AIS: Chapter 1 Accounting Information Systems: An Overview

CHAPTER ONE
ACCOUNTING INFORMATION SYSTEMS: AN OVERVIEW

1.1 AN OVERVIEW OF AIS

1.1.1 Meaning of Accounting Information System
Dear students, do you know the meaning of Accounting Information System? Well
done! Let’s define it term by term. For many, the term system generates mental images of
computers and programming. In fact, the term has much broader applicability. Some systems
are naturally occurring, whereas others are artificial. Natural systems range from the atom (a
system of electrons, protons, and neutrons) to the universe (a system of galaxies, stars, and
planets). All life forms, plant and animal are examples of natural systems. Artificial systems are
man-made. These systems include everything from clocks to submarines and social systems to
information systems.
Generally, system can be defined as a group of two or more interrelated components
or subsystems that serve a common purpose. That means, system is a set of two or more
interrelated components that interact to achieve a goal. Let’s analyze the general definition to
gain an understanding of how it applies to businesses and information systems.
Multiple components: A system must contain more than one part.
Relatedness: A common purpose relates the multiple parts of the system.
System versus subsystem: The distinction between the terms system and subsystem is a matter
of perspective. A system is called a subsystem when it is viewed in relation to the larger system
of which it is a part. Systems are almost always composed of smaller subsystems, each
performing a specific function important to and supportive of the larger system of which it is a
part. For example, the college of business is a system composed of various departments, each of
which is a subsystem. Yet the college itself is a subsystem of the University.
Purpose: A system must serve at least one purpose, but it may serve several.
System decomposition: Decomposition is the process of dividing the system into smaller
subsystem parts. This is a convenient way of representing, viewing, and understanding the
relationships among subsystems.
Subsystem interdependency: A system’s ability to achieve its goal depends on the effective
functioning and harmonious interaction of its subsystems.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

Basically there are three major components in every system, namely input, processing
and output. The input is data, raw materials, or anyt hing that is must be processed and
converted into the output. Processes refer to methods or activities or procedures used or
applied to convert input into output. Output is the goal to be achieved or the end result of a
system.

Therefore, a collection of components that work together to realize some objective forms
a system. In a system the different components are connected with each other and they are
interdependent. For example, Human body represents a complete natural system. We are also
bound by many national systems such as political system, economic system, educational system
and so forth. The objectives of the system demand that some output is produced as a result of
processing the suitable inputs. Information system is the set of formal procedures by which data
are collected, processed into information, and distributed to users. Figure 1-1 shows the
information system of a hypothetical manufacturing firm decomposed into its elemental
subsystems.
Dear students, since you are familiar with Accounting, would you define Accounting
Information System (AIS) in your own words. Do not worry! Let’s define it together. An
accounting information system is a system of collecting, storing and processing financial and
accounting data that are used by decision makers. May be it is defined as a structure that a
business uses to collect, store, manage, process, retrieve and report its financial data so that it can
be used by accountants, consultants, business analysts, managers, chief financial officers (CFOs),
auditors and regulatory and tax agencies. An accounting information system is generally a
computer-based method for tracking accounting activity in conjunction with information
technology resources. The resulting financial reports can be used internally by management or
externally by other interested parties including investors, creditors and tax authorities.
Accounting information systems are designed to support all accounting functions and activities
including auditing, financial accounting & reporting, managerial/management accounting and
tax. The most widely adopted accounting information systems are auditing and financial

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 AIS: Chapter 1 Accounting Information Systems: An Overview

reporting modules. Trained accountants who are work with AIS can ensure the highest level of
accuracy in a company's financial transactions and recordkeeping and to make financial data
easily available to those who legitimately need access to it, all while keeping data intact and
secure.
1.1.2 Complements of Accounting Information System
AIS consists five components:
1. The people who operate the system and perform various functions.
2. The procedures both manual and automated, involved in collecting, processing, and
storing data about the organization’s activities.
3. The data about the organization’s business processes.
4. The software used to process the organization’s data.
5. The information technology infrastructure, including computers, peripheral devices, and
network communications devices.

Together, these five components enable an AIS to fulfill three important functions in any
organization:
1. Collecting and storing data about the activities performed by the organization, the
resources affected by those events, and the agents who participate in the various activities
so that management, employees, and interested outsiders can review what has happened.
2. Transforming data into information that is useful for making decisions that enable
management to plan, execute, and control activities.
3. Providing controls in safeguarding organization’s assets, including its data, to ensure
that the data are available when needed and are accurate and reliable.

Dear student, we hope that the importance of AIS is now clear. Effective AIS is essential
to any organization’s long-run success. Without a means of monitoring the events that occur,
there would be no way to determine how well the organization is performing. Every organization
also needs to track the effects of various events on the resources that are under its control.
formed.

1.1.3 An Information Systems Framework

Dear student, notice that two broad classes of systems emerge from the decomposition:
the Accounting Information System (AIS) and the Management Information System (MIS). If

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 AIS: Chapter 1 Accounting Information Systems: An Overview

you have taken the course Management Information System (MIS), you may ask the difference
between accounting information system and the management information system. The
distinction between AIS and MIS centers on the concept of a transaction, as illustrated by Figure
1-2. The information system accepts input, called transactions, which are converted through
various processes into output information that goes to users.
Transactions fall into two classes: financial transactions and nonfinancial transactions.
Before exploring this distinction, let’s first broadly define transaction. Transaction is defined as
an event that affects or is of interest to the organization and is processed by its information
system as a unit of work. A financial transaction is an economic event that affects the assets
and equities of the organization, is reflected in its accounts, and is measured in monetary terms.
Sales of products to customers, purchases of inventory from vendors, and cash disbursements
and receipts are examples of financial transactions. Every business organization is legally bound
to correctly process these types of transactions. Nonfinancial transactions are events that do not
meet the narrow definition of a financial transaction. For example, adding a new supplier of raw
materials to the list of valid suppliers is an event that may be processed by the enterprise’s
information system as a transaction. Important as this information obviously is, it is not a
financial transaction, and the firm has no legal obligation to process it correctly—or at all.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

Figure 1-1: A Framework for Information Systems

Figure 1-2: Traansaction Processed By The Information Systems

A. The Accounting Information System

AIS subsystems process financial transactions and nonfinancial transactions that directly
affect the processing of financial transactions. For example, changes to customers’ names and
addresses are processed by the AIS to keep the customer file current. Although not technically
financial transactions, these changes provide vital information for processing future sales to the
customer. The AIS is composed of three major subsystems:

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 AIS: Chapter 1 Accounting Information Systems: An Overview

1. The transaction processing system (TPS), which supports daily business operations
with numerous reports, documents, and messages for users throughout the organization.
2. The general ledger/financial reporting system (GL/FRS), which produces the
traditional financial statements, such as the income statement, balance sheet, statement of
cash flows, tax returns, and other reports required by law.
3. The management reporting system (MRS), which provides internal management with
special-purpose financial reports and information needed for decision making such as
budgets, variance reports, and responsibility reports.
B. The Management Information System
The management information system (MIS) processes nonfinancial transactions that are
not normally processed by traditional AIS. Table 1-1 gives examples of typical MIS applications
related to functional areas of a firm.
Table 1-1: Examples of MIS Applications in Functional Areas
Functions Examples of MIS Applications
Finance Portfolio Management Systems
Capital Budgeting Systems
Marketing Market Analysis
New Product Development
Product Analysis
Distribution Warehouse Organization and Scheduling
Delivery Scheduling
Vehicle Loading and Allocation Model
Personnel Human Resource Management System
Employee Benefit Systems
C. AIS Subsystems
At this point, we briefly outline the role of each subsystem.
1. Transaction Processing System (TPS): The TPS is central to the overall function of the
information system by converting economic events into financial transactions, recording
financial transactions in the accounting records (journals and ledgers), and distributing
essential financial information to operations personnel to support their daily operations. The
TPS deals with business events that occur frequently. In a given day, a firm may process
thousands of transactions. To deal efficiently with such volume, similar types of transactions
are grouped together into transaction cycles. The TPS consists of three transaction cycles: the
revenue cycle, the expenditure cycle, and the conversion cycle. Each cycle captures and
processes different types of financial transactions.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

2. General Ledger/Financial Reporting Systems: The general ledger system (GLS) and the
financial reporting system (FRS) are two closely related subsystems. However, because of
their operational interdependency, they are generally viewed as a single integrated system—
the GL/FRS. The bulk of the input to the GL portion of the system comes from the
transaction cycles. The GLS is a subsystem that processes the summaries of transaction cycle
activity to update the general ledger control accounts. The FRS measures and reports the
status of financial resources and the changes in those resources. The FRS communicates this
information primarily to external users. E.g. of this information consists of traditional
financial statements, tax returns, and other legal documents.
3. Management Reporting System: The MRS provides the internal financial information
needed to manage a business. Managers must deal immediately with many day-to-day
business problems, as well as plan and control their operations. Typical reports produced by
the MRS include budgets, variance reports, cost-volume-profit analyses, and reports using
current (rather than historical) cost data.

Activity 1.1 Dear students! What is accounting information system? What are the major
subsystems of accounting information system?

1.2 BUSINESS PROCESS/ACTIVITIES/DECISION AND INFORMATION NEEDS

Dear, student we begin the study of AIS with the recognition that information is a
business resource. Like the other business resources of raw materials, capital, and labor,
information is vital to the survival of the contemporary business organization. Every business
day, vast quantities of information flow to decision makers and other users to meet a variety of
internal needs. In addition, information flows out from the organization to external users, such as
customers, suppliers, and stakeholders who have an interest in the firm. Figure 1-4 presents an
overview of these internal and external information flows. The pyramid in Figure 1-4 shows the
business organization divided horizontally into several levels of activity. Business operations
form the base of the pyramid. These activities consist of the product-oriented work of the
organization, such as manufacturing, sales, and distribution. Above the base level, the
organization is divided into three management tiers: operations management, middle
management, and top management. Operations management is directly responsible for
controlling day-to-day operations. Middle management is accountable for the short-term

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 AIS: Chapter 1 Accounting Information Systems: An Overview

planning and coordination of activities necessary to accomplish organizational objectives. Top

management is responsible for longer-term planning and setting organizational objectives. Every
individual in the organization, from business operations to top management, needs information to
accomplish his or her tasks. Notice in Figure 1-4 how information flows in two directions within
the organization: horizontally and vertically. The horizontal flow supports operations-level tasks
with highly detailed information about the many business transactions affecting the firm.

Figure1-4: Internal and External Flows of Information

Notice in Figure 1-4 how information flows in two directions:

1. Within the Organization:
 The horizontal flow: supports operations-level tasks with highly detailed information about
the many business transactions affecting the firm. (e.g. the sale and shipment of goods, the
use of labor and materials in the production process)
 The vertical flow: distributes information downward from senior managers to junior
managers and operations personnel in the form of instructions, quotas, and budgets. In
addition, summarized information pertaining to operations and other activities flows upward
to managers at all levels. Management uses this information to support its various planning
and control functions.
2. Exchanges between the organization and users in the external environment:
 Trading partners: include customer sales and billing information, purchase information for
suppliers, and inventory receipts information.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

 Stakeholders are entities outside (or inside) the organization with a direct or indirect interest
in the firm. Stockholders, financial institutions, and government agencies are examples of
external stakeholders. Information exchanges with these groups include financial statements,
tax returns, and stock transaction information. Inside stakeholders include accountants and
internal auditors. Technology is making information available to improve decisions for all
decisions makers, at the same time making the job of an accountant more interesting and
challenging, as well as providing new opportunities for you. All the decision makers within
an organization benefit from accounting technology and this is not limited to accountants.
For example, sales managers can make better decisions because the sales and collections
information from the computerized accounting system is timelier. The ability to automate
controls means that data should be more reliable, which is another benefit for the entire
organization.
Accountants with technology skills are using computers to reduce the mundane part of
their work, which allows them to be more efficient in their work. This efficiency means these
accountants have time to do more interesting work and at the same time be more valuable to their
employers.
Businesses engage in a variety of activities, including acquiring capital, selling goods or
services, buying buildings and equipment, collecting payment from customers, hiring and
training employees, paying employees, purchasing inventory, paying taxes, doing advertising
and marketing, paying vendors. Each activity requires different types of decisions and each
decision requires different types of information.
Types of information needed for decisions:
o Some is financial
o Some is nonfinancial
o Some comes from internal sources
o Some comes from external sources
An effective AIS needs to be able to integrate information of different types and from different
sources.
AIS Interaction with External and Internal Parties
The AIS interacts with external parties, such as customers, vendors, creditors, and governmental
agencies.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

Internal External
Parties Parties

• The AIS also interacts with internal parties such as employees and management.

Internal External
Parties Parties

• The interaction is typically two-way, in that the AIS sends information to and receives
information from these parties.

Activity 1.2 Dear students! What is the responsibility of operations management? What does
vertical flow of information?

1.3 SCOPE OF AIS

Accounting Information System is a subsystem that provides accounting and financial
information, as well as other information obtained in the routine processing of accounting
transaction. Hence, the scope of AIS consists 10 elements. Figure 1-5 shows that there are 10
elements in the study of AIS.
1 Technology: Your ability to plan and manage business operations depends partly on your
knowledge of the technology available. Technology provides the foundation on which AIS
and business operations rest, and knowledge of technology is critically important to your
complete understanding of the AIS discipline.
2. Databases: It is important to understand the variety of databases, both private and public;
the quantity and type of data available in these databases; and methods of retrieving those
data.
3. Reporting: To design reports generated by an information system, the accountant must
know what outputs are required or are desirable.
4. Control: Control is the mean by which we make sure the intended actually happens.
Consider how much more difficult it will be to control modern, complex business processes.
You must develop an understanding of control that is specific to the situation at hand, yet is
adaptable for the future.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

5. Business operations: Organizations engage in activities or operations, such as hiring

employees, purchasing inventory, and collecting cash from customers. An AIS operates in
concert with these business operations. Many AIS inputs are prepared by operating
departments, and many AIS outputs are used to manage these operations.
6. Events processing: As organizations undertake their business operations, events, such as
sales and purchases, occur. Data about these events must be captured and recorded to mirror
and monitor the business operations
7. Management decision making: The information used for a decision must be tailored to
the type of decision under consideration. Furthermore, the information is more useful if it
recognizes the personal management styles and preferences of the decision maker.
7. System development and operation: The information systems must be designed,
implemented, and effectively operated. Choosing the data for a report, designing that report,
and configuring an enterprise system are examples of systems development tasks that can be
accomplished by an accountant.
8. Communications: To present the results of their endeavors effectively, accountants must
possess strong oral and written communication skills.
9. Accounting and auditing principles: To design and operate the accounting system, an
accountant must know the proper accounting procedures and must understand the audits to
which the accounting information will be subjected.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

Figure 1-5 Elements in the Study of Accounting Information Systems

Activity 1.3 Dear student! What are the elements included in the scope of AIS?

1.4 USES OF ACCOUNTING INFORMATION SYSYEM

The following are some uses of AIS in a business:
i. Producing External Reports: Businesses use (AIS) to produce special reports that
follow a required structure established by organizations such as (FASB). These reports
include financial statements, tax returns, etc.
ii. Supporting Routine Activities: Managers need an (AIS) for handling routine operating
activities during the firm’s operating cycle. Computer systems excel at handling
repetitive transaction by many accounting software support these routine functions.
iii. Decision Support: Information is needed for non-routine decision support at all levels of
an organization. Some information are critical for planning, deciding, and marketing
functions.
iv. Planning and Control: An information system is required for planning and control
activities as well. Historical data can be extracted from the database and used to forecast

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 AIS: Chapter 1 Accounting Information Systems: An Overview

growth and cash flows. Planners can use data mining to reveal long-term trends and
relationships.
v. Implementing Internal Control: Internal control includes the policies, procedures, and
information system used to protect a company’s assets from loss and to maintain accurate
financial data. It is possible to build controls into a computerized accounting information
system to help reach these goals.

Activity 1.4 Dear student! Please mention some uses of accounting information system?

1.5 ROLE OF ACCOUNTANTS IN RELATION TO AIS

Dear students, the final section of this chapter deals with the role of accountant’s
relationship to the accounting information system. Accountants are primarily involved in three
ways: as system users, designers, and auditors.
1. Accountants as Users
In most organizations, the accounting function is the single largest user of information
system (IT). All systems that process financial transactions impact the accounting function in
some way. As end users, accountants must provide a clear picture of their needs to the
professionals who design their systems. For example, the accountant must specify accounting
rules and techniques to be used, internal control requirements, and special algorithms such as
depreciation models. The accountant’s participation in systems development should be active
rather than passive. The principal cause of design errors that result in system failure is the
absence of user involvement.
2. Accountants as System Designers
An appreciation of the accountant’s responsibility for system design requires a historic
perspective that predates the computer as a business information tool. Traditionally, accountants
have been responsible for key aspects of the information system, including assessing the
information needs of users, defining the content and format of output reports, specifying sources
of data, selecting the appropriate accounting rules, and determining the controls necessary to
preserve the integrity and efficiency of the information system. These traditional systems were
physical, observable, and unambiguous. The procedures for processing information were manual,
and the medium for transmitting and storing data was paper. With the arrival of the computer,

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 AIS: Chapter 1 Accounting Information Systems: An Overview

computer programs replaced manual procedures, and paper records were stored digitally. The
role accountants would play in this new era became the subject of much controversy. Lacking
computer skills, accountants were generally uncertain about their status and unwilling to explore
this emerging technology. Many accountants relinquished their traditional responsibilities to the
new generation of computer professionals who were emerging in their organizations. Computer
programmers, often with no accounting or business training, assumed full responsibility for the
design of accounting information systems. As a result, many systems violated accounting
principles and lacked necessary controls. Large system failures and computer frauds marked this
period in accounting history. By the mid-1970s, in response to these problems, the accounting
profession began to reassess the accountant’s professional and legal responsibilities for
computer-based systems. Today, we recognize that the responsibility for systems design is
divided between accountants and IT professionals as follows: the accounting function is
responsible for the conceptual system, and the IT function is responsible for the physical system.
To illustrate the distinction between conceptual and physical systems, consider the following
example: The credit department of a retail business requires information about delinquent
accounts from the AR department. This information supports decisions made by the credit
manager regarding the creditworthiness of customers. The design of the conceptual system
involves specifying the criteria for identifying delinquent customers and the information that
needs to be reported. The accountant determines the nature of the information required, its
sources, its destination, and the accounting rules that need to be applied. The physical system is
the medium and method for capturing and presenting the information. The computer
professionals determine the most economical and effective technology for accomplishing the
task. Hence, systems design should be a collaborative effort. Because of the uniqueness of each
system and the susceptibility of systems to serious error and even fraud, the accountant’s
involvement in systems design should be pervasive. In later chapters, we shall see that the active
participation of accountants is critical to the system’s success
3. Accountants as System Auditors
Auditing is a form of independent attestation performed by an expert—the auditor—who
expresses an opinion about the fairness of a company’s financial statements. Public confidence in
the reliability of internally produced financial statements rests directly on their being validated
by an independent expert auditor. This service is often referred to as the attest function.

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 AIS: Chapter 1 Accounting Information Systems: An Overview

Activity 1.5
Dear student! Explain the role of accountants in relation to accounting information system?

1.6 SUMMARY

The first section explores the information environment of the firm. It introduces basic
systems concepts, identifies the types of information used in business, and describes the flows of
information through an organization. This section also presents a framework for viewing
accounting information systems in relation to other information systems components. This
distinction is related to the types of transactions these systems process. AIS applications process
financial transactions, and MIS applications process nonfinancial transactions. The second
section then presented a general model for accounting information systems. The model is
composed of four major tasks that exist in all AIS applications: data collection, data processing,
database management, and information generation. The final section of the chapter examined
three roles of accountant as (1) users of AIS, (2) designers of AIS, and (3) auditors of AIS. In
most organizations, the accounting function is the single largest user of the AIS. The IT function
is responsible for designing the physical system, and the accounting function is responsible for
specifying the conceptual system. The physical system, and the accounting function is
responsible for specifying the conceptual system. Auditing is an independent attestation
performed by the auditor, who expresses an opinion about the fairness of a company’s financial
statements.

1.7 REVIEW QUESTIONS

Multiple Choice Questions

1. The following are subsystems of the Accounting Information System, EXCEPT:
A. Transaction Processing System.
B. Human Resources System.
C. General Ledger/Financial Reporting System.
D. Management Reporting System.
2. Which of the following is NOT a purpose of the Transaction Processing System?

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A. Managing and reporting on the status of financial investments

B. Converting economic events into financial transactions
C. Distributing essential information to operations personnel to support their daily
operations
D. Recording financial transactions in the accounting records
3. Which is NOT an accountant’s primary role in information systems?
A. system user
B. system auditor
C. system designer
D. system programmer
4. Which of the following is NOT an objective of all information systems?
A. Support for the stewardship function of management
B. Support for management decision making
C. Support for the day-to-day operations of the firm
D. All of the above are objective
Discussion Questions
1. What are the four levels of activity in the pyramid representing the business organization?
2. Distinguish between horizontal and vertical flows of information.
3. What are the elements of a system?
4. What is system decomposition and subsystem interdependency? How are they related?
5. What is the relationship among data, information, and an information system?

END

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