CHAPTER TWO

OVERVIEW OF THE BUSINESS PROCESSES

Learning objectives:
After studying this chapter, you should be able to:
Explain the basic activities companies engage in, the types of decisions they must make, and the
types of information they need to make those decisions.
Identify the major internal and external parties that AIS interacts with and the type of information
it provides each user.
Describe the major transaction cycles present in most companies.
Describe the four major steps in the data processing cycle and the major activities in each.
Describe the documents and procedures used in AIS to collect and process transaction data.
Describe the ways information is stored in computer-based information systems.
Discuss the types of information that an AIS can provide.
Information Needs and Business Processes (Activities)
Businesses engage in a variety of processes (activities), including:
• Acquiring capital
• Buying buildings and equipment
• Hiring and training employees
• Purchasing inventory
• Doing advertising and marketing
• Selling goods or services
• Collecting payment from customers
• Paying employees
• Paying taxes
• Paying vendors

Accounting Information System Lecturer: Rukiya T. 1

Each activity requires different types of decisions. Each decision requires different types of information.
Types of information needed for decisions:
Some is financial
Some is nonfinancial
Some comes from internal sources
Some comes from external source
An effective AIS need to be able to integrate information of different types and from different sources.
For example, by improving business processes leading to efficient production, Toyota has become the
largest automobile manufacturer in the world, a title held by General Motors for almost 100 years.
Table 2.1: An Overview of Business Processes, Key Decisions, and Information Needs
Business Processes Key Decisions Information Needs
Acquire capital How much? Cash flow projections
Find investors or borrow funds? Pro-forma financial statements
If borrow, best terms? Loan amortization schedule
Acquire building and Size of building? Capacity needs
equipment Amount of equipment? Building or equipment prices
Rent or buy? Market study
Location? Tax tables and depreciation
How to depreciate? regulations
Hire and train employees Experience requirements? Job descriptions
How to assess integrity and competence Applicant job history and skills
of applicants?
How to train employees?
Acquire inventory What models to carry? Market analyses
How much to purchase? Inventory status reports
How to manage inventory (store, Vendor performance
control, etc.)?
Which vendors?
Advertising and Which media? Cost analyses
marketing Content? Market coverage
Sell merchandise Markup percentage? Pro-forma income statement
Offer in-house credit? Credit card costs
Which credit cards to accept? Customer credit status
Collect payments from If offer credit, what terms? Customer account status
customers How to handle cash receipts? Accounts receivable aging report
Accounts receivable records
Pay employees Amount to pay? Sales (for commissions)
Deductions and withholdings? Time worked (hourly employees)
Process payroll in-house or use outside W4 forms
service? Costs of external payroll service
Pay taxes Payroll taxes requirements Government regulations
Sales tax requirements Total wage expense
Total sales
Pay vendors Whom to pay? Vendor invoices
When to pay? Accounts payable records
How much to pay? Payment terms

Discussion Questions 2.1:

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Examine Table 2.1 and discuss how the various information needs would be collected and reported
by a company`s AIS.
Three different types of information exist in Table 2.1:
1. Internally-generated financial data
2. Internally-generated operating data
3. Externally-generated data.
Internally generated financial data would be captured directly on source documents that are
processed by the AIS and would be reported in traditional financial statements.
Internally generated operating data can be captured in two ways. Some of this data (e.g., time
worked) would be captured on source documents. Other data (e.g., employee skills) would
traditionally be captured and stored by an information system that is not part of the AIS itself. The
AIS, however, should be redesigned so as to integrate this data with the other transaction-oriented
data.
Some of the data (e.g., information on market share and customer satisfaction) must come from
external sources. The AIS should be designed to store this data in an integrated manner with
internally generated data.
Interaction with External and Internal parties
The AIS interacts with many external parties, such as customers, vendors, creditors, and governmental
agencies as well as with internal parties such as management and employees.

Internal External
AIS
Parties Parties

The interaction is typically two ways, in that the AIS sends information to and receives information from
these parties.
Business Cycles
A transaction is an agreement between two entities to exchange goods or services or any other event that
can be measured in economic terms by an organization. Examples include:
• Selling goods to customers
• Buying inventory from suppliers
• Paying employees
• Depreciate equipment
The process that begins with capturing transaction data and ends with an informational output such as the
financial statements is called transaction processing.
Many business processes are pairs of events involved in give-get exchanges. Most organizations engage
in a small number of give-get exchanges, but each type of exchange happens many times. For example, an
organization might have thousands of sales to customers every year in exchange for cash. Likewise, it
also will continuously buy inventory from suppliers in exchange for cash.
These basic exchanges can be grouped into five major business or transaction cycles:
The revenue cycle, where goods and services are sold for cash or a future promise to receive cash.

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 The revenue cycle involves interactions between an organization and its customers, such as shipping
them goods.
The revenue cycle:
✓ Gets finished goods from the production cycle.
✓ Provides funds to the financing cycle.
✓ Provides data to the general ledger and reporting system.

The expenditure cycle, where companies purchase inventory for resale or raw materials to use in
producing products in exchange for cash or a future promise to pay cash. The expenditure cycle
involves interactions between an organization and its suppliers.
The expenditure cycle:
✓ Gets funds from the financing cycle.
✓ Provides raw materials to the production cycle.
✓ Provides data to the general ledger and reporting system.
The production cycle, where raw materials are transformed into finished goods.
The production cycle:
✓ Gets raw materials from the expenditure cycle.
✓ Gets labor from the HR/payroll cycle.
✓ Provides finished goods to the revenue cycle.
✓ Provides data to the general ledger and reporting system.
The human resources/payroll cycle, where employees are hired, trained, compensated, evaluated,
promoted, and terminated. The human resources/payroll cycle involves interactions between an
organization and its employees, government, and potential hires.
The Human Resources/Payroll cycle:
✓ Gets funds from the financing cycle
✓ Provides labor to the production cycle.
✓ Provides data to the general ledger and reporting system.
The financing cycle, where companies sell shares in the company to investors and borrow money and
where investors are paid dividends and interest is paid on loans. That means, you raise capital
(through stock or debt), repay the capital, and pay a return on it (interest or dividends). The financing
cycle deals with interactions between an organization and its lenders and owners.
The financing cycle:
✓ Gets funds from the revenue cycle.
✓ Provides funds to the expenditure and HR/payroll cycles.
✓ Provides data to the general ledger and reporting system.
These cycles process a few related transactions over and over again. For example, most revenues cycle
transactions are either selling goods or services to customers or collecting cash for those sales.
Table 2.2: Common Cycle Activities
Transaction Cycle Major Activities in the Cycle

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Revenue Receive and answer customer inquires
Take customer orders and enter them into the AIS
Approve credit sales
Check inventory availability
Initiate back orders for goods out of stock
Pick and pack customer orders
Ship goods to customers or perform services
Bill customers for goods shipped or services performed
Update (increase) Sales and Accounts Receivable
Receive customer payments and deposit them in the bank
Update (reduce) Accounts Receivable
Handle sales returns, discounts, allowances, and bad debts
Prepare management reports
Send appropriate information to the other cycles
Expenditure Request goods and services be purchased
Prepare, approve, and send purchase orders to vendors
Receive goods and services and complete a receiving report
Store goods
Receive vendor invoices
Update (increase) accounts payable
Approve vendors invoices for payment
Pay vendors for goods or services
Update (reduce) accounts payable
Handle purchase returns, discounts, and allowances
Prepare management reports
Send appropriate information to the other cycles
Human Resources/Payroll Recruit, hire, and train new employees
Evaluate employee performance and promote employees
Discharge employees
Update payroll records
Collect and validate time, attendance, and commission data
Prepare and disburse payroll
Calculate and disburse taxes and benefit payments
Prepare employee and management reports
Send appropriate information to the other cycles
Production Design products
Forecast, plan, and schedule production
Request raw materials for production
Manufacture products (transform raw materials and labor to
finished goods)
Store finished products
Accumulate costs for products manufactured
Prepare management reports
Send appropriate information to the other cycles

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Financing Forecast cash needs
Sell stock/securities to investors
Borrow money from lenders
Pay dividends to investors and interest to lenders
Retire debt
Prepare management reports
Send appropriate information to the other cycles

Every transaction cycles relates to one another and interface with the general ledger and reporting
system, which is used to generate information for both management and external parties.
In many accounting software packages, the various transaction cycle are implemented as separate
modules. Every organization does not need to implement every module. For example, retail stores do not
have a production cycle and would not implement that module. Moreover, some types of organizations
have unique requirements. Financial institutions, for example, have demand-deposit and installment loan
cycles that relate to transactions involving customer accounts and loans, respectively. In addition, the
nature of a given transaction cycle differs across different types of organizations. For example, the
expenditure cycle of a service company, such as a public accounting or a law firm, does not involve
processing transactions related to the purchase, receipt, and payment for merchandise that will be resold
to customers.
Each transaction cycle can include many different business processes or activities. Each business process
can be relatively simple or quite complex. Focus 2.1 shows how Toyota`s attention to continuously
improving its business processes has helped it become the largest and most profitable automobile
manufacturer in the world.
Focus 2.1: Improving Business Processes Helps Drive Toyota Success
Toyota`s Georgetown, Kentucky, manufacturing plant, its largest in North America, is the size of
156 football fields, employs 7,000 people, and produces a new car every 55 seconds. Because
Toyota produces a higher-quality car at a lower cost than its competitors, it is now the largest
automobile manufacturer in the world, a title General Motors had for almost a hundred years.
A major factor in its success is Toyota Production System (TPS); a set of philosophies, principles,
and business processes supported by information technology. Its goal is to continually improve so
Toyota has the most effective and most efficient manufacturing and business processes possible.
Toyota willingly shares TPS and its manufacturing and business processes with its suppliers to
help them improve their quality and efficiency. It also shares TPS with its competitors, knowing
that by the time they duplicate it Toyota will have greatly improved TPS.
Some of the principles and business processes on which TPS is built and that Toyota`s
information systems must support and enable are these:
• Performance monitoring software warns assembly line workers of equipment problems.
Workers stop production whenever necessary to prevent or correct defects.
• Their just-in-time (JIT) inventory system is one of the most sophisticated in the world.
Driverless carts take parts to assembly stations at the time they are needed so inventory
does not pile up. Suppliers must meet rigid delivery standards. For example, four hours
before they are needed Toyota software electronically notifies Johnson Controls exactly
what kind of car seats are needed for each car and the exact order in which they must be
shipped.

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 • Continuous improvement is a critical and ongoing process. No process or detail is too
small or insignificant to improve. Technology is especially important in the continous
improvement process. This emphasis on continuous improvement creates a culture that
values continuously learning and embraces change.
• Electronic displays, many connected directly to the manufacturing equipment, help
workers monitor the assembly line. Information is communicated by light colors (green
means the process is operating correctly, yellow shows a problem is being investigated,
and red shows the assembly line has stopped) and by printed messages (which machine
malfunctioned, its speed, and temperature when it broke down, and who was operating
the machine.)
• Electronic quality control devices, such as an electronic sensor on a tool or a beam of
light, monitor a process. These devices let a computer know when a tool is not used or a
required part is not picked up and used at the appropriate time.
• More than half of Toyota`s information systems employees work in operations at its
plants so they can accompany executives, team leaders, and factory workers when they
go to solve assembly line problems.
In summary, Toyota has a very clear and in-depth understanding of the business processes that
make it successful, continuously improves those process, and understands the role information
systems play in managing, supporting, and facilitating those processes.
Source: Mel Duvall, “ What`s Driving Toyota?” Baseline Magazine, September 5, 2006.

Transaction Processing: The Data Processing Cycle

Accountants have a significant role to play in the data processing cycle. For example, they must interact
with systems analysts to help answer questions such as these:
✓ What data should be entered and stored by the organization?
✓ Who should have access to them?
✓ How should the data be organized, updated, stored, accessed, and retrieved?
✓ How can both scheduled and unanticipated information needs be met?
To answer these and related questions, accountants must understand the data processing concepts.
One important function of the AIS is to efficiently and effectively process data about a company’ s
transactions. In manual (non-computer-based) systems, data are entered into journals and ledgers
maintained on paper. In computer-based systems, data are entered into computers and stored in files and
databases. The series of operations performed on data to generate meaningful and relevant information
are referred to collectively as the data processing cycle.
The data processing cycle consists of four steps: data input, data storage, data processing, and
information output.
Data Storage

Data Input Data Processing Information Output

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Data Input
The first step in processing transaction is to capture the data for each transaction that takes place and enter
them into the system. The data capture process is usually triggered by the occurrence of a business
activity. Data must be collected about three facets (aspects) of each business activity:
1. Each activity of interest
2. The resource(s) affected by each activity
3. The agents who participate in each activity
For example, the most frequent transaction in the revenue cycle is a sale, either for cash or credit. The
data about a sales transaction that need to be collected include:
Date and time of day the sale occurred
Employee who made the sale and the checkout clerk who processed the sale
Checkout register where the sale was processed
Item(s) sold
Quantity of each item sold
List price and actual price of each items sold
Total amount of the sale
For credit sales: delivery instructions, customer bill-to and ship-to addresses, and customer
name.
Historically, most businesses used paper source documents to initially collect data about their business
activities and then transferred that data into the computer. Today, however, most data about business
activities are recorded directly through computer data entry screens. Usually the data entry screen
retains the same name as the paper source document it replaced.
Table 2.1: Common Business Activities and Source Documents
Business Activity Source Documents

Revenue Cycle:

Take customer order Sales order

Deliver or ship order Delivery ticket or bill of lading

Receive cash Remittance advice or remittance list

Deposit cash receipts Deposit slip

Adjust customer account Credit memo

Expenditure Cycle:

Request items Purchase requisition

Order items Purchase order

Receive items Receiving report

Pay for items Check

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Human Resources/Payroll Cycle:

Collect employee withholding data W4 form

Record time worked by employees Time cards

Record time spent on specific jobs Job time tickets or time sheet

Well-designed source documents and data entry screens—improve both control and accuracy of
capturing data about business activities. Control is improved either by purchasing prenumbered source
documents or by having the systems automatically assign a sequential number to each new transaction.
– What does it mean if a document number is missing in the sequence?
– What does it mean if there are duplicate document numbers?
Verify transactions. For example, check for inventory availability before completing an online
sales transaction.
Prenumbering simplifies verifying that all transactions have been recorded and that none of the
documents has been misplaced. Imagine trying to balance a checkbook if the checks were not
prenumbered.
Well-designed source documents (paper forms) and data entry screens improve accuracy and
completeness by providing instructions or prompts about what data to collect, grouping logically
related pieces of information close together, using check-off boxes or pull-down menus to present the
available options, and using appropriate shading and borders to clearly separate data items.
Data input screens are usually preformatted such that they list all the data the user needs to enter.
Sometimes these screens resemble source documents and users fill out the screen the same way they
would a paper source document. It is also important for control purposes that certain transactions be
verified by the system. For example, a company could not want to sell goods to a customer who was not
paying his bills or to sell an item for immediate delivery that was out of stock. These kinds of problems
could be prevented by programming the system to check a customer`s credit limit and payment history,
as well as inventory status, before confirming a sale to a customer.
If paper documents must still be exchanged with customers or suppliers, data input accuracy and
efficiency can be further improved by using:
1. Turnaround documents, which are records of company data sent to an external party and then
returned to the system as input. Turnaround documents are prepared in machine-readable form
to facilitate their subsequent processing as input records. An example is a utility bill that is read
by a special scanning device when it is returned with its payment. For example, the stub on your
telephone bill that you tear off and return with your check when you pay the bill. The customer
account number is coded on the document, usually in machine-readable form, which reduces
the probability of human error in applying the check to the correct account.
2. Source data automation—is yet another means to improve the accuracy and efficiency of data
input. Source data automation device capture transaction data in machine-readable form at the
time and place of their origin. It capture data with minimal human intervention.
Examples include:
• ATMs used by banks
• Point-of-sale (POS) scanners used in retail stores
• Bar code scanners used in warehouses

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 • Automated gas pumps that accept your credit card.
Data Storage
A company`s data are one of its most important resources. However, the mere existence of relevant data
does not guarantee that they are useful. An organization must have ready and easy access to its data to
function properly. Therefore, accountants need to understand how data are organized and stored in an AIS
and how they can be accessed. In essence, they need to know how to manage data for maximum corporate
use.
Imagine how difficult a textbook would be to read if it were not organized into chapters, sections,
paragraphs, and sentences. Now imagine how hard it would be for a company to find a particular invoice
if all of its key documents were randomly dumped into file cabinets. Fortunately, most textbooks and
company files are organized for easy retrieval. Likewise, information in an AIS can be organized for easy
and efficient access. This section explains basic data storage concepts and definitions, such as ledgers,
journals, coding techniques, chart of accounts, and computer-based storage concepts.
Computer Based Storage Concepts
An entity is something about which information is stored. Examples of entities include employees,
inventory items, and customers. For example,
• In your university’s student information system, one entity is the student. The student information
system stores information about students.
• What are some other entities in your student information system?
Each entity has attributes, or characteristics of interest, which need to be stored. In other words,
attributes are characteristics of interest with respect to the entity. An employee pay rate and a customer
address are examples of attributes. Generally, each type of entity possesses the same set of attributes. For
example, all employees possess an employee number, pay rate, and home address. The specific data
values for those attributes, however, will differ among entities. For example, one employee`s pay rate
might be $10.00, whereas another`s might be $10.25. For example, some attributes that a student
information system typically stores about the student entity are:
✓ Student ID number
✓ Phone number
✓ Address
• What are some other attributes about students that a university might store?
Data values are stored in a physical space called a field. A field is the physical space where an attribute is
stored. For example, the space where the student ID number is stored is the student ID field.
The set of fields that contain data about various attributes of the same entity forms a record. For example,
the combination of attributes stored for one student is that Student`s record. Each intersecting row and
column is a field within a record, the contents of which are called a data value.
Related records are grouped to form a file. For example, all customer receivable records are stored in an
accounts receivable file. Two basic types of files exist. A master file is conceptually similar to a ledger in
a manual AIS. Master files store cumulative information about an organization`s resources and the agents
with whom it interacts. For example, the inventory and equipment master files store information about
important organizational resources. Similarly, the customer, supplier, and employee master files store
information about important agents with whom the organization interacts.
Master files are permanent; they exist across fiscal periods. Individual records within a master file,
however, are frequently changed. The most common type of change made to records in master files

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involves updating the data to reflect the effect of specific transactions. For example, the account balances
of individual customer accounts in the customer master file are updated to reflect new sales transactions
and payments received. Periodically, new records may also be added to a master file, and sometimes
individual records may even be deleted.

The second basic type of file is called a transaction file, which is conceptually similar to a journal in a
manual AIS. Transaction files contain records for the individual business transactions that occur during a
specific fiscal period. Transaction files are not permanent but are usually only maintained online for one
fiscal period.

A set of interrelated, centrally coordinated files is referred to as a database. For example, the accounts
receivable file might be combined with customer, sales analysis, and related files to form a customer
database.
In an AIS, the files used to store cumulative information about resources and agents are called ledgers.
We typically use the word ledger to describe the set of t-accounts. The t-account is where we keep track
of the beginning balance, increases, decreases, and ending balance for each asset, liability, owners’
equity, revenue, expense, gain, loss, and dividend account. In a manual system, ledgers are actually
books; hence the phrase “ keeping the books” refers to the process of maintaining and updating the
ledgers.
Following is an example of a ledger account for accounts receivable:
General Ledger
Account: Accounts Receivable Account Number: 120
Date Description Post ref Debit Credit Balance

01/01/11 42,069.00

01/03/11 Sales S03 1,300.00 43,369.00

01/13/11 Cash collections CR09 4,600.00 38,769.00

01/23/11 Sales S04 5,600.00 44,369.00

Most companies have both a general ledger and a set of subsidiary ledgers. The general ledger contains
summary-level data for every asset, liability, equity, revenue, and expense account of the organization. A
subsidiary ledger records all the detailed data for any general ledger account that has many individual
subaccounts. For example, the general ledger contains an account receivable account that summarizes the
total amount owed to the company by all customers. The subsidiary accounts receivable ledger has a
separate record for each individual customer, each of which contains detailed information (name, address,
purchases, payments, account balance, credit limit, etc.) about a particular customer. Subsidiary ledgers
are commonly used for accounts receivable, inventory, fixed assets, and accounts payable.
The general ledger account corresponding to a subsidiary ledger is called a control account. Control
account contains the total amount for all individual accounts in the subsidiary ledger. Thus, the accounts
payable control account in the general ledger represents the total amount owed to all vendors. The
balances in the subsidiary accounts payable ledger indicate the amount owed to each specific vendor.

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The relationship between the general ledger control account and the individual account balances in the
subsidiary ledger plays an important role in maintaining the accuracy of the data stored in the AIS.
Specifically, the sum of all entries in the subsidiary ledger should equal the amount in the corresponding
general ledger control account. For example, the inventory subsidiary ledger would contain dollar
balances and quantities for each inventory item carried. The sum of all the dollar balances in the inventory
subsidiary ledger should equal the total dollar balance in the inventory control account in the general
ledger. Any discrepancy between the total of the subsidiary ledger and the balance in the corresponding
general ledger control account indicates that an error in the recording and posting process has occurred.
Coding Techniques
The data stored in ledgers must be organized in a logical fashion. The most common way to do that is to
use coding techniques. Coding is a method of systematically assigning numbers or letters to data
items to help classify and organize them. Many different types of codes are used in business and
accounting applications. Such codes include:
Sequence codes
Block codes
Group codes
Sequence codes—with sequence codes, items (such as checks or invoices) are numbered
consecutively to ensure that there will be no gaps in the sequence. This enables the user to account
for all the items, because any missing items will cause a gap in the numerical sequence. Thus, the
numbering helps ensure that:
✓ All items are accounted for.
✓ There are no duplicated numbers, which would suggest errors or fraud.
Examples include prenumbered checks, invoices, and purchase orders.
Advantages of Sequence Codes
Sequential coding supports the reconciliation of a batch of transactions, such as sales orders, at the end
of processing. If the transaction processing system detects any gaps in the sequence of transaction
numbers, it alerts management to the possibility of a missing or misplaced transaction. By tracing the
transaction number back through the stages in the process, management can eventually determine the
cause and effect of the error. Without sequentially numbered documents, problems of this sort are
difficult to detect and resolve.
Disadvantages of Sequence Codes
Sequential codes carry no information content beyond their order in the sequence. For instance, a
sequential code assigned to a raw material inventory item tells us nothing about the attributes of the item
(type, size, material, warehouse location, and so on). Also, sequential coding schemes are difficult to
change. Inserting a new item at some midpoint requires renumbering the subsequent items in the class
accordingly. In applications where record types must be grouped together logically and where additions
and deletions occur regularly, this coding scheme is inappropriate.
Block codes—with a block code, blocks of numbers within a numerical sequence are reserved for a
particular categories having meaning to the user.
For example, the first three digits of a Social Security number make up a block code that indicates the
state in which the Social Security number was issued:
• 001– 003 New Hampshire
• 004– 007 Maine

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 • 008– 009 Vermont
Users familiar with the code can readily identify the type and model of item by code number alone. Other
examples include ledger account numbers (blocked by account type), employee numbers (blocked by
department), and customer numbers (blocked by region).
A numeric block code is a variation on sequential coding that in part remedies the disadvantages just
described. This approach can be used to represent whole classes of items by restricting each class to a
specific range within the coding scheme. A common application of block coding is the construction of a
chart of accounts.
A well-designed and comprehensive chart of accounts is the basis for the general ledger and is thus
critical to a firm’ s financial and management reporting systems. The more extensive the chart of
accounts, the more precisely a firm can classify its transactions and the greater the range of information it
can provide to internal and external users.
Advantages of block codes
Block coding allows for the insertion of new codes within a block without having to reorganize the
entire coding structure. For example, if advertising expense is account number 526, the first digit
indicates that this account is an operating expense. As new types of expense items are incurred and have
to be specifically accounted for, they may be added sequentially within the 500 account classification.
This three-digit code accommodates 100 individual items (X00 through X99) within each block.
Obviously, the more digits in the code range, the more items that can be represented.
Disadvantages of block codes
As with the sequential codes, the information content of the block code is not readily apparent. For
instance, account number 526 means nothing until matched against the chart of accounts, which identifies
it as advertising expense.
Group codes— Group codes are often used in conjunction with the block code. In group codes two
or more subgroups of digits are used to code an item. For example, the code in the upper, right-hand
corner of many checks is a group code organized as follows:
– Digits 1– 2 Bank number
– Digit 3 Federal Reserve District
– Digits 4– 7 Branch office of Federal Reserve
– Digits 8– 9 State
Advantages of group codes
Group codes have a number of advantages over sequential and block codes.
1. They facilitate the representation of large amounts of diverse data.
2. They allow complex data structures to be represented in a hierarchical form that is logical and
more easily remembered by humans.
3. They permit detailed analysis and reporting both within an item class and across different
classes of items.
Disadvantages of group codes
Ironically, the primary disadvantage of group coding results from its success as a classification tool.
Because group codes can effectively present diverse information, they tend to be overused. Unrelated
data may be linked simply because it can be done. This can lead to unnecessarily complex group codes
that cannot be easily interpreted. Finally, overuse can increase storage costs, promote clerical errors,
and increase processing time and effort.

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In designing a coding system, the following guidelines will result in a better coding system.
❖ The code should be consistent with its intended use, which requires the code designer to
determine the types of system outputs designed by users prior to selecting the code (i.e.,
the code should be consistent with its intended use, so make sure you know what users
need).
❖ Make sure the code allows for growth in the number of items to be coded (i.e., provide
enough digits to allow room for growth). For example, don`t choose a three-digit
employee code for a fast growing company with 950 employees.
❖ Make the coding system as simple as possible in order to:
• Minimize costs,
• Facilitate memorization and interpretation of coding categories, and
• Ensure employee acceptance.
❖ Make sure the coding system is consistent with:
• The company’ s organization structure
• Other divisions of the organization
Chart of Accounts
Perhaps the best example of coding in organization`s is the chart of accounts. Each general ledger
account is assigned a specific number and the chart of accounts is a list of all general ledger accounts an
organization uses. Since the codes are account numbers, they allow transaction data to be coded,
classified, and entered into the proper accounts.
The structure of the chart of accounts is an important aspects of an AIS because it affects the preparation
of financial statements and reports. Data stored in individual accounts can easily be summed for
presentation in reports, but data stored in summary accounts cannot be easily broken down (analyzed) and
reported in more detail. Consequently, it is important that the chart of accounts contain sufficient detail to
meet an organization`s information needs.
It is important to realize that the chart of accounts will differ, depending on the nature and purpose of the
organization it represents. A chart of accounts should also provide room for growth.
Accounts in the subsidiary ledgers often have longer account codes than those used in the general ledger.
Journals
Transaction data are often recorded in a journal before they are entered into a ledger. Understanding the
process of entering data into journals and then in ledgers is important. This section briefly explains that
process.
A journal entry is needed for each transaction showing the accounts and amounts to be debited and
credited. A general journal is used to record infrequent or nonroutine transactions, such as loan
payments and end-of-period adjusting and closing entries. Firms use the general journal to record
nonrecurring, infrequent, and dissimilar transactions. For example, we usually record periodic
depreciation and closing entries in the general journal.

A specialized journal is used to simplify the process of recording large numbers of repetitive transactions
such as credit sales, cash receipts, purchases on account, and cash disbursements.
Audit Trial
Audit trial is a traceable path of a transaction through a data processing system from point of origin
(whether paper or electronic) to final output or backwards from final output to point of origin. An audit

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trial provides a means to check the accuracy and validity of ledger postings and to trace all changes in
general ledger accounts from their beginning balance to their ending balance.
Discussion Question 2.4:
An audit trail enables a person to trace a source document to its ultimate effect on the financial statements
or work back from amounts in the financial statements to source documents. Describe in detail the audit
trial for the following:
a) Purchase of inventory
b) Sales of inventory
c) Employee payroll
Solution for Discussion question 2.4
a. The audit trail for the purchases of inventory would include linking purchase requisitions, purchase
orders, and receiving reports to vendor invoices for payment. All these documents would also be
linked to the check or EFT transaction used to pay for that invoice and recorded in the Cash
Disbursements Journal. In addition, these documents would all be linked to the journal entry made to
record that purchase. There would be a general ledger account number at the bottom of each column
in the journal. The journal reference would appear in the General Ledger, Inventory Ledger, and
Accounts Payable ledger.

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 Purchase
Requisition

Purchase Receiving
Invoice
Order Report

Accounts
Payable
Ledger

Cash
Payment Disbursements
Journal

General
Ledger

Trial
Balance

Financial
Statements

b. The audit trail for the sale of inventory would link the customer order, sales order, and
shipping document to the sales invoice. These documents would also be linked to the journal
entry recording the sale of that merchandise. The invoice would also be linked to the cash
received from the customer and to the journal entry to record that receipt.

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 Customer
Order

Shipping
Sales Order
Documents

Invoice Sales
Journal

Accounts
Receivable
Ledger

Payment

Cash Receipts General

Journal Ledger

Trial
Balance

Financial
Statements

c. The audit trail for employee payroll would include linking records of employee activity (time
cards, time sheets, etc.) to paychecks and to the journal entry to record payment of payroll. In
a manufacturing company, there would also be links to the job-time tickets used to allocate
labor costs to specific products or processes.

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 Employee Employee Time
Paycheck Card

Cash
Payroll
Disbursemen
Journal
ts Journal

General
Ledger

Trial Balance

Financial
Statements

Data Processing
Once data about a business activity have been collected and entered into a system, they must be
processed. This processing helps keep the data stored in files or database current.
There are four different types of file processing. These basic activities are often referred to as CRUD, an
acronym derived from the first letter of the four activities.
1. Creating or adding new data records, such as adding a new employee to the payroll master file
or database after they have been hired.
2. Reading, retrieving or viewing existing data.
3. Updating data previously stored about the activity, the resources affected by the activity, and the
people who performed the activity. e.g., recording a sale to a customer.
4. Deleting data, such as purging the vendor master file of all vendors that the company no longer
does business with. For example, removing an old customer that has not purchased anything in 5
years.
Updating can be done through several approaches, such as:
• Periodically, such as daily,(also called batch processing) or
• Immediately as each transaction occurs (also called online, real-time processing).
Batch processing
Periodic updating of the data stored about resources and agents is referred to as batch processing.
✓ Source documents are grouped into batches, and control totals are calculated.
✓ Periodically, the batches are entered into the computer system, edited, sorted, and stored in a
temporary file.
✓ The temporary transaction file is run against the master file to update the master file.
✓ Output is printed or displayed, along with error reports, transaction reports, and control totals.
Batch processing is a legacy method that continues to be used for applications, such as payroll, that

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naturally occur at fixed time periods. Batch processing permits the efficient management of a large
volume of transactions. A batch is a group of similar transactions (such as sales orders) that are
accumulated over time and then processed together.
There are two general advantages to batch processing:
First, organizations improve efficiency by grouping together large numbers of transactions into batches
rather than processing each event separately. Thus, a business can achieve an efficient allocation of its
processing resources by employing specialized, cost-effective procedures to deal with these batches.
Batch processing is an economical method of high-volume transaction processing.
Second, batch processing provides control over the transaction process. The accuracy of the process can
be established by periodically reconciling the batch against the control figure. For example, assume that
the total value of a batch of sales orders is $100,000. This number can be recorded when the batch is first
assembled and then recalculated at various points during its processing. If an error occurs during
processing (for example, a sales order is lost), then the recalculated batch total will not equal the original
batch total and the problem will be detected.
The obvious disadvantage of batch processing is that stored data are only current and accurate
immediately after the periodic batch updating process. Consequently, most companies are switching to
on-line, real-time processing for most applications.
Online, real-time processing
Immediate updating as each transaction occurs is referred to as on-line, real-time processing. On-line
data entry is more accurate than periodic batch input because the system can refuse incomplete or
erroneous entries and, because the data are being entered at the time the transaction occurs, any errors
can be easily corrected. Real-time processing ensures that stored information is always current, thereby
increasing its usefulness for making decisions.
– Transactions are entered into a computer system as they occur.
– The master file is immediately updated with the data from the transaction.
– Output is printed or displayed.
Real-time systems process the entire transaction as it occurs. Such a system has many potential
benefits, including:
✓ Improved productivity,
✓ Reduced inventory,
✓ Increased inventory turnover,
✓ Decreased lags in customer billing, and
✓ Enhanced customer satisfaction.
Because transaction information is transmitted electronically, physical source documents can be
eliminated or greatly reduced. Real-time processing is well suited to systems that process lower
transaction volumes and those that do not share common records.
A combination of the two approaches is online batch process, where transaction data are entered into the
system as they occur.
– Transactions are entered into a computer system as they occur and stored in a temporary file.
– Periodically, the temporary transaction file is run against the master file to update the master
file.
– The output is printed or displayed.
Many companies use online, real-time processing because of the competitive advantages it offers. For

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example, a few years ago Federal Express updated its mission statement to include the phrase “ Positive
control of each package will be maintained by utilizing real-time electronic tracking and tracing
systems.” The company`s online real-time system tells the exact location of each package and estimates
its arrival time. Federal Express also provides customers with software that allows them to track their
parcels.
Information Output
The final step in the data processing cycle is information output.
Forms of Information Output
Information is usually presented in one of three forms:
1. A document
2. A report
3. A response to a query
Documents
Documents are records of transaction or other company data. Some, such as checks and invoices, are
transmitted to external parties. Others, such as receiving reports and purchase requisitions, are used
internally. Documents generated at the end of the transaction processing activities are known as
operational documents to distinguish them from source documents, which are used at the beginning of
the process. Documents can be printed out or they can be stored as electronic images in a computer. For
example, Toys ‘ R’ Us uses electronic data interchange to communicate with its suppliers. Every year it
processes over half a million invoices electronically, thereby eliminating paper documents and
dramatically reducing costs and errors. This has resulted in higher profits and more accurate information.
Reports
Reports are prepared for both internal and external users. Reports are used by employees to control
operational activities and by managers to make decisions and to design strategies for the business.
External users need reports for a wide variety of reasons, such as:
✓ To evaluate company profitability,
✓ To judge creditworthiness, or
✓ To comply with regulatory requirements
Some reports, such as financial statements and sales analyses, are produced on a regular basis. Others are
produced on an exception basis to call attention to unusual conditions. Reports can also be produced on
demand.
It is important to periodically reassess the need for each report a company produces. All too often, reports
continue to be prepared long after the need for them disappears, wasting time, money, and computer
resources.
Queries
Increasingly, information needs cannot be satisfied strictly by documents or periodic reports. Instead,
problems and questions constantly arise that need rapid action or answers. To respond to this problem,
personal computers or terminals are used to query the system. A user enters a request for a specific piece
of information. That means, queries are user requests for specific pieces of information. They may be
requested:
– Periodically
– One time
When the information is found, it is retrieved, displayed, or analyzed as requested. Since many queries are

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repetitive, users will usually have a predetermined set of queries available to them. To shorten the time
required to develop the queries and to improve their efficiency, these repetitive queries are often
developed by information system (IS) specialists. Any unusual or one-time queries are usually developed
by the users themselves. When displayed on a monitor, output is referred to as “soft copy”. When printed
on paper, it is referred to as “ hard copy” .
Companies have even made it possible for their suppliers to query their databases. For example, Wal-
Mart allows many suppliers to access any information in their databases that will help them better serve
Walt-Mart`s needs, excluding any data about their competitors. This allows the suppliers to gauge how
well a product is selling in every Wal-Mart store in the world. Wal-Mart and its suppliers can maximize
sales by stocking and promoting items that are selling well. Customers are satisfied because the items
they want are almost always available.
Purpose of the Output
Whether presented in the form of paper reports or displayed on a computer screen, information is
typically produced for a specific purposes. Two of the more important categories of financial information
are:
▪ Financial statements
▪ Managerial reports
External users are provided with financial statements to meet stewardship requirements and to provide the
information needed to make decisions, such as whether to loan money to an organization or invest in it.
Internal users also use the financial statements produced by the AIS. We do not discuss financial
statements as your other accounting and finance courses focus on financial statements in great detail.
Some outputs are specifically for internal use:
An organization`s AIS must also provide managers with detailed operational information to plan, manage,
control, and evaluate company performance.
1. For planning purposes
For planning purposes, management needs information about such things as inventory status, relative
profitability of products, sale forecasts, and new product revenue and cost estimates.
Examples of outputs for planning purposes include:
– Budgets
• Budgets are an entity’ s formal expression of goals in financial terms. One of the
most common and important types of budgets is the cash budget that shows
projected cash inflows and outflows. This information is especially important to a
small business, because cash flow problems are a principal cause of small-
business failures. A cash budget can provide advance warning of cash flow
problems in time to permit corrective action to be taken.
– Sales forecasts
2. For management of day-to-day operations
To help effectively manage day-to-day operations, management needs information on business matters
such as:
✓ Production and delivery schedules,
✓ Open purchase orders, and
✓ Inventory stock status reports
3. For control purposes

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For control purposes, an organization must constantly monitor its progress so that problems can be
corrected as soon as possible. Often, monitoring is done using performance reports that compare an
organization’ s standard, or expected, performances with its actual performance. Since budgeted amounts
are estimates, there are almost certain to be variances for each item in the performance report. Therefore,
the principle of management by exception is used to interpret those results. Management by exception
is an approach to utilizing performance reports that focuses on investigating and acting on only those
variances that are significant. If actual performance is at or near budgeted figures, a manager can assume
the item is under control and no action is needed. On the other hand, significant deviations from budgeted
amounts signal the need to investigate the cause of the discrepancy and take whatever action is
appropriate to correct the problem. Examples of performance reports include comparisons of standard
and actual production rates, materials use, labor efficiency, profitability, and sales.
4. For evaluation purposes
For evaluation purposes, it is important for the AIS to store information about both traditional financial
measures and operational data. To improve the evaluation process, corporate accountants must know how
to organize existing internal company data and present them in a manner that sheds new light on
operational results. They must also collect important data from external sources. For example, companies
regularly survey their customers or hire market research firms to collect data. It is important to design the
AIS so that such externally generated measures in a manner that facilitates the preparation of reports
based on both kinds of data. Examples of evaluation reports are comparisons of the relative
performance of each salesperson, data on how well an organization meets its delivery commitments,
and how satisfied its customers are. Thus, these outputs might include:
a. Surveys of customer satisfaction.
b. Reports on employee error rates.

Behavioral Implications of Managerial Reports

According to an old saying, measurement affects behavior. As applied to business, this means that
employees tend to focus their efforts primarily on those tasks that are measured and evaluated. This can
be either good or bad, depending on the nature of the relationship between the behavior being measured
and the organization`s overall goals.
To illustrate, consider the task of customer complaint resolution. The organization wants to satisfy its
customers to the greatest extent possible, at the lowest possible cost. If customer service representatives
are evaluated solely in terms of the number of complaints resolved per unit of time, however, two types of
problems may arise: the customer service representatives may be focused on quickly resolving each
complaint in the store`s favor that they alienate some customers in the process, or customer service
representatives may “ give away the store” just to appease (settle) and please every customer with a
complaint.
– YOU GET WHAT YOU MEASURE!
For example, suppose an instructor wants to improve student learning.
– He decides to encourage better attendance by grading students on attendance (i.e.,
measuring it).
– The result will be better student attendance, i.e., you get what you measure.
– The improved attendance may or may not improve learning outcomes.
– Students may be getting better grades when attendance is measured, but not learning
more.

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 – Some students may in fact reduce their studying because they believe they can use the
attendance score to boost their grade. This behavior would be a dysfunctional result of
the measurement.

Budgets can often result in dysfunctional behavior. For example, if a budget does not include all the
funds required to purchase the equipment needed to meet performance goals, then managers may be
tempted to rent the equipment. This solution might allow them to meet their performance targets and
remain within budget but may end up costing the company more than it would have spent to purchase the
equipment outright.
For example, in order to stay within budget, the IT department did not buy a security package for its
system.
– A hacker broke in and devastated some of their data files.
– Critical security measures were foregone in order to meet budgetary goals.
– The resulting costs far outweighed the savings.

Indeed, the budgeting process itself can be dysfunctional. Management may extend a great deal of effort
in “ number crunching,” rather than focusing on how to accomplish the organization`s mission and
goals. In other words, budgeting can also be dysfunctional in that the focus can be redirected to creating
acceptable numbers instead of achieving organizational objectives.
• Does this mean organizations shouldn’ t budget?
• The saying goes, “ Not many people sit around and have a roast goose fall in their lap.”
• In other words, if you want a roast goose, you have to aim.
• With financial results, you’ re also unlikely to achieve when you don’ t aim.
• Just be careful where you aim!
Discussion Question 2.6:
Some individuals argue that accountants should focus on producing financial statements and leave the
design and production of managerial reports to information systems specialists. What are the advantages
and disadvantages of following this advice? To what extent should accountants be involved in producing
reports that include more than just financial measures of performance? Why?
Answer: There are no advantages to accountants focusing only on financial information. Both the
accountant and the organization would suffer if this occurred. Moreover, it would be very costly to have
two systems rather than one that captures and processes operational facts at the same time as it captures
and reports financial facts.
The main disadvantage of this is that accountants would ignore much relevant information about the
organization’ s activities. To the extent that such nonfinancial information (e.g., market share, customer
satisfaction, measures of quality, etc.) is important to management, the value of the accounting function
would decline. Moreover, accountants have been trained in how to design systems to maximize the
reliability of the information produced. If relevant information is not produced by the AIS, there is danger
that the information may be unreliable because the people responsible for its production have not been
trained in, or adequately aware of, the potential threats to reliability and the best measures for dealing
with those threats.
Role of the AIS
Traditionally, the AIS has been referred to as a transaction processing system because its only concern
was financial data and accounting transactions. For example, when a sale took place, the AIS would

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record a journal entry showing only the date of the sale, a debit to either cash or accounts receivable, a
credit to sales. Other potentially useful nonfinancial information about the sale, such as the time of the
day that it occurred, would traditionally be collected and processed outside of the AIS. Consequently,
many organizations developed additional information systems to collect, process, store, and report
information not contained in the AIS. Unfortunately, the existence of multiple systems creates numerous
problems and inefficiencies. Often the same data must be captured and stored by more than one system,
which not only results in redundancy across systems but also can lead to discrepancies if data are changed
in one system but not in others. In addition, it is difficult to effectively integrate data from the various
systems.
Enterprise resource planning (ERP) systems are designed to overcome these problems as they integrate
all aspects of a company`s operations with its traditional AIS. Thus, when the sales force enters an order,
the effect of the transaction automatically flows to all affected parts of the company. Inventory is updated,
production schedules are adjusted, and purchase orders are initiated to acquire any needed raw materials
and supplies. Moreover, important nonfinancial data, such as the time the activity occurred, is collected
and stored in the same system.
A key feature of ERP systems is the integration of financial with other nonfinancial operating data. The
value of such integration suggests that there may be strategic benefits to more closely linking the
traditionally separate functions of information systems and accounting, and many organizations are
beginning to combine these two functions. The importance of this trend is reflected in the fact that some
universities have merged their accounting and information systems departments.

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