CHAPTER ONE

ACCOUNTING INFORMATION SYSTEM: AN OVERVIEW

INTRODUCTION

The study of accounting information systems (AISs) is, in large part, the study of the
application of information technology (IT) to accounting systems. This chapter describes the
ways that information technology affects financial accounting, managerial accounting,
auditing, and taxation. We begin by answering the question ‘‘what are accounting
information systems’’ and then look at some new developments in the field.

Following this, we will examine some traditional roles of AISs in business.

Why should you study accounting information systems? There are many reasons, which we
will review briefly in this chapter, but one of the most important is because of the special
career opportunities that will enable you to combine your study of accounting subjects with
your interest in computer systems. In today’s job market, accounting employers expect new
hires to be computer literate. In addition, a large number of specialized employment
opportunities are available to those students who possess a deeper understanding of computer
subjects and can bring advanced computer skills to accounting jobs. The last part of this
chapter describes a number of special career opportunities for those with an interest in AISs.

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.
The information system accepts input, called transactions, which are converted through
various processes into output information that goes to users. Transactions fall into two
classes: financial transactions and nonfinancial transactions.

A financial transaction is an economic event that affects the assets and equities of the
organization, is reflected in its accounts, and is measured in monetary terms.
Sales of products to customers, purchases of inventory from vendors, and cash disbursements
and receipts are examples of financial transactions. Every business organization is legally
bound to correctly process these types of transactions.
Nonfinancial transactions are events that do not meet the narrow definition of a financial
transaction.
For example, adding a new supplier of raw materials to the list of valid suppliers is an event
that may be processed by the enterprise’s information system as a transaction. Important as
this information obviously is, it is not a financial transaction, and the firm has no legal
obligation to process it correctly—or at all.

WHAT ARE ACCOUNTING INFORMATION SYSTEMS?

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.
Accounting ===== Accounting ================Information
Information Systems
Systems

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

An accounting information system is a collection of data and processing procedures that

creates needed information for its users.

Accounting: You probably have a pretty good understanding of accounting subjects because
you have already taken one or more courses in the area. Thus, you know that the accounting
field includes financial accounting, managerial accounting, and taxation.

Accounting information systems are used in all these areas—for example, to perform tasks in
such areas as payroll, accounts receivable, accounts payable, inventory, and budgeting.
In addition, AISs help accountants maintain general ledger information, create spreadsheets
for strategic planning, and distribute financial reports. Indeed, it is difficult to think of an
accounting task that is not integrated, in some way, with an accounting information system.

The challenge for accountants is to determine how best to provide the information required to
support business and government processes. For example, in making a decision to buy office
equipment, an office manager may require information about the sources of such equipment,
the costs of alternate choices, and the purchasing terms for each choice. Where can the
manager obtain this information? That’s the job of the accounting information system.

Information versus Data

Data
Although the terms data and information are often used interchangeably, it is useful to
distinguish between them. Data (the plural of datum) are raw facts about events that have
little organization or meaning—for example, a set of raw scores on a class examination. To
be useful or meaningful, most data must be processed into useful information—for example,
by sorting, manipulating, aggregating, or classifying them. An example might be by taking
the raw scores of a class examination and computing the class average.

Data Sources
Data sources are financial transactions that enter the information system from both internal
and external sources. External financial transactions are the most common source of data for
most organizations. These are economic exchanges with other business entities and
individuals outside the firm. Examples include the sale of goods and services, the purchase of
inventory, the receipt of cash, and the disbursement of cash (including payroll). Internal
financial transactions involve the exchange or movement of resources within the
organization. Examples include the movement of raw materials into work-in-process (WIP),
the application of labour and overhead to WIP, the transfer of WIP into finished goods
inventory, and the depreciation of plant and equipment.

Data Collection
Data collection is the first operational stage in the information system. The objective is to
ensure that event data entering the system are valid, complete, and free from material errors.
In many respects, this is the most important stage in the system. Should transaction errors
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pass through data collection undetected, the system may process the errors and generate
erroneous and unreliable output. This, in turn, could lead to incorrect actions and poor
decisions by the users.

Two rules govern the design of data collection procedures: relevance and efficiency. The
information system should capture only relevant data. A fundamental task of the system
designer is to determine what is and what is not relevant. He or she does so by analyzing the
user’s needs. Only data that ultimately contribute to information (as defined previously) are
relevant. The data collection stage should be designed to filter irrelevant facts from the
system.

Efficient data collection procedures are designed to collect data only once. These data can
then be made available to multiple users. Capturing the same data more than once leads to
data redundancy and inconsistency. Information systems have limited collection, processing,
and data storage capacity. Data redundancy overloads facilities and reduces the overall
efficiency of the system. Inconsistency among redundant data elements can result in
inappropriate actions and bad decisions.

Data Processing
Once collected, data usually require processing to produce information. Tasks in the data
processing stage range from simple to complex. Examples include mathematical algorithms
(such as linear programming models) used for production scheduling applications, statistical
techniques for sales forecasting, and posting and summarizing procedures used for
accounting applications.

Database management tasks

Database management involves three fundamental tasks: storage, retrieval, and deletion. The
storage task assigns keys to new records and stores them in their proper location in the
database. Retrieval is the task of locating and extracting an existing record from the database
for processing. After processing is complete, the storage task restores the updated record to
its place in the database. Deletion is the task of permanently removing obsolete or redundant
records from the database.

Information
Information is different from data. Information is data that have been organized and
processed to provide meaning to a user. Usually, more information and better information
translates into better decisions.

Information is often defined simply as processed data. This is an inadequate definition.

Information is determined by the effect it has on the user, not by its physical form. For
example, a purchasing agent receives a daily report listing raw material inventory items that
are at low levels. This report causes the agent to place orders for more inventories. The facts
in this report have information content for the purchasing agent. However, this same report in
the hands of the personnel manager is a mere collection of facts, or data, causing no action
and having no information content.

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We can see from this example that one person’s information is another person’s data. Thus,
information is not just a set of processed facts arranged in a formal report. Information allows
users to take action to resolve conflicts, reduce uncertainty, and make decisions. We should
note that action does not necessarily mean a physical act. For instance, a purchasing agent
who receives a report showing that inventory levels are adequate will respond by ordering
nothing. The agent’s action to do nothing is a conscious decision, triggered by information
and different from doing nothing because of being uninformed.
The distinction between data and information has pervasive implications for the study of
information systems. If output from the information system fails to cause users to act, the
system serves no purpose and has failed in its primary objective.

Information System Objectives

Each organization must tailor its information system to the needs of its users. Therefore,
specific information system objectives may differ from firm to firm. Three fundamental
objectives are, however, common to all systems:

1. To support the stewardship function of management. Stewardship refers to

management’s responsibility to properly manage the resources of the firm. The
information system provides information about resource utilization to external users
via traditional financial statements and other mandated reports. Internally,
management receives stewardship information from various responsibility reports.

2. To support management decision making. The information system supplies managers

with the information they need to carry out their decision-making responsibilities.

3. The information system provides information to operations personnel to assist them in

the efficient and effective discharge of their daily tasks.

Although computers are wonderfully efficient and useful tools, they also create problems.
One is their ability to output vast amounts of information quickly. Too much information, and
especially too much trivial information, can overwhelm its users, possibly causing relevant
information to be lost or overlooked. This situation is known as information overload. It is
up to the accounting profession to determine the nature and timing of the outputs created and
distributed by an AIS to its end users.

Another problem with computerized data processing is that computers do not automatically
catch the simple input errors that humans make. A computer can be programmed to look for
(and reject) bad input, but it is difficult to anticipate all possible problems.

Yet a third problem created by computers is that they make audit trails more difficult to
follow. This is because the path that data follow through computerized systems is electronic,
not recorded on paper.

Inputs Processes Outputs

Data/Information from Sort, Organize,Calculate Information for
Internal/External Decision Makers
Sources Internal/External

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In addition to collecting and distributing large amounts of data and information, modern AISs
must also organize and store data for future uses. In a payroll application, for example, the
system must maintain running totals for the earnings, tax withholdings, and retirement
contributions of each employee in order to prepare end-of-year tax forms.

Besides deciding what data to store, businesses must also worry about how best to integrate
the stored data for end users. An older approach to this problem was to maintain
independently the data for each of its traditional organization functions—e.g. finance
marketing, human resources, and production. A problem with this approach is that even if all
the applications are maintained internally by the same IT department, there will be separate
data-gathering and reporting responsibilities within each subsystem, and each application will
store its data independently of the others. This often leads to a duplication of data-collecting
and processing efforts, as well as conflicting data values when specific information (e.g., a
customer’s address) is changed in one application but not another.

Organizations today recognize the need to integrate the data associated with their functions
into large, seamless data warehouses. This integration allows internal managers and possibly
external parties to obtain the information needed for planning, decision making, and control,
whether or not that information is for marketing, accounting, or some other functional area in
the organization.

Benefits of information:

Benefits of information may include:

• Reduction of uncertainty
• Improved decisions
• Improved ability to plan and schedule activities

Cost of producing information

Costs may include time and resources spent:

• Collecting data
• Processing data
• Storing data
• Distributing information to users

Information Generation
Information generation is the process of compiling, arranging, formatting, and presenting
information to users. Information can be an operational document such as a sales order, a
structured report, or a message on a computer screen.

Characteristics of Information
Regardless of physical form, useful information has the following characteristics: relevance,
timeliness, accuracy, completeness, and summarization.

RELEVANCE: The contents of a report or document must serve a purpose. This could be to
support a manager’s decision or a clerk’s task. We have established that only data relevant to
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a user’s action have information content. Therefore, the information system should present
only relevant data in its reports. Reports containing irrelevancies waste resources and may be
counterproductive to the user.
Irrelevancies detract attention from the true message of the report and may result in incorrect
decisions or actions.
FIGURE
1-6 THE DATA HIERARCHY
TIMELINESS: The age of information is a critical factor in determining its usefulness.
Information must be no older than the time of the action it supports. For example, if a
manager makes decisions daily to purchase inventory from a supplier based on an inventory
status report, then the information in the report should be no more than a day old.

ACCURACY: Information must be free from material errors. However, materiality is a

difficult concept to quantify. It has no absolute value; it is a problem-specific concept. This
means that, in some cases, information must be perfectly accurate. In other instances, the
level of accuracy may be lower. Material error exists when the amount of inaccuracy in
information causes the user to make poor decisions or to fail to make necessary decisions. We
sometimes must sacrifice absolute accuracy to obtain timely information.
Often, perfect information is not available within the user’s decision time frame. Therefore,
in providing information, system designers seek a balance between information that is as
accurate as possible, yet timely enough to be useful.

COMPLETENESS: No piece of information essential to a decision or task should be

missing. For example, a report should provide all necessary calculations and present its
message clearly and unambiguously.

SUMMARIZATION: Information should be aggregated in accordance with the user’s needs.

Lower level managers tend to need information that is highly detailed. As information flows
upward through the organization to top management, it becomes more summarized.

FEEDBACK: Feedback is a form of output that is sent back to the system as a source of data.
Feedback may be internal or external and is used to initiate or alter a process. For example,
an inventory status report signals the inventory control clerk that items of inventory have
fallen to, or below, their minimum allowable levels.

Internal feedback from this information will initiate the inventory ordering process to
replenish the inventories.
Similarly, external feedback about the level of uncollected customer accounts can be used to
adjust the organization’s credit-granting policies.

WHAT IS A SYSTEM?
A system is a set of interrelated components that interact to achieve a goal of an organization.
For many, the term system generates mental images of computers and programming. In fact,
the term has much broader applicability. Some systems are naturally occurring, whereas
others are artificial. Natural systems range from the atom—a system of electrons, protons,
and neutrons—to the universe—a system of galaxies, stars, and planets. All life forms, plant
and animal, are examples of natural systems. Artificial systems are man-made. These systems
include everything from clocks to submarines and social systems to information systems.

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 Elements of a System
Regardless of their origin, all systems possess some common elements. A system is a group
of two or more interrelated components or subsystems that serve a common purpose.
It means that most systems are composed of smaller subsystems and vise versa.
Let’s analyze the general definition to gain an understanding of how it applies to businesses
and information systems.

Multiple components: A system must contain more than one part. For example, a chair built
from a piece of wood and attached to a string is a system. Without the nail, it is not a system.

Relatedness: A common purpose relates the multiple parts of the system. Although each part
functions independently of the others, all parts serve a common objective. If a particular
component does not contribute to the common goal, then it is not part of the system. For
instance, a pair of ice skates and volleyball net are both components; however, they lack a
common purpose, and thus do not form a system.

SYSTEM VERSUS SUBSYSTEM

The distinction between the terms system and subsystem is a matter of perspective. For our
purposes, these terms are interchangeable. A system is called a subsystem when it is viewed
in relation to the larger system of which it is a part. Likewise, a subsystem is called a system
when it is the focus of attention. Animals, plants, and other life forms are systems. They are
also subsystems of the ecosystem in which they exist. From a different perspective, animals
are systems composed of many smaller subsystems, such as the circulatory subsystem and the
respiratory subsystem.

A system must serve at least one purpose, but it may serve several. Whether a system
provides a measure of time, electrical power, or information, serving a purpose is its
fundamental justification. When a system ceases to serve a purpose, it should be replaced.

AIS SUBSYSTEMS
A. Transaction Processing System

The TPS is central to the overall function of the information system by converting economic
events into financial transactions, recording financial transactions in the accounting records
(journals and ledgers), and distributing essential financial information to operations personnel
to support their daily operations.
The TPS deals with business events that occur frequently. In a given day, a firm may process
thousands of transactions. To deal efficiently with such volume, similar types of transactions
are grouped together into transaction cycles. The TPS consists of three transaction cycles: the
revenue cycle, the expenditure cycle, and the conversion cycle. Each cycle captures and
processes different types of financial transactions.

B. General Ledger/Financial Reporting Systems

The general ledger system (GLS) and the financial reporting system (FRS) are two closely
related subsystems.

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However, because of their operational interdependency, they are generally viewed as a single
integrated system—the GL/FRS. The bulk of the input to the GL portion of the system comes
from the transaction cycles. Summaries of transaction cycle activity are processed by the
GLS to update the general ledger control accounts. Other, less frequent, events such as stock
transactions, mergers, and lawsuit settlements, for which there may be no formal processing
cycle in place, also enter the GLS through alternate sources.

The FRS measures and reports the status of financial resources and the changes in those
resources.
The FRS communicates this information primarily to external users. This type of reporting is
called nondiscretionary because the organization has few or no choices in the information it
provides. Much of this information consists of traditional financial statements, tax returns,
and other legal documents.

C. Management Reporting System

The MRS provides the internal financial information needed to manage a business. Managers
must deal immediately with many day-to-day business problems, as well as plan and control
their operations. Managers require different information for the various kinds of decisions
they must make. Typical reports produced by the MRS include budgets, variance reports,
cost-volume-profit analyses, and reports using current (rather than historical) cost data. This
type of reporting is called discretionary reporting because the organization can choose what
information to report and how to present it. and generally more difficult challenge than
external reporting.

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