ACCOUNTING INFORMATION SYSTEMS CHAPTER-1

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CHAPTER-1
ACCOUNTING INFORMATION SYSTEMS: AN OVERVIEW

What is accounting?
Accounting is concerned with collecting, analyzing and communicating financial
information. The purpose is to help people that use this information to make more informed
decisions. If the financial information that is communicated is not capable of improving the
quality of decisions made, there would be no point in producing it. Sometimes the impression is
given that the purpose of accounting is simply to prepare financial reports on a regular basis..
While it is true that accountants undertake this kind of work, it does not represent an
end in itself. The ultimate purpose of the accountant‘s work is to give people better financial
information on which to base their decisions.
Uses of accounting:
1. Accounting provides a vital service by supplying the information decision makers
need to make reasoned choices among the alternative uses of scarce resources in the
conduct of business and economic activities.
2. Accounting helps on making decisions concerning more rational acquisition of
limited resources through better decision choices.
3. Accounting helps for efficient use of available resource through prompt detection of
inefficiencies.
4. Accounting helps for more equitable distribution of resources.
5. Accounting helps to make policy decisions relating to change in the system.
6. Accounting helps discharge of the social responsibilities of the business and industry.
7. Accounting Provides accounting information to the Government for taking decisions
on excise duties, sales taxes etc.
8. Evaluation of financial performance by managers, inventors, creditors, government
agencies, analysts and other users.
9. Planning and control of internal operations by decision makers.

Accounting as an Information System:

Accounting is an information system that measures, processes, and communicates

financial information about an economic entity; an economic entity is a unit that exists
independently, such as a business, a hospital, or a governmental body.
Accountants focus on the needs of decision makers who use financial information,
whether those decision makers are inside or outside a business or other economic entity.
Accountants provide a vital service by supplying the information decision makers need to make
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“reasoned choices among alternative uses of scarce resources in the conduct of business and
economic activities.” As shown in Figure 2.1, accounting is a link between business activities
and decision makers.

What is accounting information?

There are many definitions for accounting information:

1. Accounting information: it is the data that have been processed properly to give a full
meaning and can be used in ongoing operations and future decision-making.
2. Accounting information: all quantitative and non quantitative information that concern
with the economic events that are processed and reported by information system in the
financial statements that presented to external and internal users.
All these definitions can be collected in one definition which is:
Accounting information: is the data that have been organized and processed by accounting
system to provide a full meaning to users.

Accounting information reflects the events and facts that related to the financial and accounting
aspect of the company, and it is represent the final product of the accounting system because the
main purpose of accounting system is to provide the necessary information for decision makers.

Accounting Information Systems—A Definition

Suggests that accounting information systems (AISs) stand at the crossroads of two disciplines:
‘‘accounting’’ and ‘‘information systems.’’ Thus, the study of AISs is often viewed as the study
of computerized accounting systems. But because we cannot define an AIS by its size;

Accounting information systems exists at the intersection of two important disciplines: (1) accounting and (2)
information systems.

It is better to define it by what it does. This latter approach leads us to the following definition
that we will use as a model in this book:
Definition: “ An accounting information system is a collection of data and processing
procedures that creates needed information for its users”.
“An Accounting information system is a set of interrelated activities, documents, and
technologies designed to collect data, process it, and report information to diverse group of
internal and external decisions makers in organizations”. Well designed AIS can
significantly enhance decision making in organizations by responding to many elements of the
Financial Accounting standards Board Conceptual Framework.
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WHY STUDY ACCOUNTING INFORMATION SYSTEMS?

Business concerns, Government organizations, Accountants and individual users are commonly
facing problem for storing and communicating the information of business and accounting.
Avoiding for global competition, attracting the customers and global wise expansion of the
business we should maintain accuracy in the Accounting transactions. The priority of clear
information, quick accessing, retrieve the information, storing information is day by day
increasing. Because of that, Achieving our goals and objectives, to show our sincerity,
efficiency, and honesty in front of the government, people it is necessary. Basically we discussed
two types of essentialities for AIS.

1) Organization essentialities
2) Essentialities of Accountants

Organization essentialities:

1) Organizing for Accounting records and producing the financial records to their bankers,
government, people in easy way.
2) Making Clear design for a set of procedures to ensure that they meet all of their
government obligations, such as remitting sales, income, and payroll taxes.
3) Deciding for product prices to face competition effectively, earn sufficient profit
4) Knowing for credit extension, on what terms, and how to accurately track what
customers owe and have paid
5) To Provide better training, hiring and supervising their employees; knowing for what
competition and benefits packages to offer them; and how to process payroll.
6) Keep the track of cash inflows and outflows
7) Knowing for appropriate product mix and showroom space for carrying quantities etc.,

Essentialities of Accountants: ( Important work activities performed by Accountants)

1. Accounting system and financial reporting

2. Long term strategic planning
3. Managing the Accounting and financing
4. Internal consulting
5. Short term budgeting
6. Financial and Economic analysis
7. Process Improvement
8. Computer systems and operations
9. Performance evaluation of the organization
10. Customer and product profitability analysis. Etc.,

1.1 OVER VIEW OF ACCOUNTING INFORMATION SYSTEM

FASB developed the conceptual Frame work in the late 1970s as a guide for the development of
future accounting principles. While the jury is still out on whether the conceptual framework has
fulfilled that purpose, it is a fundamental part of accounting practice.
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Objectives of financial reporting: to provide information for decisions

Elements of financial statements:

Qualitative characteristics:
Assets, Liabilities,equity-Revenue
Primery ;relevence and reliability
Expenses-Gains, losses-
and consistancy
Comprehensive income

Assumptions : Principle: Constraints:

Economic entity- Historical cost- cost effectiveness-
Going concern- Realisation- Materiality-
Periodicity- Matching- Full Conservatism-
Monetary Unit Disclosure

You also can be fairly confident that you’ll see questions on the conceptual framework on most
accounting professional exams (CPA, and the like)
Detailed study of conceptual frame work often comprises the first part of intermediate
accounting, so we won’t go in to great detail on it here. Basically, the conceptual framework
looks like the one show in the above figure.
A well-designed accounting information system relates to the conceptual frame work by
 Capturing data on the elements of financial statements. No matter what form they take
or information technologies they use, accounting information systems documents changes
in assets, liabilities, equity, revenue expenses, gains and losses. Many continue to use a
traditional debit/credit format for doing so, although some scholars in the area have
suggested that debit and credits may have less relevance in the future.
 Transforming those data into relevant and reliable information. Well-designed
accounting information system also can gather data beyond the elements of financial
statements. Items like sales by geographic area, customer characteristics and transaction
histories, demand for inventory items, and vendor quality ratings can improve decision
making by enhancing the elements of relevance; predictive value, feedback value, and
timeliness. Additionally, internal controls in the accounting information system promote
reliability ( verifiability, neutrality, and representational faithfulness), as you’ll see in
later chapters.
 Recognizing and adapting to the cost-benefit constraint. Accounting information
systems are all about choice and trade-offs; what data should I capture? What information
technologies should I use to process them? What information should I report? Looking at
conceptual framework diagram in figure(above) you’ll see “cost effectiveness” as one of
the constraints on accounting information. Cost effectiveness reminds us that we can’t
design the world’s perfect accounting information system. Even in the best organization
with the most effective systems, you’ll find managers who want more data or different
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data, who question the system’s integrity, and/ or who want business processes to be
structured differently. As a designer, implementer, and interpreter of accounting
information systems, always keep in mind that the benefit of having data, process, and
information must outweigh the costs of obtaining or implementing them. Those costs and
benefits might be economic, behavioral, psychological, or financial, but they should
always be considered.
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Qualitative characteristics of accounting information:
The IFRS identified the qualitative characteristics of accounting information that
distinguish better (more useful) information from inferior (less useful) information for decision
making purposes.
Qualitative characteristics are either fundamental or enhancing characteristics, depending
on how they affect the decision usefulness of information. Regardless of classification, each
qualitative characteristic contributes to the decision usefulness of financial reporting information.

1. Fundamental Qualities of accounting information:

A. Relevance:

Relevance is one of the two fundamental qualities that make accounting information useful for
decision making, relevance and related ingredients of this fundamental quality are shown below.
To the accounting information be relevant it must be appropriate and convenient for decision
makers, and this property can be achieved by knowing the extent of the benefit of using
accounting information by decision makers, when this information help to reduce the alternatives
and choose the best alternative which represents the optimal decision, accounting information is
capable of making a difference in a decision when it has predictive value, confirmatory value or
both.
1. Predictive value: Accounting information has the ability to achieve the
benefit from using it in the predictive decision and expectation about the
future.
2. Confirmatory value: Relevant information also helps users confirm or
correct prior expectations.

B. Faithful representation:

Faithful representation is the second fundamental quality that makes accounting information
useful for decision making. Faithful representation and related ingredients of this fundamental
quality are shown below.

Faithful representation means that the number and descriptions match what really existed or
happened, it is necessary because most users have neither the time nor the expertise to evaluate
the factual content of the information.
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1. Completeness: All information that is necessary for faithful representation is

provided, and accounting information must be presented without omission of
essential information.
2. Neutrality: The Company cannot select information to favor one set of
interested parties over another, not influence the process of obtaining the
information and preparation the information in specific form to serve specific
person without the other. Unbiased information must be the overriding
consideration.
3. Free from error: An information item that is free from error will be a more
accurate representation of a financial item. However, Faithful representation
does not imply total freedom from error this because most financial reporting
measures involve estimates of various types that incorporate management‘s
judgment.

C. Enhancing Qualities:

Enhancing qualitative characteristics are complementary to the fundamental qualitative

characteristics. These characteristics distinguish more useful information from less useful
information. Enhancing characteristics are shown below.

1. Comparability: Information that measured and reported in a similar manner for

different companies is considered comparable, comparability enable users to
identify the real similarities and differences in economic events between
companies and between the fiscal period and other at the same economic entity
and with other economic entities at the same activity.
2. Verifiability: Verifiability occurs when independent measures, using the same
method, obtain similar result, and access to the same results by more than one
person, if we not use the same techniques and methods that are used to measure
the accounting information.
3. Timeliness: Timeliness means having information available to decision makers
before it loses its capacity to influence decision; accounting information must be
available at the right time for the decision making process.
4. Understandability: Understandability is enhanced when information is
classified, characterized and presented clearly and concisely, and it is the quality
of information that lets reasonable informed users sees its significance.

Purpose of using accounting information:

1. Measurement: Accounting information is a measure of the performance of the company
and its success because it reflects the events and the financial accounting of the company and
shows the financial situation of the company at a certain period.
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2. Evaluation: Performance evaluation for an individual can be based on accounting

information for transactions that were under that person's control. For example, a purchasing
agent might be responsible for negotiating prices on raw materials. The actual cost of purchases
made by that agent would form the basis for his evaluation. The local manager of a division
might be evaluated based on the profits earned by that division. An income statement for that
division would form the basis for her evaluation.

3. Communication: Accounting information is used to communicate. It is used to

communicate financial results to external users, such as creditors or investors. Creditors use the
information to determine how much credit to extend to the company. Investors determine
whether they want to invest in the business. Accounting information is also communicated to
managers and employees, who consider it in making decisions for future transactions.

4. Decision-Making: Accounting information can be used for decision-making. One type of

decision is whether a company should make a component itself, or purchase the part from an
outside supplier. Another type of decision would be whether the company should accept a
special order at a lower price. For either decision, financial data must be gathered and compared.
Accounting information is relied upon to make the best decision

ELEMENTS AND PROCEDURES OF AIS

In order to understand how these systems work, you have to understand the accounting terms
"business transactions" and "business processes" and how they come together to generate
financial reports. With regard to accounting information systems, business transactions can be
divided into four types of business processes:

Subsystems/elements of AIS:

1. Revenue cycle: it contains customer orders, sales, shipping/delivery, cash receipts, sales
discounts, sales return and allowances, bad debts
2. Expenditure cycle: it considers purchase requisitions, purchases, receipts of inventory,
cash disbursements, purchase returns and allowances, purchase discounts etc.,
3. Human Resource cycle: it contains hiring, training, promotion, firing payroll, taxes.
4. Financial cycle: here we should observe investment in company, procuring loans,
payment of dividends and interest, repayment of loans.
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 Is space provided to record the final disposition of the form?

 Is space provided for a signature or signatures to indicate final approval of the transaction?
 Is space provided to record the date of final disposition or approval?
 Is space provided for a dollar or other numeric total?
 Is the distribution of each copy of the form clearly indicated?

3. Post transaction to Ledgers: Ledgers are used to summarize the financial status,
including the current balance, of individual accounts. In a manual system, ledgers are actually
books; hence, the phrase “keeping the books” refers to the process of maintaining the ledgers.

The general ledger contains summary-level data for every asset, liability, equity, revenue, and
expense account of the organization. A subsidiary ledger records all the detailed data for any
general ledger account that has many individual subaccounts. Subsidiary ledgers are commonly
used for accounts receivable, inventory, fixed assets, and accounts payable. The general ledger
account corresponding to subsidiary ledger, called a control account, contains the total amount
for all individual accounts in the subsidiary ledger. Thus the accounts payable control account in
the general ledger represents the total amount owed to all vendors. The balances in the subsidiary
accounts payable ledger indicate the amount owed to each specific vendor. The relationship
between the general ledger control account and the individual account balances in the subsidiary
ledger plays an important role in maintaining the accuracy of the data stored in the AIS.
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B. Secondary functions
1. Providing information for decision making:

In secondary functions of the AIS is to provide management with information useful for decision
making. In manual systems, this information is provided in the form of reports that fall into two
main categories: Financial statements and managerial reports.

Financial Statements: The preparation of the financial statements consists of a sequence of

activities. First, all the accounts in the general ledger and their balances are listed in a report
called a trial balance. It is so named because one of its purposes is to allow the accountant to
verify that the total debit balances in various accounts equal the total credit balances in other
accounts. Once the trail balance has been prepared and checked, any necessary adjusting entries
are made.

Then another Trail Balance called the adjusted trail balance because it reflects the effects of all
adjusting entries, is prepared. The adjusted trail balance is examined to verify the equality of
debits and credits and the accuracy of all adjusting entries.

Managerial Reports: In addition to prepare financial statements, the AIS must be able to
provide managers with detailed operational information about the organization’s performance.
Like.,, Inventory status, relative profitability of products, relative performance of each
salesperson, cash collections and pending obligations, and performance in meeting its delivery
and service commitments etc.,

Budget and performance report: another concentration of AIS preparing budget and
performance report.

A budget is the formal expression of goals in financial terms. One of the most common and
important types of budgets is the cash budget. A cash budget shows projected cash inflows and
outflows. This information is especially important to a small business, because cash flow
problems are one of the principal causes of small business failures. A cash budget can provide
advance warning of cash flow problems in time to permit corrective action to be taken.

Another commonly used budget is the operating budget. An operating budget projects an
organization’s revenue and expenses for a given time period, usually a month or a year.
Typically, operating budgets are structured along the lines of financial statements.

Budgets are financial planning tools. Performance reports, in contrast, are used for financial
control. A performance report lists the budgeted and actual amounts of revenue and expenses and
also shows the variances, or differences, between these two amounts.

Behavioral Implications of managerial reports: there is an old saying that measurement

affects behavior. As applied to business, this means that employees tend to focus their efforts
primarily on those tasks that are measured and evaluated. This can be either good or bad,
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depending on the relationship between the behavior being measured and the organization’s
overall goals.

2. Internal control Considerations:

The next function of AIS is to provide adequate internal controls to accomplish three basic
objectives:

1. Ensure that the information produced by the system is reliable

2. Ensure that business activities are performed efficiently and in accordance with
management’s objectives while also conforming to any applicable regulatory policies.
3. Safe guard organizational assets, including its data.

Users of accounting information

A. Internal users:
Those Users who are involving and taking responsibility to develop the enterprise or company
and depending on inside reports, analyses of AIS for decision making called as internal users.
Types of internal users include:
1. Management: Management in every level of the business from director level to
supervisor level relies on accounting information to do their job properly. They all
use the same information for different purposes. For example, directors use it for
strategic purposes and middle management can use it to see if they are meeting
their financial targets.
2. Investors: Investors generally provide money to individual or organization to
start a business. Before investing money investors generally want to know
whether they should invest or not or if they would invest to start a business now
then how much return they will get from their investment. The investors will
decide based on the financial accounting information of that business.
3. Employers: Employers use accounting information for their own benefit,
accounting information help the employee to ensure their future benefit from the
company like pension, health provision, retirement benefit etc.
4. Owners: Business owners want to know whether their funds are being properly
used or not. Accounting information helps them to know the profitability and the
financial position of the concern in which they have invested their funds.

B. External users:
Those users are outsiders, who are interested to know our company or business accounting
information, and where we have to show our information to prove our sincerity, fairness that all
parties called as External users.
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1. Shareholders: Shareholders use the balance sheet and profit and loss account
produced by limited companies to decide if they are going to increase or decrease
their holding.
2. Creditors: Creditors (lenders) are generally focused on the information which is
related to the borrower before making a large loan such as the Bank (creditors) will
want information about the borrower regarding some criteria: the ability of the
borrower to repay the loan, the amount of assets and liabilities of the borrower,
evidence of income, tax policies and so on. The creditors will make the loan after
having this detail information through financial accounting statement of the borrower.
3. Government Regulatory Agencies: Government regulatory agencies like Federal
and State Government Agencies and Security and exchange commission want
financial accounting information which is related to the investors, business
organization or any individuals, these regulatory agencies want the information to
know that whether the business organization are following the business rules and
regulation or not or whether the investors are able to invest or make decision or not,
Security and exchange commission want accounting information to evaluate the
financial accounting disclosures of companies who sell their share or borrow money.
4. Taxing authority: Taxing authority wants financial accounting information related to
tax policies, tax laws, amount of payable tax etc. from the individual or organization.,
taxing authority wants financial accounting to know that the business organization are
following tax rules or not and their ability to pay income tax because income tax is
based on the financial accounting reports.
5. Labor unions: Labor unions want accounting information to know their future
salary.
6. Suppliers: Suppliers want to know about company‘s future goals so that they can
serve best material in coming days.
7. Customers: Sometimes customer also want to know about company on issues like
warranty, product development etc.

The Role of Accountant:

The final section of this chapter deals with the accountants’ relationship to the information
system. Accountants are primarily involved in three ways: as system users, as system designers,
and as system auditors.
1. Accountants as users:
In most organizations the accounting function is the single largest user of computer servicemen.
All systems that process financial transactions must provide a clear picture of their needs to the
professionals who design their systems. Example: the accountant must specify accounting rules
and te4chniques to be used, internal control requirements, and special algorithms such as
depreciation models. The accountant’s participation in syste4ms development should be active
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rather than passive. The principle cause of design errors that result in system failure is the
absence of user involvements.
2. Accountants as system designers:
The design of the computer system involves specifying the criteria for identifying delinquent
customers and the information that needs to be reported. The accountant determines the nature of
the information required, its sources, its destination, and the accounting rules that need to be
applied. The physical system is the medium and method for capturing and presenting the
information. The computer professionals determine the most economical and effective
technology for accomplishing the task. Hence, system should be a collaborative effort. Because
of the uniqueness of each system and the susceptibility of systems to serious error and event
fraud, the accountant’s involvement is system design should be pervasive.
3. Accountants as System Auditors:
Auditing is a form of independent attestation performed by an expert the auditor who express an
opinion about the fairness of a company’s financial statements. Audits are conducted by both
internal and external auditors. External audit is often called independent auditing because it is
performed by certified public accounting (CPA) firms that are independent of the Clint
organizations management. External auditors represent the interests of third party stake holds in
the organization, such as stockholders, creditors, and government agencies.