Chapter 1

The
Information
System:
An
Accountant’s
Perspective
Accounting Information
Systems 9e
James A. Hall

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service or otherwise on a password-protected website for classroom use.
 Objectives for Chapter 1
 Recognize the primary information flows within the business
environment.
 Understand the difference between accounting information systems
and management information systems.
 Understand the difference between financial transactions and non-
financial transactions.
 Know the principal features of the general model for information
systems.
 Understand the organizational structure and functional areas of a
business.
 Be able to distinguish between external auditing, internal auditing,
and advisory services as they related to accounting information
systems.

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 The Information Environment
 Information is a business resource.

 Operations management directly responsible for controlling

day-to-day operations.
 Middle management accountable for short-term planning and
coordinating activities to accomplish organizational
objectives.
 Top management responsible for longer-term planning and
setting organizational objectives.
 Two groups of external users: trading partners and
stakeholders.

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The Information Environment

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 Information Objectives
 The goal of an information system is to support:

The firm’s day to day operations.

Management decision making.

The stewardship function of management.

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 An Information Systems Framework
 The information system is the set of formal procedures by
which data are collected, processed into information, and
distributed to users.
 A transaction is an event that affects or is of interest to the
organization and is processed by its information system as a
unit of work.
 A financial transaction is an economic event that affect the
assets and equities of the organization, is reflected in its
accounts and is measured in monetary terms.
 A nonfinancial transaction is an event that doesn’t meet the
definition of a financial transaction.

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An Information Systems Framework

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An Information Systems Framework

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 An Information Systems Framework
 Accounting information system (AIS) processes financial and
some nonfinancial transactions. Three subsections:
The transaction processing system (TPS) which supports
daily business operations.
The general ledger/financial reporting system (GL/FRS)
which produces reports.
The management reporting system (MRS) which provides
information for decision making.
• Management information system (MIS) processes nonfinancial
transactions not processed by the AIS.

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An Information Systems Framework

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 AIS Subsystems
• The transaction processing system (TPS) :
– Converts economic events into financial transactions.
– Records financial transactions in the accounting records.
– Distributes essential financial information to support operations.
• The general ledger/financial reporting system (GL/FRS)
takes information from the TPS and other input and:
– Updates general ledger control accounts.
– Handles nondiscretionary reporting requirements.
• The management reporting system (MRS) provides the
internal information needed to manage a business and handles
discretionary reporting.

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A General Model for AIS

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 A General Model for AIS
• End users fall into two groups :
– External users include creditors, stockholders, government
agencies, suppliers and customers.
– Internal users include management and operations personnel.
– Distributes essential financial information to support operations.
• Data are facts which may or may not be processed and have
no direct effect on a user’s actions.
• Information causes a user to take an action that would
otherwise not have been taken.
• Data sources are financial transactions that enter the
information system for internal or external sources.

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 A General Model for AIS
• Data collection is the first operational stage in the
information system:
– Objective is to ensure data are valid, complete and free from
material errors.
– Only relevant data should be captured.
– Efficient collection procedures designed to collect data only once.
• Data processing tasks range from simple to complex.
• The organization’s database is its physical repository for
financial and nonfinancial data.
– Term could apply to a filing cabinet or computer disk.

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 A General Model for AIS
• The levels in the data hierarchy:
The data attribute is the most elemental piece of potentially
useful data in the database.
A record is a complete set of attributes for a single occurrence
within an entity class.
A file (or table) is a complete set of records of an identical
class.
• Database management involves three fundamental tasks:
storage, retrieval and deletion.

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 A General Model for AIS

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 A General Model for AIS
• Information generation is the process of compiling,
arranging, formatting, and presenting information to users.
• Regardless of physical form, useful information has:
Relevance: Content must serve a purpose.

Timeliness: No older than time frame of supported action.

Timeliness: No older than time frame of supported action.

Accuracy: Free from material errors.

Completeness: All essential information is present.

Summarization: Aggregated for the user’s needs.

Feedback is a form of output sent back to the system as a source of data.

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 Functional Segmentation
• Materials Management
– purchasing, receiving and stores
• Production
– production planning, quality control, and maintenance
• Marketing
• Distribution
• Personnel
• Finance

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 Functional Segmentation

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Functional Segmentation

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 The Accounting Function
• Accounting manages the financial resource of the firm:
– Captures and records transactions.
– Distributes transaction information to operations personnel.
• Value of information is determined by its reliability.
– Relevance, accuracy, completeness, summarization and
timeliness.
– Unreliable information has no value.
• Information reliability requires accounting independence.
– Accounting activities must be separate and independent of the
functional areas maintaining custody of resources.
– Accounting supports these functions with information but does
not participate in the physical activities.

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 Information Technology
• Many organization employ a combination of centralized
and distributed processing.
Centralized Data Processing:
– All data processing performed by large computer(s) in a common
data center that serves users throughout the organization.
– Lends itself to intra-organization communication and data
sharing.
Distributed Data Processing (DDP):
– Users process transactions locally with each user segment
possessing IT needs to support their operations.
– Users function independently and tend not to share data and
information.

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Information Technology

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Information Technology

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 Information Technology
• Systems development is the process organizations use to
acquire information systems.
– Can be purchased or built from scratch.
– Commercial software available for general accounting and
industry specific applications. Sometimes called turnkey
systems because can be implemented with little modification.
– Custom software is developed through a formal process called
the system development life cycle. Requires an in-house team
of qualified individuals.
• Systems maintenance may be trivial or significant.
– Between 80% - 90% of system’s total cost may be incurred
because of maintenance activities.

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 Information Technology
• Centrally organized companies with shared data use
database administration to ensure security and integrity.
• A network is a collection of computers and communication
devices that allow users to communicate, access data and
applications, and share information and resources.
– Network administration responsible for effective functioning of
hardware and software.
• Due to the highly technical, dynamically changing and
expense of IT, many executives look to IT outsourcing.
– Organization sells IT resources and leases back IT services.
– With cloud computing data centers deliver hosted IT services
over the Internet: Software as a service (SaaS), infrastructure
as a service (IaaS) and platform as a service (PaaS).
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 The Role of Accountants in AIS
• Accounts play a prominent role on system development
teams as domain experts, responsible for many aspects of
the conceptual system including specifying rules, reporting
requirements and internal control objectives.
– IT professionals determine the most economical and effective
technologies for the physical system, including data storage.
• Accountants perform audits which typically involve the AIS.
– External audit is an independent attestation and opinion (audit
report) regarding financial statement presentation.
• Requires auditors (independent CPAs) to test internal controls and
perform substantive tests of data.
• Critical element is auditor independence, which means the auditor is free
from factors that might influence the audit report.

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 The Role of Accountants in AIS
• Prior to SOX, accounting firms were permitted to provide
both advisory and attest services to clients.
– SOX legislation restricts non-audit services that auditors may
provide and prohibits auditors from providing these services:
• Other accounting services including bookkeeping, financial
information systems design and implementation, appraisal or
valuation, actuarial, and internal audit outsourcing.
• Management or human resources, broker or dealer,
investment adviser, or investment banking services.
• Legal services and expert services unrelated to the audit.
• Any other service that the Board determines, by regulation, is
impermissible.

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 The Role of Accountants in AIS
• Internal auditing is an independent appraisal function
within an organization to examine and evaluate activities.
– External auditors represent outsiders and internal auditors
represent the interests of the organization.
• Fraud audits have increased in popularity as a corporate
governance tool.
– May be initiated by managers to investigate employees or the
board to investigate management.
• Audit committees serves an independent “check and
balance” for internal audit functions and a liaison with
external auditors.
– Usually three people, one of which must be a “financial expert”.

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 Chapter 2
Introduction
to
Transaction
Processing

Accounting Information
Systems 9e
James A. Hall

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whole or in part, except for use as permitted in a license distributed with a certain product or
service or otherwise on a password-protected website for classroom use.
 Objectives for Chapter 2
• Understand the broad objectives of transaction cycles.
• Recognize the types of transactions processed by each of the
three transaction cycles.
• Know the basic accounting records used in TPS.
• Understand the relationship between traditional accounting
records and their computer-based digital equivalents.
• Be familiar with documentation techniques.
• Understand the differences between batch and real-time
processing and their impact on transaction processing.
• Be familiar with data coding schemes used in AIS.

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 An Overview of Transaction Processing
• A financial transaction is an economic event that affects the
assets and equities of the firm, is reflected in its accounts, and
is measured in monetary terms.
• Three transaction cycles: the expenditure cycle, the conversion
cycle and the revenue cycle. Every business:
– Incurs expenditures in exchange for resources (expenditure cycle).
– Provides value added through its products or services (conversion
cycle).
– Receives revenue from outside sources (revenue cycle).

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 An Overview of Transaction Processing

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 An Overview of Transaction Processing
• Expenditure Cycle: Time lag between components due to
credit relationship with suppliers.
– physical component (acquisition of goods)
– financial component (cash disbursements to the supplier)
• Conversion Cycle:
– the production system (planning, scheduling, and control of
the physical product through the manufacturing process)
– the cost accounting system (monitors the flow of cost
information related to production)
• Revenue Cycle: Time lag between components due to
credit relationship with customers.
– physical component (sales order processing)
– financial component (cash receipts)

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 Accounting Records: Manual Systems
• Source documents are used to capture and formalize
transaction data needed for transaction processing.
• Product documents are the result of transaction
processing.
• Turnaround documents - product documents of one
system that becomes source documents for another.
• Journals are chronological records of transactions.
– Special journals are used to record specific classes of
transactions that occur in high frequency.
– Register denotes certain types of special journals.
– General journal is used to record nonrecurring, infrequent, and
dissimilar transactions.

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 Accounting Records: Manual Systems

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 Accounting Records: Manual Systems

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 Accounting Records: Manual Systems

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Accounting Records: Manual Systems

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Accounting Records: Manual Systems

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 Accounting Records: Manual Systems

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 Accounting Records: Manual Systems
• Ledger is a book of accounts that reflects the financial
effects of a firm’s transactions as they are posted from the
various journals.
– General ledgers contain account information in highly
summarized control accounts.
– Subsidiary ledgers contain details for each 0f the individual
accounts that constitute a particular control account.
• Together the accounting records provide an audit trail for
tracing account balances contained in the financial
statements back to the source documents and events that
created them.
– Important in the conduct of a financial audit.

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Accounting Records: Manual Systems

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 Accounting Records: Manual Systems

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Accounting Records: Manual Systems

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 Accounting Records: Manual Systems

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 Digital Accounting Records
• Master file contains account data.
• Transaction file is a temporary file of transaction records
used to update data in a master file.
• Reference file stores data that are use as standards for
processing transactions.
• Archive file contains records of past transactions retained
for future reference
– Form an important part of the audit trail.
• Digit record audit trails are less observable than those
between hard-copy documents, but they still exist.

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 Digital Accounting Records

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 File Structures
• The flat-file model describes an environment where
individual data files are not related to other files. Leads to
three significant data redundancy problems:
• Data Storage:
– Organizations must incur the costs of multiple collection and
storage procedures.
• Data Updating:
– Changes or additions must be performed multiple times which
adds significantly to the task and cost of data management.
• Currency of Information:
– If update information is not properly disseminated, changes will
not be reflected in some users’ data, resulting in decisions based
on outdated information.

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 File Structures
• Other problems with the flat-file approach:
• Task-Data Dependency:
– User’s information set is constrained by the data user possess
and controls. This leads to the inability to obtain additional
information as needs change.
• Data Integration:
– Separate files are difficult to integrate across multiple users.

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 File Structures

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 The Database Model

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 Documentation Techniques
• Data flow diagram (DFD) uses symbols to represent
entities, processes, data flows and data stores.
– Used extensively by systems analysts to represent the logical
elements of the system but does not depict the physical system.
• Entity relationship diagram (ER) is a technique used to
represent the relationship between business entities.
– The degree of the relationship (cardinality) is the numeric
mapping between entities: one-to-one (1:1), one-to-many (1:M)
or many-to-many (M:M).
– A data model is a blueprint for the physical database.

• DFDs and ER diagrams document different system aspects

but are related.
– DFDs model systems processes and ER diagrams system data.
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 Documentation Techniques

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 Documentation Techniques

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Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques
• System flowchart is the graphical representation of the
physical relationships among key elements of a system.
– Elements include departments, manual activities, computer
programs, hard-copy and digital accounting records.
– Also describe the physical computer media being employed.
– Shows the processing of a single transaction only.

• Program flowchart provides operational details for every

program represented in a system flowchart.
– Sometimes used by accountants to verify the correctness of
program logic.
• Record layout diagrams reveal the internal structure of
digital records in a database table.

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Documentation Techniques

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 Transaction Processing Models: Batch vs. Real-Time
• Information time frame:
– Batch systems assemble transactions in groups, resulting in a
time lag. Real-time systems process transactions individually as
they occur with no time lag.
• Resources:
– Generally fewer required with a batch system.
• Operational efficiency:
– Batch processing of noncritical accounts eliminates unnecessary
activities at critical points in the process.
• Designer must consider the trade-off between efficiency
and effectiveness.

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 Transaction Processing Models: Batch vs. Real-Time
• Updating master files from transactions:
– Involves changing the value of one or more variable fields to
reflect the effects of a transaction (batch and real-time).
• Master file backup is a standard procedure to maintain file
integrity in the event that:
– An update program error corrupts the master file being updated.
– Undetected transaction errors result in corrupted balances.
– A disaster physically destroys current master files.
• Batch processing using real-time data collection:
– Popular approach that captures and processes some aspects of a
transaction when in occurs and other aspects in batch mode.
• Real-time systems process entire transactions as they occur.
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Transaction Processing Models

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 Transaction Processing Models

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 Transaction Processing Models

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 Transaction Processing Models

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 Data Coding Schemes
• Involves creating simple codes to facilitate efficient data
processing.
• Business organizations process large volumes of transactions
with similar basic attributes.
– Uncoded entries require extensive recording space, are time
consuming to record and are error prone.
• Advantages of data coding in AIS:
– Concisely represents large amounts of complex information that
would otherwise be unmanageable.
– Provides accountability over transaction completeness.
– Identifies unique transactions and accounts within a file
– Supports the audit function by providing an effective audit trail.
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 Data Coding Schemes

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 Data Coding Schemes
• Numeric group codes are used to represent complex items
or events involving two or more pieces of related data.
– Zones or fields have specific meanings.
• For example, a coding scheme for tracking sales might be
04-09-476214-99, meaning:
Store Number Dept. Number Item Number Salesperson
04 09 476214 99

• Facilitates representation of large amounts of diverse data.

• Allows complex data to be logically represented.
• Permits detailed analysis and reporting.
• Disadvantages are overuse which can increase costs and
linking of unrelated data.
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 Data Coding Schemes
• Alphabetic codes are used for many of the same purposes
as numeric codes.
– May use sequential, block or group coding techniques.
– Dramatically increases the capacity to represent large numbers of
items.
– Disadvantages are it is difficult to rationalize the meaning of the
codes and they tend to be difficult for users to sort.
• Mnemonic codes are alphabetic character acronyms and
other combinations that convey meaning.
– Common application is the two code state abbreviations or
college course coding (in combination with numeric codes).
– Codes convey a high degree of information.
– Disadvantage is limited ability to represent items within a class.
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 Chapter 3
Ethics,
Fraud and
Internal
Control
Accounting Information
Systems 9e
James A. Hall

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 Objectives for Chapter 3
• Understand the broad issues pertaining to business ethics.
• Have a basic understanding of ethical issues related to the use
of information technology.
• Be able to distinguish between management fraud and
employee fraud.
• Be familiar with common types of fraud schemes.
• Be familiar with the key features of the COSO internal control
framework.
• Understand the objectives and application of both physical and
IT control activities.
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 Ethical Issues in Business
• Ethics pertains to principles of conduct used in making choices
and guiding behavior in situations involving the concept of
right and wrong.
• Business ethics involves answering two questions:
– How do managers decide what is right in conducting business?
– Once recognized, how do managers achieve what is right?
• Businesses having conflicting responsibilities to employees,
shareholders, customers and the public.
– Every decision has consequences. Seeking a balance between the
consequences is managers’ ethical responsibility.
– The benefit from a decision must outweigh the risks and no
alternative should provide greater benefit or less risk.
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 Ethical Issues in Business
• Computer ethics analyzes the social impact of computer
technology and formulation and justification of policies for the
ethical use of technology.
– Para computer ethics involves taking an interest in computer ethics
cases and acquiring some level of skill and knowledge in the field.
• Issues of concern include:
– Privacy and ownership in the personal information industry.
– Security involving accuracy and confidentiality.
– What can an individual or organization own?
– Equity of access issues related to economic status, culture and safety.
– Environmental issues, artificial intelligence, unemployment and
displacement and computer misuse.

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 Ethical Issues in Business
• Sarbanes-Oxley Act (SOX) Section 406 requires public
companies to disclose to the SEC if they have a code of ethics
that applies to the CEO, CFO and controller.
– If a company does not have a code, it must explain why.
• Compliance with 406 requires a code of ethics that addresses:
– Procedures for dealing with conflicts of interest.
– Full and fair disclosures to ensure candid, open, truthful disclosures.
– Requiring employees to follow applicable laws, rules and regulations.
– A mechanism to permit prompt internal reporting of ethical
violations.
– Taking appropriate actions when code violations occur.

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 Fraud and Accountants
• Passage of SOX has had tremendous impact on the external
auditor’s responsibilities for fraud detection in a financial audit.
– Objective is to seamlessly blend fraud consideration into all phases of
the audit process (SAS 99).
• Fraud denotes a false representation of material fact made
with the intent to deceive and induce another to rely it to their
detriment. Act must meet five conditions:
– False representation: false statement or disclosure.
– Material fact: fact must be substantial in inducing someone to act.
– Intent to deceive: must exist or knowledge statement is false.
– Justifiable reliance: misrepresentation must have been relied on.
– Injury or loss: must have been sustained by the victim.

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 Fraud and Accountants
• Fraud in business has a more specialized meaning:
– Intentional deception, asset misappropriation or financial data
manipulation to the advantage of the perpetrator.
– White collar crime, defalcation, embezzlement and irregularities.
• Auditors encounter two types of fraud:
– Employee fraud (non-management) generally designed to convert
cash or other assets to the employee’s personal benefit.
– Management fraud does not involve direct theft and is more harmful
as it usually involves material misstatements of financial data.
• Perpetrated at levels of management above internal control structures.
• Frequently involves exaggerated financial statement results.
• Misappropriation of assets often shrouded in complex transactions involving
related third parties.

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 Fraud and Accountants
• The fraud triangle factors that contribute to fraud:
– Situational pressures that coerce an individual to act dishonestly.
– Opportunity through direct access to assets.
– Ethics which relate to one’s character and moral compass.
• A recent study suggests fraud losses equal 5% of revenue.
– Actual cost difficult to quantify and do not include indirect losses.
• Most frauds are committed by employees than managers,
the losses are much higher for managers and owners.
• Collusion in the commission of a fraud is difficult to prevent
and detect.

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 Fraud and Accountants: Underlying Problems
• Lack of Auditor Independence: Audit firms also engaged by
their clients to perform non-accounting activities.
• Lack of Director Independence: Many board of directors are
comprised of directors who are not independent.
• Questionable Executive Compensation Schemes: Stock options
as compensation result in strategies aimed at driving up stock
prices at the expense of the firm’s long-term health.
– In extreme cases financial statement misrepresentation has been
used to achieve stock prices needed to exercise options.
• Inappropriate Accounting Practices: Common characteristic to
many financial statement fraud schemes.

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 Fraud and Accountants
• SOX establishes a framework for oversight and regulation of
public companies. Principal reforms pertain to:
– Creation of the Public Company Accounting Oversight Board
(PCAOB) to set standards, inspect firms, conduct investigations
and take regulator actions.
– Auditor independence: More separation between a firm’s
attestation and non-auditing activities.
– Corporate governance and responsibility: Audit committee
members must be independent and committee must hire and
oversee the external auditors.
– Issuer and management disclosure: Increased requirements.
– Fraud and criminal penalties: New penalties for destroying or
tampering with documents, securities fraud, and taking actions
against whistleblowers.

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 Fraud and Accountants
• Corruption involves a member of the organization in
collusion with an outsider. Four principal types:
– Bribery involves an exchange of value to influence an official in
the performance of his or her lawful duties.
– An illegal gratuity is an exchange of value because of an official
act that ha been taken. Similar to a bribe, but after the fact.
– A conflict of interest occurs when an employee acts on behalf of a
third party during the discharge of his or her duties.
– Economic extortion is use or threat of force to obtain value.

• The most common fraud schemes involve some type of

asset misappropriation (almost 90%).
– Cash, checking accounts inventory, supplies, equipment and
information are the most vulnerable to abuse.

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 Fraud and Accountants: Fraud Schemes
• Skimming involves stealing cash before it is recorded on an
organization’s books.
• Cash larceny involves stealing cash after it is recorded.
– Lapping is a common technique.
• Billing schemes (vendor fraud) involves paying false
vendors by submitting invoices for fictitious goods.
– A shell company fraud includes a false vendor set-up and false
purchase orders.
– A pass through fraud involves both a legitimate and false vendor
purchase (at a much higher price).
– A pay-and-return scheme involves double payment with the clerk
intercepting the vendor reimbursement check.

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 Fraud and Accountants: Fraud Schemes
• Check tampering involves altering legitimate checks.
• Payroll fraud is the distribution of fraudulent paychecks.
• Expense reimbursement fraud involve false or inflated
expense reimbursements.
• Thefts of cash are schemes that involve the direct theft of
cash on hand.
• Non-cash misappropriations involve the theft of noncash
assets like inventory or information.
• Computer fraud is discussed in a later chapter.

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 Internal Control Concepts and Techniques
• The internal control system consists of policies, practices
and procedures to achieve four broad objectives:
• Safeguard assets of the firm.
• Ensure accuracy and reliability of accounting records and
information.
• Promote efficiency of the firm’s operations.
• Measure compliance with management’s prescribed
policies and procedures.

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 Internal Control Concepts and Techniques
• Modifying Assumptions to the Internal Control Objectives:
• Management Responsibility
– The establishment and maintenance of a system of internal control
is the responsibility of management.
• Reasonable Assurance
– Cost of achieving objectives should not outweigh the benefits.
• Methods of Data Processing
– Control techniques vary with different types of technology.
• Limitations
– These include (1) possibility of error, (2) circumvention, (3)
management override and (4) changing conditions.

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 Internal Control Concepts and Techniques
• The absence or weakness of a control is an exposure:
– May result in asset destruction or theft and corruption or
disruption of the information system.
• Preventive controls are passive techniques designed to
reduce undesirable events by forcing compliance with
prescribed or desired actions.
– Preventing errors and fraud is more cost-effective than
detecting and correcting them.
• Detective controls are designed to identify undesirable
events that elude preventive controls.
• Corrective controls are actions taken to reverse the
effects of errors detected.
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 Internal Control Concepts and Techniques
• Public company management responsibilities are codified
in Sections 302 and 404 of SOX:
– Section 302 requires management to certify organization’s
internal controls on a quarterly and annual basis.
– Section 404 requires management to assess internal control
effectiveness.
• COSO internal control framework five components:
• The control environment sets the tone for the
organization and influences control awareness.
– SAS 109 requires auditors obtain sufficient knowledge to assess
attitudes and awareness of the management, board and owners
regarding internal controls.
– As a minimum, board should adopt the provisions of SOX.
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 Internal Control Concepts and Techniques
• COSO internal control framework five components:
• Organizations must perform a risk assessment to identify,
analyze and manage financial reporting risks.
• The quality of information the AIS generates impacts
management’s ability to take actions and make decisions.
– An effective system records all valid transactions and provides
timely and accurate information.
• Monitoring is the process by which the quality of internal
control design and operations can be assessed.
• Control activities are policies and procedures to ensure
appropriate actions are taken to deal with identified risks.

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 Internal Control Concepts and Techniques
• IT controls relate to the computer environment:
– General control pertain to entity-wide IT concerns.
– Application controls ensure the integrity of specific systems.
• Physical controls relate to human activities:
– Transaction authorization is to ensure all material transactions
processed are valid.
– Segregation of duties controls are designed to minimize
incompatible functions including separating: (1) transaction
authorization and processing and (2) asset custody and record-
keeping. Successful fraud must require collusion.
– Supervision is a compensating control in organizations too
small for sufficient segregation of duties.

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 Internal Control Concepts and Techniques
• Physical controls relate to human activities:
– Accounting records consist of source documents, journals and
ledgers which capture economic essence and provide an audit trail.
– Access controls ensure that only authorized personnel have access
to firm assets.
– Independent verification procedures are checks to identify errors
and misrepresentations. Management can assess (1) individual
performance, (2) system integrity and (3) data correctness. Includes:
• Reconciling batch totals during transaction processing.
• Comparing physical assets with accounting records.
• Reconciling subsidiary accounts with control accounts.
• Reviewing management reports that summarize business activities.

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 Internal Control Concepts and Techniques
• IT application controls are associated with applications.
• Input control (edits) perform tests on transactions to ensure
they are free from errors.
– Check digit is a control digit(s) that is added to the data code when
originally assigned. Allows integrity to be established during
processing and helps prevent two common errors:
• Transcription errors occur when (1) extra digits are added to a code, (2) a
digit is omitted from a code, or (3) a digit is recorded incorrectly.
• Transposition errors occur when digits are reversed.
– Missing data check identifies blank or incomplete input fields.
– Numeric-alphabetic check identifies data in the wrong form.
– Limit checks identify fields that exceed authorized limits.

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 Internal Control Concepts and Techniques
• Input controls (cont’d):
– Range checks verify that all amounts fall within an acceptable range.
– Reasonableness checks verify that amounts that have based limit
and range checks are reasonable.
– Validity checks compare actual fields against acceptable values.
• Processing controls are programmed procedures to ensure an
application’s logic is functioning properly.
– Batch controls manage the flow of high volume transactions and
reconcile system output with original input .
– Run-to-run controls monitor batch from one process to another.
• A hash total is the summation of a nonfinancial field to keep track of records.

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 Internal Control Concepts and Techniques
• Audit trail controls ensure every transaction can be traced
through each stage to processing from source to financial
statements.
– Every transaction the system processes, including automatic ones,
should be recorded on a transaction log.
• Master file backup controls may be viewed as either a general
control or an application control.
– GFS (grandfather-father-son) backup is used with systems that use
sequential master files.
– The destructive update approach leaves no backup copy and
requires a special recovery program if data is destroyed or corrupted.
– Real-time systems schedule backups at specified daily intervals.
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 Internal Control Concepts and Techniques
• Output controls are procedures to ensure output is not lost,
misdirected or corrupted and that privacy is not violated.
– Can cause disruption, financial loss and litigation.
• Controlling hard-copy output:
– Output data can become backlogged (spooling) requiring an
intermediate output file in the printing process.
• Proper access and backup procedures must be in place to protect these files.
– Print programs controls should be designed to prevent unauthorized
copies and employee browsing of sensitive data.
– Sensitive computer waste should be shredded for protection.
– Report distribution must be controlled. End-user should examine
reports for correctness, report errors and maintain report security.

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 Chapter 4
The
Revenue
Cycle

Accounting Information
Systems 9e
James A. Hall

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Objectives for Chapter 4
• Understand the fundamental tasks performed in the revenue
cycle, regardless of the technology in place.
• Identify functional departments in the revenue cycle and the
flow of revenue transactions through the organization.
• Specify documents, journals, and accounts needed for audit
trails, records, decision making, and financial reporting.
• Understand risks associated with the revenue cycle and the
recognize controls that reduce these risks.
• Be aware of operational and control implications of technology
used to automate and reengineer the revenue cycle.

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 The Conceptual System: Sales Order Procedures
• Receive order.
– Begins with receipt of customer order which is transcribed into
a formal sales order which is placed in the customer order file
for future reference. May take days or weeks.
• Check credit.
– Before processing order, creditworthiness must be established.
• Pick goods.
– The stock release or picking ticket provides authorization to
warehouse personnel to release goods which are sent to
shipping along with the verified stock release.
– Warehouse employees adjust stock records to reflect inventory
reduction and prepares back-order records if insufficient goods.

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 The Conceptual System: Sales Order Procedures
• Ship goods.
– Shipping department uses the packing slip and shipping notice
to reconcile goods received from the warehouse.
– Goods are packaged, bill of lading is prepared, goods are given
to carrier, and shipment is recorded in the shipping log.
• Bill customer.
– Done after shipment by sending a completed sales invoice.
– Billing record-keeping includes recording the sale in the sales
journal.
– The sales journal is a special journal used for recording
completed sales transactions. Entries are summarized in a sales
journal voucher used to update the GL control account.

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 The Conceptual System: Sales Order Procedures
• Update inventory records.
– The inventory control function updates inventory subsidiary
ledger accounts from the stock release document information.
• Update accounts receivable records.
– Customer records in the accounts receivable (AR) subsidiary
ledger updated from the sales order ledger copy.
• Post to general ledger.
– General ledger function uses journal vouchers to update control
accounts.

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 The Conceptual System: Sales Return Procedures
• Prepare return slip.
– Customer records in the accounts receivable (AR) subsidiary
ledger updated from the sales order ledger copy.
• Prepare credit memo.
– If clerk has authorization, sent directly to billing function.
• Approve credit memo.
– Credit manager evaluates and return the approved credit
memo to the sales department.
• Update sales journal.
• Update inventory and AR records.

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 The Conceptual System: Cash Receipt Procedures
• Open mail and prepare remittance list.
– Remittance advice is a turnaround document.
• Record and deposit checks.
– After reconciling, employee records check in the cash receipts
journal and prepares a bank deposit slip.
• Update accounts receivable records.
• Update general ledger.
• Reconcile cash receipts and deposits.
– Employee not involved in cash receipts process reconciles
receipts by comparing (1) a copy of the prelist, (2) deposit slips
and (3) related journal vouchers.

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 Physical Systems
• Physical accounting information systems combine
technology and human activity.
– Smaller businesses tend to rely less on technology, whereas
larger companies tend to employ advanced technologies.
– Nature of the mix employed in a system impacts the internal
controls needed to control the system.
• Computers in basic technology revenue systems are
independent.
– Information between departments is communicated via hard-
copy documents.
– Maintaining physical files of source documents is critical to the
audit trail.

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 Physical Systems: Basic Sales Order Processing
• Begins with a customer placing an order.
– Sales department captures details on a sales order form.
• Credit department verifies credit and approves order.
• Warehouse sends inventory to shipping and records
inventory reduction.
• Shipping reconciles order, prepares bill of lading, ships
items, records transaction and sends stock release to billing .
• Billing department bills customer and updates sales journal.
• AR and inventory clerks update subsidiary ledgers.
– Journal vouchers and summaries are periodically sent to GL for
reconciliation and posting.

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 Physical Systems: Basic Cash Receipts Processes
• Checks and remittance advices received in mail room.
– Clerk reconciles items, endorses checks, prepares remittance list
and sends checks and list copy to cash receipts department.
– Remittance advices and list copy sent to AR.
• Cash receipts clerk records checks in cash receipts journal,
prepares deposit slip and sends checks to bank.
– Periodically a journal voucher is sent to GL department.
• AR updates customer balances and sends summary to GL.
• GL clerk reconciles amounts and posts to control accounts.
• Controller clerk performs periodic bank reconciliations.

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 Physical Systems: Advanced Technology
• Advanced technologies allow integration of accounting
with other business systems through a common
information system.
– Objective is to improve performance and reduce costs.
– Can significantly alter and simplify the revenue cycle.
– Remittance advices and list copy sent to AR.
• With an integrated sales order processing system many
functions are performed automatically to the center
computer system.
– These labor intensive activities increase operating costs and
contribute to human error.
– Technology reduces costs and errors, increasing efficiency.

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 Physical Systems: Integrated Cash Receipts
• Checks and remittance advices received in mail room.
– Clerk reconciles items, endorses checks, prepares remittance list
and sends checks, remittance advices and list to cash receipts.
• Cash receipts clerk reconciles checks and creates a record
in the cash receipts journal for each remittance advice, and
prepares deposit slip.
– Member of security group deposits checks in bank.
• System automatically closes sales invoice, posts to GL, and
prepares and distributes various management reports.
• Controller clerk periodically reconciles remittance lists,
deposit slips, cash receipts journal and GL cash account.

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 Physical Systems: Risks and Internal Controls
• Primary risks associated with revenue cycle transactions:
• Undetected data input errors:
– IT controls include data checks and check digit edits to help
prevent errors.
• Selling to un-creditworthy customers:
– Physical controls include proper transaction authorization,
including a segregation of duties between transaction
authorization and transaction processing.
– IT controls include automatic credit checking.
• Shipping incorrect items or quantities:
– Physical controls include independent verification.
– IT controls include scanner technology and automated ordering.
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 Physical Systems: Risks and Internal Controls
• Inaccurately recording transactions in journals and
accounts.
– Physical controls include transaction authorization, accounting
records, prenumbered documents, special journals, subsidiary
ledgers, general ledger control accounts, files and independent
verification:
• Shipping department reconciles goods being shipped against packing
slip to ensure customer is receiving correct items and quantity.
• Billing function reconciles original sales order with shipping notice to
ensure bills are correct and sales are recorded properly.
• GL function reconciles journal vouchers and summary reports prepared
independently in different functional areas before posting to control
accounts.
– IT controls include automated postings and file backups.

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 Physical Systems: Risks and Internal Controls
• Misappropriation of cash receipts and inventory.
– Physical controls include transaction authorization, supervision
(especially in the mail room), access controls and segregation of
duties:
• Cash receipts function should be separate from the AR function.
• Cash receipts clerk should not have access to GL cash.
• Personnel with physical custody of inventory should not update records.
– IT controls include multilevel security.
• Unauthorized access to accounting records and reports.
– Motives include attempt to create a fraud, data theft and
malicious acts.
– Physical controls include access controls and segregation of
duties such that the perpetration of a fraud requires collusion.
– IT controls include passwords and multilevel security.

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 Physical Systems: Multilevel Security
• Employs programmed techniques that permit
simultaneous access to a central system by many users
with different access privileges.
– Users are prevented from obtaining information for which they
lack authorization.
• Two common multilevel security methods:
– Access control list (ACL) method assigns privileges directly to
individuals which is burdensome in large organizations.
– Role-based access control (RBAC) creates standard tasks called
roles that are assigned specific privileges.
• Once a role is created, individuals are assigned to it.
• Easy to add or delete roles as job responsibilities change.

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 Physical Systems: Point-of-Sale (POS) Systems
• POS systems used extensively in retail establishments.
– Customers pick items from shelves and take them to a cashier.
• Clerk scans the Universal product code (UPC) of items.
– Price and description retrieved from inventory file.
– Inventory levels are updated and reordered as needed.
• System automatically calculates taxes, discounts and total.
– Non-cash payments are approved via online connection.
• At shift end, money and receipts reconciled to the internal
cash register tape with cash over and shorts accounts for.
• Cash receipts clerk prepares deposit slip for total daily cash
receipts and batch program posts entry to the GL.
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 Physical Systems: POS Control Issues
• Authorization:
– Clerk should match customer signature with credit card.
• Supervision:
– Surveillance cameras and floor security help prevent shoplifting
and employee theft.
• Access Control:
– Separate cash drawers, locked showcases and magnetic tags
attached to merchandise help control theft.
• Accounting records:
– Only supervisors should access internal cash register tapes.
• Independent verification:
– Cash drawers should be reconciled to internal register tapes.
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 Physical Systems: Reengineering
• Electronic data interchange (EDI) expedites transactions.
– Customer’s computer automatically orders inventory as needed.
– Seller processes order with little or no human involvement.
– Binding terms specified in a trading partner agreement.
– Control problems include ensuring only valid transactions are
processed and that accounting records are not compromised.
• Doing business on the Internet involves both business-to-
business (B2B) and business-to-consumer (B2C) transactions.
– Opens the door to thousands of business partners without formal
trading agreements.
– Risks include threats from computer hackers, viruses and
transaction fraud.

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Chapter 5
The
Expenditure
Cycle
Part 1:
Purchases and
Cash
Disbursements
Procedures
Accounting Information
Systems 9e
James A. Hall
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 Objectives for Chapter 5

• Recognize the fundamental tasks that constitute the

purchases and cash disbursement process.
• Identify functional areas involved in purchases and cash
disbursements and trace the flow of these transactions.
• Specify documents, journals, and accounts that provide audit
trails, promote the maintenance of records, and support
internal decision making and financial reporting.
• Understand risks associated with purchase and cash
disbursements activities and controls that reduce these risks.
• Be aware of operational features and control implications of
technology used in purchases and cash disbursement systems.

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 The Conceptual System

• Purchase processing procedures:

– Monitor inventory records, prepare purchase order. receive goods,
update inventory records, set up accounts payable.
• Vouchers payable system:
– Alternate to AP procedures that uses cash disbursement vouchers
and maintains a voucher register, providing improved control over
cash disbursements. Vouchers payable file equivalent to AP file.
– GL function posts journal voucher data.

• Cash disbursement system:

– Identify liabilities due, prepare cash disbursements, update AP
record and post to general ledger.

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 Physical Systems
• Basic Technology Expenditure Cycle:
– Computers tend to be independent PCs.
– Information between departments is communicated via hard-
copy documents.
– Maintaining physical files of source documents is critical to the
audit trail.
• In the following flowcharts note that, in many departments,
after an individual completes his or her assigned task,
documents are filed as evidence task was performed.

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 Physical Systems: Basic Purchases Processing
• Begins when inventory clerk prints purchase requisitions by
accessing the purchase requisition file.
– File created when inventory dropped to reorder point.
• Purchasing department receives the purchase requisition.
– Adds record to the digital open purchase order file.
– PO copies to vendor, inventory control, AP and receiving (blind).
• Receiving reconciles goods with packing slip and blind PO.
– Report to storeroom and purchasing department, files hard copy.
• AP reconciles invoice, purchase order and receiving report.
– Records transaction in the purchases journal.
• Gender ledger department receives journal voucher from AP
and account summary from inventory control.

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 Physical Systems: Basic Cash Disbursements System
• AP clerk reviews AP packet in open AP file, identifies items
due, and sends documents to cash disbursements.
• Cash disbursements reviews documents, prepares three-part
check and records pertinent data in the check register.
– Check and supporting documents sent for signature and mailing.
– AP packet and check copy returned to AP.
– Files check copy and sends summary journal voucher to GL.
• AP department removes the liability and sends AP summary
to GL department.
• GL department posts to the general ledger control accounts
and files the documents.

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 Physical Systems: Integrated Purchases Processing
• Departmental activity lower than basic technology system.
• Purchases computer application reads purchase requisition
file for reorders, prepares and sends PO, updates records.
• Receiving reconciles goods with packing slip and blind PO.
– Record added to receiving report file and PO closed.
– Inventory and GL control accounts automatically updated.
• AP clerk receives invoice, adds record to vendor file and files
hard-copy.
– System automatically links vendor invoice, PO and receiving
report, reconciles documents and creates virtual AP packet.
– AP clerk reviews virtual packet and if no discrepancies are found,
system automatically approves payment.

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 Physical Systems: Integrated Cash Disbursements
• Each day the DUE DATE fields of vendor invoices are
scanned for items due to be paid.
• Checks are automatically printed, signed, and distributed to
the mail room for mailing.
– Large checks receive additional signatures before mailing.
• Payments automatically recorded in check register file.
• Vendor invoices are closed.
• General ledger AP control and cash accounts updated.
• Reports transmitted to AP and cash disbursements
departments for management review and filing.

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 Expenditure Cycle Risks and Internal Controls
• Risk of unauthorized inventory purchases.
– Physical Controls: Transaction authorization
– IT Controls: Automated purchase approval

• Risk of receiving incorrect items, quantities or damaged

goods.
– Physical Controls: Independent verification and supervision
– IT Controls: Scanner technology

• Risk of inaccurately recording transactions.

– Physical controls: Transaction authorization, accounting records
and independent verification.
– IT controls: Input data edits, error messages, automated
postings, and file backups.

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 Expenditure Cycle Risks and Internal Controls

• Risk of misappropriation of cash and inventory.

– Physical Controls: Supervision, independent verification, segregation
of duties – inventory control from inventory warehouse and accounts
payable from cash disbursements.
– IT Controls: Automated three-way match and payment approval and
multilevel security.
• Risk of unauthorized access to accounting records and reports.
– Physical Controls: Access controls and segregation of duties.
– IT Controls: Password control and multilevel security.

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 Reengineering Using EDI
• Key element of success in the implementation of a trading
partner agreement to eliminate discrepancies that require
human involvement to resolve.
• Some organizations have eliminated the receiving function.
– Objective is to send goods directly to production which avoids
delays and associated handling costs.
– Accounting and auditing issues:
• How to account for inventory receipts with no receiving function and
report?
• Accounting for scrap in the production process.

• Unique risks that need to be recognized and controlled.

– Includes ensuring only valid transactions are processed and risk of
unauthorized access to accounting records.

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Chapter 6
The
Expenditure
Cycle
Part 2:
Payroll
Processing
and Fixed
Asset
Procedures
Accounting Information
Systems 9e
James A. Hall
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service or otherwise on a password-protected website for classroom use.
 Objectives for Chapter 6

• Recognize fundamental tasks of the payroll and fixed asset

processes.
• Identify functional depts. of payroll and fixed asset activities
and the flow of transactions through the organization.
• Specify the documents, journals, and accounts that provide
audit trails, promote record maintenance, and support
internal decision making, and financial reporting.
• Understand risks associated with payroll and fixed asset
activities and recognize controls that reduce these risks.
• Be aware of operational features and the control implications
of technology used in payroll and fixed asset systems.

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 Conceptual Payroll System
• Personnel dept. prepares personnel action forms to:
– Activate new employees, change pay rates, deductions and job
classifications.
• Production employees fill out two forms:
– Job tickets account for the time spent on each job. Cost
accounting uses these tickets to allocate charges to WIP.
– Time cards are used to capture the total time worked each pay
period for payroll calculations.
• After cost accounting allocates labor costs to the WIP
accounts, charges are summarized in a labor distribution
summary and forwarded to GL function.

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 Conceptual Payroll System
• Payroll dept. receives pay rate and withholding data from the
personnel dept. and hours-worked from production.
– Prepares payroll register, enters information into employee
payroll records, prepares paychecks and sends them to distribute
paycheck function, files time cards, personnel action forms and
payroll register copy
• Distribute paychecks.
• Prepare accounts payable.
• Prepare cash disbursement.
– Prepares a single check for entire payroll and deposits it in the
payroll imprest account which is used only for payroll. Copy sent
to AP and journal voucher prepared and sent to the GL function.

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 Update General Ledger
• GL function receives labor distribution summary,
disbursement voucher and journal voucher. GL clerk
makes entry which must have equal debits and credits:

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Basic Technology Payroll System

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 Basic Technology Payroll System
• Personnel action and time and attendance information
initiate the payroll process.
• Payroll department reconciles information, calculates payroll
and sends paychecks to paymaster for distribution to
employees.
• Cost accounting receives information regarding time spent
on each job for posting to the WIP subsidiary ledger.
• AP receives payroll register and authorizes cash
disbursements to deposit a check into the bank imprest
account from which payroll is drawn.
• GL department reconciles summary information and updates
accounts.

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Advanced Technology Payroll System

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 Advanced Technology Payroll System
• Larger organizations often integrate payroll processing
within the human resource management (HRM) system
which captures a wide range of personnel related data.
– Human resource clerks enter data in employee records in real time.
– Cost accounting enters job cost data in real time to create the
labor usage file.
– Biometric time clocks verify employee identify.
– Magnetic swipe ID cards work like credit cards and identify time
worked.
– Proximity cards use readers to record time worked.
– Mobile remote devices allow employees to clock in using hand-
held devices or web browsers.
– Data processing is done in batches at the end of the work period.

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Advanced Technology Payroll System – Data Processing
• Labor costs distributed to WIP, overhead and expense
accounts.
• Online labor distribution file is created.
• Payroll is calculated and an online payroll register is created.
• Employee record files are updated.
• Paychecks are prepared, signed and distributed.
• Funds to cover payroll are transferred to the payroll imprest
account and the transfer is recorded.
• Digital journal vouchers are entered and system
automatically updates the GL.

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 Payroll System Risks and Internal Controls: Risk of
Inaccurately Recording Transactions
• Risks include:
– Incorrectly calculated time and attendance data, unrecorded or
incorrectly recorded Wages Payable, and inaccurate postings.
• Physical Controls - Accounting Records:
– Control objective is to maintain audit trail for payroll records.
– Time cards, job tickets and disbursement vouchers.
– Journal info from labor distribution summary and payroll register.
– Subsidiary and GL accounts.

• Physical Controls – Independent Verification:

– Supervisor verification of time cards and attendance.
– AP clerk verification of payroll register accuracy.
– GL department reconciliation of labor distribution summary and
payroll disbursement voucher.
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 Payroll System Risks and Internal Controls: Risk of
Inaccurately Recording Transactions
• IT Controls - Data Input Edits:
– Verify the integrity of transaction data.
– Include: missing data checks, numeric-alphabetic data tests, tests
for invalid data values and check digits.
• IT Controls – Error Messages and File Backup:
– Any mismatch when posting time card or personnel action data to
an employee record should produce an error message.
– Backup procedures should be in place to reduce risk of data loss.

• IT Controls – Automated Posting to Accounts:

– Record keeping functions are automated in advanced technology
systems.
– Eliminating the human element reduces potential for error and
significantly improves efficiency.
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 Payroll System Risks and Internal Controls: Risk of
Misappropriate of Cash through Payroll Fraud

• Two general forms:

– Paying nonexistent employee by submitting fictitious timecards or
the overpayment of employee.
• Physical Controls – Transaction Authorization:
– Personnel action form helps payroll keep employee records current.
• Physical Controls – Segregation of Duties:
– Timekeeping and personnel functions should be separated.
– Because payroll has both asset custody (paychecks) and record-
keeping responsibility (employee payroll records), assign AP the
responsibility of reviewing payroll register and approving payment.
– Use an independent paymaster to distribute checks to help verify
the existence of employees.
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 Payroll System Risks and Internal Controls: Risk of
Misappropriate of Cash through Payroll Fraud
• Physical Controls – Supervision:
– Supervisor should observe timekeeping and reconcile time cards
with actual attendance.
• Physical Controls – Access Control:
– Prevent improper access to accounting records.
• IT Controls – Input Controls:
– Limit tests to detect excessive hours reported per period.
– Biometric scanners, swipe cards, and PINs help ensure that
individuals clocking in are valid employees.
– Automated tests to validate timecards against up-to-date
employee files.
– Paycheck direct deposit.

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 Payroll System Risks and Internal Controls: Risk of
Unauthorized Access to Payroll Records and
Confidential Employee Data

• Motives include:
– Malicious acts such as corrupting or deleting payroll data.
– Theft of confidential information such as Social Security Numbers,
pay rates and other personal data.
– Attempts to perpetrate a payroll fraud..

• IT Controls:
– Password protected payroll files.
– Multilevel security techniques limit access to HR, accounts payable,
cash disbursements, cost accounting and general ledger.

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 The Conceptual Fixed Asset System
• Fixed assets are the property, plant and equipment used
in the operation of a business.
• Fixed asset system processes transactions pertaining to
acquisition, maintenance and disposal of assets.
• Specific objectives:
– Process fixed asset acquisition as needed and in accordance
with formal management approval and procedures.
– Maintain adequate account records of asset acquisition, cost,
description, and physical location in the organization.
– Maintain accurate depreciation records.
– Provide management with needed information.
– Record retirement and disposal of assets.

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 Asset Acquisition, Maintenance and Disposal
• Asset acquisition begins when manager determines asset
needs to be replaced or a new fixed asset is warranted.
• Asset maintenance involves adjusting FAS subsidiary
account balances as assets depreciate.
– Depreciation calculations are internal transactions that the FAS
system bases upon a depreciation schedule.
– Physical improvements must also be recorded to increase the
subsidiary account balance and depreciation schedule.
• At the end of an asset’s useful life (or earlier), asset must be
removed from FAS subsidiary ledger (asset disposal).
– Disposals require disposal request forms and disposal reports as
source documents as well as proper approval.

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 Acquisition Procedures
• Process begins when the fixed asset accounting clerk
receives a receiving report and a cash disbursement voucher.
– Clerk creates a record of the asset in the FAS ledger and the system
automatically updates the GL and prepares journal vouchers and
reports including depreciation schedules.

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 Asset Maintenance and Disposal
• Computerized FAS automatically:
– calculates current period’s depreciation.
– updates accumulated depreciation and book-value fields in the
subsidiary records.
– posts total depreciation to the affected GL accounts.
– records depreciation transactions.

• When an asset record is deleted from the FAS, the system:

– posts an adjusting entry to the fixed asset control account in the GL.
– records losses or gains associated with the disposal.
– prepares a journal voucher.

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 Fixed Asset System Risks and Controls
• Authorization controls should be formal and explicit.
– Written request and independent approval for high-value items.
• Supervision controls are an important element in the physical
security of fixed assets.
– Ensure assets are used in accordance with organizational policies and
that they are not taken home for personal use unless authorized.
• Independent verification controls should be used by internal
auditors to test for reasonableness of fixed asset acquisitions
and approvals.
– Verify location, condition, and fair value of fixed asset against the
fixed asset records in the subsidiary ledger.
– Check programming logic for automatic calculations (depreciation).

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Chapter 7
The
Conversion
Cycle

Accounting Information
Systems 9e
James A. Hall
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 Objectives for Chapter 7
• Understand basic elements and procedures encompassing a traditional
production process.
• Understand data flows and procedures in a traditional cost accounting
system.
• Be familiar with accounting controls in a traditional environment.
• Understand principles, operating features, and technologies of lean
manufacturing.
• Understand shortcomings of traditional accounting methods in the
world-class environment.
• Know key features of activity-based costing and value stream
accounting.
• Be familiar with information systems associated with lean
manufacturing and world-class companies.

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The Conversion Cycle in a Traditional Manufacturing
Environment
• Transforms input resources such as raw materials, labor, and
overhead into finished products or services for sale
• Consists of both physical and informational activities related
to manufacturing products for sale.
• One of the following production methods is used:
– Continuous processing creates a homogeneous product through a
series of standard procedures.
– Made-to-order processing involves fabrication of discrete products in
accordance with customer specifications.
– Batch processing produces batches of discrete products.

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5
• The production schedule is the formal plan
and authorization to begin production.

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• The bill of materials (BOM) specifies the type
and quantity of RM and subassemblies used for
each unit of a finished product.

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• A route sheet shows the production path that a
particular batch follows during manufacturing.

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• The work order uses the BOM and route sheets to
specify the materials and production for each batch.

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• A move ticket records work done in each work center
and authorizes movement from one center to another.

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• A materials requisition authorizes storekeeper to
release materials into the production process.

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 Batch Production Activities
• Production planning and control:
– Specifying materials and operations requirements.
– Production scheduling.

• Material and operations requirements:

– Requirement is the difference between what is needed for the
batch and what is available in the RM inventory.
– Purchase requisitions created for additional RM needs.

• Production scheduling:
– Master schedule coordinates productions of different batches.
– Produces work orders, move tickets, and material requisitions for
each batch with copies of work orders sent to cost accounting.

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13
 Batch Production Activities
• Work centers and storekeeping:
– Production begins when workers obtain raw materials.
– When task completed move ticket authorizes batch to proceed to
next work center with copy sent to production planning.
– Finished products sent to FG warehouse and copy of work order
sent to inventory control to update FG inventory records.
– Work center supervisors send employee time cards and job tickets
to payroll and cost accounting.
• Inventory control:
– Provides production planning and control with status reports on
finished goods and raw materials inventory.
– Continual updates of raw materials inventory.
– Records completed production by updating FG inventory records.

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 EOQ Inventory Model
• Objective of inventory control is to minimize total inventory
cost while ensuring adequate inventories to meet demand.
– When and how much inventory should be purchased?
• Economic order quantity (EOQ) model based on
assumptions that may not reflect economic reality:
– Demand is constant and known with certainty.
– Ordering lead time is known and constant.
– All inventories in the order arrive at the same time.
– Total yearly cost of placing orders decreases as order quantities
increase.
– Carrying costs increase as quantity of inventory orders increases.
– No quantity discounts so purchase price is constant.
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• Objective of EOQ is to reduce total inventory costs. Figure
7.10 shows relationship between costs and order quantity.

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• Assumptions of the EOQ model produce the saw-
toothed inventory usage pattern illustrated below.

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• When parameters are subject to variation, additional
inventory units (safety stock) are added to the reorder
point to avoid stock-out events.

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 Cost Accounting Activities
• Record the financial effects of the physical events
occurring in the production process.
• Begins when the production planning and control
department sends the work order to cost accounting.
• Cost accounting clerk creates a new cost record for the
batch and files in WIP file.
• The records are updated as materials and labor are used.
– Deviations from standards are recorded to produce variances.
• Receipt of last move ticket signals completion of
production and transfer for WIP to FG inventory.
– WIP account is closed, journal vouchers are recorded and sent to
the GL department for posting to the control accounts.

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 Controls in the Traditional Environment
• Transaction authorizations:
– Production planning and control authorize the production
activity via a formal work order.
– Move tickets signed by supervisors authorize batch activities and
product movement through work centers.
– Materials requisitions and excess material requisitions authorize
storekeeper to release materials to work centers.
• Segregation of duties:
– Separation of transaction authorization and processing.
– Separation of record keeping from asset custody.
• Inventory control records separate from storerooms and warehouses.
• Cost accounting separate from production work centers.
• GL separate from subsidiary accounting records.

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23
 Controls in the Traditional Environment
• Supervision:
– Work center supervisors oversee RM usage to ensure all released
materials are used in production and waste is minimized.
– Employee time cards and job tickets are checked for accuracy.

• Direct access to assets:

– Limited access to sensitive areas.
– Quantities in excess of standards require approval .

• Indirect access to assets:

– Control over critical source documents, including the use of pre-
numbered documents.

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24
 Controls in the Traditional Environment
• Accounting records:
– Objective is to establish an audit trail for each transaction.
• Independent verification:
– Cost accounting reconciles material and labor usage with
standards and investigates variances.
– GL dept. verifies movement from WIP to FG by reconciling
journal vouchers from cost accounting and inventory
subsidiary ledgers from inventory control .
– Internal and external auditors periodically verify the raw
materials and FGs inventories through a physical count.

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25
 What is a World-Class Company?

• Maintains strategic agility, able to turn on a dime, aware of

customer needs and not resistant to paradigm change.
• Motivates and treats employees like appreciating assets with
decisions pushed to the lowest level of the organization.
• Profitably meets customer needs and continually delights
them.
• Customer satisfaction philosophy permeates all activities.
• Manufacturers follow a philosophy of lean manufacturing.

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 Principles of Lean Manufacturing
• Evolved from Toyota Production System (TPS) which is
based on the just-in-time (JIT) production model.
– Goal is improved efficiency and effectiveness in every area.
• Pull processing involves pulling products from consumer end
(demand) rather than pushing from production end (supply).
• Perfect quality (zero inventory defects) is required for pull
processing success.
• Waste minimization requires activities that do not add value
or maximize the use of scarce resources be eliminated.
– Involves financial, human, inventory and fixed assets.

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 Principles of Lean Manufacturing
• Inventory reduction is the hallmark of lean manufacturing.
– Inventories cost money, camouflage production problems and can
precipitate overproduction.
• Production flexibility strives to reduce setup time to a
minimum, allowing for the production of a greater diversity of
products quickly, without sacrificing efficiency.
• Established supplier relations are mandatory as late
deliveries, defective raw materials, or incorrect orders will shut
down production due to lack of inventory reserves.
• Team attitude requires each employee to be vigilant of
problems that threaten the continuous flow of production line.

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 Techniques and Technologies that Promote Lean
Manufacturing

• Physical reorganization of production facilities:

– Simplified facility arrangement shortens the physical distance
between activities reduces setup and processing time, handling
costs and inventories.
• Automation of the manufacturing process:
– By replacing labor with automation, firm can reduce waste,
improve efficiency, increase quality and improve flexibility.
– Traditional manufacturing consists of a range of different
machines each controlled by a single operator.
– Islands of technology is an environment where automation
exists in islands of computer numerical controlled machines
that perform multiple operations with little human involvement.

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 Techniques and Technologies that Promote Lean
Manufacturing
• Computer-integrated manufacturing (CIM) is a completely
automated environment with the objective of eliminating
non-value added activities.
• Automated storage and retrieval systems (AS/RS) are
computer-controlled conveyor systems that carry materials to
the shop floor and finished products to the warehouse.
– Reduced errors, improved inventory control, lower storage costs.
• Robotics uses robots to perform specific actions over and
over with a high degree of precision.
– Also used in hazardous environment or for performing dangerous
and accident-prone monotonous tasks.

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 Techniques and Technologies that Promote Lean
Manufacturing
• Computer-aided design (CAD) is used to design better
products faster.
– Increases productivity and accuracy and allows firms to be more
responsive to market demand.
– Shortens time between initial and final design.
– Advanced systems design product and process simultaneously.

• Computer-aided manufacturing (CAM) is the use of

computers to assist the manufacturing process.
– Output of the CAD system is fed to the CAM system.
– Benefits include improved process productivity, cost and time
estimates, process monitoring and quality, and decreased setup and
labor costs.

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35
 Value Stream Mapping
• Essential activities add value; nonessential activities do not
and should be eliminated.
• Company’s value stream includes all steps essential to
producing a product.
• Companies pursuing lean manufacturing use a value stream
map (VSM) to identify business process aspects that are
wasteful and should be eliminated.
– Works best in focused, high-volume processes which benefit from
reducing repetitive processes by even small amounts of time.
– Less effective in low-volume processes in which employees
frequently switch between multiple tasks.

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37
 Accounting in a Lean Manufacturing Environment

• Lean manufacturing requires new accounting methods and

information.
• Shows what matters to customers (quality and service).
• Identifies profitable products and customers.
• Identifies opportunities for operation and product
improvement.
• Encourages adoption of value-added activities and processes
and identifies those that do not add value.
• Efficiently supports multiple users with both financial and
non-financial information.
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38
 What’s Wrong with Traditional Accounting
Information?
• Inaccurate cost allocations occur because overhead is
assumed to be directly related to direct labor.
– Automation changes the relationship between direct labor, direct
materials, and overhead costs which becomes more significant.
– Using standard costs leads to distortions in a lean environment.

• Promotes non-lean behavior due to incentives to produce

large inventories and conceal waste in overhead allocations.
• Time lags as standard cost data are historic in nature.
– After-the-fact info is too late to be useful in a lean environment.
• Financial orientation is not always suitable for evaluations
pertaining to functionality and improvements.

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39
 Activity Based Costing (ABC)
• Method that allocates costs to facilitate planning and
control by assigning costs to activities and cost objects.
– Activities describe work performed in a firm.
– Cost objects are the reasons for performing activities.

• Assumes that activities cause costs and that products

(and other cost objects) create a demand for activities.
• First step is to determine the cost of an activity and an
appropriate activity driver that measures consumption.
– ABC uses multiple activity drivers, whereas traditional
accounting has only one, e.g. machine or labor hours.

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 Advantages and Disadvantages of ABC
• Advantages:
– More accurate costing of products/services, customers, and
distribution channels.
– Identifying the most and least profitable products and customers.
– Accurately tracking costs of activities and processes.
– Equipping managers to drive continuous improvements.
– Facilitating better marketing mix.
– Identifying waste and non-value-added activities.
• Disadvantages:
– Too time-consuming and complicated to be practical.
– Promotes complex bureaucracies in conflict with lean manufacturing
philosophy of process simplification and waste elimination.

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42
 Value Stream Accounting
• Captures costs by value stream rather than by department
or activity making it simpler than ABC accounting.
• Value streams cut across functional and departmental lines
and includes non-manufacturing costs.
• Essential aspect is defining the product family.
• Makes no distinction between direct and indirect costs.
– Raw materials based on purchases and all employee labor costs
of employees in the value stream are included.
• Typically only allocated cost is a charge for the facility
– Overhead costs which cannot be controlled are not allocated.

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45
 Information Systems that Support Lean
Manufacturing
• Materials Requirement Planning (MRP) is an automated
production planning and control system used to support
inventory management.
• Ensures adequate raw materials for production process.
• Maintains the lowest possible level of inventory on hand.
• Produce production and purchasing schedules and other
information needed to control production.

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 Information Systems that Support Lean
Manufacturing
• Manufacturing Resource Planning (MRP II) is an extension
of MRP that has evolved beyond inventory management.
– Coordinates a wide range of manufacturing activities.
– Benefits include improved customer service and cash flow, reduced
inventory, increase productivity, help in achieving long-term goals
and managing change and production flexibility.
• Enterprise Resource Planning (ERP) Systems are software
suites that integrate the entire organization into one system
connected to a single common database.
– An electronic data interchange (EDI) communication link allows
firm to interact with customers and suppliers via Internet or direct
connection.
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Chapter 8
Financial
Reporting
and
Management
Reporting
Systems
Accounting Information
Systems 9e
James A. Hall
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 Objectives for Chapter 8
• Understand the operational features of the General Ledger
System(GLS), financial reporting system(FRS), and
management reporting system(MRS).
• Be able to identify the principle operational controls
governing the GLS and FRS.
• Understand the factors that influence the design of the MRS.
• Understand the elements of a responsibility accounting
system.
• Be familiar with the financial reporting issues surrounding
XBRL.

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• The journal voucher is the source of input to
the GL with the manager offering a degree of
control against unauthorized GL entries.

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 GLS Database
• General ledger master file is the principal file in the GLS
database and is based on the chart of accounts.
– FRS draws upon the GL master to produce financial statements.

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 GLS Database
• General ledger history file has the same format as the GL
master.
– Provides historical financial data for comparative reports..
• Journal voucher file provides a record of all GL transactions
and replaces the traditional general journal.
• Journal voucher history file contains journal vouchers of
past periods for the audit trail.
• Responsibility center file contains financial data by
responsibility centers for MRS reporting.
• Budget master file contains budget data by responsibility
center.

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 Financial Reporting Procedures
• Capture the transaction.
• Record in special journal and post to subsidiary ledger.
• Post to GL periodically.
• Prepare unadjusted trial balance.
• Make, journalize and post adjusting entries.
• Prepare the adjusted trial balance.
• Prepare the financial statements.
• Journalize and post closing entries.
• Prepare the post-closing trial balance.

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 XBRL: Reengineering Financial Reporting
• Many companies post financial statements on their
websites using HTML (Hyper Text Markup Language).
– Cannot be conveniently processed through IT automation.
– Performing analysis on data requires them to be manually entered
into the user’s information system.
• The solution to the problems is XBRL (extensible Business
Reporting Language).
– Internet standard designed for business reporting and information
exchange.
– Objective is to facilitate the publication, exchange, and processing
of financial and business information.
– Derivative of XML (extensible Markup Language).

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 XML

• XML is a meta-language for describing markup languages.

• Extensible means that any markup language can be created
using XML.
– Includes the creation of markup languages capable of storing
data in relational form, where tags (formatting commands) are
mapped to data values.
– Can be used to model the data structure of an organization’s
internal database.

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 XBRL
• XML-based language for standardizing methods for
preparing, publishing, and exchanging financial information.
• First step is to select an XBRL taxonomy.
– Classification schemes that specify the data to be included in an
exchange or report.
• Next step is to cross-reference each GL account to an
appropriate XBRL taxonomy element (tag).
– Mapping organization’s internal data to XBRL taxonomy elements.
– Tags are used whenever data is disseminated to outsiders.
• Computer programs that recognize and interpret tags
general XBRL instance documents (financial reports) that
can be published and made available to users.

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 Current State of XBRL Reporting
• Likely to be the primary vehicle for delivering business
reports to investors and regulators in the near future.
• Developments in XBRL Reporting:
– Required for US banking quarterly “Call Reports”.
– SEC ruling requires large publicly held companies to adopt SBRL
by December 2015 to meet financial reporting requirements.
– Comparable developments to encourage or require SBRL in
Tokyo, Canada, China, Spain, the Netherlands and the UK.
• Use of XBRL facilitates fulfillment of legal requirements
specified in SOX.

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 Controlling the GL/FRS

• Potential risks to the FRS include:

– A defective audit trail.
– Unauthorized GL access.
– GL accounts that are out of balance with subsidiary accounts.
– Incorrect GL account balances due to unauthorized or incorrect
journal vouchers.
• Six categories of physical controls under the COSO
framework.
• Transaction authorization - Journal vouchers must be
authorized by a manager at the source department.

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 Controlling the GL/FRS
• Segregation of duties – GL clerks should not:
– have record-keeping responsibility for special journals or
subsidiary ledgers.
– prepare journal vouchers or have custody of physical assets.

• Access controls - Unauthorized GL access can cause errors,

fraud, and misrepresentations in financial statements.
– SOX requires controls that limit database access.
• Accounting records – Audit trail ensures transactions can
be accurately traced from initiation to final disposition.
– Files should be detailed enough to: (1) answer inquiries, (2)
reconstruct data if destroyed, (3) provide historical data, (4)
meet government requirements and (5) prevent, detect and
correct errors.

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 Controlling the GL/FRS
• Independent verification - GL department provides this
step within the accounting information system.
– Journal voucher listing provides relevant details of each journal
voucher posted to the GL.
– General ledger change report presents the effects of journal
voucher postings on GL accounts.
• IT application controls apply to the GL/FRS too.
– Edits and check digits ensure error free data in the GL.
– Process and output controls serve the same objectives.
– Real-time transaction processing bypasses human reconciliation
and review which provides both benefits and risks.
• Eliminating human element reduces the possibility of some error and
increases efficiency.
• Risk of applicable logic errors that could have widespread and devastating
implications for the FRS.

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 Internal Control Implications of XBRL
• Taxonomy creation: Incorrect generation results in
incorrect mapping between data and elements that could
result in material misrepresentation of financial data.
• Taxonomy mapping errors: Correctly generated XBRL
tags may be incorrectly assigned to internal database
accounts, results in material misrepresentations of
financial data.
• Validation of instance documents: Independent
verification procedures need to be established to ensure
that appropriate taxonomy and tags have been applied
before posting to a web server.

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 Management Reporting Systems
• Usually seen as discretionary reporting, but can argue that
Sarbanes-Oxley requires an effective MRS.
– Critical element of organization’s internal control structure.
– Directs attention to problems on a timely basis which promotes
effective management and supports business objectives.
• Formalization of tasks principle divides organizational areas
into tasks with clearly defined limits of responsibility.
– Purpose is to avoid an organizational structure that depends on
specific individuals.
– Organizational chart shows typical job positions in a firm.
– Allows formal specification of information needed to support tasks,
regardless of the individual performing them.

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 Management Reporting Systems
• Responsibility and authority refer to an individual’s
obligation to achieve desired results and the right to make
decisions within the limits of that obligation.
– Define the vertical reporting channels through which information
flows.
• Span of control refers to the number of subordinates directly
under the manager’s control.
– Managers with narrow spans of control need detailed reports with
summarized information for managers with broad spans of control.
• Management by exception suggests managers should limit
their attention to potential problem areas.
– Reports should focus on changes in key factors that are
symptomatic of potential problems and avoid unnecessary details.

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 Management Function, Level, and Decision Type
• Short-term planning involves the implementation of specific
plans that are needed to achieve long-range objectives.
• Control function ensures firm’s activities conform to the plan.
• Strategic planning decisions include:
– Setting firm’s goals and determining scope of business activities.
– Determining organizational structure and management philosophy.

• Strategic planning decision are long-term, require highly

summarized information, tend to be nonrecurring, have a high
degree of uncertainty and require both internal and external
sources of information.
• Strategic decisions are broad in scope and have a profound
impact on all levels of the organization.

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 Management Function, Level, and Decision Type
• Tactical planning decisions subordinate to strategic
decisions.
– Shorter term, more specific, recurring, have fairly certain outcomes,
and a lesser impact on the firm.
• Management control decisions involve motivating all
managers to use resources as productively as possible.
– Difficult to separate manager’s performance from that of the
operational unit.
• Operational control decisions deal with routine tasks.
– Structured, narrow focus, dependent on details, short time frame.
– Three basic elements: (1)Attainable standards; (2) Performance
evaluation with differences from standard noted as variances; and
(3) Taking corrective action.

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 Problem Structure
• Reflects how well decision makers understand problems.
• Three elements:
– Data: values used to represent relevant factors.
– Procedures: sequence of steps used in solving the problem.
– Objectives: results decision maker desires to attain.

• When all three elements are known with certainty, it is a

structured problem.
– Not unique, well suited for traditional data processing techniques.
• Unstructured problems exist when any characteristic is not
known with certainty.
– Normally complex and unique making traditional data processing
techniques ineffective.

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 Management Reports
• May be in paper or digital form and express information
verbally, numerically and/or graphically.
• Report objectives: To be useful, must have information
content with two general objectives:
– Reduce the level of uncertainty associated with a problem facing
the decision maker.
– Influence the behavior of the decision maker in a positive way.

• Programmed reporting provides information to solve

anticipated problems:
– Scheduled reports are produced at specified intervals.
– On-demand reports are triggered by events, not time.

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 Management Report Attributes
• Relevance – useful to decision making.
• Summarization – appropriate level of detail.
• Exception orientation – identify risks.
• Accuracy – free of material errors.
• Completeness – essential information.
• Timeliness – in time for decisions.
• Conciseness – presented with coding schemes and
calculations as appropriate to be understandable.

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 Management Reports
• Managers cannot always anticipate information needs.
• Database technology provides direct inquiry and report
generation capabilities that allow the generation of ad hoc
reports without assistance.
• Data mining is the process of selecting, exploring and
modeling data to uncover relationships and patterns.
– The verification model uses a drill-down technique to either verify
or reject a user’s hypothesis.
– The discovery model uses data mining to discover previously
unknown but important information hidden in the data.
• Successful data mining requires a data warehouse of
archived operational data.
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 Responsibility Accounting
• Every economic event that affects the organization is the
responsibility of and can be traced to an individual manager.
• The budget process helps achieve objectives by establishing
measureable financial goals for each organizational segment.
• Performance measurement and reporting take place at each
operational segment.
– Information flows upward as responsibility reports.
• Operations organized into responsibility centers:
– A cost center has responsibility for cost management within budget.
– A profit center has responsibility for cost control and revenues.
– An investment center manager has general authority to make
decisions that affect the organization including product
development and other investment decisions.
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 Behavioral Considerations
• Properly applied principles of authority, responsibility and
task formalization promote goal congruence.
– Carefully structured MRS plays important role in promoting goal
congruence while a badly designed MRS can cause actions in
opposition to organizational objectives.
• Information overload occurs when managers receive more
information than they can assimilate.
• Inappropriate performance measures can lead to behavior
that is inconsistent with firm’s objectives.
– Performance measures should consider all relevant aspects of a
manager’s responsibility – both financial and nonfinancial.

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Chapter 13
Managing the
Systems
Development
Life Cycle

Accounting Information
Systems 9e
James A. Hall
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 Objectives for Chapter 13
• Be able to identify the key stages in the SDLC.
• Recognize how a firm’s business strategy will shape its
information system.
• Understand the relationship between strategic systems
planning and legacy systems.
• Understand what transpires during systems analysis.
• Understand the TELOS model for assessing project
feasibility.
• Be familiar with cost-benefit analysis issues related to
information systems projects.
• Understand the role of accountants in the SDLC.

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 The Systems Development Life Cycle (SDLC)
• First step is to develop a systems strategy.
– Requires understanding organization’s strategic business needs.
– Developed from mission statement, competitive pressures and
current and anticipated market conditions.
– Considers the information systems’ implications pertaining to legacy
systems and user concerns.
– Produces a strategic plan and timetable for system implementation.

• Project initiation is the process of assessing systems proposals

for consistency with the strategic systems plan.
– Includes evaluating feasibility and the cost-benefit of proposals.
– Consideration of alternative conceptual designs, selection of a
design and determining whether the proposal will require in-house
development, a commercial package, or both.

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 The Systems Development Life Cycle (SDLC)
• Some organization’s needs that can only be met through
internal development.
– Requires analyzing user needs, designing processes and
databases, creating user views, programming, testing and
implementation.
• Many organizations use a commercial software package.
– Lower initial cost, shorter implementation time, better controls
and rigorous vendor testing but not without risks.
– Procedures needed to ensure software adequacy and
compatibility.
• Maintenance and support includes implementing the latest
software, in-house modifications, and establishing a user
support infrastructure.
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 Participants in Systems Development
• Systems professionals actually build the system.
– Systems analysts, systems designers, and programmers.
– Gather and analyze facts to formulate a solution to solve problems.

• End users are those for whom the system is built.

– Many users exist at all levels in the organization.
– Obtaining a clear statement of user needs is critical to system
development.
• Stakeholders are individuals who have an interest in the
system but are not end users.

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 Systems Strategy
• Objective is to link individual system projects to the strategic
objectives of the firm.
• Firms may establish a steering committee to provide
guidance and oversight for systems projects.
– Usually includes the CEO, CFO, CIO, senior management from user
areas and computer services, and internal auditors.
• Task 1: Assess strategic information needs.
– Involves the allocation of resources at the macro level, which
usually involves a time frame of three to five years.
– Key inputs in developing a sound systems strategy include:
• strategic business needs of the organization.
• the legacy systems situation.
• user feedback.

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 Systems Strategy
• Strategic business needs:
– All areas should support organization’s business strategy.
• Vision and mission:
– Requires understanding of top management’s vision, which has
shaped the organization’s business strategy.
– Organizations without a mission statement often lack a viable
system strategy and make knee-jerk responses in out of crisis.
• Industry and competency analysis:
– Industry analysis analyzes driving forces that affect industry and
organization performance, such as important trends, significant
risks, and potential opportunities.
– Competency analysis provides a complete picture of the
organization’s effectiveness as seen via four strategic filters:
resources, infrastructure, products/services, and customers.

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 Systems Strategy
• Legacy system mapped to current business processes to
determine extent they support the company mission.
– Architecture description is a formal description of system.

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 Systems Strategy
• User feedback at this point pertains to substantial perceived
problems rather than minor systems modifications.
• Recognizing the problem:
– Need for improved information system is manifested through
various symptoms that may initially seem vague.
– Reactive management responds to problems only when they
reach a crisis state and can no longer be ignored.
– Proactive management stays alert to subtle signs of problems and
aggressively looks for ways to improve organization’s system.
• Defining the problem:
– Keep an open mind and avoid drawing conclusions.
– Interactive process between managers and systems professionals
is necessary to arrive at an accurate problem definition.

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 Systems Strategy
• Specifying systems objectives:
– User information needs must be specified in terms of general
operational objectives for the new information system.
• Preliminary project feasibility study (TELOS) is conducted
to determine how best to proceed with the project.
– Technical feasibility: Is existing technology sufficient or is new
technology needed?
– Economic feasibility: Are funds available to complete project?
– Legal feasibility: Does the system allow the company to discharge
its legal responsibilities?
– Operational feasibility: Can procedural changes, personnel
retrained and skills obtained to make system feasible?
– Schedule feasibility: Can the project be implemented within an
acceptable time period?
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 System Strategy
• Systems project proposal provides management with a
basis for deciding whether or not to proceed with project.
– Summarizes findings and makes a general recommendation.
– Outlines linkage between objectives of proposed system and
business objectives of the firm.
• Task 2: Develop a strategic systems plan:
– Evaluate the pros and cons of each proposal by assessing
benefits, costs and strategic impact.
– Development proceeds on proposals with greatest potential for
supporting organization’s business objectives at the lowest cost.
• Task 3: Create an action plan:
– Translate strategy into action. The balanced scorecard (BSC)
system suggests organization be viewed from four perspectives.

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 The Balanced Scorecard
• Learning and growth perspective:
– Workers need to be in a continuous learning mode.
• Internal business process perspective:
– Metrics allow mangers to know how well business is running and
if products and services conform to customer needs.
• Customer perspective:
– Objective (customer retention) and subjective (satisfaction
survey).
• Financial perspective:
– Traditional measures that should not be overemphasized.
• Power of the model lies in the linkage between these
components.
– Identifying imbalances can lead to corrective actions.
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 Project Initiation
• Involves obtaining detailed understanding of user problem
and proposing multiple alternative solutions.
– Each assessed for feasibility and cost-benefit characteristics.
– Option selected proceeds to the construct phase.
– Depending upon needs, system will require in-house development,
commercial package, or both.
• System analysis:
– Business problem must be fully understood before a solution can
be formulated.
– A defective analysis leads to a defective or incomplete solution.
– System analysis is a two-step process: survey of current systems
and analysis of users’ needs.

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 Project Initiation: System Survey
• Disadvantages of a detailed system survey:
– Current physical tar pit can bog down the analyst with the task
of surveying a dinosaur system.
– May stifle new ideas.

• Advantages of a detailed system survey:

– Identifies aspects of the old system which should be kept.
– Thorough understanding of current system is required for
conversion to the new system.
– May allow conclusive determination of the cause of the
reported problems which may not be the information system.

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 Project Initiation: Gathering Facts
• System facts fall into the following broad classes:
– Data sources include both external and internal sources.
– Users include both managers and operations users.
– Data stores are files, databases, accounts, and source documents.
– Processing tasks are manual or computer operations.
– Data flows are the movement of documents and reports.
– Accounting and manual controls may be manual or computerized.
– Analyst must obtain a measure of transaction volume for a
specified period of time.
– An acceptable error rate must be determined for the system.
– Resource costs of new system considered as well as the escapable
costs when current system is eliminated (new system benefit).
– Bottlenecks and redundant operations should be noted during
the survey phase to avoid the same mistakes in system design.

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 Project Initiation: Fact-Gathering Techniques
• Observation involves watching physical system procedures.
• Task participation is an extension of observation.
– Analyst takes active role in performing user’s work allowing first-
hand experience of the current system problems.
• Personal interviews extract facts about current system and
user perception of requirements for the new system.
– Open-ended questions and formal questionnaires may be used.
• Reviewing key documents are another source of facts and
may include:
– Organization charts, job descriptions, accounting records, chart of
accounts, policy and procedures, financial statements and
performance reports, system flowcharts, source documents,
transaction listings, budgets and forecasts and mission statements.
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 The Analysis Step
• Intellectual process that is commingled with fact gathering.
• A systems analysis report contains survey findings, current
system problems, user needs and new system requirements.
– Details of what the system must do rather than how to do it.
– Formal contract that specifies system objectives and goals.
– Establishes in clear terms data sources, users, data files, processes,
data flows, controls and transaction volume capacity.
– Does not specify detailed design of the proposed system.

• Purpose of the conceptualization phase is to produce several

alternative conceptual solutions that satisfy requirements.
– Should highlight differences between critical features of competing
systems rather than similarities.

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 Systems Evaluation and Selection
• Formal mechanism for selecting one system.
– Optimization process that seeks to identify the best system.
• Detailed feasibility study reexamines factors that were
evaluated on a preliminary basis for each conceptual design.
– Technical feasibility scores are higher for system designs that use
established technology than for more risky options.
– Legal feasibility focuses on critical control, security and audit trail
issues and privacy and information laws.
– Operational feasibility considers the training, motivation and
experience of users.
– Schedule feasibility assesses the likelihood that the system will be
completed on schedule.
– Economic feasibility precisely looks at the cost of each alternative
and includes cost-benefit analysis.
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 Systems Evaluation and Selection
• Cost-benefit analysis helps determine if the benefits
received from a proposed system will outweigh its costs.
• Step 1: Identify costs.
– Consider both one-time and recurring costs.
• Step 2: Identify benefits.
– Consider both tangible and intangible benefits.
– When measuring cost savings, only include escapable costs.

• Step 3: Compare costs and benefits.

– Most common methods are net present value and payback.
– Net present value method deducts the present value of the costs
from the present value of benefits over the life of the system.
– Payback method is a variation of break-even analysis. The
breakeven point is reached when total costs = total benefits.
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Cost-Benefit Analysis: Identify Costs

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Cost-Benefit Analysis:
Identify Benefits—Tangible

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Cost-Benefit Analysis:
Identify Benefits—Intangible

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Example: Net Present Value and Payback Data

• When using net present value, the intangible benefits and

the design feasibility score must also be considered.

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 Systems Evaluation and Selection
• Deliverable portion of systems selection process is the
systems selection report which will be the basis of the
steering committees selection.
• Two general options: in-house development or purchase
commercial software.
– Management should have a good sense of which option to follow.
• Formal announcement of the new system is the last and most
delicate step in the project initiation phase.
– If successful, will pave the way for the new system and help ensure
acceptance among users.
– Not all users may understand new system objectives and may feel
threatened, which can lead to acts of opposition to the system.
– Top management needs to settle fears and explain the business
rationale before formal construction begins.
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 The Accountant’s Role in Managing the SDLC
• Creation of an information system is a significant financial
transaction, consuming both financial and human resources.
– Accountants concerned with the integrity of the process.
• Quality of accounting information systems and their output
rests directly on the SDLC activities that produce them.
• Accountants ensure that the following are considered:
– Only escapable (relevant) costs are used in calculations of cost
savings benefits.
– Reasonable interest rates are used in measuring present values of
cash flows.
– One-time and recurring costs are completely and accurately
reported.
– Realistic useful lives are used in comparing competing projects.
– Intangible benefits are assigned reasonable financial values.

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 The Accountant’s Role in Managing the SDLC
• Creation of an information system is a significant financial
transaction, consuming both financial and human resources.
– Accountants concerned with the integrity of the process.
• Quality of accounting information systems and their output
rests directly on the SDLC activities that produce them.
– Accountant’s responsibility is to ensure proper application of
accounting conventions and rules, and adequate controls.
• Accountants are involved in three ways:
– As end users who must provide a clear picture of their problems
and needs.
– As members of the development team.
– As auditors who must ensure that the system is designed with
appropriate and computer audit techniques.
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 The Accountant’s Role in Managing the SDLC
• Auditors routinely review organization’s systems strategy.
– Careful planning is a cost-effective way to reduce risk of creating
unneeded, unwanted, inefficient, and ineffective systems.
– Internal and external auditors have vested interests in outcome.

• Accountant’s role in conceptual design is to recognize

control implications and ensure accounting conventions and
legal requirements are understood.
– System auditability depends in part on its design characteristics.
• Accountants should ensure economic feasibility analysis:
– Only includes escapable costs in the cost-savings benefit analysis.
– Uses reasonable interest rates and realistic useful lives.
– Completely and accurately includes all costs.
– Assigns reasonable financial values to intangible benefits.

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Chapter 14
Construct,
Deliver, and
Maintain
Systems
Projects

Accounting Information
Systems 9e
James A. Hall
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 Objectives for Chapter 14
• Be able to identify the sequence of events that constitutes
the in-house development phase of SDLC.
• Be familiar with tools used to improve the success of systems
construction and delivery activities including prototyping,
CASE tools, and the use of PERT and Gantt charts.
• Understand the distinction between structured and object-
oriented design approaches.
• Understand the use of multilevel DFDs in the design of
business processes.
• Be familiar with the different types of systems
documentation and the purposes they serve.

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 Objectives for Chapter 14 (cont’d.)
• Recognize the role of accountants in the construction and
delivery of systems.
• Understand the advantages and disadvantages of the
commercial software option and be able to discuss the
decision-making process used to select commercial
software.

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 In-House Systems Development
• Problems that account for most system failures that have
plagued the systems-development life cycle (SDLC):
– Poorly specified systems requirements.
– Ineffective development techniques.
– Lack of user involvement in systems development.

• User involvement in systems development is key to success

but competent user involvement is difficult to accomplish:
– Users tend to become discouraged when they discover the time
investment required.
– Communication between end users and systems professional is
generally not fluent with miscommunication discovered too late.

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 In-House Systems Development:
Techniques for Improvement
• Prototyping:
– Providing users a preliminary working version of the system.
– Built quickly and inexpensively with intention it will be modified.
– Objective is to represent “an unambiguous functional specification,
serve as a vehicle for organizing and learning, and evolve ultimately
into a fully implemented system.”
– Effective tool for establishing user requirements.

• Computer-aided software engineering (CASE):

– Involves the use of computer systems to build computer systems.
– Upper CASE tools support analysis and design.
– Lower CASE tools support physical activities associated with
application programming and system maintenance.

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 In-House Systems Development:
Techniques for Improvement
• PERT Chart:
– Tool for showing the relationship between key activities that
constitute the construct and delivery process.
– Principal features of the diagram are:
• Activities which are the tasks to be completed in the project.
• Events mark the completion of one activity and the beginning of the next.
• Paths are routes through the diagram that connect the events from the
first to the last.
• Critical path is the path with the greatest overall time.

• Gantt Chart:
– Horizontal bar chart that presents time on a horizontal plane and
activities on a vertical plane.
– Shows the current status of the project at a glance..

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 Design Approaches
• The structured design approach is a disciplined way of
designing systems from the top down.
– Starts with “big picture” of proposed system and gradually
decomposes it into greater detail so it may be fully understood.
– Utilizes data flow diagrams (DFDs) and structure diagrams.

• The object-oriented design approach builds information

systems from reusable standard components or objects.
– Once created, standard modules can be used in other systems with
similar needs.
– A library of modules can be created for future use.
– Benefits include reduced time and cost for development,
maintenance, and testing and improved user support and flexibility
in the development process.

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 Elements of the Object-Oriented Approach
• Objects are equivalent to nouns.
• Attributes are the data that describe the objects
• Methods are actions performed on or by objects that may
change their attributes.

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 Elements of the Object-Oriented Approach
• An object class is a logical grouping of objects that share the
same attributes and methods.
• An instance is a single occurrence of an object within a class.

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 Elements of the Object-Oriented Approach
• Inheritance means each object instance inherits attributes
and methods of the class to which it belongs.

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 Systems Design
• Purpose of design phase is to produce a detailed description
of proposed system that satisfies requirements identified
during analysis and is in accordance the conceptual design.
• Follows a logical sequence of events:
– Create a data model of the business process.
– Design conceptual user views.
– Design normalized database tables.
– Design physical user views (output and input views).
– Develop process modules.
– Specify system controls.
– Perform system walkthroughs.
• Iterative process that is circular, not linear.

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 Data Modeling, Conceptual Views and Normalized
Tables
• Data modeling formalizes the data requirements of the
business process as a conceptual model.
• Entity-relationship diagram (ERD):
– Primary tool for data modeling
– Used to depict the entities or data objects in the system.

• Once entities have been represented in the data model,

data attributes of each can be described.
– Requires careful analysis of user needs and may include both
financial and non-financial data.
• Attributes represent the conceptual user view that must
be supported by normalized database tables.

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 Design Physical User Views
• Output is the information produced by the system to support
user tasks and decisions and should have these attributes:
– Relevance: information must support user’s decision or task.
– Summarization: should be done according to level of user.
– Exception orientation: Operation control reports should identify
activities about to go out of control only.
– Timeliness: Timely information that is reasonably accurate and
complete more valuable than perfect information received too late.
– Accuracy: Output must be free of material errors.
– Completeness: Ideally, no essential information should be missing.
– Conciseness: Reports should be as concise as possible.
• Systems designers must determine output types and formats
most useful to the user.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Designing Input Views
• Items to consider in designing hard-copy documents:
– How will the document be handled?
– How long will the form be stored and in what type of environment?
– How many copies are required and what size form is necessary?
– What form design should be used?
• Zones are areas on the form that contain related data.
• Embedded instructions are contained within the form, should be brief and
unambiguous, and placed in the zone to which they pertain
• Electronic input techniques fall into two basic types:
– Input from source documents requires input screens that visually
reflect the source document.
– Direct data input requires that data correct technology be
distributed to the source of the transaction.
• Data entry devices include point-of-sale terminals, magnetic ink character
recognition devices, optical character recognition devices, ATMs and voice
recognition devices.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Design the System Process
• Begins with the DFDs produced in the general design phase.
This DFD was decomposed from the context-level DVD:

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 Design the System Process
• Process 1.4 decomposed into the next level of detail:

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 Design the System Process
• Creation of structure diagram requires analysis of DFD to
divide processes into input, process and output functions.

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 Design the System Process
• Modular approach involves arranging system in hierarchy of
small, discrete modules that each perform a single task.
• Correctly designed modules are (1) loosely coupled and (2)
have strong cohesion where each module has one task.
– Coupling measuring degree of interaction between modules.
• Modules with high interaction are tightly coupled.

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 Design System Controls & Perform Walk-Through
• Last step in the detailed design phase, this includes:
– Computer processing controls.
– Database controls.
– Manual controls over input to and output from the system.
– Operational environment controls.

• Allows design team to review, modify, and evaluate controls

with a system-wide perspective that did not exist when each
module was being designed independently.
• Development team usually performs a system design walk-
through to ensure design is free from conceptual errors that
could become programmed into the final system.
– Some firms use an independent quality assurance (QA) group of
programmers, analysts, users, and internal auditors for this task.

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 Review System Documentation
• Detailed design report documents and describes system to
this point.
• Report includes:
– Design of all screen outputs, reports, and operational documents.
– ER diagrams describing the data relations in the system.
– Third normal form designs for database tables specifying all data
elements.
– Updated data dictionary describing each data element.
– Designs for all screen inputs and source documents for system.
– Context diagrams for the overall system.
– Low-level data flow diagrams of specific system processes.
– Structure diagrams for the program modules in the system, including
a pseudocode description for each module.

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 Program Application Software
• If software developed must select programming language.
• Procedural languages require programmer to specify precise
order program logic is executed
– Often called third-generation languages (3GLs) and include COBOL,
Fortran, C, and PL1.
• Event-driven languages are not procedural and program’s
code is not executed in a predefined sequence.
– External actions or events user initiates dictate program control flow.
– Microsoft Visual Basic most popular example.
• Object-oriented programming (OOP) languages are central
to achieving benefits of this approach.
– Most popular are Java and Smalltalk but learning curve is steep so
many hybrid languages have been developed.

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 Programming the System
• Regardless of language used, programs should follow a
modular approach which produces small programs that
perform narrowly defined tasks. Benefits include:
• Programming efficiency: Modules can be coded and tested
independently which vastly reduces programming time.
• Maintenance efficiency: Small modules are easier to analyze
and change which reduces maintenance time.
• Control: Small modules are less likely to contain material
errors of fraudulent logic and errors are contained within the
module.

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 Software Testing
• Programmers should test completed modules independently
before implementing them.

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 Deliver the System
• System ready to be implemented.
– Database structures are populated, equipment is purchased and
installed, employees are trained and system is documented.
• Engages efforts of designers, programmers, database
administrators, users and accountants.
• After testing individual modules, entire system should be
tested as a whole.
– Formal acceptance document should be prepared when test
results are satisfactory.
• Auditor should save data during system review for future
use.
– Serves as a base case which documents how system performed at
a point in time.

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 Documenting the System
• System documentation describes how system works.
• Designers and programmers need highly technical
documentation to debug errors and perform maintenance.
– Includes DFDs, ER diagrams, structure diagrams, system flowcharts,
program flowcharts, and program code listing.
• Computer operator use run manuals on how to run system.
• Users need documentation describing how to use the system.
– Typical user handbook contains an overview of system and major
functions, instructions on getting started, tutorials, and help features.
• Accountant (auditor) documentation includes all of the above
and document flowcharts.

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 Converting the Databases
• Database conversion is a critical step in the implementation.
– The transfer of data from its current form to the format or medium
required by the new system. Degree of conversion depends on
technology leap from old system to new.
• Data conversion is risk and precautions should be taken:
– Validation: Old database must be validated before conversion
which requires analyzing each class of data to determine if it should
be reproduced in the new system.
– Reconciliation: After conversion new database must be reconciled
against the original.
– Backup: Keep copies of the original files against discrepancies in
the converted data.

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 Converting to the New System
• With cold turkey cutover (also called the big bang approach)
firms switches to the new system and simultaneously
terminates the old system.
– Often easiest and least costly with simple systems, but riskiest
approach with more complex systems.
• Phased cutover begins operating new system in modules.
– Reduces risk of devastating failure but can create incompatibilities
between old and new subsystems.
• Parallel operation cutover involves running both the old
system and new system simultaneously for a period of time.
– Most time consuming and safest approach, but also the most costly.

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Post-Implementation Review
• Objective to measure success of system and of the process
and should consider:
• System design adequacy:
– Do physical features of the system meet user needs?
– Should consider output, usefulness, format, accuracy,
completeness, accessibility, input forms, user operations,
processing, accessibility, execution, documentation and help.
• Accuracy of time, cost and benefit estimates:
– Were there any material errors in the estimates?
– Are benefits as expected and were they fairly valued?

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 The Role of Accountants
• Role in the construct and deliver phases of the SDLC should
be significant.
• Most system failures are due to poor design and improper
implementation.
• Accountants should provide their expertise to help avoid
inadequate systems by:
– Providing technical expertise in the design phase to ensure the
AIS complies with GAAP, GAAS, SEC regulations and IRS codes.
– Specifying documentation standards for auditing purposes.
– Verifying control adequacy in accordance with SAS 78 during both
the design and implementation phase.

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 Trends in Commercial Packages
• Four factors have stimulated growth of commercial software:
– Relatively low cost of general packages.
– Prevalence of industry-specific vendors.
– Growing demand for commercial software by small businesses.
– Trend toward downsizing and distributed data processing.

• Turnkey systems are complete, tested systems ready for

implementation.
• Backbone systems provide a basic structure to build on.
• Vendor-supported systems are vendor developed and
maintained custom systems.
• ERP systems are difficult to classify as they have characteristic
of all of the other types.
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 Commercial Packages
• Advantages of commercial packages:
– Decreased implementation time and cost.
– Reduced probability of program errors.

• Disadvantages of commercial packages:

– Dependence on vendor for maintenance.
– Less flexibility and greater difficulty in modifying system.

• Four steps in choosing a commercial package:

– 1. Analyze needs and develop detailed specifications
– 2. Send out request for proposals (RFP) to prospective vendors to
serve as a comparative basis for initial screening.
– 3. Gather facts about each system using multiple sources and
techniques.
– 4. Analyze the findings and make a final selection.

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 Maintenance and Support
• May be relatively trivial or more extensive.
• Some organization’s outsource on a low-cost bidder basis.
– Justification is short-term economic benefit but isolating
maintenance activities may disrupt the flow of system-related
knowledge important to the organization.
• End user support is a critical aspect of maintenance that can
be facilitated by:
– Knowledge management which is a method for gathering,
organizing, refining, and disseminating user input.
– Can be used to create a group memory which makes an
organization more effective.

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 Appendix Section A: Case Tools
• Central Repository is the heart of the CASE system:
– Database of attributes, relations , and elements that describe all
the applications created under CASE including:
• Definition of all databases, system documentation, program code,
reusable program modules and user prototype screens.

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 CASE Models: The Data Flow Diagram Model
• The context-level DFD is a very high-level representation of
the system.

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 CASE Models: The Data Flow Diagram Model
• Next step is
to explode
the context-
level DFD
into one or
more
intermediate
-level DFDs.
• Process 1.0
decomposed
into four sub-
processes.

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 CASE Models: The Data Flow Diagram Model
• Elementary-
level DFD
provides a
clear and
precise
definition of
all elements
of a portion
of a system.
• Process 1.3
explained in
detail.

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 CASE Models
• The prototype model supports the prototyping concept.
• Design model based on concept of system decomposition.
– Any system can be decomposed into smaller sub-functions.
– Takes the elementary-level DFD and produces a structure diagram.
• DFD is a model of the conceptual system and the structure diagram is a
model of the program code that constitutes the physical system.

• One of the labor-saving advantages of CASE is its facility for

transforming the structure diagram into computer modules.
– Some CASE tools eliminate the source-code stage, forcing system
changes to be made via the DFD.
• Preserve integrity between conceptual system (the DFD) and the
physical system (program) but commits firm to a CASE tool.
• Potential control issue for auditor.

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 Case Models: The Maintenance Model
• The iceberg effect refers to fact that 80 to 90% of total
system cost is expended during the maintenance phase.
– Effect greatly reduced by the CASE maintenance model.

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 Advantages and Disadvantages of CASE
• Advantages:
– Reduced system complexity and maintenance cost.
– Increased flexibility because it tends to be a cyclical process.
– Capacity of review alternative designs.
– Quicker development process and promotion of user involvement.
– Reusable program code and documentation.
• Disadvantages:
– Fully equipped CASE tools for a mainframe can cost hundreds of
thousands of dollars.
– Developing CASE expertise takes time and learning curve is steep.
– Hundreds of CASE products available are often incompatible which
tends to tie the firm to a single product and vendor.
– CASE source code not as efficient as programmer code.

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 Appendix Section B: Output Reporting Alternatives
• Tables and matrices are used to summarize large amounts
of information.

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 Graphs and Charts
• Line graphs are used to show fluctuations in an item of
interest over time.

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 Graphs and Charts
• Scatter graphs reveal relationships among underlying data.

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Graphs and Charts

• Bar graphs
show
relationships
of total
quantities or
proportions.

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 Graphs and Charts
• Pie charts present proportional relationship of different
items to the whole.

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 Graphs and Charts
• Layer charts also show proportional relationships but allow
the addition of another dimension such as time or condition.

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 Colors
• Colors can greatly enhance report usefulness.

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