to the end-of-chapter discussion questions, problems, and cases. There is also a test bank of true-false, multiple-choice, and matching-type questions. The test bank includes short-answer problems and fill-in-the-blank questions so that instructors have a wide variety of choices. What’s New in the Twelfth Edition This edition of our book includes a number of changes from prior editions. These include A new coauthor with an international reputation in the AIS community! More Test Yourself multiple-choice questions at the end of each chapter to help students assess their understanding of the chapter material. New color—both inside and on the cover! This edition uses green to highlight information and to make the book more interesting to read. All new database chapters. Material related to the design of databases and database theory is all presented in the first database chapter, rather than spread throughout three viii Preface chapters. The following two chapters describe how to apply the theoretical concepts using Access 2010. The new approach allows instructors to easily select a desired emphasis: theory, application, or both. New database diagramming methods simplify the design process for students. Expanded coverage of topics that are increasingly important to accounting systems, including cloud computing, data mining, sustainability accounting, forensic accounting COBIT version 5, COSO’s 2010 Report on Enterprise Risk Management, enterprise controls, and internal auditing of IT. The discussion of internal controls in Chapter 10 and auditing of IT in Chapter 12 are reorganized to reflect new PCAOB standards. An expanded section in Chapter 1 on career paths for accountants interested in forensic accounting. Many new Case-in-Points that identify examples of the discussion in the textbook. These examples illustrate the topic to give students a better grasp of the material. Chapter reorganization, with database chapters moved closer to the front, as requested by our adopters. Instructors still have the flexibility to integrate the database concepts and database development anywhere in their course. An updated glossary of AIS terms at the end of the book. New AIS at Work features at the end of many chapters to help students better understand the impact of systems in a wide variety of contexts. A number of new problems and cases at the end of chapters so that instructors have more choices of comprehensive assignments for students. A new section that includes links to videos related to the concepts presented in each chapter. ACKNOWLEDGMENTS We wish to thank the many people who helped us during the writing, editing, and produc- tion of our textbook. Our families and friends are first on our list of acknowledgments. We are grateful to them for their patience and understanding as we were writing this book. Next, we thank those instructors who read earlier drafts of this edition of our textbook and provided suggestions to improve the final version. In addition, we are indebted to the many adopters of our book who frequently provide us with feedback. We sincerely appreciate Paula Funkhouser who helped us with our supplementary materials on this and several previous editions. Finally, we thank all of our many students who have given us feedback when we’ve used the book. We do listen! Mark G. Simkin Jacob M. Rose Carolyn S. Norman ix CONTENTS PART ONE AN INTRODUCTION TO ACCOUNTING INFORMATION SYSTEMS/ 1 CHAPTER 1 Accounting Information Systems and the Accountant/ 3 Introduction/ 4 What Are Accounting Information Systems?/ 4 What’s New in Accounting Information Systems?/ 9 Accounting and IT/ 14 Careers in Accounting Information Systems/ 21 CHAPTER 2 Information Technology and AISs/ 33 Introduction/ 34 The Importance of Information Technology to Accountants/ 34 Input, Processing, and Output Devices/ 36 Secondary Storage Devices/ 46 Data Communications and Networks/ 50 Computer Software/ 57 PART TWO DATABASES/ 73 CHAPTER 3 Data Modeling/ 75 Introduction/ 76 An Overview of Databases/ 76 Steps in Developing a Database Using the Resources, Events, and Agents Model/ 83 Normalization/ 91 CHAPTER 4 Organizing and Manipulating the Data in Databases/ 103 Introduction/ 104 Creating Database Tables in Microsoft Access/ 104 Entering Data in Database Tables/ 111 Extracting Data from Databases: Data Manipulation Languages/ 116 Recent Database Advances and Data Warehouses/ 123 CHAPTER 5 Database Forms and Reports/ 139 Introduction/ 140 Forms/ 140 Reports/ 147 PART THREE DOCUMENTING BUSINESS PROCESSES/ 165 CHAPTER 6 Documenting Accounting Information Systems/ 167 Introduction/ 168 Why Documentation Is Important/ 168 Primary Documentation Methods/ 171 Other Documentation Tools/ 186 End-User Computing and Documentation/ 191 CHAPTER 7 Accounting Information Systems and Business Processes: Part I/ 207 Introduction/ 208 Business Process Fundamentals/ 208 x Contents xi Collecting and Reporting Accounting Information/ 210 The Sales Process/ 215 The Purchasing Process/ 220 Current Trends in Business Processes/ 227 CHAPTER 8 Accounting Information Systems and Business Processes: Part II/ 239 Introduction/ 240 The Resource Management Process/ 240 The Production Process/ 246 The Financing Process/ 252 Business Processes in Special Industries/ 256 Business Process Reengineering/ 260 PART FOUR INTERNAL CONTROL SYSTEMS AND COMPUTER CRIME, ETHICS, AND PRIVACY/ 271 CHAPTER 9 Introduction to Internal Control Systems/ 273 Introduction/ 274 1992 COSO Report/ 276 Updates on Risk Assessment/ 278 Examples of Control Activities/ 281 Update on Monitoring/ 289 2011 COBIT, Version 5/ 290 Types of Controls/ 292 Evaluating Controls/ 293 CHAPTER 10 Computer Controls for Organizations and Accounting Information Systems/ 307 Introduction/ 308 Enterprise Level Controls/ 308 General Controls for Information Technology/ 312 Application Controls for Transaction Processing/ 324 CHAPTER 11 Computer Crime, Fraud, Ethics, and Privacy/ 341 Introduction/ 342 Computer Crime, Abuse, and Fraud/ 342 Three Examples of Computer Crimes/ 348 Preventing Computer Crime and Fraud/ 354 Ethical Issues, Privacy, and Identity Theft/ 361 PART FIVE SPECIAL TOPICS IN ACCOUNTING INFORMATION SYSTEMS/ 377 CHAPTER 12 Information Technology Auditing/ 379 Introduction/ 380 The Audit Function/ 380 The Information Technology Auditor’s Toolkit/ 386 Auditing Computerized Accounting Information Systems/ 389 Information Technology Auditing Today/ 396 CHAPTER 13 Developing and Implementing Effective Accounting Information Systems/ 409 Introduction/ 410 The Systems Development Life Cycle/ 410 xii Contents Systems Planning/ 412 Systems Analysis/ 414 Detailed Systems Design/ 419 Implementation, Follow-Up, and Maintenance/ 428 CHAPTER 14 Accounting on the Internet/ 447 Introduction/ 448 The Internet and World Wide Web/ 448 XBRL—Financial Reporting on the Internet/ 451 Electronic Business/ 455 Privacy and Security on the Internet/ 461 CHAPTER 15 Accounting and Enterprise Software/ 481 Introduction/ 482 Integrated Accounting Software/ 482 Enterprise-Wide Information Systems/ 486 Selecting a Software Package/ 496 Glossary/ 509 Index/ 521 PART ONE AN INTRODUCTION TO ACCOUNTING INFORMATION SYSTEMS CHAPTER 1 Accounting Information Systems and the Accountant CHAPTER 2 Information Technology and AISs Part One of this book introduces the subject of accounting information systems. It defines accounting’s principal goal, which is to communicate relevant information to individuals and organizations, and describes the strong influence of information technology on this communication process. Chapter 1 defines accounting information system and then discusses some current events that impact accountants and the profession. This chapter also examines the impact of information technology on financial accounting, managerial accounting, auditing, and taxation. Finally, Chapter 1 describes a number of career opportunities for accounting majors who also are proficient in AISs. Chapter 2 provides an overview of information technology that is relevant to accounting professionals. It begins by identifying six reasons that make information technology very important to accountants, and then discusses the current American Institute of Certified Public Accountants survey of the top 10 information systems technologies. Of course, the focus of this chapter is on modern technology and its impact on AISs. Therefore, it discusses computer input devices, central processing units, secondary storage devices, and output devices in detail. Because communication links are so important to AISs, this chapter also examines various communication and network arrangements, including client/server computer and wireless technology. The chapter concludes with descriptions of various types of computer software. 1 Chapter 1 Accounting Information Systems and the Accountant INTRODUCTION DISCUSSION QUESTIONS WHAT ARE ACCOUNTING INFORMATION PROBLEMS SYSTEMS? CASE ANALYSES Accounting Information Systems—A Definition The Annual Report Accounting Information Systems and Their Role Performance Management Company in Organizations The CPA Firm WHAT’S NEW IN ACCOUNTING INFORMATION SYSTEMS? READINGS AND OTHER RESOURCES Cloud Computing—Impact for Accountants ANSWERS TO TEST YOURSELF Sustainability Reporting Suspicious Activity Reporting Forensic Accounting, Governmental Accountants, After reading this chapter, you will: and Terrorism 1. Be able to distinguish between such terms as ‘‘systems,’’ ‘‘information systems,’’ ‘‘informa- Corporate Scandals and Accounting tion technology,’’ and ‘‘accounting information ACCOUNTING AND IT systems.’’ Financial Accounting 2. Learn how information technology (IT) influ- Managerial Accounting ences accounting systems. Auditing 3. Be familiar with suspicious activity reporting. Taxation 4. Understand how financial reporting is changing with advances in IT, such as XBRL. CAREERS IN ACCOUNTING INFORMATION 5. Appreciate how IT allows management accoun- SYSTEMS tants to use business intelligence to create dash- Traditional Accounting Career Opportunities boards and scorecards. Systems Consulting 6. Know why auditors provide a variety of assur- Certified Fraud Examiner ance services. Information Technology Auditing and Security 7. Be more aware of what is new in the area of accounting information systems. AIS AT WORK—CONSULTING WORK FOR CPAS 8. Be familiar with career opportunities that com- SUMMARY bine accounting and IT knowledge and skills. KEY TERMS YOU SHOULD KNOW TEST YOURSELF 3 4 PART ONE / An Introduction to Accounting Information Systems Cloud computing.... It’s about reallocating the IT budget from maintenance—such as keeping servers running, performing upgrades, and making backups—to actually improving business processes and delivering innovation to the finance organization. Gill, R. 2011. Why cloud computing matters to finance. Strategic Finance 92(7): 43–47. INTRODUCTION The study of accounting information systems (AISs) is, in large part, the study of the application of information technology (IT) to accounting systems. This chapter describes the ways that IT affects financial accounting, managerial accounting, auditing, and taxation. We begin by answering the question ‘‘what are accounting information systems’’ and then look at some new developments in the field. Following this, we will examine some traditional roles of AISs in organizations. Why should you study AISs? There are many reasons, which we will review briefly in this chapter, but one of the most important is the special career opportunities that will enable you to combine your study of accounting subjects with your interest in computer systems. In today’s job market, accounting employers expect new hires to be computer literate. In addition, a large number of specialized and highly compensated employment opportunities are only available to those students who possess an integrated understanding of accounting and IT and can bring that understanding to bear on complicated business decisions. The last part of this chapter describes a number of special career opportunities for those with an interest in AISs. WHAT ARE ACCOUNTING INFORMATION SYSTEMS? What do the following have in common: (1) a shoebox filled with a lawyer’s expense receipts, (2) the monthly payroll spreadsheet in the computer of an auto-repair shop, (3) the Peachtree accounting system for a small chain of dry cleaning stores, and (4) the enterprise resource planning (ERP) system of a large manufacturer? The answer is that they are all examples of AISs. How can such a wide range of accounting applications each qualify as an AIS? The answer is that this is the essence of what AISs are—collections of raw and stored data (that together typically serve as inputs), processing methods (usually called ‘‘procedures’’), and information (outputs) that serve useful accounting purposes. Do such systems have to be computerized? The first example—the shoebox—suggests that they do not. Can they be complicated? The last example—an ERP system—illustrates one that is. Accounting Information Systems—A Definition Accounting information systems (AISs) stand at the crossroads of two disciplines: account- ing and information systems. Thus, the study of AISs is often viewed as the study of computerized accounting systems. But because we cannot define an AIS by its size, it is better to define it by what it does. This latter approach leads us to the following definition that we will use as a model in this book: CHAPTER 1 / Accounting Information Systems and the Accountant 5 Definition: An accounting information system is a collection of data and pro- cessing procedures that creates needed information for its users. Let us examine in greater detail what this definition really means. For our discussion, we’ll examine each of the words in the term ‘‘accounting information systems’’ separately. Accounting. You probably have a pretty good understanding of accounting subjects because you have already taken one or more courses in the area. Thus, you know that the accounting field includes financial accounting, managerial accounting, and taxation. AISs are used in all these areas—for example, to perform tasks in such areas as payroll, accounts receivable, accounts payable, inventory, and budgeting. In addition, AISs help accountants to maintain general ledger information, create spreadsheets for strategic planning, and distribute financial reports. Indeed, it is difficult to think of an accounting task that is not integrated, in some way, with an AIS. The challenge for accountants is to determine how best to provide the information required to support business and government processes. For example, in making a decision to buy office equipment, an office manager may require information about the sources of such equipment, the costs of alternate choices, and the purchasing terms for each choice. Where can the manager obtain this information? That’s the job of the AIS. AISs don’t just support accounting and finance business processes. They often cre- ate information that is useful to nonaccountants—for example, individuals working in marketing, production, or human relations. Figure 1-1 provides some examples. For this information to be effective, the individuals working in these subsystems must help the developers of an AIS identify what information they need for their planning, decision making, and control functions. These examples illustrate why an AIS course is useful not only for accounting majors but also for many nonaccounting majors. Information (versus Data). Although the terms data and information are often used interchangeably, it is useful to distinguish between them. Data (the plural of datum) are raw facts about events that have little organization or meaning—for example, a set of raw scores on a class examination. To be useful or meaningful, most data must be processed into useful information—for example, by sorting, manipulating, aggregating, or classifying them. An example might be computing of the class average from the raw scores of a class examination. Application Examples of AIS Information Supply chain Demand trends, inventory levels and warehouse management, supplier rela- management tionship management. Finance Cash and asset management, multicompany and multicurrency management, credit card transaction summaries. Marketing Sales management, sales forecasts and summaries, customer relationship management. Human resources Workforce planning tools and employee management, benefits management, payroll summaries and management. Production Inventory summaries, product cost analysis, materials requirement planning. FIGURE 1-1 Examples of useful information an AIS can generate for various business functions. 6 PART ONE / An Introduction to Accounting Information Systems Do raw data have to be processed in order to be meaningful? The answer is ‘‘not at all.’’ Imagine, for example, that you take a test in a class. Which is more important to you—the average score for the class as a whole (a processed value) or your score (a raw data value)? Similarly, suppose you own shares of stock in a particular company. Which of these values would be least important to you: (1) the average price of a stock that was traded during a given day (a processed value), (2) the price you paid for the shares of stock (an unprocessed value), or (3) the last price trade of the day (another unprocessed value)? Raw data are also important because they mark the starting point of an audit trail— that is, the path that data follow as they flow through an AIS. In a payroll system, for example, an input clerk enters the data for a new employee and the AIS keeps track of the wages due that person each pay period. An auditor can verify the existence of employees and whether each employee received the correct amount of money. Case-in-Point 1.1 A former payroll manager at the Brooklyn Museum pleaded guilty to embezzling $620,000 by writing paychecks to ‘‘ghost employees.’’ Dwight Newton, 40, admitted committing wire fraud by adding workers to the payroll who did not exist and then wiring their wages directly into a joint bank account that he shared with his wife. Under a plea agreement, Newton must repay the museum the stolen funds. He was ordered to forfeit $77,000 immediately, sell his Barbados timeshare, and liquidate his pension with the museum.1 Despite the potential usefulness of some unprocessed data, most end users need financial totals, summary statistics, or exception values—that is, processed data—for decision-making purposes. Figure 1-2 illustrates a model for this—a three stage process in which (1) raw and/or stored data serve as the primary inputs, (2) processing tasks process the data, and (3) meaningful information is the primary output. Modern AISs, of course, harness IT to perform the necessary tasks in each step of the process. For example, a catalog retailer might use some Web pages on the Internet to gather customer purchase data, then use central file servers and disk storage to process and store the purchase transactions, and finally employ other Web pages and printed outputs to confirm and distribute information about the order to the appropriate parties. Although computers are wonderfully efficient and useful tools, they also create prob- lems. One is their ability to output vast amounts of information quickly. Too much information, and especially too much trivial information, can overwhelm its users, possibly causing relevant information to be lost or overlooked. This situation is known as informa- tion overload. It is up to the accounting profession to determine the nature and timing of the outputs created and distributed by an AIS to its end users. Another problem with computerized data processing is that computers do not auto- matically catch the simple input errors that humans do. For example, if you were performing payroll processing, you would probably know that a value of ‘‘−40’’ hours Inputs Processes Outputs Data/Information from Sort, Organize, Information for Internal/External Calculate Internal/External Sources Decision Makers FIGURE 1-2 An information system’s components. Data or information is input, processed, and output as information for planning, decision-making, and control purposes. 1 http://www.payroll-fraud.com/rc009.html CHAPTER 1 / Accounting Information Systems and the Accountant 7 for the number of hours worked was probably a mistake—the value should be ‘‘40.’’ A computer can be programmed to look for (and reject) bad input, but it is difficult to anticipate all possible problems. Yet a third problem created by computers is that they make audit trails more difficult to follow. This is because the path that data follow through computerized systems is electronic, not recorded on paper. However, a well-designed AIS can still document its audit trail with listings of transactions and account balances both before and after the transactions update the accounts. A major focus of this book is on developing effective internal control systems for companies, of which audit trails are important elements. Chapters 9, 10, and 12 discuss these topics in detail. In addition to collecting and distributing large amounts of data and information, modern AISs must also organize and store data for future uses. In a payroll application, for example, the system must maintain running totals for the earnings, tax withholdings, and retirement contributions of each employee in order to prepare end-of-year tax forms. These data organization and storage tasks are major challenges, and one of the reasons why this book contains three chapters on the subject (see Chapters 3, 4, and 5). Besides deciding what data to store, businesses must also determine the best way to integrate the stored data for end users. An older approach to this problem was to maintain independently the data for each of its traditional organization functions—for example, finance, marketing, human resources, and production. A problem with this approach is that, even if all the applications are maintained internally by the same IT department, there will be separate data-gathering and reporting responsibilities within each subsystem, and each application may store its data independently of the others. This often leads to a duplication of data-collecting and processing efforts, as well as conflicting data values when specific information (e.g., a customer’s address) is changed in one application but not another. Organizations today recognize the need to integrate the data associated with their functions into large, seamless data warehouses. This integration allows internal managers and possibly external parties to obtain the information needed for planning, decision making, and control, whether or not that information is for marketing, accounting, or some other functional area in the organization. To accomplish this task, many companies are now using large (and expensive) enterprise resource planning (ERP) system software packages to integrate their information subsystems into one application. An example of such a software product is SAP ERP, which combines accounting, manufacturing, and human resource subsystems into an enterprise-wide information system—that is, a system that focuses on the business processes of the organization as a whole. We discuss these systems in more depth in Chapter 15. SAP, SAS Institute, IBM, and Oracle have recognized the need for integrated information and therefore developed business intelligence software to meet this need. The latest innovation is predictive analytics, which these software developers are adding into their main software suites. Predictive analytics includes a variety of methodologies that managers might use to analyze current and past data to help predict future events. In March 2010, IBM opened a predictive analytics lab in China, which is the latest in an estimated $12-billion commitment to build out IBM’s analytics portfolio.2 Case-in-Point 1.2 Accountants and other managers are using predictive analytics, a tech- nique that takes advantage of data stored in data warehouses, to create systems that allow them to use their data to improve performance. FedEx uses these tools to determine how customers will react to proposed price changes or changes in service. The police force in 2 http://itmanagement.earthweb.com/features/article.php/3872536/Business-Intelligence-Software-and- Predictive-Analytics.html 8 PART ONE / An Introduction to Accounting Information Systems Richmond, Virginia, uses predictive analysis tools and a database of police calls and crime incident data to predict where and when crimes are most likely. Their system even includes information about weather and local events.3 Systems. Within the accounting profession, the term ‘‘systems’’ usually refers to ‘‘com- puter systems.’’ As you probably know, IT advances are changing the way we do just about everything. Just a few years ago, the authors never imagined that people could someday purchase a book from a ‘‘virtual bookstore’’ on the Internet using a wireless laptop, while sipping on a latte in a Starbucks. The explosion in electronic connectivity and commerce is just one of the many ways that IT influences how people now access information or how firms conduct business. Today, IT is a vital part of what accountants must know to be employable. Returning to our definition, you probably noticed that we did not use the term ‘‘computer,’’ although we did use the term ‘‘processing procedures.’’ You already know the reason for this—not all AISs are computerized, or even need to be. But most of the ones in businesses today are automated ones and thus the term ‘‘processing procedures’’ could be replaced by the term ‘‘computerized processing’’ for most modern AISs. In summary, it is convenient to conceptualize an AIS as a set of components that collect accounting data, store it for future uses, and process it for end users. This abstract model of data inputs, storage, processing, and outputs applies to almost all the traditional accounting cycles with which you are familiar—for example, the payroll, revenue, and expenditure cycles—and is thus a useful way of conceptualizing an AIS. Again, we stress that many of the ‘‘end users’’ of the information of an AIS are not accountants, but include customers, investors, suppliers, financial analysts, and government agencies. Accounting Information Systems and Their Role in Organizations Information technology (IT) refers to the hardware, software, and related system compo- nents that organizations use to create computerized information systems. IT has been a major force in our current society and now influences our lives in many personal ways—for example, when we use digital cameras to take pictures, access the Internet to make a purchase or learn about something, or e-mail friends and family. It is perhaps less clear that computer technology has also had profound influences on commerce. In this information age, for example, fewer workers actually make products while more of them produce, analyze, manipulate, and distribute information about business activities. These individuals are often called knowledge workers. Companies find that their success or failure often depends upon the uses or misuses of the information that knowledge workers manage. Case-in-Point 1.3 According to a 2010 report from InfoTrends, mobile knowledge workers make up more than 60% of the total workforce in Brazil, Germany, India, and Japan. This number is even higher in the United States—over 70% of the total workforce. Current projections suggest that these numbers are expected to grow through 2014.4 The information age has important implications for accounting because that is what accountants are—knowledge workers. In fact, accountants have always been in the ‘‘infor- mation business’’ because their role has been, in part, to communicate accurate and relevant financial information to parties interested in how their organizations are perform- ing. The information age also includes the increasing importance and growth of e-business, 3 Whiting, R. 2006. Predict the future—or try, anyway. Information Week (May): 38–43. 4 http://www.infotrends.com/public/Content/Press/2011/01.20.2011a.html CHAPTER 1 / Accounting Information Systems and the Accountant 9 conducting business over the Internet or dedicated proprietary networks and e-commerce (a subset of e-business) which refers mostly to buying and selling on the Internet. In many ways, accounting is itself an information system—that is, a communicative process that collects, stores, processes, and distributes information to those who need it. For instance, corporate accountants develop financial statements for external parties and create other reports (such as accounts receivable aging analyses) for internal managers. But users of accounting information sometimes criticize AISs for only capturing and reporting financial transactions. They claim that financial statements often ignore some of the most important activities that influence business entities. For example, the financial reports of a professional basketball team would not include information about hiring a new star because this would not result in journal entries in the franchise’s double-entry accounting system. Today, however, AISs are concerned with nonfinancial as well as financial data and information. Thus, our definition of an AIS as an enterprise-wide system views accounting as an organization’s primary producer and distributor of many different types of information. The definition also considers the AIS as process focused. This matches the contemporary perspective that accounting systems are not only financial systems. WHAT’S NEW IN ACCOUNTING INFORMATION SYSTEMS? The last few years have witnessed some of the most startling changes in the uses and applications of AISs, causing us to reassess our understanding and use of accounting data. Below are a few examples. Cloud Computing—Impact for Accountants In Chapter 2 we identify the basics of cloud computing, but in this section we want to discuss why this technology is important to accountants and then describe some of the current issues surrounding cloud computing as it relates to accounting professionals. According to Ron Gill, cloud computing is a way of using business applications over the Internet—such as the way you use the Internet for your bank transactions. Think of cloud computing as a way to increase IT capacity or add capabilities without investing in new infrastructure, training new people, or licensing new software. Mostly, we’re talking about a subscription-based or pay-per-use service that makes IT’s existing capabilities scalable whenever the need exists. Estimates suggest that the fast-growing cloud computing industry will reach $42 billion by 2012.5 Cloud computing resources may be categorized as data storage, infrastructure and platform, or application software (i.e., business applications such as purchases, HR, sales, etc.). If a firm would like to take advantage of cloud computing, it would most likely need to subscribe to all three of these categories from the service provider. For example, business applications depend on company data that is stored in the database, and data storage depends on the appropriate infrastructure.6 Experts identify a number of important benefits of using the cloud, as depicted in Figure 1-3. One is the ability to only pay for the applications that you use. Of course, 5 Rashty, J. and J. O’Shaughnessy. 2010. Revenue recognition for cloud-based computing arrangements. The CPA Journal 80(11): 32–35. 6 Du, H. and Y. Cong. 2010. Cloud computing, accounting, auditing, and beyond. The CPA Journal 80(10): 66–70. 10 PART ONE / An Introduction to Accounting Information Systems Pay As You Use Lower Total 24×7 Support Cost of Ownership (TCO) Device and Reliability, Location Scalability, and Independent Sustainability Easy and Agile Why Cloud Secure Storage Deployment Computing? Management Frees Up Highly Lower Capital Utility Based Internal Automated Expenditure Resources FIGURE 1-3 Examples of the reasons cloud computing is becoming popular. Source: N-Axis Software Technologies. this sort of flexibility also suggests that a firm has the ability to quickly modify the scale of its IT capability. Another benefit is that an organization may not have to purchase or operate expensive hardware and software—providers own and operate the equipment and software, much as a taxi company owns and operates its own fleet of vehicles. Also, cloud computing providers offer only one (current) version of an application, so individual firms no longer have to deal with expensive, time-consuming upgrades for software. Case-in-Point 1.4 For years, millions of people who attended the 10-day Taste of Chicago Festival carried around a 28-page brochure to find the various foods and music offerings. In 2009, the city posted this information online—a cloud technology from Microsoft that now delivers the same information right to the festival-goers’ smartphones.7 Accountants always talk about cost-benefit trade-offs. We just identified several possible benefits surrounding this new technology, so it is appropriate to mention that there are also costs and/or concerns. The first potential concern is reliability of the Internet since this is the medium for delivering all cloud services. Other issues include (1) data security measures that the provider offers, such as appropriate internal controls, (2) the quality of service that the provider gives the firm (i.e., careful crafting of the service contract is similar to that of any outsourcing contract, which includes vigilant monitoring of services for quality purposes), and (3) the reliability of the service provider, such as ongoing concern issues. Accordingly, management accountants, internal auditors, and external auditors will need to evaluate the different risks that a firm may face if it decides to ‘‘use the cloud.’’ 7 Barkin, R. 2011. The cloud comes down to earth. Retrieved from http://americancityandcounty.com/technology/ cloud-computing-201101/ CHAPTER 1 / Accounting Information Systems and the Accountant 11 Employee Health Indicators Economic Factors Employee Safety Factors Tobacco use Sales revenue Fleet car accidents High cholesterol Net earnings Lost workdays Absenteeism Share price Employee accidents FIGURE 1-4 Examples of sustainability items of interest to a firm and data that would be col- lected to report on each item of interest. Sustainability Reporting Sustainability reporting focuses on nonfinancial performance measures that might impact an organization’s income, value, or future performance. A survey conducted in 2005 indicated that only 32% of the top 100 U.S. companies (based on revenue) issued sustainability reports, while a similar survey in 2008 indicated that the reporting rate increased to 73%.8 Case-in-Point 1.5 Johnson & Johnson began setting environmental goals in 1990, and reported to the public in 1993 and 1996. In 1998, they began annual sustainability reports for two reasons: because it’s the right thing to do and to create shareholder wealth through increased profits. The result is that Johnson & Johnson is a company that has experienced continued and sustained growth.9 You might be asking yourself why this is an AIS issue if the information is ‘‘nonfinancial’’ in nature. As you will discover in Chapter 15, enterprise-wide systems are widely used to collect qualitative as well as quantitative information for decision making within organizations. In fact, management control systems are the backbone of sustainability reports. That is, organizations need to establish well-defined sustainability strategies that identify achievable and measurable goals.10 Figure 1-4 identifies examples of sustainability items of interest to firms and some of the data that would be collected to report on each item of interest. Suspicious Activity Reporting A number of suspicious activity reporting (SAR) laws now require accountants to report questionable financial transactions to the U.S. Treasury Department. Examples of such transactions are ones suggestive of money laundering, bribes, or wire transfers to terrorist organizations. Federal statutes that mandate SARs include sections of the Annunzio- Wylie Anti-Money Laundering Act (1992), amendments to the Bank Secrecy Act of 1996, and several sections of the USA PATRIOT Act (2001). Institutions affected by these laws include (1) banks, (2) money service businesses such as currency traders, (3) broker dealers, (4) casinos and card clubs, (5) commodity traders, (6) insurance companies, and (7) mutual funds. Over the years, such filings have enabled the federal government to investigate a wide number of criminal activities, gather evidence, and in some cases, repatriate funds 8 Borkowski, S., M. Welsh, and K. Wentzel. 2010. Johnson & Johnson: A model for sustainability reporting. Strategic Finance 92(3): 29–37. 9 Borkowski, S., M. Welsh, and K. Wentzel. 2010. Johnson & Johnson: A model for sustainability reporting. Strategic Finance 92(3): 29–37. 10 Busco, C., M. Frigo, E. Leone, and A. Riccaboni. 2010. Cleaning up. Strategic Finance 92(1): 29–37. 12 PART ONE / An Introduction to Accounting Information Systems sent overseas. Testimony to the importance of suspicious activity reporting is the growth of SAR filings—from about 62,000 reports in 1996 to over 1.6 million reports in 2008. Case-in-Point 1.6 A cooperating witness indicated that a pharmaceutical network was selling controlled drugs through affiliated Web sites to customers without authorized pre- scriptions. To evade U.S. laws, the owners located their headquarters in Central America and their Web servers in the Middle East. A federal investigation and a SAR filed by a financial institution involved in the matter documented almost $5 million in suspicious wire transfers. The result was indictments against 18 individuals and the repatriation of over $9 million from overseas accounts as part of the forfeiture proceedings.11 Suspicious activity reporting impacts AISs in several ways. Because so much of the information within AISs is financial, these systems are often used to launder money or fund criminal activities. A corollary to this fact is that AISs document financial activities in the course of daily transaction processing, and therefore become important sources of SAR evidence and subsequent legal action. Finally, SAR can act as a deterrent to criminal or terrorist activities—and therefore an important control for AISs. Figure 1-5 contains a classification of SAR reports for 10 years of filings from banks and other depository institutions—one of the most important sources of these filings. In this figure, note the importance of money laundering and check fraud. Rank Suspicious Activity Type Filings (Overall) Percentage (Overall)% 1 BSA/Structuring/Money Laundering 1,503,003 48.28 2 Check Fraud 333,862 10.72 3 Other 270,152 8.68 4 Counterfeit Check 155,141 4.98 5 Credit Card Fraud 154,506 4.96 6 Mortgage Loan Fraud 113,071 3.63 7 Check Kiting 101,107 3.25 8 Identity Theft 69,325 2.23 9 False Statement 67,902 2.18 10 Defalcation/Embezzlement 63,392 2.04 11 Unknown/Blank 63,069 2.03 12 Consumer Loan Fraud 53,588 1.72 13 Misuse of Position or Self Dealing 30,899 0.99 14 Wire Transfer Fraud 29,574 0.95 15 Mysterious Disappearance 26,465 0.85 16 Debit Card Fraud 17,480 0.56 17 Commercial Loan Fraud 16,524 0.53 18 Counterfeit Instrument (Other) 13,542 0.43 19 Computer Intrusions 12,307 0.40 20 Counterfeit Credit/Debit Card 12,177 0.39 21 Terrorist Financing 3,178 0.10 22 Bribery/Gratuity 2,932 0.09 Total: 3,113,196 100.00 FIGURE 1-5 A classification of suspicious activity report filings using Form TD F 90-22.47 from depository institutions, April 1, 1996 to December 31, 2006. Source: Web site of the U.S. Treasury Department (2008). 11 http://www.fincen.gov/law_enforcement/ss/html/Issue14-story5.html CHAPTER 1 / Accounting Information Systems and the Accountant 13 Forensic Accounting, Governmental Accountants, and Terrorism Forensic accounting has become a popular course at many universities over the past decade and some universities now have a number of specialized courses that are included in a fraud examination track or a forensic accounting track so that students may specialize in this area of accounting.12 In general, a forensic accountant combines the skills of investigation, accounting, and auditing to find and collect pieces of information that collectively provide evidence that criminal activity is in progress or has happened. British Prime Minister Gordon Brown claims that financial information and forensic accounting has become one of the most powerful investigative and intelligence tools available in the fight against crime and terrorism.13 Terrorists need money to carry out their criminal activity, and as a result, forensic accountants have become increasingly important in the fight against such activities because forensic accountants use technology for data mining. For example, a program that is well known to auditors is Audit Command Language (ACL), which is a popular data extraction software tool that can be used to spot anomalies and trends in data. One example of the use of AISs for this purpose is banking systems that trace the flow of funds across international borders. Other examples include (1) identifying and denying financial aid to terrorist groups and their sympathizers; (2) tracing arms and chemical orders to their final destinations, thereby identifying the ultimate—perhaps unauthorized—purchasers; (3) using spreadsheets to help plan for catastrophic events; (4) using security measures to control cyber terrorism; and (5) installing new internal controls to help detect money laundering and illegal fund transfers. But where do terrorists get the money to finance their activities? Generally speaking, they rely on the following sources for funding: state sponsors, individual contributions, corporate contributions, not-for-profit organizations, government programs, and illegal sources—and here is where government accountants can play an important part in the fight against terrorism. Apparently, terrorists choose to live unpretentiously, they exploit weaknesses in government assistance programs, and are skillful at concealing their activities.14 Similar to forensic accountants, governmental accountants can use data extraction software to spot anomalies, suspicious activity, or red flags that might suggest illegal transactions. Corporate Scandals and Accounting Although corporate frauds and scandals are hardly new, the latest set of them has set records for their magnitude and scope. Of particular note are the Enron scandal and the case against Bernard Madoff. The Enron scandal is important because of the amount of money and jobs that were lost and also because so much of it appears to be directly related to the adroit manipulation of accounting records. Although the details of these manipulations are complex, the results were to understate the liabilities of the company as well as to inflate its earnings and net worth. The opinion of most experts today is that the mechanics of these adjustments might not have been illegal, but the intent to defraud was clear and therefore criminal. 12 Examples include Georgia Southern University, West Virginia University, and North Carolina State University. 13 Nelson, D. 2011. The role of forensic accounting in terrorism. Retrieved from http://www.ehow.com/pring/ facts_5895389_role-forensic-accounting-terrorism.html 14 Brooks, R., R. Riley, and J. Thomas. 2005. Detecting and preventing the financing of terrorist activities. The Journal of Government Financial Management 54(1): 12–18. 14 PART ONE / An Introduction to Accounting Information Systems Accounting rules allow for some flexibility in financial reporting. Unfortunately, some financial officers have exploited this flexibility to enhance earnings reports or present rosier forecasts than reality might dictate—that is, they ‘‘cooked the books.’’ Examples are Scott Sullivan, former Chief Financial Officer at WorldCom, Inc., Mark H. Swartz, former Chief Financial Officer at Tyco International, Inc., and Andrew Fastow, former Chief Financial Officer at Enron. While some accountants have been guilty of criminal and unethical behavior, others have emerged from the scandals as heroes. These include Sherron Watkins, who tried to tell Ken Lay that the numbers at Enron just didn’t add up, and Cynthia Cooper, an internal auditor at WorldCom, who blew the whistle on the falsified accounting transactions ordered by her boss, Scott Sullivan. As the credit crunch worked its way through the economy in 2008, a number of financial institutions either collapsed or narrowly avoided doing so and accounting was in the news once again. In March 2009, Bernard Madoff pleaded guilty to 11 federal felonies and admitted that he turned his wealth management business into a Ponzi scheme that defrauded investors of billions of dollars. Named for Charles Ponzi, this is a pyramid fraud in which new investment funds are used to pay returns to current investors. The fraud relies on new money continuously entering the system so that investors believe their money is actually earning returns. The problem is that when new money stops flowing, the pyramid collapses. ACCOUNTING AND IT IT is pervasive and impacts every area of accounting. Instantaneous access is available to the Internet via mobile communication devices such as cell phones, iPads, smart phones, and so on, which enable activities to take place anytime and anywhere. For example, managerial accountants can complete important work tasks while traveling in the field, auditors can communicate with each other from remote job sites (auditing the same client), staff accountants can text message one another from alternate locations, and tax experts can download current information on tax rulings. Figure 1-6 provides an overview of the major areas within the field of accounting that are impacted by IT. This section of the chapter considers the influence of IT on each of them. Taxation Financial IT Auditing Accounting Managerial Accounting FIGURE 1-6 Overview of the major areas of accounting that are impacted by information tech- nology. CHAPTER 1 / Accounting Information Systems and the Accountant 15 Financial Accounting The major objective of financial accounting information systems is to provide relevant information to individuals and groups outside an organization’s boundaries—for example, investors, federal and state tax agencies, and creditors. Accountants achieve these infor- mational objectives by preparing such financial statements as income statements, balance sheets, and cash flow statements. Of course, many managers within a company can also use financial reports for planning, decision making, and control activities. For example, a manager in charge of a particular division could use such profitability information to make decisions about future investments or to control expenses. Figure 1-7 depicts an organization’s financial accounting cycle, which begins with analyzing and journalizing transactions (e.g., captured at the point of sale) and ends with its periodic financial statements. Accounting clerks, store cashiers, or even the customers themselves input relevant data into the system, which stores these data for later use. In financial AISs, the processing function also includes posting these entries to general and subsidiary ledger accounts and preparing a trial balance from the general ledger account balances. Nonfinancial Data. The basic inputs to, and outputs from, traditional financial account- ing systems are usually expressed in monetary units. This can be a problem if the AIS ignores nonmonetary information that is also important to users. For example, an investor might like to know what the prospects are for the future sales of a company, but many financial AISs do not record such information as unfulfilled customer sales because such sales are not recognizable financial events—even though they are important ones. This is the basic premise behind REA accounting—the idea of also storing important nonfinancial information about resources, events, and agents in databases precisely because they are Analyze, Journalize Transactions Close General Ledger Account Summarize (Income/Expenses) Accounts, General Ledger Posting Accounting Preparation of Cycle Financial Trial Balance Statements Preparation Adjusted Trial Period-End Balance Adjusting Entries Preparation FIGURE 1-7 The accounting cycle. Source: http://bookkeeping-financial-accounting-resources.com/images/accountingcycle.jpg. 16 PART ONE / An Introduction to Accounting Information Systems relevant to the decision-making processes of their users. We discuss the REA framework in greater detail in Chapter 6. Inadequacies in financial performance measures have encouraged companies to con- sider nonfinancial measures when evaluating performance. Some of the advantages include: (1) a closer link to long-term organizational strategies; (2) drivers of success in many indus- tries that are intangible assets (such as intellectual capital and customer loyalty), rather than the assets allowed on balance sheets; (3) such measures that can be better indicators of future financial performance; and (4) investments in customer satisfaction that can improve subsequent economic performance by increasing revenues and loyalty of existing customers, attracting new customers, and reducing transaction costs.15 Several professional associations now formally recognize that nonfinancial performance measures enhance the value of purely financial information. For example, in 1994 a special committee of the American Institute of Certified Public Accountants (AICPA) recommended several ways that businesses could improve the information they were providing to external parties by including management analysis data, forward-looking information such as opportunities and risks, information about management and shareholders, and background information about the reporting entity. Similarly, in 2002, the American Accounting Association (AAA) Financial Accounting Standards Committee recommended that the Securities and Exchange Commission (SEC) and the Financial Accounting Standards Board (FASB) encourage companies to voluntarily disclose more nonfinancial performance measures. Real-Time Reporting. Another impact of IT on financial accounting concerns the timing of inputs, processing, and outputs. Financial statements are periodic and most large companies traditionally issue them quarterly, with a comprehensive report produced annu- ally. With advances in IT that allow transactions to be captured immediately, accountants and even the AIS itself can produce financial statements almost in real-time. Of course, some of the adjustments that accountants must make to the records are not done minute by minute, but a business can certainly track sales and many of its expenses continuously. This is especially useful to the retailing executives, many of whom now use dashboards. We discuss dashboards in more depth in Chapter 15 and also show an example of a sales dashboard (Figure 15-8). Interactive Data and Extensible Business Reporting Language. A problem that accountants, investors, auditors, and other financial managers have often faced is that data used in one application are not easily transferable to another. This means that accountants may spend hours preparing spreadsheets and reports that require them to enter the same data in different formats over and over. Interactive data are data that can be reused and carried seamlessly among a variety of applications or reports. Consider, for example, a data item such as total assets. This number might need to be formatted and even calculated several different ways for reports such as filings with the SEC, banks, performance reports, and so on. With interactive data, the data are captured once and applied wherever needed. Interactive data require a language for standardization that ‘‘tags’’ the data at its most basic level. As an example, for total assets, this would be at the detail level for each asset. Extensible business reporting language (XBRL) is emerging as the language of choice for this purpose. As of 2010, the SEC requires public companies to file their financial 15 http://nikhils-nick18.blogspot.com/2010/06/non-financial-performance-measures-what.html CHAPTER 1 / Accounting Information Systems and the Accountant 17 reports in XBRL format. In addition, many companies, software programs, and industries are beginning to incorporate XBRL for creating, transforming, and communicating financial information. We discuss XBRL in more detail in Chapter 14 and you can learn about its status at http://www.xbrl.org. Case-in-Point 1.7 The Federal Deposit Insurance Corporation (FDIC) insures bank deposits over a specific amount. FDIC wanted to create an Internet-based Central Data Repository that stored all the call (quarterly) data they received from more than 7,000 banks. They convinced their software vendors to incorporate XBRL language to standardize the data. The tagged data the FDIC receives from banks now has improved accuracy and can be published and made available to users much more quickly than before.16 Managerial Accounting The principal objective of managerial accounting is to provide relevant information to organizational managers—that is, users who are internal to a company or government agency. Cost accounting and budgeting are two typical parts of a company’s managerial accounting system. Let us examine each of them in turn. Cost Accounting. Due to globalization, decentralization, deregulation, and other fac- tors, companies are facing increased competition. The result is that companies must be more efficient and must do a better job of controlling costs. The cost accounting part of managerial accounting specifically assists management in measuring and controlling the costs associated with an organization’s various acquisition, processing, distribution, and selling activities. In the broadest sense, these tasks focus on the value added by an organization to its goods or services, and this concept remains constant whether the organization is a manufacturer, bank, hospital, or police department. Take health care for an example. Although much controversy surrounded the health care legislation that was signed into law in 2010, there is one fact that most agree upon—that the health care industry is a very large portion of the U.S. economy and that it is growing rapidly as the baby boomer generation reaches retirement age. These facts, coupled with increased regulatory demands on health care providers and hospitals, suggest the need for sophisticated accounting systems to maintain critical data, as well as the need for up-to-date reports for decision making. Case-in-Point 1.8 Survey data from more than 100 hospital CFOs suggest five major themes regarding the evolution of financial practices in health care. Two of those themes are (1) a greater focus on internal controls, supported by information and management systems, and (2) an increased reliance on business analysis (i.e., requirement to develop and measure business performance).17 Activity-Based Costing. One example of an AIS in the area of cost accounting is an activity-based costing (ABC) system. Traditionally, cost accountants assigned overhead (i.e., indirect production costs) on the basis of direct labor hours because the number of labor hours was usually directly related to the volume of production. The problem with this traditional system is that, over time, increasing automation has caused manufacturers 16 http://www.xbrl.org/us/us/FFIEC%20White%20Paper%2002Feb2006.pdf 17 Langabeer, J., J. DellliFraine, and J. Helton. 2010. Mixing finance and medicine. Strategic Finance 92(6): 27–34. 18 PART ONE / An Introduction to Accounting Information Systems to use less and less direct labor. Thus, managers became frustrated using this one method of assigning overhead costs when a clear relationship between labor and these overhead expenses no longer seemed to exist. Instead, managers in a variety of manufacturing and service industries now identify specific activities involved in a manufacturing or service task, and then assign overhead costs based on the resources directly consumed by each activity. Although activity-based costing techniques have been available for several decades, they are more common now that computerized systems can track costs. Moreover, these systems can move an organization in new strategic directions, allowing corporate executives to examine fundamental business processes and enabling them to reengineer the way they do business. ABC systems can also play an essential strategic role in building and maintaining a successful e-commerce business because they can answer questions about production costs and help managers allocate resources more effectively. Case-in-Point 1.9 Chrysler, an American car manufacturer, claims that it has saved hundreds of millions of dollars since introducing activity-based costing in the early 1990s. ABC showed that the true cost of certain parts that Chrysler made was 30 times what had originally been estimated, a discovery that persuaded the company to outsource the manufacture of many of those parts.18 Corporate Performance Measurement and Business Intelligence. Another exam- ple of an AIS used in the area of cost accounting is in corporate performance measurement (CPM). In a responsibility accounting system, for example, managers trace unfavorable performance to the department or individuals that caused the inefficiencies. Under a responsibility accounting system, each subsystem within an organization is only accountable for those items over which it has control. Thus, when a particular cost expenditure exceeds its standard cost, managers can take immediate corrective action. In addition to the traditional financial measures, cost accountants also collect a variety of nonfinancial performance measures to evaluate such things as customer satisfaction, product quality, business innovation, and branding effectiveness. The balanced scorecard measures business performance in four categories: (1) financial performance, (2) customer knowledge, (3) internal business processes, and (4) learning and growth. A company may choose to rank these categories to align with their strategic values. For example, a company may stress ‘‘customer knowledge’’ because customer satisfaction is important to its market position and planned sales growth. Balanced scorecards and corporate performance measurement are not new ideas. But with the Internet, integrated systems, and other advanced technologies, balanced scorecards and other approaches to CPM are becoming increasingly valuable business intelligence tools. Businesses use key performance indicators (KPIs) to measure and evaluate activities in each quadrant of the balanced scorecard. For instance, a financial KPI might be return on investment. In the customer area, a company might track the number of new customers per month. Also new is the use of dashboards (Figure 1-8) to monitor key performance metrics. Dashboards usually appear in color, so that red, for example, might indicate a failure to meet the goal. Another indicator might be up and down arrows to show how a key activity performs for a certain time period. Dashboards are especially useful to managers who appre- ciate the presentation of important performance data in easy-to-understand graphic formats. 18 http://www.economist.com/node/13933812 CHAPTER 1 / Accounting Information Systems and the Accountant 19 Closed Sales YTD Closed Sales QTD Sales by Country YTD YTD Sales Sales QTD 136 123 590 0 1,200,000 0 500,000 267 262,000 24,523 Sum of Amount in USD (Thousands) Sum of Amount in USD Sum of Amount in USD Billing Country Canada UK US Other Target 900,000, Stretch target 1.2M Target 450,000, Stretch target 500,000 Closed Sales by Industry New Business Pipeline Sum of Amount in USD (Thousands) 200 Sum of Amount in USD (Millions) 1 150 100 0.5 50 0 0...... n g 06 y. 06 ri. 06 06 o. io in al /P 20 op 20 at 20 20 ct An al ic pe Pr ry ch ril ay os lif ds os ua Ap ua e ar M op lu
