Accounting Information System

Chapter One
Accounting Information systems: An Overview

Learning Objectives:
1. Explain what an accounting information system (AIS) is.
2. Describe the basic functions AIS performs.
3. Discuss why studying the design and management of AIS is important.
4. Explain the role played by the AIS in a company’s value chain.
5. Discuss ways that the AIS can add value to a business.
6. Describe the basic strategies and strategic positions that a business can adopt.
7. Contrast the basic strategies and strategic positions that a business can adopt.

1.1. Introduction
A system is a set of two or more interrelated components to achieve a goal. Systems are
almost always composed of smaller subsystems, each performing a specific function
important to and supportive of the larger system for which it is a part.

An accounting information system is a collection of resources such as people and

equipment designed to transform financial data into information. The information is
communicated to a wide variety of decision makers. AIS perform this transformation whether
they are essentially manual or computerized.

Organizations depend on information systems in order to stay competitive. Information is just

as much as a resource as plant and equipment. Productivity, which is crucial to staying
competitive, can be increased through better information systems. Accounting as an
information system identifies, collects, processes and communicates economic information
about an entity to a wide variety of people.

AIS consist of five components:

i. The people who operate the system and perform various functions.
ii. The procedures both manual and automated involved in collecting, processing, and
storing data about organization’s activities.
iii. The data about the organization’s transactions
iv. The software used to process the organization’s data
v. The information technology infrastructure including computers, peripheral
devices, and network communication devices.

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The five components together enable AIS to fulfill three important functions in any
organization.
i. It collects and stores data about activities and transactions.
ii. It processes data into information that is useful for making decisions.
iii. It provides adequate controls to safeguard the organization’s assets including its data,
to ensure that the data are available when needed and are accurate and reliable.

1.2. Information Systems

The term information system suggests the use of computer technology in an organization
to provide information to users. A computer based information system is a collection of
computer hardware and software designed to transform data into useful information. There
are several types of computer based information systems. These include the following:
1) Electronic Data Processing (EDP) - is the use of computer technology to
perform an organization’s transaction oriented data processing. EDP is a fundamental
accounting information system application in every organization. As computer technology
has become commonplace, the term data processing has come to have the same
meaning as EDP.
2) Management Information Systems (MIS) - describes the use of computer
technology to provide decision-oriented information to managers. MIS provides a wide
variety of information beyond that which is associated with data processing in
organizations. It recognizes that managers within organizations use and require
information in decision-making, and that computer based information systems can assist
in providing information to managers.

Functional MIS Systems- many organizations apply the MIS concept to specific
functional areas within the organization. This indicates the tailoring of MIS concept to the
development of specific information systems to support decision-making in a particular
well-defined organization subunit.
i. Marketing Information System- is an MIS that provides information to be
used by a marketing function. Much of the information is obtained from the
organization’s accounting information system. Examples are sales summaries and cost
information. Other information must be gathered from the organization’s environment.
Examples of environmental information would include customer preference data,
customer profiles, and information on competitor’s products.
ii. Manufacturing Information System- is an MIS that provides information to
be used by the manufacturing function. Much of the information is obtained from the
organization’s accounting information system. Examples are inventory summaries and
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cost information. Other information must be gathered from the organization’s
environment. Examples of environmental information would include raw materials
data, potential new vendor profiles, and information on new manufacturing
techniques.
iii. Human Resource Information System- is an MIS that provides information
to be used by the human resource (personnel) function. Much of the information is
obtained from the organization’s accounting information system. Examples are wage
and payroll tax summaries and benefit information. Other information must be
gathered from the organization’s environment. Examples of environmental information
would include government regulation data, and general labor market information.
iv. Financial Information System- is an MIS that provides information to be
used by the finance function. Much of the information is provided by the organization’s
accounting information system. Examples are cash flow summaries and payment
information. Other information must be gathered from the organization’s environment.
Examples of environmental information would include interest rate data, lender
profiles, and information on credit markets.
3) Decision Support Systems (DSS) - provide data processed into a decision
making format for the end user. A DSS requires the use of decision models and
specialized databases, and differs significantly from a DP system. A DSS is designed for
specific types of decisions for specific users. It is directed at serving specific non-routine
information requests by mangers. A familiar example is the use of spreadsheet software
to perform what if analysis of operating or budgeted data such as sales forecasts by
marketing personnel.
4) Expert Systems (ES) – are knowledge based information systems that use the
knowledge about a specific application area to act as an expert consultant to end-users.
Like DSSs an ES requires the use of decision models and specialized databases. Unlike
DSSs an ES is also requires the development of a knowledge base- the special knowledge
that an expert possesses in a decision area and an inference engine- the process by
which the expert makes a decision. An ES attempts to replicate the decisions that would
be made by an expert, human decision maker in the same decision situation. An ES
differs from DSS in that the DSS assists the user in making a decision, whereas an ES
makes the decision.
5) Executive Information System (EIS) – is a system tailored to the strategic
information needs of top-level management. Much of the information used by top-level
management comes from sources other than an organization’s information systems.
Examples are meetings, memos, television, periodicals, and social activities. But some

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information must be processed by the organization’s information systems. An EIS
provides top-level management with easy access to selective information that has been
processed by the organization’s information systems. This selective information concerns
the key success factors that top-level management has identified as being critical to the
organization’s success. Actual versus projected market share for product groups and
budget versus actual profit and loss data for divisions might be key success factors for
top-level executive.
6) Accounting Information System (AIS) – is computer-based system designed
to transform accounting data into information. However, AIS is used broadly to include
transaction processing cycles, the use of information technology and the development of
information systems.

1.3. Why Study the AIS?

Effective AIS is essential to the organization’s long run success.
i. It enables monitoring the events that occur and how well an organization works.
ii. It also tracks the effect of various events on the resources that the organization
controls.
iii. Information about the agents who participate in the events is used to assign
responsibility for actions taken.

In statement of financial accounting concepts No. 2, the Financial Accounting Standard Board
(FASB) defined accounting as an information system. It also stated that the primary
objective of accounting is to provide information that is useful to decision makers.
Therefore, it is not surprising that the accounting education change commission
recommended that the accounting curriculum should emphasize that accounting is an
information identification, development, and measurement and communication
process.

The AIS course focuses on understanding how the accounting system works i.e. how to
collect data about the organization’s activities and transactions; how to transform that data
into information that management can use to run the organization; and how to ensure the
availability, reliability and accuracy of that information. Hence, it complements the other
accounting courses.

The AIS course fits into both the accounting and information system curricula. Study of AIS
fundamental to accounting because change shall be incorporated in the accounting curricula.
The commission suggested that the accounting curriculum should be designed to provide
students with a solid understanding of three essential concepts:

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i. The use of information in decision making
ii. The nature, design, use and implementation of an AIS
iii. Financial information reporting

The other accounting course that you take (Financial Accounting, Managerial Accounting, Tax
and Audit) focus on your role as a reporter of information. Thus, studying about the design
and management of AIS is important because of the following reasons.
i. To understand how the accounting system works.
9 How to collect data about an organization’s activities and transactions
9 How to transform that data into information that management can use to run the
organization
9 How to ensure the availability, reliability, and accuracy of that information
ii. Auditors need to understand the systems that are used to produce a company’s financial
statements.
iii. Tax professionals need to understand enough about the client’s AIS to be confident that
the information used for tax planning and compliance work is complete and accurate.
iv. One of the fastest growing types of consulting services entails the design, selection, and
implementation of new Accounting Information Systems.
v. A survey conducted by the Institute of Management Accountants (IMA) indicates that
work relating to accounting systems was the single most important activity performed
by corporate accountants.

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

Three factors influence the design of AIS:

i. Developments in information technology (IT)
ii. The organization’s strategy
iii. The organizational culture

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 Accounting Information System

Organizational
Strategy
Culture

AIS

Information
Technology

Fig 1.1 Factors influencing the design of Accounting Information System

IT is profoundly changing the way that accounting and many other business activities are
performed. It is also essential to know the costs and benefits of new IT developments. This
requires developing basic understanding of business strategies and how IT can be used to
implement those strategies as well as how new developments in IT create an opportunity to
modify those strategies.

Moreover, because the AIS functions within an organization, it should be designed to reflect
the values of that organizational culture. The design of AIS also influences the organizational
culture by controlling the flow of information within the organization. For example, an AIS
that makes information easily accessible and widely available is likely to increase pressures
for more decentralized and autonomy.

There are 10 most important activities performed by accountants

i. Accounting systems and financial reporting
ii. Long-term strategic planning
iii. Managing the accounting and finance function
iv. Internal Consulting
v. Short-term budgeting
vi. Financial and economic analyses
vii. Process improvement
viii. Computer systems and operations
ix. Performance evaluation
x. Customer and product profitability analyses

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1.4. The Role of the AIS in the Value Chain

The objective of most organizations is to provide value to their customers. This requires
performing a number of different activities. These activities are conceptualized as forming a
value chain. A business will be profitable if the value it creates is greater than the cost of
producing its products or services.

An organization’s value chain consists of nine interrelated activities that collectively describe
everything it does. The five primary activities consist of the activities performed in order to
create, market, and deliver products and services to customers and also to provide post-sales
services and support. They directly provide value to its customers. These are:
1) Inbound logistics- consists of receiving, storing, and distributing the materials that are
inputs used by the organization to create the services and products that it sells.
2) Operations- activities that transform inputs into final products or services.
3) Outbound logistics- are the activities involved in distributing finished products or
services to customers.
4) Marketing and sales- refers to the activities involved in helping customers to buy the
organization’s products or services.
5) Service- activities that provide post sale support to customers. Examples are repairs and
maintenance services.

1. Firm Infrastructure
2. Human Resources
3. Technology
4. Purchasing

1. Inbound 2. Operations 3. Outbound 4. Marketing 5. Services

Logistics Logistics & sales

Fig 1. 2. The Value Chain

Organizations also perform a number of other support activities that enable the five primary
activities to be performed efficiently and effectively. Those support activities can be grouped
into four categories:

1) Firm Infrastructure- refers to the accounting, finance, legal support, and general
administrative activities that are necessary for any organization to function. The AIS is
part of the firm infrastructure.
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2) Human resources- activities that include recruiting, hiring, training, and providing
employee benefits and compensation.
3) Technology- activities that improve a product or service. Examples include research and
development, improvements in information technology, web site development, and
product design.
4) Purchasing- includes all the activities involving in procuring raw materials, supplies,
machinery, and the buildings used to carry out the primary activities.

It shall be recalled that systems are often composed of subsystems. Thus, each step in an
organization’s value chain is itself a system consisting of a set of activities. For example, the
sales and marketing step includes such activities as market research, calling on customers,
order processing, and credit approval. In addition, an organization’s value chain is itself a
part of a larger system.

The value chain concept can be extended by recognizing that organizations must interact
with suppliers, distributors, and customers. An organization’s value chain and the value
chains of its suppliers, distributors, and customers collectively form a value system.

1.5. How Can AIS Add Value to an Organization?

The value chain model shows that the AIS is support activity. Thus, AIS can add value to
the organization by providing accurate and timely information so that the five primary value
chain activities can be performed more effectively and efficiently. Well-designed AIS can do
this by:
1) Improving the quality and reducing the cost of products and services- an AIS
for example can monitor machinery so that operators are notified immediately when the
process falls outside acceptable quality limits. This helps not only maintain product
quality but also reduces the amount of wasted materials and the costs of having to
rework anything.
2) Improving efficiency- well designed AIS can help improve the efficiency of operations
by providing more timely information. For example, a just in time manufacturing
approach requires constant, accurate, up to date information about raw materials
inventories and their costs.
3) Improved decision making- an AIS can improve decision making by providing
accurate information in a timely manner.
4) Sharing of knowledge- a well-designed AIS can make it easier to share knowledge
and expertise, perhaps thereby improving operations and even providing a competitive
advantage.

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Well designed AIS can also help an organization profit by improving the efficiency and
effectiveness of its supply chain. For example, allowing customers to directly access the
company’s inventory and sales order entry systems can reduce the cost of sales and
marketing activities. Moreover, if such access reduces customers’ costs and time of ordering,
both sales and customer retention rates may increase.

1.6. Data and Information

Data refers to any and all of the facts that are collected, stored, and processed by an
information system. Three kinds of data need to be collected for any activity. These are:
i. Facts about the event itself,
ii. The resources affected by the event, and
iii. The agents who participated in that event. Consider selling process as an example.

Data need to be collected about the sale event itself (such as date of sale, total amount etc),
data about the resources being sold (identity of the goods or services), and data about the
agents who participated in the sale event (the identity of the customer and the salesperson).
Once data have been collected, the AIS will transform the facts so that they will be used to
make decisions. Thus information is data that have been organized and processed to
provide meaning. The following diagram depicts the characteristics of Useful Information

Relevant Timely

Reliable Understandable

Complete Verifiable

Fig 1.3 Characteristics of Useful Information

1.7. Decision Making

There are different models of decision-making and problem solving process. All those models
depict that decision-making is a complex, multi-step activity. Decision making involves the
following steps:
1. Identify the problem
2. Select a method for solving the problem

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3. Collect data needed to execute the decision
4. Interpret the outputs of the model.
5. Evaluate the merits of each alternative
6. Choose and execute the preferred solution

The AIS can provide assistance in all phases of decision-making. Different decision models
and analytical tools can be provided to users. Query languages can facilitate the gathering of
relevant data upon which to make the decision. Various tools such as graphical interfaces can
help the decision maker interpret the results of a decision model and evaluate and choose
among alternative course of action. Finally the AIS can provide feedback on the results of
actions.

The degree to which AIS can support decision-making depends, however, on the type of
decision being made. Decisions may be categorized either in terms of the degree of structure
or by their scope.

1.7.1. Decision Structure

Decisions vary in terms of the degree they are structured. Decisions are classified into three
in this regard.
1) Structured decisions- are repetitive, routine, and understood well enough that they
can be delegated to lower level employees in the organization. For example, the decision
about extending credit to established customers require only knowledge about the
customer’s credit limit and current balance. Structured decisions can often be automated.
2) Semi structured decisions- are characterized by incomplete rules for making the
decisions and the need for subjective assessments and judgments to supplement formal
data analysis. Setting a marketing budget for a new product is a typical example.
Although such decisions can’t be fully automated, they are often supported by computer
based decision aids.
3) Unstructured decisions - are nonrecurring and non-routine decisions. For example,
choosing the cover of a magazine, hiring senior management, and selecting basic
research projects to be undertaken. No framework or model exists to solve such
problems. Instead, they require considerable judgment and intuition. Nevertheless,
unstructured decisions can be supported by computer based decision aids that facilitate
gathering information from diverse sources.

1.7.2. . Decision Scope

Decisions vary in terms of the scope of their effect. This will include:

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1) Operational control- concerns the effective and efficient performance of specific
tasks. Decisions relating to inventory management and extending credit are examples of
operational control activities.
2) Management control- concerns the effective and efficient use of resources for
accomplishing organizational objectives. Budgeting, developing human resource
practices and deciding on research projects and product improvements are examples of
management control activities.
3) Strategic planning- concerns the establishing of organizational objectives and policies
for accomplishing those objectives. Setting financial and accounting policies, developing
new product lines, and acquiring new businesses are examples of strategic planning
decisions.

There exists a correspondence between a manager’s level in an organization and his decision
making responsibilities.

1) Top management-unstructured and semi structured decisions, involving strategic

decisions.
2) Middle managers-deal with semi structured decisions, involving management control.
3) Lower level supervisors and employees- face semi structured or structured
decisions involving operational control.

1.8. Value of Information for Decision Making

The value of information is the benefit produced by the information minus the cost of
producing it. The information produced by well-designed AIS can improve decision making in
several ways:

1. Identifies situations requiring management action. For example, a cost report with a
large variance might stimulate management to investigate and if necessary take
corrective action.
2. Reducing uncertainty, accounting information provides a basis for choosing among
alternative actions. For example, accounting information is often used to set prices and
determine credit policies.
3. Information about the results of previous decisions provides valuable feedback that can
be used to improve future decisions.

Nevertheless, although more information is often better, this is only true to a point. There
are limits to the amount of information that the human mind can effectively absorb and
process. Information overload occurs when those limits are passed. Information overload is

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costly because decision-making quality declines while the costs of providing that information
increase. Thus, information overload reduces the value of information. Consequently,
information system designers must consider how advances in IT can help decision makers
more effectively filter and condense information thereby avoiding information overload.

Moreover, it is important to recognize that there are costs associated with producing
information. Those costs include the time and resources spent in colleting, processing, and
storing data as well as the time and resources used in distributing the resulting information
to decision makers. There are also many opportunities to invest in additional IT to improve
the overall performance of the AIS. Most organization, however, do not have unlimited
resources to invest in improving their information systems. Therefore, another important
decision involving identifying which potential AIS improvements are likely to yield the
greatest return. Making this decision wisely requires that accountants and information system
professionals

1.9. AIS and Corporate Strategy.

There are two basic strategies that companies can follow:
1. A product differentiation strategy entails adding some features or services to a
product that are not provided by competitors. Doing so allows a company to charge a
premium price to its customers.
2. A low cost strategy entails striving to be the most efficient producer of a product or a
service.
Sometimes companies can succeed in both producing a better product than competitors and
in doing at costs below its industry average. Usually, however, companies must choose
between the two basic strategies. If they concentrate on being the lowest cost producers,
they will have to forego some value added features that might differentiate their product. If
they focus on product differentiation, they most likely will not have the lowest costs in the
industry. Thus a business strategy involves making choices.

The choice of a business strategy involves the selection of a specific strategic position they
shall adopt. There are three strategic positions.

1. Variety based strategic position involves producing or providing a subset of the

industry’s products or services.
2. Need based strategic position involve trying to serve most or all of the needs of a
particular group of customers. This entails first identifying a target market.

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3. Access based strategic position involves serving a subset of customers who differ
from other customers in terms of factors such as geographic locations or size, which
creates different requirements for serving those customers.

The above strategic positions are not mutually exclusive and indeed often overlap. For
example, a company may adopt elements of all the three. Choosing a strategic position is
important because it enables the company to focus its efforts; otherwise, it risks trying to be
everything to everybody.

1.10. Information Technology and Business Strategy

New developments in IT affect the design of AIS. Because an AIS functions within an
organization, it should be designed to reflect the values of that organizational culture. In
addition to directly affecting the way that organizations carry out their value chain activities,
IT such as the Internet can also affect significantly both strategy and strategic positioning.
For example, it dramatically cuts costs, thereby helping companies to implement a low cost
strategy.

1.11. The Role of AIS

An organization’s AIS play an important role in helping it adopt and maintain a strategic
position. Achieving a close fit among activities requires that data be collected about each
activity. It is also important that the information system collect and integrate both financial
and non-financial data about the organization’s activities. The Internet makes strategy more
important than ever. Traditionally, the AIS was used as transaction processing system
because it was concerned about financial data. To handle non-financial data, other systems
were used leading to redundancy and problem in updating data.

Enterprise resource planning (ERP) systems-integrate all aspects of a company’s

operations with traditional AIS. They are designed to overcome these problems as they
integrate all aspects of a company’s operations with its traditional AIS. For example, when a
sales order is entered by the sales force, the effect of the transaction automatically flows to
all affected parts of the company. Inventory is updated, production schedules are adjusted,
and purchase orders of raw materials and supplies are initiated. More over, important non-
financial data such as the time of sale are collected and stored in the same system.

A key feature of ERP systems is the integration of financial with other non-financial operating
data. The value of such integration is to suggest that there may be strategic benefits to more
closely linking traditionally separate functions of information systems and accounting, and
many organizations are beginning to combine these two functions.

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