The Traditional Accounting Information System

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The Traditional Accounting Information System

• Chapter 3

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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 accountings ability to
enhance value
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Pacioli The Father of Traditional Accounting

• 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
• the memorandum book,
• the journal and
• the ledger.

The memorandum book should include notations of
every transaction, large and small, in whatever
currency was being used and in as much detail as
time and circumstance allowed.
The journal was the source for the ledger, where
the double entry bookkeeping was done.
It was in the ledger that the businessman could
learn before anyone else whether he was a success
or a failure
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Rules for Accounting

• Chart of Accounts See Exhibit 3-1
• classify and summarize financial measurements
• nominal accounts vs real accounts
• One compendium of sample charts of accounts and
  accounting procedures for different industries is
  The Encyclopedia of Accounting Systems
• Charles Sprague Any occurrence accounting
  transaction 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 Owners Equity

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Exhibit 2-1 Sample Chart of Accounts
Account Title
Account
Account Title
Account

• Current Assets
• Cash 110
• Accounts Receivable 130
• Allowance for Doubtful Accounts 140
• Inventory 160
• Prepaid Insurance 180
• Notes Receivable 190
• Property, Plant, and Equipment 200
• Land 210
• Building 220
• Accumulate Depreciation Building 230
• Equipment 240
• Accumulated Deprec. Equipment 250
• Current Liabilities
• Accounts Payable 310
• Long-Term Debt
• Bonds Payable 410

• Stockholders Equity
• Common Stock 510
• Capital in Excess 520
• Retained Earnings 550
• Revenue and Expense Summary 590
• Revenue
• Revenue 610
• Interest Revenue 620
• Rent Revenue 630
• Expenses
• Purchases 710
• Freight on Purchases 720
• Purchase Returns 730
• Selling Expenses 740
• General and Admin. Expenses 750
• Interest Expense 760
• Extraordinary Loss (pretax) 770

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Exhibit 3-2 Steps in the Accounting Cycle and
Their Objectives
During the accounting period
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Exhibit 3-2 Steps in the Accounting Cycle and
Their Objectives
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Exhibit 3-2 Steps in the Accounting Cycle and
Their Objectives
At the beginning of the next accounting period
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Irwin/McGraw-Hill
Ó The McGraw-Hill Companies, Inc., 2000
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Step Identify Accounting Transactions to be
Recorded

• 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 organizations assets,
  liabilities, or owners equity. These events
  include
• 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

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Step 2 - Journalize Accounting Transaction Data

• 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

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Step 3 Post Journal Data to Ledgers

• 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

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Step 4 Prepare Unadjusted Trial Balance

• 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 beinvestigated

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Exhibit 3-5 Unadjusted Trail Balance Illustrated
Click to Open
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Step 5 Journalize and Post Adjusting Entries

• Adjusting entries are required when their is no
  source document to trigger a transaction
• Passage of time ( interest or depreciation)
• Correct Errors
• Record Changes in Estimates
• Recording Deferrals
• Recording Accruals
• Reclassifying balances
• Recognizing inventory losses

Source documents from earlier transactions are
the primary information sources for adjusting
entries.
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Step 6 Prepare Adjusted Trial Balance

• 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
  years 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

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Step 7 Prepare Financial Statements

• 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
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Step 8 Journalize and Post Closing Entries

• 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.

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Step 9 Prepare Post-Closing Trial Balance

• 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.

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Step 10 Journalize and Post Reversing Entries

• 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.

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Applying Information Technology to the Accounting
Cycle

• Human information processing challenges
• Human Error
• Human inefficiency
• Paper based communication is costly
• Reasons why IT is not used
• 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

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Criticisms Of The Traditional Accounting System
Architecture

• 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 because they have different criteria
  for reporting financial information.
• Manufacturing recognizes revenue when a product
  is shipped to a customer
• Marketing recognizes revenue when the customer
  is billed for the product.
• The entire accounting process is automated.

• Example
• Two business events
• Shipping to customer 8 Journal entries
• Billing customer 8 Journal Entries
• Adjusting for Revenue Recognition 8 Journal
  Entries

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Criticisms of the Traditional Accounting System
Architecture

• 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

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Multiple Views of the Same Business Event
Marketing people wants to know about the order to
evaluate pricing, plan advertising campaigns, and
target selling efforts.
Executive management wants to know about the
order to evaluate its impact on the organization
Investors and creditors want to know about all
orders to assess the profitability of their
investments and the likelihood of a return on
their investment
SALE
Personnel view
Production view
Personnel people want to know about the order to
pay sales commissions.
Production people want to know about the order to
plan production processes
Marketing view
Executive view
Investors and creditors view (GAAP)
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The Proliferation of Accounting Subsystems
Business Event
System D Edit Audit Calculate Summarize Stored D
ata
System C Edit Audit Calculate Summarize Stored D
ata
System B Edit Audit Calculate Summarize Stored D
ata
System A Edit Audit Calculate Summarize Stored D
ata
Functional Views
Functional Views
Functional Views
Functional Views
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Criticisms of Traditional Accounting Systems and
Processes

• 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).

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• 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.

Architecture of Traditional Accounting
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Accounting Data A Subset of Business Data
(Limited view limited data)
Data that describes Business Activities
Acct. Data
Business Activities
Accountants filter data
General Ledger
Limited Output Views / Formats
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The Heart of the Problem with Traditional Systems
Process Classifies and summarizes transaction
data
Output Produces narrow functional views
Input Narrow set of transactions
Narrow functional views drive the selection of
transactions, classification, and summarization
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Are These Criticisms Valid?

• 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
• Todays 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.

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Ways That Accounting Can Enhance Its Value to the
Organization
Helping Management Define Business Process Rules
- To help management define business process
rules presupposes involvement in an
organizations business processes. We should
develop an AIS architecture that enables
accountants to exercise influence over the
development and implementation of business
processes rules throughout the business process.
Providing More Useful Information - Traditional
accounting measures are expressed almost
exclusively in monetary terms a practice that
precludes information on productivity,
performance, reliability and other
multidimensional data that cannot be easily
expressed in monetary terms.
Helping to Embed Real-Time Information Processes
into Business Processes - Accountants should
provide meaningful, direct input into the design,
development, and implementation of real-time
information processes that execute business rules
and gather business data.
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Role of the Office of the CFO (Chief Financial
Officer)

• Insightful contributions into the strategy and
  planning process
• Measures that focus and motivate the organization
• Information and analysis that provides insight
  into how value is being created and how progress
  is being matched to strategic initiatives.
• Leadership of major financial initiatives.

We think objectives such as these provide
justification for changing the architecture of
any information system that limits the potential
of information providers in adding value to an
organization.
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Event-Driven IT Application Overview
Enterprise-wide Information Customers
Business Events
Business Event Processor (business and information
processing rules)
Business Data Repository
Reporting Facility (Information processing rules)
Business Event Data
Useful Information
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• 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.

Characteristics of Future Architecture