Chapter 1

Accounting Information System: An Overview

Definition of Terms

System – a set of two or more interrelated components that interact to achieve a goal.

- Most system are composed of smaller sub systems that support the larger system.

Example: The College of Business and Accountancy is a system composed of two

departments. Each of which is a subsystem. Moreover, the college itself is a subsystem
of the university

• Each subsystem is designed to achieve one or more organizational goals.

Changes in subsystems cannot be made without considering the effect on
other subsystems and on the system as a whole.

Goal Conflict – occurs when a subsystem’s goals are inconsistent with the goals of
another subsystem or with the system as a whole.

Goal Congruence – occurs when a subsystem achieves its goals while contributing to the
organization’s overall goal.

- The larger the organization and the more complicated the system, the more
difficult it is to achieve goal congruence.

Data – facts that are collected, recorded, stored, and processed by an information
system.

- Businesses need to collect several kinds of data, such as the activities that take
place, the resources affected by the activities, and the people who participate in the
activity.
Example: The business needs to collect data about a sale (date, total amount), the
resource sold (good or service, quantity sold, unit price), and the people who
participated (customer, sales person)

Information – the data that have been recognized and processed to provide meaning
and improve the decision-making process.

- Users make better decisions as the quantity and quality of information increase.
- However, there are limits to the amount of information the human mind can
absorb and process

Information Overload – occurs when those limits are passed, resulting in a decline
in decision-making quality and an increase in the cost of providing that
information.
Information Technology (IT) – used by system designers to help decision-makers more
effectively filter and condense information.

Value of Information – the benefit produced by information minus the cost of producing
it.

- Benefits of information include reduced uncertainty, improved decisions, and

improved ability to plan and schedule activities.
- The cost includes the time and resources spent to produce and distribute the
information.

• Information costs and benefits can be difficult to quantify, and it is difficult to

determine the value of information before it has been processed and utilized.
Nevertheless, the expected value of information should be calculated as
effectively as possible so that the cost of producing the information do not
exceed its benefits.

Characteristics of Useful Information

RELEVANT Reduces uncertainty, improves decision-making, or confirms or corrects
prior expectations.
RELIABLE Free from error or bias, accurately represents organization events or
activities.
COMPLETE Does not omit important aspects of the events or activities it measures.
TIMELY Provided in time for decision-makers to make decisions.
UNDERSTANDABLE Presented in a useful and intelligent format.
VERIFIABLE Two independent, knowledgeable people produce the same
information.
ACCESSIBLE Available to users when they need it and in a format they can use.

INFORMATION NEEDS AND BUSINESS PROCESSES

Business Process – a set of related, coordinated, and structured activities and tasks that
are performed by a person, a computer, or a machine, and that help accomplish a
specific organizational goal.

To make effective decisions, organizations must decide:

a. What decisions they need to make,

b. What information they need to make the decisions, and
c. How to gather and process the data need to produce the information.
Information Needs

SAMPLE Business Processes, Key Decisions, and Information Needs

BUSINESS KEY DECISIONS INFORMATION NEEDS
PROCESSES
Acquire capital • How much • Cash flow projections
• Find investors or borrow funds • Pro forma financial statements
• If borrowing, obtaining best terms • Loan amortization schedule
Acquire building • Size of building • Capacity needs
and equipment • Amount of equipment • Building and equipment prices
• Rent or buy • Market study
• Location • Tax tables and depreciation
• How to depreciate regulations
Hire and train • Experience requirements • Job descriptions
employees • How to assess integrity and • Applicant job history and skills
competence 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 • Mark-up percentage • Pro forma income statement
• Offer in-house credit • Credit card costs
• Which credit cards to accept • Customer credit status
Collect payments • If offering credit, what terms • Customer account status
from 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 • HR forms
service • Costs of external payroll service
Pay taxes • Payroll tax requirements • Government regulations
• Sales tax requirements • Total salaries expense
• Total Sales
Pay vendors • Whom to pay • Vendor invoices
• When to pay • Accounts payable records
• How much to pay • Payment terms
Business Processes
Sample Interactions between an Organization and External and Internal Parties

Purchase orders Customer orders

Goods and services Goods and services
Vendors Customers
Vendor invoices Customer invoices

Vendor payments

Investment funds Labor & services

Investors Dividends Wages, salaries Employees

Financial Statements Accounting & Commissions
Information
Loans
System Managerial reports &

Loans payments Financial Statements Management

Creditors
Budgets &
Financial Statements
Accounting entries

Deposits Regulations and tax forms

Government
Banks Withdrawals Taxes & Reports Agencies
Bank statements

Transaction – 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:

→ Selling goods to customers

→ Buying inventory from suppliers
→ Paying employees

Transaction Processing – the process of capturing transaction data, processing it, storing
it for later use, and producing information output, such as a managerial report or a
financial statement.

Many business activities are pairs of events involved in a GIVE-GET EXCHANGE.

Give-Get Exchange – transactions that happen a great many times, such as giving up
cash to get inventory from a supplier and giving employees a paycheck in exchange for
their labor.

Business Processes or Transaction Cycles – the major give-get exchanges that occur
frequently in most companies.

Five Major Business Processes or Transaction Cycles

1. The Revenue Cycle – activities associated with selling goods and services in
exchange for cash or a future promise to receive cash.

2. The Expenditure Cycle – activities associated with purchasing inventory for resale
or raw materials in exchange for cash or a future promise to pay cash.

3. The Production or Conversion Cycle – activities associated with using labor, raw
materials and equipment to produce finished goods.

4. The Human Resources/Payroll Cycle – activities associated with hiring, training,

compensating, evaluating, promoting, and terminating employees.

5. The Financing Cycle – activities associated with raising money by selling shares in
the company to investors and borrowing money as well as paying dividends and
interest.

Common Cycle Activities

TRANSACTION MAJOR ACTIVITIES IN THE CYCLE
CYCLE
Revenue • Receive and answer customer inquiries
• 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 (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 vendor invoices for payment
• Pay vendors for goods and services
• Update (reduce) accounts payable
• Handle purchase returns, discounts and allowances
• Prepare management reports
• Send appropriate information to the other cycles
Human • Recruit, hire, and train new employees
Resources/Payroll • 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
• Store finished products
• Accumulate costs for products manufactured
• Prepare management reports
• Send appropriate information to the other cycles
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

General Ledger and Reporting System – information-processing operations involved in

updating the general ledger and preparing reports for both management and external
parties.

The figure below shows how these various transaction cycles relate to one another and
interface with the general ledger and reporting system, which is used to generate
information for both management and external parties
The AIS and Its Subsystems

Financing Expenditure Human

Cycle Cycle Resources

General Ledger and Reporting System

Production Revenue
Cycle Cycle

ACCOUNTING INFORMATION SYSTEMS

Accounting Information System (AIS) – is the intelligence – the information-providing

vehicle of accounting (the language of business)

- can be a paper-and-pencil manual system, a complex system using the latest in

IT, or something in between.

Six Components of an AIS

1. The people who use the system;

2. The procedures and instructions used to collect, process and store data;
3. The data about the organization and its business activities;
4. The software used to process the data;
5. The information technology infrastructure, including the computers, peripheral
devices, and network communication devices used in the AIS; and
6. The internal controls and security measures that safeguard AIS data
These six components enable an AIS to fulfill three important business functions.

1. Collect and store data about organizational activities, resources, and personnel.
Organizations have a number of business processes, such as making a sale or
purchasing raw materials, which are repeated frequently.
2. Transform data into information so management can plan, execute, control, and
evaluate activities, resources, and personnel.
3. Provide adequate controls to safeguard the organization’s assets and data.

HOW AIS CAN ADD VALUE TO AN ORGANIZATION

1. Improving the quality and reducing the cost of products or service

2. Improving efficiency
3. Sharing knowledge
4. Improving the efficiency and effectiveness of its supply chain
5. Improving the internal control structure
6. Improving decision making

THE AIS AND CORPORATE STRATEGY

Factors Influencing Design of the AIS

An organization’s AIS play an important role in helping it adopt and maintain a strategic
position. Achieving a close fit among activities requires the data be collected about
each activity. It is also important that the information system collect and integrate both
financial and nonfinancial data about the organization’s activities.

THE ROLE OF AIS IN THE VALUE CHAIN

Value Chain – linking together of all the primary and support activities in a business. Value
is added as a product pass through the chain.
Primary Activities – value chain activities that produce, market and deliver products and
services to customers and provide post-delivery service and support.

Five Primary Activities

1. Inbound logistics consists of receiving, storing, and distributing the materials an

organization uses to create the services and products it sells. For example, an
automobile manufacturer receives, handles, and stores steel, glass, and rubber.

2. Operations activities transform inputs into final products or services. For example,
assembly line activities convert raw materials into a finished car.

3. Outbound logistics activities distribute finished products or services to customers.

An example is shipping automobiles to car dealers.

4. Marketing and sales activities help customers buy the organization’s products or
services. Advertising is an example of a marketing and sales activity.

5. Service activities provide post-sale support to customers. Examples include repair

and maintenance services.

Support Activities – value chain activities such as firm infrastructure, technology,

purchasing, and human resources that enable primary activities to be performed
efficiently and effectively.

Four Categories of Support Activities

1. Firm infrastructure is the accounting, finance, legal, and general admission

activities that allow an organization to function. The AIS is part of the firm structure.

2. Human resources activities include recruiting, hiring, training, and compensating

employees.

3. Technology activities improve a product or service. Examples include research

and development, investments in IT, and product design.

4. Purchasing activities procure raw materials, supplies, machineries, and the

buildings used to carry out the primary activities.

Supply Chain – an extended system that includes an organization’s value chain as well
as its suppliers, distributors, and customers.