TOPIC 1: Nature and Definitions of Information and information

Systems and environment

What Is a System?
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.

Elements of a System
Regardless of their origin, all systems possess some common elements. To specify:
A system is a group of two or more interrelated components or subsystems that serve a
common purpose. 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
yo-yo carved from a single piece of wood and attached to a string is a system. Without
the string, 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 a volleyball net are both components. They lack a com-
mon purpose, however, 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 sub- systems, such as the circulatory
subsystem and the respiratory subsystem.

- Purpose. 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.

We begin the study of AIS with the recognition that information is a business resource.
Like the other business resources of raw materials, capital, and labor, information is vital
to the survival of the contemporary business organization. Every business day, vast quan-
tities of information flow to decision makers and other users to meet a variety of internal
needs. In addition, information flows out from the organization to external users, such
as customers, suppliers, and stakeholders who have an interest in the firm. Figure 1-1 pre-
sents an overview of these internal and external information flows.

The pyramid in Figure 1-1 shows the business organization divided horizontally
into several levels of activity. Business operations form the base of the pyramid. These
activities consist of the product-oriented work of the organization, such as manufactur-
ing, sales, and distribution. Above the base level, the organization is divided into three
management tiers: operations management, middle management, and top management.
Operations management is directly responsible for controlling day-to-day operations.
Middle management is accountable for the short-term planning and coordination of
activities necessary to accomplish organizational objectives. Top management is respon-
sible for longer-term planning and setting organizational objectives. Every individual
in the organization, from business operations to top management, needs information to
accomplish his or her tasks.

Notice in Figure 1-1 how information flows in two directions within the organiza-
tion: horizontally and vertically. The horizontal flow supports operations-level tasks
with highly detailed information about the many business transactions affecting the firm

This includes information on events such as the sale and shipment of goods, the use of
labor and materials in the production process, and internal transfers of resources from
one department to another. The vertical flow distributes summarized information about
operations and other activities upward to managers at all levels. Management uses this
information to support its various planning and control functions. Information also flows
downward from senior managers to junior managers and operations personnel in the
form of instructions, quotas, and budgets.

The evolution of information systems models

Over the past 50 years, a number of different approaches or models have represented
accounting information systems. Each new model evolved because of the shortcomings
and limitations of its predecessor. An interesting feature in this evolution is that the new-
est technique does not immediately replace older models. Thus, at any point in time,
various generations of systems exist across different organizations and may even coexist
within a single enterprise. The modern auditor needs to be familiar with the operational
features of all AIS approaches that he or she is likely to encounter. This study deals exten-
sively with five such models: manual processes, flat-file systems, the database approach,
the REA (resources, events, and agents) model, and ERP (enterprise resource planning)
systems. Each of these is briefly outlined in the following section.

The Manual Process Model

The manual process model is the oldest and most traditional form of accounting
systems. Manual systems constitute the physical events, resources, and personnel that
characterize many business processes. This includes such tasks as order-taking, warehousing
materials, manufacturing goods for sale, shipping goods to customers, and placing orders
with vendors. Traditionally, this model also includes the physical task of record keeping.
Often, manual record keeping is used to teach the principles of accounting to business
students. This approach, however, is simply a training aid. These days, manual records
are never used in practice.

Nevertheless, there is merit in studying the manual process model before mastering
computer-based systems. First, learning manual systems helps establish an important
link between the AIS course and other accounting courses. The AIS course is often the
only accounting course in which students see where data originate, how they are col-
lected, and how and where information is used to support day-to-day operations. By
examining information flows, key tasks, and the use of traditional accounting records in
transaction processing, the students’ bookkeeping focus is transformed into a business
processes perspective.
Second, the logic of a business process is more easily understood when it is not
shrouded by technology. The information needed to trigger and support events such as
selling, warehousing, and shipping is fundamental and independent of the technology
that underlies the information system. For example, a shipping notice informing the bill-
ing process that a product has been shipped serves this purpose whether it is produced
and processed manually or digitally. Once students understand what tasks need to be
performed, they are better equipped to explore different and better ways of performing
these tasks through technology.
Finally, manual procedures facilitate understanding internal control activities, includ-
ing segregation of functions, supervision, independent verification, audit trails, and
access controls. Because human nature lies at the heart of many internal control issues,
we should not overlook the importance of this aspect of the information system.

The Flat-File Model

The flat-file approach is most often associated with so-called legacy systems. These are
large mainframe systems that were implemented in the late 1960s through the 1980s.
Organizations today still use these systems extensively. Eventually, modern database
management systems will replace them, but in the meantime accountants must continue
to deal with legacy system technologies.
The flat-file model describes an environment in which individual data files are not
related to other files. End users in this environment own their data files rather than share
them with other users. Thus, stand-alone applications rather than integrated systems per-
form data processing.
When multiple users need the same data for different purposes, they must obtain
separate data sets structured to their specific needs. Figure 1-12 illustrates how customer
sales data might be presented to three different users in a durable goods retailing organi-
zation. The accounting function needs customer sales data organized by account number
and structured to show outstanding balances. This is used for customer billing, AR main-
tenance, and financial statement preparation. Marketing needs customer sales history
data organized by demographic keys. They use this for targeting new product promotions
and for selling product upgrades. The product services group needs customer sales data
organized by products and structured to show scheduled service dates. Such information
is used for making after-sales contacts with customers to schedule preventive mainte-
nance and to solicit sales of service agreements.
The data redundancy demonstrated in this example contributes to three signifi-
cant problems in the flat-file environment: data storage, data updating, and currency of
information. These and other problems associated with flat files are discussed in the fol-
lowing sections.

The Database Model

An organization can overcome the problems associated with flat files by implementing the
database model to data [Link] the organization’s data in a central location, all
users have access to the data they need to
achieve their respective objectives. Access to the data resource is controlled by a database
management system (DBMS). The DBMS is a special software system that is programmed
to know which data elements each user is authorized to access. The user’s program sends
requests for data to the DBMS, which validates and authorizes access to the database in
accordance with the user’s level of authority. If the user requests data that he or she is
not authorized to access, the request is denied. Clearly, the organization’s procedures for
assigning user authority are an important control issue for auditors to consider.
The most striking difference between the database model and the flat-file model is the
pooling of data into a common database that all organizational users share. With access
to the full domain of entity data, changes in user information needs can be satisfied without
obtaining additional private data sets. Users are constrained only by the limitations of
the data available to the entity and the legitimacy of their need to access it. Through data
sharing, the following traditional problems associated with the flat-file approach may be
overcome:
- Elimination of data redundancy. Each data element is stored only once, thereby
eliminating
data redundancy and reducing data collection and storage costs. For example, customer
data exists only once, but is shared by accounting, marketing, and product services users.
To accomplish this, the data are stored in a generic format that supports multiple users.
Single update. Because each data element exists in only one place, it requires only a single
update procedure. This reduces the time and cost of keeping the database current.
- Current values. A single change to a database attribute is automatically made
available to
all users of the attribute. For example, a customer address change is immediately reflected
in the marketing and product services views when the billing clerk enters it.
Flat-file and early database systems are called traditional systems. Within this context, the
term traditional means that the organization’s information systems applications (its pro-
grams) function independently of each other rather than as an integrated whole. Early data-
base management systems were designed to interface directly with existing flat-file programs.
Thus when an organization replaced its flat files with a database, it did not have to spend mil-
lions of dollars rewriting its existing programs. Indeed, early database applications performed
essentially the same independent functions as their flat-file counterparts.
Another factor that limited integration was the structured database models of the
era. These models were inflexible and did not permit the degree of data sharing that is
found in modern database systems. Whereas some degree of integration was achieved
with this type of database, the primary and immediate advantage to the organization was
the reduction in data redundancy.
True integration, however, would not be possible until the arrival of the relational
database model. This flexible database approach permits the design of integrated sys-
tems applications capable of supporting the information needs of multiple users from a
common set of integrated database tables. We should note, however, that the relational

The REA Model

REA is an accounting framework for modeling an organization’s critical resources,
events, and agents (REA) and the relationships between them. Once specified, both
accounting and nonaccounting data about these phenomena can be identified, captured,
and stored in a relational database. From this repository, user views can be constructed
that meet the needs of all users in the organization. The availability of multiple views
allows flexible use of transaction data and permits the development of accounting infor-
mation systems that promote, rather than inhibit, integration.
The REA model was proposed in 1982 as a theoretical model for accounting. 2
Advances in database technology have focused renewed attention on REA as a practical
alternative to the classical accounting framework. The following summarizes the key ele-
ments of the REA models.
Resources
Economic resources are the assets of the organization. They are defined as objects that
are both scarce and under the control of the enterprise. This definition departs from the
traditional model because it does not include AR. An account receivable is an artifact
record used simply to store and transmit data. Because it is not an essential element of
the system, it need not be included in the database. Instead, AR values are derived from
the difference between sales to customers and the cash received in payment of sales.
Events
Economic events are phenomena that affect changes in resources. They can result from
activities such as production, exchange, consumption, and distribution. Economic events
are the critical information elements of the accounting system and should be captured in
a highly detailed form to provide a rich database.
Agents
Economic agents are individuals and departments that participate in an economic event.
They are parties both inside and outside the organization with discretionary power to use
or dispose of economic resources. Examples of agents include sales clerks, production
workers, shipping clerks, customers, and vendors.
The REA model requires that accounting phenomena be characterized in a manner
consistent with the development of multiple user views. Business data must not be prefor-
matted or artificially constrained and should reflect all relevant aspects of the underlying
economic events. As such, REA procedures and databases are structured around events
rather than accounting artifacts such as journals, ledgers, charts of accounts, and double-
entry accounting.

Enterprise Resource Planning Systems

Enterprise resource planning (ERP) is an information system model that enables an
organization to automate and integrate its key business processes. ERP breaks down
traditional functional barriers by facilitating data sharing, information flows, and the
introduction of common business practices among all organizational users. The imple-
mentation of an ERP system can be a massive undertaking that can span several years.
Because of the complexity and size of ERPs, few organizations are willing or able to com-
mit the necessary financial and physical resources and incur the risk of developing an ERP
system in-house. Hence, virtually all ERPs are commercial products. The recognized leaders
in the market are SAP, Oracle, Baan, J.D. Edwards & Co., and PeopleSoft Inc.
ERP packages are sold to client organizations in modules that support standard pro-
cesses. Some common ERP modules include:
 Asset Management
 Financial Accounting
 Human Resources
 Industry-Specific Solutions
 Plant Maintenance
 Production Planning
 Quality Management
 Sales and Distribution
 Inventory Management
One of the problems with standardized modules is that they may not always meet the
organization’s exact needs. For example, a textile manufacturer in India implemented an ERP
package only to discover that extensive, unexpected, and expensive modifications had to be
made to the system. The ERP would not allow the user to assign two different prices to the
same bolt of cloth. The manufacturer charged one price for domestic consumption, but
another (four times higher) for exported products. That particular ERP system, however,
provided no way to assign two prices to the same item while maintaining an accurate
inventory count.

Steps of Accounting information System

The three steps of an accounting information system are input, processing, and output. Data is
the raw ingredient used in these processes.

Some of the data may be obtained from a source document, and other data is obtained from
the database where it had previously been stored. When the data has been processed, the final
result is usually information. Information is more useful than data. Take, for example,
another process that a bakery might use to bake chocolate chip cookies. While computers
might not necessarily need to be involved, we begin the process by assembling a bunch of
raw ingredients such as eggs, sugar, flour, chocolate chips, and oil, in a large bowl. Taking a
spoonful of what is in the bowl at the time is not very pleasing to the taste buds or “useful” to
someone craving a chocolate chip cookie. We process the raw ingredients by mixing them
well and turning them into dough, cutting them into shapes, baking them, and glazing them.
Similarly, raw data about a single sale contained on the sales invoice, such as customer name,
date of sale, and amount of sale, is individually not very useful to a financial statement user
such as an investor. However, by processing the data related to the sale, making sure it is
correct by checking that the number of items ordered were in stock and actually shipped,
aggregating it with other sales for the period, and producing an income statement containing
the sales for the period is substantially more useful than the individual pieces of data relating
to a single sale.