PUBLIC SERVICE COLLEGE OF OROMIA

Course Title: Accounting Information system

Course code: ACPF 452
Cr. Hrs : 3 Pré recuisîtes _________________

Table of Contents
1.1 Introduction...................................................................................................................................7

1.2 What is an Accounting Information System?..............................................................................8

1.3 Components and Functions of AIS...............................................................................................8

1.4 Why Study AIS?.............................................................................................................................9

1.5 Sub Systems of AIS......................................................................................................................10

1.7 Types of Information Systems.....................................................................................................12

1.9 Principles of an Accounting Information System............................................................................16

1.11 Manual vs Computerized Accounting System...............................................................................17

1.10The Systems Development Life Cycle.............................................................................................19

Summary..................................................................................................................................................20

2.1 Files versus Databases.................................................................................................................25

2.2 Advantages of Database Systems................................................................................................26

2.3 Logical and Physical Views of Data............................................................................................27

2.4 Schemas........................................................................................................................................28

2.5 Relational Databases...................................................................................................................30

2.6 Designing a Relational Database................................................................................................30

2.7 Two Approaches to Database Design..........................................................................................31

2.8 Database Systems and the Future of Accounting......................................................................32

2.9 Database Design Process.............................................................................................................32

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3.1 Introduction to e-Business...........................................................................................................37

3.2 Benefits of E-Business..................................................................................................................37

3.3 Time To Market...........................................................................................................................38

3.4 Reduction of costs and return on investments (ROI)................................................................38

3.5 Characterization of the e-Business.............................................................................................39

3.6 Front Office/Back Office.............................................................................................................41

3.7 Presentation of the different concepts........................................................................................41

3.8 Intranet.........................................................................................................................................42

3.9 Usefulness of an intranet.............................................................................................................44

3.10 Advantages of an Intranet...........................................................................................................44

3.11 Implementation of the Intranet..................................................................................................45

3.12 Extranet........................................................................................................................................45

3.13 e-Procurement..............................................................................................................................45

4.1 Introduction.................................................................................................................................50

4.2 Sales Order Processing................................................................................................................51

4.3 Transaction Flows in Account Receivable Systems...................................................................55

4.4 Cash Receipts Application System..............................................................................................58

4.5 Summary......................................................................................................................................64

5.1 Introduction.................................................................................................................................69

5.2 System Definition and Functions in Purchase Application System..........................................70

5.3 Recourse Management or Payroll System.................................................................................77

5.4 Cash Disbursement Application System....................................................................................80

5.5 Summary......................................................................................................................................83

6.1 Introduction.................................................................................................................................88

6.2 Production-Cycle Applications...................................................................................................88

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6.3 Property Accounting Application...............................................................................................93

6.4 Summary......................................................................................................................................96

7.1 Introduction...............................................................................................................................100

7.2 Why Control and Security Are Important...............................................................................101

7.3 Overview of Control Concepts..................................................................................................101

7.4 Levels of Control........................................................................................................................102

7.5 Control Frameworks.................................................................................................................103

7.6 Enterprise Risk Management – Integrated Framework (ERM)............................................104

7.7 .1 The Internal Environment....................................................................................................106

7.7.2 External influences................................................................................................................109

7.7.3 Objective Setting....................................................................................................................110

7.7.4 Event Identification...............................................................................................................110

7.7.5 Risk Assessment and Risk Response.....................................................................................111

7.7.6 Control Activities...................................................................................................................114

7.8 Project development and acquisition controls.........................................................................115

7.9 Change management controls...................................................................................................116

7.10 Monitoring.................................................................................................................................117

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Course Description:

This course presents the underlying concepts fundamental to understanding of AIS. Topics
included are basic terminology, components and Principles of AIS, systems theory; systems
development life cycle; techniques and tools of systems analysis; design and documentation
(such as data flow diagram, structure charts, functional decomposition, prototyping, user
interface design, and database management programming with Visual Basic).

It also discusses the role of E-business (electronic commerce) in today’s business organizations,
telecommunication concepts and applications as well as the Internet, presents basic information
processing and data storage concepts. An overview of transaction processing applications in
Revenue, expenditure, production and finance activities cycles of business activity; control
issues related to these business activities will also be provided.

Course Objectives:

This course is concerned with the techniques and methodologies useful to create and develop
accounting systems. The objective, in this regard, is to make the students appreciate and use the
various techniques for analyzing and designing accounting systems, databases, etc. After
completion of this course, the students will be able to:

 Explain system theory, types and nature of information system;

 Describe the business Activities, decisions performed in the major business cycles and
processing of data about those business activities;
 Identify fundamental concepts of database technology and its effect on AIS;
 Design AIS to provide the information needed to make key decisions in each business
cycle;
 the business Activities &decisions performed in the major business cycles and the
collection and processing of data about those business activities;
o Revenue cycle
o Expenditure cycle
o Production cycle
o Finance cycle

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 Demonstrate tools of AIS work, such as data flow diagrams and flow-charting;
 Explain the role of E- commerce;
 Describe how a processed Data can be stored, and the internal control process

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 UNIT ONE

ACCOUNTING INFORMATION SYSTEM: OVERVIEW

 Objectives
After studying this unit the reader should be able to:

 Explain what an accounting information system (AIS) is and describe the basic
functions it performs.
 Explain sub systems of AIS
 Discuss why studying accounting information systems are important.
 Explain the different types of information systems.
 identify factors attribute for good accounting information system
 Identify the steps required for systems development life cycle
 identify the difference between manual accounting procedure and computerized
accounting system

Contents:
1.1Introduction…………………………………………………………………………….Error:
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1.2What is an Accounting Information System?............................................................. Error:

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1.3Components and Functions of AIS………………………………………………….. Error:

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1.4Sub Systems of AIS…………………………………………………………………. Error:

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1.5Why Study AIS?............................................................................................................ Error:

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1.6Types of Information Systems………………………………………………………. Error:

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1.7Principles of an Accounting Information System…………………………………… Error:

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 1.8The Systems Development Life Cycle……………………………………………….. Error:
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1.9Manual vs Computerized Accounting System……………………………………… Error:

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1.10Summary………………………………………………………………………………Error:
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1.1Introduction

A system is a set of two or more interrelated components that interact to achieve a goal. Systems
are almost always composed of smaller subsystems, each performing a specific function
important to and supportive of the larger system of which it is a part. For example, the College of
Business is a system composed of various departments, each of which is a subsystem. Yet, at the
same time, the college itself is a subsystem of the university. When the Systems Concept is used
in systems development, changes in subsystems cannot be made without considering the effect
on other subsystems and the system as a whole. Goal Conflict occurs when a decision or action
of a subsystem is inconsistent with another subsystem or the system as a whole. Goal
Congruence is achieved when a subsystem achieves its goals while contributing to the
organization’s overall goal. The systems concept also encourages Integration, which is
eliminating duplicate recording, storage, reporting, and other processing activities in an
organization.
1.2 What is an Accounting Information System?

An Accounting Information System (AIS) is a system that collects, records, stores, and
processes data to produce information for decision makers. Another definition: “An accounting
information system is a unified structure within an entity, such as a business firm, that
employees physical resources and other components to transform economic data into accounting
information, with the purpose of satisfying the information needs of a variety of users.
1.3 Components and Functions of AIS

Six components of an Accounting Information System

1. The people who operate the system and perform various functions
2. The procedures and instructions, both manual and automated, involved in
collecting, processing, and storing data about the organization’s activities
3. The data about the organization and its business processes
4. The software used to process the organization’s data
5. The information technology infrastructure, including computers, peripheral
devices and network communications devices used to collect, store, process and
transmit data and information
6. The internal controls and security measures that safeguard the data in the AIS.

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 These six components enable an Accounting Information System to fulfill three
important business functions:

1. Collect and store data about organizational activities, resources, and personnel
2. Transform data into information that is useful for making decisions so
management can plan, execute, control and evaluate activities, resources and
personnel
3. Provide adequate controls to safeguard the organization’s assets, including its
data, to ensure that the assets and data are available when needed and the data are
accurate and reliable.
Self Check Exercise

1. What is accounting information system?

2. What are the components of AIS?
3. What are functions of AIS?
4. Discuss about the subsystems of AIS.
1.4 Why Study AIS?
 The Study of AIS is Fundamental to Accounting

According to statement of financial accounting concepts No. 2, the primary objective of

accounting is to provide information useful to decision makers. Therefore, it is highly
recommended that the accounting education change commission recommended that the
accounting curriculum should emphasize that accounting is an information identification,
development, measurement, and communication process. The accounting education change
commission suggested that the accounting curriculum should be designed to provide students
with a solid understanding of three essential concepts:

• The use of information in decision making

• The nature, design, use, and implementation of an AIS
• Financial information reporting
The other accounting course that you take (financial accounting, managerial accounting, tax and
audit) focus on your role as a preparer or reporter of information. In contrast AIS focuses on
understanding how the accounting system works: how to collect data about an organization’s
activities and transactions; how to transform that data into information that management can use
to run the organization. Thus AIS course complements the other accounting courses you will
take.

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  The AIS Course Complements Other Systems Courses

There are many other systems courses that cover the design and implementation of information
systems, and that help you develop specialized skills in such areas as data bases expert systems
and telecommunications. The AIS course differs from these other information system courses in
its focus on accountability and control. These issues are important because in most large business
organizations the managers are not the owners. Instead, the owners have entrusted management
with assets and hold them accountable for their proper use.

Data and information are among an organization’s most valuable assets. To see why, consider
what would happen if an organization lost all information about what its customers owed it or if
a list of its most profitable customers was obtained by a competitor. Clearly, the AIS must
include controls to ensure safety and availability of the organization’s data. Controls are also
needed to ensure that the information produced from that data is both reliable and accurate.
These topics usually receive little attention in other system courses. Thus the AIS course
complements other system courses you may take.

Concerns about data reliability and security are relevant not only to accountants, but also to all
information systems professionals. More over, since typically the AIS is one of the largest
systems in most organizations, information systems professionals should have a basic
understanding of how it works. Thus the AIS course is an important part of the education of
information systems students.

1.5 Sub Systems of AIS

Most organizations engage in many similar and repetitive transactions. A transaction is

an agreement between two entities to exchange goods or services or any other event that
can be measured in economic terms by an organization. The process that begins with
capturing transaction data and ends with an informational output such as the financial
statements is called transaction processing. Business activities are pairs of events
involved in a give-get exchange. These transaction types can be grouped into the five
basic cycles, each of which constitutes a basic subsystem in the AIS:

a. The revenue cycle consists of the activities involved in selling goods or services
and collecting payment for those sales.

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 b. The expenditure cycle consists of the activities involved in buying and paying for
goods or services used by the organization.
c. The human resources/payroll cycle consists of the activities involved in hiring and
paying employees.(part of expenditure cycle)
d. The production cycle consists of the activities involved in converting raw
materials and labor into finished products. (Only manufacturing companies have a
production cycle; retail organizations buy finished goods for resale to others.
e. The financing cycle consisted of those activities involved in obtaining the
necessary funds to run the organization and in repaying creditors and distributing
profits to investors.
The basic activities in each of the five cycles can be described in terms of a give-to-get relation.
For example, the expenditure cycle entails giving up cash in order to get goods and services.
Similarly, the revenue cycle entails giving up goods and services in order to get cash. The five
cycles (or subsystems) of the AIS are related to one another and how each feeds data to the
general ledger and reporting system that provides information to both internal and external users.

1.6 Accounting Information System (AIS) Vs Management Information

System (MIS)
The AIS is a subsystem of Management Information System that records, processes and reports
information related to the financial aspects of business events. All AISs report events using
accounting methods to achieve accounting objectives which determine the system’s scope:

AIS subsystem process financial transactions and non financial transactions that directly affect
the processing of financial transactions. For example changes to customers’ names and
addresses are processed by the AIS to keep the customer file current. The AIS is composed of
three major subsystems:

1. The transaction processing system (TPS):

2. The general ledger/ financial reporting system
3. The management reporting system

A Management Information System is a system that provides information needed to manage

organizations efficiently and effectively. Further, it is regarded as a subset of the overall internal

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controls procedures in a business, which cover the application of people, documents,
technologies, and procedures used by management accountants to solve business problems such
as costing a product, service or a business-wide strategy. Management Information System
(MIS) is a combination of people, procedures and machines intended to provide information for
management decision making. The MIS processes nonfinancial transactions that are not
normally processed by traditional AIS. (Both AIS and MIS will be discussed in detail in the
following section)

Activity
1. Why are you studying AIS?

______________________________________________________________________________
________________________________________________________________________

1.7Types of Information Systems

To design marketing programs, for instance, marketing managers rely on summary information
gleaned from a dedicated customer-relationship management system. Let’s look at some of the
widely available information systems designed to support people at the operational and upper-
management levels.

I. Operations Support Systems

Operations support systems are generally used by managers at lower levels of the organization—
those who run day-to-day business operations and make fairly routine decisions. They could be
categorized as: transaction processing systems, process control systems, or design and
production systems.

a. Transaction Processing Systems

Most of an organization’s daily activities are recorded and processed by its transaction
processing system (TPS), which receives input data and converts them into output—information
—intended for various users. Input data are called transactions—events that affect a business. A
financial transaction is an economic event: it affects the firm’s assets, is reflected in its
accounting statements, and is measured in monetary terms. Sales of goods to customers,
purchases of inventory from suppliers, and salaries paid to employees are all financial
transactions. Everything else is a non-financial transaction. The marketing department, for
example, might add some demographic data to its customer database. The information would be
processed by the firm’s TPS, but it wouldn’t be a financial transaction.

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Figure 1.1, “Transaction Processing System” illustrates a TPS in which the transaction is a
customer’s electronic payment of a bill. As you can see, TPS output can consist not only of
documents sent to outside parties (in this case, notification of payment received), but also of
information circulated internally (in the form of reports), as well as of information entered into
the database for updating.

Figure 1.1. Transaction Processing System

b. Process Control Systems

Process control refers to the application of technology to monitor and control physical processes.
It’s useful, for example, in testing the temperature of food as it’s being prepared or gauging the
moisture content of paper as it’s being manufactured. Typically, it depends on sensors to collect
data periodically. The data are then analyzed by a computer programmed either to make
adjustments or to signal an operator.

Harrah’s uses process-control technology to keep customers happy. At any given point, some
slot machines are down, whether because a machine broke or ran out of money or somebody hit
the jackpot. All these contingencies require immediate attention by a service attendant. In the
past, service personnel strolled around looking for machines in need of fixing. Now, however, a
downed slot machine sends out an “I need attention” signal, which is instantly picked up by a
monitoring and paging system called Messenger Plus and sent to a service attendant.

c. Design and Production Systems

Modern companies rely heavily on technology to design and make products. Computer-aided
design (CAD) software, for instance, enables designers to test computer models digitally before
moving new products into the prototype stage. Many companies link CAD systems to the
manufacturing process through computer-aided manufacturing (CAM) systems that not only
determine the steps needed to produce components but also instruct machines to do the necessary
work. A CAD/CAM system can be expanded by means of computer-integrated manufacturing
(CIM), which integrates various operations (from design through manufacturing) with functional
activities ranging from order taking to final shipment. The CIM system may also control

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industrial robots—computer-run machines that can perform repetitive or dangerous tasks. A CIM
system is a common element in a flexible manufacturing system (FMS), which makes it possible
to change equipment setups by reprogramming computer-controlled machines that can be
adapted to produce a variety of goods. Such flexibility is particularly valuable to makers of
customized products.

Activity : A financial transaction is an economic event: it affects the firm’s assets, is reflected in its
accounting statements, and is measured in monetary terms is a type of _______________________
information systems.

Feedback!

It is included in Transaction Processing System (TPS)

II. Management Support Systems

Mid- and upper-level managers rely on a variety of information systems to support decision-
making activities, including management information systems, decision support systems,
executive support systems, and expert systems.

a. Management Information Systems

A management information system (MIS) extracts data from a database to compile reports, such
as sales analyses, inventory-level reports, and financial statements, to help managers make
routine decisions. The type and form of the report depend on the information needs of a
particular manager. At Harrah’s, for example, several reports are available each day to a games
manager (who’s responsible for table-game operations and personnel): a customer-analysis
report, a profitability report, and a labor-analysis report.

b. Decision Support Systems

A decision support system (DSS) is an interactive system that collects, displays, and integrates
data from multiple sources to help managers make non-routine decisions. For example, suppose
that a gaming company is considering a new casino in Pennsylvania (which has just legalized
slot machines). To decide whether it would be a wise business move, management could use a
DSS like the one illustrated in Figure 1.2, “Decision Support System”. The first step is to extract
data from internal sources to decide whether the company has the financial strength to expand its
operations. From external sources (such as industry data and Pennsylvania demographics),
managers might find the data needed to determine whether there’s sufficient demand for a casino
in the state. The DSS will apply both types of data as variables in a quantitative model that
managers can analyze and interpret. People must make the final decision, but in making sense of
the relevant data, the DSS makes the decision-making process easier—and more reliable.

Figure 1.2. Decision Support System

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 c. Executive Information Systems

Senior managers spend a good deal of their time planning and making major decisions. They set
performance targets, determine whether they’re being met, and routinely scan the external
environment for opportunities and threats. To accomplish these tasks, they need relevant, timely,
easily understood information. Often, they can get it through an executive information system
(EIS), which provides ready access to strategic information that’s customized to their needs and
presented in a convenient format. Using an EIS, for example, a gaming-company executive
might simply touch a screen to view key summary information that highlights in graphical form
a critical area of corporate performance, such as revenue trends. After scanning this summary,
our executive can “drill down” to retrieve more detailed information—for example, revenue
trends by resort or revenue trends from various types of activities, such as gaming, hotel, retail,
restaurant, or entertainment operations.

d. Artificial Intelligence

Artificial intelligence (AI) is the science of developing computer systems that can mimic human
behavior. Ever since the term was coined in 1956, AI has always seemed on the verge of being
“the next big thing.” Unfortunately, optimistic predictions eventually collided with
underwhelming results, and many experts began to doubt that it would ever have profitable
applications. In the last decade, however, some significant advances have been made in AI—
albeit in the area of game playing, where activities are generally governed by small sets of well-
defined rules. But even the game-playing environment is sometimes complex enough to promote
interesting developments. In 1997, for example, IBM’s Deep Blue—a specialized computer with
an advanced chess-playing program—defeated the world’s highest-ranked player.

More recently, several AI applications have been successfully put to commercial use. Let’s take
a brief look at two of these: expert systems and face-recognition technology.

Activity: List the type of information systems?

_____________________________________________________________________________________
_______________________________________________________________________

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Feedback!

As you can read from the above topics the basic types of information systems are: -
transaction processing systems(TPS), process control systems, design and production systems,
management information systems(MIS), decision support systems(DSS), executive support
systems, and expert systems

1.9 Principles of an Accounting Information System

In designing and developing an efficient and effective accounting information system (or simply
referred to as an accounting system), it is important that certain basic principles be followed.
These principles or design features make accounting systems run efficiently. A good and an
effective system whether computerized or manual-includes the following features: control,
compatibility, flexibility, a favorable cost/benefit relationship, and useful output.
1) Control: Managers need control over operations. Internal controls are the methods and
procedures used to authorize transactions and safeguard assets.
2) Compatibility: A compatible is one that works smoothly with the business’s operations,
personnel, and organizational structure. A compatible accounting information system
conforms to the needs of the business.
3) Flexibility: Organizations evolve. They develop new products, sell off unprofitable
operations and acquire new ones, and adjust employee pay scales. Changes in the business
often call for changes in accounting system. A well-designed system is flexible if it
accommodates changes without needing a complete overhaul.
4) Favorable Cost-Benefit Relationship: Achieving control, comparability, and flexibility
costs money. These costs reduce a company’s net income, so managers often must settle for
less than the perfect accounting system. They strive for a system that offers maximum
benefits at a minimum cost-that is, a favorable cost/benefit relationship. As a matter of fact, a
major consideration in developing an accounting system is cost. The system must be cost
effective; the benefit obtain from the information must outweigh the cost of providing it. For
example, the value of each accounting report should be at least equal to the cost of producing
it.
5) Useful output: To be successful, information must be understandable, relevant, reliable,
timely, and accurate. Designers of accounting systems must consider the needs and
knowledge of the various users so that the systems out put (reports and statements) will be
useful. For example, sales managers may need weekly reports of sales and factory

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 supervisors may need daily reports of production. Others with differing responsibilities (such
as vice-president) may need such reports only monthly or quarterly.
Activity 2: Discuss the steps needed for the systems development life cycle
Activity 3: Discuss factors attribute for good accounting information system

1.11 Manual vs Computerized Accounting System

Computerized accounting systems have replaced manual systems in many organizations-even

small businesses. In discussing the three stages of data processing- input, process and output-we
can observe the difference between a computerized accounting system and a manual accounting
system.

The relationship among the three stages of data processing is shown in Figure 1.1.

Processing
Input (Data) Output
(Accounting) (Report)

Figure 1.3. The Three Stages of Data Processing

Inputs represent data from source documents, such as sales receipts, bank deposit slips, and fax
orders and other telecommunications. Inputs are usually grouped by type. For example, a firm
would enter cash-sale transactions separately from credit sales and purchase transactions.

In manual accounting system, processing includes journalizing transactions, posting to the

accounts, and preparing the financial statements. A computerized system also processes but
without the intermediate steps (journal, ledger, and trial balance).

Outputs are the reports used for decision-making, including the financial statements (income
statement, balance sheet, and so on). Many companies make better decisions-and prospering –
because of the reports produced by their accounting system. From computer’s viewpoint, a trial
balance is also a report. But a manual system would treat the trial balance as a processing step
leading to the statements. Figure 1.4 is an overview of computerized accounting system.

Figure 1.4 Overview of a Computerized Accounting System

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 Computerized Accounting System

Journals
PERSONNEL ACCOUNTING RECORDS
Ledgers
Input transactions, request
reports, protect records
Accessed for
Posted
reports
INPUT HARDWARE
Entered,
edited Printed to OUTPUT
I
paper,
SOFTWARE
screen

REPORTS

Summary of the Accounting Cycle: Computerized and Manual

The following table summarizes the accounting cycle under both systems;

Computerized System Manual System

 Start with the account balances in the  Same.

ledger at the beginning of the period.  Analyze and journalize transactions as
 Analyze and classify business they occur.
transactions by type. Access appropriate  Post journal entries to the ledger
means for data entry. accounts.
 Computer automatically posts  Compute the unadjusted balance in each
transactions as a batch or when entered account at the end of the period.
on-line.  Enter the trial balance on the work
 The unadjusted balances are available sheet, and complete the work sheet.
immediately after each posting.  Prepare the financial statements.

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  The trial balance, if needed, can be Journalize and post the adjusting entries.
accessed as a report. Journalize and post the closing entries.
 Enter and post the adjusting entries. Print  Prepare the post closing trial balance.
the financial statements. Run automatic This trial balance becomes step 1 for the
closing procedure after backing up the next period.
period’s accounting records.
 The next period’s opening balances are
created automatically as a result of
closing.
Figure 1.5 Comparisons of the Accounting Cycle in a Computerized and a Manual System

Activity 4

1. Compare and contrast manual accounting system VS computerized accounting system by

enumerating their advantages and disadvantages.
_________________________________________________________________________
_________________________________________________________________________
________________________________________________________________

1.10The Systems Development Life Cycle

Companies in a very competitive global business world are constantly looking for new, faster
and more reliable ways of obtaining information.
Companies usually change their systems for one of the following reasons:

 Changes in user or business needs

 Technological changes
 Improved business processes
 Competitive advantage
 Productivity gains
 Growth
 Downsizing
 Systems integration
 Systems age and need to be replaced
Developing quality, error-free software is a difficult, expensive and time consuming task. Most
software development projects delivers less that one expects, and takes more time and money
than expected. Developers start cutting corners by omitting some of the basic systems
development steps. Omitting these steps will only lead to disaster.

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Whether systems changes are major or minor, most companies go through a systems
development life cycle. There are five steps for the Systems Development Life Cycle (SDLC).
These are discussed as follows:

1) Systems Analysis
 The information needed to purchase or develop a new system is gathered.
 Requests for systems development are prioritized.
 If a project passes, the current system is surveyed to define the nature and scope of the
project and to identify its strengths and weaknesses.
 Then an in-depth study of the proposed system is conducted to determine its feasibility.
 If the system is found feasible, the information needs of system users and managers are
identified and documented.
 A report is prepared and submitted to the information systems steering committee.
2) Conceptual Design
During the conceptual design, the company decides how to meet user needs. The first step is
to identify and evaluate appropriate design alternatives:
 Purchase the software
 Develop the software in-house
 Outsource system development to someone else
3) Physical Design
 Input and output documents are designed,
 Computer programs are written,
 Files and databases are created,
 Procedures are developed, and
 Controls are built into the new system
4) Implementation and conversion constitute the capstone phase during which all the
elements and activities of the system come together. New hardware or software is installed
and tested. Standards and controls for the new system are established and system
documentation completed. The final step is to deliver the operational system to the
organization. A final report is sent to the information systems steering committee.
5) Operations and Maintenance
Modifications are made as problems arise or as new needs become evident.

Summary

An accounting information system is a collection of resources designed to transform data in to

information. This information is communicated to wide variety of decision makers. We use the
term accounting information system broadly to include transaction processing cycles, the use of
information technology and the development of information systems.
Most organizations experience similar types of economic events. These events generate
transactions that may be grouped according to four common cycles of business activities:
revenue cycle, expenditure cycle, production cycle, and financial cycle. An internal control

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structure consists of the policies and procedures established to provide reasonable assurance that
specific organizational objectives will be achieved. Transaction cycles offer a systematic
framework for the analysis and design of information systems in that there is a similar objective
for each of various cycles. This objective is to be an integral part of an organization’s internal
control structure.
The information system function is responsible for data processing. The organizational structure
and location of a large information system department with functional organization were
assumed and common functions within the department were discussed. Office automation
describes the use of electronic messages and documents; the use electronic data interchange
(EDI) computer integrated manufacturing (CIM) etc. organizational context.
Internal control process: a process designed to provide reasonable assurance regarding the
achievements of objectives in reliability of financial reporting, effectiveness and efficiency of
operations, and compliance with applicable laws and regulations.
Production cycle: events related to the transformation of resources into goods and services.
Revenue cycle: events related to the distribution of goods and services to other entities and
collection of related payments.
Transaction processing cycle: consists of one or more application systems.
User-oriented: a philosophy of design that fosters a set of attitudes and an approach system
development that consciously considers organizational context.

Answer to Activity 1

1. What are the basic functions and components of an accounting system?

1 To collect and store data about the organization’s business activities and transactions
efficiently and effectively:
 Capture transaction data on source documents.
 Record transaction data in journals, which present a chronological record of what
occurred.
 Post data from journals to ledgers, which sort data by account type.
2 To provide management with information useful for decision making:

20
  In manual systems, this information is provided in the form of reports that fall
into two main categories:
– financial statements
– managerial reports
3 To provide adequate internal controls:
 Ensure that the information produced by the system is reliable.
 Ensure that business activities are performed efficiently and in accordance with
management’s objectives.
 Safeguard organizational assets.

Answers to learning activities

Activity

1. Why study AIS?

 In Statement of Financial Accounting Concepts No. 2, the FASB...
– Defined accounting as an information system.
– Stated that the primary objective of accounting is to provide information useful to
decision makers.
 The Accounting Education Change Commission recommended that the accounting
curriculum should provide students with a solid understanding of three essential
concepts:
1. The use of information in decision making
2. The nature, design, use and implementation of an AIS
3. Financial information reporting
 To understand how the accounting system works.
 How to collect data about an organization’s activities and transactions
 How to transform that data into information that management can use to run the
organization
 How to ensure the availability, reliability, and accuracy of that information
 Auditors need to understand the systems that are used to produce a company’s financial
statements.

21
  Tax professionals need to understand enough about the client’s AIS to be confident that
the information used for tax planning and compliance work is complete and accurate.
 One of the fastest growing types of consulting services entails the design, selection, and
implementation of new Accounting Information Systems.
 A survey conducted by the Institute of Management Accountants (IMA) indicates that
work relating to accounting systems was the single most important activity performed by
corporate accountants.
Activity
3. What are the factors for good accounting system? , Define them
 Control. Managers need control over operations. Internal controls are the methods and
procedures used to authorize transactions and safeguard assets
 Compatibility. A compatible is one that works smoothly with the business’s operations,
personnel, and organizational structure. A compatible accounting information system
conforms to the needs of the business.
 Flexibility. An accounting system should be able to accommodate a variety of users and
changing information needs
 Favorable cost benefit relationship. Organizations need to strive for a system that offers
maximum benefits at a minimum cost-that is, a favorable cost/benefit relationship.
 Useful output. To be successful, information must be understandable, relevant, reliable,
timely, and accurate
Activity

4. Compare and contrast manual accounting system VS computerized accounting system by

enumerating their advantages and disadvantages.
In general, an accounting system includes the processes and procedures by which an
organization’s financial information is received, registered, recorded, handled, processed, stored,
reported, and disposed of. Manual accounting system is an accounting system that performs data
processing manually. (It will be cost effective only for small firms). On the other hand,
computerized accounting makes use of computers to handle raw data, manipulate the data, and
report the results quickly and accurately. Advantages of computerized accounting system
include:

22
- It enables to handle complex and large transactions easily;
- It increases efficiency, accuracy, speed, and timeliness;
- It reduces cost in relation to record keeping (cost per transaction)
- It handles large volume of data;
- It enables efficient storage, computation, retrieval, and auditability;
Disadvantages of computerized accounting system include:

- High initial cost investment to plan, install, test, and implement the computer system
properly;
- Thus, it may not be cost-effective for small firms with lesser volume of data to process
- Initial implementation may be time taking;
- It requires specialized skill;
- Slow acceptance may there be by employees, clients, creditors, and auditors.
The advantages of computerized accounting will be the disadvantage for manual system
and vice versa.

23
 CHAPTER TWO

DATA STORAGE APPROACH

Learning Objectives:

1. Explain the importance and advantages of databases, as well as the difference between
database and file-based legacy systems.
2. Explain the difference between logical and physical views of a database
3. Explain fundamental concepts of database systems such as DBMS, schemas, the data
dictionary, and DBMS languages
4. Describe what a relational database is and how it organizes data
5. Create a set of well-structured tables to properly store data in a relational database

Contents:
2.1 Files versus Databases……………………………………………………………………. Error:
Reference source not found

2.2 The Importance and Advantages of Database Systems………………………………. Error:

Reference source not found

2.3 Logical and Physical Views of Data……………………………………………………. Error:

Reference source not found

2.4 Schemas………………………………………………………………………………….. Error:

Reference source not found

2.5 Relational Databases……………………………………………………………………. Error:

Reference source not found

2.6 Designing a Relational Database……………………………………………………….. Error:

Reference source not found

2.7 Two Approaches to Database Design………………………………………………….. Error:

Reference source not found

2.8 Database Systems and the Future of Accounting……………………………………… Error:

Reference source not found

2.9 Database Design Process………………………………………………………………… Error:

Reference source not found

2.1Files versus Databases

24
Relational databases underlie most modern integrated AISs. They are the most popular type of
database used for transaction processing. In this chapter, we’ll define the concept of a database.
Let’s examine some basic principles about how data are stored in computer systems.
• An entity is anything about which the organization wishes to store data. At your college or
university, one entity would be the student.
• A file is a set of logically related records, such as the payroll records of all employees.
• Fields contain data about one customer such as the customers address, customer name, and so
on.
• All the fields for one customer form a record.
• A set of related records, such as all customer records, forms a file.
• A set of interrelated files forms a database.
STUDENTS
Student ID Last Name First Name Phone Number Birth Date
333-33-3333 Sima Alemu 0911-333333 10/11/84
111-11-1111 Sanders Negede 0982-444444 11/24/86
123-45-6789 Motuma Ararisa 0947-555555 04/20/85

Fig 2.1. The basic elements of data hierarchy

We use the term database to mean the collected data sets that are organized and stored as an
integral part of a firm’s computer-based information system. In turn, we define the term data sets
as flexible data structures. Data sets include groupings of data that are logically related as well as
the files with which we are familiar

Most firms developing new systems and applications for use in today’s business environment
choose the database approach to data management. Data independence, a critical feature of the
data-base approach, is the separation of data from the various applications that access and
process the data. Data independence is achieved by interposing the database management system
(DBMS) software between the database and the users of the data (e.g., the application programs.
A database management system (DBMS) acts as an interface between the database and the
various application programs. As technology improves many companies are developing very
large databases called data warehouses. Data mining is the process of analyzing data repositories
for new knowledge about the company’s data and business processes.
2.2Advantages of Database Systems

Note to Students: Some of the job announcements for accounting positions require the
knowledge and skills from experience in using MS Access. Most accounting students will audit
or work for a company that uses database technology to store, process, and report accounting
transactions. Database technology is widespread because it provides organizations with the
following benefits:

1) Data integration: Integration is achieved by combining master files into larger “pools” of
data that many application programs can access. An example is an employee database that

25
 consolidates data formerly contained in payroll, personnel, and job skills master files. This
makes it easier for information to be combined in unlimited ways
2) Data sharing: Integrating data makes it easier to share data with all authorized users.
3) Reporting flexibility: Reports can be revised easily and generated as needed and the
database can be easily browsed to research a problem or obtain detailed information
underlying a summary report.
4) Minimal data redundancy and data inconsistencies: Because data items are usually stored
only once, data redundancy and data inconsistencies are minimized.
5) Data independence: Because data and the programs that use them are independent of one
another, each can be changed without having to change the other. This makes programming
easier and simplifies data management.
6) Central management of data: Data management is more efficient because a database
administrator is responsible for coordinating, controlling, and managing data.
7) Cross-functional analysis: In a database system, relationships, such as the association
between selling costs and promotional campaigns, can be explicitly defined and used in the
preparation of management reports.
8) One-time Data Entry and Storage: In the database approach to data management data are
input into the database once, stored in a particular location, and available for use by multiple
applications and users.
2.3Logical and Physical Views of Data

In file-oriented systems, programmers must know the physical location and layout of records
used by a program; they must reference the location, length, and format of every field they
utilize. When data is used from several files, this process becomes more complex. Database
systems overcome this problem by separating the storage and use of data elements. Two separate
views of the data are provided: Logical view and physical view

The logical view is how the user or programmer conceptually organizes and understands the
data. The physical view refers to how and where the data are physically arranged and stored in
the computer system.

26
Figure 4.2 multiple logical views of data.
As shown in Figure 4.2, database management system (DBMS) software handles the link
between the way data are physically stored and each user’s logical view of the data. DBMS
allows the user to access, query, and update data without reference to how or where it is
physically stored The user only needs to define the logical data requirements The operating
system translates DBMS requests into instructions to physically retrieve data from various disks.

• Separating the logical and physical views of data also means users can change their
conceptualizations of the data relationships without making changes in the physical
storage. The database administrator can also change the physical storage of the data
without affecting users or application programs.

Activity

1. A customer’s name would be a:

a. Database
b. File
c. Field
d. Record
2. Which of the below would is a file?

a. A customer’s name
b. Data about one customer
c. All inventory records
d. Data about one inventory item
3. The database technology benefit that makes it easier for information to be
combined in unlimited ways is:

a. Data sharing
b. Data independence
c. Central management of data
d. Data integration
4. The data view that shows how the user or programmer conceptually organizes and
understands the data is the

a. Record layout view

b. Logical view

27
 c. Physical view
d. None of the above
2.4 Schemas
A schema describes the logical structure of a database. Three levels of schemas: the conceptual,
the external, and the internal.

28
Student Record Class Record
Student No. --character [9] Class Name --character [9]
Student Name --character [26] Dept No. --integer [4], non-null, index=itemx
SAT Score --integer [2], non-null, index=itemx Course No. --integer [4], non-null, index=itemx

Figure 2.3 Three levels of schemas

The conceptual-level schema is the organization-wide view of the entire database. The
external-level schema consists of a set of individual user views of portions of the database, each
of which is also referred to as a subschema. The internal-level schema provides a low-level
view of the database. It describes how the data are actually stored and accessed, including
information about record layouts, definitions, addresses, and indexes.

The Data Dictionary

The data dictionary contains information about the structure of the database. The data elements
composing the database are fully described in a data dictionary, which serves as a repository
containing facts about the structure of the data elements employed in applications.

• Accountants are frequently involved in developing conceptual- and external-level

schema.
• An employee’s access to data should be limited to the subschema of data that is relevant
to the performance of his job.

Database Management System (DBMS) Languages

The data definition language (DDL) is used to (1) build the data dictionary, (2) initialize or
create the database, (3) describe the logical views for each individual user or programmer, and
(4) specify any limitations or constraints on security imposed on database records or fields.
The data manipulation language (DML) is used for data maintenance, which includes such
operations as updating, inserting, and deleting portions of the database.
The data query language (DQL) is used to interrogate the database. The DQL retrieves, sorts,
orders and presents subsets of the database in response to user queries.
A report writer is a language that simplifies report creation.
2.5Relational Databases
A data model is an abstract representation of the contents of a database.
The relational data model represents everything in the database as being stored in the form of
tables like the one shown in Figure 2.1. Technically, these tables are called relations (hence the
name relational data model), but we will use the two words interchangeably.
Each row in a relation, called a tuple (which rhymes with couple), contains data about a specific
occurrence of the type of entity represented by that table. For example, each row in the inventory
table in Figure 2.1 contains data about a particular student.

29
Types of Attributes
A primary key is the attribute, or combination of attributes, that uniquely identifies a specific
row in a table. The primary key for the student table in Figure 2.1 is the Student ID.
A foreign key is an attribute in a table that is a primary key in another table. Foreign keys are
used to link tables.
2.6Designing a Relational Database
 Option 1: Store All Data in One Uniform Table.
This approach has two disadvantages:
1. It creates a great deal of redundancy in terms of stored data. For example, because there are
three separate inventory items sold, the sales invoice number 102 is listed three times with the
invoice and customer data is repeated each time an item is sold.
2. The second problem that can occur is referred to as an insert anomaly, because there is no
way to store information about prospective customers until they actually make a purchase.

 Option 2: Vary the Number of Columns

In this option, the data storage is to record the sales invoice and customer information just once.
We still have disadvantages. This approach does not reduce some of the redundancy and some of
the anomalies associated with the data storage scheme. The problems associated with Options 1
and 2 can be solved with a relational database.

Basic Requirements of a Relational Database

 Every column in a row must be single valued.
 Primary keys cannot be null.
 Foreign keys, if not null, must have values that correspond to the value of a
primary key in another table.
 All nonkey attributes in a table should describe a characteristic about the
object identified by the primary key.

Primary key is the attribute, or combination of attributes, that uniquely identifies a specific row
in a table. As a result, the value for a primary key cannot be blank (null). If it was blank, then
there would be no way to identify a specific row and retrieve any data.
The entity integrity rule ensures that every row in every relation must represent data bout some
specific object in the real world.
Foreign keys are used to link rows in one table to rows in another table.
This is referred to as the referential integrity rule that ensures the consistency of the database.
For example, the customer number is a foreign key in the sales table that relates to the customer
number that is a primary key in the customer table. Foreign keys can have a null value. Some
customers that pay cash may not want to give up their identity which would be able to allow a
company to track them. Therefore, their will be some customer number fields that will be left
blank.
Nonkey attributes are items in a table that are neither a primary key nor a foreign key. As
previously described as the fourth basic requirement for a relational database; all nonkey
attributes in a table should describe a characteristic about the object identified by the primary
key.

30
2.7Two Approaches to Database Design

One approach is called normalization, which starts with the assumption that everything is
initially stored in one large table. The details of the normalization process are beyond the scope
of this course but can be found in any database textbook. Note that normalization is also spelled
normalization.

Another alternative way to design well-structured relational databases involves semantic data
modeling. Under this approach, the database designer uses knowledge about how business
processes typically work and about the information needs associated with transaction processing
to draw a graphical picture of what should be included in the database. The resulting figure can
then be directly used to create a set of relational tables that are in third normal form (3NF).

2.8Database Systems and the Future of Accounting

Database systems may profoundly affect the fundamental nature of accounting. For instance,
database systems may lead to the abandonment of the double-entry accounting model. If the
amounts associated with a transaction are entered into a database system correctly, then it is
necessary to store them only once, not twice. Database systems also have the potential to
significantly alter the nature of external reporting. Why not simply make a copy of the
company’s financial database and make it available to external users in lieu of the traditional
financial statements?

Focus 1 discusses this possibility in more detail.

Perhaps the most significant effect of database systems will be in the way accounting
information is used in decision making. Relational databases, however, provide query languages
that are powerful and easy to use. Managers can concentrate solely on specifying what
information they want. Finally, relational DBMSs provide the capability of integrating financial
and operational data.
2.9Database Design Process

Changes in business strategy and practices or new IT developments lead to the need for a new
system and the process starts over. There are five basic steps in database design.

1. Systems Analysis
2. Conceptual Design
3. Physical Design
4. Implementation and Conversion
5. Operation and Maintenance

The first stage (systems analysis) consists of initial planning to determine the need for and
feasibility of developing a new system. The second stage (conceptual design) includes
developing the different schemas for the new system, at the conceptual, external, and internal

31
levels. The third stage (physical design) consists of translating the internal-level schema into the
actual database structures that will be implemented in the new system. The fourth stage
(implementation and conversion) includes all the activities associated with transferring data from
existing systems to the new database AIS, testing the new system, and training employees how to
use it. The fifth and final stage is using and maintaining the new system.

Accountants can and should participate in every stage of the database design process.
Accountants may provide the greatest value to their organizations by taking responsibility for
data modeling. Data modeling is the process of defining a database so that it faithfully represents
all aspects of the organization, including its interactions with the external environment. Data
modeling Occurs during both requirements analysis and design stage. Two important tools to
facilitate data modeling are:

• Entity-relationship diagramming

• REA data model

Entity-Relationship Diagrams

An entity-relationship (E-R) diagram is a graphical technique for portraying a database schema.

An entity-relationship (E-R) diagram shows the various entities being modeled and the important
relationships among them. An entity is anything about which the organization wants to collect
and store information. In an E-R diagram, entities are depicted as rectangles. E-R diagrams can
be used to represent the contents of any kind of database.

The REA Data Model

The REA data model was developed for use in designing AIS. The REA data model focuses on
the business semantics underlying an organization’s value chain activities.
Three Basic Types of Entities
The REA data model is so named as it has three distinct categories:
R—resources the organization acquires and uses
E—events (business activities) in which the organization engages
A—agents participating in these events

32
 Fig 2.4 Sample REA Diagram

Fig 2.5 REA Diagram for Revenue Cycle

Summary

Relational databases underlie most modern integrated AISs. They are the most popular type of
database used for transaction processing.

In file-oriented systems, programmers must know the physical location and layout of records
used by a program; they must reference the location, length, and format of every field they
utilize. When data is used from several files, this process becomes more complex. Database
systems overcome this problem by separating the storage and use of data elements. Two separate
views of the data are provided: Logical view and physical view

The logical view is how the user or programmer conceptually organizes and understands the
data. The physical view refers to how and where the data are physically arranged and stored in
the computer system.

Self Check Test

1. What is a major advantage of database systems over file-oriented transaction

33
 processing systems?
2. What is the difference in logical view and physical view?
3. Describe the different schemas involved in a database structure. What is the role of
accountants in development of schemas?
4. What is a data dictionary?
5. List the four languages used within a DBMS.
Answer to Activity

1. C 2. C 3. D 4.B

Answer to Self Check Test

1. Database systems separate logical and physical views. This separation is referred to as
program-data independence. Such separation facilitates developing new applications
because programmers can concentrate on coding the application logic (what the program
will do) and do not need to focus on how and where the various data items are stored or
accessed. In the file-oriented transaction systems, programmers need to know physical
location and layout of records which adds another layer of complexity to programming.
2. The logical view is how the user or programmer conceptually organizes and understands
the data, such as data organized in a table. The physical view, on the other hand, refers to
how and where the data are physically arranged and stored on a disk, tape, or CD-ROM
media.
3. A schema describes the logical structure of a database. There are three levels of
schemas. First, the conceptual-level schema is an organization-wide view of the entire
database listing all data elements and relationships between them. Second, an external-
level schema is a set of individual user views of portions of the database, each of which is
referred to as a subschema. Finally, an internal-level schema provides a low-level view
of the database includes descriptions about pointers, indexes, record lengths, etc.
Accountants are primarily involved in the development of conceptual- and external-level
schemas; however, database knowledgeable accountants may participate in developing an
internal level schema.
4. A data dictionary is a means by which information about the structure of a database is
maintained. For each data element stored in the database, there is a corresponding record
in the data dictionary that describes it. The DBMS usually maintains the data dictionary.
Inputs to the dictionary include various new data, changed data, and deleted data. Output
from the data dictionary may include a variety of reports useful to programmers, database
designers, and other users of the information system. Accountants have a very good
understanding of the data elements that exist in a business organization, so when an
organization is developing a database, accountants should be allowed to participate in the
development of the data dictionary.
5. The four languages used within a DBMS are data definition language, data manipulation
language, data query language, and a report writer.

34
 CHAPTER THREE

INTRODUCTION TO ELECTRONIC BUSINESS

 Objectives
After studying this unit the reader should be able to:

 Explain what E-Business is and describe the basic functions it performs.

 Describe the benefits of e-business
 Explain the different types of terminologies: Internet, Intranet and Extranet

Contents

3.1 Introduction to e-Business………………………………………………………………. Error:

Reference source not found

3.2 Benefits of e-Business…………………………………………………………………… Error:

Reference source not found

3.3 Time To Market………………………………………………………………………….. Error:

Reference source not found

3.4 Reduction of costs and ROI…………………………………………………………….. Error:

Reference source not found

3.5 Characterization of the e-Business…………………………………………………….. Error:

Reference source not found

3.6 Front Office/Back Office……………………………………………………………….. Error:

Reference source not found

3.7 Presentation of the different concepts…………………………………………………… Error:

Reference source not found

3.8 Intranet…………………………………………………………………………………. Error:

Reference source not found

35
3.9 Usefulness of an intranet………………………………………………………………. Error:
Reference source not found

3.10 Advantages of an Intranet……………………………………………………………… Error:

Reference source not found

3.11 Implementation of the Intranet………………………………………………………….. Error:

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3.12 Extranet………………………………………………………………………………….. Error:

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3.13 e-Procurement…………………………………………………………………………. Error:

Reference source not found

3.1 Introduction to e-Business

It is widely acknowledged today that new technologies, in particular access to the Internet, tend
to modify communication between the different players in the professional world, notably:

 Relationships between the enterprise and its clients,

 The internal functioning of the enterprise, including enterprise-employee relationships,

 The relationship of the enterprise with its different partners and suppliers.
The term "e-Business" therefore refers to the integration, within the company, of tools based on
information and communication technologies (generally referred to as business software) to
improve their functioning in order to create value for the enterprise, its clients, and its partners.
E-Business no longer only applies to virtual companies (called click and mortar) all of whose
activities are based on the Net, but also to traditional companies (called brick and mortar).
The term e-Commerce (also called Electronic commerce), which is frequently mixed up with the
term e-Business, as a matter of fact, only covers one aspect of e-Business, i.e. the use of an
electronic support for the commercial relationship between a company and individuals.

36
The purpose of this document is to present the different underlying "technologies" (in reality,
organizational modes based on information and communication technologies) and their
associated acronyms.
3.2Benefits of E-Business

The goal of any e-Business project is to create value. Value can be created in different manners:

1) As a result of an increase in margins, i.e. a reduction in production costs or an increase in

profits. E-Business makes it possible to achieve this in a number of different ways:
 Positioning on new markets
 Increasing the quality of products or services
 Prospecting new clients
 Increasing customer loyalty
 Increasing the efficiency of internal functioning
2) As a result of increased staff motivation. The transition from a traditional activity to an e-
Business activity ideally makes it possible to motivate associates to the extent that:
 The overall strategy is more visible for the employees and favors a common
culture
 The mode of functioning implies that the players assume responsibilities
 Teamwork favors improvement of competences
3) As a result of customer satisfaction. As a matter of fact, e-Business favors:
 a drop in prices in connection with an increase in productivity
 improved listening to clients
 products and services that are suitable for the clients' needs
 a mode of functioning that is transparent for the user
4) As a result of privileged relationships with the partners. The creation of communication
channels with the suppliers permits:
 Increased familiarity with each other
 Increased responsiveness
 Improved anticipation capacities
 Sharing of resources that is beneficial for both parties

37
An e-Business project can therefore only work as soon as it adds value to the company, but also
to its staff, its clients, and partners.

Activity 1.
The goal of any e-Business project is to create value. How can value be created?
______________________________________________________________________________
______________________________________________________________________________
3.3Time To Market

"Time To Market" is the time that is necessary to bring a product on the market from a time an
idea was put forward. Worldwide, new technologies provide an incredible source of inspiration
to formalize ideas while making Time-To-Market even more critical because of the rapid flow
of information and speedy competition.
3.4Reduction of costs and return on investments (ROI)

The use of new technologies for the functioning of an enterprise makes it possible to reduce the
costs on the different levels of its organization in time.

Nonetheless, implementation of such a project is generally very costly and necessarily leads to
organizational changes, which may cause upheaval in the practices of its employees. It is
therefore essential to determine the return on investment (ROI) of such a project, i.e. the
difference between the expected profits and the required overall investment, taking into account
the cost of human resources mobilized.
3.5Characterization of the e-Business

A company can be viewed as an entity providing products or services to clients with the support
of products or services of partners in a constantly changing environment. The functioning of an
enterprise can be roughly modeled in accordance with a set of interacting functions, which are
commonly classified in three categories:

 Performance functions, which represent the core of its activity (core business), i.e. the
production of goods or services. They pertain to activities of production, stock management,
and purchasing (purchasing function);

38
 The management functions, which cover all strategic functions of management of the
company; they cover general management of the company, the human resources (HR)
management functions as well as the financial and accounting management functions;
 The support functions, which support the performance functions to ensure proper
functioning of the enterprise. Support functions conver all activities related with sales (in
certain cases, they are part of the core business) as well as all activities that are transversal to
the organization, such as management of technological infrastructures (IT, Information
Technology function).
Activity 2

The functioning of an enterprise can be roughly modeled in accordance with a set of

interacting functions, which are commonly classified in three categories. List and
describe them.

________________________________________________________________________
________________________________________________________________________
________________________________________________________________________

39
Enterprises are generally characterized by the type of commercial relationships they maintain.
Dedicated terms therefore exist to quality this type of relationship:

 B To B (Business To Business, sometimes written B2B) means a commercial relationship

business to business based on the use of a numerical support for the exchange of
information.
 B To C (Business To Consumer, sometimes wrritten B2C) means a relationship between a
company and the public at large (individuals). This is called electronic commerce, whose
definition is not limited to sales, but rather covers all possible exchanges between a company
and its clients, from the request for an estimate to after-sales service;
 B To A (Business To Administration, sometimes written B2A) means a relationship between
a company and the public sector (tax administration, etc.) based on numerical exchange
mechanisms (tele-procedures, electronic forms, etc.).

40
As an extension of these concepts, the term B To E (Business To Employees, sometimes
written B2E) has also emerged to refer to the relationship between a company and its employees,
in particular through the provision of forms directed at them for managing their carreer, vacation,
or their relationship with the company committee.
Activity 3
Enterprises are generally characterized by the type of commercial relationships they maintain.
Name them:
______________________________________________________________________________
______________________________________________________________________________
_____________________________________________________________________________

3.6Front Office/Back Office

The terms Front Office and Back Office are generally used to describe the parts of the company
(or of its information system) that are dedicated, respectively, to the direct relationship with the
client and proper management of the company.
The Front-Office (sometimes also called Front line) refers to the front part of the enterpriser
that is visible to the clients.
In turn, Back Office refers to all parts of the information system to which the final user does not
have access. The term therefore covers all internal processes within the enterprise (production,
logistics, warehousing, sales, accounting, human resources management, etc.)

3.7Presentation of the different concepts

41
Implementing an e-Business project necessarily involves the deployment of an enterprise
network through which enterprise-specific services are accessible in client-server mode,
generally via a web interface which can be queried by using a simple navigator.

Nonetheless, the implementation of computer tools is not sufficient. It is therefore believed that
an enterprise only actually implements an e-Business project as soon as it implements a new
organization based on new technologies.
The concept of e-Business is nonetheless very flexible and covers all possible uses of
information and communication technologies (ICT) for any and all of the following activities:

I. Making the relationships between the enterprise and its clients and different partners
(suppliers, authorities, etc.) more efficient

II. Developing new business opportunities

III. Facilitating the internal flow of information

IV. Controlling the different processes of the enterprise (production, warehousing,

purchasing, sales, human resources, etc.)
The goal is therefore to create privileged communication channels between the enterprise and its
environment and link them with its internal processes to better control internal and external
costs.

3.8Intranet

An intranet is a set of Internet services (for example a web server) inside a local network, i.e.
only accessible from workstations of a local network, or rather a set of well-defined networks
that are invisible (or inaccessible) from the outside. It involves the use of Internet client-server
standards (using TCP/IP) protocols such as, for example, the use of Web
browsers (HTTP protocol-based client) and Web servers (HTTP protocol), to create
an information system inside of an organization or enterprise.

42
An intranet is generally based on a three-tier architecture, comprising:
 clients (generally Web browsers);
 one or several application servers (middleware): a web server which makes it possible to
interpret CGI, PHP, ASP or other scripts and translate them into SQL queries to query a
database;
 a database server.
In this manner, the client machines handle the graphical interface while the different servers
handle the data. The network makes it possible to exchange queries and the responses between
clients and servers.

An intranet naturally has several clients (the computers of the local network) and may also
comprise several servers. A large enterprise may, for example, have a web server for each

43
service to provide an Intranet comprising a federator web server linking the different servers that
are managed for each service.
3.9Usefulness of an intranet

An intranet within an enterprise makes it easy to make a wide variety of different documents
available to employees, which provides centralized and coherent access to the enterprise's
knowledge, which is referred to as capitalization of knowledge. In this manner, it is generally
necessary to define the access rights of the users of the Intranet to the documents located thereon,
and consequently authentication of such access rights to provide them with personalized access
to certain documents.
Documents of any kind (text, images, videos, sounds, etc.) can be made available on an Intranet.
In addition, an Intranet may provide a very interesting groupware function, i.e. allow group
work. Here are some of the functions which may be provided by an Intranet:
 Access to information regarding the enterprise (bulletin board)
 Access to technical documents
 Search engine for documentations
 Exchange of data among coworkers
 Staff roster
 Project management, decision-making aid, agenda, computer-aided engineering
 Electronic messaging
 Discussion forum, distribution list, direct chat
 Videoconference
 Internet portal
An Intranet therefore favors communication within the enterprise and limits errors as a result of
poor flow of information. Information available on the Intranet must be updated to prevent
version conflicts.
3.10 Advantages of an Intranet

An Intranet makes it possible to create an information system at a low cost (specifically, the cost
of an Intranet may very well be limited to the cost of the material, its maintenance and updating,
with client workstations operating with free navigators, a server running under Linux with the
Apache web serve, and the database server MySQL).

On the other hand, considering the "universal" nature of the means in play, any type of machine
can be connected to the local network, i.e. the Intranet.
3.11 Implementation of the Intranet

44
An Intranet must be designed in accordance with the needs of the enterprise or of the
organization (at the level of the services to be implemented). The Intranet must therefore not
only be designed by the computer engineers of the enterprise, but within the scope of
a project which takes into account the needs of all the parties interacting with the company.
Insofar as physical setup is concerned, it is sufficient to set up a web server (for example a
machine running under Linux with the Apache web server and the database server MySQL or
rather a server under Windows with the web server Microsoft Internet Information Server). It is
then sufficient to configure a domain name for the server (for
exampleintranet.votre_entreprise.com. Please note that there are CMS systems (content
management systems) which allow management of the publication of pages by a team of editors.
Activity 4
What is Intranet? _____________________________________________________________
3.12 Extranet

An extranet is an extension of the information system of the company to its partners located
outside of the network.
Access to the extranet must be secured to the extent that the same provides access to the
information system for persons located outside of the enterprise.

This might involve simple authentication (authentication via user name and password) or strong
authentication (authentication via a certificate). It is recommended to use HTTPS for all web
pages that are consulted from the outside to secure the transport of HTTP queries and answers
and to prevent, in particular, the open transfer of the password on the network.
An extranet is therefore neither an Intranet nor an Internet site. It is rather a supplementary
system providing, for example, the clients of an enterprise, its partners or its subsidiaries with
privileged access to certain computer resources of the enterprise via a Web interface.

3.13 e-Procurement

The term "e-Procurement" (for Electronic Procurement, sometimes written eprocurement) refers
to the use of new technologies to automate and optimize the purchasing function of the company.
The term refers to a B2B exchange, i.e. a transaction between two companies, which allows a
buyer to consult the product catalog of a seller online and to directly place orders according to a

45
well defined purchasing workflow. Thanks to e-procurement, the process of requesting estimates,
issuing a purchase order and billing is handled electronically and in a centralized manner at the
level of the two enterprises, which makes it possible to shorten the ordering and delivery times
while simplifying the purchasing process. Overall, e-procurement therefore makes it possible to
cut cost and improve handling of purchasing matters.
The term e-tendering (electronic bid) is sometimes used to refer to the use of the Internet to
request estimates on one hand and receive bids on the other.
The term e-sourcing (electronic sourcing) refers to the use of the Internet to identify and contact
new suppliers for a given type of product.

Summary

The term "e-Business" therefore refers to the integration, within the company, of tools based on
information and communication technologies (generally referred to as business software) to
improve their functioning in order to create value for the enterprise, its clients, and its partners.
E-Business no longer only applies to virtual companies (called click and mortar) all of whose
activities are based on the Net, but also to traditional companies (called brick and mortar). The
term e-Commerce (also called Electronic commerce), which is frequently mixed up with the
term e-Business, as a matter of fact, only covers one aspect of e-Business, i.e. the use of an
electronic support for the commercial relationship between a company and individuals.

Activity 5

What is e-Procurement? _________________________________________________________

Self Check Test

1. What is E-Business
2. Discuss Advantages of Intranet
3. What is Extranet
Answer to Activities

46
1. The goal of any e-Business project is to create value. Value can be created in different
manners:

 As a result of an increase in margins

 As a result of increased staff motivation.
 As a result of customer satisfaction.
 As a result of privileged relationships with the partners.
2. A company can be viewed as an entity providing products or services to clients with the
support of products or services of partners in a constantly changing environment. The
functioning of an enterprise can be roughly modeled in accordance with a set of interacting
functions, which are commonly classified in three categories:

 Performance functions, which represent the core of its activity (core business), i.e.
the production of goods or services. They pertain to activities of production, stock
management, and purchasing (purchasing function);

 The management functions, which cover all strategic functions of management of

the company; they cover general management of the company, the human
resources (HR) management functions as well as the financial and accounting
management functions;
 The support functions, which support the performance functions to ensure proper
functioning of the enterprise. Support functions conver all activities related with
sales (in certain cases, they are part of the core business) as well as all activities
that are transversal to the organization, such as management of technological
infrastructures (IT, Information Technology function).
3. Enterprises are generally characterized by the type of commercial relationships they
maintain. Dedicated terms therefore exist to quality this type of relationship:

 B To B (Business To Business, sometimes written B2B) means a commercial

relationship business to business based on the use of a numerical support for the
exchange of information.
 B To C (Business To Consumer, sometimes wrritten B2C) means a relationship
between a company and the public at large (individuals). This is called electronic

47
 commerce, whose definition is not limited to sales, but rather covers all possible
exchanges between a company and its clients, from the request for an estimate to
after-sales service;
 B To A (Business To Administration, sometimes written B2A) means a
relationship between a company and the public sector (tax administration, etc.)
based on numerical exchange mechanisms (teleprocedures, electronic forms, etc.).
4. An intranet is a set of Internet services (for example a web server) inside a local network, i.e.
only accessible from workstations of a local network, or rather a set of well-defined networks
that are invisible (or inaccessible) from the outside. It involves the use of Internet client-
server standards (using TCP/IP) protocols such as, for example, the use of Web
browsers (HTTP protocol-based client) and Web servers (HTTP protocol), to create
an information system inside of an organization or enterprise.

5. The term "e-Procurement" (for Electronic Procurement, sometimes written eprocurement)

refers to the use of new technologies to automate and optimize the purchasing function of the
company.

Answer To Self Check Test

1. The term "e-Business" therefore refers to the integration, within the company, of tools based
on information and communication technologies (generally referred to as business software)
to improve their functioning in order to create value for the enterprise, its clients, and its
partners.

2. An Intranet makes it possible to create an information system at a low cost (specifically, the
cost of an Intranet may very well be limited to the cost of the material, its maintenance and
updating, with client workstations operating with free navigators, a server running under
Linux with the Apache web serve, and the database server MySQL).

On the other hand, considering the "universal" nature of the means in play, any type of
machine can be connected to the local network, i.e. the Intranet.
3. An extranet is an extension of the information system of the company to its partners located
outside of the network.

48
Access to the extranet must be secured to the extent that the same provides access to the
information system for persons located outside of the enterprise.

CHAPTER FOUR

49
 THE REVENUE CYCLES: SALES TO CASH COLLECTIONS

Learning Objectives:

After careful reading of this unit the reader must be able to:

1. Describe the basic business activities and related information processing operations
performed in the revenue cycle.
2. Discuss the key decisions that need to be made in the revenue cycle, and identify the
information needed to make those decisions.
3. Document your understanding of the revenue cycle.

Contents
4.1 Introduction……………………………………………………………………………… Error:
Reference source not found

4.2 Sales Order Processing………………………………………………………………….. Error:

Reference source not found

4.3 Transaction Flows in Account Receivable Systems…………………………………… Error:

Reference source not found

4.4 Cash Receipts Application System…………………………………………………….. Error:

Reference source not found

4.5 Summary…………………………………………………………………………………. Error:

Reference source not found

4.1Introduction

The revenue cycle is a recurring set of business activities and related information processing
operations associated with providing goods and services to customers and collecting cash in
payment for those sales.

Most enterprises, both for profit and not for profit, generate revenue through activities that
constitute their revenue cycle. The revenue cycle is the simplest form if the direct exchange of
finished goods or services is made on cash in a single transaction between a seller and a buyer
and is more complex when sales is processed on credit basis. Many days or weeks may pass
between sales processing and the subsequent receipt of cash. This time lag splits the revenue
transactions into two phases:

1. the physical phase, involving the transfer of assets or services from seller to the buyer
2. the financial phase, involving the receipt of cash by the seller in payment of the account
receivable

50
Hence, the revenue cycle actually consists of two major subsystems (assuming sales on credit
basis):

1. the sales order processing system and

2. the account receivable system

4.2 Sales Order Processing

A sales order application system comprises the procedures involved in accepting and shipping
customer orders and in preparing invoices that describe products services, and assessment.

The sales order is the interface between the various function necessary to process a customer
order. These functions are sales order, credit, finished goods, shipping, billing, accounts
receivable, and general Ledger.

1. The Sales Department (Sub System1)

The sales process begins in the sales department with the receipt of a customer order indicating
the type and quantity of merchandise being requested.
The sales order captures such vital information as the name and address of the customer making
the purchase; the customer’s account number; the name, number, and description of the items
sold; the quantities and unit prices of each item sold, and other financial information such as
taxes, discounts, and freight charges.

After processing sales order the sales department produces multiple copies of sales order to
distribute for credit authorizations, packing slips, stock release documents, shipping notices,
sales invoices, and ledger posting. In an actual system, the various sales order copies would be
numbered or color-coded to signify their purpose and distribution. After preparing the sales
order, the sales clerk files one copy of it in the customer open order file for future reference to
facilitate communication with customer in their order status. To facilitate customer inquiries, the
open order file should organize and filed alphabetically by customer name.

2. Credit Departments (Sub System2)

A credit department is responsible to determine whether the customer is credit worthy or not
before the shipment of goods made. For regular customers, the credit check involves determining
that the total amount of credit granted does not exceed management’s general or specific
authorization. For new customers, a credit check is necessary to establish the terms of sale to the
customer. The sales order function and credit valuation should be separated to maintain good
internal control system by separation of duties.

Once credit has been approved, the sales order function distributes the sales order set. One copy
of each sales order is forwarded to billing, allowing the billing function to anticipate the receipt
of matching shipping advices from the shipping function. One copy-usually called the packing
slip copy-is forwarded to shipping. This copy authorizes shipping to receive goods from finished

51
goods for shipping. Another copy-usually called the stock copy-is forwarded to finished goods.
This copy authorizes stores to release goods from its custody for shipment to customers.

In some cases, a customer’s order may require that a production order be issued to produce the
goods, because the goods are not in stock. Such situations arise when the order is for a special
nonstick item or they are customized in their nature.

Finished Goods Department

The sales department sends the stock release (also called the picking ticket) copy of the sales
order to the warehouse. This document identifies which items of inventory must be located and
picked from the warehouse shelves. It also provides formal authorization for the warehouse clerk
to release custody of the specified assets. After picking the stock, the clerk initials the stock
release copy to indicate that the order is complete and accurate. Any out-of-stock items are noted
on the stock release copy. One copy of the stock release travels with the goods to the shipping
department, and the other is filed in the warehouse to provide a record of the transaction.
Shipping should sign the stock copy to acknowledge receipt of the quantities noted thereon from
finished goods. The clerk then adjusts the stock records to reflect the reduction in inventory. The
stock records are not the formal accounting records for these assets. Charging the warehouse
clerk with responsibility for asset custody and record-keeping would be a weakness in internal
control. The inventory accounting records are kept in the inventory control department.

Shipping Department

Before the arrival of the goods and the stock release copy, the shipping department receives the
packing slip and shipping notice copies from the sales department. The packing slip travels with
the goods to the customer to describe the contents of the order. The shipping notice informs the
billing department that the customer’s order has been filled and shipped. This document contains
such pertinent facts as the date of shipment, items and quantities shipped the carrier, and freight
charges.

Upon receiving the goods from the warehouse, the shipping clerk reconciles the physical items
with the stock release documents, the packing slip, and the shipping notice to verify the
correctness of the order. This is an important step and the last opportunity to detect errors before
shipment. This shipping clerk packages the goods, attaches the packing slip to the container,
completes the shipping notice, and prepares a bill of lading. The bill of lading is a formal
contract between the seller and the shipping company (carrier) that transports the goods to the
customer. This document establishes legal ownership and responsibility for assets in transit.

The shipping clerk transfers custody of the goods, the packing slip, and two copies of the bill of
lading to the carrier, then performs the following tasks:

1. Records the shipment in the shipping log

2. Sends the stock release document and the shipping notice to the billing department as
proof of shipment.
3. Files one copy each of the bill of lading and the shipping document.

52
 Billing Department

Shipping forwards documentation of the shipment to the billing function. This documentation is
termed the shipping advice and is usually the stock copy of the sales order and a copy of the bill
of lading. Billing pulls the related open order documentation, verifies the order, then prepares the
invoice by extending the charges for actual quantities shipped, freight charges (if any) , and taxes
(if any). Invoices are mailed to customers. Invoices are recorded in the sales journal and posting
copies are sent to accounts receivable. Sends the shipping document to the sales department to
close the open customer file. Periodically, a journal voucher is prepared and forwarded to the
general ledger function for posting to the general ledger.

The sales journal is a special journal for recording sales transactions. Each sales invoice is
entered in the journal as a separate item. At the end of the period the clerk summarizes these
entries and prepares a journal voucher that is sent to the general ledger for posting. Each journal
voucher represents a general journal entry and identifies the general ledger accounts affected.
Current transactions, adjusting entries, and closing entries are all entered into the general ledger.

Accounts Receivable Department

The accounts receivable department posts from the ledger copy of the sales order to the customer
accounts in the accounts receivable subsidiary ledger. Each ledger copy of the sales order
increases a customer’s account for the full amount of the sale. After posting, the AR clerk files
the ledger copy. Periodically, the clerk summarizes the individual account balance into a single
figure and sends this to the general ledger.

General Ledger Department

By the close of the processing period, the general ledger has received journal vouchers from the
billing and an account summary from the accounts receivable department.

The account summary independently provided by the accounts receivable department is used to
verify the internal accuracy of the overall process. By reconciling journal vouchers and account
summaries received from operating departments, the general ledger can detect many types of
errors.

The above-discussed functions in an organization's sales order application are clearly shown on
the following flow diagram.

53
 A data flow diagram for sales order application system

Finished 7 Shipping

4 Goods
Credit

2 3 5

Customer
9

1 Sales
order
6

11 Billing 10 A/R

13 Details
Customer
12
G/L Data
Data flow key

1. Order
2. Sales order
3. Approved sales order
4. Shipping order
5. Packing slip
6. Billing memo
7. shipping advice
8. shipment

54
 9. shipping advice
10. invoice
11. posting memo
12. journal voucher
13. Control total.

Activity 1

1. What is the difference between billing and accounts receivable function?

______________________________________________________________________________
________________________________________________________________________

4.3Transaction Flows in Account Receivable Systems

 Overview

Accounts receivable represents that money owed by customers for merchandise sold or services
rendered. Since most of the sale in modern business made on credit, accounts receivable often
represents the majority of an organization's working capital. Accounts receivable also maintains
customer credit and payment history information, which is useful in the overall administration of
company credit policies. Account receivable systems includes the followings.

I. Cash Receipts Department

The mail room under cash receipt department receives customer’s check along with a source
document called the remittance advice. The remittance advice is a portion of the original
invoice used to bill the customer. When payment is made, the customer tears off the remittance
advice portion and return it to the seller with the cash payment.

The cashier verifies the accuracy and completeness of the checks against the remittance advice.
After reconciling, the cashier records the cash receipts in the cash receipts journal. Next, the
clerk progress a bank deposit slip in triplicate showing the total amount of the day’s receipts and
forwards the checks and two copies of the deposit slip to the bank. Upon the deposit of the funds,
the bank teller validates the deposit slip and returns a copy to the controller.

Customer remittance sips are then forwarded to account receivable for posting from cash receipts
department. Accounts receivable does not have access to the cash or checks that accompany
customer remittance.

55
 II. Billing

Invoices, credit memos, and other invoice adjustments are routed to accounts receivable for
posting to the customer accounts. This maintains a separation of functions. Billing does not have
direct access to the accounts receivable records.

III. Accounts Receivable

A company is responsible for maintaining the subsidiary accounts receivable ledger. A control
account is maintained in the general ledger department. Debits and credits are posted to the
customer accounts from the posting media-remittance advices, invoices, and so on-received
from billing and cash receipts. This maintains separation of functions. Periodically, customer
statements are mailed directly to customers by the accounts receivable department. Periodic
processing also includes the preparation of an aged trial balance of the accounts receivable
subsidiary ledger for review by the credit department. Other types of customer credit reports may
be prepared based on the needs of the company. Such reports are often prepared as a by-product
of the processing required to send customers their statements.

IV. Credit

Credit department functions in an accounts receivable application system include the approval of
sales returns and allowances and other adjustments to customer accounts, the review and
approval of the aged trial balance to ascertain customer’s creditworthiness, and the initiation of
write-off memos to charge accounts to bad-debt expense.

V. General Ledger

General ledger maintains the accounts receivable control account. Debits and credits are posted
to the accounts receivable control account from the journal vouchers/control totals received from
billing and cash receipts. These amounts are reconciled to the control totals sent to the general
ledger directly from accounts receivable, this reconciliation is an important control in the
accounts receivable application system.

VI. Write-off of Accounts Receivable

The central feature in a write-off procedure is an analysis of past due accounts, usually done with
an aged trial balance. Numerous techniques are available to collect past due accounts (e.g.,
follow-up letters, collection agencies), but some accounts are ultimately worthless. In this case
the credit manager initiates a write-off, which is approved by the treasure. On approval, accounts
receivable is authorized to write off the account. A copy of the authorization is also sent to an
independent third party (internal audit) for purposes of record keeping. This is necessary because
after the write-off, accounts receivable no longer has an active record of the account. Note that
internal audit confirms write-offs directly with the customer to ensure that no collections have
been made on written-off accounts. An employee might intercept a customer’s payment on
account and then arrange for the account to be written off, so that the customer does not continue
to be billed for the amount.

56
The above functions will be shown with a flow diagram below.

2
Cash receipts
1 G/L

Customer data Customers

12
Accounts
Details receivable 13 14

11
Receiving
Internal
8 9
audit
7 5

3 Credit
manager Billing
4

Treasurer

57
 15

Data flow key

1. remittance advices
2. control total
3. sales return memo
4. sales return advice
5. credit memo
6. write off memo
7. write off advice
8. aged trial balance
9. journal voucher
10. control total
11. worthless account list
12. statements
13. total write offs
14. write off confirmation
15. write off memo

Activity 2

1. What is the role of credit department in the accounts receivable application system?

______________________________________________________________________________
________________________________________________________________________

2. What is ageing analysis?

58
4.4 Cash Receipts Application System

 Overview

This is an application system used to control the flow of information and documents regarding
cash receipts. Most of a company’s cash receipts are generated though sales. Sales, of course,
may be made either for cash or on account. Although sales accounts are handled through the
company’s billing and collection system, the end product of sales on account and subsequent
billings is the receipt of cash.

I. Cash Received on Account Application System

In order to have appropriate internal control on receipt of cash the company should separate the
followings functions.

A. Mailroom

Customer remittances on account are received in the mailroom. The mail is opened and the
checks and remittance advices are separated. Checks are restrictively endorsed and totaled. A
remittance list that documents the payments received is prepared. The remittance list is balanced
to the total of the checks received, and the agreement of these amounts is approved. A copy of
the remittance list and the remittance advices are forwarded to accounts receivable. The checks
and a control total are forwarded to cash receipts for deposit. A copy of the remittance list and
the control total are filed by date.

B. Cash Receipts

The basics objective in any cash receipts application is to minimize exposure to loss. Procedures
such as immediate deposit of receipts intact centralization of cash handling, maintenance of
minimal cash balances and immediate recording of cash transactions are fundamental control
techniques. Physical safeguards such as cash registers, vaults, immediate endorsement of checks,
and limited access to cash areas are generally necessary as well.

Checks received from the mailroom are combined with cash receipts, and a deposit slip is
prepared in three copies. The remittance slip and control total received from the mailroom are
balanced to the deposit slip, and the agreement of these amounts is approved. The remittance list
is then used to post the amount of the payments received from the mailroom into the cash
receipts journal. A journal voucher is prepared and forwarded to the general ledger. The
remittance list, control total, and a copy of the deposit slip are filed by date. The deposit is for
warded intact to the bank.

59
 C. Accounts Receivable

The remittance advices are posted to the accounts receivable ledger. The postings to the ledger
are totaled. The control total is balanced to the remittance list. The agreement of these amounts is
approved. The remittance advices are sorted and filed by customer. The remittance list and a
copy of the control total of postings are filed by date. A copy of the control total is forwarded to
the general ledger.

D. General Ledger

The journal voucher from cash receipts and the control total received from accounts receivable
are compared. The amounts are then posted to the general ledger. The source of posting the
general ledger is the cashier’s journal voucher notification of the amount of the deposit of the
payments received. This amount must agree with the total of items posted to the accounts
receivable ledger. The journal voucher and the control total are filed by date.

E. Bank

The bank accepts the deposit and validates a copy of the deposit slip. The validated copy of
the deposit slip is returned to Internet audit. The validated deposit slip is filed by date.

F. Internal Audit

Internal audit receives the periodic bank statement. Independent bank reconciliation is a
significant control in a cash-received on account application system.

To control incoming cash received through the mail, it is important that no one in the
mailroom (where the correspondence is opened), in the cashier’s office (where the money is
summarized and a deposit prepared), or in the accounts receivable section (where the assert
reduction is recorded) has complete control over the transaction. In many systems, the
invoice or statement that is sent to a customer is prepared in such a way that the portion with
the name and address of the customer is returned with the payment. This is common with
telephone, utility, and department store invoices, and provides good documentation for the
payment

The source of posting the general ledger is the journal voucher notification issued by the
cashier indicating the amount of the deposit of cash receipts. This amount must agree with
the accumulated total of the items posted to the subsidiary receivable file. Validated copies of
the deposit slip go to the internal auditor, who uses them when reconciling the ban account.
The control of actual cash (as opposed to checks) received by mail relies largely on direct
supervision.

G. Remittance advice

Send to: FTR Corporation

60
 Mauritius road, P. O. Box, 12445

Addis Ababa

Remittance advice

Date costumes No Amount paid check No

____________________________________________________________

Please return the upper portion with your payment thank you

To: Selam- Saffron

Tanzania road

P. O. Box: 2542

Addis Ababa

Due data customer No Amount clue

Data Invoice No Designation Amount

due.
Tank you for giving FTR corporation the chance to serve you

Previous balance

Payments

Credits

Late fees

Tax

Ending balance

II. Cash Sales Application System

61
The significant difference between a cash sales application system and cash received on account
application system is that there is no previous asset record (customer account balance) in a cash
sales system. The generation of initial documentation is thus the focal point of the control
system. Once a record has been prepared, cash sales are subject to accounting control. The major
feature of this system is the separation of the following functions:

A. Finished Goods

The finished goods department has custody of the assets that are available for sale to customers.
Sales to customers are documented on sales orders. A sales order indicates the amount due for
the purchase as well as the inventory control numbers of the items being sold.

B. Cash Receipts

The customer takes a copy of the sales order to cash receipts. The cash receipts department
records the sale in a cash register or other secure device, accepts the customer’s payment, and
issues a sales receipt (two copies) to the customer. Number files the sales order. At the end of the
day, the daily cash summary is generated and includes a control total of the day’s cash sales. One
copy of this total is forwarded to the general ledger: the other copy is filed by date.

C. Billing

Sales orders are reviewed by reasonableness and posted to the sales journal. Any inventory
control information contained on sates could be processed at this point. A journal voucher is
prepared to summarize cash sales. The sales orders are filed by date. The journal voucher is
forwarded to general ledger.

D. General Ledger

The journal voucher from the billing department and the control total received from the cash
receipts department are compared. The amounts are then posted to the general ledger. Note that
the source of posting the general ledger is the journal voucher notification by billing indicating
the amount of sales orders received. This amount must agree with the total of the cash received
from customers by cash receipts. Finished goods do not release goods until the customer returns
from the cash receipts department with a sates receipt. The goods are released with the sales
receipt. A copy of the sales receipt is filed in the finished goods department.

62
 Data flow diagram- cash receipt application system is shown on next page

1
Stores Billing
Customer 2
Data

5 4 7
G/L

Cash
Customer 12
Receipts Internal
audit

13

8 14

10 11 Details
Mailroo
m A/R

63
Bank
 15

Data flow key

1. cash sales 9. checks

2. sales slip 10. remittance advice

3. sales slip [Link] total mail receipts

4. sales receipt 12. journal voucher

5. goods released 13. deposit

6. journal voucher 14. deposit slip

7. control total cash sales 15. bank statement

8. mail receipts

Activity 3

1. What are the basic objectives in any cash receipts application?

______________________________________________________________________________
________________________________________________________________________

4.5Summary

 The sales process begins with a customer contacting the sales department. This initial
contact may be by telephone, mail, or in person. The sales department captures the
essential details of this event on a sales order. This information triggers a number of
tasks.
 The first step in the sales process is to authorize the transaction by obtaining credit
approval for the customer.
 When credit is approved, the sales information is released to the billing, warehouse, and
shipping processes.

64
  The next step is to ship the merchandise, which should be done as soon after credit
approval as possible. If required to wait too long, the customer may cancel the order and
go elsewhere. The shipping process reconciles the products received from the warehouse
with the sales information that it received earlier. This reconciliation ensures that the firm
sends the correct goods to the customer. If an error has occurred, such as the warehouse
releasing the wrong products or quantities, the problem should be detected at this point.
Assuming all is well with the order; the goods will be packed and shipped via common
carrier to the customer. The shipping information is then sent to the billing process.
 The billing process compiles the relevant facts about the transaction (product prices,
handling charges, freight, taxes and discount terms) and bills the customer. The billing
department then transmits this information to the accounts receivable and inventory
control processes.
 Accounts receivable receives the billing information and records this in the customer’s
account.
 Likewise, inventory control uses information from billing to adjust the inventory records
to reflect a decrease in inventory.
 Periodically (after each batch, daily, weekly, monthly, or so forth) the billing, accounts
receivable, and inventory control transmit summarized information to the general ledger
process. This includes: (1) the total of all sales from billing; (2) the total increases to
accounts receivable. From this information, the general ledger posts to the control
accounts affected by sales transactions during this period. In addition, the general ledger
process reconciles these independently compiled summaries to identify record-keeping
errors. For example, if billing had failed to bill a customer or accounts receivable had
recorded an incorrect amount, a discrepancy between their summarized figures would be
detected in the general ledger process.

Cash receipts are obtained from four major sources:

(1) Collection on accounts receivable and cash sales

(2) Conversion of other assets into cash
(3) Bank loans, bond issues and sales of stock
(4) Refunds from suppliers

Answers to learning activities

Learning activity 1

1. What is the distinction between billing and accounts receivable?

65
 The distinction between billing and accounts receivable is important to maintain separation
of functions. Billing is responsible for invoicing individual sales transactions, and accounts
receivable maintains customer- accounts information and sends periodic statements of
account to customers. Billing does not have access to the financial records (the receivable
ledger), and the financial records are independent of the invoicing operation.

Learning activity 2

1. What is the role of credit department in the accounts receivable application system?

Credit department functions in an accounts receivable application system include the approval of
sales returns and allowances and other adjustments to customer accounts, the review and
approval of the aged trial balance to ascertain customer’s creditworthiness, and the initiation of
write-off memos to charge accounts to bad-debt expense.

2. What is ageing analysis?

Ageing analysis involves the review of individual subsidiary account receivable, thereby
determining the number of day an account is past due from the due date. It usually involves
determining the age of the account and assigning the related probability of uncollectible.

Learning activity 3

1. What are the basic objectives in any cash receipts application?

The basics objective in any cash receipts application is to minimize exposure to loss. Procedures
such as immediate deposit of receipts intact centralization of cash handling, maintenance of
minimal cash balances and immediate recording of cash transactions are fundamental control
techniques. Physical safeguards such as cash registers, vaults, immediate endorsement of checks,
and limited access to cash areas are generally necessary as well.

Checks received from the mailroom are combined with cash receipts, and a deposit slip is
prepared in three copies. The remittance fist and control total received from the mailroom are
balanced to the deposit slip, and the agreement of these amounts is approved. The remittance list
is then used to post the amount of the payments received from the mailroom into the cash
receipts journal. A journal voucher is prepared and forwarded to the general ledger. The
remittance list, control total, and a copy of the deposit slip are filed by date. The deposit is for
warded intact to the bank.

Check Your Progress

1. Which of the following departments should mach shipping documents with open sales orders
and prepares daily sales summaries?

66
 A. Billing
B. Sales order
C. Accounts receivable
D. Shipping

2. Which of the following departments should normally be responsible for the preparation and
journalizing of credit memos upon the receipt of approved sales return memos to authorize a
reduction in customer’s balances because of returned goods?

A. Receiving
B. Accounts receivable
C. Credit
D. Billing

3. Which document often accompanies merchandise shipped to a customer?

A. Picking list
B. Packing slip
C. Credit memo
D. Sales order

4. Which activity is part of the sakes order entry process?

A. Setting customer credit limits

B. Preparing a bill of lading
C. Checking customer credit
D. Approving sales returns

5. For good internal control credit memos should be approved by the

A. Credit manager
B. Sales manager
C. Billing manager
D. Treasurer

1. For adequate internal control, the department responsible for preparing checks for signature
should be

A. The department that signs the checks.

67
 B. The accounts payable department
C. The purchasing department
D. The treasury department

2. In cash receipts application system, the remittance list is prepared in the mail room should be
directly forwarded to

A. Finished goods
B. Billing
C. Accounts receivable

D General ledger

. In a cash receipts application system, the cash remittances received in the mail room should be
directly forwarded to

A. Cash receipts
B. Billing
C. Accounts receivable
D. General ledger

Answers to Check your Progress Questions

1. A
2. D
3. B
4. E
5. A
6. B
7. D
8. C

68
 CHAPTER FIVE

THE EXPENDITURE CYCLE: PURCHASING TO CASH DISBURSEMENTS

After careful reading of this unit the reader must be able to:

1. Describe the basic business activities and related information processing operations
performed in the expenditure cycle.
2. Discuss the key decisions to be made in the expenditure cycle, and identify the
information needed to make those decisions.
3. Document an understanding of the expenditure cycle.

Contents
5.1 Introduction……………………………………………………………………….. Error:
Reference source not found

69
5.2 System Definition and Functions in Purchase Application System………………. Error:
Reference source not found

5.3 Recourse Management or Payroll System………………………………………… Error:

Reference source not found

5.4 Cash Disbursement Application

System……………………………………………….Error: Reference source not found

5.5 Summary……………………………………………………………………………………
Error: Reference source not found

5.1Introduction

The expenditure cycle is a recurring set of business activities and related data processing
operations associated with the purchase of and payment for goods and services. An
organization's expenditure cycle includes the function required to acquire goods and services that
are utilized by the organization in conducting its operations. The expenditure cycle includes the
acquisition of goods for resale or use in production, the acquisition of property and equipment
and the acquisition of person service.

The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash
disbursement system and the applicable parts of the general ledger system.

Expenditure cycle Operations include:-

- The preparation of purchase and recording of purchase order.

- The receipt of goods and the recording of the cost of inventory.
- The receipt of vendor invoices and the recording accounts payable.
- The preparation of employee pay-checks and the recording of payroll activities.
- The preparation and recording of cash disbursements, including payroll.

70
 Purchasing

Accounts
payable cash
disbursement
system

General Expenditure
ledger
System Cycle Inventory
System

Payroll
system

The Over all Expenditure Cycle

5.2 System Definition and Functions in Purchase Application System

 Overview

In some companies, all purchases of goods and services are channeled through and controlled by
centralized purchasing department. In others, the authority to place orders with vendors is
dispersed through out the company- a decentralized approach. Centralized purchasing may yield
increased quantity discounts stronger market position, better inventory control, buyer
specialization, and the like. Decentralized purchasing may also have some benefits because of
fast responsiveness of the purchaser and decentralized buyers may have greater knowledge of the
use and specifications of the desired goods and thereby maintain optimal inventory levels. As in
any organizational decision, the choice is largely one of management style and philosophy.

System Definitions and Functions

The purchasing (p) /accounts payable (AP) / cash disbursement (CD) system is an interacting
structure of people, equipment, methods, and controls that is designed to accomplish the
following primary functions:-

71
First the purchasing (p) /accounts payable (AP) / cash disbursement (CD) systems handle the
repetitive work routines of the departments listed by capturing and recording data related to the
day-to-day operations of those departments. The recorded data then may be used to generate
source documents (such as purchase orders and receiving reports) and to produce internal and
external reports.

Second the P/AP/CD system prepares a number of reports that support personnel at various
levels for different decisions will be used through out the paper:

Description of Information flows

1- Purchase requisition sent from inventory control department to purchasing department.

2- Purchase requisitions from various other departments sent to purchasing department.
3- Purchase order sent to vendor.
4- Purchase order notification sent to various other departments or to inventory control
department.
5- Purchase order notification sent to receiving department.
6- Purchase order notification sent to accounts payable department.
7- Goods and Services received from vendor.
8- Receiving notification sent to accounts payable department.
9- Receiving notification sent to purchasing department.
10- Invoice received from vendor.
11- Approved voucher sent to cashier.
12- Accounts payable notification and inventory cost information sent to general ledger
system.
13- Check sent to vendor by cashier.
14- Paid voucher returned to accounts payable department.
15- Notification of the cash disbursement sent from cashier to general ledger system

The process associated with reordering inventory involve several important concept and
techniques, such as cyclical reordering, reorder point analysis, economic order quantity (EOQ)
analysis, and ABC analysis.

A purchase application system includes the five basic functions:

1/ Purchase requisition is prepared & approved.

2/ Purchase order issued.

3/ Materials received.

4/ Establish payable

5/ Checks are prepared.

72
 1. Purchase requisition

A department which requires a material prepare a purchase requisition and send to a purchase
department.

2. Order Goods and Services

To place an order for goods and service the buyer first involve in vendor selection and then a
potential vendors will be evaluate with respect to such factors as unit price, quality, service,
promised delivery dates, terms, reliability, and amount purchased from the vendor to date.

3. Receive Goods and Services

When good arrive at the receiving department, it wills inspect and counted. This process helps to
insure that the right goods in a correct amount are received in acceptable condition and
nonconforming goods are rejected (returned) to the supplier. Notation of rejected goods is added
to the vendor service record in the vendor master file.

Once the condition of the goods has been approved the process of complete receiving report by
noting the quantity received on the approved purchase order receiving notification. Once
annotated with the quantity received the purchase order receiving notification become a
receiving report, which is the document used to record merchandize receipts.

As in the case of the receipt of goods, services received also should be documented properly.
Some organizations use an acceptance report to acknowledge formally the satisfactory
completion of a service contract. The acceptance report supports the payment due to the vendor
in the same way as the receiving report.

4. Establish Payable

The first step in establishing the payable involves validating the vendor invoice. This process is
triggered by receipt of the vendor invoice, a business document that notifies the purchaser of an
obligation to pay the vendor for goods or services that were ordered by and shipped to the
purchaser.

The process comprises a number of steps. First, the vendor invoice is compared against data on a
copy of the purchase order (Po accounts payable notification) to make sure that (1) the purchase
has been authorized and (2) invoices quantities, prices and terms conform to the purchase order
agreement. Next, the invoice is matched against the receiving report to determine that the goods
or services actually have been received and that goods have been transferred to stores. Finally,
the invoice is cheeked for accuracy of computed discounts, extension, and total amount due.

If the data items do not agree, the invoice is rejected and follow up procedures are initiated. If the
data item agrees, the invoice is approved and the validated invoice is then used to record the
payable. Note that the vendor master file is also updated at this point to reflect purchase history
data.

73
A payable is recognized and recorded by simultaneously:

 Creating a record on the accounts payable master file.

 Updating the inventory master file for the cost of the item received.
 Notifying the general ledger system of the amount of the payable that was recorded ( see
the data flow "GL payable update")

5. Make Payment

The payment schedule adopted will depend on the availability of any favorable discounts for
prompt payment and on the organizations current cash position. Some companies will pay
multiple invoices with one check to minimize the cost of processing invoices. Most cash
managers will attempt to optimize cash balances to help achieve a fourth system goal. that is to
insure that the amount of cash.

Data flow diagram for purchase application system.

Receivi
ng
7

5 3

1 Purchas Vendor
Stores
ing
2 10

4 11

9 13
A/P Cash

Payment
Details 12

Vender

Data

74
Data flow key

1. Requisition
2. Acknowledgement
3. Purchase order
4. Purchase advice
5. Receiving advice
6. Shipment
7. Receiving advice
8. Receiving report
9. Notice of receipt
10. Invoice
11. Approved invoice
12. Voucher package
13. Payment

Processing Non Invoiced Disbursements

Disbursements that are not typically supported by invoices such as, repayment of debt obligation
and interest and the like. In this case we may have a true voucher system and a non voucher
system. In a true voucher system the expenditure and payable recognize before cash payment is
made. But in a non-voucher system payable is not recognize before cash payment is made.

The following diagram is a logical data flow diagram that shows the processing of non-invoiced
payments under two different assumptions:

(1) A true voucher system is used in which all expenditures must be vouched that is, formally
approved for payments and recorded as a payable before they can be paid, and

(2) A non-voucher system is employed.

75
1/ assuming a true voucher system is used.

Payment Disburse GL
requiest ment payable

record
Prepare
Originating
disburse disburse General

ment ment ledger

voucher voucher

Vouchers

Payable

Master File
Payment GL cash
disburse
notification
ment
update
Check

Prepar Issue
e cheek
chec and
k recor
d
pay Payee
ment
Payment

76
2/ assuming a non-voucher system is used.

General ledger
system

GL cash
disbursement
up date
up Prepair
date
Payment Approve Approved
check
request paiment
payment request

Originating Cash disbursement

departement Check
transaction file

Payment Issue check

and record
notification payment

Payee
Payment

77
Activity 1

1. Describe the major functions in purchase application system?

______________________________________________________________________________
______________________________________________________________________________
_____________________________________________________________________

2. Distinguish between accounts receiving and stores

______________________________________________________________________________
________________________________________________________________________

5.3 Recourse Management or Payroll System

 Overview

A payroll / personnel system involves all phases of payroll processing and personnel reporting.
The system provides a means of promptly and accurately paying employees, generating the
necessary payroll reports, and supplying management with the required employee skills
information. The processing should include a deduction for with holding taxes, specialized
deductions, government reporting, and internal personnel requirements. An efficient system is
necessary to establish and maintain good employer-employee relationships.

System Function in Payroll Application Program

Two data flows enter the payroll system from departmental managers and supervisor's attendance
time records and job time records. Attendance time records shows the time period that
employees are in attendance at the job site and available for work. These records are used to
calculate the gross amount of each employees pay. Job time records on the other hand reflect that
start and stop times on specific jobs. Their purpose is to allow the distribution of payroll costs to
jobs in process (or to other accounts).

Attendance time records maintained near the entrance of the workplace and after take the
physical form of time sheets that are stamped as employees come and go. Job time records are
prepared at the worksite by employees entering the time each job is started and stopped.

"Reconcile hours worked" compares the total hours of each works as shown by at the attendance
time record with the hours reflected on the job time records for that employee. The hours should
agree. This reconciliation's is one of the payroll system control plans.

A. Personnel

The personnel office is responsible for placing people on the company’s payroll, specifying rates
of pay, and authorizing all deductions from pay. All changes such as adding, or deleting
employees, changing pay rates, or changing levels of deductions from pay must be authorized by

78
the personnel office. The personnel function is distinct from time keeping and from payroll
preparation function.

B. Time keeping

The time keeping function is responsible for the preparation and control of time reports and job
time tickets. In manufacturing firm, an hourly employee typically clocks on and off of the job. At
the end of the period, the employee's time card or time report indicates the amount of time that
the employee was on the job and the time that he or she expects to receive pay for. Time keeping
is responsible for collecting and maintaining time cards and reconciling these data to job time
summary reports that are received from production.

C. Payroll

The payroll department is responsible for the actual computation and preparation of payroll. Note
that preparing payroll is independent of preparation of the input data on which pay is based, the
time reports and personnel data. Personnel data are received from the personnel office; time
reports are received from time keeping. The payroll register details the computation of net pay
(gross pay less deductions from pay). Pay checks are sent cash payment for signature, review,
and distributions. A copy of the payroll register is sent to accounts payable to initiate the
recording of a voucher for the payroll.

79
Data flow diagram for payroll application system (for manufacturing firm)

1
Personnel

Production

2 Payroll data

3 Details
Payee
Time Payroll
10
Keeping
6

12

4 5 Cash 11 Bank
Payment
7

Cost A/P
14 13
Distribution
9 8
Internal
G/L audit

80
Data flow key

1. authorization 8. voucher
2. job time summary 9. journal voucher
3. job time cards 10. paychecks
4. job time report 11. voucher check
5. payroll register 12. canceled checks
6. paychecks 13. bank statement
7. voucher check 14. control total

Activity 2

1. Describe the major features of and operations in a payroll application system

___________________________________________________________________________
_____________________________________________________________________

5.4 Cash Disbursement Application System

 Overview

Cash disbursements result primarily from payments to vendors (accounts payable) and
employees (payroll). The cash disbursement application system should separate the following
functions Objectives

I. Accounts Payable

The accounts payable department receives copies of the purchase requisition, purchase order
receiving report and vendor invoice. These documents are reviewed, certified as to completeness,
and assemble in a voucher package. The voucher package is filed by date.

Periodically the voucher package file is reviewed and voucher packages that are due are pulled
for payment. Accounts payable performs payment processing calculating the amount due,
discount (if any), and other such items. A voucher check is prepared for each voucher. Voucher
checks are posted to the voucher register. A total of these postings are prepared. Voucher
packages are posted to the accounts payable ledger. This posting is summarized on a journal
voucher and a distribution voucher. The voucher checks, voucher packages, and control total are
approved and forwarded to the cash disbursements department. The journal voucher is forwarded

81
to general ledger. The distribution voucher is forwarded to the department managing the expense
ledger.

II. Cash Disbursements

After the voucher checks and voucher packages are reviewed the checks are signed and the
voucher packages are canceled and filed by number. The voucher checks are then posted to a
check register. This posting is total and reconciled to the control total received from accounts
payable. Voucher checks are forwarded directly to the payees. The control total is forwarded to
general ledger.

III. Expense Ledger

The distribution voucher is posted to the expense ledger and/or inventory ledger as appropriate.
A distribution summary is prepared, reconciled to the distribution voucher, and approved. The
distribution voucher and a copy of the distribution report are filed by date. A copy of the
distribution summary is for warded to general ledger.

IV. General Ledger

The distribution summary received from the expense ledger the journal voucher received from
accounts payable and the control total from cash disbursements are reconciled and the totals are
posted to the general ledger. The distribution summary received from the expense ledger, the
journal voucher received from the accounts payable department, and the control total from the
cash disbursements department are filed by date.

V. Internal audit

The canceled checks are received from the bank along with the bank statement. Independent
bank reconciliation is an important control in a cash disbursement application system.

VI. Voucher Systems

A voucher system is essentially a review technique. A system in which every organizational

expenditure must be documented with an approved voucher. The real control over disbursements
is a final review of documents evidencing the entire transaction prior to the authorization of
payment. A voucher payable system, unlike the accounts payable system encompasses all
expenditures, including trade accounts, payroll capital expenditure, and so on.

82
Data flow diagram for cash disbursement application system

3
Payment A/P
2
data

Details
Cash
Expense
ledger
Payee Disburs
4 ement

5 6

7
G/L

Bank Internal
8 Audit

Data Flow Key

1. voucher check

[Link] details

[Link] voucher

4. check

5. control total

[Link] report

7. concealed checks

8. bank statement

83
Activity 3

1. Define an imp rest fund system

______________________________________________________________________________
________________________________________________________________________

5.5Summary

The general P/AP/CD system entails several different files. The accounts payable master file is a
repository of all unpaid vendor invoices. In creating the records that compose typical accounts
payable master file information to be captured should be limited to data that lead to
accomplishing the goals of the system. The file designee should consider how the file would be
processed when the cash manager is deciding what payment to make. For example, the manager
may want to merge vender invoices so that the total amount due each vendor can be
accumulated. Alternatively, the manager might want to select specific invoices for payment.

Purchasing personnel when selecting an appropriate vendor usually accesses the vender master
file. During processing, vender data are retrieved to prepared purchase orders and to issue
payments. In addition to storing identification data the file is used by management to evaluate
vender performance and to make various ordering decisions.

The purchase order master file is a compilation of open purchase orders and includes the status
of each item on order. To keep track of a purchase, the purchasing department generally creates a
record in the purchase order, including information about the status of each item on order. The
order is closed only on receipt and acceptance of all goods detailed on the order.

The other file appearing in the data flow diagrams are:

(a) The inventory master file. This file contains a record of each inventory item that is stoked
in the warehouse or is regularly ordered from a vendor. These records are used to manage
the inventory and to support the inventory in the general ledges.
(b) Recording report file. This is a transaction file of receiving report documents. Physically,
the reserving reports are often a duplicate copy of the purchase order document.
Therefore, a typical receiving report would comprise a heeder section-containing the
same information as a purchase order header-and one or more receiving report lines-
showing each item's identification card, description, quantity ordered (unless the bylined
copy was used), quantity received, and data received.

84
 (c) Cash disbursements transaction file. the purchase of this file to show in chronological
sequence the details of each cash payment made. Accordingly each record in this file
normally would show the date the payment is recorded, vendor identification,
disbursement voucher number (if the voucher system is used), vendor invoice number
and gross invoice amount, cash discount taken on each invoice, net invoice amount,
check amount and check number.

The payroll system, as you might guess, has need for its own files. The employee/payroll master
file contains employee identification data as well as data used for the computation of employee
paychecks. Employee payroll records are keyed by an employee identification code. The
employee code can be designed so as to reflect certain employee attributes, such as departments,
factory and positions. Such code numbers can be used to provide management with labor-cost
distribution.

Cash payments are applied in four major ways:

(1) Payments on trade accounts payable and payrolls

(2) Investments in other assets
(3) Repayments of bank loans and bond issues
(4) Payments for operating expenses

Answers to learning activities

Activity 1

1. Describe the major functions in purchase application system?

The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash
disbursement system and the applicable parts of the general ledger system.

Expenditure cycle Operations include:-

- The preparation and recording of purchase orders.

- The receipt of goods and the recording of the cost of inventory.
- The receipt of vendor invoices and the recording accounts payable.
- The preparation of employee pay-checks and the recording of payroll activities.
- The preparation and recording of cash disbursements, including payroll.

2. Distinguish between receiving and stores

When good arrived at the receiving department, there is inspected and counted. This process
helps to insure that the right goods in a correct amount are received in acceptable condition.

85
Nonconforming goods are rejected (returned) to the supplier. Notation of rejected goods is added
to the vendor service record in the vendor master file.

Once the condition of the goods has been approved the process of complete receiving report by
noting the quantity received on the approved purchase order receiving notification. Once
annotated with the quantity received the purchase order receiving notification become a
receiving report, which is the document used to record merchandize receipts.

The stores department acknowledges receipt of the goods from receiving by signing the
receiving report and then forwarding the receiving report to accounts payable.

Activity 2

1. Describe the major features of and operations in a payroll application system

The HRM/payroll cycle is a recurring set of business activities and related data processing
operations associated with effectively managing the employee work force.

1. Update master payroll file

2. Update tax rates and deductions
3. Validate time and attendance data
4. Prepare payroll
5. Disburse payroll
6. Calculate employer-paid benefits and taxes
7. Disburse payroll taxes and other deductions

• The first activity in the HRM/payroll cycle involves updating the payroll master file to
reflect payroll changes such as new hires, terminations, changes in pay rates, or changes
in discretionary withholdings.
• It is important that all payroll changes are entered in a timely manner and are properly
reflected in the next pay period.
• The second activity in the HRM/payroll cycle involves updating information about tax
rates and other withholdings.
• These changes happen whenever updates about changes in tax rates and other payroll
deductions are received from various government units and insurance companies.
• The third activity in the payroll cycle is to validate each employee’s time and attendance
data.
• This information comes in various forms, depending on an employee’s status.

86
 • The fourth activity in the payroll cycle involves preparing payroll.
• Data about the hours worked are provided by the department in which the employee
works.
• Pay rate information is obtained from the payroll master file.
• The person responsible for preparing paychecks cannot add new records to this file.

• The fifth activity is actual disbursement of paychecks to employees.

• Most employees are paid either by check or by direct deposit of the net pay amount into
the employee’s bank account.

• The six activity is calculating tax and benefits. Some payroll taxes and employee benefits
are paid directly by the employer.
• Federal and state laws require employers to contribute a specified percentage of each
employee’s gross pay to federal and state unemployment compensation insurance funds.
• Employers often contribute to health, disability, and insurance premiums.

• The final activity in the payroll process involves paying the payroll tax liability and the
other voluntary deductions of each employee.
• An organization must periodically prepare checks or use electronic transfer to pay the
various tax liabilities incurred.

Activity 3

1. Define an imp rest fund system

An imp rest fund is a fund maintained at a specified, predetermined amount. At all times, the
amount of cash on hand plus documented expenditures should equal the specified amount of the
tend, periodically, an impress fund is replenished: documented expenditures (petty cash
vouchers) are reviewed and approved, and a check is drawn to the fund or custodian of the fund
for the amount necessary to bring the fund back to its specified amount separate checking
accounts may be maintained for payroll and other expense categories such as dividend payments.

Check Your Progress

1. In a purchase application system, which of the following departments should normally be

responsible for the preparation of the purchase order?

A. Cash disbursement
B. Purchasing

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 C. Accounts payable
D. Stores

2. In a purchase application system, which of the following departments should normally be

responsible for the preparation of the requisitions?

A. Cash disbursement
B. Purchasing
C. Receiving
D. Stores

3. In order to provide accountability for purchasing, copies of purchase requisitions should be

sent to

A. The vendor
B. Cash disbursement
C. Accounts payable
D. Receiving

4. In payroll application system, which of the following should be responsible for payroll
register?

A. Personnel department
B. Payroll department
C. Cash payment department
D. Time keeping department.

5. In a payroll application system, which of the following should be responsible for the
authorization of pay rates for employees?

A. Personnel department
B. Payroll department
C. Cash disbursement
D. Time keeping department

6. In cash disbursements application systems, the voucher package should be canceled by

A. Cash disbursement
B. Accounts payable

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 C. Expense ledger distribution
D. General ledger

7. Which of the following documents should normally be included in a voucher package?

A. Vendor invoice
B. Purchase order
C. Both A and B
D. Neither A nor B

Answers to Check Your Progress Questions

1. B. 2. D. 3. C. 4. B. 5. A. 6. A 7. c

CHAPTER SIX: PRODUCT CYCLE

Careful study of this unit will enable the reader to:

1. Describe the major business activities and related information processing operations
performed in the production cycle.
2. Explain how a company’s cost accounting system can help it achieve its manufacturing
goals.
3. Identify major threats in the production cycle, and evaluate the adequacy of various
control procedures for dealing with those threats.

Contents
6.1 Introduction.................................................................................Error: Reference source not found

6.2 Production-Cycle Applications...................................................Error: Reference source not found

6.3 Property Accounting Application..............................................Error: Reference source not found

6.4 Summary......................................................................................Error: Reference source not found

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6.1 Introduction

The production cycle is a recurring set of business activities and related information processing
operations associated with the manufacture of products. Production control, inventory control,
inventory control, cost accounting are typical functions in the production cycle of manufacturing
firms. Few if any production-cycle activities exist as separate functions in non manufacturing
firms, but to same existent moat organization hold some inventories and manage some type of
production control are relevant to most organizations. This section discusses accounting
applications systems found in an organization’s production cycles. The central feature of the
illustrated applications is the segregation of duties to achieve organizational independence.

6.2 Production-Cycle Applications

 Overview

This section provides an overview of the transaction flows necessary to support the function of
production control, inventory control, and cost accounting within a manufacturing firm.

Production Control

Cost accounting system focus on the management of manufacturing inventories: materials, work-
in process (WIP), and finished goods. Internal control over inventories and production is based
on separation of functions and basic records and documentation, such as production orders,
material requisition forms, and labor time cards. Protection of inventories from physical theft
involves security and access provisions as well as periodic physical counts and tests against
independent records.

File and Reports

Production control involves planning which products to produce and scheduling production to
make optimal use of resources. Basic production requirements are provided by the bill of
materials and master operations list. Detailed materials specifications for a product are recorded
on the bill of materials. The bill of materials lists all required parts and their descriptions in
subassembly order. The bill can be used as a ready reference for replacement parts, as an aid in
troubleshooting subassemblies, or as a parts list for the end user. By distributing copies of bills to
all affected departments, management can ensure uniform access to accurate, up-to-date
information at every operation, their sequencing, and their related machine requirements are
specified in the master operations list for a product. The bill of materials and the master
operation list are used extensively in the production control function. In a standard cost system,
the standard material and labor costs might be included on the bill of materials and master
operations list.

Determining what products to manufacture requires an integration of the demand for a product,
the product requirements, and the production resources available to the firm. Resources available
for production are communicated to the production control function through inventory status

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reports and factor availability reports. A few material status report details the material resource
in inventory that are available for production. A factory availability report communicates the
availability of labor and machine resources. Demand requirements for a product depend on
whether it is custom-manufactured per customer order or routinely manufactured for inventory.
If the product is manufactured for inventory, production requirements depend on a sales forecast,
which may be sent to production control from the sales or marketing department. Sales forecast
must be related to the amount of a product held in inventory. This information is provided in a
finished goods status report, which lists the quantities of products plan lists.

Transaction Flows

The production order serves as authorization for the production departments to make certain
products. Materials requisitions are issued for each production order to authorize the inventory
department to release materials to the production department. The items and quantities shown on
a materials requisition are determined from the specifications in the product’s bill of materials
requisition are determined from the specifications in the products bill of materials. Note the flow
of the materials requisition and production order in figure 1 the cost accounting function receives
a copy of the production order directly from producer is complete. In similar fashion, cost
accounting receives copies of materials requisitions from both the inventory control function and
the production departments. This distribution of documents implements an adequate segregation
of duties and provides accountability for the production departments.

Labor operations are recorded on job time cards. These cards are posted to production orders and
forwarded to the cost accounting department. The periodic reconciliation of time cards to
production labor reports is an important internal control function.

Production status reports are periodically sent from the production department to the production
control function. A production status report details the work completed on individual production
orders as they move through the production process. It is used to monitor the status of open
production orders and to revise the departmental production schedules as necessary.

The central document in the foregoing process is the production order. A copy of the production
order is sent to the cost accounting function to establish a WIP record for each job.

Cost Accounting

The cost accounting department is responsible for maintaining a file of WIP cost records. New
records are added to this file upon receipt of new production orders. Initiated by production
control, materials costs are posted to this file from copies of materials requisition. Direct labor
costs are posted from job time tickets. Overhead costs are often applied on the basis of direct
labor hours or direct labor costs and, therefore, are posted at the same time as labor costs. Cost
accounting initiates a journal voucher reflecting each batch of job time tickets posted that
contains a debit to WIP and credits to payroll and manufacturing overhead. This journal voucher
is transmitted and posted to the general ledger.

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As production orders are completed and goods are transferred to inventory, several documents
must be update. Productions control the production order from its file of open production orders.
Cost accounting closes the related WIP record , summarizes this activity, and communicates a
completed production cost summary to various managers. The finished goods inventory records
are updated to reflect the availability of the product.

Control of production efficiency requires comparisons of actual production with scheduled

production and an analysis of related variances. Production control also requires a comparison
and analysis of other factors, including budgeted cost versus actual cost for individual production
order and /or departments, and facility usage versus facility availability by department. The
control of inventory loss and the maintenance of optimal inventory levels are also important to
overall production control.

Inventory Control

The control of inventories is accomplished through a series of inventory records and reports that
provide such information as inventory use, inventory balances, and minimum and maximum
levels of stock. Recorder points and procedures are established. A reorder point is the level of
inventory at which it is desirable to order or produce additional items to avoid an out-or-stock
condition. The development of reorder points requires an analysis of product demand, ordering
or production lead time, inventory holding costs, and the costs associated with an out-of-stock
condition such as lost sales or inefficient use of production facilities.

Because inventory control aims at minimizing total inventory cost, an important decision to be
made is the size of each purchase order quantity, that is, the most economic order quantity
(EOQ). The reorder quantity must balance two system costs- total carrying costs and total
ordering costs. A formula for calculating the EOQ is

where

EOQ = economic order quantity (units)

R= requirements for the item this period (units)

S= purchasing cost per order

P= unit cost

I = inventory carrying cost per period, expressed as a percentage of the

period inventory value

Once the EOQ has been calculated, the timing of the order must be decided; that is, the reorder
point must be determined. If the order lead time and the inventory usage rate are known,

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determining the reorder point is straightforward. Lead time is the time between placing an order
and the receipt of the goods. The inventory usage rate is the quantity of the goods used over a
period of time. The reorder point should be where the inventory level reaches the number of
units that would be consumed during the lead time. In a formula:

Reorder point = lead time x average inventory usage rate

Perpetual inventory records are the best source of the inventory information necessary to
calculate the EOQ. The units in the beginning inventory, on order, receipts, issues, and balance
on hand, should be included in these records. Appropriate control over inventories requires
periodic verification of items on hand. This can be done on a rotating basis when perpetual
inventory records exist, or it can be done with a periodic physical count.

An important part of inventory control is the evaluation of inventory turnover to determine the
age, condition, and status of stock. Special controls should be established to write down obsolete
and slow-moving inventory items and to compare the balance to an appropriately established
inventory level. A stock status report showing detailed use by period is especially helpful in
maintaining the inventory at a proper level and controlling slow-moving items.

Control over inventory includes methods of storing and handling. Items need to be classified and
properly identified so that they can be located appropriately and so that proper verification and
reporting are possible. The storage and handling of items must provide security against
embezzlement, protection against damage or spoilage, avoidance of obsolescence, and assurance
of proper control.

Inventory is a substantial investment. An inventory control system should provide status reports
on each active product so that the company can reasonably meet customer demands. Because of
the large number of inventory items and the variety of transactions affecting them, it is difficult
to keep inventory and production information up-to-date with manual systems. A computerized
inventory control system can result in a substantial reduction in inventory investment. These
savings include a reduction in inventory without a corresponding decrease in service,
determination of economic order quantities and order points, establishment of adequate safety
stocks, and forecasts of future demand based on current and past information. Usage records,
turnover and obsolescence analyses, reorder cult to generate in purely manual systems.

Just-in time (JIT) Production

Just-in time (JIT) production is a term used to describe a production system in which parts are
produced only as they are required in subsequent operations. JIT systems differ from
conventional productions systems in the inventories of Work In – process, raw materials, and
finished goods are minimized or totally eliminated. The raw materials inventory, work –in
process inventory, and finished goods inventory are shown within dash-line boxes to indicate
that they are eliminated to the extent possible in JIT production. The terms minimum inventory
production system (MIPS), material as needed (MAN), and zero inventory productions system
(ZIPS) also describe this concept of minimizing inventories.

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Inventories serve as a buffer between different operations. Inventories are eliminated by
carefully analyzing operations to yield a constant production rate that will balance input and
output at the various stages of production. JIT production also emphasizes quality control.
Because inventories are minimized, defective production has to be corrected immediately if the
constant flow of production is to be sustained. Vendors guarantee timely delivery of defect-free
parts that may be placed immediately into production rather than first being placed into raw
materials inventory.

The financial benefits of JIT production system is primarily from the overall reduction in
inventory levels. This reduces a firm’s total investment in inventories. Costs such as handling
and storing materials, obsolescence, storage space, and financing charges on total inventory cost
are reduced, perhaps significantly. Other benefits include possible lower labor costs as
operations are redesigned for constant-flow production, quantity discounts from vendors who in
return receive long-term contracts, and increased emphasis on quality production and the
corresponding reduction in the cost of waste and spoilage.

Activity 1

1. What is JIT production system?

___________________________________________________________________________
_____________________________________________________________________

2. Describe the EOQ formula.

___________________________________________________________________________
_____________________________________________________________________

6.3 Property Accounting Application

 Overview

Property accounting applications concern an organization’s fixed assets and investments. An

important element of effective internal control is the accurate and timely processing of
information relating to fixed assets and investments. Such processing is accomplished through
the use of special accounting applications that provide for accounting, operational, and
management information needs (see Figure 3).

Fixed Assets

There are four objectives of fixed asset of investment accounting application:

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 1. Maintain adequate records that identify assists with description, cost, and physical location.
2. Provide for appropriate deprecation and/or amortization calculations for book and tax
purposes.
3. Provide for reevaluation for insurance and replacement cost purposes.
4. Provide management with reports for planning and controlling the individual asset items.

Fixed assets are tangible properties such as land, buildings, machinery, equipment, and furniture
that are used in the normal conduct of a business.

Property

Transactions

Reconciliation of
Investments Periodic discrepancies
and fixed
asset Compari
son

Record
in Prope
property rty
legers legers

Periodic
processing

Depreciation Other
Insurance management
Calculation &replacement reports
costs

These items are relatively permanent and often represent a company’s largest investment.
Transactions that change the amount of investment in fixed assets tend to occur infrequently and
usually involve relatively large amounts of money.

A company accumulates many assets over the life of the business, disposes of assets(by
retirement, sale, or other means), moves assets from one location to another, and match the
costs(other than land) to revenues by means of periodic depreciation charges over the estimated
useful life of the asset. To accomplish these tasks efficiently and to provide adequate control, an
automated system is frequently required.

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Every organization, including those on a cash basis, should keep a ledger of fixed assets as an aid
to effective control. A fixed –asset register is a systematic listing of an organizations fixed assets.
A separate section of the fixed asset register is usually kept for each major category of asset. This
categorization should be consistent with the general ledger account descriptions. For example, an
organization may have separate ledger accounts for buildings, furniture and fixtures, and
automobiles. There would be a separate section for each of these categories. Assets themselves
should be labeled with identifiers linked to the fixed-asset register.

When each asset is acquired, it should be tagged and entered in the fixed asset register. The total
dollar amount shown in the register should agree with the general ledger control accounts. For
this reason, entries must be made in the fixed-asset register not only to record addition but also to
asset sales or other dispositions.

Several entries must be made when an asset is disposed of. The first records the date of disposal.
The second entry removes the accumulated depreciation taken to date. A fixed-asset register
functions as a subsidiary ledger to the corresponding general ledger control accounts.

Investment

Investments, like fixed assets, require separate records; typically, an investment register is used
to provide accounting control over investments. As with all other assets, custody of investment
should be separate and distinct from record keeping. The investment register should contain all
relevant information, such as certificate number and the par value of securities, to facilitate
identification and control. All investment transaction should be duly authorized and documented.
A common control practice with respect to the physical handling of investment securities is to
require two people to be present when the firms safe deposit box or other depositor is entered.

Internal Accounting Control Practices

The following questions suggest the internal accounting control procedures that would be
expected in a property application system.

A. Do procedures require authorization by an official or committee for expenditures (possibly

over certain amounts) for
1. Capital assets?
2. Repairs and maintenance?
B. Are actual expenditures compared to budgets and additional approvals required if budget
authorization is exceeded?
C. Do written procedures exist that provide for distinguishing between capital additions and
repair and maintenance?
D. Do procedures require formal authorization for the sale retirement, or scrapping of capital
assets?

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E. Are these records maintained by people other than those who are responsible for the
property?
F. Are the detailed records balanced at least annually with the general ledger controls?
G. Are the detailed record balanced at least annually with the general ledger controls?
H. Are physical inventories of property taken periodically under the super vision of employees
who are not responsible for the custody of recording of such properties?
I. Are periodic appraisals of property made for insurance purposes?
J. Are significant discrepancies between book records and physical inventories reported to
management?
K. With regard to small tools:
1. Are these physical safeguarded and is responsibility for them clearly defined?
2. Are they issued only upon written authorization?

Activity 2

1. Describe the major features of a property accounting application system

___________________________________________________________________________
_____________________________________________________________________

6.4Summary

Production control, inventory control, and property accounting are typical production cycle
applications in manufacturing firms. A production control application system, plans and
schedules production and issues production orders to authorize production activities. Material
requisition forms and job time cards are used to trace production costs to individual production
orders. A model production application control application system includes a separation of the
following functions: production control, the production departments, inventory control, cost
accounting and general ledger.

Inventory control is accomplished through a series of records and reports that provide
information concerning inventory use and inventory balances. Perpetual inventory records are
the best source of inventory information. The storage and handling of inventory items must
provide assurance of adequate control.

Property accounting applications concern an organization’s fixed assets and investments.

Property accounting applications maintain records that identify an organization’s fixed assets and
investments, provide for appropriate depreciation for financial and tax purposes, provide

97
information for insurance purposes, and provide information to management concerning use and
availability of an organization’s fixed assets and investments.

Answers to activities

Learning activity 1

3. What is JIT production system?

Just-in time (JIT) production is a term used to describe a production system in which
parts are produced only as they are required in subsequent operations. JIT systems differ
from conventional productions systems in the inventories -

Vendor Raw Customer

Finished
Operat Work- Operatio
goods
materi n Inventory
ion in
als
Proce 2
Invento
1 ss
ry
Inven
Just- in Time (JIT) Production. of Work In – process, raw materials, and
tory finished goods
are minimized or totally eliminated. The raw materials inventory, work –in process
inventory, and finished goods inventory are shown within dash-line boxes to indicate that
they are eliminated to the extent possible in JIT production. The terms minimum
inventory production system (MIPS), material as needed (MAN), and zero inventory
productions system (ZIPS) also describe this concept of minimizing inventories.

4. Describe the EOQ formula

EOQ =

2xRxS

PxI

Where

EOQ = economic order quantity (units)

R= requirements for the item this period (units)

S= purchasing cost per order

P= unit cost

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 I = inventory carrying cost per period, expressed as a percentage of the
period inventory value

Learning activity 2

2. Describe the major features of a property accounting application system

One of the features of fixed asset includes its objectives;

5. Maintain adequate records that identify assists with description, cost, and
physical location.
6. Provide for appropriate deprecation and/or amortization calculations for book
and tax purposes.
7. Provide for reevaluation for insurance and replacement cost purposes.
8. Provide management with reports for planning and controlling the individual
asset items.

Check You Progress

1. In a production control application system, which of the following documents serves as

authorization to release raw materials to the production department?
A. Production order
B. Job time card
C. Journal voucher
D. Material requisition
2. In a production control application system, which of the following departments should
receive copies of production orders?

A. Inventory control
B. Cost accounting
C. Purchasing
D. General ledger

3. In a production control application system, which of the following documents serves as

authorizations to the production departments to make certain products?

A. Production order
B. Job time card

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 C. Material requisition
D. Journal voucher

4. Which of the following is a characteristic of (JIT) production?

A. Parts are produced only as they are required in subsequent operations

B. A constant flow production rate
C. Both A and B
D. Neither A nor B

5. One of the following is not a fixed asset?

A. Land
B. Building
C. Organization cost
D. Machinery

Answers to Check Your Progress

1. D
2. B
3. A
4. C
5. C

CHAPTER 7

CONTROL AND ACCOUNTING INFORMATION SYSTEMS

Learning Objectives:

 Explain basic control concepts and why computer control and security are important.
 Compare and contrast the COBIT, COSO, and ERM control frameworks.
 Describe the major elements in the internal environment of a company.
 Describe the four types of control objectives that companies need to set.
 Describe the events that affect uncertainty and the techniques used to identify them.

100
  Explain how to assess and respond to risk using the Enterprise Risk Management model.
 Describe control activities commonly used in companies.
 Describe how to communicate information and monitor control processes in
organizations.

Contents
7.1 Introduction.................................................................................Error: Reference source not found

7.2 Why Control and Security Are Important................................Error: Reference source not found

7.3 Overview of Control Concepts...................................................Error: Reference source not found

7.4 Levels of Control.........................................................................Error: Reference source not found

7.5 Control Frameworks........................................................................Error: Reference source not found

7.7 Enterprise Risk Management – Integrated Framework (ERM)

7.7.1 The Internal Environment..........................................................Error: Reference source not found

7.7.2 External influences......................................................................Error: Reference source not found

7.7.3 Objective Setting.........................................................................Error: Reference source not found

7.7.4 Event Identification.....................................................................Error: Reference source not found

7.7.5 Risk Assessment and Risk Response.........................................Error: Reference source not found

7.7.6 Control Activities.........................................................................Error: Reference source not found

7.8 Project development and acquisition controls..........................Error: Reference source not found

7.9 Change management controls....................................................Error: Reference source not found

7.10 Monitoring...................................................................................Error: Reference source not found

7.1Introduction

An overview of Accounting Information Systems Threats

According to Newman, "a threat to a computer system is any potential occurrence, either
accidental or malicious, that can have an undesirable effect on the assets and resources of the
organization." Mainly speaking, there are two types of threats. One type of threats is internal
threats. The other type of threats is external threats.

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Internal threats are from insiders. Since insiders know where the most important data resides and
they may have physical access to facilities and equipment, they are more dangerous to a certain
extent. Within internal threats, there are non-deliberate threats and deliberate threats.

The non-deliberate threats are usually security holes, which are the results of poorly configured
systems from the poorly trained or under-trained individuals. Even if they do not intend to
impose any threats, they facilitate another individual conducting the intrusive activity. The
deliberate threats are from the insiders who are deliberately attempting to circumvent security
controls for dishonest reasons. They are government or corporate spies, the disgruntled or ex-
employees, or the temporary employees.

External threats are from outsiders, who are competitors, corporate spies, hackers, crackers,
phreakers, Hactivists, or malicious outsiders. Vulnerability is the "undesirable system
characteristics" (Newman). A threat may take advantage of vulnerability. There are technical
vulnerabilities since the software that runs the network is becoming more and more complicated.

"An attack on a computer system or network involves the exploitation of the vulnerabilities,
which result in a threat against the resource." Integrity threat, denial of service threat, and
disclosure threat are threats to network components. Water, fire, gas, electrical surges, etc. may
form threats to hardware components. Human manipulation such as additions, modifications, and
deletions may form threats to software components. Software modifications consist of
information leak, trapdoor, Trojan horse, and virus.

Why Accounting Information Systems Threats Are Increasing

More than 60% of organizations have recently experienced a major control failure for
some of the following reasons:

 Increase in number of information systems means that information is available to

an increasing number of workers.
 Distributed (decentralized) computer networks are harder to control than
centralized mainframe systems.
 Wide area networks are giving customers and suppliers access to each other’s
systems and data, making confidentiality a major concern
Some of the reasons why organizations did not adequately protect their data are:
 Computer control problems have been underestimated and downplayed
 The control implications of moving from centralized, host-based computer

102
 systems to a networked or Internet-based system have not been fully understood
 Many companies have not realized that data security is crucial to their survival
 Productivity and cost pressures have motivated management to forgo time-
consuming control measures
Any potential adverse occurrence or unwanted event that could be injurious to either the
accounting information system or the organization is referred to as a threat or an event.
The potential dollar loss should a particular threat become a reality is referred to as the
exposure or impact of the threat, and the probability that the threat will happen is the
likelihood associated with the threat
7.2Why Control and Security Are Important
As an accountant you must have a good understanding of Information Technology (IT) and it’s
capabilities and risks.

Although internal control objectives remain the same regardless of the data processing method,
computer-based AIS requires different internal control policies and procedures.
One of the primary objectives of an accounting information system is to control a business
organization.
One of management’s basic functions is to ensure that enterprise objectives are achieved. Thus
management’s decisions pertaining to controls are crucial to the firm’s success in meeting its
objectives.
Management expects accountants to
(1) take a proactive approach to eliminating system threats and
(2) detect, correct and recover from threats when they occur
7.3Overview of Control Concepts

My simple definition of internal control is:

To keep the honest employees honest and get rid of the dishonest employees
Internal control is the process implemented by the board of directors, management and those
under their direction to provide reasonable assurance that the following control objectives are
achieved:
 Safeguarding assets, including preventing or detecting, on a timely basis, the unauthorized
acquisition, use or disposition of material company assets
 Maintaining records in sufficient detail to accurately and fairly reflect company assets
 Providing accurate and reliable information
 Providing reasonable assurance that financial reporting is prepared in accordance with GAAP
 Promoting and improving operational efficiency, including making sure company receipts
and expenditures are made in accordance with management and directors’ authorizations
 Encouraging adherence to prescribed managerial policies
 Complying with applicable laws and regulations.
The internal controls can be categorized as;
1) Preventive Controls deter problems before they arise; anticipate the problem
2) Detective Controls discover problems as soon as they arise; what we normally called
in auditing as “following the problem.”

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 3) Corrective Controls remedy control problems that have been discovered. They
include procedures taken to identify the cause of a problem, correct resulting errors or
difficulties, and modify the system so that future problems are minimized or
eliminated. Again in auditing, in addition to reporting the cause of problems, we
were required to give management the effect of the problem that answers
management’s reply: “So what?”
4) General Controls are designed to make sure an organization’s control environment is
stable and well managed. Some of the more important general controls are
a) Information Systems Management Controls
b) Security Management Controls;
c) Information Technology Infrastructure Controls; And
d) Software Acquisition, Development And Maintenance Controls
5) Application Controls prevent, detect and correct transaction errors and fraud. They
are concerned with the accuracy, completeness, validity and authorization of the data.

7.4Levels of Control

Many people feel there is a basic conflict between creativity and controls. In other words,
you can’t have both. Four levels of control to help companies to reconcile this conflict

(1) The first is a concise belief system that communicates company core values to
employees and inspires them to live by them
(2) A boundary system helps employees act ethically by setting limits beyond which
an employee must not pass
(3) To ensure the efficient and effective achievement of important goals, a diagnostic
control system measures company progress by comparing actual performance to
planned performance (budget)
(4) An interactive control system helps top-level managers with high-level activities
that demand frequent and regular attention, such a developing company strategy,
setting company objectives, understanding and assessing threats and risks,
monitoring changes in competitive conditions and emerging technologies, and
developing responses and action plans to proactively deal with these high-level
issues
Activity 1

What type of internal controls finds the problem before it occurs?

a. Detective controls
b. Preventive controls
c. General controls
d. Corrective controls
7.5Control Frameworks

Control Objectives for Information and related Technology (COBIT) Framework

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The Information Systems Audit and Control Foundation (ISACF) developed the Control
Objectives for Information and related Technology (COBIT) framework. COBIT is a
framework of generally applicable information systems security and controls practices of
Information Technology control. The framework allows

a) Management to benchmark the security and control practices of Information

Technology environments,
b) User of Information Technology services to be assured that adequate security and
control exist, and
c) Auditors to substantiate their opinions on internal control and to advise on Information
Technology security and control matters
The framework addresses the issue of control from three dimensions:

(1) Business objectives. To satisfy business objectives, information must conform to

criteria called business requirement for information. To satisfy business objectives,
information must conform to certain criteria referred to as “business requirements
for information.”
The criteria are divided into seven distinct yet overlapping categories that map into
COSO objectives:

•Effectiveness (relevant, pertinent, and timely)

•Efficiency
•Confidentiality
•Integrity
•Availability
•Compliance with legal requirements
•Reliability
(2) Information Technology resources. This includes people, application systems,
technology, facilities and data
(3) Information Technology processes: These are broken into four domains:
 Planning and organization,
 Acquisition and implementation,
 Delivery and support and
 Monitoring
The Committee of Sponsoring Organizations Internal Control Framework

The Committee of Sponsoring Organizations (COSO) is a private-sector group

consisting of the American Accounting Association, the AICPA, the Institute of
Internal Auditors, the Institute of Management Accountants and the Financial
Executives Institute. In 1992, COSO issued the Internal Control – Integrated
Framework, which defines internal controls and provides guidance for evaluating
and enhancing internal control systems

COSO’s internal control model has five crucial components,

1. Control environment

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 2. Control activities
3. Risk assessment
4. Information and communication
5. Monitoring
COSO’s Enterprise Risk Management Framework

7.6Enterprise Risk Management – Integrated Framework (ERM)

Expands on the elements of the internal control integrated framework and

provides an all-encompassing focus on the broader subject of enterprise
risk management. The purpose is to achieve all the goals of the control
framework and help the organization to:

 Provide reasonable assurance that company objectives and goals are

achieved and problems and surprises are minimized
 Achieve its financial and performance targets
 Assess risks continuously and identify the steps to take and the
resources to allocate to overcome or mitigate risk
 Avoid adverse publicity and damage to the entity’s reputation
The basic principles behind enterprise risk management are:

 Companies are formed to create value for their owners

 Company management must decide how much uncertainty it will
accept as it creates value
 Uncertainty results in risk, which is the possibility that something will
occur to affect adversely the company’s ability to create value or to
erode existing value
 Uncertainty can also results in an opportunity, which is the possibility
that something will occur to affect positively the company’s ability to
create or preserve value
 The Enterprise Risk Management – Integrated Framework (ERM)
helps management manage uncertainty, and its associated risk and
opportunity, so they can build and preserve value
The elements of the ERM are provided as follows:

Strategic objectives are high-level goals that are aligned with and support
the company’s mission

Strategic planning is designed to help managers answer critical questions

in a business. These questions include:

 What is the organization’s position in the marketplace?

 What does the organization want its position to be?
 What trends and changes are occurring in the marketplace?
 What are the best alternatives to help the organization achieve
its goals?

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 Operations objectives deal with the effectiveness and efficiency of the
company operations, such as performance and profitability goals and
safeguarding assets

Reporting objectives help ensure the accuracy, completeness and

reliability of internal and external company reports, of both a financial and
Nonfinancial nature.

Compliance objectives help the company comply with all applicable laws
and regulations.

 The eight interrelated risk and control components of COSO are described
as follows:

1. Internal environment. This is the tone or culture of a company and helps

determine how risk conscious employees are.
2. Objective setting. ERM ensures that company management puts into place a
process to formulate strategic, operations, reporting and compliance objectives
that support the company’s mission and that are consistent with the company’s
tolerance for risk.
3. Event identification. ERM requires management to identify events that may
affect the company’s ability to implement its strategy and achieve its objectives
4. Risk assessment. Identified frisks are assessed to determine how to manage them
and how they affect the company’s ability to achieve its objectives.
5. Risk response. To align identified risks with the company’s tolerance for risk,
management can choose to avoid, reduce, share, or accept the risks.
6. Control activities. To implement management’s risk responses, control policies
and procedures are established and implemented throughout the various levels and
functions in the organization.
7. Information and communication. Information about the company and the
various ERM components must be identified, captured and communicated so
employees can fulfill their responsibilities
8. Monitoring. To remain effective, ERM processes must be monitored on an
ongoing basis and modified as needed
The ERM Framework versus the Internal Control Framework

The internal control framework has been widely adopted as the principal way to
evaluate internal controls, as required by the Sarbanes-Oxley Act. However, it has
too narrow a focus.

The ERM is a more comprehensive framework which takes a risk-based, rather

than a controls-based approach to the organization that is oriented toward the
future and constant change

Activity 2

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 Which of the following objectives involves parties external to the organization?

a. Strategic objectives
b. Compliance objectives
c. Operation objectives
d. Reporting objectives

Activity 3

Which of the following is not a component Committee of Sponsoring Organizations

(COSO)?

a. Event identification
b. External environment
c. Risk identification
d. B and C
e. All of the above are components of COSO
7.7.1 The Internal Environment
The internal environment is the most important component of the ERM and internal control
frameworks. An internal environment consists of items such as the following:
1. Management’s philosophy, operating style and risk appetite
2. The board of directors
3. Commitment to integrity, ethical values and competence
4. Organizational structure
5. Methods of assigning authority and responsibility
6. Human resource standards
7. External influences
Management’s philosophy, operating style and risk appetite
Companies have a risk appetite, which is the amount of risk a company is willing to accept in
order to achieve its goals and objectives. The more responsible management’s philosophy and
operating style and the more clearly they are communicated, the more likely employees will
behave responsibly. Management’s philosophy, operating style and risk appetite can be assessed
by answering questions such as these:
 Does management take undue business risks to achieve its objectives, or does it
assess potential risks and rewards prior to acting?
 Does management attempt to manipulate such performance measures as net income
so that its performance can be seen in a more favorable light?
 Does management pressure employees to achieve results regardless of the methods,
or does it demand ethical behavior? In other words, does management believe the
ends justify the means?
The board of directors
The Sarbanes-Oxley Act requires all public companies to have an audit committee composed
entirely of outside (nonemployee), independent directors.

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The audit committee is responsible for overseeing the corporation’s internal control structure, its
financial reporting process, and its compliance with related laws, regulations and standards.
Commitment to integrity, ethical values, and competence
It is important to create an organizational culture that stresses integrity and commitment to both
ethical values and competence.
Companies endorse integrity as a basic operating principle by actively teaching and requiring it.
Management should consistently reward and encourage honesty and give verbal labels to hones
and dishonest behavior.
Management should develop clearly stated policies that explicitly describe honest and dishonest
behaviors.
Companies should require employees to report any dishonest, illegal or unethical acts and
discipline employees who knowingly fail to report violations.

Organizational structure
Important aspects of organizational structure include:
 Centralization or decentralization of authority
 Assignment of responsibility for specific tasks
 Whether there is a direct reporting relationship (i.e. functional organizational structure or
Divisional organizational structure) or more of a matrix structured. A matrix
organizational structure is a design that utilizes functional and divisional chains of
commend simultaneously in the same part of the organization. Organization charts for
the three mentioned structures are attached to this chapter six instructors’ manual.
 Organization by industry, product line geographical location, or by a particular
distribution or marketing network
 The way responsibility allocation affects management’s information requirements
 The organization of the accounting and information system functions
 The size and the nature of company activities
Methods of assigning authority and responsibility
Authority and responsibility are assigned through formal job descriptions; employee training;
operating plans, schedules, and budgets; a formal company code of conduct; and a written policy
and procedures manual.
Human resource standards
The following policies and procedures are important:
(1) Hiring. To obtain the most qualified and ethical employees, hiring should be based on
educational background, relevant work experience, past achievements, honesty and
integrity, and how well potential employees meet written job requirements
A thorough background check includes verifying educational and work experience,
talking to references, checking for a criminal record, and checking credit records.
(2) Compensating. It is important to pay employees a fair and competitive wage. Poorly paid
employees are likely to feel resentment and make up the difference in their wages by
stealing money or property, or both.
(3) Training. Training programs should familiarize new employees with their responsibilities;
expected levels of performance and behavior; and the company’s policies and procedures,

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 history, culture and operating style. Training on fraud and ethics such as;
 Fraud awareness
 Ethical considerations
 Punishment for fraud and unethical behavior
(4) Evaluating and Promoting. Employees should be given periodic performance appraisals
that help them understand their strengths and weaknesses. Promotion should be based on
performance and how well qualified employees are for the net position.
(5) Discharging. A company should take care when firing employees. To prevent sabotage or
copying confidential data before they leave, dismissed employees should be removed from
sensitive jobs immediately and denied access to the information system.
(6) Managing Disgruntled Employees. Some employees who commit fraud are seeking
revenge for a perceived wrong done to them. Hence, companies should have procedures for
identifying disgruntled employees and either helping them resolve their feelings or
removing them from jobs where they might be able to harm the organization or perpetrate a
fraud.
(7) Vacations and rotation of duties. Many fraud schemes such as lapping and kiting require
the ongoing attention of the perpetrator. Many of these employee frauds are discovered
when the perpetrator is suddenly forced, by illness or accident, to take time off.

On audits, employees that did not take vacation were considered to be a potential fraud
indicator. Also, we conducted an audit investigation of a bartender whom was refilling
the liquor bottles in the storage room with some water to cover his pilferage of funds. So,
we recommended that all the bartenders for the clubs be rotated. This bartender was the
only one to complain and later quite his job on base at the club. This resolved the
problem of lost funds.

(8) Confidentiality Agreements and Fidelity Bond Insurance. All employees,

suppliers, and contractors should be required to sign and abide by a nondisclosure or
confidentiality agreement. Fidelity bond insurance coverage of key employees
protects companies against losses arising from deliberate acts of fraud by bonded
employees.
(9) Prosecute and Incarcerate Hackers and Fraud Perpetrators.
Most fraud cases and hacker attacks go unreported and are not prosecuted for several
reasons:

a) Companies are reluctant to report computer crimes and intrusions – a recent

study showed only 36% reporting intrusions – because a highly visible fraud
is a public relations disaster.
b) Law enforcement officials and the courts are so busy with violent crimes that
they have little time for computer crimes in which no physical harm occurs.
c) Fraud is difficult, costly and time-consuming to investigate and prosecute
d) Many law enforcement officials, lawyers and judges lack the computer skills
needed to investigate, prosecute and evaluate computer crimes.
e) When fraud cases are prosecuted and a conviction is obtained, the sentences
received are often light.

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 7.7.2 External influences
 Financial Accounting Standards Board (FASB)
 Public Company Accounting Oversight Board (PCAOB)
 Security and Exchange Commission (SEC)

Activity 4

What is the most important component of the ERM?

a. Internal environment
b. Risk assessment
c. Control activities
d. Information and communication
Activity 5

Which of the following statements is false?

a. An internal environment consists of an organizational structure.

b. Control activities is a component of COSO ERM.
c. The Sarbanes-Oxley Act requires all public companies to have an audit
committee.
d. Companies endorse integrity as a basic operating principle by actively
teaching and reporting it.

7.7.3 Objective Setting

Objective setting is the second ERM component because it must precede the other six
components.

Top management, with board approval, needs to articulate why the company exists and
what it hopes to achieve.

This is often referred to as the corporate vision or mission.

The company uses its mission statement as a base from which it sets and
prioritizes corporate objectives.

Strategic objectives, which are high-level goals that support the company’s mission and
are intended to create shareholder value, must be set first.

Operations objectives, which are a product of management preferences, judgments, and

style, may vary significantly amount entities. Operation objectives deal with the

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 effectiveness and efficiency of company operations, such as performance and
profitability goals and safeguard assets.

Compliance objectives help the company comply with all applicable laws and
regulations.

Reporting objectives help ensure the accuracy, completeness and reliability of internal
and external company reports, of both a financial and non-financial nature. They also
improve decision making and monitor company activities and performance more
efficiently.

Activity 6

What corporate objective is based on a company’s mission statement?

a. Strategic objectives
b. Operations objectives
c. Compliance objectives
d. Reporting objectives
7.7.4 Event Identification

COSO defines an event as an incident or occurrence emanating from internal or external

sources that affects implementation of strategy or achievement of objectives.

A few of the events, or threats, that the company will face are:

1. Choosing an inappropriate technology

2. Unauthorized system access
3. Tapping into data transmission
4. Loss of data integrity
5. Incomplete transactions
6. System failures
7. Incompatible systems

Some of the more common techniques companies use to identify events follow. One, two
or more of these techniques are used together.

 Use comprehensive lists of potential events

 Perform an internal analysis
 Monitor leading events and trigger points
 Conduct workshops and interviews
 Perform data mining and analysis
 Analyze business processes
Activity 7

The third ERM component is

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 a. Objective setting
b. Risk assessment
c. Information and Communication
d. Event identification

7.7.5 Risk Assessment and Risk Response

The fourth and fifth components of COSO’s ERM mode are risk assessment and risk
response. The risks that exists before management takes any steps to control the
likelihood or impact of a risk is inherent risk. The risk that remains after management
implements internal controls, or some other response to risk, is residual risk.

The ERM model indicates that there are four ways to respond to risk:

1. Reduce. The most effective way to reduce the likelihood and impact of
risk is to implement an effective system of internal controls
2. Accept. Accepts the likelihood and impact of the risk by not acting to
prevent or mitigate it
3. Share. Share some of the risk or transfer it to someone else. For example,
buy insurance, outsource an activity, or enter into hedging transactions.

Auditing definition of hedges: hedges protect an entity against the risk of

adverse price or interest-rate movements on its assets, liabilities, or
anticipated transactions. A hedge avoids or reduces risk by
counterbalancing losses with gains on separate positions.

Hedge, in securities, is a transaction that reduces the risk of an investment.

Hedge fund is a special type of investment fund with fewer restrictions on

the types of investments it can make. Of note is a hedge fund’s ability to
sell short. In exchange for the ability to use more aggressive strategies,
hedge funds are more exclusive, i.e., fewer people, usually only the
wealthy, are allowed to invest in hedge funds.

There are three main types of hedges; fair value hedges, cash flow hedges
and foreign currency hedges; which are beyond the scope of this class.

4. Avoid. Risk is avoided by not engaging in the activity that produces the
risk. This may require the company to sell a division, exit a product line,
or not expand as anticipated.
Accountants can assess and reduce inherent risk using the risk assessment and
response strategy.

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 Estimate Likelihood and Impact

Some events pose a greater risk because the probability of their occurrence is
more likely. For example, a company is more likely to be the victim of a fraud
than of an earthquake, and employees are more likely to make unintentional errors
than they are to commit fraud

Identify Controls

Management must identify one or more controls that will protect the company
from each event.

Estimate Costs and Benefits

No internal control system can provide foolproof protection against all events, as
the cost would be prohibitive. In addition, because many controls negatively
affect operational efficiency, too many controls slow the system and make it
inefficient. The benefits of an internal control procedure must exceed its costs.
Benefits can be hard to quantify, but include:

• Increased sales and productivity

• Reduced losses
• Better integration with customers and suppliers
• Increased customer loyalty
• Competitive advantages
• Lower insurance premiums
Costs are usually easier to measure than benefits. Primary cost is personnel,
including:

• Time to perform control procedures

• Costs of hiring additional employees to effectively segregate duties
• Costs of programming controls into a system
Other costs of a poor control system include:

• Lost sales
• Lower productivity
• Drop in stock price if security problems arise
• Shareholder or regulator lawsuits
• Fines and penalties imposed by governmental agencies
One way to estimate the value of internal controls involves expected loss, the
mathematical product of impact and likelihood:

Expected loss = Impact x Likelihood

Determine Cost/Benefit Effectiveness

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 Implement Control or Avoid, Share, or Accept the Risk

When controls are cost-effective, they should be implemented so that risk can be
reduced.

Risks that are not reduced must be accepted, shared, or voided

Activity 9

The cost of conducting and compiling the end of the month inventory is $20,000 and the
risk of an inventory error is 12% without a validation procedure and 2% with the
validation procedures. The expected to retake and compile the inventory without a
validation procedure is $1,200 and with the validation procedure is only $300. The cost
of the validation procedure is $650. What is the net expected benefit of validation
procedure?

a. $250
b. $350
c. $450
d. $600

7.7.6 Control Activities

The sixth component of COSO’s ERM model is control activities, which are policies,
procedures, and rules that provide reasonable assurance that management’s control
objectives are met and the risk responses are carried out. Generally, control procedures
fall into one of the following categories:

1. Proper authorization of transactions and activities

Management establishes policies for employees to follow and then empowers

employees to perform accordingly. This empowerment called authorization,
is an important part of an organization’s control procedures.

Authorizations are often documented by signing, initializing, or entering an

authorization code on a transaction document or record. Computer systems are
now capable of recording a digital signature, a means of signing a document
with a piece of data that cannot be forged.

Employees who process transactions should verify the presence of the

appropriate authorization(s).

Certain activities or transactions may be of such consequence that

management grants specific authorization for them to occur.

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 For example, management review and approval are often required for
sales in excess of $20,000, capital expenditures in excess of $10,000, or
uncollectible write-off in excess of $5,000.

In contrast, management can authorize employees to handle routine transactions

without special approval, a procedure knows as general authorization.

2. Segregation(separation) of duties
 Authorization – approving transactions and decisions
 Recording – preparing source documents; entering data into online
systems; maintaining journals, ledgers, files or databases; preparing
reconciliations; and preparing performance reports
 Custody – handling cash, tools, inventory, or fixed assets; receiving
incoming customer checks; writing checks on the organization’s bank
account.
If two of these three functions are the responsibility of a single person,
then problems can arise. Collusion is when two or more people are
working together to override the preventive aspect of the internal control
system

Segregation of Systems Duties:

a. Systems administration. Systems administrators are responsible for

ensuring that the different parts of an information system operate
smoothly and efficiently
b. Network management. Network managers ensure that all applicable
devices are linked to the organization’s internal and external networks
and that the networks operate continuously and properly
c. Security management. Security management ensures that all aspects
of the system are secure and protected from all internal and external
threats
d. Change management. These individuals manage all changes to an
organization’s information system to ensure they are made smoothly
and efficiently and to prevent errors and fraud
e. Users. Users record transactions, authorize data to be processed, and
use system output
f. Systems analysis. Systems analysts help users determine their
information needs and then design an information system to meet
those needs
g. Programming. Programmers take the design provided by systems
analysts and create an information system by writing the computer
programs
h. Computer operations. Computer operators run the software on the
company’s computers. They ensure that data are input properly and
correctly processed and needed output is produced

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 i. Information system library. The information system librarian
maintains custody of corporate databases, files and programs in a
separate storage area called the information system library
j. Data control. The data control group ensures that source data have
been properly approved, monitors the flow of work through the
computer, reconciles input and output, maintains a record of input
errors to ensure their correction and resubmission, and distributes
systems output
7.8 Project development and acquisition controls
1. Strategic master plan. To align an organization’s information system with
its business strategies, a multiyear strategic master plan is developed and
updated yearly
2. Project controls. A project development plan shows how a project will
be completed, including the modules or tasks to be performed and who will
perform them, the dates they should be completed, and project costs.
Project milestones – significant points when progress is reviewed
and actual and estimated completion times are compared.

A performance evaluation of project team members should be

prepared as each project is completed.

3. Data processing schedule. To maximize the use of scarce computer

resources, all data processing tasks should be organized according to a
data processing schedule.
4. Steering committee. A steering committee should be formed to guide and
oversee systems development and acquisition
5. System performance measurements. For a system to be evaluated
properly, it must be assessed using system performance measurements.
Common measurements include throughput (output per unit of
time), utilization (percentage of time the system is being
productively used) and response time (how long it takes the
system to respond).

6. Post-implementation review. After a development project is completed, a

post-implementation review should be performed to determine if the
anticipated benefits were achieved.
To simplify and improve systems development, some companies hire a
systems integrator, a vendor who uses common standards and manages a
cooperative systems development effort involving its own development
personnel and those of the client and other vendors. Companies that use
systems integrators should:

 Develop clear specifications

 Monitor the systems integration project

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 7.9 Change management controls

Change management is the process of making sure changes do not negatively

affect systems reliability, security, confidentiality, integrity and availability.

Design and use of documents and records

The proper design and use of electronic and paper documents and records help ensure the
accurate and complete recording of all relevant transaction data.

Safeguarding assets, records and data

In addition to safeguarding cash and physical assets such as inventory and equipment, a
company needs to protect its information. Many people mistakenly believe that the
greatest risks companies face are from outsides. Companies also face significant risks
from customers and vendors that have access to company data. Some of the computer-
based controls that can be put into place to safeguard assets include:

 Create and enforce appropriate policies and procedures

 Maintain accurate records of all assets
 Restrict access to assets
 Protect records and documents
Independent checks on performance

 Top level reviews. Management at all levels should monitor company results
and periodically compare actual company performance to (a) planned
performance, as shown in budgets, targets and forecasts; (b) prior period
performance; and (c) the performance of competitors
 Analytical reviews. An analytical review is an examination of the
relationship between different sets of data
 Reconciliation of two independently maintained sets of records
 Comparison of actual quantities with recorded amounts
 Double-entry accounting: debits must equal credits
 Independent review. After one person processes a transaction, a second
person sometimes reviews the work of the first.

Activity 10

Which of the following does not violate separation of duties?

a. Approving purchase orders and receiving items ordered

b. Approving payment to vendors and completing the monthly bank
reconciliation
c. Receiving checks in the mail and maintaining the cash receipts journal
d. Writing checks and receiving checks in the mail.

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Information and Communication

Accounting Information Systems has five primary objectives:

1) Identify and record all valid transactions

2) Properly classify transactions
3) Record transactions at their proper monetary value
4) Record transactions in the proper accounting period
5) Properly present transactions and related disclosures in the financial
statements
7.10 Monitoring

Perform ERM Evaluations

Implement Effective Supervision

Use Responsibility Accounting

Monitor System Activities

There are software packages available to review computer and network security
measures, detect illegal entry into systems, test for weaknesses and
vulnerabilities, report weaknesses found, and suggest improvements. Software is
also available to monitor and combat viruses, spyware, spam and pop-up ads and
to prevent browsers from being hijacked. All system transactions and activities
should be recorded in a log that indicates who accessed what data, when and from
which online device.

The Privacy Foundation estimated that one-third of all American workers with
access to computers are monitored, and that number is expected to increase.

CNN News (March 19, 2001), estimated that Seventy-five percent of all
companies in the United States currently monitor their employee’s computers.
And now it has spread to the home.

In monitoring employees computers at work or at home, companies must be

careful to ensure that they don’t violate the employee’s privacy.

To help, one way would be to have written policies that employees agree
to in writing which indicate:

 The technology employees use on the job belongs to the company

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 It was learned that if a government employee uses a
government computer at work, during workings hours to
compile a computer program; that program does not belong to
the individual employee; it’s government property.

 E-mails received on company computers are not private and can be

read by supervisory personnel
 Employees should not use technology in any way to contribute to a
hostile work environment
Perhaps some of you have also seen this happen; many government
activities/offices have taken the computer games off their computers.

Track Purchased Software

The Business Software Alliance (BSA) is very aggressive in tracking down and
finding companies who violate software license agreements. Companies should
periodically conduct software audits

Conduct Periodic Audits

One way to monitor risk and detect fraud and errors is to conduct periodic
external and internal audits, as well as special network security audits. Internal
audits involve reviewing the reliability and integrity of financial and operating
information and providing an appraisal of internal control effectiveness. Internal
audits can detect excess overtime, underused assets, obsolete inventory, padded
travel expense reimbursements, excessively loose budgets and quotas, poorly
justified capital expenditures and production bottlenecks.

Employ a Computer Security Officer and Computer Consultants

A computer security officer (CSO) is in charge of AIS security and should be

independent of the information system function and report to the COO or CEO. The
overwhelming number of new tasks related to SOX and other forms of compliance has
led many larger companies to delegate all compliance issues to a chief compliance
officer (CCO).

Engage Forensic Specialists

Forensic accountants specialize in fraud detection and investigation. Forensic

accounting is now one of the fastest-growing areas of accounting due to the
Sarbanes-Oxley law, new accounting rules such as SAS No. 99, and boards of
directors demanding that forensic accounting be an ongoing of the financial
reporting and corporate governance process. Most forensic accountants are CPAs,
and many have received specialized training with the FBI, the IRS, or other law

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 enforcement agencies. Computer forensics is discovering, extracting,
safeguarding and documenting computer evidence such that its authenticity,
accuracy and integrity will not succumb to legal challenges.

Install Fraud Detection Software

People who commit fraud tend to follow certain patterns and leave behind clues,
such as things that do not make sense. Software has been developed to uncover
these fraud symptoms. ReliaStar Financial used a fraud detection package from
IBM to detect the following:

 Hundreds of thousands of dollars in fraudulent claims from a Los Angeles

chiropractor. The software noticed that all of the chiropractor’s patients
lived more than 50 miles from the doctor’s office and flagged the bills for
investigation.
 A Long Island doctor who submitted bills weekly for a rare and expensive
procedure that is normally done once or twice in a lifetime
 A podiatrist who saw four patients and the billed ReliaStar for almost 500
separate procedures
Other companies have neural networks (programs that mimic the brain and have
learning capabilities), which are quite accurate in identifying suspected fraud.

Implement a Fraud Hot Line

The Sarbanes-Oxley Act mandates that companies set up mechanisms for

employees to report abuses such as fraud.

Fraud hotlines provide a means for employees can anonymously report fraud.

Self Check Test

1. What are the three functions of internal controls?

2. What are the two categories of internal controls?
3. What is the difference between general and specific authorization?
4. What was the primary objective of the Foreign Corrupt Practices Act?
5. What is COSO?
6. What are the major components of control as defined in the COSO
internal control model report?
7. What is a weakness of the internal control concept of the separation of
duties?
8. Classify the following controls as preventive, detective, or corrective:
Periodic bank reconciliation. Separation of cash and accounting records.
Maintaining backup copies of master and transaction files. Pre-
numbering of sales invoices. Chart of accounts. Retinas scan before

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 entering a sensitive R & D facility. Resubmission of transactions for
subsequent processing. Internal auditor rechecking the debits and credits
on the payment voucher. Depositing all cash receipts intact. Qualified
accounting personnel
Answer to Activity Questions:

Activity Question Answers

Number Answer Number Answer

1 B 6 D

2 C 7 A

3 B 8 D

4 D 9 A

5 A 10 D

Answer to Self Check Test:

1. Preventive, detective, and corrective

2. General and application
3. Authorizations are often documented by signing, initializing, or entering an authorization
code on a transaction document or record. Management may deem that certain
transactions are of a routine nature and as such may authorize employees to handle such
transactions without special approval. This is known as general authorization. Other
transactions may be of such consequence that management grants specific authorization
for them to occur. Usually management must approve of such transactions and oversee
them to completion, requiring an additional signature required on checks exceeding a
given dollar amount. Management should have written policies on both specific and
general authorization for all type of transactions.
4. The primary objective of the Foreign Corrupt Practices Act is to prevent the bribery of
foreign officials by American companies.
5. The COSO defines internal control as a process implemented by management, the board
of directors, and those under their direction to provide reasonable assurance that control
objectives are achieved regarding effectiveness and efficiency of operations, reliability of
financial reporting, and compliance with applicable laws and regulations.
6. The major components of control are: the control environment; control activities; risk
assessment; information and communication; monitoring of performance.
7. When a system effectively incorporates a separation of duties, it should be difficult for
any one employee to defeat the system and commit embezzlement. The problem with the
separation of duties comes when two or more employees agree to defeat the system for
their own dishonest ends. This problem is known as collusion. When two or more
employees act together to defeat the internal controls of the system, they may likely
succeed in their endeavor for a time. It is more difficult to detect such activity because
the employees may have planned to "cover their tracks." This is why independent review
of transaction activity by third parties is important to monitor that internal controls are in

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 place and working as designed.
8. Detective. Preventive. Corrective. Preventive. Preventive. Preventive. Corrective.
Detective. Preventive. Preventive

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