CBFS4203 Acc Information System

Faculty of Science and Technology
CBFS4203
Accounting Information System
Copyright © Open University Malaysia (OUM)

CBFS4203
ACCOUNTING
INFORMATION
SYSTEM
Rina Md Anwar
Hasniza Yahya
Bong Kit Siang

Project Directors: Prof Dato’ Dr Mansor Fadzil
Assoc Prof Dr Norlia T. Goolamally
Open University Malaysia
Module Writers: Rina Md Anwar

Hasniza Yahya
Universiti Tun Abdul Razak
Bong Kit Siang
Universiti Tenaga Nasional
Moderator: Norhaslinda Zakaria

Management & Science University
Editor: Christine Ling Bee Fong

Developed by: Centre for Instructional Design and Technology

First Edition, November 2008
Copyright © Open University Malaysia, March 2011, CBFS4203

All rights reserved. No part of this work may be reproduced in any form or by any means
without the written permission of the President, Open University Malaysia (OUM).
Copyright © Open
Copyright Open University
University Malaysia
Malaysia (OUM)
(OUM)
Table of Contents
Course Guide ix-xiv

Topic 1 Accounting Information System: An Overview 1
1.1 A Framework for Information System 3
1.1.1 The Accounting Information System (AIS) 6
1.1.2 The Management Information System (MIS) 6
1.2 The Revolution of Telecommunications Infrastructure 7
1.2.1 The Manual Process Model 8
1.2.2 The Flat File Model 9
1.2.3 The Database Model 11
1.2.4 The REA Model 12
1.2.5 ERP Systems 13
1.3 The Role of the Accountant 15
1.3.2 Accountants as the System Designers 15
1.3.3 Accountant as the System Auditors 16
Summary 16
Key Terms 16
References 17
Topic 2 Information and Business Operation 18

2.1 Information and Business Operations 19
2.2 Information and Business Management 22
2.3 Basic Business Processing 23
2.4 Business Processing Activities 24
2.4.1 Entering Customer Orders 24
2.4.2 Billing Customers 25
2.4.3 Collecting Customer Payments 26
2.4.4 Keeping Track of Inventory 28
2.4.5 Purchasing Stock and Materials 29
2.4.6 Paying Bills 30
2.4.7 Paying Employees 31
2.4.8 Reporting Financial Information 32
Summary 34
Key Terms 34
References 34

iv X TABLE OF CONTENTS
Topic 3 Accounting Records and Documentation Techniques 35

3.1 Accounting Records in Manual Systems 36
3.1.1 Documents 36
3.1.2 Journal 39
3.1.3 Ledgers 43
3.2 Accounting Records in Computer-Based Systems 44
3.3 Documentation Technique 46
3.3.1 Entity Relationship Diagram 47
3.3.2 Data Flow Diagrams 49
3.3.3 Flowcharts 55
Summary 60
Key Terms 61
References 61
Topic 4 Control and Accounting Information Systems 62

4.1 Need for Control and Audit of Computers 63
4.1.1 Organisational Costs of Data Loss 64
4.1.2 Incorrect Decision Making 65
4.1.3 Costs of Computer Abuse 65
4.1.4 Value of Computer Hardware, Software and 65
Personnel
4.1.5 High Costs of Computer Error 66
4.1.6 Maintenance of Privacy 66
4.1.7 Controlled Evolution of Computer Use 66
4.2 Overview of Control Concepts 67
4.2.1 Functions of Internal Control 67
4.2.2 Effects of Computers on Internal Controls 68
4.3 Computer-Based Information Systems Control 72
4.3.1 The Management Control Framework 72
4.3.2 The Application Control Framework 89
Summary 100
Key Terms 100
References 101
Topic 5 Accounting Transaction Cycles 102

5.1 Economic Events 103
5.2 Economic Events and Accounting Transactions 106
Summary 113
Key Terms 113
References 114

TABLE OF CONTENTS W v
Topic 6 Revenue Cycle Applications 115

6.1 Revenue Cycle Business Activities 116
6.1.1 Processing Customer Orders 120
6.1.2 Delivery/Shipping of Goods or Providing A Service 121
6.1.3 Invoicing and Recording Accounts Receivable 121
6.1.4 Accounts Receivable Ledger 122
6.2 Internal Controls Procedures for the Revenue Cycle 123
6.3 Computer Application Systems for the Revenue Cycle 123
6.4 Controls in the Computer Environment 128
6.4.1 Order Entry System 129
6.4.2 Shipping System 130
6.4.3 Billing System 130
6.4.4 Cash Receipts System 131
Summary 132
Key Terms 133
References 133
Topic 7 Expenditure Cycle Applications 134

7.1 Purchasing and Cash Disbursement SUBSYSTEMS 135
7.1.1 Purchasing Subsystems 137
7.1.2 Cash Disbursement Subsystems 139
7.1.3 Internal Controls for Purchase and Cash 141
Disbursement Activities
7.1.4 Computer Application Systems for Purchase and 142
Cash Disbursement Activities
7.1.5 Controls in the Computer Environment 145
7.2 Payroll and Fixed Asset Subsystems 148
7.2.1 Payroll Subsystems 148
7.2.2 Fixed Asset Subsystems 152
7.2.3 Internal Controls Procedures for the Payroll 154
Subsystem
7.2.4 Computer Application Systems for Payroll Activities 154
7.2.5 Controls in the Computer Environment 156
Summary 157
Key Terms 158
References 158
Topic 8 Production Cycle Applications 159

8.1 Production Cycle Activities 160
8.1.1 Product Design 161
8.1.2 Planning and Scheduling 162
8.1.3 Product Operations 162
8.1.4 Cost Accounting 162

vi X TABLE OF CONTENTS
8.2 Internal Controls Procedures for Production Cycle 165

8.3 Computer Application Systems for the Production Cycle 166
8.3.1 Inventory System 166
8.3.2 Cost Accounting System 166
8.4.1 Inventory System 166
8.4.2 Cost Accounting System 167
Summary 168
Key Terms 168
References 168
Topic 9 General Ledger and Reporting System 169

9.1 General Ledger and Reporting Activities 170
9.1.1 Updating General Ledger 172
9.1.2 Post Adjusting Entries 173
9.1.3 Prepare Financial Statements 174
9.1.4 Produce Managerial Reports 174
9.2 Internal Controls for General Ledger and Reporting System 175
9.3 Computer Application Systems 175
9.3.1 Journal Entry & Financial Reporting System 176
9.3.2 Property System 178
9.4.1 Property System 179
9.4.2 Journal Entry and Financial Reporting Systems 180
Summary 181
Key Terms 181
References 181

COURSE GUIDE

COURSE GUIDE  ix
COURSE GUIDE DESCRIPTION

You must read this Course Guide carefully from the beginning to the end. It tells
you briefly what the course is about and how you can work your way through
the course material. It also suggests the amount of time you are likely to spend in
order to complete the course successfully. Please keep on referring to the Course
Guide as you go through the course material as it will help you to clarify
important study components or points that you might miss or overlook.
INTRODUCTION
CBFS4203 Accounting Information System is one of the courses offered by the
Faculty of Science and Technology at Open University Malaysia (OUM). This
course is worth 3 credit hours and should be covered over 8 to 15 weeks.
COURSE AUDIENCE
This course is offered to all students taking the Bachelor in Information
Technology programme. This module aims to impart the fundamentals of
accounting information system.
As an open and distance learner, you should be able to learn independently and
optimise the learning modes and environment available to you. Before you begin
this course, please confirm the course material, the course requirements and how
the course is conducted.
STUDY SCHEDULE
It is a standard OUM practice that learners accumulate 40 study hours for every
credit hour. As such, for a three-credit hour course, you are expected to spend
120 study hours. Table 1 gives an estimation of how the 120 study hours could be
accumulated.

x  COURSE GUIDE
Table 1: Estimation of Time Accumulation of Study Hours
Study
Study Activities
Hours
Briefly go through the course content and participate in initial discussions 3
Study the module 60

Attend 3 to 5 tutorial sessions 10
Online participation 12
Revision 15
Assignment(s), Test(s) and Examination(s) 20
TOTAL STUDY HOURS 120
LEARNING OUTCOMES
By the end of this course, you should be able to:
1. Describe the meaning of accounting information system as compared to
management information system;
2. Discuss the development in accounting, the criticism, architecture and the
alternative information system architecture; and
3. Discuss business process modeling including control and audit in
accounting information system environment.
COURSE SYNOPSIS
This course is divided into 8 topics. The synopsis for each topic is presented below:
Topic 1 gives the learners a brief overview of accounting information system

places the subject of accounting information systems from accountantÊs
perspectives.
Topic 2 explains how information flows within a business to support business

operations and how Information System might help in managing a business. This
topic also describes several basic business information processing activities.
Topic 3 describes the relationship between accounting records to documentation

techniques used in both manual and computer-based systems.

COURSE GUIDE  xi
Topic 4 describes the existence of a sound system for internal control in order to
ensure asset safeguarding, data integrity, system effectiveness and system
efficiency.
Topic 5 explains preliminary topics that are common to all three transaction
processing cycles, namely the revenue cycle, the expenditure cycle and the
conversion cycle.
Topic 6 describes the revenue cycle activities. This includes internal control
procedures, computer application system and controls in the computer
environment for revenue cycle activities.
Topic 7 describes the expenditure cycle activities (purchasing and cash

disbursement and payroll). This includes internal control procedures, computer
application system and controls in the computer environment for expenditure
cycle activities.
Topic 8 discusses the production cycle activities internal controls, procedures for
production cycle, computer application system for production cycle and controls
in the computer environment for the production cycle activities.
Topic 9 discusses the general ledger and reporting activities. This includes
internal control procedures, computer application system, and controls in the
computer environment for the financial cycle activities.
TEXT ARRANGEMENT GUIDE

Before you go through this module, it is important that you note the text
arrangement. Understanding the text arrangement should help you to organise
your study of this course to be more objective and more effective. Generally, the
text arrangement for each topic is as follows:
Learning Outcomes: This section refers to what you should achieve after you
have completely gone through a topic. As you go through each topic, you should
frequently refer to these learning outcomes. By doing this, you can continuously
gauge your progress of digesting the topic.
Self-Check: This component of the module is inserted at strategic locations

throughout the module. It is inserted after you have gone through one sub-
section or sometimes a few sub-sections. It usually comes in the form of a
question that may require you to stop your reading and start thinking. When you
come across this component, try to reflect on what you have already gone
through. When you attempt to answer the question prompted, you should be

xii  COURSE GUIDE
able to gauge whether you have understood what you have read (clearly,
vaguely or worse you might find out that you had not comprehended or retained
the sub-section(s) that you had just gone through). Most of the time, the answers
to the questions can be found directly from the module itself.
Activity: Like Self-Check, activities are also placed at various locations or

junctures throughout the module. Compared to Self-Check, Activity can appear
in various forms such as questions, short case studies or it may even ask you to
conduct an observation or research. Activity may also ask your opinion and
evaluation on a given scenario. When you come across an Activity, you should
try to widen what you have gathered from the module and introduce it to real
situations. You should engage yourself in higher order thinking where you might
be required to analyse, synthesise and evaluate instead of just having to recall
and define.
Summary: You can find this component at the end of each topic. This component
helps you to recap the whole topic. By going through the summary, you should
be able to gauge your knowledge retention level. Should you find points inside
the summary that you do not fully understand, it would be a good idea for you
to revisit the details from the module.
Key Terms: This component can be found at the end of each topic. You should go
through this component to remind yourself of important terms or jargons used
throughout the module. Should you find terms here that you are not able to
explain, you should look for the terms from the module.
References: References is where a list of relevant and useful textbooks, journals,

articles, electronic contents or sources can be found. This list can appear in a few
locations such as in the Course Guide (at References section), at the end of every
topic or at the back of the module. You are encouraged to read and refer to the
suggested sources to elicit the additional information needed as well as to
enhance your overall understanding of the course.
PRIOR KNOWLEDGE
No prior knowledge is required.
ASSESSMENT METHOD
Please refer to myINSPIRE.
Copyright © Open
Copyright Open University
University Malaysia
Malaysia (OUM)
(OUM)
COURSE GUIDE  xiii
REFERENCES
Boockholdt, J., L. (1999). Accounting information systems. Singapore: McGraw-Hill.
Dunn, C., Cherrington, J. O. & Hollander, A., S. (2005). Enterprise information

systems: A pattern-based approach (3rd ed.). Singapore: Mc Graw Hill.
Hall, J., A. (2001). Accounting information systems. Ohio: Thomson Learning.
Nickerson, R., C. (2001). Business and information systems. New Jersey: Prentice Hall.
OÊbrien, J., A. (2003). Introduction to information system. New York: McGraw-

Hill Irwin.
Robert, C., N. (2001). Business and information systems. New Jersey: Prentice Hall.
Romney & Steinbart. (2003). Accounting information systems (4th ed.). New Jersey:
Prentice Hall.
Ron, W. (1999). Information systems control and audit. New Jersey: Prentice Hall.
Wilkinson et al. (2002). Accounting information systems (4th ed.). New York: John
Wiley and Sons, Inc.

xiv  COURSE GUIDE

Topic X Accounting
1 Information
System:
An Overview
LEARNING OUTCOMES
By the end of this topic, you should be able to:
1. Define system, subsystem and Information System;
2. Distinguish the differences between Accounting Information
System (AIS) and Management Information Systems (MIS);
3. Explain two classifications of transaction;
4. Discuss the evolution of information system model; and
5. Explain three roles of accountant in AIS.

2 X TOPIC 1 ACCOUNTING INFORMATION SYSTEM: AN OVERVIEW
X INTRODUCTION
„To cope with the rapid growth of the company, a sophisticated

accounting software package, Sun Account, was installed in 1995. The
result was radical improvements in accounting procedures. Today, for
example, it takes less than 10 minutes rather than a day to produce an ad
hoc special report. Many reports are generated, helping functional
managers make quicker and better decisions. The system is also much
more reliable and internal and external auditing is easier. Headquarters
knows what is going on almost as soon as it occurs. All these
improvements have led to a substantial growth in revenue and profits for
the firm.‰
(SOURCE: Condensed from IT Asia, August 1995.)
Taken from Information Technology for Management, Second Edition

Update by Efraim Turban, Ephraim McLean and James Wetherbe.
John Wiley & Sons © 2001
In this topic, we will look into a brief overview of accounting information system.
The first section will introduce you to the framework of the Accounting
Information Systems. Then, the evolution of information systems will be
discussed in the second section. There are five models discussed in this section
which are the Flat File System, the Database, the Resource, Event Agents (REA)
and Enterprise Resource Planning (ERP) systems. Finally, section 1.3 focuses on
the three different roles of accountant: as users, designers and auditors.

TOPIC 1 ACCOUNTING INFORMATION SYSTEM: AN OVERVIEW W 3
1.1 A FRAMEWORK FOR INFORMATION

SYSTEM
ACTIVITY 1.1
Imagine you are in a grocery store like Carrefour or Giant. You are there
to buy household needs for the whole week. Suddenly, when you arrive
at the cashier, the whole transaction processing system crashed down
and you are not able to bring home any of the goods. How do you think
business information system directly affect your life?
Before we look at the framework, let us look at Table 1.1 for the definition of
system, subsystem and information system.
Table 1.1: Definition of System, Subsystem and Information System
Term Definition
System Group of elements that are integrated with the common
purpose of achieving one objective.
Subsystem System within a system, or where the situations when there is a
system exist on more than one level.
Information Organised combination of people, hardware, software, and
System communication networks and data resources that stores,
retrieves, transforms, and disseminates information in an
organisation.
Information System (IS) is divided into 2 subsystems (refer Figure 1.1).
Figure 1.1: Two major subsystem of IS

Let us look closely to Figure 1.2. Figure 1.2 shows an example of Information
System (IS) for a manufacturing firm. Obviously, we can see the main difference
between AIS and MIS is the type of transaction they processed. The domain of the
AIS can be identified by using the framework shown in Figure 1.2. We should
note that the framework is just a conceptual view. The organisation of a real IS
could be different from Figure 1.1. Normally, in real world environment, the AIS
and MIS application will be integrated in order to have an efficient business
operations and to ensure the business operation run smoothly.
Figure 1.2: Framework for information system

Source: Hall, J. (2001). Accounting information systems. Ohio: Thomson Learning.
As we know, the basic configuration of an IS is input resources transformed into

outputs resources by going through certain processes. Figure 1.3 shows the type
of transactions processed by the IS. The transactions (financial and non-financial)
are considered as inputs, and will go through various processes. Later the
outputs will be received by users.

Figure 1.3: Transactions processed by the information system

We talk about transaction all the time. However, what is the exact meaning of
transaction? Transaction is an event that affects or is of interest to the organisation
and that is processed by its information system as a unit of work. According to
Hall (2004), transaction can be classified into two which are:
• Financial transaction; and
• Non-financial transaction.
Now, let us look at Table 1.2 for the definition of financial and non-financial
transaction.
Table 1.2: Two classifications of Transaction

No. Classification Definition Examples
1 Financial Economic event that affects the assets • Product sales.
transaction and equities of the organisation, is • Inventory
reflected in its accounts, and is purchase.
measured in monetary items.
2 Non-financial All events processed by the • Adding new
transaction organisationÊs information system that customer to the list.
do not meet the narrow definition of a • Updating the
financial transaction, and is measured in supplierÊs
non-monetary items. information log.
SELF-CHECK 1.1
Distinguish between financial and non-financial transactions? Give

three examples of each category.

1.1.1 The Accounting Information System (AIS)

AIS involved in processing both financial and non-financial transactions. The AIS
consists of three major subsystems.
(i) Transaction Processing System (TPS)

A Transaction Processing System records and processes data from business
operations on daily basis. This system produces productÊs information for
internal and external use. Within a TPS, there are three (3) transaction cycles:
(a) Revenue cycle
(b) Expenditure cycle
(c) Production/conversion cycle
Each cycle has various activities that differentiate themselves with each
other. However, we will discuss these cycles later in Topic 6, 7 and 8.
(ii) General Ledger (GL) / Financial Reporting System (FRS)

GL/FRS produces traditional financial statements. They normally viewed
as a single system although they were actually two different subsystems.
Generally, General Ledger System (GLS) will get the input mostly from the
transaction cycles. Summary of the general ledger control accounts will be
updated after GLS has processed the summary of the transaction cycle
activities. The Financial Reporting System (FRS) will measure and report the
status and changes of the financial resources such as income statement, tax
returns and other reports required by the law.
(iii) Management Reporting System (MRS)

MRS provides financial reports and information needed by the management
during decision making phase. Examples of the reports are budgets, variance
reports and others.
1.1.2 The Management Information System (MIS)

The Management Information System (MIS) involved in processing the non-
financial transactions that are not processed by traditional AIS. In certain cases,
sometimes it requires to integrate both financial and non-financial data. This
involved both AIS and MIS. Let us look at an example of AIS and MIS integration
in a payroll system.

The payroll department will get personnel data from Personnel/Human

Resource department. In Human Resources Department, they use MIS
application such as Human Resource Information Systems. Meanwhile, each
employeeÊs total working will be supplied by the Production Department
which uses an AIS application, specifically in the Expenditure Cycle. In
situations where the manager requires any related reports like total payout
for the month for each employee, total overtime payment for each employee,
integration will have to take place. Hence, the coordination between these two
systems is very important since it may produce unreliable information if done
wrongly.
MIS INTEGRATION AIS
Currently, most of the organisations have included both AIS and MIS features in
their information systems. This is to enhance the uses of the information systems
and at the same time to improve the operations of the organisation. Because of
this situation, the traditional role of accountants has changed as they are required
to provide the correct and reliable non-financial data.
1.2 THE REVOLUTION OF

TELECOMMUNICATIONS INFRASTRUCTURE
Before the existence of the current AIS, there were a few models that have been
used. The new models have been created because of the drawbacks and
limitations of the previous models. The newest model usually did not
immediately replace the older models. In some cases, different organisations may
have different generations of the models.
The Information System comprises of five models, as shown in Figure 1.4.

Figure 1.4: Evolution of information system model
1.2.1 The Manual Process Model

This model is the oldest and the most traditional systems. Manual systems
represent the physical resources, events and staff that involved in business
processes. This model also includes the physical task of record keeping.
Nowadays, the manual models are seldom used in an organisation. Figure 1.5
illustrates the elements needed in Manual Process Model.
Figure 1.5: The manual process model

However, this model is useful for learning the basic business concepts manually,
before moving on to the computer based system. Besides, the logic business
process is much easier to understand when we separate the technology with the
process. We can easily understand the internal control activities such as audit
trails and access controls through the understanding of manual process.
1.2.2 The Flat File Model

The flat file model is also known as legacy systems. This model does not promote data
sharing. Thus, any same data/file needed by different individual or departments must
be provided for each of them. This is contrast to the database management systems.
Although the legacy systems are being replaced by the database management systems,
there are organisations that are still utilising the systems.
In this environment, each data files are not related to each other. For instance, in
an organisation, if there are 10 departments using one same file, the legacy
system will have 10 same files in it. The data will be processed individually. Any
changes of data must be updated in all files. Thus, it will make the process more
tedious. The individual/department must be aware of any updates and promptly
update the same files at all different location/department.
Now, let us look at Figure 1.6 which illustrates the flat file model.

Figure 1.6: Flat file model

Refer to Figure 1.6, there are 3 different users using their own stand-alone system.
Each system used specific files for their application.
(i) Accounting section through Billing/Accounts Receivable System uses
Customer Data, Sales Invoices and Cash Receipts.
(ii) Marketing section through Product Promotion System uses Customer Data
and Sales Invoice.
(iii) Product Services through Service Scheduling System uses Customer Data
and Product Services Schedule.

If the Accounting section updates the data in Sales Invoice file, then the file in
Product Promotion System must be updated too. Data redundancies exist
because the same files exist in the different system in an organisation. This can
lead to three problems, as shown in Table 1.3.
Table 1.3: Problems That Will Occur Due to Data Redundancies
Problem Explanation
Data storage Unnecessary storage costs of paper documents and/or
magnetic form.
Data updating Modifications must be performed several times.
Currency of Potential problem of failing to update all affected files.
information
1.2.3 The Database Model

This database model is widely used in most of the organisation. It was designed
to overcome the problems caused by the flat file model. Database is a set of
interrelated files or a collection of data arranged for ease and speed of search and
retrieval. Figure 1.7 shows the example of database model for an organisation.
Figure 1.7: Database model

Based on the figure, the users are the Accounting, Marketing and Product
Services department. Those departments are using the same file, the Customer
Sales. But, the difference is that each department has a different user view. For
example, Accounting department only need to view Current Account Receivable.

The Customer Sales file is stored in the Database, which is managed and
controlled by the Database Management Systems (DBMS).
Each user has their own level of access to the database. When user submit their
request for viewing the data, the DBMS will validate and authorise the access to
the database based on the userÊs level of authority. The request will be denied if
the users are trying to access the data that is not authorised for them.
This database model is slightly different with the flat file model, where it
promotes the data sharing concept. The data sharing can solve the problems
caused by the flat file model such as data redundancy.
The early database system is called traditional systems where at that time the
DBMS were designed to interface directly with the flat file programs. It will be
easier and cheaper when the organisation replaced their flat file with the database
systems. But still, this early database system has the limitations. However, the
existence of relational database model really improved the database systems in
terms of flexibility and reliability.
1.2.4 The REA Model

REA is an acronym signifying that the data model contains information about
three fundamental types of objects that are Resource, Events and Agent.
McCarthy introduced REA model in 1982 as a domain specific theory for the
design of accounting information system. The REA model is also known as a
technique for capturing information about economic phenomena. It describes a
business as a set of economic resource, economic events and economic agents as
well as relationship among them.
Although the REA model was proposed as a result of the study of accounting
theories, it can be applied to many other business domains. It can be used for
inventory control by assigning goods to resources, transfers to events and owners
to agent. Beside that, it also can be used for payroll by assigning the lengths of
time to resource, time cards to events and employees to agents. This REA model
is a promising modeling technique for developing business applications because
it has a solid foundation and it can be applied to nearly all business domains.
Here the REA model is a conceptual modelling tool specifically designed to provide
structure for designing AIS databases. REA model provides structure in two ways:
(a) Identifying what entities should be included in the AIS database; and
(b) Prescribing how to structure the relationships among the entities in the AIS
database.

As we know the REA model is an alternative view of accounting the model is

built upon an organisationÊs resource, events and agents and how these are been
related. Application of the REA model yields a centralised (relational) database.
Here user views can be created for all users of organisational information not just
accountants. The key elements of the REA model are summarised as follows:
(a) Resources
Resources obtained and used by an organisation. Resources can be defined
as the assets of the organisation that have economic values that can generate
profits such as inventory, factories and land.
(b) Events
Events are the various business activities that occur in an organisation and
affect the resources. Data are collected during the activities. Events can be
divided into three classes:
(i) Operating Events
Activities that produce goods and services.
(ii) Information Events
Activities related to any recorded/stored information.
(iii) Decision/Management Events
Activities which resulted in decision making and its implementation.
(c) Agents
Agents are the people and departments inside or outside the organisation
that take part in the events and at the same time can affect resources. Agents
can decide whether to use or to remove those resources. Employees,
suppliers and customers are some of the examples of agents.
1.2.5 ERP Systems

Enterprise Resource Planning (ERP) is an information system that provides the
integration of an organisationÊs business processes/activities. It facilitates data
sharing and flows of information. In addition ERP introduces the common
business exercises/practices to all users in the organisation.
ERP is a complex and large size system which can take several years before it can
be implemented. Because of this, only few organisations take the risk to develop
in-house ERP system. Normally ERP system is sold to customer as commercial
products. This commercial ERP includes the standard processes only. Therefore,
problems may occur because it does not meet the organisationÊs requirements or
needs. Thus, the organisations have to modify their business activities or modify

the ERP system or sometimes could be both. This is to make sure the success in
the implementation of the ERP systems.
Table 1.4 summarises the characteristics of ERP.
Table 1.4: Characteristics of ERP
Characteristics of ERP
1. Facilitate data sharing.
2. Facilitate flows of information.
3. Introduces common business exercises.
4. Contains complex and large size system.
5. Requires several years of constructions before it can be completed.
6. Normally comes as commercial product.
7. Need to be tailored to individualÊs organisational needs / requirements.
SELF-CHECK 1.2
In the table provided below, write down at least two major
characteristics of each information systems model as discussed earlier in
Section 1.2. Research on the Internet to find out real life example of each
model. Have fun!
Model Characteristics Example

Manual Process 1.
2.
Flat File 1.
2.
Database 1.
2.
REA 1.
2.
ERP 1.
2.

1.3 THE ROLE OF THE ACCOUNTANT
ACTIVITY 1.2
Have you ever been in a bank? Whether you are withdrawing money,
depositing money, making payments etc, you are indirectly deals with
accounting transactions. Now, try to list out the roles of accountants.
In this section, we will examine the accountantsÊ role in the current business
environment. Basically, accountants involved in three roles/ways (refer to Figure
1.8).
Figure 1.8: Role of accountants in business environment
1.3.1 Accountants as the Users

The accounting function is one of the largest users of computer systems. An
accountant need to know their expectations and needs for the systems. They have
to provide the details and clear information to the people who are involved in the
system development. This is really important as any incomplete or vague
information will give impact to the implementation and use of the systems.
1.3.2 Accountants as the System Designers

An accountant should actively involve during system development process.
Besides providing the needs of the systems, an accountant must also involve as a
system designer. Normally they will involve in designing the conceptual model.
Beside, they have to monitor and do the testing process. This is to ensure that the
controls are implemented and functioning properly. The sufficient controls are
needed in order to make sure the data is reliable and accurate.

1.3.3 Accountant as the System Auditors

Information Technology (IT) auditing is one of the types of audits that are
commonly performed. The purpose of IT auditing is to review and evaluate the
internal controls that protect the system. As a system auditor, an accountant will
evaluate and check the integrity of the selected components of the system. This is
to ensure that the system conform to the organisations objectives and also the
internal control standards.
SELF-CHECK 1.3
What are the three roles played by accountants with respect to the
information system?
• The main difference between AIS and MIS is the type of transaction they
processed.
• The AIS process both financial and non-financial transactions, while the MIS
process the non-financial transaction only.
• The evolution of the Information Systems shows that each new model has
been created to overcome the problems and limitations of the previous
models.
• Finally, the role of accountants in the current business environment has
changed.
• An accountant plays important role as a user, systems designer and also as a
system auditor.
Database model Flat file model

Database management systems (DBMS) Manual process model
ERP systems REA model

Hall, J. (2001). Accounting information systems. Ohio: Thomson Learning.

OÊbrien, J. A. Introduction to information system. New York: McGraw-Hill Irwin.

Topic X Information
2 and Business
Operation
LEARNING OUTCOMES
1. Diagram typical flow of information in business operations.
2. Explain how the information is being used by the management in
an organisation;
3. Explain eight business processing activities used in businesses;
4. Differentiate between sales order and invoice;
5. Recognize statements as compared to account receivable reports;
6. Describe how to keep track of inventories; and
7. Determine the input and output of purchasing activities.
X INTRODUCTION
Information systems provide information to support the operations and
management of businesses and other organisations. In order to understand
information systems, it is first necessary to understand how businesses and other
types of organisations operate and managed. It is also important for us to know
how businesses use information in their various functions, and how common
business activities process information. This topic shows how information flows
within a business to support business operations. Later, we will explain how
information helps in the management of a business. Lastly, this topic will
describe several basics business information processing activities.

TOPIC 2 INFORMATION AND BUSINESS OPERATION W 19
2.1 INFORMATION AND BUSINESS

OPERATIONS
ACTIVITY 2.1
In some industries, wholesalers are not used. The retailer buys

directly from the manufacturer. In other industries, wholesalers are
used extensively. Why would a manufacturer want to use a
wholesaler to sell and distribute its products instead of passing the
products directly to a retailer?
Why would a retailer want to purchase goods from a wholesaler

rather than directly from a manufacturer?
Business operation is defined as all activities involved in producing finished

goods and providing services to an organisation. These activities need to ensure
that the organisation makes profit. Examples of business operation activities are
like manufacturing products, processing orders and purchasing raw materials.
For these purposes, we need information to ensure the business operations run
smoothly. The information needed in these operations include what service to
provide, when to reorder inventory and how much we owe the suppliers.
The information will flow between people within a department as well as from
one department to another. The information could be submitted through a
document, voice or computer. The flow of information will be discussed in the
next paragraph.

20 X TOPIC 2 INFORMATION AND BUSINESS OPERATION
Figure 2.1: Information flow related to sales

Source: Robert, C. N. (2001). Business and information systems. New Jersey: Prentice Hall.
Figure 2.1 shows the flow of information related to the sales of goods. The flow
starts once the customers submit order for items they want to purchase. The sales
department receives the customer orders information and sends the information
to the shipping department. This department views the information and pack the
goods based on the order and send it to the respective customer. The shipping
information will then be sent to the billing department. The billing department
prepares the billing information which includes the amount that the customer
needs to pay and send it to the customer and accounts receivable department.
Customers who receive the billing information will now send the payment to the
organisation which directly goes to the accounts receivable department. Accounts
receivable department manages the customer bills and sends reminder to the
customers who have not paid their bills within the stipulated time.

Figure 2.2: Information flow related to inventory control

Figure 2.2 illustrates the flows of information for inventory control. The shipping
department sends the shipping information to the inventory control department.
This includes the quantity they have sent to the customer. Receiving department
send information on the inventory received from vendors to the inventory control
department. The inventory reorder information will be sent to purchasing
department by the inventory control department. This happens when the
inventory level is below the stated level.

Figure 2.3: Information flow related to purchasing.

Figure 2.3 shows the flow of information related to purchasing goods. The
purchasing department receives the information on inventory reorder from
inventory control department and prepares the purchasing information and sends
it to the respective supplier and also to accounts payable department. The supplier
sends the billing information to the organisation specifically the accounts payable
department. The receiving department sends information on which items they
have received from the supplier to the account payable department. Payment will
be made to the supplier by the accounts payable department.
The flow of information might be different for each organisation. This depends
on the type of business they operate.
2.2 INFORMATION AND BUSINESS

MANAGEMENT
Besides supporting the business operations, information is also used by the
management of the organisation. Normally, management uses information to
assist them in decision making. They also involved in preparing short or long

term planning for the organisation. Thus, the information is really important to
the management.
Besides, the management uses the information to manage the business such as
deciding which customer deserves to purchase from the organisation on credit
basis and which suppliers to choose for purchasing the inventories.
In general, information is really a crucial thing for the management since they are
the one who manage the organisation and need to make decisions and do the
planning. The information needed is produces from the information that flows
within the organisation. Refer to Figure 2.2 which shows the information flow for
inventory control. Here, the manager needs to do the inventory reordering
decision. The inventory control department keeps track of the quantity of
inventory that the organisation has in stock and when the inventory level is low,
the department is able to detect it. Customer order information received by the
sales department which is then uses this information to forecast sales. Once the
manager receives the information on the low level of inventory, he or she can use
the sales forecast to decide on the quantity of the inventory to reorder. Therefore,
the information flows is to the manager in order for him or her to make decision.
2.3 BASIC BUSINESS PROCESSING

The business operations and management use the information for various
information processing activities. These activities involve people and computers
(if any) which receive the data and process it, then store the data using various
type of storage media and later on produce information based on the processed
data.
Businesses perform many information processing activities, but in this section,

only eight common activities will be discussed.

Figure 2.4: Information flow

2.4 BUSINESS PROCESSING ACTIVITIES

In this section, we will discuss the eight business processing activities. Let us
begin with the first activity ă entering customerÊs orders.
2.4.1 Entering Customer Orders
ACTIVITY 2.2
Before setting up any businesses, do you think a market survey is
necessary to determine the success of the business? Always, why
gathering potential customer requirements are a good beginning
step to start up any business?
Entering customer order is the first activity of the business information processing
which occur in the sales department. This activity receives orders from customers
indicating the type and quantity of the goods requested. Customers may place their
order through telephone, sending them by mail, or even fill in an order form
(manually or electronically). Hence, the orders are usually not in a standard format.
Figure 2.5 shows the example of customer order form.

Figure 2.5: A customer order

Sales department must ensure that the inventory is sufficient according to the
order. Besides, the department also needs to determine whether credit should be
extended to the customer. After that, the sales order will be prepared by the sales
department. An example of sales order is shown in figure 2.6. This document,
which is also called as shipping order is the output for this activity. It contains the
customerÊs particular, items ordered and the quantity. The sales department
sends the sales order to the shipping department.
Figure 2.6: A sales order

2.4.2 Billing Customers

Sales order is used to verify the items that should be delivered to the customer.
Sometimes when the items are not sufficient, the quantity shipped is different
from the quantity ordered. For that reason, the shipping department need to
write the actual quantity shipped in the copy of the sales order. Refer to Figure
2.7 for the example of the sales order with the actual quantity shipped. The
shipping department sends the copy of the sales order to the billing department.

Then, the billing department will prepare the customerÊs invoice based on the
information in the copy of the sales order.
Figure 2.7: The sales order from the shipping department

The billing department then sends the invoice to the customer and another copy
to the account receivable department. The sales order in Figure 2.7 is the input for
the billing activity while customerÊs invoice in Figure 2.8 is the output.
Figure 2.8: An invoice

2.4.3 Collecting Customer Payments

The copy of the invoice received from the billing department is used to keep track
the customerÊs record. Payment from customers will be recorded and reminders
will be sent to the customers who have not paid their bills within the stipulated
time. The accounts receivable department sends the summary of invoices charges

and payments to the customers and prepare the reports of accounts receivable to
other departments or functions of the organisation.
Copy of the invoice and payment from customers are the input for this activity.
Outputs for the activity includes the statement which is the summary of the
invoice charges and payments, overdue notices or reminders and the reports of
accounts receivable. The accounts receivable department sends this report to the
general accounting department. Refer to Figure 2.9 for the example of the
statement and Figure 2.10 is the account receivable report.
Figure 2.9: A statement

Figure 2.10: An accounts receivable report


2.4.4 Keeping Track of Inventory

An organisation must keep track of its inventory in order to meet the customerÊs
requirements or orders. Once the inventory level is low, the person in charge
should be aware and reorder the items. The department involve in this activity is
the inventory control department.
The inputs for this activity are the sales order from the shipping department and
the receiving notice from the receiving department which indicates the quantity
of items received from suppliers. Figure 2.11 shows the example of receiving
notice. The inventory reorder report and the inventory value report are the
output for this activity. Figure 2.12 shows the example of the inventory reorder
report which is send to the purchasing department. The inventory value report as
shown in Figure 2.13 will be sent to the general accounting department.
Figure 2.11: A receiving notice

Figure 2.12: An inventory reorders report


Figure 2.13: An inventory value report

Processing in this activity involves keeping track of the quantity on hand for each
item in inventory. The inventory control department updates this quantity from
data in the sales orders and receiving notices.
The type of inventory described here is called finished goods inventory because it
deals with final products which are ready for sale. Manufacturing, wholesaling
and retailing are some of the business use this type of inventory. However,
manufacturers do not prepare the inventory reorder report but they produces a
report indicating what items should be manufactured.
In general, manufacturers have three types of inventory:

(a) Finished goods inventory · final products.
(b) Raw materials inventory · materials and parts used for manufacturing
process.
(c) Work-in-process inventory · involves partially manufactured items.
2.4.5 Purchasing Stock and Materials

The purchasing department will handle the purchasing process from the
suppliers. The department needs to identify the best suppliers before they
purchase the items. The best suppliers chosen based on criteria such as the best
price offered, sales terms and delivery time. Once the suppliers have been
selected, the purchasing department prepares the purchase order which contains
the items need to be purchased.

The input to this activity is the inventory reorder report which is from the
inventory control department and the output is the purchase order as shown in
Figure 2.14. The purchasing department sends one copy of the purchase order to
the supplier and another one to the accounts payable department.
Figure 2.14: A purchase order

2.4.6 Paying Bills

The copy of the purchase order received from the purchasing department is used
to keep track the purchase record. The accounts payable department is the one
who handle this activity. Once the supplier has sent the items, this department
will pay the supplier based on the invoice sent by the supplier.
The inputs for this activity are the copy of the purchase order from the
purchasing department, the invoice from supplier and a copy of the receiving
notice received from the receiving department. The outputs are the payment to
the supplier and the accounts payable report which summarize the supplier
charges and payments for the specific month. Refer Figure 2.15 for the example of
the accounts payable report which is sent to the general accounting department.
Figure 2.15: An accounts payable report


2.4.7 Paying Employees

The payroll department involve with this activity. The employee will be paid and
the payroll report will be prepared.
The input for this activity is the employee work report. This report is based on
the type of the employee. If the employee is paid based on hourly basis, the
report prepared is the time sheet which shows the total of hours the employee
has accomplished for each day. Figure 2.16 shows the example of the time sheet.
For an employee who is paid a fixed salary, the report shows the attendance for
all working days and for the absence day, the reason must be stated.
Figure 2.16: A time sheet

.
The output includes the paycheck received by the employee and the payroll
report. Refer to Figure 2.17 for the example of the payroll report. This report will
be sent to the general accounting department by the payroll department.

Figure 2.17: A payroll report.

2.4.8 Reporting Financial Information

The last activity is the reporting financial information which is normally found in
all businesses. The purpose of this activity is to provide financial reports to the
management and the stakeholder/stockholder. An organisation keeps the
financial accounts for each revenue it receives and expenses it pays.
Revenue is obtained from sales and other resources such as investments, while
the expenses includes purchasing the inventories and assets, paying the
employees, maintaining and disposal of the assets and others. Reports will be
prepared by the general accounting department, which is called the financial
statements. This report summarised the organisationsÊ accounts.
The inputs for this activity are reports on revenue, expenses, assets and liabilities.
The outputs are the financial statements such as the income statements and the
balance sheet, as shown in Figure 2.18.

Figure 2.18: Financial statements.

SELF-CHECK 2.1
1. How does the Purchasing Department know when to purchase
more goods?
2. For what business information processing activities is a sales
order an input?

• This topic has shown how information flows in business operations, how
managers use information in decision making, and how businesses perform
basic information processing.
• Although a business could handle this flow, use, and processing of
information without the aid of computers and related technology, using
computer information systems for these activities can greatly increase a
businessÊ efficiency and effectiveness.
Manufacturer Retailer
Operations Wholesaler
Boockholdt, J. L. (1999). Accounting information systems. Singapore: McGraw-Hill.

Robert, C. N. (2001). Business and information systems. New Jersey: Prentice Hall.

Topic X Accounting
3 Records and
Documentation
Techniques
LEARNING OUTCOMES
1. Describe the documents and procedures used in AIS to collect and
process transaction data;
2. Describe the relationship among accounting records in forming an
audit trail in both manual and computer-based systems;
3. Explain three types of document used in AIS;
4. Compare the function of journal with ledgers;
5. Examine the documentation techniques used to represent systems;
and
6. Develop flowcharts based on given scenario.
X INTRODUCTION
Traditionally in accounting world, accountants require pencils, papers and a
basic calculator. We record all accounting transactions on T-accounts that
represents Debit and Credits transaction. We use calculator to balance out the
Debit side of our T-accounts to the Credit side of the same account. As the result,
we will post the difference (if any) to indicate the imbalanced condition of the T-
account. However, this traditional approach has been gradually changed to

36 X TOPIC 3 ACCOUNTING RECORDS AND DOCUMENTATION TECHNIQUES
computerised system, which eliminates most of manual record keeping process

done by human. However, the knowledge of how a manual system should
operate is very fundamental so that the computerised documentation techniques
will have minimal flaw after implemented.
The first section of this topic describes the relationship among accounting
records in forming an audit trail in both manual and computer based systems.
Then, we will examine the documentation techniques used to represent system.
At the end, we will look at documentation techniques for manual and
computer-based systems.
3.1 ACCOUNTING RECORDS IN MANUAL

SYSTEMS
ACTIVITY 3.1
In a manual system, adequate documents and records are needed to

provide an audit trail of activities within a system. In computer
systems, documents might not be used to support the initiation,
execution and recording of some transactions. What is the effect of
this on the internal control of a company?
3.1.1 Documents
Previously, most organisations uses paper based documents as a common way
for data collection. These data will then be transferred to the computer for the
later use. Currently, these data will be directly stored in the computers through
the specific system.
Basically there are three types of documents, as mentioned in Figure 3.1.
Figure 3.1: Types of documents in accounting systems

TOPIC 3 ACCOUNTING RECORDS AND DOCUMENTATION TECHNIQUES W 37
(a) Source Document

Source document is the initial input to the accounting process and normally
serve as an original record of a transaction. It is an early document in the
accounting cycle and it captures the key data of a transaction. The examples
of source documents are Purchase Orders, Time Cards, Cash Receipts and
others.
Figure 3.2 shows the creation of a source document.
Figure 3.2: Creation of a source document

Source: James, A. H. (2001). Accounting information systems. Ohio: Thomson Learning.
It is a part of the revenue cycle. When customers make an order, the sales
clerk will prepare multiple copies of sales order. These documents then will
go into the sales system. The information in these documents will be used
by various departments or functions such as Credit, Billing and others.
Thus, it will cause other activities to start in those departments.
Now, let us look at an example below.
Example:
A copy of the Sales Order will be sent to the Credit Department. It will
cause the checking or approval process begins. The personnel in the
department will use the information in the sales order to verify the
customerÊs creditworthiness.

(b) Product Document

Product documents are the document that is being prepared after a
transaction had happened. Product document can serve as an output for
one system. Refer to Figure 3.3, the source document act as an input for
Sales System while the product document which is customerÊs bill will act
as an output.
Figure 3.3: A product development

(c) Turnaround Document

The final document is turnaround document. Turnaround document is a
document which acts as an output for one system and become an input for
another system. Figure 3.4 shows the example of turnaround document. It is
based on the previous example of source and product document.
We can take other example like credit card monthly statement sent by the
credit card company to their customers. Most of the statements consist of
two parts:
(i) Statement of the account
(ii) Remittance advice
The remittance advice contains the customerÊs name, account number, the
total credit and also the minimum payment required for that particular
month. Normally, the statement is produced by the Billing Department.
When customer makes payment, they will include the remittance advice
along with the cheque. The remittance advice will be received by the
accounts department. The information in remittance advice such as account
holder name and account number will be used as an input to the accounts
department.

Figure 3.4: A turnaround document

SELF-CHECK 3.1
Can a turnaround document contain information that is
subsequently used as a source document? Why or why not?
3.1.2 Journal
A journal is an initial record in which the effects of transactions on accounts are
recorded. When transactions happen, we record all relevant facts in chronological
order. The data for journals come from the documents such as sales order. The
journal will keep all records of transactions and will be posted to the specific
account. Figure 3.5 shows the process of recording the sales order to the sales
journal.
Figure 3.5: Sales order recorded in sales journal


There are two types of journal, as shown in Figure 3.6.
Figure 3.6: Types of journal
(a) Special Journal

This is used to record specific categories/classes of transactions. The
specific categories/classes will be grouped in a special journal, thus can be
processed efficiently. Figure 3.7 shows an example of special journal,
specifically sales journal.
The sales journal will only record the sales transactions. Each time
processing period ends, the sales clerk will post the amounts to the specified
ledger account. The frequency for processing could be either in daily,
weekly or monthly basis. From Figure 3.7, we can see that these amounts
are posted to account number 401.
Another example of special journal includes cash receipts journal, where it

will record the cash receipts transaction such as cash and credit sales.
Figure 3.7: Sales journal

Source: Boockholdt, J. L. (1999). Accounting information systems. Singapore: McGraw-Hill.

(b) General Journal

The general ledger is a journal which is used to record the infrequent and
different transactions. Figure 3.8 shows the example of the general ledger.
Currently, most of the organisations have been using journal voucher
system to replace the general journal. A journal voucher is a source
document which contains a single entry of each account specified in the
general ledger. It is used to record summaries of routine and non routine
transactions. We also use this document to record the summary of adjusted
and closed entries.
For example, there are two accounts in the general ledger:

(i) Accounts receivable
(ii) Sales account
Hence, in the journal voucher, there will be only two accounts stated along
with the amount in that journal voucher.
Figure 3.8: A general journal

Another document to be considered is the chart of accounts. Chart of accounts

lists all account name and number for an organisation. During the process of
recording event into journals, accountant will refer to the chart of accounts. This
is to make sure accounts chosen by the accountant are listed in the Accounting
Information Systems.

The chart of accounts is one of the most important documents we need to

consider in Accounting Information Systems. The chart provides complete
reference for the accounts in an organisation. Hence, it is important to make sure
the chart of accounts is well designed.
The chart of accounts could be different within an organisation since the

functions and business activities might vary from one organisation to another.
Figure 3.9 shows a chart of accounts example. It shows the account name along
with the account number. The account number consists of three digits. This is one
of the coding techniques for AIS application, called Block Codes. This technique
corresponds to the entire class of items by restricting each class to a particular
range within the coding scheme.
Figure 3.9: A chart of accounts


Table 3.1 summarises the Block Codes representation.
Table 3.1: Block Codes Representation
Digit Representation Example

First Account Classification 100 = Current Assets
200 = Fixed Assets
500 = Revenue
Second Primary financial sub-accounts within each 110 = petty cash
category. 120 = petty cash
Numbers were assigned to accounts to match 130 = accounts receivable
the order of their appearance in financial
statements
Third Specific account to which the transaction data 611 = cash revenue
will be posted 612 = credit revenue
Another thing to be considered when building the chart of accounts is the

scalability. The chart of accounts should allow the insertion of new or additional
accounts.
3.1.3 Ledgers
A ledger is sometimes called as a book of financial records. We use ledger to
summarise the financial status of an organisation such as the current balance of
accounts. Normally, the various journals will post the financial transaction
information to the ledgers. The information will be used to prepare the financial
statements, internal reports and also to support the daily transactions. Figures
3.10 show the flow of financial information from the source document and finally
end at the general ledger.
Figure 3.10: Flow of information from the economic event to the general ledger

Basically, there are two types of ledgers, as shown in Figure 3.11.
Figure 3.11: Types of ledger
(a) General Ledgers

General ledgers have the summary of activities for each account in the
organisation.
(b) Subsidiary Ledgers

Subsidiary ledger records the details for any account in the general ledger
that owns many subaccounts. For example, one of the accounts in the
general ledger is the account receivable. Subsidiary ledger for the accounts
receivable could be the separate account for each customer. The total of
account balance in the subsidiary ledger must be the same with the balance
in the accounts receivable in the general ledger.
3.2 ACCOUNTING RECORDS IN COMPUTER-

BASED SYSTEMS
ACTIVITY 3.2
How about organising an event without a planner? How about

leading a nation without a minister? And, how about running a
business without a system? Respond to the questions above by
posting your answer in myLMS.

Planning to record transactions in specific location may help organising accounting

transaction better. In computer-based systems, the accounting records are
represented by four different types of magnetic files as summarises by Table 3.2.
Table 3.2: Different Types of Magnetic Files
No. Type of Files Description Example

1 Master File A master file contains all accounts data. General and subsidiary
When transactions occur, the related ledgers.
data in the master files will be updated.
2 Transaction A temporary file which contains Sales orders and cash
File transaction records. These records will receipts.
be used to change and update data in
the master file.
3 Reference File A file which has a collection of data Product price lists
used as standards or reference for used for preparing
processing the transactions. the customer invoices
4 Archive File Files which have records of past Lists of former
transactions. employees, lists of
These files will be used for future preceding sales
reference in the organisation. transactions.
Figure 3.12 illustrates the relationship of these files in forming an audit trail.
Figure 3.12: Accounting records in a computer-based system


The accounting records described in the manual system or computer-based

system provide an audit trail for tracing transactions from source documents to
the financial statements. The audit trails in computer-based system is still exist,
although it is less noticeable than in traditional manual system.
Figure 3.12 shows how computer files can function as audit trail in an
organisation. It begins by capturing the economic events. The sales are recorded
manually using source documents. Then the data in the source documents will be
transferred to the magnetic files, specifically the transaction files. However, this
will depend on the organisation because some organisations are no longer using
the physical source documents. Hence, the transactions are directly captured on
the magnetic media.
The next step is to update the related master file subsidiary and also the control
accounts. During this process, we may edit the account transactions. For example,
the available credit for each customer will be identified by the system by referring
to the credit file. Any credit problems will be rejected and stored in the error file.
The remaining records will be used to update the related master files. Hence, only
these transactions are added as the sales journal into the archive file.
The original transaction file is not required for audit trail purposes because the
valid transactions have been copied to the journal. The file then can be deleted
and the system is now ready for the next batch of the sales orders.
SELF-CHECK 3.2
What is meant by „Audit Trail?‰
3.3 DOCUMENTATION TECHNIQUE
ACTIVITY 3.3
How do you relate DFD to Activity Diagram in Unified Modeling
Language? You may go to the internet and locate the answers to
this question.

3.3.1 Entity Relationship Diagram

ERD describe information needed and/or the type of information that is to be
stored in the database
Entity Relationship Diagram (ERD) is a documentation technique used to

construct conceptual data model and it describes the data needed and also the
type of data that is to be stored in the database. It acts as a data modeling
technique that creates a graphical representation of the entities, and the
relationships between entities, within an information system.
ERD can be used as a tool for communication during analysis phase in the system
development process. The three main components of an ERD and their functions
are summarised in the following Table 3.3.
Table 3.3: Main Components of ERD and Their Functions

No. Item Symbols Descriptions
1. Entity Entity is an object in the real world
environment.
In AIS, an entity is a resource (cash), an
event (receiving cash) or an agent
(customer).
2. Relationship A relationship captures how two or more
entities are related to one another.
3. Attributes Attributes are the properties or

characteristics of an entity.
Relationships may also have attributes.
Attributes are drawn as ovals connected
to their owning entity sets by a line.

Figure 3.13 shows the symbols used for an ERD.
Figure 3.13: Entity relationship diagram symbols

The relationship between entities can also be described in terms of cardinality.
Cardinality specifies the number of instances of one entity that can be associated with
each instance of another entity. A relationship can be one-to-one (1:1), one-to-many
(1: M) or many-to-many (M:N). Cardinality can reflect the policy of an organisation.
Table 3.4 explains the symbols used for an ERD.
Table 3.4: Symbols used for an ERD
No. Symbols Relationship Cardinality Explanation

1 Assigned (1 : 1) Each salesperson
is assigned to one
automobile. Each
Entities: automobile is
Salesperson, Automobile assigned to one
salesperson.
2 Places (1: M) Each customer
placed more than
one order Each
Entities:
order is placed by
Customer, Order one customer.

3
Supply (M: N) Each vendor
supplied more
Entities:
than one items.
Vendor, Inventory. Each item is
supplied by more
than one vendor.
3.3.2 Data Flow Diagrams

A Data Flow Diagram (DFD) is a graphical representation of the data flow
through an information system. We also use DFD to visualise the data processing
or so called structural design. It is a common practice for a system
analyst/designer to firstly draw a context-level DFD which shows the interaction
between the system and outside entities. This context-level DFD is then
decomposed to show more detail of the system being modeled.
A data flow diagram illustrates the processes, data stores, and external entities in
a business or other system and the data flows between these things.
Four diagrammatical components are used to develop a DFD. Table 3.5 illustrates
these components.
Table 3.5: Diagrammatic Components Used to Develop a DFD
Item Descriptions
Data Flow • Data in motion, moving from one place to another in a system.
• Represent the results of a query to a database, the contents of a
printed report or data on a data entry computer display form.
• Should only represent data, not control.
• Represented by an arrow.
• Should be named as a noun.
Process • The work or actions performed on data so that they are
transformed, stored or distributed.
• Represents the transformation of data in the system. This
represents something that happens in the system.
• Represented by a circle or rounded rectangle.
• Should be named as a verb.

External Entity • The origin and/or destination of data.

• Also called a 'Source/Sink'.
• Represented by a square or oval.
Data Store • Repository for data.
• Represented by two parallel lines, sometimes connected by a
vertical line.
Figure 3.14 shows the symbols used for DFD.
Figure 3.14: Data flow diagram symbols

Source: Romney & Steinbart. Accounting information systems 9/E. New Jersey: Prentice Hall.
Basic data flow diagram elements are shown in Figure 3.15. The external entities
are A, J and K, where A is the source and J, K are the destination. The system
starts at A where it generates data flow B which is then goes to process C. The
outputs for process C are data flows D and E. E then goes to J, while D goes to
process F. Process F uses data flow D and G and later on process the data. The
process then will produce output G and I. The data flow I is sent to the external
entity or data destination, K. Figure 3.16 shows the data flow diagram of
customer payment which is related to Figure 3.15.

Figure 3.15: Basic data flow diagram elements

Figure 3.16: Data flow diagram of customer payment process

Data flow may consist of more than one data element. Therefore it is important to
decide on the number of line required for the data flow. For example, sometimes
customer has made payment and would like to query regarding their payment.
So, here the different data flow should be used because the payment and
inquiries is different in terms of the purposes. Refer to Figure 3.16.

Figure 3.17: Splitting customer payments and inquiries

Decomposition of DFD can be defined as the act of going from a single system to
its component processes or in other words from the highest level DFD to the
lowest level. The highest level view of the system is a context diagram.
A context diagram is a special DFD that is designed to show the system and the
external entities that send data to and/or receive data from the information system.
It contains only one process, no data stores, data flows and the external entities
(sources/sinks). The sources/sinks represent its environmental boundaries.
Figure 3.18 shows the context diagram of a payroll processing procedure. The
employee data is received from the human resource department, while the time
card received from various departments. These data then will be processed and
the system produces four different data that are:
(i) Tax report and payment for government agencies.
(ii) Employee payment for employees.
(iii) Payroll account deposit at the bank.
(iv) Payroll report for the management.

Figure 3.18: Context diagram for payroll processing

Table 3.6 shows the major processing activities and data flows involved in payroll
processing. Using the information in the table, the context diagram is
decomposed into lower level or we called it as Level 0 diagram, as shown in
Figure 3.19. The data coming from the human resources department were
grouped together and named as „employee data‰.
Table 3.6: Activities and Data Flows in Payroll Processing
Activities Data Inputs Data Outputs

Update • New employee form • Updated employee/payroll file
employee/payroll • Employee change form
file
• Employee/payroll file

Pay employees • Time cards • Employee checks

• Employee/payroll file • Payroll register
• Tax rates table • Updated employee/payroll file
• Payroll check
• Payroll cash disbursements
voucher
Prepare reports • Employee/payroll file • Payroll report
Pay taxes • Employee/payroll file • Tax report
• Tax payment
• Payroll tax cash disbursements
voucher
• Updated employee/payroll file
Update general • Payroll tax cash • Updated general ledger
ledger disbursements voucher
• Payroll cash
disbursements voucher
Figure 3.19: DFD for payroll processing


The level 1 for Process 2.0 (pay employees) is shown in Figure 3.20. It expands
employees pay process into more detail process. Each of the process in Figure
3.19 can be decomposed into their own level 1 diagram to show the detail
processes.
Figure 3.20: DFD for process 2.0 in payroll processing

3.3.3 Flowcharts
A flowchart is a formalised graphic representation of a program logic sequence,
work or manufacturing process. It describes the physical relationship between the
entities or components.
Figure 3.21 shows the symbols used to create flowcharts. Each symbol represents
different processes or tasks. Besides flow charts use special connector symbols to
jump between positions on a same page and from other page to another page.
This are very useful to lessen the mess happened when the flow lines go across
each other.

Figure 3.21: Common flowcharting symbols


Figure 3.21: Common flowcharting symbols (cont)
Basically there are three types of flowchart.
(a) Document Flowchart

Document flowchart shows the flow of documents through the system. It
illustrates the relationship among processes and the documents that flow
between them. This flowchart is much more details if compare to data flow
diagrams. We can see the separation of functions in one system. The
flowchart is very useful to refer when analysing whether the control
procedures are sufficient or not. It can disclose any weaknesses in the
system such as lack of communication flows. Figure 3.22 is the example of
flowchart which clearly shows the departments/functions involved in a
system.

Figure 3.22: Flowchart showing areas of activity

(b) System Flowchart

System flowcharts are used to represent the relationship between parts of a
system that are the inputs, processes and outputs. It also shows the type of
media that is being used for a particular system such as magnetic disks and
file.
Figure 3.23 shows the example of system flowchart for sales processing.
Sales terminal are used to capture sales. The terminals will edit the sales
data and print out receipt for customer. The sales data will be stored in the
sales data file on a disk. At the end of each day, the sales data will be
summarised and the batch totals will be printed. Example of batch total is
the total sales for all sales transactions. The summarised data will be
processed again and same goes to the batch total that will be generated and
printed once more. The amount of batch totals then will be compared with
the batch totals generated from the earlier processing. All errors and
exceptions will be reconciled. The accounts receivable, inventory, sales
marketing databases and the general ledger will be updated. Users can use
the inquiry processing system in order to know the account and inventory
status and also the sales analysis.

Figure 3.23: System flowcharts of sales processing.

(c) Program Flowchart

A program flowchart illustrates the logic used in programs. This flowchart
shows the detail of each process for each program that exists in a system
flowchart. Figure 3.24 shows the relationship between system and program
flowchart.

Figure 3.24: Relationship between system and program flowcharts

SELF-CHECK 3.3
Differentiate System Flowchart to ProgramÊs Flowchart. Fill in the table
below for your comparison.
SystemÊs Flowchart ProgramÊs Flowchart
• Previously, most businesses used paper source document to initially collect

data about their business activities and then transferred the data into the
computer. However, it has changed now where most of the data about
business activities are recorded directly through computer data entry screens.
• Documentation includes the narratives, flowcharts, diagrams, and other
written material that explain how a system works.
• Each one of the documentation serves different functionality for the
organisation.

Archive file General ledgers

Attributes Journal
Batch Master file
Cardinality Product document
Chart of accounts Reference file
Data flow diagram Sales journal
Document flowcharts Source document
Entity Special journal
ERD Subsidiary ledgers
Flowcharts System flowcharts
General journal Transaction file
Boockholdt, J. L. (1999). Accounting information systems. Singapore: McGraw-

Hill.
Dunn, C., Cherrington, J.O & Hollander, A.S. (2005). Enterprise information
systems: A pattern-based approach (3rd ed.). Mc Graw Hill.
James, A. H. (2001). Accounting information systems. Ohio: Thomson Learning.
Romney & Steinbart. Accounting information systems 9/E. New Jersey: Prentice
Hall.

Topic X Control and
4 Accounting
Information
Systems
LEARNING OUTCOMES
1. Discuss the need for control and audit of accounting information
systems;
2. Examine the effects of computers on traditional internal control
principles; and
3. Identify the general control and application control of computer
based control.
X INTRODUCTION
Figure 4.1: Computerised system vs manual system
What can you conclude from the cartoon strip shown above? What would
happen if a business losses control over their accounting transactions?

TOPIC 4 CONTROL AND ACCOUNTING INFORMATION SYSTEMS W 63
Computers perform much of the data processing required in both the private and
public sectors of our economies today. The accounting information systems are
now getting more complex in order to meet the increasing needs of information
by the society. Therefore, it is important to maintain the data integrity while
processing it because people could always question the control implemented
during the data processing. Uncontrolled use of computers can have a
widespread impact on a society.
In this topic, we will discuss on why we need control in accounting information

system at the first place. Secondly, we will explore the control concepts including
itÊs objectives, types of functions and the nine major effects of internal control in
AIS. Then, we will learn about management framework on computer based
control in AIS. Finally, we will discuss on the applications of computer based
information system controls in AIS.
4.1 NEED FOR CONTROL AND AUDIT OF

COMPUTERS
Let us begin by looking at why in the first place we need to have the audit for
computers. Nowadays, computers are being used extensively to help/ease the
business operations of an organisation. It is also provide data for the decision making
process. Because of the functions of the computers and also the decreasing cost of
computer technology, it makes more organisations keen to use the computers to
process their data. Therefore, it is significant to control the use of the computers.
There are seven major reasons for establishing a function to examine controls
over computer-based data processing, as summarised by Figure 4.2.

64 X TOPIC 4 CONTROL AND ACCOUNTING INFORMATION SYSTEMS
Figure 4.2: Why we need to examine the controls computer-based data processing
These seven points will be explained in the next subsections.
4.1.1 Organisational Costs of Data Loss

Data is one of the major and important resources needed by an organisation to
continue with their business operations. Anything happened to the data can
effect the organisation.
For example, a large department store could face problems when anything
unexpected happened such as the accounts receivable has been destroyed. Unless
its customers are honest and can remember what they have purchased from the
store, the firm might suffer a big loss when customers fail to pay their debts. If
there are no proper back-ups for the computer data, the loss of data through
program error, natural disaster and others could happened. Thus, the data cannot
be recovered and as a result, the business operations of the organisations could be
disrupted. This can happened when existing controls for the computers are taken
for granted.

4.1.2 Incorrect Decision Making

The decision making process is part of the task for the managers. Managers
normally require data for this process. The quality of the decisions is depending
on the quality of the data. Therefore, it is important for an organisation to have
control over their computers and data.
Figure 4.3: Quality decisions is depending on the quality of data
The importance of accurate data in a computer system depends on the types of

decisions made. If managers are dealing with the strategic planning decisions,
some errors of the data can be tolerated. If managers are making the management
and operational control decisions, any errors could not be tolerated.
4.1.3 Costs of Computer Abuse

Computer abuse is the negligent unauthorised activity that affects the
availability, confidentiality, or integrity of computer resources. Computer abuse
includes fraud, theft, malicious damage, viruses, unauthorised use, denial of
service and abuse of privileges. If this happens, the business operations could
also be disrupted.
4.1.4 Value of Computer Hardware, Software and

Personnel
Besides data, computer hardware, software and personnel are part of the
components of an information system. Thus, it is important to take great care of
these components. An organisation might invest millions in hardware and
software. If hardware failure happened or the software corrupted, then the
organisation might be unable to continue their business operations. The
personnel are important to assist the organisation to achieve its missions and
goals. Besides personnel is the one who operate and maintain the information
systems for the organisation.

4.1.5 High Costs of Computer Error

ACTIVITY 4.1
Imagine you are in a supermarket checking out a bag of sugar. The

price listed on the display rack was RM 1.40 per pack. When the
cashier scans the sugar pack, the monitor displays RM14.00 per pack.
How do you think human error can contribute to computer error?
Nowadays, computers have carried out many important and vital functions in
the organisation. For example, computers monitor the condition of patients
during surgical procedure, direct the flight of a missile and others. Thus, any
error occur to the computers could end up in loss of life, permanent disability of
people or damage to the environment.
4.1.6 Maintenance of Privacy

Data is one of the important resources for the organisation. Today, people tend to
give their data to any organisation for taxation, medical, educational, banking,
and employment purposes. When submitting the data to the respective
organisation, people could be questioning whether those organisations protect
their data or not. People are concerned about the privacy of their own data. This
include whether the data has been passed to other parties, the data has been used
for other purposes or the data is being used to represent other people. This could
happen when there is no control on the data and this can lead to a disastrous
situation.
4.1.7 Controlled Evolution of Computer Use

Occasionally, people are concern about the use of computer technology in the
society. Example such as the use of computers to support the nuclear weapons
command control systems and the use of computers to replace the human being jobs.
ACTIVITY 4.2
What do you think of replacing human toll operators at all lanes of PLUS
highway to the automatic toll booth lanes (like Touch and Go and Smart
Tag)? Will this affect the rate of unemployment in the country?

SELF-CHECK 4.1
1. What is the best way to prevent loss of data?

2. Computer abuse includes seven primary activities. Name four
of them.
4.2 OVERVIEW OF CONTROL CONCEPTS

Internal control is broadly defined as a process designed to provide reasonable
assurance regarding the achievement of objectives in the following categories:
(a) Effectiveness and efficiency of operations
(b) Reliability of financial reporting
(c) Compliance with applicable laws and regulations
(d) Safeguarding of assets
The internal control structure consists of the policies and procedures. These are
used to provide a reasonable level of assurance so that the organisationÊs
objectives will be accomplished.
ACTIVITY 4.3
Why do you think organisation needs auditor?
4.2.1 Functions of Internal Control

Internal controls carry out three important functions as summarised by Table 4.1.
Table 4.1: Three Important Functions of Internal Controls
Controls Descriptions
Preventive Preventive controls are designed to avoid any possible future problems.
controls This is the most cost-effective compare to detective controls. When
implementing this control, it hinders errors and thus avoids the cost of
correction. Examples of preventive controls include effective control of
physical access to assets and data, proper segregation of the employee
tasks and competent personnel.

Detective These controls are needed because sometimes the problems cannot be
controls prevented. The controls will find out the problems once they occur.
Detective controls are usually more expensive than preventive controls.
Example is such as double checking of the calculations, confirmation of
bank balances and systems review (internal auditing).
Corrective These controls are designed to correct errors once they are detected. This
controls includes procedures taken to identify the cause of a problem, fix the
errors and do the modification to the system so that the future problems
are eliminated or at least minimised. Examples are such as
documentation and reporting systems to keep problems under
management observation until they have been solved or the defect has
been corrected and back-up procedures.
4.2.2 Effects of Computers on Internal Controls

The implementation of internal control in an organisation can assure the
organisation achieve the goals of asset safeguarding, data integrity, system
effectiveness and system efficiency.
The use of computers affects the implementation of these internal control

components (refer Figure 4.4).
Figure 4.4: Effects of internal control implementation

These controls have been implemented and tailored to fit in with a computer
environment. The following subsections will briefly explain these components.
(a) Separation of Duties

In a manual system, different personnel should be responsible for the
authorisation of transactions, recording transactions and custody of the
assets. With the separation of duties, it can prevent or detect errors and
abnormalities.
In a computer system, this idea of separation of duties does not always

apply. For example, a program can reconcile a vendor invoice against a
receiving document and print a cheque for the amount to be paid to a
creditor. These functions are considered as incompatible in the manual
system. However, it might be inefficient and ineffective to put these
functions in separate programs. As an alternative, separation of duties must
be presented in a different form. Once it is confirmed the program executes
properly, the capability/ability to run the program in production mode and
the capability/ability to change the program must be separated.
(b) Delegation of Authority and Responsibility

Both manual and computer systems required a clear delegation of authority
and responsibility. In computer systems, some resources are shared among
multiple users, therefore the delegation process is not so easy. When
multiple users access the same data and the integrity of the data is violated,
then the respective personnel have to trace who is responsible for violating
the data, identifying and correcting the error.
Most of the organisations have tried to overcome this problem by assigning

a single user as the owner of the data. This user is responsible for the
integrity of the data in the organisation.
In end user computing, users are involved in developing, modifying,

operating and maintaining their own systems. Therefore, the delegation of
authority and responsibility is unclear for end user computing.
(c) Competent and Trustworthy Personnel

It is not easy to find good and well trained information system personnel.
Due to high turnover rate, it is difficult to evaluate the competency and
integrity of the personnel. With the emerging of technology, it has reduced
the managementÊs ability to evaluate the skills of information systems
personnel.

(d) System of Authorisations

In a manual system, the work of personnel are being examine in order to
evaluate whether the procedures of authorisation is sufficient or not.
In a computer system, the authorisation procedures and computer program

are embedded together. For example, in the sales system, the order entry
module might determine the price to be charged to the customer. Therefore,
auditors need to examine both the work of personnel and authenticity of the
program processing.
(e) Adequate Documents and Records

In a manual system, an audit trail of activities within the system required
sufficient documents and records.
In a computer system, the initiation, execution and recording of some

transactions does not need any documents. For example, customerÊs order
received by telephone in the online system will be entered directly into the
system. So, no document is required to initiate the order transaction. In
certain cases, some transactions can be activated automatically by the
system. For example, the inventory program could automatically reorder
items when stock level fall below a certain quantity. Thus, it is not possible
to trace the transaction. The nonexistence of a visible audit trail is not a
problem for auditors, provided that system have been designed to maintain
a record for all events and the record can be easily accessed.
(f) Physical Control Over Assets and Records

Physical control over access to assets and records is crucial in both manual
and computer systems. However, it differs between both systems.
In a manual system, an individual who wish to commit a fraud, may need

to go to the different physical location to access the records.
In a computer system, all records are normally maintained at one site where
the computer is located. Therefore the individual who wish to commit a
fraud does not need to go the different location to access the record.
(g) Adequate Management Supervision

In a manual system, the supervision of personnel activities and work is a
simple and easy task. It is because the managers and personnel are often at
the same site.

In a computer system, the supervision of personnel activities and work need

to be carried out distantly. The computer system must have a build-in
administrative control to monitor the employee through observation and
inquiry. It also makes the personnel activities less observable/noticeable.
From time to time managers must access the audit trail of their personnel
activities and observe it for unauthorised activities.
(h) Independent Checks on Performance

In a manual system, independent checks are carried out because normally
personnel tend to forget the procedures, make actual mistakes and fail to
follow the given procedures. This activity is done by an independent party.
It helps to discover any errors or abnormalities.
In a computer system, an independent check on performance normally does

not have so much value. Usually the program code in a computer system is
authorised, accurate and complete, thus the procedures will be always
followed by the computer system. As an alternative, the controls more focus
to the authenticity of the program code.
(i) Comparing Recorded Accountability with Assets

Data and the assets that the data claim to represent should be compared
periodically to determine its incompleteness and accuracies.
In a manual system, independent personnel prepare the data for comparison

and evaluation purposes.
In a computer system, the data is prepared using the software embedded in

the computer system. For example, sorting an inventory file by warehouse
location and preparing counts by inventory item at the different
warehouses can be done by implementing a program into the computer
system. Abnormalities might not be discovered if unauthorised changes
happen to the program or data files the program uses. Example when
someone steals an inventory item from a warehouse. Hence, the internal
controls must be applied to make sure the authenticity of program code.
This is because the data prepared for comparison purposes cannot be
applied with the traditional separation of duties.

SELF-CHECK 4.2
1. How the use of computerized system can affect the top

management decision making?
2. In manual systems, how do work personnel be given access to
important documents?
4.3 COMPUTER-BASED INFORMATION

SYSTEMS CONTROL
ACTIVITY 4.4
Think about a manager in your current or previous job. Why

managers are important in motivating subordinates to work?
4.3.1 The Management Control Framework

The management control framework in computer-based information systems
consist of:
(a) Top Management Control
(b) System Development Control
(c) Programming Management Control
(d) Data Resource Management Controls
(e) Security Management Control
(f) Operations Management Control
(g) Quality Assurance Management Controls
Now, let us look at these frameworks in more detail.

(a) Top Management Control
An organisationÊs information system must be aligned with a company's
business vision and strategic business goals. Thus, the management needs
to prepare a master plan for the information systems function. The plan
consists of short-term and long-term goals. All projects which the

organisation needs to complete in order to enable the organisation achieve

its long and short range goals must be included in the plan.
A strategic plan is normally related to the long-term planning, which is

three to five years into the future. The contents of a strategic plan are as
following:
(i) Current information assessment

This includes the information on the existing or current information
systems such as the functions, the capabilities of the system, the
advantages and disadvantages of the system.
The hardware and software used for the current information systems
also provided in this assessment. Besides, the current personnel
resources and the current threats and opportunities are also included.
(ii) Strategic directions

This includes the information on the future information systems and
also the strategies for intra-organisational and inter-organisational.
(iii) Development strategy

The development strategy consists of:
• The vision statement for information technology.
• The databases required for the future information systems.
• The hardware and software for the future information systems.
• The future personnel resources.
• The future financial resources.
• The methods required for monitoring the implementation of the
strategy.
The operational plan is normally the short-term planning, which it can be weeks,
months or years (maximum to three years) into the future. The contents of an
operational plan are summarised in Table 4.2:

Table 4.2: Content of Operational Plan
No. Content Descriptions
1. Progress report (a) List of achieved and failed current planned proposal.
(b) Changes on major hardware and software platform.
(c) Additional ideas and plans to start the project.
2. Initiatives to be (a) Acquisition of personnel resources.

undertaken (b) Acquisition of financial resources.
(c) The systems that are going to be developed.
(d) Changes on hardware and software platform.
3. Implementation This includes the timeline for the project/plan. It should

schedule have the estimated start and finish dates. The control
procedures that need to be applied also included in the
implementation schedule.
Both the strategic and operational plan need to be reviewed frequently and
updated if necessary. Evaluation should take place few times a year to make sure
that any new systems components can be added and the current ones can be
maintained. During the evaluation process, the functionality, stability,
complexity, cost, strengths and weaknesses of the current system need to be
assessed. These criteria are assessed in order to know whether it is sufficient to
supports the organisationÊs business needs. The user should be asked on the
system they used, whether it meets their requirement or they need any new
technologies to be used. Therefore, the management should prepare and approve
the plan along with the sufficient budgets. Besides, the management should
allocate budget for an emergencies case such as changes of new hard disk
because of hard disk failure and also any unexpected maintenance requirements.
The controlling functions by the top management are also very critical. The
controlling functions involved in controlling the information systems activities
and also control the users of information services. This function also involves in
determining the when the actual activities of the information systems is different
with the planned activities.
The management should carry out control towards the activities done by the
information systems personnel through the implementation of:
• Standards - provided specific guidelines for behaviour.

• Policies - provided broad and general guidelines for behaviour.

Both standards and policies should be documented, reviewed frequently and

updated if necessary. Then these documents must be disseminated among the
staff. Existing staff must always be reminded and the new staff must be informed
of the policies and standards. The management should also develop policies and
implement procedures that encourage users to use the information services
effectively and efficiently.
Another control that is important is the implementation of documentation and

procedures. Quality documentation assists in communication and progress
review during the system development process. It can also used by the new staff
who involved with the system development. Besides, the documentation is useful
when it comes to the system maintenance especially when the original
programmer resigns and other people took over his or her work.
ACTIVITY 4.5
Write a short paragraph on what do you understand about

„Standard Operating Procedures‰? Post your opinion in myLMS
forum and compare your answer with other coursemates.
(b) System Development Control

Preventive controls are appropriate procedures for system and program
changes. Those controls lessen the errors and abnormalities created by new
systems or when changes happened to the existing system.
An organisation should form a steering committee to involve in reviewing the

proposed new system. This is to prevent the implementation of new systems that
are inefficient, ineffective and did not meet the organisationÊs requirements.
Documentation is an essential thing to be considered. All manual and

computerised procedures should have sufficient documentation. It enables
programmers and analysts to understand the existing procedures before
performing any changes. Documentation provides auditors with the necessary
information during the auditing activity. The organisation should have
required procedures for authorising and documenting changes to existing
programs and systems. When the maintenance process takes place, the
programmer does the changes to the system. Chief Information Officer requires
the programmer to list down the changes in the program change record. At the
same time, programmer needs to do changes in the documentation too. The
Chief Information Officer then reviews the changes and its documentation.
This procedure prevents changes that would cause errors or abnormalities.

Testing must be done by the people who are involved in the development
process. The new system must be tested and modify it if necessary before
implementing it. This is to minimize errors after the system has been
installed. Some of the testing includes system testing, unit testing,
acceptance testing and others.
(c) Programming Management Control

Programmer is one of the personnel who involved in the development
process. Programmers are often classified as:
(i) Application programmers

Develop and maintain programs for application systems.
(ii) System programmers

Develop and maintain system software. System software is a software
such as operating systems, database management systems, and
communications software, which provides general functions useful to
a wide range of application software.
Both of the system can present substantial control problems for the
management. System software is critical to an organisation; therefore errors
in system software can affect any application systems that use the system
software. Moreover, system software frequently has to run in privileged
mode to carry out its functions. The privilege mode here refers to a special
execution status that enables the system to avoid many standard controls,
which this status can be abused. For example, system software might be used
to gain unauthorised access to private data that can be sold to competitors.
It is a difficult task to control the system programmers, where they normally

work individually or in a small group. Therefore, it is difficult to implement
the controls such as separation of duties and independent checks on
performance. Sometimes, the programmers need power for producing the
best work especially in the situation where they are working in the tight
deadlines. Some of the following measures can be implemented to minimize
the controlling problems towards the programmers:
(i) Hire only high-quality system programming staff

Management needs to be strict during checking the candidateÊs
background and interviewing when hiring system programmers.

(ii) Separate duties to the most possible extend

Separation of duties should be implemented if more than one system
programmer is employed. For example, one programmer will do the
coding and another one will do the testing.
(iii) Develop and document methods and performance standards

System programmers should know what is expected from them and
understand that they should follow the organisationÊs approach, so
that it is similar to the organisationÊs control objectives.
(iv) Restrict the powers of system programmers

During production periods, system programmers should only have
the same powers as application programmers, meaning that they
should not be allowed to play around with the system software. In
addition, they should be allowed to develop and test system software
that runs in privileged mode only during special test periods.
(v) Keep a manual and machine log of system programmer activities

Each system programmer should have secure logs of their activities.
These logs should be analysed frequently to verify whether
unauthorised activities have occurred.
(vi) Employ outside consultants to evaluate system programming work

If internal expertise is not available to evaluate the work of system
programmers, outside experts might be hired from time to time to
review the work of system programmers.
(vii) Have application programmers periodically evaluate system programmers

The quality of work carry out by the system programmer could be
evaluated by the system programming group.
Besides the above measures, actually the most important control that can be
implemented is to train the system programmers to follow the organisationÊs
policies. If the management exercising high ethical behaviour and informing
a clear expectation that all employees must follow this standard, then the
system programmer might think it is difficult to abuse their power.
(d) Data Resource Management Controls

Information systems process many sets of data every day. When an event
occurs that destroys one or more of them, data backup procedures can be
used to prevent the loss of data. Such events are like floods, lightning,
hacking and others. For these reasons, computer operators regularly make
backup copies of all computer data, which is stored later in different

location with the original data. If the data is destroyed or loss, the person in
charge can retrieve back the data from the backup copy.
The management usually comes out with control policies that describe the
data backup procedures. These policies include:
(i) Procedures for making copies of the data.
(ii) Storing the data separately from the original.
(iii) Reconstruct the data if they are destroyed.
The nature of these procedures depends on the processing method and on the
technology use by the accounting system. The back up procedures in batch
processing, online real time systems and local area networks is different as
explained in the followings:
(i) Data backup in batch processing systems

The standard method for backing up data in a batch processing
system, or a batch system with online update, uses the grandfather-
father-son technique. It requires the data center to be available at all
times three generations for each master file. The most recent version of
the master file is the „son‰. Employees use this generation in daily
processing, and it requires a backup copy. The previous generation
master file, the „father‰, is the version that was updated to produce
the current one. If the current file is destroyed, computer operators can
recreate it from the father. The „grandfather‰ is the version that was
updated to produce the father. Computer operators can use it to
recreate both the father and the son.
Figure 4.5: Grandfather-father-son technique

The grandfather-father-son technique works well in batch processing

systems because these systems update master files daily, weekly, or
monthly. An online real time system updates its master files
continually and it is not cost effective for this systems.
(ii) Data backup in online real time systems

The standard method of file backup in online real time systems uses a
transaction log with periodic master file dumps. A file dump occurs
when the computer operator copies the contents of an online data set to
a removable device. This serves as a backup of the data set in case the
original online copy is destroyed. Management establishes policies that
determine how frequently file dumps should occur, but commonly they
are done once or twice each day. The file dump provides a backup data
set as of the time of the dump. But because transactions occur
continually in an online real time system, the backup copy quickly
becomes out of date. As a result, the computer operator also maintains a
transaction log. This contains a copy of all transactions posted to the
data set since the last file dump. While posting a transaction to the data
set, the system also copies it to the transaction log. If the online data set
is accidentally destroyed, the operator recreates it from the transaction
log and the most recent file dump.
(iii) Data backup in local area networks

Local area networks (LANs) store data on workstations and on file
servers. Making regular backups is important in these systems because
these data devices are less protected than those in a data center.
A file server frequently has attached to it a backup disk or tape drive.

The LAN administrator periodically copies the contents of all files to a
magnetic disk or tape mounted in this drive. The same drive may
contain another disk or tape used as a transaction log while the LAN is
in operation. Procedures for routine backups at the file server are
important because users of individual workstations frequently forget
to make backup copies.
Workstation users, like operators of all personal computers, should make

regular backup copies of files stored at their locations. Many use
magnetic diskettes for this purpose, although individual workstations
may also include backup drives. The following are good procedures for
making data backups with workstations and personal computer systems
(refer Figure 4.6).

Figure 4.6: Good procedures for making data backups
• Make full backups

Most backup system can, if the user wishes, back up only files that
have changed since the last backup. However, backing up all files
(including those that have not changed) makes the process of
restoring damaged files much easier.
• Back up applications programs

This avoids having to reinstall and customize a program from its
original diskettes.
• Use the verify option

Most of the backup systems can copy the file and then read it to
verify that the copy is correct. This is to ensure that the backup file
is similar to the original file.

• Back up every day

Most of the backup systems can do this automatically.
• Test the backups

The only way to be sure the backup system works properly is to
periodically restore the backups and test the restored files.
• Store backup copies off-site

This protects from loss of data due to unavoidable circumstances
at the user location.
• Maintain a boot disk

This is a copy of the computerÊs startup configuration and operating
system made by a utility program. It can be used to recreate the
hardware settings in case of a complete hard drive failure.
• Save some tapes or disks permanently

A common practice is to save all data each month. This is useful if
someone wants to recreate a file that was erased several months before.
• Rotate new tapes and disks

Tapes and disks have a limited life time; therefore the current ones
can be used for certain periods only. By changing to the new ones,
it can reduce the chance of tape or disk failure.
A contingency plan is a formal document that describes procedures to deal

with unusual events that are not part of the normal daily routine.
Contingency plans describe the response necessary to deal with the types of
event that may occur such as fires, explosions, floods and others. A
contingency plan affects several crucial accounting applications; therefore it
can be considered a general control. Proper segregation of duties at the data
center requires that critical functions performed at the data center be
separated.

A contingency plan should include:
1 Adequate insurance coverage
2 Designate an alternative processing

location
3 Identify vital applications
4 Designate an off-site storage

location
5 Assign responsibility
Figure 4.7: Contingency plan
• Provide adequate insurance coverage

Insurance should be adequate to replace equipments and software
destroyed during unexpected events. Management should also
purchase business loss insurance, which compensates the organisation
for the costs of reconstructing the database and for any revenues lost
due to computer downtime.
• Designate an alternative processing location

If a data center is destroyed, the MIS activity may require many months
to place it in operation again. Therefore, it is important for the
organisation to have another data centers at a different location. The
alternative site must have similar processing capacity to process all
crucial applications.
• Identify vital applications

Vital applications are the applications that the organisation requires to
continue operating. If a data center is destroyed, the MIS activity must
implement these applications first at an alternative processing location.
Management must identify vital applications and ensure that they can
be implemented quickly at the alternative site.
• Designate an off-site storage location

Management should find a new place at a different location from the
data center. This is to store items necessary to continue operating the
vital applications. These include copies of system software, programs,
backup data files, documentation and operating instructions.

• Assign responsibility
Management should assign responsibility to an individual for
maintaining and implementing an up to date contingency plan.
Someone must be appointed and how they can be contacted if
something happens. If the key personnel are unavailable, a list of
alternative personnel and how they can be contacted must be included.
The plan should also identify and assign other responsibilities necessary
to begin operation at the alternative site.
(e) Security Management Control

Information security administrators are responsible for ensuring that
information systems assets are secure. Assets are secure when the expected
losses that will occur over some time are at an acceptable level. There are
two types of information security:
(i) Physical security

Protects the physical information system assets of an organisation
such as personnel, hardware, facilities, supplies, and documentation.
(ii) Logical security

Protects data/information and software.
Security administrators have responsibility for controls over malicious and non
malicious threats to physical security and malicious threats to logical security.
A major task of security administrators is to conduct a security program, which
is a is a series of ongoing, regular, periodic reviews conducted to ensure that
assets associated with the information systems functions are safeguarded
adequately.
Authority and responsibility must be clearly divided among various

functions in an organisation. Table 4.3 summarises various functions and
their responsibility.
Table 4.3: Authority and Responsibility among Various Functions
Functions Responsibilities
System administration Systems administrators are responsible for ensuring that the
different parts of an information system operate smoothly
and efficiently.
Network management Network managers ensure that all applicable devices are
linked to the organisationÊs internal and external networks
and operate continuously and properly.

Security management Security management is charged with ensuring that all

aspects of the system are secure and protected from all
internal and external threats.
Change management These individuals manage all changes to an organisationÊs
information system to ensure they are made smoothly and
efficiently and to prevent errors and fraud.
Users Users of departmentÊs record transactions, authorise data to
be processed, and use system output.
System analysis Systems analyst helps users determine their information
needs and then design an information system to meet those
needs.
Programming Programmers take the design provided by systems analysts
and create an information system by writing the computer
programs.
Computer operations Computer operations run the software on the companyÊs
computers. They ensure that data are properly input to the
computer, processed correctly, and needed output is
produced.
Information system The information system librarian maintains custody of
library corporate databases, files, and programs in a separate
storage area called the information system library.
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.
It is important to ensure that different people carry out these functions.

Allowing a person to do two or more jobs exposes the company to the
possibility of fraud.
These physical access controls can be used to ensure the security of a system:
(i) Computer equipment should be kept in a locked room with access
restricted to authorised personnel.
(ii) The entrance to the computer room should be limited to maximum
two entrances. Security guards should be placed near the room and
closed circuit television system must be installed.
(iii) Personnel should be provided with an ID which is used to enter the
buildings or rooms. The entry and exit for each employee can be
recorded and traced.

(iv) Require visitors to sign a log as they enter and leave the site. Brief
them on company security policies, assign visitorÊs badges, and escort
them to their destinations.
(v) Use a security alarm system to detect unauthorised access after
working hours.
(vi) Restrict access to private, secured telephone lines or to authorised
terminals or PCs.
(vii) Install locks on PCs and other computer devices.
(viii) Restrict access to off-line programs, data and equipments.
(ix) Locate hardware and other critical system components away from
dangerous or flammable materials.
(x) Install fire and smoke detectors and fire extinguishers.
For logical access control, users should be allowed to access data they are
authorised to use and view. They also can perform specific functions only
such as viewing, copying, inserting and deleting data. It is also important to
protect data from those outside the organisation.
To restrict logical access, a system must differentiate between authorised and

unauthorised users, utilise what the user knows or possesses, where the user is
accessing the system, or some personal characteristics. Refer to the followings:
(i) User IDs and passwords

A password mechanism is the most popular method used to
authenticate a user. Anyway this mechanism cannot guarantee that
the real user is who the system acknowledges him/her to be. When
signing on to a system, users identify themselves by entering a unique
user ID. Users then enter password. If the user-entered ID and
password match those in the computer, then the system assume it is
an authorised user. In addition, the user could be asked a personal
question such as motherÊs maiden name, favorite car and others. This
normally has been set during the registration of user ID.
(ii) Physical possession identification

People can be identified by ID cards that contain a personÊs name, ID
number, picture, and other related information. Some of the cards can
be read by computer and/or security devices such as door locks.
Security can be increased significantly if a user is required to have
both an ID card and a password before accessing to the system.

(iii) Biometric identification

Biometrics is automated methods of recognising a person based on a
physiological or behavioural characteristic such as fingerprints, voice
patterns, retina prints, facial patterns and others. Biometric technologies
are becoming the foundation of an extensive array of highly secure
identification and personal verification solutions. When a person needs
to access the system, he or she need to use the biometric identification,
which is matched against those stored in the computer.
(iv) Compatibility tests

Compatibility test use an access control matrix, which is a list of
authorised user ID numbers and passwords, a list of all files, data, and
programs; and the access each user has to them. When an individual
tries to access data or programs or operate the system, a compatibility
test should be performed to determine if the user is authorised to
perform the desired action. This procedure is to prevent both
unintentional errors and deliberate attempts to manipulate the system.
(f) Operations Management Control

Operations management is responsible for the daily running of hardware
and software facilities so that:
(i) Production application systems can accomplish their work.
(ii) Development staff can design, implement, and maintain application
systems.
Specifically, operations management performs nine major functions:

(i) Managing day-to-day operations of an organisationÊs hardware/software
platform. Managing wide area and local area network operations.
(ii) Managing data preparation and entry.
(iii) Operating a production control section to manage input/output,
schedule jobs, manage user service-level agreements, manage charge
out, and acquire consumables.
(iv) Managing an organisationÊs library of machine readable files.
(v) Managing the documentation that supports the information systems
function and the inventory of acquired and licensed software held by
an organisation.
(vi) Operating a help desk and technical support function for users of the
information systems function.

(vii) Monitoring performance and ensuring adequate hardware/software

capacity is available.
(viii) Managing operations that are outsourced.
Operations management must ensure that each function has its own methods
and performance standards. Besides, expert personnel are hired to perform
each function and operations personnel are trained and managed properly.
Control over computer operations govern the activities that support the
daily execution of either test or production systems. Three types of controls
that must exist are:
(i) Those that prescribe the functions that either human operators or
automated operations facilities must perform.
(ii) Those that prescribe how jobs are to be scheduled on the
hardware/software platform.
(iii) Those that prescribe how hardware is to be maintained in good
operating order.
Network operations govern the activities of wide area and local area
networks.
(i) In wide area networks, careful control should be exercised over
network control terminals. These terminals allow powerful access and
action privileges to be executed to monitor and maintain a network.
(ii) In local area networks, file servers must be secured. Unauthorised access
to a file server can allow an intruder to interrupt the operations of a local
area network or compromise data integrity within the network.
Data preparation and data entry facilities should be designed to promote

speed and accuracy. The data entry operators should be well trained to
perform data preparation and data entry tasks. Suitable backup must exist
for input data and data preparation and data entry devices.
In production control, the control must be exercised over receipt of input

and dispatch of output. This is to ensure the input is accepted only from
authorised parties, input is submitted on a timely basis and output is
provided only to authorise parties. Job schedules must be prepared to
ensure only authorised production jobs are performed.
(g) Quality Assurance Management Controls

Quality assurance personnel within the information systems function are
concerned with ensuring that the information systems achieved certain

quality goals and that development, implementation, operation, and

maintenance of information systems comply with a set of quality standards.
The QA function associated with the information systems functions has

takes place for six reasons:
(i) Increasing on organisations producing safety critical systems where
high levels of quality must be achieved.
(ii) Users are becoming more demanding about the quality of software
they use.
(iii) Organisations are undertaking more ambitious projects when they
build software.
(iv) Organisations have become more worried about their liabilities if they
produce and sell malfunctioning software.
(v) Poor control over the development, implementation, operation, and
maintenance of information systems can be costly.
(vi) Improving the quality of the goods and services so that they can
compete more effectively with their competitors.
Quality assurance personnel perform the following major functions:

(i) Developing quality goals for the information system function overall
and for individual information systems projects.
(ii) Developing, disseminate and maintaining standards for the
information systems function.
(iii) Monitoring compliance with QA standards.
(iv) Identifying areas for improvement.
(v) Reporting to management.
(vi) Training personnel in QA standards and procedures.
QA personnel must be well trained and competent. They must also have a
high level of interpersonal skills. Finding suitable people with the range of
skills required is quite difficult. Furthermore, many information systems
professionals prefer to work in development rather than quality assurance
roles.

4.3.2 The Application Control Framework

The main objective of application controls is to ensure the integrity of a specific
applicationÊs inputs, stored data, programs, data transmissions, and outputs.
General controls and application controls are necessary because application
controls will be much more effective in the presence of strong general controls. If
application controls are weak, the information system output is likely to contain
errors. Incorrect data can lead to poor management decision making and can
negatively affect a companyÊs relationship with customers, suppliers and other
external parties.
The application control framework consists of:

• Boundary control
• Input controls
• Communication controls
• Data Processing and Storage Controls
• Output controls
Figure 4.8: Application control framework

(a) Boundary Control

The boundary subsystem establishes the interface between the prospective
user of a computer system and the computer system itself. Controls in the
boundary subsystem have three major purposes:
(i) To establish the identity and authenticity of prospective users of a
computer system.
(ii) To establish the identity and authenticity of the resources that users
wish to utilise. Users must ensure that they are given valid resources.
(iii) To restrict the actions taken by users who obtain computer resources
to a set of authorised actions. Users may be allowed to utilise
resources only in restricted ways.
There is a marked increase in the use of and strength of boundary controls

today due to:
(i) Widespread deployment of distributed systems has resulted in many
users being isolated physically.
(ii) The rapid growth of electronic commerce systems has resulted in
substantial work being undertaken on measures to identify and
authenticate the parties who exchange monies via these systems.
Several major types of controls that are being used in the boundary
subsystem are summarised in Table 4.4.
Table 4.4: Type of Controls Being Used in Boundary Subsystem
Controls Descriptions
Cryptographic Controls can be used to protect the integrity of data used
within the boundary subsystem.
Access controls Can be used to prevent unauthorised access to and use of
resources.
Audit trail Events in the boundary subsystem must be recorded in an
accounting audit trail. An operations audit trail records
resource-oriented events.
Existence controls This is to restore the boundary subsystem in the event of
failure.

(b) Input Controls

Components in the input subsystem are responsible for bringing both data
and instructions into an application system. Both types of input must be
validated. Any errors detected must be controlled to ensure the input is
accurate, complete, unique and timely.
There are different types of approaches used to enter data into an

application system:
(i) Immediate entry of data into an application system.
(ii) Recording the data on some type of medium prior to the data being
entered into an application system.
The following source data controls regulate the integrity of input:
(i) Form design

Source documents and other forms should be designed to help in
minimizing errors and exceptions. Forms are normally prenumbered
to ensure the better control.
(ii) Prenumbered forms sequence test

When sequentially prenumbered forms are used, the system should be
programmed to identify and report missing or duplicate form
numbers.
(iii) Turnaround documents

A turnaround document is a record of company data sent to an
external party and then returned by the external party to the system as
an input. Turnaround documents are prepared in machine-readable
form to facilitate their subsequent processing as input records.
Because turnaround documents are system outputs that come back as
machine-readable input records, they are much more accurate than
input records prepared by manual keying. An example is a utility bill
that requires a special scanning device to read the bar code when the
bill is returned with a payment.
(iv) Cancellation and storage of documents

Documents that have been entered into the system previously should
be canceled so they cannot be unintentionally or illegally reentered
into the system. Paper documents can be destroyed, such as stamping
them paid. For an electronic document, a flag can be placed in the
database as an indicator that the document has been canceled.

Original source documents should be retained for as long as needed to

satisfy legal requirements.
(v) Authorisation and segregation of duties

Sufficient segregation of duties should be maintained to ensure the
source documents are prepared by authorised personnel.
(vi) Visual scanning

Source documents should be scanned for accuracy before being
entered into the system.
(vii) Check digit verification

A check digit that is computed from the other digits is contained in an
authorised ID numbers.
(viii) Key verification

It is expensive and used only for crucial input. It consists of an
employee re-keying data into the computer, which compares the two
sets of keystrokes and highlights inconsistencies for correction.
Figure 4.9 summarises edit check that are used in input validation routines.
Figure 4.9: Edit check that are used in input validation routines

(i) A sequence check tests if a batch of input data is in the proper

numerical or alphabetical sequence.
(ii) A field check determines if the characters in a field are of the proper
type. For example, a check on a numerical field would indicate an
error if it contained blanks or alphabetic characters.
(iii) A sign check determines if the data in a field have the appropriate
arithmetic sign. For example, data in an inventory balance field should
never possess a negative sign
(iv) A validity check compares ID numbers or transaction codes with those
already authorised. For example, if a sale to customer 12345 is entered,
the computer must locate customer 12345 in the customer database to
confirm that the sale was indeed made to a valid customer.
(v) A limit check tests a numerical amount to ensure that it does not
exceed a predetermined upper or lower limit. For example, the hours-
worked field in weekly payroll input can be compared with a
maximum amount, such as 60 hours.
(vi) A range check is similar to a limit check except that it has both upper
and lower limits. Range checks are used on transaction date fields,
since a date should be within a few days of the current date.
(vii) A reasonableness test determines the logical correctness of input and
stored data. For example, a RM1000 monthly salary increase is
reasonable for an executive with a current salary of RM15000 per
month but not for a data entry clerk making RM1000 per month.
(viii) A redundant data check uses two identifiers in each transaction record
to confirm that the correct database record has been updated. For
example, the customer account number and the first five letters of the
customerÊs name can be used to retrieve the correct customer master
record from the accounts receivable file.
(ix) A capacity check ensures that the data will fit into the assigned field.
For example, 2323421112 will not fit in an eight digit field.
(c) Communication Controls

The communication subsystem is responsible for transmitting data among
all the other subsystem within a system or for transmitting data to or
receiving data from another system. The integrity of data within the
subsystem can be damaged by destructions in transmission media such as
attenuation, distortion and noise, hardware and software component
failure, active subversive threats such as insertion, deletion, modification,

and duplication of messages, changes to the order of messages or denial of

messages services and others.
Two important controls that must be executed within the communication

subsystems are:
(i) Line error controls

Line errors can be detected via loop checks, parity checks, and cyclic
redundancy checks. They can be corrected using forward error
correction techniques or retransmission.
(ii) Flow controls

Flow controls are needed because two nodes in a network could be
different in terms of the rate at which they receive and process data.
The examples of flow control are:
• Stop-and-wait flow control - the simplest form.
• The sliding window flow control - more complex, but makes better
use of the available channel capacity.
Line controls and flow controls are combined within the link management
protocols applied over a communication line. Three widely used link
protocols are:
(i) HDLC
(ii) SDLC
(iii) ATM protocols
Several types of control can be used in the communication subsystem to

reduce exposure from subversive threats that are:
(i) Link encryption - used to protect the integrity of data traversing a
communication line between two nodes.
(ii) End-to-end encryption - used to protect the integrity of data passing
between a sender and receiver.
(iii) Stream ciphers - used to make it more difficult to analyse patterns in
cipher text.
(iv) Error propagation codes - used to detect unauthorised changes to
blocks of data in a message
(v) Message authentication codes - used to identify changes to the content
of a message.

(vi) Message sequence numbers - used to identify subversive attacks that

deny message services.
(vii) Request-response mechanisms - used to identify subversive attacks
that deny message services.
(d) Data Processing and Storage Controls

The database subsystem provides functions to define, create, modify, delete,
and read data in an information system. Several major types of controls
must be implemented in the database subsystem to improve the reliability
of its components and to protect the integrity of data stored in the database.
Some of the controls are:
(i) Access controls - restrict the actions that users can do on the database.
(ii) Integrity constraints - maintain the accuracy, completeness, and
uniqueness of instances of the constructs used within the conceptual
modeling or data modeling approach used to design the database.
Application programs should use certain update and reporting
protocols to prevent and to detect data integrity violations.
(iii) Concurrency controls - must exist to prevent inconsistent updating or
reading of the database, when data is shared among multiple users.
(iv) Cryptographic controls - preserve the privacy of data in the database.
(v) File handling controls - reduce the likelihood of accidental removal of
data.
(vi) Audit trails control - maintain a chronology of all events that occur in
the subsystem.
(vii) Existence controls - must be implemented to restore the database in
the event of loss.
Common controls that help preserve the integrity of data processing and
stored data are as follows:
(i) Policies and procedures

These should be established for the following aspects of data
processing and storage:

Figure 4.10: Five aspects of data processing
Employees should sign contracts that require them to maintain the

privacy and confidentiality of the company data.
(ii) Data control function

Application in which a large number of paper forms are entered into
the system should have a data control function set up. Data control logs
the data as they are received, checks for user authorisations, monitors
processing, reconciles control totals after each processing step, notifies
users of incorrect inputs, and reenters all error corrections.
(iii) Reconciliation procedures

All transactions and other system updates should be reconciled to
control reports, file status/update reports, or other control mechanisms.
This is done in the end of each day, or occasionally if there is continuous
processing happened. Besides, general ledger accounts should be
reconciled to subsidiary account totals on a regular basis.
(iv) External data reconciliation

Database totals should periodically be reconciled with data maintained
outside the system. For example, the number of employee records in the
payroll file can be compared with the total from human resources to
detect attempts to add bogus employees to the payroll database.

(v) Exception reporting

When files are scanned or processed, all unusual conditions should be
listed.
(vi) Data currency checks

A „date of last transaction‰ field can be scanned periodically to
identify records that are more than a year old. This is to trace any
outdated data. This happens when suppliers or customers go out of
the business, employees has resigned and others.
(vii) Default values

In certain cases, fields are left blank if a standard default value is to be
used. For example, if the hours worked field in the payroll input is left
blank, an employee could be paid for 160 hours.
(viii) Data matching

In certain cases, two or more items of data must be matched before an
action can take place. For example, the system could verify that
information on the vendor invoice matches on both the purchase order
and the receiving report before paying a vendor.
(ix) File labels

These labels can protect data files from unintended misuse. There are
few examples of labels:
• An external label such as paper label attached to a storage device
contains the file name, contents and date processed.
• Internal labels are written in machine-readable form on the data
recording media. There are three different internal labels:
− A volume label identifies the entire contents of each separate
data recording medium, such as a hard disk, diskette, or tape
reel.
− A header label located at the beginning of each file contains the
file name, expiration date and other identification data.
− A trailer label located at the end of the file contains file control
totals, which are checked against those accumulated during
processing.
(x) Write protection mechanism

These protect against the accidental writing over or erasing of data
files.

(xi) Database protection mechanism

Database systems use these mechanisms to provide data protection:
• Database administrators - establish and enforce procedures for
accessing and updating the database.
• Data dictionaries - ensure that data items are defined and used
consistently.
• Concurrent update controls - protect records from errors that
occur when two or more users attempt to update the same record
concurrently. This is done by locking out one user until the system
has finished processing the update entered by the other user.
(xii) Data conversion controls

Conversion controls are needed to ensure that the new data storage
mediums are free of errors when the data from old files and databases
entered into new data structures. The old and new systems should be
run in parallel at least once and the results should be compared to
identify inconsistencies. Besides, this is to make sure the new systems
run smoothly before the old system is shut down. Data conversion
should be carefully supervised and reviewed by internal auditors.
(xiii) Data security

A properly supervised data library is one essential means of preventing
loss of data. A librarian logs data files in and out, internal and external
labels, write protection mechanisms, and backup copies of data files
stored at a secure off-site location to ensure data integrity. The data file
storage area also should be protected against fire, dust, excess heat or
humidity, and other conditions that could harm stored data.
(e) Output Controls

The output subsystem provides functions that determine the content of data
that will be provided to users, the ways data will be formatted and
presented to users, and the ways data will be prepared for and routed to
users. Companies should establish, document, and follow procedures
designed to ensure that all system outputs conform to the organisationÊs
integrity objectives, policies and standards.
The procedures would ensure that the company does the following:
(i) Reviews all output for reasonableness and proper format.
(ii) Reconciles corresponding output and input control totals on a daily
basis.

(iii) Distributes computer output to the appropriate user departments.

(iv) Protects sensitive or confidential outputs that are being delivered to
users from unauthorised access, modification, and misrouting.
(v) Stores sensitive or confidential output in a secure and locked area.
(vi) Requires users to carefully review the completeness and accuracy of
all computer output that they receive.
(vii) Shreds or destroys highly confidential data such as list of outdated
customer.
(viii) Corrects any errors found on the output reports.
Five sets of controls are exercised over these functions that are:
(i) Inference controls

These controls are used to filter the output that users are allowed to
see. They are important in regulating access to statistical databases
where users are allowed to obtain summary information about data
but the privacy of persons about whom data is stored must be
preserved. Inference controls work by either restricting query set sizes
or disturbing the input or output of a statistical function.
(ii) Batch output production and distribution controls

Ensure that batch output is not lost or corrupted or that the privacy of
data is not violated during its preparation and routing to users.
(iii) High quality design of batch reports facilitates controls

Has been employed over batch output as it passes through the various
production and distribution phases. For example, the title page can be
used to show important control information like the authorised recipients
of the report, the security classification of information contained in the
report, and the period of time during which the report must be retained.
(iv) Online output production and distribution controls

Ensure that online output is not lost or corrupted and that the privacy
of data is not violated during its preparation and routing to users.
(v) Audit trail controls and a set of existence controls for output
subsystem
Audit trail controls maintain the chronology of events from the time
the content of output is determined to the time the output is presented
to users. Existence controls enable either batch or online output to be
recovered in the event of loss.

SELF-CHECK 4.3
1. Why is there a need for control and audit of computer systems?

2. What are the implications of a company losing its:
(a) Personnel master file
(b) Inventory master file
3. Differentiate standards to policies.
4. Explain grandfather-father-son techniques in your own words.
• A sound system of internal control must exist in order to ensure asset

safeguarding, data integrity, system effectiveness, and system efficiency.
• Use of computers does not affect the basic objectives of internal control.
• However, it affects how these objectives must be achieved.
Audit trail Field check

Authorisation Limit check
Compatibility tests Policies
Contingency plan Preventive controls
Corrective controls Progress report
Detective controls Sequence check
Edit checks Sign check
Edit programs Standards
Validity check

Ron, W. (1999). Information systems control and audit. New Jersey: Prentice Hall.
Romney & Steinbart. Accounting information systems 9/E. New Jersey: Prentice Hall.

Topic X Accounting
5 Transaction
Cycles
LEARNING OUTCOMES
1. Explain how economic events are recorded as accounting
transactions;
2. Describe four transaction cycles that makes up an accounting
transaction processing system;
3. Describe four input acquisition activities;
4. Categorise business activities into their respective cycles; and
5. Discuss the application systems constituting each transaction
cycle.
X INTRODUCTION
„Net4Barter pioneered the Indian corporate barter industry, when it

commenced operations in June 2000. The company developed a huge
opportunity for barter transactions among Indian companies. It enabled
companies to buy products and services·without spending cash· by paying
in kind, which in turn can resolve their excess stock problems.
The solution Net4Barter needed revolved around the creation of an organized

trade exchange at a national level which facilitates trade among a network of
companies.

TOPIC 5 ACCOUNTING TRANSACTION CYCLES W 103
The implementation of Microsoft® Business SolutionsăNavision® has helped

Net4Barter to restructure business processes. It has enabled the company to
automate its bartering transaction processes and also to integrate transaction
workflow and processes with accounting. The company is now competent to
maintain its barter balances and manage transaction status updates in real
time, which has helped the company to save as much as 40 percent on
operating costs.‰
Source: http://www.microsoft.com/india/casestudies/net4barter.aspx
How do you think barter system can be implemented in our 21st century? In your
opinion, how does accounting system transactions can help barter systems?
This topic presents an overview of accounting transaction cycles which form the
basis of Accounting Information Systems. There are three main cycles which
consist of the revenue cycle, the expenditure cycle and the production cycle. A
part from that, we will also discuss another topic which is very important in AIS
called general ledger and reporting systems. Some authors consider the general
ledger and reporting system as another cycle called financial cycle. In this topic,
we will look at the cycles in general before proceed to next topics which gives
detail information on each cycle.
5.1 ECONOMIC EVENTS

Economic events such as receipt of payment or pay for purchases occur in
business activities cycle. It is recorded as accounting transactions in accounting
systems. Accounting systems are designed to record, summarise and report the
results of economic events for organisations. Although all organisations differ in
their operations, all of them still engage in the business activities. Figure 5.1
below summarises the business activities in most organisations.

104 X TOPIC 5 ACCOUNTING TRANSACTION CYCLES
Figure 5.1: The cycle of basic business activities

From figure 5.1 above, we know that in whatever business activities, the main
objective is to increase the capital of the company. The cycle of business activities
begin when capital is invested in a business. These sources may come from the
owners of the business or they may come from creditors. If the source comes from
the owners, the investment is considered as the ownersÊ equity. If the source
comes from creditors, the investment is either long-term debt or current liabilities
to the company. In many businesses, most of the capital is used to purchase long-
term productive assets which help to increase the capital of the firm. The business
reports the results of its operations to the sources of its capital from time to time.
In short, capital investment comprises of two significant economic events:
(i) Raising capital; and
(ii) Using capital to acquire productive assets
Figure 5.2: Economic events in a capital investment
Another event that occurs during this activity is producing business reports to its
sources of capital. It is necessary to maintain those sources especially when
additional capital is needed later.

The second component of the cycle of business activities is the acquisition of

materials and overhead items such as supplies. These inputs are used to increase
the capital of the business too. However, business transactions are usually done
on credit basis. Therefore, when the business purchases inputs, it receives the
inputs on the condition that the payment will be made at a certain date. Basically,
the business records an obligation to pay and pays when the due date arrived.
The activities involve in input acquisition are summarised by Figure 5.3.
Figure 5.3: Input acquisition activities
The next step in the cycle of activities is the conversion of inputs into goods or
services (production). The business sells these goods or services to increase its
capital. The conversion/production process is different for each business.
For manufacturing companies, they buy raw material, apply labour and overhead
to them, and produce an output as the finished goods. On the other hand, service
companies convert inputs into outputs in the form of services. As for the
merchandising companies such as retailers and wholesalers, little labour is used
because they purchase inventories of goods, repackage them and then market
them. Nevertheless, all three businesses use inventories of supplies in their
conversion processes. Also, only one economic event occurs during this conversion
which is the consumption of labour, materials and overhead to produce products
or services that can be sold.
Finally, the last component in the figure is the sale of the goods or services that
were actually the outputs of the conversion process. When these are sold at a
profit, the capital investment of the business increases. Also, additional cash is
available for reinvestment, or for making payments to the sources of capital in the
form of dividends and interest. By providing a source of additional capital, the
sales component completes the cycle of business activities. In sum, the activities

involve in this cycle is receiving a customer order, delivering goods to the

customer, requesting payment for the goods, and receiving payment.
Table 5.1 summarises the economic events in the cycle of business activities.
Table 5.1 Events in the Business Activity Cycle
Business Cycle Activity Events

Capital investment • Raise capital
• Use capital to acquire property
• Periodic reporting
Input acquisition • Request inputs to the conversion process
• Receive inputs
• Record obligation to pay
• Pay for inputs
Conversion sales • Consume labour, material and overhead
• Receive request for goods and services
• Deliver to customer
• Request payment
• Receive payment
Source: Boockholdt, J.L. (1999). Accounting information systems. Singapore: McGraw-Hill.
5.2 ECONOMIC EVENTS AND ACCOUNTING

TRANSACTIONS
Economic events exist in any business activities. They are recorded as accounting
transactions by an accounting system. The system then summarises the transaction
and creates useful reports to the company. Meanwhile, the business activities that
trigger the economic events are called cycles of accounting transactions.
These accounting cycles consists of accounting transactions that occur in a normal

and routine sequence. For example, a sales transaction is normally followed by a
shipping process, a billing transaction and a cash receipts transaction. These are
normal business activities in a revenue cycle. Table 5.1 above shows all the events
included in four basic business cycle activities. From these business cycle activities,
we can identify the four accounting transaction cycles accordingly. The capital
investment can be identified as the financial / general ledger and reporting cycle, the
input acquisition can be identified as the expenditure cycle, the conversion can also

be identified as the conversion / production cycle and the sales activity can be
identified as the revenue cycle. Table 5.2 summarises the relationship between
business activity and their respective cycles.
Table 5.2: Business Activities and Their Respective Cycles
Business Activity Cycle

Capital Investments Financial / General Ledger
Input Acquisition Expenditure Cycle
Conversion Conversion / Production cycle
Sales Activity Revenue Cycle
In this section, we will examine the accounting cycles in more detail. First, letÊs
start with the financial cycle.
The financial cycle also known as the general ledger and reporting system
consists of two main functions:
(a) To raise capital; and
(b) To use the capital to purchase assets such as property, plant and equipment.
Accurate recording must be done in this cycle in order to see the flow of
information. Transactions such as getting capital from owners or creditors, using
that capital to purchase assets and reporting back to owners and creditors on how
the capital is being used are important to be recorded. Another event which is also
important is periodic reporting to the sources of capital. In financial cycle, the basic
financial statement provides periodic reporting. These statements include the
balance sheet, the income statement and the statement of cash flows. The
summaries in these statements come from the general ledger. Periodic reporting to
the sources of capital is important because it enables a business to raise additional
capital. In Figure 5.4, we can see that there are three accounting application systems
that record the events in the financial cycles. They are the property, the journal
entry, and the financial reporting systems. The relationship among these
application systems and the sources of capital is also illustrates in this figure.

Figure 5.4: The financial cycle

Next, we will look at the expenditure cycle in the accounting transaction cycles.
The expenditure cycle consists of transactions to acquire raw materials and

overhead items for the production cycle. The events include in the expenditure
cycle are requesting the items, receiving the items, recording the obligation to pay
for the items, and paying for the items. Most businesses use a purchasing
department to purchase raw materials and supplies. It starts with a purchasing
agent who orders material from a selected vendor. The vendor delivers the
materials and mails an invoice. The business uses the invoice to record the
payable and later pays the vendor when the payment is due. When the vendor is
paid according to the terms of the sale, the vendor again sells items to the
business. This causes the sequence of the transactions to form a cycle. The
application systems in the expenditure cycle execute these transactions. They
include the purchasing, receiving, voucher, and cash disbursement systems.
Figure 5.5 shows the relationships among vendors and the subsystems in the
expenditure cycle.

Figure 5.5: The expenditure cycle

Now that we understand the events in the expenditure cycle, letÊs move on to the
revenue cycle.
The revenue cycle records all sales made by the company and all payment
received. The sales are in terms of services provided or finished goods, which is the
product of production cycle. As mentioned earlier, there are four economic events
involved in this cycle: receiving an order from a customer, delivering goods or
services to the customer, requesting payment from the customer, and receiving the
payment. These transactions may occur separately or at the same time based on
type of sale. If the sale is a cash sale, then sales order, delivery, request for
payment, and payment occur at the same time. Therefore, accounting systems
normally record these four events with one transaction. However, when companies
sell goods or services on credit, each of the events occurs at separate times. When a
customer pays and the accounting system records the cash receipt, the business is
willing to sell again to the customer. This causes the cycle of transactions to repeat.
Companies that sell in credit use four application systems in the revenue cycle. The
applications are the order entry, shipping, billing, and the cash receipts systems.
Companies that sell on a cash basis frequently use a point-of-sale system that
combines the four economic events in one transaction. Figure 5.6 provides a
graphical representation of the transactions in the revenue cycle.

Figure 5.6: The revenue cycle

Finally, we will examine the last cycle in the accounting transaction cycles which
is the conversion cycle or also known as the production cycle.
The conversion cycle contains transactions incurred when raw materials are
transformed into finished goods for sale. Only one economic event exists in the
production cycle which is consuming materials, labour, and overhead. In
manufacturing and service companies, either actual or standard material and
labour costs are recorded in a cost ledger as conversion occurs. Overhead costs are
allocated in the cost ledger, usually based on the amount of labour used. These
costs become associated with the products and are matched with revenue when the
products are sold. However, in merchandising companies, costs of conversion are
recorded when incurred and matched against revenue in the same period. In
conversion cycle, there are three main application systems which are cost
accounting system to record material, labour and overhead cost, payroll system to
generate and calculate paycheck to each employee and inventory system to
maintain record of inventory on hand. Depending on the type of organisation, the
conversion cycle may contain either two or three application systems. For example,
payroll system is needed by all type of organisations, while cost accounting system
is needed by manufacturing and service companies, and inventory system is
needed by manufacturing and merchandising companies. In merchandising and
manufacturing companies, the systems in the production cycle provide interfaces
between the expenditure and revenue cycles. However, the production cycle
cannot be represented as a circle like other cycles since it contains only one event.

In Figure 5.7, an example of a merchandising company is use to show the

interfaces between the expenditure and revenue cycles and the inventory and
payroll system in the company. Originally, the company maintains a
merchandise inventory for sale. When the expenditure cycle make a purchase and
receive the products, the inventory will increase. However, when there is a sale
and the revenue cycle ships the products, the inventory will decrease. These
transactions are recorded by the inventory system. Meanwhile, the payroll
system in a merchandising company compensates sales and administrative
personnel for their work.
Figure 5.7: The conversion cycle in a merchandising company

On the other hand, a manufacturing company has different activities. We will

look at this example based on figure 5.8 below. A manufacturing company
always has raw materials, work in process and finished goods inventories. The
production process uses raw materials and converts them into finished goods.
Raw materials are obtained from the expenditure cycle and finished goods are
sent to the revenue cycle to be sold. The cost accounting, payroll and inventory
systems provide interfaces by recording transactions during the production
process. Figure 5.8 shows a graphical representation of the production cycle in a
manufacturing company.

Figure 5.8: The conversion cycle in a manufacturing company

Just as accounting transaction cycles were identified with basic business

activities, accounting application systems can be identified with economic events,
as shown in Table 5.3. This illustration identifies 14 application systems, which
the following topics will describe.
Table 5.3: Economic Events and Application Systems that Process Them
Transaction Cycles Economic Event Application System

Financial Raise capital Journal entry
Consume capital Property
Periodic reporting Financial reporting
Expenditure Request inputs Purchasing
Receive inputs Receiving
Obligation to pay Voucher
Payment Cash disbursement
Conversion Consume labour, material, Cost accounting, payroll, and
overhead inventory
Revenue Receive request Order entry
Deliver Shipping
Request payment Billing
Receive payment Cash receipts
Source: Boockholdt, J.L. (1999). Accounting information systems. Singapore: McGraw-Hill.

SELF-CHECK 5.1
1. Name the three transaction cycles that exist in all businesses.
2. Name the major subsystems of the expenditure cycle.
3. Name the major subsystems of the conversion cycle.
4. Name the major subsystem of the revenue cycle.
• So far, we have learned the activities that form the processing of accounting
transactions.
• We have looked at how the accounting transactions cycles are formed using
the business cycle activities.
• We can also identify the four cycles in the accounting transaction processing
system which are the revenue, expenditure, conversion and financial cycles.
• In each cycle, we have also learned the type of accounting application systems
associated each cycle.
Application system Expenditure cycle

Capital investment Financial cycle
Conversion Input acquisition
Conversion cycle Revenue cycle
Cycle of business Sales
Economic event activities Transaction cycle


Nickerson, R. C. (2001). Business and information systems. New Jersey: Prentice Hall.

Topic X Revenue Cycle
6 Applications
LEARNING OUTCOMES
1. Describe the business activities involved in the revenue cycle;
2. Employ the flow chart of revenue cycle;
3. Interpret the process of revenue cycle transactions using computer;
4. Describe the internal control procedure needed in revenue cycle;
and
5. Construct the DFD for revenue cycle.
X INTRODUCTION
In previous topic, we have studied the accounting transaction cycles in general.
From this topic onwards, we will look into each transaction cycle in more detail.
We will start with the revenue cycle in this topic. Revenue cycle involves selling
of goods or services to customers and receiving payment for the goods or services
being purchased. This includes activities such as customer orders, customer
payments and sales of inventories or services. The process begins when a
customer makes an order to purchase a product or service from a company. The
company will then ship the products or perform the service. An invoice will be
shipped to the customers and the customers will settle the payments using cash
or credits. If it is a credit sale, the company will check the customerÊs credit
history before they approve the sale.

116 X TOPIC 6 REVENUE CYCLE APPLICATIONS
6.1 REVENUE CYCLE BUSINESS ACTIVITIES

As mentioned in the introduction, the revenue cycle is used to record transactions
involve in selling and shipping of goods and the receipt of cash from customers.
It is also useful to monitor and summarise the activities occur in revenue cycle. In
any types of firms, revenue cycle comprises of two subsystems which are:
(a) Sales order processing system; and
(b) Cash receipt systems.
During these transactions, there are several accounts involved. In sales order
processing, the primary accounts involved include:
(a) Sales, from inventories or services
(b) Accounts receivable
(c) Cash
A part from the above accounts, it is also possible to have other accounts when
certain activities such as goods returned, discount purchases and other related
activities occur in the revenue cycle. The accounts include:
• Sales returns and allowances
• Sales discounts
• Sales taxes
• Unearned revenues
• Allowance for doubtful accounts
After looking at the accounts involved, we will examine the activities that occur
in revenue cycle. Table 6.1 below summarises the activities involved.

TOPIC 6 REVENUE CYCLE APPLICATIONS W 117
Table 6.1: Activities Involved in Revenue Cycle
Activity Description
Customer orders This event occurs when customers want to purchase any goods
or services from the firm.
Verification of This event occurs when customers want to pay their invoices
customer credit and using credit. The customerÊs payment history and credit limit
credit limits will be verified by the credit department.
Determination of This event occurs to make sure that the inventory is available in
inventory the warehouse.
availability
Shipment of goods This event occurs when a company has to deliver the purchase
to customers products to the buyers.
Customer billing, This event occurs when purchases are made by customers. For
including handling any discount sales or any shipping charges, it will be included in
of discounts and the customerÊs bill.
shipping costs
Receipt of cash from This event occurs when customers pay the amount they owe to
customers the company
Determination of This event occurs when inspection is done to check for any
overdue accounts overdue payment.
Receipt of returned This event occurs when goods purchased are returned by the
goods customers due to damage or dissatisfaction.
Based on the events in revenue cycle, many reports and documentations are
prepared or generated. The documents include:
• Sales orders, prepared by sales personnel in the sales department.
• Packing and shipping documents, prepared by shipping personnel in the
shipping department.
• Billing invoices, prepared by accounts receivable personnel in account
receivable department.
• Remittance advises, which often are part of billing invoices and are returned
by customers with payments.
• Checks from customers for the payment of goods or services.
• Deposit slips, prepared by cash receipts personnel in cash receipt department.
In revenue cycle business activities, customers can buy products using either cash
or credit. Several main functions normally occur in any sale such as:

• Customer places an order for goods or services.

• Firm accepting customer requests for goods or services.
• Firm delivers or ships the goods or performs services
to customers.
• Firm sends invoices to customers.
• Firm deals with any returned goods.
• Firm receives and records cash receipts when customer
make payments.
However, if sales are based on credit, additional functions are involved:

• Firm checks on customerÊs credit history and credit limit before approving or
rejecting the credit requests.
• Records the accounts receivable.
• Sends periodical statements to customers.
• Deals with bad debts.
An example of a data flow diagram for sales order processing and cash receipt
processing is shown in the example in Figure 6.1. The processes start when a
customer places an order and firm checks for credit history. Once approved,
goods are picked from the warehouse and ship to the customer together with a
packing slip. The shipping department also sends another copy of packing slip as
well as bill-of-lading to the billing department. On the other hand, sales
department prepares several copies of sales order and send them to warehouse
and billing department. Billing department sends invoice to customer and other
information to be recorded in sales journal, account receivable and general
ledger. Inventory account is also updated based on the information given by the
billing department. When customer makes payment, check and remittance advice
are sent to mail room and sort by the clerk. The check is deposited into the bank
while the remittance advice is sent to account receivable. Then, account
receivable, general ledger and cash receipt journal are updated.
Another example shown is data flow diagram for goods that have been returned
(Figure 6.2). The processes start when customer rejects or returns the goods they
purchase due to damage or dissatisfaction. When the returned good is received, it
is sent to warehouse together with a return slip for restocking purpose. Another
return slip is sent to sales department where several credit memo copies are
prepared. Copies of credit memo are used to update sales journal on return sales,
account receivable, inventory and general ledger.

Figure 6.1: Example of sales order processing and cash receipt processing system: DFD of
sales order processing and cash receipt processing subsystems

Figure 6.2 illustrates an example of DFD for sales return process.
Figure 6.2: DFD of sales returned process
Below are detail summaries of all activities that are involved in revenue cycle the
categories comprise of:
(a) Processing customer orders;
(b) Delivery/shipping goods;
(c) Preparing invoices/billing; and
(d) Recording in accounts receivable ledger.
6.1.1 Processing Customer Orders

Let us look at the activities involve in processing customer orders:
(a) Accepting requests from customers;
(b) Preparing sales order; and
(c) Preparing picking list.

Activities involve in approving credit request and credit limits:

(a) Screening for new customers by checking on their background.
(b) Setting maximum limit based on the customerÊs income or payment
capability.
(c) Processing requests to increase limit for customerÊs with good credit history.
(d) Periodic checks on existing customers.
ACTIVITY 6.1
What makes some peopleÊs credit history becomes bad and further
been blacklisted by financial institution?
6.1.2 Delivery/Shipping of Goods or Providing a

Service
Activities involve in delivery/shipping of goods:
(a) Receiving sales order and picking list.
(b) Preparing the dispatch order and necessary documents such as packing slip,
bill-of-lading and shipping notice.
Activities involve in providing a service:

(a) Recording labour and materials used (job card).
6.1.3 Invoicing and Recording Accounts Receivable

Activities involve in billing:
(a) Receiving shipping notice.
(b) Preparing batch totals and invoice.
Details on sales invoice:

(a) Invoice number
(b) Name of supplier
(c) ABN
(d) Date of invoice

(e) Description of goods

(f) Quantity of goods
(g) GST inclusive price
(h) Discount allowed
Terms:
(a) 2/7-2% discount if account is paid within 7 days.
(b) n/30-net amount payable within 30 days.
(c) 10/eom-payment required within 10 days after the end of the month.
(d) net cash 30 days- payment required within 30 days of the end of the month
in which delivery is made.
Types of invoicing are summarised in Table 6.2 below.
Table 6.2: Types of Invoices
Types of Invoicing Description

Pre-invoicing Invoice prepared when sales order is approved
Post-invoicing Invoice prepared and dispatched after delivery of goods or
services
6.1.4 Accounts Receivable Ledger

Customers are referred to as debtors. Accounts receivable is an asset. Subsidiary
ledger maintains asset details. Source document for this ledger is sales invoice
issued. Statement of accounts sent to customers at end of each period showing
details of account transactions and outstanding balance.
Credit or adjustment notes were prepared when goods are returned. They are
recorded in sales returns journals.
Bad debts:
• Amounts owing by debtors that are unable to be collected
Revenue cycle ends with customer payments that may take the form of:
(a) Cash - from cash sales.
(b) Cheques - most common form of payment.
(c) Bank transfers.

(d) Direct deposits or EFT.
Details of all payments are recorded in the cash receipts journal.
6.2 INTERNAL CONTROLS PROCEDURES FOR

THE REVENUE CYCLE
In this section, we will describe the internal controls procedure needed in
revenue cycle:
(a) Prompt transfer of customer orders to sales orders.
(b) Strict procedures for granting credit.
(c) Set policy on credit amounts and terms and discounts.
(d) Prompt invoicing in separate department.
(e) Segregation of duties on
(i) Dispatch; and
(ii) Invoice preparation.
(f) Proper authorisation procedures for discounts, returns and allowances and
bad debt write offs.
(g) Sequentially pre-numbered invoices, receipts etc.
(h) Cash registers with sealed till roles.
6.3 COMPUTER APPLICATION SYSTEMS FOR

THE REVENUE CYCLE
Routine activities in sales order processing and cash receipts can be done
manually or automatically using computer. In this section, we will focus on
routine transactions that have been automated.
Let us see the objectives of this system. The objectives are:

(a) To record the information in the same categories as a manual system;
(b) To quickly produce the documentation required;
(c) To record reservation of goods and services ordered;
(d) To easily generate details reports for management use ;
(e) To reduce labour costs; and

(f) To reduce errors in pricing.
A computer-based accounting system in the revenue cycle uses four application

systems:
• The order entry;
• Shipping;
• Billing; and
• Cash receipts applications.
(a) Order Entry Application

The purpose of the order entry application is to record a customerÊs request
for goods or services, to obtain credit approval for the customer, and to
ensure that the order is filed. Procedures for credit approval usually require
the credit department to establish a credit limit for each customer. This
credit limit is the maximum unpaid balance the customer is allowed to
have. Whenever an order is received from a customer, the order entry
system determines if the order would cause the outstanding balance to
exceed the credit limit. If so, the customerÊs order is disapproved.
Figure 6.3 contains a flowchart of an online real time order entry system. A
sales clerk enters data from a customerÊs purchase order. A computer
program validates the data entered by the clerk, verifies that the order is
within the customerÊs credit limit, and creates a sales order detail record.
The program produces two documents. An order acknowledgement is
mailed to the customer confirming acceptance of the order. The sales
register provides a list of all sales orders entered by the clerk.

Figure 6.3: An order entry application

Source: Boockholdt J. L. (1999). Accounting information systems. Singapore: McGraw-Hill.
Older accounting systems used batch processing for this application. With
such a system, a clerk prepared sales orders and accumulated them in
batches. The clerk also created a control total, called a batch total, for each
batch. The batch system then applied the processing steps described above
to transactions a batch at a time. Clerks checked the batch total after each
processing step to ensure that no transactions were lost.
Online real time systems provide query capability, allowing users to

examine the contents of specific records in the file. In this order entry
application, a sales clerk may query the customer master file to determine a
customerÊs balance, credit limit, or terms of sale. The clerk may also query
the order entry detail file to determine the status of a past order.
(b) Shipping Application

The purposes of the shipping application are to ensure that merchandise is
shipped prior to the date desired by the customer and that the customer is
promptly billed for the merchandise. Figure 6.4 shows an online real time
shipping system. A shipping clerk examines the contents of the sales order
detail file and identifies orders that are due for shipment. The program
creates a record in the shipments file for each order that is due and reduces
the quantity on hand for that item in the inventory master file. It produces
two copies of the shipping notice. One serves as a bill of lading and another
goes to the warehouse as a packing list.

Figure 6.4: A shipping application

(c) Billing Application

The purposes of the billing application are to prepare sales invoices for
merchandise that has been shipped and to record the sale in the appropriate
accounts. This application also produces credit memos to document sales
returns and sales allowances. These credit memos, similar to sales invoices,
are mailed to the affected customers.
The flowchart of the system in Figure 6.5 shows these procedures. The
program creates a sales invoice and an invoice detail record for each
shipment record created in the billing application. It also allows a billing
clerk to enter data creating credit memos. The program adds invoice detail
records to the accounts receivable change log file and produces a record
summarising the transactions for the general ledger batch summary file.
The clerk prints a daily document register from the contents of the invoice
detail file. A clerk may query the invoice detail file to determine the status
of a specific unpaid sales invoice.
Every month, the system prints customer statements and an aged trial
balance. Many companies practice cycle billing, which means they print and
mail statements to their customers on certain day of the month. This avoids
the difficulties of producing all customer statements at the monthÊs end.

Figure 6.5: A billing application

(d) Cash Receipt Application

The purpose of the cash receipts application is to record payments made by
customers for credit sales. It also deletes paid invoice records from the
invoice detail file. Figure 6.6 shows these procedures.

Figure 6.6: A cash receipts application

A clerk enters data from remittance advices and creates a cash receipts
detail record from each. The computer program matches each cash receipt
detail record with its appropriate invoice detail record, deletes the invoice
detail record, and prints a register of deleted invoices. It posts the cash
receipt to the appropriate customer master record, adds a record for each
cash receipt to the accounts receivable change log file and produces a record
summarising these transactions for the general ledger batch summary file.
The clerk executes another program that prints a daily cash receipt register
from the cash receipts detail file.
6.4 CONTROLS IN THE COMPUTER

ENVIRONMENT
There are many risks associates with transactions in revenue cycle which may
expose a company to certain problems. Risks such as incorrect posting of
accounts, errors in invoices or sales to customers with bad credit history may
affect the companyÊs revenue. In order to counteract these risks, general controls
and application controls must be set up by a company.
General control involves segregations of units, proper documentations, proper

authorisations for transactions such as credit sales or change of procedures and
also access controls such as password requirements for accessing certain ledgers
or files and restricted terminal functions.

Application controls in revenue cycle can be categorised by the following

categories:
(a) Input controls
Detect and prevent errors when data is input.
(b) Processing controls
Detect and prevent errors while processing is in progress.
(c) Output controls
Detect and prevent errors in outputs from processing.
Below are some control measures to validate data in revenue cycle activities.
6.4.1 Order Entry System

(a) Input control
(i) Completeness tests
The program verifies that all data have been entered in each field. For
example:
TRANSACTION-CODE, TRANSACTION-DATE, SALES-ORDER-

NUMBER, SALES-TERMS, PRODUCT-CODE, PRODUCT-PRICE,
PRODUCT-QUANTITY, TRANSACTION-AMOUNT
(ii) Validity test

The program checks entered data for customer number against lists of
existing valid CUSTOMER-NUMBER.
(b) Processing control

(i) Limit test
The program verifies that sale does not exceed pre-established credit
limit.
(c) Output control

(i) Visual verification
The data control group examines documents for proper preparation.

(ii) Record count

The data control group verifies that number of order acknowledgements
equals the number of valid sales order transactions shown on the error
listing.
6.4.2 Shipping System

(a) Input control
(i) Validity test
The program verifies that cut off date is in the form of AA-BB-CCCC,
where AA<13, BB<32, and CCCC is numeric.

(i) Completeness test
The program verifies that each record contains SHIPPING-NOTICE-
NUMBER.
(c) Output control

(i) Record count
The data control group verifies that the number of shipping notices
equals the number of records in shipments file shown on shipments
register.
6.4.3 Billing System

(a) Input control
(i) Validity test
The program checks for valid CUSTOMER-NUMBER.
(ii) Completeness test

The program verifies that all data have been entered in all required
fields such as:
TRANSACTION-CODE, TRANSACTION-DATE, SALES-ORDER-

NUMBER, SALES-TERMS, PRODUCT-CODE, PRODUCT-PRICE,
PRODUCT-QUANTITY, TRANSACTION-AMOUNT


The program verifies that INVOICE-NUMBER has been entered for
each record.
(ii) Reasonableness test

The program verifies that on a document, TRANSACTION-
AMOUNT<RM99, 999.
(iii) Control total

The program verifies that the total postings to the customer master file
= total amounts in the accounts receivable change log file = total debits
and total credits in general ledger batch summary file.
(c) Output control

(i) Record Count
The data control group verifies that the number of credit memo and
invoices printed are the same as the numbers shown on the credit
memo and invoice registers.
(ii) Visual verification

The data control group examines invoices and credit memos for
proper preparation.
6.4.4 Cash Receipts System

(a) Input control
The program verifies that all data has been entered in all required
fields.
(ii) Validity test

The program checks for valid CUSTOMER-NUMBER.


(i) Control total
The program verifies that total postings to the customer master file
must equals the total amounts in the accounts receivable log file equal
the total debits and total credits in general ledger batch summary file.
(c) Output control

(i) Control total
The data control group verifies that total amount of listings on deleted
invoice register = total listings on cash receipts register.
SELF-CHECK 6.1
1. Distinguish between a packing slip, shipping notice and a bill

of lading.
2. At which point in the revenue cycle are independent
verification controls necessary?
• The AIS should be designed to maximise the efficiency with which the basic
activities in the revenue cycle are performed.
• The AIS must also incorporate adequate internal control procedures to
mitigate threats such as uncollectible sales, billing errors, and lost or
misappropriated inventory and cash.
• Control procedures also are needed to ensure that the information provided
for decision making is both accurate and complete.

Bill of lading Remittance advice

Credit limit Sales invoice
Credit memo Sales order
Packing slip

Hall, J. A. (2001). Accounting information systems. Ohio: Thomson Learning.
Romney & Steinbart. Accounting Information Systems 9/E. New Jersey: Prentice Hall.
Wilkinson et al. Accounting information systems 4/E. New York: John Wiley and
Sons, Inc.

Topic X Expenditure
7 Cycle
Applications
LEARNING OUTCOMES
1. Explain four types of subsystems in the expenditure cycle;
2. Describe the activities involve in each subsystems;
3. Analyse and develop the flow-chart of expenditure cycle;
4. Explain the computer processes involve in expenditure cycle; and
5. Describe the control practices and procedures relevant to
expenditure cycle.
X INTRODUCTION
This topic describes an overview of the expenditure cycle in Accounting
Transaction Processing cycles. As you have learnt in Topic 5, expenditure cycle
involves the activities such as purchasing of raw materials, finished goods or
services from vendors, disbursing of cash for the goods being purchased, paying
salaries to employees and dealing with the fixed assets in a company. To make it
easier to understand, we will divide this topic into two sections: the purchase and
the cash disbursement subsystems, and the payroll and the fixed asset
subsystems. It is important to separate the payroll transactions because of two
reasons. First, payroll systems must withhold amounts for deductions and taxes
and summarise these in cumulative earnings reports. This is unnecessary when
doing other general purchasing. Second reason is because payroll systems
produce paychecks only to the employees. This is because if payroll checks and
other general checks are combined, it is easy to hide any fraud in payroll system.

TOPIC 7 EXPENDITURE CYCLE APPLICATIONS W 135
7.1 PURCHASING AND CASH DISBURSEMENT

SUBSYSTEMS
ACTIVITY 7.1
What are the differences between purchasing and cash disbursement?
The purchasing and cash disbursement activities are two separate subsystems in
the expenditure cycle.
First, we will discuss on purchasing subsystems in the expenditure cycle. When

an inventory level has dropped to a certain level, a clerk will make a purchase.
The company will review several vendors before deciding on which vendor to
buy from. When the vendor delivers the inventory, the company will store the
inventory in the warehouse. The vendor will send an invoice to the company
stating the amount due and the vendorÊs account payable is updated. The
purchasing process is complete here.
Next, we will look at the processes involve in the cash disbursement subsystems.
A clerk will check for amount due in the account payable and prepare a payment
check. The check is sent to the vendor and concurrently, the general ledger will be
updated.
You will notice that these transactions involve several accounts. Among those
accounts are:
(a) Inventory
(b) Account payable
(i) Purchase account
(ii) VendorÊs account
(c) Cash

136 X TOPIC 7 EXPENDITURE CYCLE APPLICATIONS
Figure 7.1: Accounts involved in the cash disbursement subsystems
You will also notice that there are various reports and documentations generated
during this process. The documents include:
(a) Purchase requisition ă a document that allows a purchase transaction to be
made.
(b) Purchase order ă a document that indicates the details of the items to be
purchased.
(c) Blind copy ă a blank copy of purchase order.
(d) Receiving report ă a document that indicates the details of items such as
quantity.
(e) VendorÊs invoice ă Bills from the vendor on the items being purchased.
(f) Voucher register ă a register that shows the companyÊs account payable.
Based on the above reports, let us look at the events that trigger them.
A purchase requisition is prepared when the inventory clerk detects that the
inventory level has dropped to a certain level.
The purchase requisition is then sent to the purchasing department and several
copies of purchase order will be prepared by the purchasing clerk and distribute to
several departments. One of the purchase order called blind copy which contains

no details, is sent to receiving department to force the receiving clerk to inspect the
inventories upon arrival. After inspection, a receiving report is prepared. An
invoice will be sent by the vendor separately and once receive, the account payable
will be updated. The clerk in accounts payable department prepares a voucher in a
voucher register in order to show the liability of the company.
Now that we know how the reports are produced, we will take a look at the
detail processes involve in the purchasing and cash disbursement subsystems in
the next section.
7.1.1 Purchasing Subsystems

(a) Request for Purchase
Purchasing department is responsible for any purchases. Goods can be
categorised as general goods and special items. Purchase requisition is used
to ensure control and accuracy.
(b) Vendor Selection and Order Placement

This can be achieved by following the steps below:
(i) Identifying the best vendor from a list of potential vendors
• Check for price and quantity available.
• Check for delivery time.
• Check for terms of delivery.
(ii) Place order with selected vendor

• Includes description such as quantity, unit price, total price, trade
discount and delivery date.
(c) Goods Received

The arrival of goods is accompanied by a delivery note showing:
(i) Description, source and quantity that has been delivered.
(ii) Space for signature of the person accepting the goods.
(iii) Goods have been checked for quantity and quality.
(iv) Goods received note raised and attached to delivery note for filing. A
copy is sent to accounts payable department.

(d) Storekeeping
Goods received are stored in a secure place. There will be safeguarded by
authorised persons. Goods will only be released upon proper authorisation-
goods/materials requisition note. Authorised dispatch note is required for
dispatch of goods sold. Figure 7.2 summarises the storekeeping functions.
Figure 7.2: Storekeeping functions
Within stock levels, the storekeeper must maintain appropriate level to

facilitates production and sales functions as well as maintain a ÂbufferÊ of
stock for emergencies.
(i) Physical stock verification

• Inventory is counted and amounts and other details are recorded
on stock sheets.

• Verification objectives are:

− Accounting valuation
− Loss through theft or misuse
− Physical state of stock
− Allow proper cut-off procedures to be carried out
(ii) Perpetual inventory system

• Maintains a set of records that ensure that stock movements are
recorded on a continuous and consistent basis by competent staff
• Stock cards maintain a record of stock movements in the stores
• Accuracy is verified by a stocktaking
• Physical stock is compared to records to identify errors
(e) Processing invoice by supplier

(i) Tax invoice is received and checked for accuracy using goods received
note
(ii) Liability is recorded when tax invoice is received and verified
(f) Account payable and general ledger update

(i) Accounts payable may be adjusted by adjustment or credit notes
received for returned goods
7.1.2 Cash Disbursement Subsystems

(a) Check for payment of items that is due
Clerk checks the account payable for any amount due
(b) Prepare checks to vendors

(i) If any amount is due, payment check will be prepared and distribute
to vendor.
(ii) Supplier payments can be in the form of:
• Cash;
• Cheques (most common form of payment);
• Bank transfers; or

• Direct deposits or EFT.
(c) Control accounts and general ledger update

Control accounts for account payable and cash as well as general ledger will
be updated once the payment has been made.
However, we know that sometimes a company prefers to make a purchase

based on the credit term. In credit term, there are additional functions
involved such as:
• Applying for credit facility from vendors;
• Recording accounts payable;
• Requesting adjustment notes;
• Checking periodical statements from vendors; and
• Approving vendor invoices.
After looking at the above details, you might still want to know more about
the processes. There are seven processes involved in the DFD:
(a) Review needs;
(b) Purchase Inventory;
(c) Receive goods;
(d) Update inventory;
(e) Update control accounts ;
(f) Prepare cash disbursement; and
(g) Update general ledger.
To help you understand better, Figure 7.3 shows the processes in data flow
diagram.

Figure 7.3: Example of purchase and cash disbursement processes: DFD of

purchasing and cash disbursement processes
7.1.3 Internal Controls for Purchase and Cash

Disbursement Activities
This section states the internal controls needed in purchasing and cash
disbursement processes.
(a) Pre numbered purchase orders.
(b) Authorised personnel to initiate all purchases.
(c) Deliveries accepted on verification of purchase order.
(d) Invoices, purchase orders and receiving reports are matched to verify
invoice for processing and payment.
(e) Expected refunds are followed up.
(f) Paid invoices are cancelled with a stamp-ÂpaidÊ or ÂpunchÊ.
(g) Cheque signatories have limits.
(h) Only authorised person is responsible for petty cash fund.
(i) Accounts payable is reconciled on a regular basis.
(j) Inventory is protected and accounted for both physically and in term of
dollar value.
(k) Reorder levels are maintained.

(l) Proper authorisation procedure is applied before release of goods from

stores.
(m) Segregate related departments such as inventory from warehouse and cash
from general ledger and account payable.
7.1.4 Computer Application Systems for Purchase and

Cash Disbursement Activities
Routine activities in purchasing and cash disbursement can be done manually or
automatically using computer. However, in this section we will focus on routine
transactions that have been automated.
(a) Purchasing Application

The purpose of the purchasing application is to identify materials, supplies,
and equipment for requisition; to select a vendor for these items; and to
ensure that the items are requested and received. Figure 7.4 shows the
sources for inputs to an online real time computerised purchasing system.
Figure 7.4: A purchasing application

(b) Receiving Application

The purpose of the receiving application is to ensure that all receipts of
materials, supplies, and equipment are authorised, and to record their
receipts in the accounting records. A system flowchart of an online real time
receiving system is shown in Figure 7.5.

Figure 7.5: A receiving application

(c) Voucher Application

The purpose of the voucher application is to record the obligation to pay a
supplier. Inputs to this system are vendor invoices and records from the
receipts, open purchase order and purchase order detail files. Figure 7.6
shows the procedures in a voucher system.
Figure 7.6: A voucher application


(d) Cash Disbursement Application

The purpose of this application system is to ensure that payments are made
to vendors in the proper amount and at the proper time. Figure 7.7 shows a
flowchart for this system.
Figure 7.7: A cash disbursements application


7.1.5 Controls in the Computer Environment

As we have discussed in previous topics, there are many risks associated with
transaction cycles including the expenditure cycle. Therefore, certain controls need
to be implemented. This section describes the application controls applicable to the
activities described in this topic only. They are stated according to categories,
which are input, processing and output. LetÊs look at the application controls below
that validate the input data in computer based system.
(a) Purchasing System

(i) Input:
• Completeness test
− Program verifies that all data has been entered such as
REQUISITION-NUMBER, INVENTORY-ITEM-NUMBER, ITEM-
DESCRIPTION, ITEM-QUANTITY, DELIVERY-DUE-DATE.
− Purchasing agent enters all required data such as VENDOR-
NUMBER, PURCHASING-AGENT-NAME, VENDOR-
PRODUCT-NUMBER, ITEM-UNIT-PRICE.
• Validity test
− Program checks for entered digit on VENDOR-NUMBER and
validate against a valid VENDOR-NUMBER list.
(ii) Processing:
• Record count
Program verifies that the number of new purchase numbers = the

number of purchase requisitions + the number of records from order
entry, production control, and inventory systems.
(iii) Output:
• Record count
− Program verifies that the number of new records in the
purchase order detail file = the number of line items on
purchase orders.

(b) Receiving System

(i) Input:
• Completeness test
− Program verifies that all required data has been entered such
as PURCHASE-ORDER-NUMBER, RECEIVED-QUANTITY,
ITEM-NUMBER, ITEM-DESCRIPTION, VENDOR-NAME.
(ii) Processing:
• Record count
− Program verifies that the quantity of goods received equal to
the number of quantity ordered.
(iii) Output:
• Record count
− Program verifies that the number of lines on the voucher
register = the number of records added to the voucher file.
(c) Voucher system

(i) Input:
• Consistency test
− Program verifies that total of GENERAL-LEDGER-AMOUNT
fields equals NET-AMOUNT field.
• Validity test
− Program verifies that dates are of the form AA-BB-CCCC,
where AA<13,BB<32 and CCCC is numeric.
(ii) Processing:
• Record count
− Program verifies that the decease in the number of open
purchase order records = the increase in the number of
pending invoice records, the number of records in the old
pending invoice file = the number of records in the new
pending invoice file + the number of new voucher records,
decrease in the number of receipts records = the increase in the
number of pending invoice records.

(iii) Output:
• Record count
(d) Cash disbursement system

(i) Input:
• Consistency test
− Program verifies that the amount of cash disbursement
transaction entered is equal to vendorÊs account payable.
(ii) Processing:
• Record count
− Program verifies that the number of records in the old voucher
file = the number of records in the new voucher file + the
number of cash disbursement transaction records.
(iii) Output:
• Record count
• Limit test
− Program flags for review by data control group for
transactions amounts more than RM100,000.
• Run-to-run controls
− Data control group verifies that total amount of checks = total
amounts of vouchers disclosed on control reports and check
register.

ACTIVITY 7.2
What are the three documents that must accompany the payment of
an invoice?
Discuss where these three documents originate and the resulting
control implications.
7.2 PAYROLL AND FIXED ASSET SUBSYSTEMS

So far, we have looked at the first part of expenditure cycle which is purchasing
subsystem and cash disbursement subsystem. This section discusses on the
second part of expenditure cycle which are payroll subsystem and fixed asset
subsystem. First, we will look at the activities involved in the payroll subsystem.
Then we will look at the fixed asset subsystems.
7.2.1 Payroll Subsystems
ACTIVITY 7.3
Imagine you own a small business with ten employees. What information
do you need in order to run a payroll system for your employees? How
would you go about the record keeping for your mini-payroll system?
The payroll subsystem is a part of the human resources management system. It

includes activities to effectively manage the employee workforce. The input for
the payroll processing is obtained from the job ticket or time card of an employee.
Then, the payroll department calculates the amount payable for each employee
and prepares the paycheck. Account payable will authorise the cash
disbursement and finally, general ledger will be updated.
There are several accounts involved in this transaction such as:
• Account payable
• Cash
• Wages

Figure 7.8 presents a context diagram for the payroll system which shows the
relationships with the HRM system and other parts of the AIS. This figure shows
five major sources of inputs to the payroll system and one output.
The inputs come from HRM department, various departments, government

agencies, employees and insurance and other companies. On the other hand, the
output comes from the bank. We will discuss on the sources of input first.
• The HRM department gives information on any payroll changes such as
new hiring, firing or any pay rate changes due to raises or promotions.
• The various departments provide data about actual hours the employees
work such as time and attendance data.
• Government agencies provide tax rates and instructions for meeting
regulatory requirements.
• Employees provide information on any withholdings and deductions such
as pension, housing loan deduction or any donations.
• Finally, insurance companies and other organisations provide instructions
for calculating and remitting various withholdings.
As for the output, checks are the payroll systemÊs principal output. Based on the
dataflow in the context diagram, we know that employees receive individual
paychecks in compensation for their services. On the other hand, a payroll check
is sent to the bank to transfer funds from the companyÊs regular accounts to its
payroll account. Finally, checks are also issued to government agencies, insurance
companies, and other organisations to meet company obligations such as paying
for taxes and insurance premiums. In addition, the payroll system also produces
a variety of reports for internal and external use.
Figure 7.8: Context diagram of the payroll portion of the HMR/payroll cycle.

Now that we understand the inputs and outputs of the payroll system, let us look
at Figure 7.9 which shows the seven basic activities in the payroll cycle. Before we
proceed, it is a good idea to remember that payroll is one of AIS applications that
continues to be processed in batch mode. This is because:
(a) Paychecks are prepared periodically either weekly or biweekly or monthly;
and
(b) Most employees are paid at the same time which makes it appropriate to
process the transactions in batch.
Below are the descriptions of all processes show in Figure 7.9.
(a) Update Payroll Master File

The first activity in the HRM/payroll cycle involves updating the payroll
master file to reflect various types of payroll changes: new hiring,
terminations, changes in the pay rates, or changes in discretionary
withholdings (circle 1.0 in Figure 7.9). The HRM department provides this
information. Although payroll is processed in batch mode, Figure 7-8 shows
that the HRM department has online access to make these changes to the
payroll master file. Appropriate edit checks, such as validity checks on
employee number and reasonableness tests for the changes being made, are
applied to all payroll change transactions. It is important that all payroll
changes are entered in a timely manner and are properly reflected in the next
pay period. Records of employees who quit or are fired should not be deleted
immediately, however because some year-end reports require data about all
employees who worked for the organisation at any time during the year.
(b) Update Tax Rates and Deductions

The second activity in the HRM/payroll cycle is updating information
about tax rates and other withholdings (circle 2.0 in Figure 7.9). The payroll
department makes these changes, but the changes occur in frequently. They
happen when the payroll department receives updates about changes in tax
rates and other payroll deductions from various government units and
insurance companies.
(c) Validate Time and Attendance Data

The third step in the payroll cycle is to validate each employeeÊs time and
attendance data (circle 3.0 in Figure 7.9). This information comes in various
forms, depending on an employeeÊs pay status.

(d) Prepare Payroll

The fourth step in the payroll cycle is preparing payroll (circle 4.0 in Figure 7.9).
The department in which the employee works provides data about the hours
worked and a supervisor usually confirms the data. Pay rate information is
obtained from the payroll master file.
(e) Disburse Payroll

The next step is actual disbursement of paychecks to employees (circle 5.0 in
Figure 7.9). Most employees are paid either by check or by direct deposit of
the net pay amount into their personal bank account. Unlike cash payments,
both methods provide a means to document the amount of wages paid.
(f) Calculate Employer ă Paid Benefits and Taxes

The employer pays some payroll taxes and employee benefits directly
(circle 6.0 in Figure 7.9). For example, employers must pay social security
taxes, in addition to the amounts withheld from employee paychecks.
(g) Disburse Payroll Taxes and Miscellaneous Deductions

The final activity in the payroll process is paying the payroll tax liabilities
and the other voluntary deductions of each employee (circle 7.0 in Figure
7.9). An organisation must periodically prepare checks or use electronic
funds transfer to pay the various tax liabilities incurred.
Figure 7.9: Level 0 DFD for the payroll cycle


In Figure 7.10 below, a typical batch-oriented HRM/payroll system is presented.

This document flowchart shows two types of activities: daily and periodical
activities.
Figure 7.10: HRM/payroll chart

7.2.2 Fixed Asset Subsystems

The fixed asset subsystem is used to record the property, plant and equipment
used in an organisation. Some of the examples of fixed assets are building,
furniture, machinery and land. These fixed assets are depreciable, therefore,
accurate recording for these assets are needed. There are three main functions of
fixed asset systems which are the acquisition, the maintenance and the disposal of
fixed assets.

The accounts involved in this transaction are:

• Account payable
• Fixed asset
The DFD of fixed asset system is similar to purchase subsystems where it

involves purchase department, accounts payable, receiving, cash disbursement
and general ledger. The only different is in fixed asset an authorization is needed
whenever the asset acquisition and asset disposal are about to be done.
LetÊs examine the tasks involved in the fixed asset system.
(a) Asset Acquisition

The first task in fixed asset is asset acquisition. This process begins when
there is a need to get a new or to replace an existing fixed asset. After
considering the cost and other benefits, an approval will be given before the
asset can be purchased. The purchase process is similar to purchase
subsystem describe above.
(b) Asset Maintenance

As we know, assets such as machinery and motor vehicles will depreciate
over time because of the usage. Therefore, it is important for a company to
adjust its asset account based on certain calculation since the value has been
depreciated. The information is recorded in a document called depreciation
schedule.
(c) Asset Disposal

The last task in fixed asset system is asset disposal. Asset will be removed or
disposed of when it is no longer useful, damage or become obsolete. A
manager in charge will first request the asset to be disposed of and wait for
the approval. Once it has been approved, a disposal report is prepared and
sent to the accounting systems and remove from the related account.
We have now completed the study of three tasks in the fixed asset system. As for
the internal controls and controls in the computer environment, the procedures
and processes are similar to purchase systems described above. Therefore, from
this section onwards, we will only look at the payroll system in particular.

7.2.3 Internal Controls Procedures for the Payroll

Subsystem
In payroll subsystem, several internal controls should be implemented to prevent
exposure to certain risks associated with this cycle. Some of the controls needed
are:
(a) Sound hiring procedures, including verification of job applicantÊs skills,
references and employment history.
(b) Thorough documentation of hiring procedures.
(c) Training on current developments in employment law.
(d) Segregation of duties: HRM versus payroll and paycheck distribution.
(e) Reconciliation of time card data with job-time ticket data.
(f) Direct deposit.
(g) Updated employee list and pay rates provided by personnel department
(h) Paycheck
(i) Prepared only based on properly prepared payroll register.
(ii) Pre numbered.
(iii) Signed only if properly prepared.
(iv) Imprest bank account used.
(v) Distributed by persons not involved in payroll process.
(vi) Voided checks kept.
(vii) Unclaimed checks listed and investigated.
7.2.4 Computer Application Systems for Payroll

Activities
Figure 7.11 contains a system flowchart of a payroll system. Similar to cash
disbursement system, the payroll application uses batch processing. In this
system, a supervisor approves timecards for payment, batches them, and
establishes a control total over the total hours worked in a batch. A data entry
clerk enters the timecard data in a computer file. Some systems validate each data
record during its data entry. Others create the transaction file and then validate
them one batch at a time, producing an error listing. The validation program
produces a payroll transaction file, which the system sorts into employee number
sequence. A program calculates pay and deductions, updates the cumulative

earnings data in the employee master file, and prints the payroll register. After
payroll clerks have reviewed the register for errors, another program prints
paychecks and creates records for the general ledger batch summary file.
Figure 7.11: A payroll application


7.2.5 Controls in the Computer Environment

This section describes similar data validation techniques and divides them
according to input, processing and output categories.
(a) Input
• Program verifies that all required input have been entered such as
EMPLOYEE-NUMBER, EMPLOYEE-NAME, HOURS-WORKED.
(ii) Control total

• Program verifies that total number of hours on batch transactional
form = total number of hours on valid payroll transactions + total
number of hours on erroneous payroll transactions.
(b) Processing
(i) Record count
• Number of input transaction records = number of output
transaction records.
(i) Control total
• Total hours in input file = total hours in output file.
(c) Output
(i) Limit test
• Program flags for review by data control group for any
transactions with amounts more than RM10,000.
(i) Record count
• Program verifies that the number of paychecks = the number of
payroll transaction records.
(i) Control total
• Program verifies that total amount of paychecks = total debits to
general ledger accounts = total credits to general ledger accounts.
(i) Run-to-run controls
• Data control group compares control totals taken on paycheck
amounts and disclosed on control report and payroll register.

ACTIVITY 7.4
Prepare a worksheet in MS Excel that tabulates all of possible
deductions a payroll system of a company may consider. You may
research the information needed from the internet. Discuss and
exchange your answers with other course mates, and post them on
myLMS forum.
SELF-CHECK 7.1
1. What documents are included in the audit trail for payroll?
2. List out two accounts that are involved in Fixed Asset
Subsystem.
3. What are the five possible input sources that were fed into the
payroll subsystem?
• As a summary, we can understand that the efficiency and effectiveness of the

activities in the expenditure cycle can significantly affect a companyÊs overall
performance.
• IT can help improve the efficiency and effectiveness with which expenditure
cycle activities are performed.
• In particular, EDI, bar coding and EFT can significantly reduce the time and
costs associated with ordering, receiving and paying for goods.
• The payroll system must be designed to meet government regulations as well
as managementÊs information needs.
• Incomplete or erroneous payroll records not only impair decision making, but
also can result in fines and imprisonment.
• Thus, the design of an efficient and effective payroll system is vital.
• It is also important, however, to have a well designed HRM system.
• The knowledge and skills of employees are valuable assets and must be
carefully managed, developed, and maintained.

Imprest Voucher register

Payroll register VendorÊs invoice
Time card Purchase order
Purchase requisition Receiving report
Blind copy
Boockholdt, J. L., (1999). Accounting information systems. Singapore: McGraw-Hill.


Topic X Production
8 Cycle
Applications
LERANING OUTCOMES
1. Describe four basic activities and related data processing
operations performed in the production cycle;
2. Discuss the key decisions that must be made in the production
cycle and identify the information required to make those
decisions;
3. Explain the process of production cycle transactions using
computer;
4. Identify internal control procedures in production cycle; and
5. Explain two computerized application of production cycle.
X INTRODUCTION
This topic provides you with detail information about production cycle in
Accounting Transaction Cycles. The activities in this cycle relates to operations
associated with the manufacturing of products. The main activity in production
cycle is to convert the inputs such as raw materials, labours and overhead into
finished product. That is why this cycle is also known as conversion cycle.

160 X TOPIC 8 PRODUCTION CYCLE APPLICATIONS
8.1 PRODUCTION CYCLE ACTIVITIES

Production cycle is also an important part of accounting transaction cycles. This cycle
is closely related to other cycles such as revenue and expenditure cycles. Context
diagram in Figure 8.1 shows how the production cycle is linked to other subsystems
in a companyÊs AIS. LetÊs examine the relationship shows in Figure 8.1 below.
Figure 8.1: Context diagram of the production cycle

The revenue cycle provides information on customer orders and sales forecast to
the production cycle. This information is used to plan for the quantity of inventory
that will be produced. In return, the production cycle send information about
quantity of finished goods that have been produced and quantity that is available
for sale. The production cycle also send information about the needs of raw
materials to the expenditure cycle using purchase requisition forms. In exchange,
the expenditure cycle provides information about the raw materials that have been
purchased together with other expenditure as the overhead costs. The production
cycle also send information on labour needs to payroll cycle while payroll cycle
sends information on labour costs and availability in return. Finally, production
cycle sends information on cost of goods manufactured to the general ledger and
reporting system, and summary reports are sent to the management.
In sum, several functions are involved such as the acquisition of raw materials
and labours, the transfer of raw materials and overhead into production, the
transfer of finished goods into inventory and finally the sale of the inventory.
Next, we will look at Figure 8.2 which shows the four basic activities in the
production cycle:

TOPIC 8 PRODUCTION CYCLE APPLICATIONS W 161
(a) Product design;

(b) Planning and scheduling;
(c) Production operations; and
(d) Cost accounting.
Figure 8.2 also illustrates the information flows between each of those activities
and other AIS cycles.
Figure 8.2: Level 0 DFD of the production cycle

8.1.1 Product Design

Product design is the first step in the production cycle. The objective of this activity
(circle 1.0 in Figure 8.2) is to design a product that meets customer requirements in
terms of quality, durability and functionality while simultaneously minimising
production costs.
Documentation associated with these events includes:

(a) Bill of materials; and
(b) Operations list.

8.1.2 Planning and Scheduling

The second step in the production cycle is planning and scheduling (circle 2.0 in
Figure 8.2). The objective of this step is to develop a production plan that is
efficient enough to meet existing orders and anticipated short-term demand
without creating excess inventories.
Documents associated with these events include:

(a) Master production schedule (MPS);
(b) Materials requisition; and
(c) Move tickets.
8.1.3 Product Operations

The third step in the production cycle is the actual manufacturing of products
(circle 3.0 in Figure 8.2). This activity differs among companies according to the
type of product being manufactured and the degree of automation that the
company used in the production process. Although the activity is different
among companies, the required data remain the same as stated below:
(a) Raw materials that have been used.
(b) Labour hours that have been spent.
(c) Machine operations that have been performed.
(d) Manufacturing overhead costs that have been incurred.
8.1.4 Cost Accounting

The final step in the production cycle is cost accounting (circle 4.0 in Figure 8.2).
The three principal objectives of the cost accounting system are:
(a) To provide information for planning, controlling and evaluating the
performance of production operations;
(b) To provide accurate cost on data about products for use in pricing and
product mix decisions; and
(c) To collect and process the information used to calculate the inventory and
cost of goods sold that appear in the companyÊs financial statements.
So far, we have learnt the four basic functions of production cycle and their
objectives. Figure 8.3 below illustrates typical online AIS for the production cycle.
Let us look at the departments and the data storages involved in this process.

Figure 8.3 Online production cycle information system

The departments involve are sales, production planning, engineering, cost

accounting, inventory and factory workstations.
The production cycle databases involved are bill of materials, operation list,
master production schedule, inventory, production orders and work in process.
The process begins when there is new order from customers or whenever there is
new sales forecast entered by the sales department. Then, production planning
department uses the information together with information on current inventory
level to develop the master production schedule and store in the database. To
authorise the production of specific goods, new records are added to the
production order file. At the same time, new records are also added to the work in
process file to accumulate data on cost. In the mean time, when the engineering
department enters product specification for new products, new records will be
created in the bill of materials and operation list files. The engineering department
accesses both files to examine the design of similar products in order to develop the
specification. The department also accesses the general ledger and inventory files to
get information about the costs of any alternative in designing the products. When
the list of operations to be performed is ready, they are display at the appropriate
workstations. Similar instructions are sent to the computer integrated

manufacturing (CIM) interface to guide the operation of computerised machinery

and robots. Finally, materials requisitions are sent to the inventory stores
department to authorise the release of raw materials into production.
During the process illustrates in Figure 8.3, four types of cost data have been
accumulated which are raw materials, direct labour, machinery and equipment,
and manufacturing overhead. Let us now examine how these four categories of
cost data are collected.
First, we will learn how cost on raw materials is collected. Whenever a material
requisition is being issued, the raw materials are sent to production and a debit
will be made in work in process account. If additional materials are needed,
another debit is made to work in process. On the other hand, work in process
account is credited whenever unused materials are returned to the inventory
department. The usage data to calculate the cost is collected by scanning the
materials when they are released from or returned to the inventory department
because most of the materials are bar coded. For those without bar coded, the
inventory clerk uses online terminals to enter the usage data.
Next, we will examine how the cost for direct labour is collected. For direct
labour, a job time ticket can be used to collect data about labour activity. This
document records the amount of time a worker spent on each specific job task.
Alternatively, workers can also enter this data using online terminals at each
factory workstation. To improve the efficiency of this process, firms can also
introduce coded identification cards, which workers would be able to use using a
badge reader or bar code scanner when they start and finish any task.
Another cost to be collected is data on machinery and equipment usage. This data
is collected at each step in the production process, often together with data about
labour costs.
For example, when workers record their activities at a particular workstation,

the system can also record information identifying the machinery and
equipment used and the duration of such use.
Finally, we will examine how cost of manufacturing overhead is collected.

Manufacturing overhead is any manufacturing costs that are not economically
significant to trace directly to specific jobs or processes. Examples include the costs
of water, power and other utilities; miscellaneous supplies; rent, insurance, and
property taxes for the factory plant; and the salaries of factory supervisors. Most of
these costs are collected by the expenditure cycle information system (see Topic 7).

Thus far, we have focused on accounting costs associated with the production of
inventory. However, the AIS also collect and process information about the
property, plant, and equipment used in the production cycle. This is because such
fixed assets represent a significant portion of total assets for many companies, and
so it is important to monitor this investment. Some authors include fixed assets
system in the production cycle but some include this in the expenditure cycle. For
this module, fixed assets have been included in the expenditure cycle in Topic 7.
8.2 INTERNAL CONTROLS PROCEDURES FOR

PRODUCTION CYCLE
ACTIVITY 8.1
What do you understand by the term „S.O.P‰? Will it be helpful to

have „S.O.P‰ for every department in an organisation?
Internal controls procedures in production cycle are use to make the processing
in the cycle run smoothly. Table 8.1 lists some of the procedures used in
production cycle.
Table 8.1: Procedures Used in Production Cycle
No. Procedure
1 Improved information about the effects of product design on costs.
2 Detailed data about warranty and repair costs.
3 Better production planning systems.
4 Review and approval of fixed asset acquisitions; budgetary controls.
5 Restrict physical access to inventories and fixed assets.
6 Document all movement of inventory through the production process.
7 Identification of all fixed assets.
8 Periodic physical counts of inventory.
9 Adequate insurance.
10 Data entry edit controls; use of bar code scanning where feasible; reconciliation of
recorded amounts with periodic physical counts.
11 Backup and disaster recovery planning; restricting access to cost data.
12 Improved and timelier reporting.

8.3 COMPUTER APPLICATION SYSTEMS FOR

THE PRODUCTION CYCLE
8.3.1 Inventory System

This system is use to maintain inventory records and to notify managers when
the inventory level of a specific item requires replenishing. It is important to
record every transaction in order to prevent overstocking or under stocking
which can lead to a loss in a company.
8.3.2 Cost Accounting System

This system is use to determine the costs of products manufactured or services
provided and to record those costs in the accounting records. The costs come
from direct material, labour and overhead and are being recorded in an account
called the work in process (WIP). Job order costing and process costing are two
most commonly use in cost accounting systems.

ENVIRONMENT
This section describes controls use in the computer environment according to
input, processing and output categories.
8.4.1 Inventory System

(a) Input
• Verify the existence of item number and quantity on receiving
report transactions, verify the existence of item number, quantity,
and general ledger account number on materials requisition
transactions.
(ii) Validity test
• Verify that the item number on a transaction exists in the
inventory master record.

(b) Processing
(i) Record counts
• Program verifies that the number of debits to the inventory account
= the number of receiving reports.
• Program verifies that the number of credits = the number of
materials requisitions.
(c) Output
(i) Control total
• Clerk verifies from control report that all transactions were processed.
8.4.2 Cost Accounting System

(a) Input
• Verify that all fields have been entered with data in the materials
transaction and labour transaction records.
(b) Processing
(i) Control total
• In the online real time system, program verifies that total costs
recorded in job cost file = total cost recorded in cost center file.
(ii) Record count

• Verify that the number of new job records + the number of records in
the old job cost file = the number of records in the new job cost file.
(c) Output
(i) Control totals
• Data control group verifies that total cost of jobs on job purge
control report = total of job cost reports.
(ii) Run-to-run controls

• In batch system, data control group verifies that total on register =
total transactions disclosed on error listings.

SELF-CHECK 8.1
1. What activities are involved in the production system? The cost

accounting system?
2. What are the three main functions does inventory control serve
in the production process?
• In short, you should understand the four basic activities involve in the
production cycle.
• The activities are product design, production planning and scheduling,
production operations and cost accounting.
• Companies must also invest in IT continuously in order to improve the
efficiency of these activities.
• Apart from that, we have also listed the internal control procedures use in the
cycle and described the processes involve in this cycle using computer.
Bill of materials Move tickets

Master Production Schedule (MPS) Production cycle
Material requisition


Topic X General Ledger
9 and Reporting
System
LEARNING OUTCOMES
1. Identify four basic activities performed in the general ledger and
reporting system;
2. Explain the key decisions that must be made in the financial cycle;
3. Identify the information required to make the key decisions in
financial cycle;
4. Describe the process of financial cycle transactions using
computer; and
5. Discuss the control practices and procedures in financial cycle.
X INTRODUCTION
As a future accountant, you must be able to know the basic accounting
transaction processing cycle. After completed all accounting transaction
processing cycle in previous topics, we will now discuss on the general ledger
and reporting system in this topic. It tells about the operations of information
processing involved in updating the general ledger and preparing the reports
that summarise the results of an organisationÊs activities.

170 X TOPIC 9 GENERAL LEDGER AND REPORTING SYSTEM
9.1 GENERAL LEDGER AND REPORTING

ACTIVITIES
ACTIVITY 9.1
What entities need to be recorded in a General Ledger?
As we have learnt in previous topics, general ledger is an important element in

AIS. It is used as a hub to connect to every subsystem in the companyÊs AIS
through information flows. Basically, all summaries of transactions from other
subsystems become sources of input to general ledger and reporting systems.
The following are sources of data collected by the systems.
• Each of the accounting cycle subsystems described in Topic 6 to 8 provides
information about regular transactions as summarised by Figure 9.1.
Figure 9.1: Regular transactions in accounting cycle

TOPIC 9 GENERAL LEDGER AND REPORTING SYSTEM W 171
• The treasurer provides information about financing and investing activities,

such as the issuance or retirement of debt and equity instruments and the
purchase or sale of investment securities.
• The budget department provides budget numbers.
• The controller provides adjusting entries.
On the other hand, the outputs are reports which are sent to external and internal
user. The flow of this information is illustrated in Figure 9.2 below.
Figure 9.2: Context diagram of the general ledger and reporting system
The information flows in this system must be organised and stored in a way that
meets the various information needs of the internal and external users. For
example, managers need detailed information about the results of operations in
their particular area of responsibility. Investors and creditors want periodic
financial statements to help them assess the organisationÊs performance.
Currently, the investors and creditors are demanding more detailed and frequent
reports from the system. Government agencies also have periodic information
requirements that must be met by a company. Therefore, the design of the
general ledger and reporting system must be able to produce regular periodic
reports and to support real time inquiry needs.
For example, departmental managers should be able to access actual versus

planned performance at any time so that any differences can be identified
early in the process and corrective actions can be made. Likewise, the
treasurer must be able to closely monitor cash flows so that deviations from
forecasts can be identified in time and adjustment on short term borrowings
plans can be made.

Now that we have studied the context diagram in Figure 9.2, we will look at the
detail processes in level 0 of DFD show in Figure 9.3 below.
Figure 9.3: Level 0 DFD for the general ledger and reporting system
There are four basic activities performed in the general ledger and reporting
system as illustrates in Figure 9.3. The first three activities which are update
general ledger, post adjusting entries and prepare financial statements represent
the basic steps in the accounting cycle which end with the creation of the
traditional set of financial statements. The fourth activity which is produce
managerial reports indicates that, in addition to financial reports for external
users, the AIS also produces reports for internal management. LetÊs examines
each of these activities in more detail.
9.1.1 Updating General Ledger

As shown in Figure 9.3, the first activity in the general ledger system (circle 1.0) is
updating the general ledger. Updating consists of posting journal entries that
originate from two sources:
(a) Accounting Subsystem

Each of the accounting subsystem described in Topic 6 to 8 creates a journal
entry to update the general ledger. In theory, we can say that the general
ledger could be updated for each individual transaction. In practice,
however, the various accounting subsystem usually update the general
ledger by means of summary journal entries that represent the results of all

transactions that occur during a given period of time (day, week, or month).
LetÊs look at the example in revenue and expenditure cycles.
The revenue cycle subsystem would generate a summary journal entry

debiting accounts receivable and cash and crediting sales for all sales made
during the update period. Similarly, the expenditure cycle would generate
summary journal entries to record the purchase of supplies and inventories
and to record cash disbursements in payment for those purchases.
(b) Treasurer
The treasurerÊs office creates individual journal entries to update the
general ledger for non routine transactions such as the issuance or
retirement of debt, the purchase or sale of investment securities, or the
acquisition of treasury stock.
Journal entries to update the general ledger may be documented on a form called
a journal voucher. Figure 9.3 shows that the individual journal entries used to
update the general ledger are then stored in the journal voucher file. Therefore,
we can find the information in general ledger located in a manual AIS as well.
However, notice that the journal voucher file is a by-product of, not an input to,
the posting process. The journal voucher file is also one of the important parts of
the audit trail.
9.1.2 Post Adjusting Entries

The second activity in the general ledger system is posting various adjusting
entries (circle 2.0 in Figure 9-2). These adjusting entries originate from the
controllerÊs office, after the initial trial balance has been prepared. The trial
balance is a report that lists the balances for all general ledger accounts. Its name
reflects the fact that if all activities have been properly recorded, the total of all
debit balances in various accounts should equal the total of all credit balances. As
shown in Figure 9.3, information about these adjusting entries is stored in the
journal voucher file. After all adjusting entries have been made an adjusted trial
balance is prepared. The adjusted trial balance serves as the input to the next step
in the general ledger and financial reporting cycle which is the preparation of
financial statements.

9.1.3 Prepare Financial Statements

As mentioned in section 9.1.2, the third activity in the general ledger and
reporting system is preparing financial statements (circle 3.0 in Figure 9.2). The
income statement is prepared first, using data from the revenue and expense
account balances in the adjusted trial balance. The balance sheet is prepared next.
This activity requires closing entries that zero all revenue and expense accounts
and transferring the net income or loss to retained earnings. The third major
financial statement produced in this system is the statement of cash flows. It uses
data from the income statement and balance sheet to provide details about the
organisationÊs investment and financing activities.
9.1.4 Produce Managerial Reports

The final activity in the general ledger and reporting system (circle 4.0 in Figure
9.2) is producing various managerial reports. Examples of general ledger control
reports include:
(a) Lists of journal vouchers by numerical sequence, account number, or date;
and
(b) Lists of general ledger account balances.
These reports are used to verify the accuracy of the posting process. Several budgets
are produced for planning and evaluating performance of an organisation. The
operating budget depicts planned revenues and expenditures for each organisational
unit. The capital expenditures budget show planned cash inflows from operations
with planned expenditures and are used to determine the organisationÊs borrowing
needs.
In sum, the processes described above form the general ledger and reporting
system, which we discuss in this topic. To have a better understanding of these
processes, Figure 9.4 below illustrates the general ledger and reporting system in
detail using a flowchart.

Figure 9.4: Flowchart of an online general ledger and reporting system

9.2 INTERNAL CONTROLS FOR GENERAL

LEDGER AND REPORTING SYSTEM
Internal controls procedures for general ledger and reporting system are
important since this system deals with other subsystems in the AIS. The
procedures are listed below:
• Input and processing controls
• Reconciliations and control reports
• Audit trail
• Access controls
• Backup and disaster recovery procedures
9.3 COMPUTER APPLICATION SYSTEMS

There are two main computer applications in GL and reporting systems that you
should know. First is Journal Entry and Financial Reporting System and second
is property system. We will examine each application in the section below.

9.3.1 Journal Entry & Financial Reporting System

The detail process of journal entry system and financial reporting system is
shown in Figure 9.5 and 9.6 below.
Figure 9.5: A journey entry system


Figure 9.6: A financial reporting system

The purpose of the journal entry system is to post to the general ledger all transactions
that are not processed by other application systems. These include transactions that
record the acquisition of capital from the issue of stocks and bonds, the receiving of
cash from bank loans, and the acquisition and disposition of property. Meanwhile, the
purpose of the financial reporting system is to close the general ledger and to produce
financial statements and performance reports. It uses the journal entry system to
record adjustments made to the accounts during the closing process. That is why some
accountants identify the two systems as the general ledger system.

9.3.2 Property System

Property system deals with the fixed assets in a firm. The purpose of a property
system is to maintain an accurate record of all property, plant and equipment
that is depreciable. It also maintains records of annual and accumulated
depreciation on this property.
Figure 9.7: A property application



ENVIRONMENT
This section describes the controls use according to input, processing and output
categories.
9.4.1 Property System

(a) Input
• Verify that all master file fields are completed on the voucher or
capital work order records.
(ii) Validity test

• Verify that an account number represents valid asset account.
(b) Processing
(i) Record count
• Program verifies that the number of changes to the property
master file = the number of vouchers + the number of retirement
orders + the number of capital work orders.
(ii) Control total

• Program verifies that total debits to general ledger batch summary
file = batch total of vouchers + batch total of capital work orders.
(c) Output
(i) Control total
• Program verifies that total credits to general ledger batch
summary file = total of retirement work orders.

9.4.2 Journal Entry and Financial Reporting Systems

(a) Input
• Input program determines that all data in required fields are
entered.
(ii) Consistency test

• For any journal voucher, sum of debits = sum of credits.
(b) Processing
(i) Record count
• Number of records from input general ledger batch summary file
= number of records in detail postings file + number of records in
output general ledger batch summary file.
(i) Consistency test

• For each transaction, sum of debits = sum of credits.
(c) Output
(i) Run-to-run control
• Data control group reconciles totals on control report, error listing,
and transaction register.
• Data control group uses transaction register to reconcile the
differences between first and second trial balances.
SELF-CHECK 9.1
1. What are the three distinct phases of the financial accounting

process? How often are each of these functions performed?
2. What information is contained in a journal voucher?

• In general, the general ledger and financial reporting system integrates and
summarises the results of various accounting subsystems in revenue,
expenditure and production cycles.
• As discussed before, the general ledger acts as a central master file in the AIS.
• That is why, it is important to implement control procedures stated in this
topic in order to ensure its accuracy and security.
• The controls include edit checks of the journal voucher records posted to the
general ledger, access controls, an adequate audit trail, and appropriate
backup and disaster recovery procedures.
• This topic also discuss about the main applications use in this system which
are Journal Entry and Financial reporting System and Property System.
Adjusted trial balance General ledger batch summary file

Depreciation Journal voucher
General journal listing

Hall, J. A., (2001) Accounting information systems. Ohio: Thomson Learning.

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Faculty of Science and Technology

Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

Module Writers: Rina Md Anwar

Moderator: Norhaslinda Zakaria

Editor: Christine Ling Bee Fong

Developed by: Centre for Instructional Design and Technology

First Edition, November 2008

Copyright © Open University Malaysia, March 2011, CBFS4203

Topic 2 Information and Business Operation 18

Copyright © Open University Malaysia (OUM)

Topic 3 Accounting Records and Documentation Techniques 35

Topic 4 Control and Accounting Information Systems 62

Topic 5 Accounting Transaction Cycles 102

Copyright © Open University Malaysia (OUM)

Topic 6 Revenue Cycle Applications 115

Topic 7 Expenditure Cycle Applications 134

Topic 8 Production Cycle Applications 159

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8.2 Internal Controls Procedures for Production Cycle 165

Topic 9 General Ledger and Reporting System 169

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Copyright © Open University Malaysia (OUM)

COURSE GUIDE DESCRIPTION

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Table 1: Estimation of Time Accumulation of Study Hours

Briefly go through the course content and participate in initial discussions 3

Study the module 60

Topic 1 gives the learners a brief overview of accounting information system

Topic 2 explains how information flows within a business to support business

Topic 3 describes the relationship between accounting records to documentation

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Topic 7 describes the expenditure cycle activities (purchasing and cash

TEXT ARRANGEMENT GUIDE

Self-Check: This component of the module is inserted at strategic locations

Copyright © Open University Malaysia (OUM)

Activity: Like Self-Check, activities are also placed at various locations or

References: References is where a list of relevant and useful textbooks, journals,

Dunn, C., Cherrington, J. O. & Hollander, A., S. (2005). Enterprise information

Hall, J., A. (2001). Accounting information systems. Ohio: Thomson Learning.

OÊbrien, J., A. (2003). Introduction to information system. New York: McGraw-

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Copyright © Open University Malaysia (OUM)

Copyright © Open University Malaysia (OUM)

„To cope with the rapid growth of the company, a sophisticated

Taken from Information Technology for Management, Second Edition

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1.1 A FRAMEWORK FOR INFORMATION

Table 1.1: Definition of System, Subsystem and Information System

Information System (IS) is divided into 2 subsystems (refer Figure 1.1).

Figure 1.1: Two major subsystem of IS

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Figure 1.2: Framework for information system

As we know, the basic configuration of an IS is input resources transformed into

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Figure 1.3: Transactions processed by the information system

Table 1.2: Two classifications of Transaction

Distinguish between financial and non-financial transactions? Give

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1.1.1 The Accounting Information System (AIS)

(i) Transaction Processing System (TPS)

(ii) General Ledger (GL) / Financial Reporting System (FRS)

(iii) Management Reporting System (MRS)

1.1.2 The Management Information System (MIS)