Accounting Information Technology and Business Solutions 2 nd

Accounting, Information Technology, and Business Solutions, 2 nd Edition By Hollander, Denna, Cherrington The Traditional Accounting Information System Chapter 3 Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Objectives Describe the nature of the traditional accounting cycle and its relationship to business events Describe the impact of IT on the traditional accounting system Describe the limitations of the traditional accounting system architecture Describe how the traditional accounting system architecture limits accounting’s ability to enhance value Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Pacioli: The Father of Traditional Accounting n n n Pacioli was not really the inventor, but was “the first accountant to combine his knowledge with the technology that enabled authors to print books using a movable type and a printing press to instruct the world on the subject in print”. Pacioli documented the double entry, chart of account classification scheme used to record and store accounting data. To keep the accounts in balance, Pacioli proposed a rigorous process for recording, maintaining, and reporting accounting data. Pacioli suggested the use of three books: ä ä ä the memorandum book, The memorandum book should include notations the journal and The journal of every large small, in whatever was transaction, the source for theand ledger, where the currency was beingwas used and in as much detail as the ledger. It was double bookkeeping done. in theentry ledger that the businessman could learn before time and circumstance allowed. anyone else whether he was a success or a failure Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Rules for Accounting n Chart of Accounts See Exhibit 3 -1 ä ä classify and summarize financial measurements nominal accounts vs real accounts n One compendium of sample charts of accounts and accounting procedures for different industries is The Encyclopedia of Accounting Systems n Charles Sprague “Any occurrence [accounting transaction] n must be either an increase or a decrease of values, and there are three classes of values [assets, liabilities, and equity]. . . in every transaction at least two of the occurrences must appear. . . on opposite sides of the above list. ” Assets = Liabilities + Owner’s Equity Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Exhibit 2 -1 Sample Chart of Accounts Account Title n Current Assets ä ä ä n 110 130 140 160 180 190 200 Land 210 Building 220 Accumulate Depreciation Building 230 Equipment 240 Accumulated Deprec. Equipment 250 Current Liabilities: ä n Cash Accounts Receivable Allowance for Doubtful Accounts Inventory Prepaid Insurance Notes Receivable Account Title ä ä ä n Accounts Payable Long-Term Debt: ä Bonds Payable Irwin/Mc. Graw-Hill ä ä ä ä 410 520 550 590 Revenue Interest Revenue Rent Revenue 610 620 630 Expenses: ä 310 Common Stock Capital in Excess Retained Earnings Revenue and Expense Summary Revenue: ä n Account Stockholder’s Equity: ä Property, Plant, and Equipment: ä n Account ä Purchases Freight on Purchases Purchase Returns Selling Expenses General and Admin. Expenses Interest Expense Extraordinary Loss (pretax) 710 720 730 740 750 760 770 Ó The Mc. Graw-Hill Companies, Inc. , 2000

Exhibit 3 -2: Steps in the Accounting Cycle and Their Objectives During the accounting period Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Exhibit 3 -2: Steps in the Accounting Cycle and Their Objectives At the end of the accounting period Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Exhibit 3 -2: Steps in the Accounting Cycle and Their Objectives At the beginning of the next accounting period Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Nonfinancial systems Business event Information customers Financial statements and notes Audit statements and notes Accounting Cycle Process Record transaction data Analyze business event data Ignore event data Journals Financial statement notes Irwin/Mc. Graw-Hill Post journal data to the ledger Ledgers Prepare and adjust the trial balance Prepare statements and notes Trial balance Financial statements and notes Correct and adjust Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step : Identify Accounting Transactions to be Recorded n The purposes of this first step are to identify the business events that can be considered accounting transactions and to collect relevant economic data about those transactions. Accounting transactions are the business events that cause a change in the organization’s assets, liabilities, or owner’s equity. These events include ä ä ä n Exchanges of resources and obligations between the reporting firm and outside parties (reciprocal transfers or non-reciprocal transfers) Internal Events within the firm that affect its resources or obligations but that do not involve outside parties Economic and environmental events beyond the control of the company (changes in values) Accounting transactions are typically accompanied by a source document prepared by someone other than the accountant Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 2 - Journalize Accounting Transaction Data n n n Measure and record the economic impact of transactions Transactions are recorded in a journal - Debit, Credit, date, account number, amounts , and descriptions General journal and Special Journals Historical Cost Principle Posting References and page numbers Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 3: Post Journal Data to Ledgers n n n The process of transferring transaction data from the journals to the ledger accounts is called posting General Ledger and Subsidiary Ledgers Totals of Special Journal Columns are posted An audit trail should provide the capability to trace an individual transaction from its initial recording all the way through the accounting process to the final figures in the financial statements Reconciliation is the process of summing the subsidiary ledgers and comparing the total with the balance in the general ledger control account Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 4: Prepare Unadjusted Trial Balance n n n The unadjusted trial balance is a list of general ledger accounts and their account balances Convenient method of determining that the sum of the Debit account balances equals the sum of the Credit account balances If the trail balance does not balance the source of the error must be investigated Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Exhibit 3 -5 Unadjusted Trail Balance Illustrated Click to Open Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 5: Journalize and Post Adjusting Entries n Adjusting entries are required when their is no source document to trigger a transaction ä ä ä ä Passage of time ( interest or depreciation) Correct Errors Record Changes in Estimates Recording Deferrals Recording Accruals Reclassifying balances Recognizing inventory losses Irwin/Mc. Graw-Hill Source documents from earlier transactions are the primary information sources for adjusting entries. Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 6: Prepare Adjusted Trial Balance n n n The adjusted trial balance lists all the account balances that will appear in the financial statements (with the exception of retained earnings, which does not yet reflect the current year’s net income and dividends). The purpose of the adjusted trial balance is to confirm debit-credit equality, taking all Adjusting journal entries into consideration. Confirm Debit Credit Balance Source for preparation of the Financial Statements Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 7 Prepare Financial Statements n n n The primary objective of financial accounting is to provide information that is useful to decision-makers. Financial statements can be produced for a period of any duration. However, monthly, quarterly, and annual statements are the most common. The income statement, retained earnings statement, and balance sheet are prepared directly from the adjusted trial balance. The temporary account balances are transferred to the income statement, and the permanent account balances are transferred to the balance sheet. FS Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 8 Journalize and Post Closing Entries n n Closing entries reduce the temporary accounts (e. g. , revenues, expenses, and dividends) to a zero (closed) balance. Closing entries are recorded in the general journal at the end of the accounting period and are posted to the appropriate ledger accounts. Permanent accounts are not closed because they carry asset, liability, and owner's equity balances to the next accounting period. The retained earnings account is the only permanent account involved in the closing process. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 9 Prepare Post-Closing Trial Balance n n A post-closing trial balance lists only the balances of the permanent accounts after the closing process is finished. (The temporary accounts have zero balances. ) This step is taken to check for debit-credit equality after the closing entries are posted. Firms with a large number of accounts find this a valuable procedure because the chance of error increases with the number of accounts and postings. The retained earnings account is now stated at the ending balance and is the only permanent account with a balance different from the one shown in the adjusted trial balance. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Step 10 Journalize and Post Reversing Entries n n n At the beginning of the next period, the accountant may prepare and post reversing entries to compensate for the difference in timing between the occurrence of an actual economic reality, and the recording of the economic event in the accounting system. Reversing entries use the same accounts and amounts as adjusting entries but with the debits and credits reversed. These entries reverse adjusting entries made at the end of one period and prepare the accounting records for normal processing of business events in the new period. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Applying Information Technology to the Accounting Cycle n Human information processing challenges ä ä ä n Reasons why IT is not used: ä ä n n Human Error Human inefficiency Paper based communication is costly technology does not exist technology is not cost effective Using IT to replicate a manual system is not efficient The accounting architecture needs to be changed Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Criticisms Of The Traditional Accounting System Architecture n n n One criticism of the traditional architectures is a lack of integration across functional areas of the organization. Example: an international computer manufacturer that maintains a separate chart of accounts and ledgers for its manufacturing and marketing divisions Example: because they have different criteria for Two business events • Shipping to customer reporting financial information. 8 Journal entries Manufacturing recognizes revenue • Billing customer when a product is shipped to a customer 8 Journal Entries • Adjusting for Revenue Marketing recognizes revenue when the Recognition customer is billed for the product. 8 Journal Entries The entire accounting process is automated. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Criticisms of the Traditional Accounting System Architecture n n Activities are performed to provide service to the customer Many systems exist to record and report on activities Different managers want different views of the data to make decisions in their area of influence Too many systems Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Multiple Views of the Same Business Event Marketing people wants to Investors and creditors want know about the order to Executive management to know about all orders to evaluate pricing, plan SALE wants to know about the assess the profitability of their advertising campaigns, and order to evaluate its investments and the likelihood target selling efforts. impact on the organization Personnel viewof a return on their investment Production view Personnel people want to know about the order to pay sales commissions. Marketing view Irwin/Mc. Graw-Hill Investors and creditors view (GAAP) Production people want to know about the order to plan production processes Executive view Ó The Mc. Graw-Hill Companies, Inc. , 2000

The Proliferation of Accounting Subsystems Business Event System A System B System C System D Edit Audit Calculate Summarize Stored Data Functional Views Irwin/Mc. Graw-Hill Functional Views Ó The Mc. Graw-Hill Companies, Inc. , 2000

Criticisms of Traditional Accounting Systems and Processes n n n There is a proliferation of often conflicting, nonintegrated systems and subsystems within a single organization. The architecture captures data about a subset of an organization's business events (the accounting transactions). Data are not recorded and processed in real-time The architecture stores and processes only a limited number of characteristics about accounting transactions. The architecture captures and stores duplicate data in a highly summarized form The architecture stores financial data to satisfy one primary view (perspective). Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Architecture of Traditional Accounting Irwin/Mc. Graw-Hill • Based primarily on financial reporting: – Income Statement & Balance Sheet • Build new/alternative systems for alternative views of business data. • Confine recorded information to “accounting transactions. ” • Store and summarize information in ledgers. Ó The Mc. Graw-Hill Companies, Inc. , 2000

Accounting Data: A Subset of Business Data (Limited view & limited data) Data that describes Business Activities Irwin/Mc. Graw-Hill Acct. Data Accountants filter data General Ledger Limited Output Views / Formats Ó The Mc. Graw-Hill Companies, Inc. , 2000

The Heart of the Problem with Traditional Systems Input: Narrow set of transactions Process: Classifies and summarizes transaction data Output: Produces narrow functional views Narrow functional views drive the selection of transactions, classification, and summarization Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Are These Criticisms Valid? n n n The criticisms we have presented simply highlight the difficulties of adapting the traditional accounting system architecture to a rapidly changing world. Today's business world is fast paced, more information intensive, and involves complex business transactions beyond Pacioli's wildest dreams Today’s information customers are very demanding. They desire a larger variety of faster, customized information products delivered in a variety of modes. For example, many people now want their information system to produce a much broader array of information products such as balanced scorecards. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Ways That Accounting Can Enhance Its Value to the Organization Helping Management Define Providing More Useful Helping to Embed Real-Time Business Process Rules - To help Information Traditional Information Processes into management define business process accounting measures are expressed Business Processes - Accountants rules presupposes involvement in an almost exclusively in monetary should providebusiness meaningful, direct input organization’s processes. terms: a practice that precludes We into thedevelop design, an development, and that should AIS architecture information on productivity, implementation of real-time enables accountants to exercise performance, reliability and other information processes that execute influence over the development andbe multidimensional data that cannot business rules and gather business data. implementation of business processes easily expressed in monetary terms. rules throughout the business process. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Role of the Office of the CFO (Chief Financial Officer) n n Insightful contributions into the strategy and planning process Measures that focus and motivate the We think objectives such as organization these provide justification for Informationchanging and analysis that provides the architecture of any that created limits insight intoinformation how valuesystem is being the potential of information and how progress is being matched to providers in adding value to an strategic initiatives. organization. Leadership of major financial initiatives. Irwin/Mc. Graw-Hill Ó The Mc. Graw-Hill Companies, Inc. , 2000

Event-Driven IT Application Overview Enterprise-wide Information Customers Business Event Data Business Event Processor (business and information processing rules) Irwin/Mc. Graw-Hill Business Data Repository Reporting Facility (Information processing rules) Useful Information Ó The Mc. Graw-Hill Companies, Inc. , 2000

Characteristics of Future Architecture Irwin/Mc. Graw-Hill • Based on business events (business activities) rather than information customer views. • Supports business process simplification and change. • Integrates all business data. • Integrates information processes and real-time controls. Ó The Mc. Graw-Hill Companies, Inc. , 2000