CHAPTER 8

Financial Reporting and

Management Reporting
Systems
 The General Ledger System

the general ledger system (GLS) is a hub

connected to the other systems of the firm
through spokes of information flows.
Transaction cycles process individual events
that are recorded in special journals and
subsidiary accounts.
 THE JOURNAL VOUCHER

The source of input to the general ledger

is the journal voucher.
A journal voucher, which can be used to
represent summaries of similar
transactions or a single unique
transaction, identifies the financial
amounts and affected general ledger
(GL) accounts.
THE GENERAL LEDGERS DATABASE
 THE GLS DATABASE

The GLS database includes a variety of files. Whereas these will vary from
firm to firm, the following examples are representative .

1.) General ledger Master File

- is the principal file in the GLS database. This file is based on the
organizations published chart of accounts. Each record in the GL master
is either a separate GL account (for example, sales) or the control
account (such as ARcontrol) for a corresponding subsidiary ledger in
the transaction processing system.

2.) General Ledger History File

- has the same format as the GL master. Its primary purpose is to
provide historical financial data for comparative financial reports

3.) General Voucher File

- is the total collection of the journal vouchers processed in the
current period. This file provides a record of all general ledger
transactions and replaces the traditional general journal.
4.) Journal Voucher History File
- contains journal vouchers for past periods. This historical
information
supports managements stewardship responsibility to account for
resource utilization. Both the current and historical journal voucher files
are important links in the firms audit trail.

5.) Responsibility Center File

- contains the revenues, expenditures, and other resource utilization
data for each responsibility center in the organization. The MRS draws
upon these data for input in the preparation of responsibility reports for
management.

6.) Budget Master File

- contains budgeted amounts for revenues, expenditures, and other
resources for responsibility centers. These data, in conjunction with the
responsibility center file, are the basis for responsibility accounting,
which is discussed later in the chapter.
 GLS PROCEDURES
As we have seen in previous chapters, certain aspects of GLS update
procedures are performed as either a separate operation or integrated within
transaction processing systems. Our focus in the next section is on the
interrelationship between the GLS and financial reporting. This involves
additional updates in the form of reversing, adjusting, and closing entries.
Lets now turn our attention to the financial reporting system.

The Financial Reporting System

This reporting obligation is met via the FRS. Much of the information
provided takes the form of standard financial statements, tax returns,
and documents required by regulatory agencies such as the Securities
and Exchange Commission (SEC).

The primary recipients of financial statement information are external

users, such as stockholders, creditors, and government
agencies.
 SOPHISTICATED USERS WITH
HOMOGENEOUS INFORMATION NEEDS

Because the community of external users is vast and their

individual information needs may vary, financial statements are
targeted at a general audience. They are prepared on the
proposition that the audience comprises sophisticated users with
relatively homogeneous information needs.

In other words, it is assumed that users of financial reports

understand the conventions and accounting principles that are
applied and that the statements have information content that is
useful.
FINANCIAL REPORTING PROCEDURES

1.) Capture the transaction. Within each transaction cycle,

transactions are recorded in the appropriate transaction file.

2.) Record in special journal. Each transaction is entered

into the journal. Recall that frequently occurring classes of
transactions, such as sales, are captured in special journals. Those
that occurring frequently are recorded in the general journal or
directly on a journal voucher.

3.) Post to subsidiary ledger. The details of each

transaction are posted to the affected subsidiary accounts.
4.) Post to general ledger. Periodically, journal
vouchers, summarizing the entries made to the special
journals and subsidiary ledgers, are prepared and posted to
the GL accounts. The frequency of updates to the GL will be
determined by the degree of system integration.

5.) Prepare the unadjusted trial balance. At the

end of the accounting period, the ending balance of each
account in the GL is placed in a worksheet and evaluated in
total for debitcredit equality.

6.) Make adjusting entries. Adjusting entries are

made to the worksheet to correct errors and to reflect
unrecorded transactions during the period, such as
depreciation.
7.) Journalize and post adjusting entries. Journal
vouchers for the adjusting entries are prepared and posted to the
appropriate accounts in the GL.

8.) Prepare the adjusted trial balance. From the

adjusted balances, a trial balance is prepared that contains all the
entries that should be reflected in the financial statements.

9.) Prepare the financial statements. The balance

sheet, income statement, and statement of cash flows are
prepared using the adjusted trial balance.
10.) Journalize and post the closing entries. Journal
vouchers are prepared for entries that close out the income
statement (temporary) accounts and transfer the income or loss
to retained earnings. Finally, these entries are posted to the GL.

11.) Prepare the post-closing trial balance. A trial

balance worksheet containing only the balance sheet accounts
may now be prepared to indicate the balances being carried
forward to the next accounting period.
 XBRLReengineering Financial Reporting

eXtensible Business Reporting Language

(XBRL) - is the Internet standard specifically designed for business
reporting and information exchange.
The objective of XBRL is to facilitate the publication, exchange, and
processing of financial and business information. XBRL is a derivative of
another Internet standard called XML (eXtensible Markup Language).

XML (eXtensible Markup Language) - is a

metalanguage for describing markup languages. The term extensible
means that any markup language can be created using XML.
This includes the creation of markup languages capable of storing
data in relational form in which tags (or formatting commands) are
mapped to data values. Thus, XMLcan be used to model the data
structure of an organizations internal database.
XBRL - is a XML-based language that was designed to provide the financial
community with a standardized method for preparing, publishing, and
automatically exchanging financial information, including financial statements of
publicly held companies.
Controlling the FRS
Sarbanes-Oxley legislation requires that management
design and implement controls over the financial reporting
process. This includes the transaction processing systems that
feed data into the FRS.

In previous chapters we studied control techniques

necessary for the various transaction systems. Here we will
examine only the controls that relate to the FRS. The potential
risks to the FRS include:

1. A defective audit trail.

2. Unauthorized access to the general ledger.
3. GL accounts that are out of balance with subsidiary
accounts.
4. Incorrect GL account balances because of unauthorized or
incorrect journal vouchers.
 SAS 78/COSO CONTROL ISSUES

Transaction Authorization
The journal voucher is the document that authorizes an entry
to the general ledger. Journal vouchers have numerous sources,
such as the cash receipts processing, sales order processing, and
the financial reporting group. It is vital to the integrity of the
accounting records that the journal vouchers be properly
authorized by a responsible manager at the source department.

Segregation of Duties
The task of updating the general ledger must be separate
from all accounting and asset custody responsibility within the
organization. Therefore, individuals with access authority to GL
accounts should not:
Therefore, individuals with access authority to GL accounts
should not:

1. Have record-keeping responsibility for special journals or

subsidiary ledgers.
2. Prepare journal vouchers.
3. Have custody of physical assets.

Access Controls
Unauthorized access to the GL accounts can result in errors,
fraud, and misrepresentations in financial statements. SOX
legislation explicitly addresses this area of risk by requiring
organizations to implement controls that limit database access to
authorized individuals only.
 Accounting Records
The audit trail is a record of the path that a transaction takes through
the input, processing, and output phases of transaction processing. This
involves a network of documents, journals, and ledgers designed to
ensure that a transaction can be accurately traced through the system
from initiation to final disposition.
The general ledger and other files that constitute the audit trail
should be detailed and rich enough to:
1. Provide the ability to answer inquiries, for example, from
customers or vendors
2. Be able to reconstruct files if they are completely or partially
destroyed
3. Provide historical data required by auditors
4. Fulfill government regulations
5. Provide a means for preventing, detecting, and correcting
errors.
 Independent Verification
In previous chapters we have portrayed the general ledger function
as an independent verification step within the accounting information
system.

The FRS produces 2 Operational Reports:

1.) The journal voucher listing

it provides relevant details about each journal

voucher posted to the GL.

2.) The general ledger change report

presents the effects of journal voucher postings to

the GL accounts.
 INTERNAL CONTROL IMPLICATIONS OF XBRL
Although the potential benefits of XBRL and associated Web
technologies have been extensively researched, less attention
has been given to the potential control implications of using
XBRL.
There are three areas of specific
concern:
1.) TAXONOMY CREATION. Taxonomy may be generated incorrectly,
which results in an incorrect mapping between data and taxonomy elements
that could result in material misrepresentation of financial data. Controls
must be designed and put in place to ensure the correct generation of XBRL
taxonomies
2.) TAXONOMY MAPPING ERROR. The process of mapping the
internal database accounts to the taxonomy tags needs to be controlled.
Correctly generated XBRL tags may be incorrectly assigned to internal
database accounts resulting in material misrepresentation of financial
data.
3.) VALIDATION OF INSTANCE DOCUMENTS. As noted,
once the mapping is complete and tags have been stored in the internal
database, XBRL instance documents (reports) can be generated.
Independent verification procedures need to be established to validate the
instance documents to ensure that appropriate taxonomy and tags have
been applied before posting to a Web server
Management
Reporting
System(MRS)
The Management Reporting System

Management reporting has long been

recognized as a critical element of an
organizations internal control structure.

Management reporting is often called

discretionary reporting.
Factors That Influence the MRS Design
1.) Management principles
2.) Management function, level and
Decision
3.) type
Problem structure
4.) Types of management reports
5.) Responsibility accounting
6.) Behavioral considerations
(1) Management
Principles
Management principles provide insight into management information
needs. The principles that most directly influence the MRS are formalization
of tasks, responsibility and authority, span of control, and management by
exception.
a.) Formalization of Tasks
The formalization of tasks principle suggests that management should
structure the firm around the tasks it performs.
b.) Responsibility and Authority
The principle of responsibility refers to an individuals obligation to
achieve desired results. Responsibility is closely related to the principle
of authority.
c.) Span of Control
A managers span of control refers to the number of subordinates
directly under his or her control. The size of the span has an impact
on the organizations physical structure.
d.) Management by Exception

The principle of management by exception

suggests that managers should limit their attention
to potential problem areas (that is, exceptions)
rather than being involved with every activity or
decision.
(2) Management Function,
Level and Decision Type
Kinds Management Functions
Categories of Planning and Control Decisions
Elements of Operational Control Decisions
Two kinds Management Functions:

Planning
The planning function is concerned with making decisions about the
future activities of the organization.

Control
The control function ensures that the activities of the firm conform to
the plan. This entails evaluating the operational process (or individual)
against a predetermined standard and, when necessary, taking corrective
action.
 4 Categories of Planning and Control Decisions

1.) Strategic Planning Decisions

Setting the goals and objectives of the firm.
Determining the scope of business activities
Determining or modifying the organizations
structure.
Setting the management philosophy

2.) Tactical Planning Decisions

Tactical planning decisions are subordinate to strategic decisions and

are made by middle management. These decisions are shorter term, more
specific, recurring, have more certain outcomes, and have a lesser impact
on the firm than strategic decisions.
3.) Management Control Decisions

Management control involves motivating managers in all

functional areas to use resources, including materials,
personnel, and financial assets, as productively as possible.

4.) Operational control decisions

Operational control ensures that the firm operates in

accordance with pre-established criteria.
3 Elements of Operational Control
Decisions
STANDARDS. Standards are pre-established levels of
performance that managers believe are attainable.

PERFORMANCE EVALUATION. The decision maker

compares the performance of the operation in question
against the standard. The difference between the two is the
variance.

TAKING CORRECTIVE ACTION. After comparing the

performance to the standard, the manager takes action to
remedy any out-of-control condition.
(3) Problem Structure
Structured and Unstructured
Structured Problem
The structure of a problem reflects how well
the decision maker understands the problem.

Structured Problem has 3 Elements:

1. Data
2. Procedures
3. Objectives
Example: Payroll calculation

1. Data

(Hours Worked, Hourly Rate, and Withholding Tax)

2. Procedures

Gross Pay = (Hours worked) x (Pay rate)

Net pay = Gross pay Withholdings

3. Objectives

is to discharge the firms financial

obligation to its employees.
Unstructured Problems
Problems are unstructured when any of the three
elements identified previously are not known with certainty.

Example:
1.) How to increase our target market?
2.) What might be the long-term consequences?
3.) Is my organization consistent with my strategy?
(4) Types of Management Report
Programmed Report and Ad Hoc Report
Programmed Reporting

Provide information to solve problems that users have anticipated.

Scheduled reports according to an established time frame.

This could be daily, weekly, quarterly, and so on.

On-demand reports are triggered by events, not by the

passage of time.
Report Attributes

RELEVANCE. Each element of information in a report must

support the managers decision.

SUMMARIZATION. Reports should be summarized

according to the level of the manager within the
organizational hierarchy.
EXCEPTION ORIENTATION. Control reports should
identify activities that are at risk of going out of control
and should ignore activities that are under control.

ACCURACY. Information in reports must be free of

material errors. A material error will cause the user to
make the wrong decision
(or fail to make a required decision).
COMPLETENESS. Information must be as complete as
possible. Ideally, no piece of information that is essential to
the decision should be missing from the report.

TIMELINESS. If managers always had time on their side, they

may never make bad decisions. However, managers cannot
always wait until they have all the facts before they act.

CONCISENESS. Information in the report should be presented

as concisely as possible.
Ad Hoc Reporting

Managers cannot always anticipate their information

needs. This is particularly true for top and middle
management.

Data mining

is the process of selecting, exploring, and modeling

large amounts of data to uncover relationships and
global patterns that exist in large databases but are
hidden among the vast amount of facts.
(5) RESPONSIBILITY
ACCOUNTING
Phases of Responsibility Accounting
Responsibility Centers
 RESPONSIBILITY ACCOUNTING
This concept implies that every economic event that affects
the organization is the responsibility of and can be traced to an
individual manager.

2 Phases of Responsibility Accounting

(1.) Setting Financial Goals: The Budget Process

The budget process helps management achieve its financial

objectives by establishing measurable goals for each
organizational segment.

(2.) Measuring and Reporting Performance

Performance measurement and reporting take place at

each operational segment in the firm.
Responsibility Centers
To achieve accountability, business entities frequently
organize their operations into units called responsibility centers.

COST CENTERS. A cost center is an organizational unit

with responsibility for cost management within
budgetary limits.

PROFIT CENTERS. A profit center manager has

responsibility for both cost control and revenue
generation.

INVESTMENT CENTERS. The manager of an

investment center has the general authority to make
decisions that profoundly affect the organization.
(6) BEHAVIORALCONSIDERATIONS
Goal Congruence
Information Overload
Inappropriate Performance Measures
 Goal Congruence
Goal Congruence is a result of the alignment of goals to
achieve an organizational objectives
A carefully structured MRS plays an important role in promoting and
preserving goal congruence.
On the other hand, a badly designed MRS can cause dysfunctional
actions that are in opposition to the organizations objectives.

Information overload
Information overload occurs when a manager receives more information
than he or she can assimilate. This happens when designers of the reporting
system do not properly consider the managers organizational level and
span of control.