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CORE CONCEPTS OF

Accounting
Information
Systems
Twelfth Edition

Mark G. Simkin, Ph.D.
Professor
Department of Accounting and Information Systems
University of Nevada

Jacob M. Rose, Ph.D.
Professor
Department of Accounting and Finance
University of New Hampshire

Carolyn Strand Norman, Ph.D., CPA
Professor
Department of Accounting
Virginia Commonwealth University

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Library of Congress Cataloging-in-Publication Data
Simkin, Mark G.
Core concepts of accounting information systems/Mark G. Simkin, Carolyn Strand Norman, Jake Rose.—12th ed.
p. cm.
Rev. ed. of: Core concepts of accounting information systems/Nancy A. Bagranoff, Mark G. Simkin, Carolyn Strand Norman.
11th ed. c2010.
Includes index.
ISBN 978-1-118-02230-6 (pbk.)
1. Accounting–Data processing. 2. Information storage and retrieval systems–Accounting. I. Norman, Carolyn Strand.
II. Rose, Jake. III. Bagranoff, Nancy A. Core concepts of accounting information systems. IV. Title.
HF5679.M62 2012
657.0285– dc23
2011029036
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1

In memory of my father, Edward R. Simkin
(Mark G. Simkin)
Chase your big dreams!
(Jacob M. Rose)
Thank you to my students—you’re the best!
(Carolyn S. Norman)

ABOUT THE AUTHORS
Mark G. Simkin received his A.B. degree from Brandeis University and his MBA and Ph.D. degrees from the Graduate School of Business at the University of California, Berkeley.
Before assuming his present position of professor in the Department of Accounting and
Information Systems, University of Nevada, Professor Simkin taught in the Department of
Decision Sciences at the University of Hawaii. He has also taught at California State University, Hayward, and the Japan America Institute of Decision Sciences, Honolulu; worked as a research analyst at the Institute of Business and Economic Research at the University of California, Berkeley; programmed computers at IBM’s Industrial Development—Finance
Headquarters in White Plains, New York; and acted as a computer consultant to business companies in California, Hawaii, and Nevada. Dr. Simkin is the author of more than 100 articles that have been published in such journals as Decision Sciences, JASA, The Journal of Accountancy, Communications of the ACM, Interfaces, The Review of Business and
Economic Research, Decision Sciences Journal of Innovative Education, Information
Systems Control Journal, and the Journal of Bank Research.
Jacob M. Rose received his B.B.A degree, M.S. degree in accounting and Ph.D. in accounting from Texas A&M University and he passed the CPA exam in the state of Texas. Dr. Rose holds the position of professor at the University of New Hampshire, where he is the director of the Master of Science in Accounting Program. He previously taught at Southern Illinois
University, Montana State University, the University of Tennessee, Bryant University, and the University of Oklahoma, and he was an auditor with Deloitte and Touche, LLP. Professor
Rose has been recognized as the top instructor in accounting at multiple universities, and he has developed several accounting systems courses at the graduate and undergraduate levels.
He is also a prolific researcher, publishing in journals such as The Accounting Review;
Accounting, Organizations and Society; Behavioral Research in Accounting; Journal of
Information Systems; International Journal of Accounting Information Systems; Journal of Management Studies; and Accounting Horizons. Professor Rose has been recognized as the top business researcher at three universities, and he received the Notable Contribution to the Information Systems Literature Award, which is the highest research award given by the Information Systems Section of the American Accounting Association.
Carolyn Strand Norman received her B.S. and M.S.I.A. degrees from Purdue University and her Ph.D. from Texas A&M University. Dr. Norman is a Certified Public Accountant
(licensed in Virginia) and also a retired Lieutenant Colonel from the United States Air
Force. At the Pentagon, she developed compensation and entitlements legislation, working frequently with House and Senate staffers. Prior to assuming her current position,
Dr. Norman taught at Seattle Pacific University where she co-authored the book, XBRL
Essentials with Charles Hoffman, and was selected as Scholar of the Year for the School of
Business and Economics. Dr. Norman has published more than 50 articles in journals such as The Accounting Review; Accounting, Organizations and Society; Behavioral Research in Accounting; Journal of Accounting and Public Policy; Journal of Information Systems; Advances in Accounting Behavioral Research; Issues in Accounting Education; and
Journal of Accounting Education. She is currently the Interim Chair of the Accounting
Department at Virginia Commonwealth University.

iv

PREFACE
Information technologies affect every aspect of accounting, and as technologies advance, so does our accounting profession! For example, accountants no longer spend much of their day footing ledgers and making hand calculations. Today, accountants use the many helpful functions in spreadsheet software and update or change calculations instantly. And increasingly, the Internet continues to change the way accountants work.
Because most accounting systems are computerized, accountants must understand software and information systems to turn data into financial information and develop and evaluate internal controls. Business and auditing failures continue to force the profession to emphasize internal controls and to rethink the state of assurance services. As a result, the subject of accounting information systems (AIS) continues to be a vital component of the accounting profession.
The purpose of this book is to help students understand basic AIS concepts. Exactly what comprises these AIS concepts is subject to some interpretation, and is certainly changing over time, but most accounting professionals believe that it is the knowledge that accountants need for understanding and using information technologies and for knowing how an accounting information system gathers and transforms data into useful decisionmaking information. In this edition of our textbook, we include the core concepts of
Accounting Information Systems indicated by chapter in the table below. The book is flexible enough that instructors may choose to cover the chapters in any order.
ACCOUNTING INFORMATION SYSTEMS
COURSE CONTENT AREA COVERAGE
AIS Applications
Auditing
Database Concepts
Internal Control
Management of Information Systems
Management Use of Information
Systems Development Work
Technology of Information Systems
Use of Systems Technology

7, 8, 15
12
3, 4, 5
9, 10, 11
1, 2, 13
1, 6, 7, 8, 14, 15
13
All chapters
All chapters

About This Book
The content of AIS courses continues to vary widely from school to school. Some schools use their AIS courses to teach accounting students how to use computers. In other colleges and universities, the course focuses on business processes and data modeling. Yet other courses emphasize transaction processing and accounting as a communication system and have little to do with the technical aspects of how underlying accounting data are processed or stored.
Given the variety of objectives for an AIS course and the different ways that instructors teach it, we developed a textbook that attempts to cover the core concepts of AIS. In writing the text, we assumed that students have completed basic courses in financial and managerial accounting and have a basic knowledge of computer hardware and software concepts. The text is designed for a one-semester course in AIS and may be used at the community college, baccalaureate, or graduate level. v vi Preface
Our hope is that individual instructors will use this book as a foundation for an AIS course, building around it to meet their individual course objectives. Thus, we expect that many instructors will supplement this textbook with other books, cases, software, or readings. The arrangement of the chapters permits flexibility in the instructor’s subject matter coverage. Certain chapters may be omitted if students have covered specific topics in prior courses.
Part One introduces students to the subject of AIS. In the first chapter, we lay the basic foundation for the remainder of the text and set the stage for students to think about the pervasiveness of technology that is common to organizations and the impact technology has on the accounting profession. This chapter also includes a section on careers in AIS that is designed to introduce students to the career paths that combine accounting with the study of information systems. Students taking the AIS course may or may not have had an earlier course in information technology. Chapter 2 allows those who did not have such a course to learn about the latest technologies and emphasizes their use in accounting.
For students who have had earlier courses in computers and/or information systems, this chapter serves as a review but might also contain new technologies that students have not studied in other courses.
Part Two discusses data modeling and databases. Chapter 3 begins our coverage by discussing database concepts in general, describing how to design database tables and relationships, and discussing how databases promote efficient storage of the data needed to support business decisions. This chapter also responds to increasing instructor interest in teaching the REA approach to data modeling. Chapter 4 describes how to use the latest version of Microsoft Access to create databases and extract data from databases. Chapter 5 continues the discussion of how to use Microsoft Access to develop database forms and reports. Chapters 4 and 5 are more ‘‘how to’’ than the other chapters in the book, and they allow the instructor to guide students with hands-on experience in using software to implement the database concepts they have learned.
Part Three begins with Chapter 6 and a discussion of systems documentation, a matter of critical importance to the success of an AIS and also to an understanding of an information system. This chapter describes the various tools that accountants can use to document an AIS for their own and others’ understanding of information flows. Business processes and software solutions for improving those processes are gaining in importance in today’s businesses. Chapters 7 and 8 discuss several core business processes and highlight a number of Business Process Management (BPM) solutions that are currently available in the marketplace. Instructors who focus on transaction cycles in their AIS courses may choose to use supplemental pedagogical tools, such as software and practice sets, to cover this material in more depth.
Part Four is an overview of internal controls and the potential consequences of missing, weak, or poorly developed controls. Although the subject of internal control appears repeatedly throughout the book, we examine this subject in depth in Chapters 9 and 10. These two chapters introduce students to internal controls that are necessary at each level of the organization. Chapter 11 focuses on computer crime, ethics, and privacy to help students understand the need for internal controls.
The last section of the book examines special topics in AIS. Chapter 12 introduces the topic of auditing in an IT environment. Information technology auditing is an increasingly important field and represents a great career opportunity for students who understand both accounting and IT. Recognizing that some students in AIS courses may have completed courses in management information systems (MIS) and thus are already familiar with systems development topics, the emphasis in Chapter 13 is on the accountant’s role in

Preface

vii

designing, developing, implementing, and maintaining a system. Although we integrated
Internet technology throughout this book, its influence on accounting information systems is so great that we devoted a special chapter to it. Chapter 14 provides a basic overview of Internet concepts, discusses financial reporting on the Internet including an expanded section on XBRL, explores the accounting components of e-business, and covers the issues of privacy and security. Finally, in Chapter 15, we discuss accounting and enterprise software, and the chapter provides advice related to AIS selection.

Special Features
This edition of our book uses a large number of special features to enhance the coverage of chapter material as well as to help students understand chapter concepts. Thus, each chapter begins with an outline and a list of learning objectives that emphasize the important subject matter of the chapter. This edition of the book also includes many new real-world
Cases-in-Point, which are woven into the text material and illustrate a particular concept or procedure. Each chapter also includes a more detailed real-world case as an end-of-chapter
AlS-at-Work feature.
Each chapter ends with a summary and a list of key terms. To help students understand the material in each chapter, this edition also includes multiple-choice questions for selfreview with answers and three types of end-of-chapter exercises: discussion questions, problems, and cases. This wide variety of review material enables students to examine many different aspects of each chapter’s subject matter and also enables instructors to vary the exercises they use each semester. The end-of-chapter materials also include references and other resources that allow interested students to explore the chapter material in greater depth. In addition, instructors may wish to assign one or a number of articles listed in each chapter reference section to supplement chapter discussions. These articles are also an important resource for instructors to encourage students to begin reading professional journals. We include articles from Strategic Finance, The Journal of Accountancy, and The
Internal Auditor, which represent the journals of three important accounting professional organizations. There are two major supplements to this textbook. One is an instructor’s manual containing suggested answers to the end-of-chapter discussion questions, problems, and cases. There is also a test bank of true-false, multiple-choice, and matching-type questions.
The test bank includes short-answer problems and fill-in-the-blank questions so that instructors have a wide variety of choices.

What’s New in the Twelfth Edition
This edition of our book includes a number of changes from prior editions. These include
• A new coauthor with an international reputation in the AIS community!
• More Test Yourself multiple-choice questions at the end of each chapter to help students assess their understanding of the chapter material.
• New color—both inside and on the cover! This edition uses green to highlight information and to make the book more interesting to read.
• All new database chapters. Material related to the design of databases and database theory is all presented in the first database chapter, rather than spread throughout three

viii Preface chapters. The following two chapters describe how to apply the theoretical concepts using Access 2010. The new approach allows instructors to easily select a desired emphasis: theory, application, or both. New database diagramming methods simplify the design process for students.
• Expanded coverage of topics that are increasingly important to accounting systems, including cloud computing, data mining, sustainability accounting, forensic accounting
COBIT version 5, COSO’s 2010 Report on Enterprise Risk Management, enterprise controls, and internal auditing of IT.
• The discussion of internal controls in Chapter 10 and auditing of IT in Chapter 12 are reorganized to reflect new PCAOB standards.
• An expanded section in Chapter 1 on career paths for accountants interested in forensic accounting. • Many new Case-in-Points that identify examples of the discussion in the textbook. These examples illustrate the topic to give students a better grasp of the material.
• Chapter reorganization, with database chapters moved closer to the front, as requested by our adopters. Instructors still have the flexibility to integrate the database concepts and database development anywhere in their course.
• An updated glossary of AIS terms at the end of the book.
• New AIS at Work features at the end of many chapters to help students better understand the impact of systems in a wide variety of contexts.
• A number of new problems and cases at the end of chapters so that instructors have more choices of comprehensive assignments for students.
• A new section that includes links to videos related to the concepts presented in each chapter. ACKNOWLEDGMENTS
We wish to thank the many people who helped us during the writing, editing, and production of our textbook. Our families and friends are first on our list of acknowledgments. We are grateful to them for their patience and understanding as we were writing this book.
Next, we thank those instructors who read earlier drafts of this edition of our textbook and provided suggestions to improve the final version.
In addition, we are indebted to the many adopters of our book who frequently provide us with feedback. We sincerely appreciate Paula Funkhouser who helped us with our supplementary materials on this and several previous editions. Finally, we thank all of our many students who have given us feedback when we’ve used the book. We do listen!
Mark G. Simkin
Jacob M. Rose
Carolyn S. Norman

ix

CONTENTS
PART ONE

AN INTRODUCTION TO ACCOUNTING INFORMATION SYSTEMS/ 1
Accounting Information Systems and the Accountant/

CHAPTER 1

Introduction/ 4
What Are Accounting Information Systems?/ 4
What’s New in Accounting Information Systems?/
Accounting and IT/ 14
Careers in Accounting Information Systems/ 21

9

Information Technology and AISs/

CHAPTER 2

33

Introduction/ 34
The Importance of Information Technology to Accountants/
Input, Processing, and Output Devices/ 36
Secondary Storage Devices/ 46
Data Communications and Networks/ 50
Computer Software/ 57

PART TWO

DATABASES/

CHAPTER 3

3

34

73

Data Modeling/

75

Introduction/ 76
An Overview of Databases/ 76
Steps in Developing a Database Using the Resources, Events, and Agents Model/
Normalization/ 91

CHAPTER 4

Organizing and Manipulating the Data in Databases/

Introduction/ 104
Creating Database Tables in Microsoft Access/ 104
Entering Data in Database Tables/ 111
Extracting Data from Databases: Data Manipulation Languages/
Recent Database Advances and Data Warehouses/ 123

CHAPTER 5

Database Forms and Reports/

83

103

116

139

Introduction/ 140
Forms/ 140
Reports/ 147

PART THREE

DOCUMENTING BUSINESS PROCESSES/

CHAPTER 6

Documenting Accounting Information Systems/

Introduction/ 168
Why Documentation Is Important/ 168
Primary Documentation Methods/ 171
Other Documentation Tools/ 186
End-User Computing and Documentation/

CHAPTER 7

167

191

Accounting Information Systems and Business Processes: Part I/

Introduction/ 208
Business Process Fundamentals/

x

165

208

207

Contents

Collecting and Reporting Accounting Information/
The Sales Process/ 215
The Purchasing Process/ 220
Current Trends in Business Processes/ 227

CHAPTER 8

xi

210

Accounting Information Systems and Business Processes: Part II/

239

Introduction/ 240
The Resource Management Process/ 240
The Production Process/ 246
The Financing Process/ 252
Business Processes in Special Industries/ 256
Business Process Reengineering/ 260

PART FOUR INTERNAL CONTROL SYSTEMS AND COMPUTER CRIME, ETHICS, AND PRIVACY/
CHAPTER 9

Introduction to Internal Control Systems/

271

273

Introduction/ 274
1992 COSO Report/ 276
Updates on Risk Assessment/ 278
Examples of Control Activities/ 281
Update on Monitoring/ 289
2011 COBIT, Version 5/ 290
Types of Controls/ 292
Evaluating Controls/ 293

CHAPTER 10

Computer Controls for Organizations and Accounting Information Systems/

307

Introduction/ 308
Enterprise Level Controls/ 308
General Controls for Information Technology/ 312
Application Controls for Transaction Processing/ 324

CHAPTER 11

Computer Crime, Fraud, Ethics, and Privacy/

341

Introduction/ 342
Computer Crime, Abuse, and Fraud/ 342
Three Examples of Computer Crimes/ 348
Preventing Computer Crime and Fraud/ 354
Ethical Issues, Privacy, and Identity Theft/ 361

PART FIVE SPECIAL TOPICS IN ACCOUNTING INFORMATION SYSTEMS/ 377
CHAPTER 12

Information Technology Auditing/

Introduction/ 380
The Audit Function/ 380
The Information Technology Auditor’s Toolkit/ 386
Auditing Computerized Accounting Information Systems/
Information Technology Auditing Today/ 396

CHAPTER 13

379

389

Developing and Implementing Effective Accounting Information Systems/

Introduction/ 410
The Systems Development Life Cycle/

410

409

xii Contents
Systems Planning/ 412
Systems Analysis/ 414
Detailed Systems Design/ 419
Implementation, Follow-Up, and Maintenance/

CHAPTER 14

Accounting on the Internet/

Introduction/ 448
The Internet and World Wide Web/ 448
XBRL—Financial Reporting on the Internet/
Electronic Business/ 455
Privacy and Security on the Internet/ 461

CHAPTER 15

Index/

509

521

447

451

Accounting and Enterprise Software/

Introduction/ 482
Integrated Accounting Software/ 482
Enterprise-Wide Information Systems/ 486
Selecting a Software Package/ 496

Glossary/

428

481

PART ONE
AN INTRODUCTION TO ACCOUNTING
INFORMATION SYSTEMS

CHAPTER 1
Accounting Information Systems and the Accountant
CHAPTER 2
Information Technology and AISs

Part One of this book introduces the subject of accounting information systems. It defines accounting’s principal goal, which is to communicate relevant information to individuals and organizations, and describes the strong influence of information technology on this communication process. Chapter 1 defines accounting information system and then discusses some current events that impact accountants and the profession. This chapter also examines the impact of information technology on financial accounting, managerial accounting, auditing, and taxation. Finally, Chapter 1 describes a number of career opportunities for accounting majors who also are proficient in AISs.
Chapter 2 provides an overview of information technology that is relevant to accounting professionals. It begins by identifying six reasons that make information technology very important to accountants, and then discusses the current American Institute of Certified
Public Accountants survey of the top 10 information systems technologies. Of course, the focus of this chapter is on modern technology and its impact on AISs. Therefore, it discusses computer input devices, central processing units, secondary storage devices, and output devices in detail. Because communication links are so important to AISs, this chapter also examines various communication and network arrangements, including client/server computer and wireless technology. The chapter concludes with descriptions of various types of computer software.

1

Chapter 1
Accounting Information Systems and the Accountant

INTRODUCTION

DISCUSSION QUESTIONS

WHAT ARE ACCOUNTING INFORMATION
SYSTEMS?

PROBLEMS

Accounting Information Systems—A Definition
Accounting Information Systems and Their Role in Organizations

CASE ANALYSES
The Annual Report
Performance Management Company
The CPA Firm

WHAT’S NEW IN ACCOUNTING INFORMATION
SYSTEMS?

READINGS AND OTHER RESOURCES

Cloud Computing—Impact for Accountants

ANSWERS TO TEST YOURSELF

Sustainability Reporting
Suspicious Activity Reporting
Forensic Accounting, Governmental Accountants, and Terrorism
Corporate Scandals and Accounting

ACCOUNTING AND IT
Financial Accounting
Managerial Accounting
Auditing
Taxation

CAREERS IN ACCOUNTING INFORMATION
SYSTEMS
Traditional Accounting Career Opportunities
Systems Consulting
Certified Fraud Examiner
Information Technology Auditing and Security

AIS AT WORK—CONSULTING WORK FOR CPAS
SUMMARY

After reading this chapter, you will:
1. Be able to distinguish between such terms as ‘‘systems,’’ ‘‘information systems,’’ ‘‘information technology,’’ and ‘‘accounting information systems.’’ 2. Learn how information technology (IT) influences accounting systems.
3. Be familiar with suspicious activity reporting.
4. Understand how financial reporting is changing with advances in IT, such as XBRL.
5. Appreciate how IT allows management accountants to use business intelligence to create dashboards and scorecards.
6. Know why auditors provide a variety of assurance services.
7. Be more aware of what is new in the area of accounting information systems.
8. Be familiar with career opportunities that combine accounting and IT knowledge and skills.

KEY TERMS YOU SHOULD KNOW
TEST YOURSELF

3

4 PART ONE / An Introduction to Accounting Information Systems
Cloud computing . . . . It’s about reallocating the IT budget from maintenance—such as keeping servers running, performing upgrades, and making backups—to actually improving business processes and delivering innovation to the finance organization.
Gill, R. 2011. Why cloud computing matters to finance.
Strategic Finance 92(7): 43–47.

INTRODUCTION
The study of accounting information systems (AISs) is, in large part, the study of the application of information technology (IT) to accounting systems. This chapter describes the ways that IT affects financial accounting, managerial accounting, auditing, and taxation. We begin by answering the question ‘‘what are accounting information systems’’ and then look at some new developments in the field. Following this, we will examine some traditional roles of AISs in organizations.
Why should you study AISs? There are many reasons, which we will review briefly in this chapter, but one of the most important is the special career opportunities that will enable you to combine your study of accounting subjects with your interest in computer systems. In today’s job market, accounting employers expect new hires to be computer literate. In addition, a large number of specialized and highly compensated employment opportunities are only available to those students who possess an integrated understanding of accounting and IT and can bring that understanding to bear on complicated business decisions. The last part of this chapter describes a number of special career opportunities for those with an interest in AISs.

WHAT ARE ACCOUNTING INFORMATION SYSTEMS?
What do the following have in common: (1) a shoebox filled with a lawyer’s expense receipts, (2) the monthly payroll spreadsheet in the computer of an auto-repair shop,
(3) the Peachtree accounting system for a small chain of dry cleaning stores, and (4) the enterprise resource planning (ERP) system of a large manufacturer? The answer is that they are all examples of AISs. How can such a wide range of accounting applications each qualify as an AIS? The answer is that this is the essence of what AISs are—collections of raw and stored data (that together typically serve as inputs), processing methods (usually called
‘‘procedures’’), and information (outputs) that serve useful accounting purposes. Do such systems have to be computerized? The first example—the shoebox—suggests that they do not. Can they be complicated? The last example—an ERP system—illustrates one that is.

Accounting Information Systems—A Definition
Accounting information systems (AISs) stand at the crossroads of two disciplines: accounting and information systems. Thus, the study of AISs is often viewed as the study of computerized accounting systems. But because we cannot define an AIS by its size, it is better to define it by what it does. This latter approach leads us to the following definition that we will use as a model in this book:

CHAPTER 1 / Accounting Information Systems and the Accountant

5

Definition: An accounting information system is a collection of data and processing procedures that creates needed information for its users.
Let us examine in greater detail what this definition really means. For our discussion, we’ll examine each of the words in the term ‘‘accounting information systems’’ separately.

Accounting. You probably have a pretty good understanding of accounting subjects because you have already taken one or more courses in the area. Thus, you know that the accounting field includes financial accounting, managerial accounting, and taxation. AISs are used in all these areas—for example, to perform tasks in such areas as payroll, accounts receivable, accounts payable, inventory, and budgeting. In addition, AISs help accountants to maintain general ledger information, create spreadsheets for strategic planning, and distribute financial reports. Indeed, it is difficult to think of an accounting task that is not integrated, in some way, with an AIS.
The challenge for accountants is to determine how best to provide the information required to support business and government processes. For example, in making a decision to buy office equipment, an office manager may require information about the sources of such equipment, the costs of alternate choices, and the purchasing terms for each choice.
Where can the manager obtain this information? That’s the job of the AIS.
AISs don’t just support accounting and finance business processes. They often create information that is useful to nonaccountants—for example, individuals working in marketing, production, or human relations. Figure 1-1 provides some examples. For this information to be effective, the individuals working in these subsystems must help the developers of an AIS identify what information they need for their planning, decision making, and control functions. These examples illustrate why an AIS course is useful not only for accounting majors but also for many nonaccounting majors.

Information (versus Data). Although the terms data and information are often used interchangeably, it is useful to distinguish between them. Data (the plural of datum) are raw facts about events that have little organization or meaning—for example, a set of raw scores on a class examination. To be useful or meaningful, most data must be processed into useful information—for example, by sorting, manipulating, aggregating, or classifying them. An example might be computing of the class average from the raw scores of a class examination.

Application

Examples of AIS Information

Supply chain management Demand trends, inventory levels and warehouse management, supplier relationship management.

Finance

Cash and asset management, multicompany and multicurrency management, credit card transaction summaries.

Marketing

Sales management, sales forecasts and summaries, customer relationship management.

Human resources

Workforce planning tools and employee management, benefits management, payroll summaries and management.

Production

Inventory summaries, product cost analysis, materials requirement planning.

FIGURE 1-1 Examples of useful information an AIS can generate for various business functions.

6 PART ONE / An Introduction to Accounting Information Systems
Do raw data have to be processed in order to be meaningful? The answer is ‘‘not at all.’’ Imagine, for example, that you take a test in a class. Which is more important to you—the average score for the class as a whole (a processed value) or your score (a raw data value)? Similarly, suppose you own shares of stock in a particular company. Which of these values would be least important to you: (1) the average price of a stock that was traded during a given day (a processed value), (2) the price you paid for the shares of stock
(an unprocessed value), or (3) the last price trade of the day (another unprocessed value)?
Raw data are also important because they mark the starting point of an audit trail— that is, the path that data follow as they flow through an AIS. In a payroll system, for example, an input clerk enters the data for a new employee and the AIS keeps track of the wages due that person each pay period. An auditor can verify the existence of employees and whether each employee received the correct amount of money.

Case-in-Point 1.1 A former payroll manager at the Brooklyn Museum pleaded guilty to embezzling $620,000 by writing paychecks to ‘‘ghost employees.’’ Dwight Newton, 40, admitted committing wire fraud by adding workers to the payroll who did not exist and then wiring their wages directly into a joint bank account that he shared with his wife. Under a plea agreement, Newton must repay the museum the stolen funds. He was ordered to forfeit $77,000 immediately, sell his Barbados timeshare, and liquidate his pension with the museum.1
Despite the potential usefulness of some unprocessed data, most end users need financial totals, summary statistics, or exception values—that is, processed data—for decision-making purposes. Figure 1-2 illustrates a model for this—a three stage process in which (1) raw and/or stored data serve as the primary inputs, (2) processing tasks process the data, and (3) meaningful information is the primary output. Modern AISs, of course, harness IT to perform the necessary tasks in each step of the process. For example, a catalog retailer might use some Web pages on the Internet to gather customer purchase data, then use central file servers and disk storage to process and store the purchase transactions, and finally employ other Web pages and printed outputs to confirm and distribute information about the order to the appropriate parties.
Although computers are wonderfully efficient and useful tools, they also create problems. One is their ability to output vast amounts of information quickly. Too much information, and especially too much trivial information, can overwhelm its users, possibly causing relevant information to be lost or overlooked. This situation is known as information overload. It is up to the accounting profession to determine the nature and timing of the outputs created and distributed by an AIS to its end users.
Another problem with computerized data processing is that computers do not automatically catch the simple input errors that humans do. For example, if you were performing payroll processing, you would probably know that a value of ‘‘−40’’ hours

Inputs

Processes

Outputs

Data/Information from
Internal/External
Sources

Sort, Organize,
Calculate

Information for
Internal/External
Decision Makers

FIGURE 1-2 An information system’s components. Data or information is input, processed, and output as information for planning, decision-making, and control purposes.
1

http://www.payroll-fraud.com/rc009.html

CHAPTER 1 / Accounting Information Systems and the Accountant

7

for the number of hours worked was probably a mistake—the value should be ‘‘40.’’ A computer can be programmed to look for (and reject) bad input, but it is difficult to anticipate all possible problems.
Yet a third problem created by computers is that they make audit trails more difficult to follow. This is because the path that data follow through computerized systems is electronic, not recorded on paper. However, a well-designed AIS can still document its audit trail with listings of transactions and account balances both before and after the transactions update the accounts. A major focus of this book is on developing effective internal control systems for companies, of which audit trails are important elements.
Chapters 9, 10, and 12 discuss these topics in detail.
In addition to collecting and distributing large amounts of data and information, modern AISs must also organize and store data for future uses. In a payroll application, for example, the system must maintain running totals for the earnings, tax withholdings, and retirement contributions of each employee in order to prepare end-of-year tax forms.
These data organization and storage tasks are major challenges, and one of the reasons why this book contains three chapters on the subject (see Chapters 3, 4, and 5).
Besides deciding what data to store, businesses must also determine the best way to integrate the stored data for end users. An older approach to this problem was to maintain independently the data for each of its traditional organization functions—for example, finance, marketing, human resources, and production. A problem with this approach is that, even if all the applications are maintained internally by the same IT department, there will be separate data-gathering and reporting responsibilities within each subsystem, and each application may store its data independently of the others. This often leads to a duplication of data-collecting and processing efforts, as well as conflicting data values when specific information (e.g., a customer’s address) is changed in one application but not another.
Organizations today recognize the need to integrate the data associated with their functions into large, seamless data warehouses. This integration allows internal managers and possibly external parties to obtain the information needed for planning, decision making, and control, whether or not that information is for marketing, accounting, or some other functional area in the organization. To accomplish this task, many companies are now using large (and expensive) enterprise resource planning (ERP) system software packages to integrate their information subsystems into one application. An example of such a software product is SAP ERP, which combines accounting, manufacturing, and human resource subsystems into an enterprise-wide information system—that is, a system that focuses on the business processes of the organization as a whole. We discuss these systems in more depth in Chapter 15.
SAP, SAS Institute, IBM, and Oracle have recognized the need for integrated information and therefore developed business intelligence software to meet this need. The latest innovation is predictive analytics, which these software developers are adding into their main software suites. Predictive analytics includes a variety of methodologies that managers might use to analyze current and past data to help predict future events. In March 2010, IBM opened a predictive analytics lab in China, which is the latest in an estimated $12-billion commitment to build out IBM’s analytics portfolio.2

Case-in-Point 1.2 Accountants and other managers are using predictive analytics, a technique that takes advantage of data stored in data warehouses, to create systems that allow them to use their data to improve performance. FedEx uses these tools to determine how customers will react to proposed price changes or changes in service. The police force in
2

http://itmanagement.earthweb.com/features/article.php/3872536/Business-Intelligence-Software-andPredictive-Analytics.html

8 PART ONE / An Introduction to Accounting Information Systems
Richmond, Virginia, uses predictive analysis tools and a database of police calls and crime incident data to predict where and when crimes are most likely. Their system even includes information about weather and local events.3

Systems. Within the accounting profession, the term ‘‘systems’’ usually refers to ‘‘computer systems.’’ As you probably know, IT advances are changing the way we do just about everything. Just a few years ago, the authors never imagined that people could someday purchase a book from a ‘‘virtual bookstore’’ on the Internet using a wireless laptop, while sipping on a latte in a Starbucks. The explosion in electronic connectivity and commerce is just one of the many ways that IT influences how people now access information or how firms conduct business. Today, IT is a vital part of what accountants must know to be employable. Returning to our definition, you probably noticed that we did not use the term
‘‘computer,’’ although we did use the term ‘‘processing procedures.’’ You already know the reason for this—not all AISs are computerized, or even need to be. But most of the ones in businesses today are automated ones and thus the term ‘‘processing procedures’’ could be replaced by the term ‘‘computerized processing’’ for most modern AISs.
In summary, it is convenient to conceptualize an AIS as a set of components that collect accounting data, store it for future uses, and process it for end users. This abstract model of data inputs, storage, processing, and outputs applies to almost all the traditional accounting cycles with which you are familiar—for example, the payroll, revenue, and expenditure cycles—and is thus a useful way of conceptualizing an AIS. Again, we stress that many of the ‘‘end users’’ of the information of an AIS are not accountants, but include customers, investors, suppliers, financial analysts, and government agencies.

Accounting Information Systems and Their Role in Organizations
Information technology (IT) refers to the hardware, software, and related system components that organizations use to create computerized information systems. IT has been a major force in our current society and now influences our lives in many personal ways—for example, when we use digital cameras to take pictures, access the Internet to make a purchase or learn about something, or e-mail friends and family. It is perhaps less clear that computer technology has also had profound influences on commerce. In this information age, for example, fewer workers actually make products while more of them produce, analyze, manipulate, and distribute information about business activities. These individuals are often called knowledge workers. Companies find that their success or failure often depends upon the uses or misuses of the information that knowledge workers manage.

Case-in-Point 1.3 According to a 2010 report from InfoTrends, mobile knowledge workers make up more than 60% of the total workforce in Brazil, Germany, India, and Japan. This number is even higher in the United States—over 70% of the total workforce. Current projections suggest that these numbers are expected to grow through 2014.4

The information age has important implications for accounting because that is what accountants are—knowledge workers. In fact, accountants have always been in the ‘‘information business’’ because their role has been, in part, to communicate accurate and relevant financial information to parties interested in how their organizations are performing. The information age also includes the increasing importance and growth of e-business,
3
4

Whiting, R. 2006. Predict the future—or try, anyway. Information Week (May): 38–43. http://www.infotrends.com/public/Content/Press/2011/01.20.2011a.html CHAPTER 1 / Accounting Information Systems and the Accountant

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conducting business over the Internet or dedicated proprietary networks and e-commerce
(a subset of e-business) which refers mostly to buying and selling on the Internet.
In many ways, accounting is itself an information system—that is, a communicative process that collects, stores, processes, and distributes information to those who need it.
For instance, corporate accountants develop financial statements for external parties and create other reports (such as accounts receivable aging analyses) for internal managers. But users of accounting information sometimes criticize AISs for only capturing and reporting financial transactions. They claim that financial statements often ignore some of the most important activities that influence business entities. For example, the financial reports of a professional basketball team would not include information about hiring a new star because this would not result in journal entries in the franchise’s double-entry accounting system.
Today, however, AISs are concerned with nonfinancial as well as financial data and information. Thus, our definition of an AIS as an enterprise-wide system views accounting as an organization’s primary producer and distributor of many different types of information.
The definition also considers the AIS as process focused. This matches the contemporary perspective that accounting systems are not only financial systems.

WHAT’S NEW IN ACCOUNTING INFORMATION SYSTEMS?
The last few years have witnessed some of the most startling changes in the uses and applications of AISs, causing us to reassess our understanding and use of accounting data.
Below are a few examples.

Cloud Computing—Impact for Accountants
In Chapter 2 we identify the basics of cloud computing, but in this section we want to discuss why this technology is important to accountants and then describe some of the current issues surrounding cloud computing as it relates to accounting professionals.
According to Ron Gill, cloud computing is a way of using business applications over the
Internet—such as the way you use the Internet for your bank transactions. Think of cloud computing as a way to increase IT capacity or add capabilities without investing in new infrastructure, training new people, or licensing new software. Mostly, we’re talking about a subscription-based or pay-per-use service that makes IT’s existing capabilities scalable whenever the need exists. Estimates suggest that the fast-growing cloud computing industry will reach $42 billion by 2012.5
Cloud computing resources may be categorized as data storage, infrastructure and platform, or application software (i.e., business applications such as purchases, HR, sales, etc.). If a firm would like to take advantage of cloud computing, it would most likely need to subscribe to all three of these categories from the service provider. For example, business applications depend on company data that is stored in the database, and data storage depends on the appropriate infrastructure.6
Experts identify a number of important benefits of using the cloud, as depicted in
Figure 1-3. One is the ability to only pay for the applications that you use. Of course,
5

Rashty, J. and J. O’Shaughnessy. 2010. Revenue recognition for cloud-based computing arrangements. The CPA
Journal 80(11): 32–35.
6 Du, H. and Y. Cong. 2010. Cloud computing, accounting, auditing, and beyond. The CPA Journal 80(10): 66–70.

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PART ONE / An Introduction to Accounting Information Systems

Pay As You Use

Lower Total
Cost of Ownership
(TCO)

24×7 Support

Reliability,
Scalability, and
Sustainability

Device and
Location
Independent

Easy and Agile
Deployment

Utility Based

Why Cloud
Computing?

Highly
Automated

Frees Up
Internal
Resources

Secure Storage
Management

Lower Capital
Expenditure

FIGURE 1-3 Examples of the reasons cloud computing is becoming popular. Source: N-Axis
Software Technologies.

this sort of flexibility also suggests that a firm has the ability to quickly modify the scale of its IT capability. Another benefit is that an organization may not have to purchase or operate expensive hardware and software—providers own and operate the equipment and software, much as a taxi company owns and operates its own fleet of vehicles. Also, cloud computing providers offer only one (current) version of an application, so individual firms no longer have to deal with expensive, time-consuming upgrades for software.

Case-in-Point 1.4 For years, millions of people who attended the 10-day Taste of Chicago
Festival carried around a 28-page brochure to find the various foods and music offerings. In
2009, the city posted this information online—a cloud technology from Microsoft that now delivers the same information right to the festival-goers’ smartphones.7
Accountants always talk about cost-benefit trade-offs. We just identified several possible benefits surrounding this new technology, so it is appropriate to mention that there are also costs and/or concerns. The first potential concern is reliability of the Internet since this is the medium for delivering all cloud services. Other issues include (1) data security measures that the provider offers, such as appropriate internal controls, (2) the quality of service that the provider gives the firm (i.e., careful crafting of the service contract is similar to that of any outsourcing contract, which includes vigilant monitoring of services for quality purposes), and (3) the reliability of the service provider, such as ongoing concern issues.
Accordingly, management accountants, internal auditors, and external auditors will need to evaluate the different risks that a firm may face if it decides to ‘‘use the cloud.’’
7

Barkin, R. 2011. The cloud comes down to earth. Retrieved from http://americancityandcounty.com/technology/ cloud-computing-201101/ CHAPTER 1 / Accounting Information Systems and the Accountant

11

Employee Health Indicators

Economic Factors

Employee Safety Factors

Tobacco use
High cholesterol
Absenteeism

Sales revenue
Net earnings
Share price

Fleet car accidents
Lost workdays
Employee accidents

FIGURE 1-4 Examples of sustainability items of interest to a firm and data that would be collected to report on each item of interest.

Sustainability Reporting
Sustainability reporting focuses on nonfinancial performance measures that might impact an organization’s income, value, or future performance. A survey conducted in
2005 indicated that only 32% of the top 100 U.S. companies (based on revenue) issued sustainability reports, while a similar survey in 2008 indicated that the reporting rate increased to 73%.8

Case-in-Point 1.5 Johnson & Johnson began setting environmental goals in 1990, and reported to the public in 1993 and 1996. In 1998, they began annual sustainability reports for two reasons: because it’s the right thing to do and to create shareholder wealth through increased profits. The result is that Johnson & Johnson is a company that has experienced continued and sustained growth.9
You might be asking yourself why this is an AIS issue if the information is ‘‘nonfinancial’’ in nature. As you will discover in Chapter 15, enterprise-wide systems are widely used to collect qualitative as well as quantitative information for decision making within organizations. In fact, management control systems are the backbone of sustainability reports. That is, organizations need to establish well-defined sustainability strategies that identify achievable and measurable goals.10 Figure 1-4 identifies examples of sustainability items of interest to firms and some of the data that would be collected to report on each item of interest.

Suspicious Activity Reporting
A number of suspicious activity reporting (SAR) laws now require accountants to report questionable financial transactions to the U.S. Treasury Department. Examples of such transactions are ones suggestive of money laundering, bribes, or wire transfers to terrorist organizations. Federal statutes that mandate SARs include sections of the AnnunzioWylie Anti-Money Laundering Act (1992), amendments to the Bank Secrecy Act of 1996, and several sections of the USA PATRIOT Act (2001). Institutions affected by these laws include
(1) banks, (2) money service businesses such as currency traders, (3) broker dealers, (4) casinos and card clubs, (5) commodity traders, (6) insurance companies, and (7) mutual funds. Over the years, such filings have enabled the federal government to investigate a wide number of criminal activities, gather evidence, and in some cases, repatriate funds
8

Borkowski, S., M. Welsh, and K. Wentzel. 2010. Johnson & Johnson: A model for sustainability reporting.
Strategic Finance 92(3): 29–37.
9 Borkowski, S., M. Welsh, and K. Wentzel. 2010. Johnson & Johnson: A model for sustainability reporting.
Strategic Finance 92(3): 29–37.
10 Busco, C., M. Frigo, E. Leone, and A. Riccaboni. 2010. Cleaning up. Strategic Finance 92(1): 29–37.

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PART ONE / An Introduction to Accounting Information Systems

sent overseas. Testimony to the importance of suspicious activity reporting is the growth of SAR filings—from about 62,000 reports in 1996 to over 1.6 million reports in 2008.

Case-in-Point 1.6 A cooperating witness indicated that a pharmaceutical network was selling controlled drugs through affiliated Web sites to customers without authorized prescriptions. To evade U.S. laws, the owners located their headquarters in Central America and their Web servers in the Middle East. A federal investigation and a SAR filed by a financial institution involved in the matter documented almost $5 million in suspicious wire transfers.
The result was indictments against 18 individuals and the repatriation of over $9 million from overseas accounts as part of the forfeiture proceedings.11
Suspicious activity reporting impacts AISs in several ways. Because so much of the information within AISs is financial, these systems are often used to launder money or fund criminal activities. A corollary to this fact is that AISs document financial activities in the course of daily transaction processing, and therefore become important sources of SAR evidence and subsequent legal action. Finally, SAR can act as a deterrent to criminal or terrorist activities—and therefore an important control for AISs.
Figure 1-5 contains a classification of SAR reports for 10 years of filings from banks and other depository institutions—one of the most important sources of these filings. In this figure, note the importance of money laundering and check fraud.
Rank
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22

Suspicious Activity Type

Filings (Overall)

Percentage (Overall)%

BSA/Structuring/Money Laundering
Check Fraud
Other
Counterfeit Check
Credit Card Fraud
Mortgage Loan Fraud
Check Kiting
Identity Theft
False Statement
Defalcation/Embezzlement
Unknown/Blank
Consumer Loan Fraud
Misuse of Position or Self Dealing
Wire Transfer Fraud
Mysterious Disappearance
Debit Card Fraud
Commercial Loan Fraud
Counterfeit Instrument (Other)
Computer Intrusions
Counterfeit Credit/Debit Card
Terrorist Financing
Bribery/Gratuity
Total:

1,503,003
333,862
270,152
155,141
154,506
113,071
101,107
69,325
67,902
63,392
63,069
53,588
30,899
29,574
26,465
17,480
16,524
13,542
12,307
12,177
3,178
2,932
3,113,196

48.28
10.72
8.68
4.98
4.96
3.63
3.25
2.23
2.18
2.04
2.03
1.72
0.99
0.95
0.85
0.56
0.53
0.43
0.40
0.39
0.10
0.09
100.00

FIGURE 1-5 A classification of suspicious activity report filings using Form TD F 90-22.47 from depository institutions, April 1, 1996 to December 31, 2006. Source: Web site of the U.S. Treasury
Department (2008).
11

http://www.fincen.gov/law_enforcement/ss/html/Issue14-story5.html

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Forensic Accounting, Governmental Accountants, and Terrorism
Forensic accounting has become a popular course at many universities over the past decade and some universities now have a number of specialized courses that are included in a fraud examination track or a forensic accounting track so that students may specialize in this area of accounting.12 In general, a forensic accountant combines the skills of investigation, accounting, and auditing to find and collect pieces of information that collectively provide evidence that criminal activity is in progress or has happened. British
Prime Minister Gordon Brown claims that financial information and forensic accounting has become one of the most powerful investigative and intelligence tools available in the fight against crime and terrorism.13
Terrorists need money to carry out their criminal activity, and as a result, forensic accountants have become increasingly important in the fight against such activities because forensic accountants use technology for data mining. For example, a program that is well known to auditors is Audit Command Language (ACL), which is a popular data extraction software tool that can be used to spot anomalies and trends in data.
One example of the use of AISs for this purpose is banking systems that trace the flow of funds across international borders. Other examples include (1) identifying and denying financial aid to terrorist groups and their sympathizers; (2) tracing arms and chemical orders to their final destinations, thereby identifying the ultimate—perhaps unauthorized—purchasers; (3) using spreadsheets to help plan for catastrophic events; (4) using security measures to control cyber terrorism; and (5) installing new internal controls to help detect money laundering and illegal fund transfers.
But where do terrorists get the money to finance their activities? Generally speaking, they rely on the following sources for funding: state sponsors, individual contributions, corporate contributions, not-for-profit organizations, government programs, and illegal sources—and here is where government accountants can play an important part in the fight against terrorism. Apparently, terrorists choose to live unpretentiously, they exploit weaknesses in government assistance programs, and are skillful at concealing their activities.14 Similar to forensic accountants, governmental accountants can use data extraction software to spot anomalies, suspicious activity, or red flags that might suggest illegal transactions.

Corporate Scandals and Accounting
Although corporate frauds and scandals are hardly new, the latest set of them has set records for their magnitude and scope. Of particular note are the Enron scandal and the case against Bernard Madoff. The Enron scandal is important because of the amount of money and jobs that were lost and also because so much of it appears to be directly related to the adroit manipulation of accounting records. Although the details of these manipulations are complex, the results were to understate the liabilities of the company as well as to inflate its earnings and net worth. The opinion of most experts today is that the mechanics of these adjustments might not have been illegal, but the intent to defraud was clear and therefore criminal.
12

Examples include Georgia Southern University, West Virginia University, and North Carolina State University.
Nelson, D. 2011. The role of forensic accounting in terrorism. Retrieved from http://www.ehow.com/pring/ facts_5895389_role-forensic-accounting-terrorism.html 14 Brooks, R., R. Riley, and J. Thomas. 2005. Detecting and preventing the financing of terrorist activities. The
Journal of Government Financial Management 54(1): 12–18.
13

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Accounting rules allow for some flexibility in financial reporting. Unfortunately, some financial officers have exploited this flexibility to enhance earnings reports or present rosier forecasts than reality might dictate—that is, they ‘‘cooked the books.’’ Examples are Scott Sullivan, former Chief Financial Officer at WorldCom, Inc., Mark H. Swartz, former Chief Financial Officer at Tyco International, Inc., and Andrew Fastow, former
Chief Financial Officer at Enron. While some accountants have been guilty of criminal and unethical behavior, others have emerged from the scandals as heroes. These include
Sherron Watkins, who tried to tell Ken Lay that the numbers at Enron just didn’t add up, and Cynthia Cooper, an internal auditor at WorldCom, who blew the whistle on the falsified accounting transactions ordered by her boss, Scott Sullivan.
As the credit crunch worked its way through the economy in 2008, a number of financial institutions either collapsed or narrowly avoided doing so and accounting was in the news once again. In March 2009, Bernard Madoff pleaded guilty to 11 federal felonies and admitted that he turned his wealth management business into a Ponzi scheme that defrauded investors of billions of dollars. Named for Charles Ponzi, this is a pyramid fraud in which new investment funds are used to pay returns to current investors. The fraud relies on new money continuously entering the system so that investors believe their money is actually earning returns. The problem is that when new money stops flowing, the pyramid collapses. ACCOUNTING AND IT
IT is pervasive and impacts every area of accounting. Instantaneous access is available to the Internet via mobile communication devices such as cell phones, iPads, smart phones, and so on, which enable activities to take place anytime and anywhere. For example, managerial accountants can complete important work tasks while traveling in the field, auditors can communicate with each other from remote job sites (auditing the same client), staff accountants can text message one another from alternate locations, and tax experts can download current information on tax rulings.
Figure 1-6 provides an overview of the major areas within the field of accounting that are impacted by IT. This section of the chapter considers the influence of IT on each of them. Taxation

Financial
Accounting

IT

Auditing

Managerial
Accounting

FIGURE 1-6 Overview of the major areas of accounting that are impacted by information technology.

CHAPTER 1 / Accounting Information Systems and the Accountant

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Financial Accounting
The major objective of financial accounting information systems is to provide relevant information to individuals and groups outside an organization’s boundaries—for example, investors, federal and state tax agencies, and creditors. Accountants achieve these informational objectives by preparing such financial statements as income statements, balance sheets, and cash flow statements. Of course, many managers within a company can also use financial reports for planning, decision making, and control activities. For example, a manager in charge of a particular division could use such profitability information to make decisions about future investments or to control expenses.
Figure 1-7 depicts an organization’s financial accounting cycle, which begins with analyzing and journalizing transactions (e.g., captured at the point of sale) and ends with its periodic financial statements. Accounting clerks, store cashiers, or even the customers themselves input relevant data into the system, which stores these data for later use. In financial AISs, the processing function also includes posting these entries to general and subsidiary ledger accounts and preparing a trial balance from the general ledger account balances. Nonfinancial Data. The basic inputs to, and outputs from, traditional financial accounting systems are usually expressed in monetary units. This can be a problem if the AIS ignores nonmonetary information that is also important to users. For example, an investor might like to know what the prospects are for the future sales of a company, but many financial
AISs do not record such information as unfulfilled customer sales because such sales are not recognizable financial events—even though they are important ones. This is the basic premise behind REA accounting—the idea of also storing important nonfinancial information about resources, events, and agents in databases precisely because they are

Analyze,
Journalize
Transactions
Close General
Ledger Account
(Income/Expenses)

Preparation of
Financial
Statements

Adjusted Trial
Balance
Preparation

Summarize
Accounts, General
Ledger Posting
Accounting
Cycle
Trial Balance
Preparation

Period-End
Adjusting Entries

FIGURE 1-7 The accounting cycle. Source: http://bookkeeping-financial-accounting-resources
.com/images/accountingcycle.jpg.

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PART ONE / An Introduction to Accounting Information Systems

relevant to the decision-making processes of their users. We discuss the REA framework in greater detail in Chapter 6.
Inadequacies in financial performance measures have encouraged companies to consider nonfinancial measures when evaluating performance. Some of the advantages include:
(1) a closer link to long-term organizational strategies; (2) drivers of success in many industries that are intangible assets (such as intellectual capital and customer loyalty), rather than the assets allowed on balance sheets; (3) such measures that can be better indicators of future financial performance; and (4) investments in customer satisfaction that can improve subsequent economic performance by increasing revenues and loyalty of existing customers, attracting new customers, and reducing transaction costs.15
Several professional associations now formally recognize that nonfinancial performance measures enhance the value of purely financial information. For example, in 1994 a special committee of the American Institute of Certified Public Accountants (AICPA) recommended several ways that businesses could improve the information they were providing to external parties by including management analysis data, forward-looking information such as opportunities and risks, information about management and shareholders, and background information about the reporting entity. Similarly, in 2002, the American
Accounting Association (AAA) Financial Accounting Standards Committee recommended that the Securities and Exchange Commission (SEC) and the Financial Accounting Standards
Board (FASB) encourage companies to voluntarily disclose more nonfinancial performance measures. Real-Time Reporting. Another impact of IT on financial accounting concerns the timing of inputs, processing, and outputs. Financial statements are periodic and most large companies traditionally issue them quarterly, with a comprehensive report produced annually. With advances in IT that allow transactions to be captured immediately, accountants and even the AIS itself can produce financial statements almost in real-time. Of course, some of the adjustments that accountants must make to the records are not done minute by minute, but a business can certainly track sales and many of its expenses continuously.
This is especially useful to the retailing executives, many of whom now use dashboards.
We discuss dashboards in more depth in Chapter 15 and also show an example of a sales dashboard (Figure 15-8).

Interactive Data and Extensible Business Reporting Language. A problem that accountants, investors, auditors, and other financial managers have often faced is that data used in one application are not easily transferable to another. This means that accountants may spend hours preparing spreadsheets and reports that require them to enter the same data in different formats over and over. Interactive data are data that can be reused and carried seamlessly among a variety of applications or reports. Consider, for example, a data item such as total assets. This number might need to be formatted and even calculated several different ways for reports such as filings with the SEC, banks, performance reports, and so on. With interactive data, the data are captured once and applied wherever needed.
Interactive data require a language for standardization that ‘‘tags’’ the data at its most basic level. As an example, for total assets, this would be at the detail level for each asset.
Extensible business reporting language (XBRL) is emerging as the language of choice for this purpose. As of 2010, the SEC requires public companies to file their financial
15

http://nikhils-nick18.blogspot.com/2010/06/non-financial-performance-measures-what.html

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reports in XBRL format. In addition, many companies, software programs, and industries are beginning to incorporate XBRL for creating, transforming, and communicating financial information. We discuss XBRL in more detail in Chapter 14 and you can learn about its status at http://www.xbrl.org.

Case-in-Point 1.7 The Federal Deposit Insurance Corporation (FDIC) insures bank deposits over a specific amount. FDIC wanted to create an Internet-based Central Data
Repository that stored all the call (quarterly) data they received from more than 7,000 banks.
They convinced their software vendors to incorporate XBRL language to standardize the data. The tagged data the FDIC receives from banks now has improved accuracy and can be published and made available to users much more quickly than before.16

Managerial Accounting
The principal objective of managerial accounting is to provide relevant information to organizational managers—that is, users who are internal to a company or government agency. Cost accounting and budgeting are two typical parts of a company’s managerial accounting system. Let us examine each of them in turn.

Cost Accounting. Due to globalization, decentralization, deregulation, and other factors, companies are facing increased competition. The result is that companies must be more efficient and must do a better job of controlling costs. The cost accounting part of managerial accounting specifically assists management in measuring and controlling the costs associated with an organization’s various acquisition, processing, distribution, and selling activities. In the broadest sense, these tasks focus on the value added by an organization to its goods or services, and this concept remains constant whether the organization is a manufacturer, bank, hospital, or police department.
Take health care for an example. Although much controversy surrounded the health care legislation that was signed into law in 2010, there is one fact that most agree upon—that the health care industry is a very large portion of the U.S. economy and that it is growing rapidly as the baby boomer generation reaches retirement age. These facts, coupled with increased regulatory demands on health care providers and hospitals, suggest the need for sophisticated accounting systems to maintain critical data, as well as the need for up-to-date reports for decision making.
Case-in-Point 1.8 Survey data from more than 100 hospital CFOs suggest five major themes regarding the evolution of financial practices in health care. Two of those themes are
(1) a greater focus on internal controls, supported by information and management systems, and (2) an increased reliance on business analysis (i.e., requirement to develop and measure business performance).17

Activity-Based Costing. One example of an AIS in the area of cost accounting is an activity-based costing (ABC) system. Traditionally, cost accountants assigned overhead
(i.e., indirect production costs) on the basis of direct labor hours because the number of labor hours was usually directly related to the volume of production. The problem with this traditional system is that, over time, increasing automation has caused manufacturers
16
17

http://www.xbrl.org/us/us/FFIEC%20White%20Paper%2002Feb2006.pdf
Langabeer, J., J. DellliFraine, and J. Helton. 2010. Mixing finance and medicine. Strategic Finance 92(6): 27–34.

18

PART ONE / An Introduction to Accounting Information Systems

to use less and less direct labor. Thus, managers became frustrated using this one method of assigning overhead costs when a clear relationship between labor and these overhead expenses no longer seemed to exist. Instead, managers in a variety of manufacturing and service industries now identify specific activities involved in a manufacturing or service task, and then assign overhead costs based on the resources directly consumed by each activity. Although activity-based costing techniques have been available for several decades, they are more common now that computerized systems can track costs. Moreover, these systems can move an organization in new strategic directions, allowing corporate executives to examine fundamental business processes and enabling them to reengineer the way they do business. ABC systems can also play an essential strategic role in building and maintaining a successful e-commerce business because they can answer questions about production costs and help managers allocate resources more effectively.

Case-in-Point 1.9 Chrysler, an American car manufacturer, claims that it has saved hundreds of millions of dollars since introducing activity-based costing in the early 1990s.
ABC showed that the true cost of certain parts that Chrysler made was 30 times what had originally been estimated, a discovery that persuaded the company to outsource the manufacture of many of those parts.18

Corporate Performance Measurement and Business Intelligence. Another example of an AIS used in the area of cost accounting is in corporate performance measurement
(CPM). In a responsibility accounting system, for example, managers trace unfavorable performance to the department or individuals that caused the inefficiencies. Under a responsibility accounting system, each subsystem within an organization is only accountable for those items over which it has control. Thus, when a particular cost expenditure exceeds its standard cost, managers can take immediate corrective action.
In addition to the traditional financial measures, cost accountants also collect a variety of nonfinancial performance measures to evaluate such things as customer satisfaction, product quality, business innovation, and branding effectiveness. The balanced scorecard measures business performance in four categories: (1) financial performance, (2) customer knowledge, (3) internal business processes, and (4) learning and growth. A company may choose to rank these categories to align with their strategic values. For example, a company may stress ‘‘customer knowledge’’ because customer satisfaction is important to its market position and planned sales growth.
Balanced scorecards and corporate performance measurement are not new ideas.
But with the Internet, integrated systems, and other advanced technologies, balanced scorecards and other approaches to CPM are becoming increasingly valuable business intelligence tools. Businesses use key performance indicators (KPIs) to measure and evaluate activities in each quadrant of the balanced scorecard. For instance, a financial KPI might be return on investment. In the customer area, a company might track the number of new customers per month.
Also new is the use of dashboards (Figure 1-8) to monitor key performance metrics.
Dashboards usually appear in color, so that red, for example, might indicate a failure to meet the goal. Another indicator might be up and down arrows to show how a key activity performs for a certain time period. Dashboards are especially useful to managers who appreciate the presentation of important performance data in easy-to-understand graphic formats.
18

http://www.economist.com/node/13933812

CHAPTER 1 / Accounting Information Systems and the Accountant

Closed Sales YTD

Closed Sales QTD

YTD Sales

Sales by Country YTD

Sales QTD

0

1,200,000

19

136

123

0

590

500,000

267
Sum of Amount in USD (Thousands)

24,523

262,000
Sum of Amount in USD

Billing Country

Sum of Amount in USD
Canada

Target 900,000, Stretch target 1.2M

150
100

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20
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Industry
Manufacturing
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..

0

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50

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200

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1

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Other

New Business Pipeline
Sum of Amount in
USD (Thousands)

Sum of Amount in
USD (Millions)

US

Target 450,000, Stretch target 500,000

Closed Sales by Industry

Insurance
Retail

UK

Stage
Services

Account Type
Prospect
Other
Customer-Direct

FIGURE 1-8 An example of an executive dashboard.

Case-in-Point 1.10 Accounting and advisory firms often work with organizations to select appropriate software to serve their information and IT needs. Most dashboards can be adapted for use at the highest level of the firm—even at the board of directors’ level—or at any level below. Four of the industry leaders that offer software that can design a dashboard are IBM (Cognos), Actuate (PerformanceSoft), SAP (Business Objects/Pilot Software), and iDashboard.19 Budgeting. A budget is a financial projection for the future and is thus a valuable managerial planning aid. Companies develop both short- and long-range budget projections.
Short-range budget projections disclose detailed financial plans for a 12-month period, whereas long-range budgets are less-detailed financial projections for five or more years into the future. Management accountants are normally responsible for an organization’s budget.
A good budgetary system is also a useful managerial control mechanism. Because managers use budgets to predict future financial expectations, they can compare the causes of significant variations between actual and budgeted results during any budget period.
Through timely performance reports that compare actual operating results with prescribed norms, managers are able to identify and investigate significant variations. While negative variations are normally cause for concern, favorable budget variations are not always good
19

Ballou, B., D. Heitger, and L. Donnell. 2010. Creating effective dashboards. Strategic Finance 91(9): 27–32.

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PART ONE / An Introduction to Accounting Information Systems

news either. For example, managers might find cheaper inputs and have a positive variation from the standard cost, but such savings might cause quality problems with the finished product. Regardless of whether variations are positive or negative, managers can use the information for better decision making.

Auditing
The traditional role of auditing has been to evaluate the accuracy and completeness of a corporation’s financial statements. In recent years, however, the individuals working in
CPA firms would probably argue that they are actually in the assurance business—that is, the business of providing third-party testimony that a client complies with a given statute, law, or similar requirement. Historically, the growth of such assurance services can be traced to a conference of the AICPA in 1993, which created a Special Committee on
Assurance Services to identify and formalize some other areas (besides financial audits) in which accountants could provide assurance services. Figure 1-9 describes the first six areas identified by the committee.
Today, there are several additional areas in which auditors can perform assurance work, many involving AISs. One example is to vouch for a client’s compliance with the new HIPAA laws—for example, the privacy requirements of the Health Insurance
Portability and Accountability Act. Another example is CPA Trust Services, a set of professional service areas built around a set of common principles and criteria related to the risks and opportunities presented by IT environments. Trust services include online privacy evaluations, security audits, tests of the integrity of information processing systems, verification of the availability of IT services, and tests of systems confidentiality.
Despite the rise in ancillary assurance services, auditors mainly focus on traditional financial auditing tasks. As noted earlier, computerized AISs have made these tasks more challenging. For example, automated data processing also creates a need for auditors to

Risk Assessment
Provide assurance that an organization’s set of business risks is comprehensive and manageable.
Business Performance Measurement
Provide assurance that an organization’s performance measures beyond the traditional measures in financial statements are relevant and reasonable for helping the organization to achieve its goals and objectives.
Information Systems Reliability
Provide assurance that an organization’s information system has been designed to provide reliable information for decision making.
Electronic Commerce
Provide assurance that organizations doing business on the Internet can be trusted to provide the goods and services they promise, and that there is a measure of security provided to customers.
Health Care Performance Measurement
Provide assurance to health care recipients about the effectiveness of health care offered by a variety of health care providers.
Eldercare Plus
Provide assurance that various caregivers offering services to the elderly are offering appropriate and high-quality services.

FIGURE 1-9 Assurance services identified by the American Institute of Certified Public Accountants Special Committee on Assurance Services.

CHAPTER 1 / Accounting Information Systems and the Accountant

21

evaluate the risks associated with such automation. Chapter 12 discusses the audit of computerized AISs and the ways in which auditors use IT to perform their jobs.
In addition to the auditing and assurance businesses mentioned above, many CPA firms also perform management consulting tasks—such as helping clients acquire, install, and use new information systems. The AIS at Work feature at the end of this chapter describes one such consulting area. However, the corporate accounting scandals mentioned earlier have led members of the SEC and the U.S. Congress to question whether a CPA firm can conduct an independent audit of the same systems it recently assisted a client in installing and using—a concern intensified when audit staff at Arthur Andersen LLP apparently deliberately destroyed auditing papers for the Enron corporation that many believe would have confirmed doubts. Thus, the Sarbanes-Oxley Act of 2002 (SOX) expressly forbids such potential conflicts of interest by disallowing CPA firms from simultaneously acting as a
‘‘management consultant’’ and the ‘‘independent auditor’’ for the same firm.
Despite this requirement, however, there are still many areas in which CPA firms provide consulting services to clients. Examples include business valuations, litigation support, systems implementation, personal financial planning, estate planning, strategic planning, health care planning, financing arrangements, and forensic (fraud) investigations.

Taxation
Although some individuals still complete their income tax returns manually, many now use computer programs such as TurboTax for this task. Such tax preparation software is an example of an AIS that enables its users to create and store copies of trial tax returns, examine the consequences of alternative tax strategies, print specific portions of a return, and electronically transmit complete copies of a state or federal tax return to the appropriate government agency.
IT can also help tax professionals research challenging tax questions—for example, by providing access to electronic tax libraries online, and more up-to-date tax information than traditional paper-based libraries. Also, tax professionals may subscribe to an online tax service by paying a fee for the right to access databases of tax information stored at centralized computer locations. Online services can provide tax researchers with databases of federal and state tax laws, tax court rulings, court decisions, and technical advice.

CAREERS IN ACCOUNTING INFORMATION SYSTEMS
Our introductory remarks to this chapter suggest a variety of reasons why you should study
AISs. Of them, perhaps the most interesting to students is the employment opportunities available to those who understand both accounting and information systems.

Traditional Accounting Career Opportunities
Certainly, a number of traditional accounting jobs are available to those who choose to study accounting as well as AISs. After all, what accounting system is not also an AIS? Because technology now plays such a strong role in accounting, managerial accounting, auditing, and taxation, AIS majors enjoy the advantage of understanding both traditional accounting concepts and information systems concepts. Recognizing the importance to accountants of knowledge about information systems, the AICPA developed a new designation: Certified

22

PART ONE / An Introduction to Accounting Information Systems

Information Technology Professional (CITP), which accountants can earn if they have business experience and if they pass an examination.

Systems Consulting
A consultant is an outside expert who helps an organization solve problems or provides technical expertise on an issue. Systems consultants provide help with issues concerning information systems—for example, by helping an organization design a new information system, select computer hardware or software, or reengineering business processes (so that they operate more effectively).
One of the most important assets a consultant brings to his or her job is an objective view of the client organization and its processes and goals. AIS students who are skilled in both accounting and information systems make particularly competent systems consultants because they understand how data flow through accounting systems as well as how business processes function. Systems consultants can help a variety of organizations, including professional service organizations, private corporations, and government agencies. This broad work experience, combined with technical knowledge about hardware and software, can be a valuable asset to CPA clients. Because it is likely that a newly designed system will include accounting-related information, a consultant who understands accounting is particularly helpful. Many systems consultants work for large professional service organizations, such as Accenture or Cap Gemini Ernst & Young. Others may work for specialized organizations that focus on the custom design of AISs.
Consulting careers for students of AISs also include jobs as value-added resellers
(VARs). Software vendors license VARs to sell a particular software package and provide consulting services to companies, such as help with their software installation, training, and customization. A VAR may set up a small one-person consulting business or may work with other VARs and consultants to provide alternative software solutions to clients.

Case-in-Point 1.11 Martin and Associates is a regional consulting firm in the Midwest, started by Kevin Martin in 1983. Kevin, a CPA, left a job with a large accounting firm to open an accounting business that helps companies implement AISs. Today the company describes itself as a ‘‘firm dedicated to delivering accounting, ERP, and CRM solutions to our clients and alliances.’’ The staff at Martin and Associates are professionals with CPA and IT experience—many have dual degrees or double majors.20

Certified Fraud Examiner
As we discussed earlier in this chapter, forensic accounting is becoming a sought after area for accountants to study and develop their skills. At the same time, due to increased concerns about terrorism and corporate fraud, these specialized accountants are in high demand.
An accountant can acquire the Certified Fraud Examiner (CFE) certification by meeting the qualifications of the Association of Certified Fraud Examiners (ACFE). To become a
Certified Fraud Examiner, an individual must first meet the following qualifications: have a bachelor’s degree, at least 2 years of professional experience in a field either directly or indirectly related to the detection or deterrence of fraud, be of high moral character, and agree to abide by the Bylaws and Code of Professional Ethics of the ACFE. If these are met, then the individual may apply for the CFE examination.
20

http://www.martinandassociates.com

CHAPTER 1 / Accounting Information Systems and the Accountant

23

Information Technology Auditing and Security
Information technology (IT) auditors concern themselves with analyzing the risks associated with computerized information systems. These individuals often work closely with financial auditors to assess the risks associated with automated AISs—a position in high demand because so many systems are now computerized. Information systems auditors also help financial auditors decide how much time to devote to auditing each segment of a company’s business. This assessment may lead to the conclusion that the controls within some portions of a client’s information systems are reliable and that less time need be spent on it—or the opposite.
IT auditors are involved in a number of activities apart from assessing risk for financial audit purposes. Many of these auditors work for professional service organizations, such as Ernst & Young, Deloitte & Touche, PricewaterhouseCoopers, or KPMG. Figure 1-10 identifies a partial listing of the types of services offered by Ernst & Young.
IT auditors might be CPAs or be licensed as Certified Information Systems Auditors (CISAs)—a certification given to professional information systems auditors by the
Information Systems Audit and Control Association (ISACA). To become a CISA, you must take an examination and obtain specialized work experience. Many CISAs have accounting and information systems backgrounds, although formal accounting education is not required for certification. IT auditors are in more demand than ever today, in part because of the Sarbanes-Oxley legislation, specifically Section 404, which requires documenting and evaluating IT controls.

Case-in-Point 1.12

While efficiencies in compliance with requirements of the SarbanesOxley Act of 2002 will help in the future, the numbers of hours necessary to document and evaluate internal controls, including IT controls, means more work for those with IT audit skills. According to 2004 and 2005 surveys by the Controllers’ Leadership Roundtable research, audit fee increases for the Big Four, in compliance with Section 404, ranged from
78% for Deloitte & Touche to 134% for PricewaterhouseCoopers.21

Sometimes the best way to assess the risks associated with a computerized system is to try to breach the system, which is referred to as penetration testing. These tests are usually conducted within a systems security audit in which the organization attempts to determine the level of vulnerability of their information systems and the impact such weaknesses might have on the viability of the organization. If any security issues are

Assurance Services
• Financial statement attestation
• Internal control reporting
• Assess procedures and controls concerning privacy and confidentiality, performance measurement, systems reliability, outsourced process controls, information security
Business Risk Services
Fraud Investigation and Dispute Services
Technology and Security Risk Services
Specialty Advisory Services

FIGURE 1-10 A sample of the many types of services offered by Ernst & Young LLP, one of the largest international professional service organizations.
21

Goff, J. 2005. Fractured fraternity. CFO Magazine (September): 1–3.

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PART ONE / An Introduction to Accounting Information Systems

discovered, the organization will typically work swiftly to correct the problems or at least mitigate the impact they might have on the company.

AIS AT WORK
Consulting Work for CPAs
Businesses and government entities have always been concerned about disaster recovery or continuity planning. However, the events of September 11, 2001 and Hurricane Katrina made everyone even more aware of the necessity of preparing for a disaster. Auditors can help. Continuity planning is an internal control specifically designed to ensure that operations, including IT functions, can continue in the event of a natural or man-made disaster. IT and Internet technologies are vulnerable to man-made attacks, such as viruses and worms. The absence of a continuity plan is a reportable condition under Statement on
Auditing Standards No. 60, Communication of Internal Control Related Matters Noted in an Audit.
A CPA can help a business to draw up a business continuity plan. As noted in a recent article in New Accountant, some Fortune 500 companies will pay $40,000 or more for such a disaster recovery planning engagement.22 These plans include sections on backup and recovery procedures for all IT, off-site locations for data storage, and information about hot
(fully equipped for immediate use) or cold (leased facilities that do not include hardware and software) sites available for use should physical facilities become inaccessible or damaged.
The plans also include contact information for the management recovery team. Copies of the plan, of course, must be stored off-site. Ideally, each member of the management recovery team has at least one copy at home or in another easily accessible location off-site.
A disaster recovery plan is of no use if it is not tested regularly. Such testing is vital to learn where there may be weaknesses. As an example, during an early Internet worm crisis, many managers found that they were actually storing information regarding who to contact in an emergency on their computers! Naturally, when the computers went down so did this vital information. Full-blown testing of a disaster recovery plan is expensive and time consuming. Sometimes it is difficult for managers to understand the importance of it since they can’t see a direct link to enhancing their income. However, the auditor may need to make the case.

SUMMARY
Computerized information systems collect, process, store, transform, and distribute financial and nonfinancial information for planning, decision making, and control purposes.
Data are raw facts; information refers to data that are meaningful and useful.
Accountants and other managers are using predictive analytics, a technique that takes advantage of data stored in data warehouses to improve performance.
22 Reed, R., and D. Pence. 2006. Enhancing consulting revenues with disaster recovery planning. New Accountant
714: 13–14.

CHAPTER 1 / Accounting Information Systems and the Accountant

25

IT refers to the hardware, software, and related system components that organizations use to create computerized information systems.
Cloud computing is a way of using business applications over the Internet.
The basic concept of sustainability reporting is that a company focuses on nonfinancial performance measures that might impact its income, value, or future performance.
By law, the accountants in many specific financial institutions must now file suspicious activity reports that document potential instances of fraud, money laundering, or money transfers to terrorist organizations.
A forensic accountant combines the skills of investigation, accounting, and auditing to find and collect pieces of information that collectively provide evidence that criminal activity is in progress or has happened.
Some of the recent corporate scandals involved manipulation of accounting data, which led to the passage of legislation to protect investors.
IT affects virtually every aspect of accounting, including financial and managerial accounting, auditing, and taxation.
Financial accounting information is becoming increasingly relevant and important as advances in
IT allow for creation of new reporting systems.
Managerial accounting is impacted by IT in the following areas: balanced scorecards, business intelligence, dashboards, and other key performance indicators.
Auditors perform many types of assurance services, in addition to financial statement attestation.
The availability of tax software and extensive tax databases influences both tax preparation and tax planning.
There are many reasons to study AISs, and one of the most important is the availability of many exciting career opportunities.

KEY TERMS YOU SHOULD KNOW accounting information systems (AIS) activity-based costing (ABC) systems audit trail balanced scorecard business intelligence
Certified Fraud Examiner (CFE)
Certified Information Systems Auditors (CISAs)
Certified Information Technology Professional
(CITP)
cloud computing cost accounting
CPA Trust Services dashboards data e-business e-commerce enterprise resource planning (ERP) system extensible business reporting language (XBRL) financial accounting information systems forensic accounting

information information age information overload
Information Systems Audit and Control
Association (ISACA) information technology (IT) information technology (IT) auditors interactive data key performance indicators (KPIs) knowledge workers penetration testing
Ponzi scheme predictive analytics
REA accounting responsibility accounting system suspicious activity reporting (SAR) sustainability reporting systems consultants value-added resellers (VARs)

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PART ONE / An Introduction to Accounting Information Systems

TEST YOURSELF
Q1-1. Which of the following is NOT true about accounting information systems (AISs)?
a. All AISs are computerized
b. AISs may report both financial and nonfinancial information
c. AISs, in addition to collecting and distributing large amounts of data and information, also organize and store data for future uses
d. A student who has an interest in both accounting and IT, will find many job opportunities that combine these knowledge and skills areas
Q1-2. Which of the following is likely to be information rather than data?
a. Sales price

c. Net profit

b. Customer number

d. Employee name

Q1-3. With respect to a computerized AIS, computers:
a. Turn data into information in all cases
b. Make audit trails easier to follow
c. Cannot catch mistakes as well as humans
d. Do not generally process information more quickly than humans
Q1-4. A dashboard is:
a. A computer screen used by data entry clerks for input tasks
b. A physical device dedicated to AIS processing tasks
c. A summary screen typically used by mangers
d. A type of blackboard used by managers to present useful information to others
Q1-5. The Sarbanes-Oxley Act of 2002:
a. Enables U.S. officers to wire tap corporate phones if required
b. Decreases the amount of work done by auditors and accountants
c. Forbids corporations from making personal loans to executives
d. Requires the Chief Executive Officer of a public company to take responsibility for the reliability of its financial statements
Q1-6. The acronym SAR stands for:
a. Simple accounting receipts
b. Suspicious accounting revenue
c. Suspicious activity reporting
d. Standard accounts receivable
Q1-7. Which of the following is not true regarding assurance services?
a. Auditors of public companies are no longer allowed to provide assurance services to any public company as a result of the Sarbanes-Oxley Act of 2002
b. Assurance services include online privacy evaluations
c. Activity-based costing is not a type of assurance service
d. Only CPAs can provide assurance services to clients
Q1-8. Assigning overhead costs based on the resources, rather than only direct labor, used in manufacturing is an example of:
a. Activity-based costing (ABC)
b. Budgeting

CHAPTER 1 / Accounting Information Systems and the Accountant

27

c. Cost-plus accounting
d. Financial, rather than managerial, accounting
Q1-9. Which of these acronyms represents a law involving health assurance and privacy?
e. XBRL
c. CITP
b. HIPAA
d. SOX
Q1-10. Which of these acronyms stands for a computer language used for reporting business activities? e. XBRL
a. ABC
c. CITP
b. HIPAA
d. SOX
Q1-11. Which of these acronyms is a certification for information professionals?
a. ABC

a. ABC

c. CITP
b. HIPAA
Q1-12. Which of the following describes ‘‘cloud computing’’?

d. SOX

e. XBRL

a. Business applications over the Internet
b. It’s a subset of e-business
c. The ability of a company to exchange data with its subsidiaries
d. None of the above

DISCUSSION QUESTIONS
1-1. Take a survey of the students in your class to find out what jobs their parents hold. How many are employed in manufacturing? How many are employed in service industries? How many could be classified as knowledge workers?
1-2. Hiring an employee and taking a sales order are business activities but are not accounting transactions requiring journal entries. Make a list of some other business activities that would not be captured as journal entries in a traditional AIS. Do you think managers or investors would be interested in knowing about these activities? Why or why not?
1-3. Advances in IT are likely to have a continuing impact on financial accounting. What are some changes you think will occur in the way financial information is gathered, processed, and communicated as a result of increasingly sophisticated IT?
1-4. XBRL is emerging as the language that will be used to create interactive data that financial managers can use in communication. How do you think the use of interactive data might enhance the value of a company’s financial statements?
1-5. Discuss suspicious activity reporting. For example, do you think that such reporting should be a legal requirement, or should it be just an ethical matter? Do you think that the majority of
SAR activity is illegal, or are these mostly false alarms?
1-6. Managerial accounting is impacted by IT in many ways, including enhancing CPM. How do you think a university might be able to use a scorecard or dashboard approach to operate more effectively? 1-7. Look again at the list of assurance services shown in Figure 1-9. Can you think of other assurance services that CPAs could offer which would take advantage of their AIS expertise?
1-8. Interview a sample of auditors from professional service firms in your area. Ask them whether they plan to offer any of the assurance services suggested by the AICPA. Also, find out if they offer services other than financial auditing and taxation. Discuss your findings in class.
1-9. This chapter described several career opportunities available to students who combine a study of accounting with course work in AISs, information systems, and/or computer science. Can you think of other jobs where these skill sets would be desirable?
1-10. This chapter stressed the importance of IT for understanding how AISs operate. But is this the only skill valued by employers? How important do you think analytical thinking skills or writing skills are? Discuss.

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PART ONE / An Introduction to Accounting Information Systems

PROBLEMS
1-11. What words were used to form each of the following acronyms? (Hint: each of them can be found in the chapter.)
a. AAA

i. CPM

q. PATRIOT Act

b. ABC

j. ERP

r. REA

c. AICPA

k. FASB

s. SAR

d. AIS

l. HIPAA

t. SEC

e. CFO

m. ISACA

u. SOX

f. CISA

n. IT

v. VARs

g. CITP

o. KPI

w. XBRL

h. CPA

p. OSC

1-12. The accounting profession publishes many journals such as the Journal of Accountancy,
Internal Auditor, Strategic Finance, and Management Accounting. Choose three or four issues from each of these journals and count the number of articles that are related to IT.
In addition, make a list of the specific technology discussed in each article (where possible).
When you are finished, decide whether you believe IT is influencing the field of accounting.
1-13. Nehru Gupta is the controller at the Acme Shoe Company, a large manufacturing company located in Franklin, Pennsylvania. Acme has many divisions, and the performance of each division has typically been evaluated using a return on investment (ROI) formula. The return on investment is calculated by dividing profit by the book value of total assets.
In a meeting yesterday with Bob Burn, the company president, Nehru warned that this return on investment measure might not be accurately reflecting how well the divisions are doing.
Nehru is concerned that by using profits and the book value of assets, division managers might be engaging in some short-term finagling to show the highest possible return. Bob concurred and asked what other numbers they could use to evaluate division performance.
Nehru said, ‘‘I’m not sure, Bob. Net income isn’t a good number for evaluation purposes.
Since we allocate a lot of overhead costs to the divisions on what some managers consider an arbitrary basis, net income won’t work as a performance measure in place of return on investment.’’ Bob told Nehru to give some thought to this problem and report back to him.

Requirements
1. Explain what managers can do in the short run to maximize return on investment as calculated at Acme. What other accounting measures could Acme use to evaluate the performance of its divisional managers?
2. Describe other instances in which accounting numbers might lead to dysfunctional behavior in an organization.
3. Search the Internet and find at least one company that offers an information system (or software) that might help Nehru evaluate his company’s performance.
1-14. In a recent article in the New York Times, Jeff Zucker—CEO of NBC-Universal—described the digital age as ‘‘trading analog dollars for digital pennies.’’23 Discuss this comment from the viewpoint of each of the following:
a. A music company executive
23

b. A consumer

c. A TV executive

Arango, T. 2008. Digital sales exceed CDs at Atlantic. New York Times (November 26): p. B7.

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29

1-15. What is new in the field of AISs today? Select one new trend that was not mentioned in the chapter, but that you feel is important. Write a short report describing your findings. Be sure to provide reasons why you feel that your choice of topic is important, and therefore of interest to others in your class.
1-16. The participants of such recreational activities as hang gliding, soaring, hiking, rock collecting, or skydiving often create local ‘‘birds-of-a-feather’’ (affinity) organizations. Two examples are the Chicago sky divers (http://www.chicagoskydivers.com) or the soaring club of western Canada (http://www.canadianrockiessoaring.com). Many of these clubs collect dues from members to pay for the printing and mailing costs of monthly newsletters. Some of them maintain only minimal accounting information on manual pages or, at best, in spreadsheets. a. What financial information are such clubs likely to collect and maintain?
b. Assuming that the club keeps manual accounting records, would you consider such systems accounting information systems? Why or why not?
c. Assume that the club treasurer of one such organization is in charge of all financial matters, including collecting and depositing member dues, paying vendor invoices, and preparing yearly reports. Do you think that assigning only one person to this job is a good idea? Why or why not?
d. What benefits would you guess might come from computerizing some or all of the club’s financial information, even if there are less than 100 members? For example, do you think that such computerization is likely to be cost effective?
1-17. Many companies now provide a wealth of information about themselves on their Web sites.
But how much of this information is useful for investment purposes? To help you answer this question, imagine that you have $10,000, which you must invest in the common stock of a publicly-held company.
a. Select a company as specified by your instructor and access its online financial reports.
Is the information contained in the reports complete? If not, why not? Is the information contained in these reports sufficient for you to decide whether or not to invest in the company? If not, why not?
b. Now select an online brokerage Web site such as E*Trade and look up the information of that same company. Does the information provided by the brokerage firm differ from that of the company itself? If so, how? Again, answer the question: Is the information contained in these reports sufficiently detailed and complete for you to decide whether to invest in it?
If not, why not?
c. Access the Web site of an investment rating service such as Value Line. How does the information on this third site differ from that of the other two? Again, answer the question:
‘‘Is the information contained on the site sufficiently detailed and complete for you to decide whether to invest in the stock? If not, why not?’’
d. What do these comparisons tell you about the difference between ‘‘data’’ and
‘‘information’’?
1-18. The Web site of FinCen—the Financial Crimes Enforcement Center Network (a department of the U.S. Treasury)—maintains a Web site at http://www.fincen.gov. On the left side of its home page, you will find links to information for various types of companies including banks, casinos, money service businesses, insurance companies, security and futures traders, and dealers in precious metals and jewelry—that is, the companies mandated by various federal laws to file
SARs. Select three of these types of companies, and for each type, use the information provided on these secondary pages to list at least two types of financial transactions or activities that should be considered ‘‘suspicious.’’

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CASE ANALYSES
1-19. The Annual Report
The annual report is considered by some to be the single most important printed document that companies produce. In recent years, annual reports have become large documents.
They now include such sections as letters to the stockholders, descriptions of the business, operating highlights, financial review, management discussion and analysis, segment reporting, and inflation data as well as the basic financial statements. The expansion has been due in part to a general increase in the degree of sophistication and complexity in accounting standards and disclosure requirements for financial reporting.
The expansion also reflects the change in the composition and level of sophistication of users. Current users include not only stockholders but also financial and securities analysts, potential investors, lending institutions, stockbrokers, customers, employees, and
(whether the reporting company likes it or not) competitors. Thus, a report that was originally designed as a device for communicating basic financial information now attempts to meet the diverse needs of an expanding audience.
Users hold conflicting views on the value of annual reports. Some argue that annual reports fail to provide enough information, whereas others believe that disclosures in annual reports have expanded to the point where they create information overload. The future of most companies depends on acceptance by the investing public and by their customers; therefore, companies should take this opportunity to communicate well-defined corporate strategies.

Requirements
1. The goal of preparing an annual report is to communicate information from a company to its targeted users. (a) Identify and discuss the basic factors of communication that must be considered in the presentation of this information. (b) Discuss the communication problems a company faces in preparing the annual report that result from the diversity of the users being addressed.
2. Select two types of information found in an annual report, other than the financial statements and accompanying footnotes, and describe how they are useful to the users of annual reports.
3. Discuss at least two advantages and two disadvantages of stating well-defined corporate strategies in the annual report.
4. Evaluate the effectiveness of annual reports in fulfilling the information needs of the following current and potential users: (a) shareholders, (b) creditors, (c) employees, (d) customers, (e) financial analysts.
5. Annual reports are public and accessible to anyone, including competitors. Discuss how this affects decisions about what information should be provided in annual reports.
6. Find the annual report for a company that includes sustainability reporting. What information does the company disclose? Do you think such information is helpful to investors? 1-20. Performance Management Company
Neil Rogers is the controller for Performance Management Company (PMC), a manufacturing company with headquarters in San Antonio, Texas. PMC has seven concrete product

CHAPTER 1 / Accounting Information Systems and the Accountant

31

plants located throughout the Southwest region of the United States. The company recently switched to a decentralized organizational structure. In the past, the company did not try to measure profitability at each plant. Rather, all revenues and expenses were consolidated to produce just one income statement.
Under the new organizational structure, each plant is headed by a general manager, who has complete responsibility for operating the plant. Neil asked one of his accountants, Scott
McDermott, to organize a small group to be in charge of performance analysis. This group is to prepare monthly reports on performance for each of the seven plants. These reports consist of budgeted and actual income statements. Written explanations and appraisals are to accompany variances. Each member of Scott’s group has been assigned to one specific plant and is encouraged to interact with management and staff in that plant to become familiar with operations.
After a few months, Neil began receiving complaints from the general managers at several of the plants. The managers complained that the reports were slowing down operations and they felt as though someone was constantly looking over their shoulders to see if they were operating in line with the budget. They pointed out that the performance analysis staff is trying to do their job (i.e., explanation of variances). The most vocal plant manager claimed that ‘‘those accountants can’t explain the variances—they don’t know anything about the industry!’’
The president of PMC, Ross Stewart, also complained about the new system for performance evaluation reporting. He claimed that he was unable to wade through the seven detailed income statements, variances, and narrative explanations of all variances each month. As he put it, ‘‘I don’t have time for this and I think much of the information I am receiving is useless!’’

Requirements
1. Do you think it is a good idea to have a special staff in charge of performance evaluation and analysis?
2. In a decentralized organization such as this one, what would seem to be the best approach to performance evaluation?
3. What information would you include in a performance evaluation report for Mr. Stewart?

1-21. The CPA Firm
Bill Berry is the lead audit partner and the managing partner for The CPA Firm (TCF), LLP.
He was recently reviewing the firm’s income statement for the previous quarter, which showed that auditing revenues were about 5% below last year’s totals while tax revenues were about the same. Bill also noted that the income from auditing was 10% less than for the previous year. During the past few years, competition for new audit clients has been intense so TCF partners decided that it would be wise for the firm to lower its hourly billing rates for all levels in the firm.
The firm’s client base is closely held firms that are mostly very successful sole proprietors, as well as a number of small- and medium-size companies. Bill and the other partners have been brainstorming ways to expand the revenue base of the organization. Knowing that
IT is a tool that the firm can use to develop new lines of business, TCF hired several college graduates over the past few years with dual majors in accounting and information systems or computer science. Given the recent financial results, Bill wants to encourage the other partners to consider the potential to the firm of offering other professional services. 32

PART ONE / An Introduction to Accounting Information Systems

Requirements
1. Would it make the most sense for Bill to consider developing new types of clients or to consider offering different types of services to the types of clients typically served by
TCF?
2. Bill remembers that the AICPA developed a list of various types of assurance services that auditing firms might consider offering. Describe three of these assurance services that might be a good fit for this CPA firm. (Hint: Visit the AICPA’s Web page or a Web site of a large accounting firm for a listing of assurance services.)
3. What might TCF do to fully use the combined strengths in accounting and information systems/computer science of its new staff auditors?

READINGS AND OTHER RESOURCES
Beaumier, C. 2008. Anti-money-laundering compliance: Elements of a successful program. Bank
Accounting & Finance 21(2): 39–42.
Cheney, G. 2007. Are auditors patriot act ready? Accounting Today 21(22): 14.
Hannon, N. 2006. The lead singer gets a chorus. Strategic Finance 87(11): 59–60.
Monterio, B. 2011. XBRL and its impact on corporate tax departments. Strategic Finance 92(8):
56–58.
Thomson, J. and U. Iyer. 2011. XBRL and ERM: Increasing organizational effectiveness. Strategic
Finance 92(11): 64–66.

Accounting Songs: http://www.youtube.com/watch?v=Fr_DMRZ730k CyberNet Fraud: http://www.youtube.com/watch?v=qifcAo6Bp6M Identity Theft: http://www.youtube.com/watch?v=LmS3Vt419wk Sustainability Reporting Software: http://pro.gigaom.com/2010/05/sustainability-reporting-software-an-overview/ Sustainability Software Video: http://www.tririga.com/products/environmental-sustainability-software ANSWERS TO TEST YOURSELF
1. a

2. c

3. c

4. c

5. c

6. c

7. d

8. a

9. b

10. e

11. c

12. a

Chapter 2
Information Technology and AISs

INTRODUCTION

PROBLEMS

THE IMPORTANCE OF INFORMATION
TECHNOLOGY TO ACCOUNTANTS

CASE ANALYSES

Six Reasons

Savage Motors (Software Training)

The Top Ten Information Technologies

Backwater University (Automating a Data Gathering
Task)

INPUT, PROCESSING, AND OUTPUT DEVICES
Input Devices
Central Processing Units
Output Devices

SECONDARY STORAGE DEVICES

Pucinelli Supermarkets (Validating Input Data)

Bennet National Bank (Centralized versus
Decentralized Data Processing)
Morrigan Department Stores (The Ethics of Forced
Software Upgrading)

READINGS AND OTHER RESOURCES

Magnetic (Hard) Disks
CD-ROMs, DVDs, and Blu-Ray Discs

ANSWERS TO TEST YOURSELF

Flash Memory
Image Processing and Record Management Systems

DATA COMMUNICATIONS AND NETWORKS
Communication Channels and Protocols
Local and Wide Area Networks
Client/Server Computing
Wireless Data Communications
Cloud Computing

COMPUTER SOFTWARE
Operating Systems
Application Software
Programming Languages

AIS AT WORK—USING IPADS AT THE
MERCEDES-BENZ CAR DEALERSHIP
SUMMARY
KEY TERMS YOU SHOULD KNOW
TEST YOURSELF
DISCUSSION QUESTIONS

After reading this chapter, you will:
1. Be able to describe why information technology is important to accounting information systems and why accountants should know about this technology. 2. Understand why computer processor speeds are not particularly important to most accounting information systems.
3. Be familiar with source documents and why they are important to AISs.
4. Know some common AIS uses for POS input,
MICR media, and OCR.
5. Be able to explain in general terms the value of secondary storage devices to AISs.
6. Understand why data communications are important to AISs.
7. Be able to describe some advantages of client/server computing.
8. Be able to explain the advantages and disadvantages of cloud computing.

33

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Surveys of business report that annual IT expenditures approach 50 percent of new capital investment for most U.S. corporations.
Henderson, B., K. Kobelsky, V. Richardson, and R. Smith. 2010.
The relevance of information technology expenditures.
Journal of Information Systems 24(2): 39–77.

INTRODUCTION
In automated accounting systems, information technology (IT) serves as a platform on which other system components rely. The purpose of this chapter is to discuss IT subjects in detail—especially as they relate to AISs. Because most students in AIS courses have already taken a survey computer class, the discussions here are brief. This chapter may nonetheless serve as a review of computer hardware and software concepts or as a study of how IT helps organizations accomplish strategic accounting goals.
It is helpful to view an accounting information system as a set of five interacting components: (1) hardware, (2) software, (3) data, (4) people, and (5) procedures. Computer hardware is probably the most tangible element in this set, but ‘‘hardware’’ is only one piece of the pie—and not necessarily the most important piece. For example, most organizations spend more money on people (in wages and salaries) than on computer hardware and software combined. Similarly, computer hardware must work together with the other system components to accomplish data processing tasks. Without computer software, for example, the hardware would stand idle. Without data to process, both the hardware and the software would be useless. Without procedures, accounting data could not be gathered accurately or distributed properly. And finally, without people, it is doubtful that the rest of the system could operate for long or be of much use.
What all this means is that ‘‘information technology’’ is a fuzzy term that includes more than computer hardware. In this chapter, we concentrate on computer hardware (in the next three sections of the chapter) and software (in the final section). But you should remember that these items must interact with all the other system components to create successful AISs.

Case-in-Point 2.1 CPA Crossings is a small consulting company in Rochester, Minnesota, that provides IT services to both CPA firms and the organizations they serve. In helping companies install document management systems, general partner John Higgins notes that such matters as (1) defining work flow policies and procedures and (2) understanding the difference between document management systems and electronic documents themselves are the keys to successful implementations—not ‘‘technology.’’1

THE IMPORTANCE OF INFORMATION TECHNOLOGY
TO ACCOUNTANTS
Although it may be tempting to dismiss ‘‘information technology’’ as more important to computer people than accountants, this would be a mistake. In fact, most of the references
1

Higgins, J. 2006. Street talk: Reader views. Accounting Technology 22(3): 7

CHAPTER 2 / Information Technology and AISs

35

at the end of this chapter make it clear that ‘‘IT’’ and ‘‘accounting systems’’ are intimately related. Here are six reasons why IT is important to accountants.

Six Reasons
One reason for IT’s importance is that information technology must be compatible with, and support, the other components of an AIS. For example, to automate the accounting system of a dry-cleaning business, the owners will have to consider what tasks they’ll want their system to accomplish, identify what software package or packages can perform these tasks, and perhaps evaluate several different computer hardware configurations that might support these packages. These concerns are the subject of ‘‘systems analysis’’—the topic covered in Chapter 13.
A second reason why information technology is important is because accounting professionals often help clients make hardware and software purchases. For example, large expenditures on computer systems must be cost-justified—a task usually performed with accounting expertise and assistance. For this reason, many consulting firms now specialize in, or have departments for, management advisory services to perform these consulting tasks. Understanding IT is critical to these efforts.
A third reason why information technology is important to accountants is because auditors must evaluate computerized systems. Today, it is no longer possible for auditors to treat a computer as a ‘‘black box’’ and audit around it. Rather, auditors must audit through or with a computer. This means that auditors must understand automation and automated controls and also be able to identify a computerized system’s strengths and weaknesses.
We discuss these matters in Chapter 12.
A fourth reason why IT is important to accountants is because they are often asked to evaluate the efficiency (e.g., costliness and timeliness) and effectiveness (usually strategic value) of an existing system. This is a daunting task, requiring a familiarity with the strengths and weaknesses of the current system, as well as an understanding of what alternate technologies might work better.
A fifth reason why information technology is important to accountants is because IT profoundly affects the way they work today and will work in the future. This includes new ways of gathering and recording information; new types of systems that accountants will use (both to perform personal tasks and to communicate their work to others); new types of hardware, software, and computer networks upon which these systems will run; and even new ways to audit these systems.

Case-in-Point 2.2 Target is a retailer with 1,755 stores in the United States (in 2011) and over $60 billion in retail sales. Many of its suppliers claim that the chain’s sophisticated technology is ‘‘the best in the business,’’ enabling managers to make fast, accurate decisions on its many merchandising operations. Attention to detail is also important, including color coding department areas within the store and automating operations at checkout stands. Says
Target president Kenneth Woodrow, ‘‘If people have to wait in line, it means we don’t respect their time.’’2
A final reason why information technology is important to accountants is because understanding how IT affects accounting systems is vital to passing most accounting certification examinations. For example, sections of both the CPA and CMA examinations contain questions about information technology.
2

Frederick, J. 2008. Target adheres to core strategy in midst of tough economy. Drug Store News 30(5): 130.

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The Top Ten Information Technologies
Annually, the AICPA conducts a voluntary annual survey of its members to identify the
‘‘top 10 information system technologies’’ affecting the study and practice of accounting.
Figure 2-1 provides the set for 2010. For the sixth year in a row, ‘‘information security’’ tops the list, although the general topic of ‘‘security’’ involves almost all the other items in the list as well.
Because of their importance, we discuss many of the items in Figure 2-1 in various chapters of the text itself. For example, Chapters 9, 10, 11, 12, and 14 discuss the topic of information security (item 1 on the list). Similarly, we discuss backup solutions and disaster recovery in Chapter 3, small business software in Chapter 15, and mobile computing in Chapter 1.

INPUT, PROCESSING, AND OUTPUT DEVICES
Figure 2-2 suggests that the hardware of a computer system includes the computer itself—for example, a microcomputer—as well as the keyboards, printers, hard disks, and similar devices that help the computer perform input and output tasks. These devices are commonly called peripheral equipment because they typically surround the computer and help it process data.
One way to classify peripheral equipment is by the tasks they perform. Thus, input equipment (such as computer mice and keyboards) enable users to enter data into a computer system, output equipment (such as monitors and printers) enable users to see processed results, secondary storage devices (such as hard disks) enable users to store data for future reference, and communications equipment (such as internal networking cards) enable users to transmit data over data networks. Like any other system, these distinct pieces of computer equipment must work together to accomplish data processing tasks.
Most accounting transactions are processed in a three-phase operation called the input-processing-output cycle. For convenience, we shall look at technologies that assist AISs in each of these areas in this order.

Input Devices
The starting point of the input-processing-output cycle—especially when processing accounting data—is input. Thus, even where the amount of data is small, most AISs require input methods and procedures that ensure complete, accurate, timely, and costeffective ways of gathering and inputting accounting data. Usually, there are several ways of capturing accounting data, so system designers must pick those input procedures and devices that best meet these system objectives.

Source Documents and Data Transcription. The starting point for collecting accounting data in many AISs is a source document. Manual examples include time cards, packing slips, survey forms, employee application forms, patient intake forms, purchase invoices, sales invoices, cash disbursement vouchers, and travel reimbursement forms.
Computerized examples include airline reservation screens, bank deposit screens, and
Web-based customer-order forms.
Source documents are important to AISs because (1) they are human readable and
(2) they can be completed by the user. Source documents are also important because

CHAPTER 2 / Information Technology and AISs

Rank

Item

Explanation

1

Information Security

2

4

Securing and controlling information distribution
Backup solutions, disaster planning, and business continuity
Secure electronic collaboration

5

Paperless technology

6

Laptop security

7

Small business software

8

Mobile computing

9

Tax software and electronic filing

10

Server virtualization and consolidation

3

37

The ability to protect the components of an AIS from such threats as viruses, password intrusions, and physical harm. Protecting and securing the transmission and distribution of digital data—for example, using encryption.
The ability to continue business operations in the event that a disaster such as an earthquake occurs.
The need to secure electronic transmissions for both clients and collaborating employees.
The ability of employees to communicate and produce digital documents.
The need to secure laptops from theft, the data they transmit (from being compromised) and the information they store if the device itself is lost or stolen
The importance of new Microsoft Office, Google Apps, and similar software for office productivity.
An employee or contractor’s ability to work anywhere and communicate with the office at any time.
A tax filer or preparer’s ability to create and/or file a tax return electronically.
The ability of a large single server to do the work of serveral smaller ones.

FIGURE 2-1 The AICPA’s Top 10 Information Technologies for 2010. Source: AICP.org.

Secondary Storage Equipment
USB
Drive

Hard Disk
Drive

CD-Rom
Drive

DVD
Drive

Scanner

CRT
Monitor

Keyboard
Input
Equipment

Central
Processing
Unit (CPU)

MICR Reader

Printer

Audio
Speaker

Mouse
Touch
Screen
Modem

POS Terminal

Automated
Teller Machine
(ATM)

Communications Equipment

FIGURE 2-2 A central processing unit and examples of peripheral equipment.

Large
Display
Screen

Output
Equipment

38

PART ONE / An Introduction to Accounting Information Systems

they provide evidence of a transaction’s authenticity (e.g., a signed cash disbursement voucher authorizes a cash disbursement), are the starting point of an audit trail, and (in emergencies) can serve as backup in the event that the computer files created from them are damaged or destroyed.
The greatest disadvantage of manually-prepared source documents is that they are not machine readable. Thus, in order to process source-document data electronically, the data must first be transcribed into machine-readable media. This data transcription is mostly an inefficient, labor-intensive, time-consuming, costly, and nonproductive process that has the potential to bottleneck data at the transcription site, embed errors in the transcribed data, and provide opportunities for fraud, embezzlement, or sabotage. Is it any wonder, then, that most AISs capture data that are already in machine-readable formats?
The paragraphs that follow describe some devices that overcome these problems.

POS Devices. Because most of the information required by retailers can be captured at the point at which a sale is made, retail businesses now commonly use automated point-of-sale (POS) devices to gather and record pertinent data electronically at that time. One example is the ‘‘smart cash registers’’ that connect to offsite computers. Another example is the bar code readers that interpret the universal product code (UPC) commonly printed on supermarket and variety store items (Figure 2-3). Non-UPC bar codes are used extensively in transportation and inventory applications to track shipments (e.g.,
Federal Express), by warehouse employees to log received merchandise, by universities to identify equipment, by the U.S. Post Office to route mail, and by publishers to identify books using ISBN numbers (see the bar code on the back of this book for an example).
POS systems allow retailers to centralize price information in online computers, avoid the task of affixing price stickers to individual items on retail store shelves, and update prices easily when required. With such systems, for example, the sales data obtained at the checkout counter of a convenience store can be transmitted directly to a computer where they can be verified for accuracy, reasonableness, and completeness and also stored for later uses—for example, preparing sales reports. Figure 2-4 lists other advantages of
POS data collection systems, which are actually growing in use despite the maturity of the technology. Magnetic Ink Character Recognition. The banking industry pioneered the development of magnetically-encoded paper, commonly called magnetic ink character recognition (MICR). You are probably familiar with MICR characters—the odd-looking numbers printed on the bottom of your checks (Figure 2-5). This type font has been standardized for the entire country by the American National Standards Institute (ANSI).
Thus, a check you write anywhere in the United States or Canada is machine readable by any bank.

0

64200 11589

6

FIGURE 2-3 An example of the universal product code (UPC), which is often preprinted on the labels of retail products for merchandise identification and computerized checkout.

CHAPTER 2 / Information Technology and AISs

39

1. Clerical errors, such as a salesperson’s incorrect reading of a price tag, are detectable, and even potentially correctable, automatically.
2. Such standard procedures as the computation of a sales tax, the multiplication of prices times quantities sold, or the calculation of a discount can be performed using the register-terminal as a calculator.
3. Processing errors caused by illegible sales slips can be reduced.
4. Credit checks and answers to questions about customers’ account balances are routinely handled by using the cash register as an inquiry terminal.
5. The inventory-disbursements data required for inventory control are collected as a natural part of the sales transaction.
6. A breakdown listing by the computer of sales by type of inventory item, dollar volume, sales clerk, or store location is possible because the data required for such reports are collected automatically with the sales transaction and may be stored for such use.
7. Sales and inventory personnel levels can be reduced because the manual data processing functions required of such personnel have largely been eliminated.

FIGURE 2-4 Advantages of POS systems.
Non-numeric symbols
AMOUNT SYMBOL

ON US SYMBOL

TRANSIT NUMBER SYMBOL
DASH SYMBOL

FIGURE 2-5 The MICR symbols of the American Banking Association (ABA).

One advantage of MICR coding is that it is both machine readable and human readable.
Another advantage is that MICR coding is quite flexible: documents of varying sizes, thicknesses, or widths may be used. The chief disadvantage of MICR is that the magnetic strength (called the ‘‘magnetic flux’’) of the characters diminishes over time. This makes
MICR documents unreliable when they must be input repeatedly.

Optical Character Recognition. Optical character recognition (OCR) uses optical, rather than magnetic, readers to interpret the data found on source documents. Typical
OCR devices use light-sensing mechanisms and laser technology to perform the characterrecognition function required to interpret recorded data. Mark-sense media (such as the type used in computerized exams) use simple rectangles or ovals as ‘‘characters’’ that you blacken with a pencil. More sophisticated versions of OCR can read complete character sets of numbers and letters (Figure 2-6a) and are therefore more versatile as input.
Accounting uses of OCR include the billing statements of public utility companies, credit card issuers, and insurance companies, mortgage payment coupons, telephone bills, subscription renewal forms, and airline tickets. Most of these forms are turnaround documents—that is, documents that are initially prepared by a company, then sent to individuals, and finally returned to the organization for further data processing. Like MICR

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PART ONE / An Introduction to Accounting Information Systems

(a)

(b)

FIGURE 2-6 Some common computer input devices. (a) This versatile optical character reader from Scan Corporation can read OCR characters, bar codes, and magnetic stripes. (b) This credit card reader from Squareup™ allows small business owners such as electricians or limousine drivers to use their cell phones for customer credit card payments. Source: ADATA Technology
(USA) Co., Ltd.

encoding, the chief advantage of OCR is a source document that is both human readable and machine readable.

Plastic Cards with Magnetic Strips. Many plastic cards have a magnetic strip attached to one side of them that can store permanent information and therefore provide input data when required. Typically, the ‘‘mag strip’’ stores information about the user—for example, a checking account number, credit card number, room number, or security clearance code. In the United States, the magnetic strip on these cards has been divided into distinct physical areas, and by agreement, each major industry using these cards has its own assigned space. Thus, the International Airline Transport Association (IATA), the American Banking Association (ABA), and the savings and loan industry each encode information pertinent to their individual needs on such plastic cards without fear that, by accident, these cards will be misused in another application.
AISs use mag-strip cards to capture data at the time these cards are used (Figure 2-6b).
For example, credit cards can include passwords that ATM machines can examine every time someone uses the card. This also facilitates data gathering because reliable electronic equipment reads the strip, thus eliminating human error.
Case-in-Point 2.3 In the United States, many gambling casinos issue mag-strip ‘‘club cards’’ to their customers, who use them as internal credit cards for playing slot machines, poker machines, and so forth. These cards free customers from the task of cashing checks or getting change. But these same cards also enable casinos to gather data on player activities—information that managers can subsequently use to make better decisions about extending credit limits or providing complimentary meals and hotel rooms.3

Microcomputer Input Devices. Many specialized devices now help users input data into their microcomputers. Keyboards are perhaps the most common input device.
3

From the authors.

CHAPTER 2 / Information Technology and AISs

41

Computer mice, touch pads, joy sticks, and similar devices enable users to control a screen cursor, create graphic images, reposition screen objects, or select items from display menus. Touch screens enable users to make menu choices simply by touching a display screen with a finger or stick. Web cams provide live video input to a computer. Computer pens or styluses permit users to enter data on video screens and are especially popular with signature screens at store checkout counters or personal data assistant (PDA) devices such as Blackberries. These PDAs enable their users to make phone calls as well as maintain personal data such as address books, appointment calendars, and check registers.
Newer models also incorporate wireless technology that provides access to the Internet—a practical feature for e-mail users.

Digital Cameras. Although many people only use digital cameras in recreational settings, accountants also use them for documenting (1) inventories of large assets such as trucks, cranes, and buildings, (2) damage to vehicles or offices due to accidents, vandalism, or natural disasters for insurance purposes, and (3) new or existing employees for identification and security purposes. Like many cell phones, newer digital cameras can upload pictures directly to the Internet—an advantage, for example, when instant documentation is useful. As suggested by the following Case-in-Point, the benefits of digital photographs must be weighed against their potential social costs.
Case-in-Point 2.4 Red-light cameras automate the process of ticketing motorists who drive through red traffic lights (Figure 2-7). Such cameras enable municipalities to enforce driving laws at important traffic intersections and often substantially increase revenues from traffic violations. Proponents of red-light cameras argue that red-light cameras reduce accidents and that the funds they generate can be used to pay for other important police work.
Critics counter that the cameras are only revenue generators and that they pose an important threat to an individual’s right to privacy.4

FIGURE 2-7 An example of a red-light camera. Source: istockphoto.
4

http://www.thenewspaper.com/news/18/1886.asp

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PART ONE / An Introduction to Accounting Information Systems

Biometric Scanners. Many accounting applications must verify that a user has legitimate access to a system—for example, can view corporate personnel files. Authentication systems based on what you know require you to input codes, account numbers, passwords, or similar values. These are low-security systems because users can easily forget, lose, or guess such information, making these systems vulnerable to attack and misuse. Systems based on what you have require physical keys, magnetic cards, or similar physical media—but suffer many of the same problems as password-based authenticating systems. Biometric scanners authenticate users based on who they are. Behavioral systems recognize signatures, voices, or keystroke dynamics. Physiological systems recognize fingerprints, irises, retinas, faces, and even ears. Most of these devices connect directly to computer USB ports or are integrated in computer keyboards, mice, or Web cams. The two most common biometric systems use fingerprint or iris scanners to authenticate users
(Figure 2-8). While most fingerprints have similar features, for example, experts have yet to discover pairs with the same minute details since 1892 when records were kept. Iris scans record vein patterns in the colored portion of the eye and are even more accurate than fingerprints because of the wider variability in vein patterns and the fact that even the right and left eye of the same person are not identical.
Biometric authentication begins with enrollment—the process of creating digital templates for legitimate users. Template files are small, requiring about 256 bytes for a fingerprint and 512 bytes for an iris scan. To authenticate a user, the scanner takes a new sample from the individual and compares it to known templates. Unlike passwords, the new samples will not perfectly match the template. The hamming distance measures how close the two match.
Case-in-Point 2.5 The AICPA now requires the fingerprints of all candidates wishing to take the CPA exam. The system, maintained by Prometric, matches each candidate’s fingerprint with other personal identification in order to increase the security and integrity of the exams—over 60,000 test sections each year.5

(a) fingerprint scanner

(b) iris scanner

FIGURE 2-8 (a) An inexpensive USB fingerprint scanner. Source: Courtesy of BioEnable. (b) An inexpensive iris scanner. Source: Courtesy of LG Electronics.

5

Anonymous. 2008. CPA exam now requires fingerprints. Practical Accountant 4(6): 7.

CHAPTER 2 / Information Technology and AISs

43

Central Processing Units
Once data have been captured (and perhaps transcribed into machine-readable formats), they usually must be processed to be valuable to decision makers. These processing tasks are performed by the central processing unit (CPU) of a computer system (Figure 2-9).
In the computer industry, the terms computer and CPU are often used interchangeably.
Computing power starts with the most limited microcomputers (aka ‘‘personal computers’’ or ‘‘PCs’’) and increases in capabilities such as speed, multiuser support, and peripheral equipment with minicomputers, mainframe computers, and supercomputers. A growing segment of the microcomputer market is the portable systems—that is, netbook computers, laptop computers, and the even more compact PDAs and cell phones.
Steve Jobs, president of Apple Computer Corporation, describes computing today as the ‘‘post PC era.’’ Electronic readers and computer tablets such as the Kindle and iPad devices are a new category of portable computing systems that fit neatly into this vision.
Although many people now buy these devices for personal uses, commercial applications are emerging. We provide one example in the following Case-in-Point, and another example in the AIS-in-Action feature at the end of this chapter.

Case-in-Point 2.6 Michael Klein is the president of OpenAir, an airline charter company in Gaithersburg, Maryland, and an avid iPad user. He is one of many airline pilots who now take these devices on flights instead of the bulky manuals and charts once required by the
Federal Aviation Administration. The FAA approved the devices in early 2011, and airlines hope to save millions of dollars in reduced paper costs with them. ‘‘It’s better than paper,’’ says Klein. ‘‘It does everything for you.’’6
Primary Memory
Random Access Memory (RAM)
(contains the computer’s operating system instructions, application program instructions, and user data)
Flow of data and instructions
Cache
(high-speed buffer memory) Flow of data and instructions
Microprocessor
Arithmetic-Logic Unit (ALU)

Control Unit

(performs arithmetic and logic functions) (interprets program instructions and supervises the activities of primary memory and the ALU)

FIGURE 2-9 A schematic of a central processing unit. In some computers, the ‘‘Level 2’’ (highspeed buffer) cache is part of the microprocessor unit.
6

Levin, A. 2011. iPads give flight to paperless airplanes. USA Today (March 18): 1.

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The accounting systems of the smallest businesses—for example, a bicycle repair shop—can often be implemented entirely on a desktop microcomputer. In contrast, the inventory control systems of the nation’s largest vendors—for example, Walmart—require multiuser systems that may employ several centralized mainframes working in tandem.
One of the biggest challenges facing businesses today is identifying the right combination of computing technologies—that is, computers of various sizes, networks, and related software—that best meet their IT needs. Dollar for dollar, organizations usually get the most processing power and the cheapest software with microcomputers, which helps explain why modern organizations buy so many of them. Reasons to retain older mainframe systems include (1) the need to support multiuser processing capabilities that work best on such systems; (2) the advantages of centralized processing—for example, simplified control over hardware, software, and user accesses to databases; and (3) the huge costs that organizations typically incur when replacing these legacy systems.

Primary Memory. Figure 2-9 indicates that the two main components of a CPU are its primary memory and its microprocessor, with cache, or buffer, memory serving as the interface between these components. The purpose of primary memory is to store data and program instructions temporarily for immediate processing and execution. In microcomputers, this primary or random access memory (RAM) consists of individual bytes, each capable of storing a single character of data—for example, a letter or punctuation mark. RAM capacities are typically measured in gigabytes (billions of bytes). Most accounting software require minimum amounts of primary memory to operate properly, so ‘‘RAM size’’ is often a key concern when matching computer hardware to software requirements for smaller AIS applications.

Microprocessors. Computers cannot manipulate data or execute instructions directly in primary memory. Rather, these tasks are performed by the CPU’s microprocessor.
Examples include Intel Corporation’s Core i5 and i7 chips. The arithmetic-logic unit
(ALU) portion of these microprocessor chips performs arithmetic tasks (such as addition and multiplication), as well as logic tasks (such as comparisons). In contrast, the control unit of the processor supervises the actual data processing—for example, transferring data from primary memory to the ALU, performing the required task (e.g., adding two numbers together), and transferring the answer back to primary memory. Multicore processors such as Intel’s quad-core models integrate more than one processor on the same chip, thus potentially improving processing speeds beyond those of single-core chips.

Computers, Processor Speeds, and AISs. Computer processing speeds are typically measured in megahertz (MHz or millions of computer clock cycles per second) or
MIPS (millions of instructions per second). However, the most important thing to know about processor speeds is that they are rarely important in accounting applications. This is because the input-processing-output cycle characteristic of most accounting tasks requires input and output operations as well as processing procedures in order to perform specific tasks. An example is a payroll application, which must input, process, and output the data from each time card. The speeds of the input/output (I/O) operations involved in this application are orders of magnitude slower than the internal speeds of the processor(s), thus explaining why most computers are I/O bound, not process bound computers. What this means to accounting applications is that designers must typically look elsewhere for ways to speed computer throughput—that is, the time it takes to process business transactions such as payroll time cards—for example, by employing faster data transmission.

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Output Devices
Accounting data are meaningless if they cannot be output in forms that are useful and convenient to end users. Printed, hard-copy output is one possibility, but video or soft-copy output on monitor screens, audio output, and file output to secondary storage devices such as hard disks are other possibilities that we explore here. Outputs are especially important to AISs because their outputs are usually the basis of managerial decision making and therefore the goal of the entire system.

Printers. The hope for a paperless office has yet to be realized, and most AISs still produce many types of printed outputs—for example, transaction summaries, financial statements, exception reports, spreadsheet-based budget reports, word processing documents, and graphs. Many printers now also perform the functions of fax machines, copiers, and scanners, enabling these devices to serve as input devices, transmission devices, and standalone copying devices.
Printers fall into three general categories: (1) dot matrix, (2) ink jet, and (3) laser.
Dot-matrix printers are impact printers that employ tiny wires in a print head to strike an inked ribbon and create tiny dots on a print page. These printers are popular with small-business users because they are inexpensive and can print multipart (‘‘carbon’’) paper—an important feature commonly used in commercial cash registers to print multiple copies of credit card receipts.
Ink-jet printers create characters by distributing tiny bubbles or dots of ink onto pages. The print resolutions of these printers (commonly measured in dots per inch or dpi) tend to be higher than dot-matrix printers, while printing speeds (commonly measured in pages per minute or ppm) tend to be lower than laser printers. But most ink-jet printers can print in colors—a capability lacking in many dot-matrix and laser printers—enabling them to print graphics and colored pictures as well as text documents.
Laser printers create printed output in much the same way as duplicating machines.
The costs of laser printers are higher than dot-matrix or ink-jet printers, but print quality is usually superior and output speeds are much faster. Laser printers are often the printer of choice for commercial users because of this speed advantage. Many laser printers can now also print in color. Additionally, many of the newer printers can be connected wirelessly to local area networks, allowing their owners to print documents from both local and remote locations. Video Output. Because hard-copy outputs clutter offices with paper and take time to print, many AISs use fast, soft-copy video screen displays instead. Computer monitors are perhaps the most common type of video output, but the airport display screens showing arrivals and departures, stadium scoreboards, highway billboards, and the signage of many private stores are also forms of computerized video outputs.
The monitors of most netbook, laptop, and desktop computers use flat-panel, liquid crystal display (LCD) or plasma screens to create video outputs in the same way that televisions do. The picture elements (pixels) in both types of screens are tiny, discrete dots of color that are arranged in a matrix. Super video graphics adapter (SVGA) refers to a pixel matrix of about 1200 (in width) by 800 pixels (in height). High definition displays such as found in HDTVs typically use 1280 pixels by 720 pixels. However, the exact dimensions are not standardized and vary with the manufacturer.

Multimedia. Multimedia combines video, text, graphics, animation, and sound to produce multidimensional output. By definition, multimedia presentations also require

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advanced processor chips, sound cards, and fast video cards to work properly. One accounting use of multimedia is storing the pictures of employees in personnel files.
Another is recording verbal interviews with audit clients. A third is preparing instructional disks for tax accountants. Accounting uses of multimedia are likely to grow as the cost of producing multimedia applications becomes cheaper and new applications are found for this stimulating form of output. Multimedia applications are now also common on the
Internet.

SECONDARY STORAGE DEVICES
Primary memory is volatile memory, meaning memory that loses its contents when electrical power is lost. In contrast, AISs must store data on permanent media that maintain their accuracy and integrity, yet permit these systems to access and modify information quickly and easily. This is the purpose of secondary storage (also called mass storage or auxiliary storage). Like primary memory, the basic unit of secondary storage is a byte, and secondary storage capacities are measured in kilobytes (1,024 bytes), megabytes (1,024 kilobytes), gigabytes (1,024 megabytes), or terabytes (1,024 gigabytes).
In this section, we examine several types of secondary storage: magnetic (hard) disks,
CD-ROMs, DVD disks, Blu-Ray discs, and USB flash disks. Common to all these media is the concept of a computer record. Like manual systems, computerized AISs must maintain information about payroll activities, warehouse inventories, and accounts receivable data in permanent files. In each such file, a computer record is a collection of information about one file entity—for example, one employee on a payroll file (Figure 2-10).

Magnetic (Hard) Disks
A magnetic (hard) disk (Figure 2-11) consists of one or more spinning platters, each surface of which has an iron oxide coating that can be magnetized to record information.
The smallest hard disks use only a single, double-sided platter, whereas larger-capacity hard disks use multiple platters. The disk system can access (or write) records from any portion of the platter by moving its read/write heads in toward the center of the disk platters or outward to their outer edges. To avoid contamination from dust or smoke particles, most hard disks are permanently sealed in their boxes.
To further guard against disk failures as well as increase storage capacities, manufacturers now also offer redundant arrays of inexpensive disks (RAIDs)—see Figure 2-12. In effect, these are stacks of hard disks, each similar to the disk system shown in Figure 2-11.
RAIDs are also commonly used for archiving functions—and therefore critical to AISs in the event of an unforeseen disaster. one computer record
9

20

50

50

5

Social
Security
Number

Name

Street
Address

City,
State

Zip
Code

alphabetic data field

1

4

30

Pay
Hourly
Code Rate

101

Withholding Other
Amounts
Information

numeric data field

FIGURE 2-10 The format for the computer record of an employee on a payroll file.

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Disk platters

47

Read/write head

Surface of platter stores data

FIGURE 2-11 A schematic of a multiplatter hard disk. The read/write head assembly moves the read/write heads inward (toward the central spindle) or outward as needed, allowing the system to access the data on any portion of any platter.

One advantage of magnetic disk media is their large storage capacities—now commonly measured in gigabytes for microcomputers and terabytes for commercial AISs. Another advantage is their fast data transfer rates, which now can exceed 100 million characters per second. Finally, perhaps their most important advantage is the ability to directly access any specific record without sequential searching—a capability made possible by the fact that disk records are assigned individual disk addresses (that act like post office box addresses).
This accessing capability is useful for online applications such as airline reservations or bank account inquiries, when users require immediate access to specific records, and explains why magnetic disks are also called direct access storage devices (DASDs).

FIGURE 2-12 A redundant array of inexpensive disks (RAID). Source: http://www.orbitmicro.com. 48

PART ONE / An Introduction to Accounting Information Systems

CD-ROMs, DVDs, and Blu-Ray Discs
Three types of secondary storage devices currently popular with microcomputer users are CD-ROMS, DVDs, and Blu-ray discs. All three media store data digitally and read disk information optically.

CD-ROMs. The term CD-ROM is an acronym for ‘‘compact disk-read only memory.’’
The name is appropriate because CD-ROMs are the same size and appearance as audio CDs.
CD-ROMs contain microscopic pits that are etched along a spiraling track in their substrate surfaces. Laser beams interpret the presence or absence of a pit as the ‘‘one’’ or ‘‘zero’’ of binary codes.
CD-ROMs come in three types. The oldest, prerecorded versions are similar to those on which music or software is distributed. Newer ‘‘CD-R’’ media are blank CDROMs that can be recorded (only once) with inexpensive CD encoding devices. These are worm (write-once, read-many) media. Finally, the newest ‘‘CD-RW’’ media are rewritable, allowing AISs to use them as low-capacity hard disks.
One advantage of CD-ROMs is the fact that they are a removable medium with storage capacities in excess of 650 megabytes per disk—the equivalent of 300,000 pages of text!
This makes CD-ROMs ideal for storing large amounts of accounting data or reference materials. Because CD-ROMs are read with laser beams, data transfer rates are also very fast and wear and tear is minimal, even with continuous usage. Finally, the worm characteristic of CD-ROMs and CD-Rs make them useful for archiving files securely (i.e., storing files on a medium that cannot be changed). But CD-ROMs suffer from at least one drawback—the fact that worm media cannot be updated (because new information cannot be written on them once they have been encoded).
DVDs. A digital video disk or DVD closely resembles a CD-ROM in that it too is a 5-inch plastic disk that uses a laser to encode microscopic pits in its substrate surface. But the pits on a DVD are much smaller and encoded much closer together than those on a CD-ROM.
Also, a DVD can have as many as two layers on each of its two sides (compared to the single-layered, single-sided CD-ROM). The end result is a medium that can hold as much as 17 gigabytes of data—over 25 times the capacity of a standard CD-ROM disk. The two greatest advantages of DVDs are therefore (1) a storage medium that can archive large amounts of data and (2) a single, light-weight, reliable, easily transportable medium. Newer
DVDs are writeable and even rewriteable.

Blu-Ray Discs. Blu-ray disc writers encode the same-size disk medium as CDs and
DVDs, but the disks can store more information on them—up to 25 gigabytes of data. The disks first became commercially available in 2006, and their name comes from the blue color of the shorter wavelength laser beams used to encode and read the disks. BD-Rs are read-only media that can be written only once, while BD-REs can be erased and re-recorded multiple times.
At present, most Blu-ray discs in the United States and Canada are used for movies and video games, mainly because their standard format enables easy recording in high definition and also inhibits illegal copying better than DVD formats. But accounting applications are growing—especially their use as a backup medium for large databases.

Flash Memory
Flash memory is solid-state memory that comes in various forms. Examples include the flash drives that use the USB ports of microcomputers (Figure 2-13), the PCMCIA memory

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FIGURE 2-13 This USB flash drive from AData corporation plugs into a standard USB connector on a microcomputer. Despite its small size, it stores 1 gigabyte of data. Source: ADATA Technology (USA) Co., Ltd. cards used with laptops, the memory sticks used in digital cameras, the memory cards used with video games, and the RAM of newer microcomputers. The term ‘‘solid state’’ means that there are no moving parts (unlike the hard disk in Figure 2-11)—everything is electronic rather than mechanical.
USB drives can store gigabytes of data in an erasable format. Because data transfer rates are high and the devices themselves compact, they are particularly useful to accountants for creating backups of important files and transporting them offsite. Costs are low—under
$20 for smaller capacity USB drives.

Image Processing and Record Management Systems
The life cycle of business documents begins with their creation, continues with their storage and use, and ends with their destruction. Two important tools that can help managers with such tasks are image processing systems and record management systems.

Image Processing. Image processing allows users to store graphic images in digital formats on secondary storage media (e.g., the images taken by digital cameras). Thus, image processing systems are able to capture almost any type of document electronically, including photographs, flowcharts, drawings, and pages containing hand-written signatures. Commercial users of image processing include (1) insurance companies that use image processing to store claims forms and accident reports, (2) banks that use image processing to store check images, (3) hospitals that use image processing to store medical diagnostic scans, and (4) the internal revenue service that uses image processing to capture and store tax return data.
Image processing offers several advantages. One is the fast speeds at which images can be captured—a benefit of special importance to high-volume users such as banks. Another advantage is the reduced amount of physical storage space required (compared to paper storage). A third advantage is the convenience of storing images in computer records, which can then be sorted, classified, retrieved, or otherwise manipulated as needs require.
A final advantage is the ability to store images in central files, thus making copies available to many users at once, even at the same time. (This last advantage is an important benefit to government agencies and medical offices, where personnel no longer have to ask ‘‘who’s got the file?’’ This is the topic of the AIS at Work at the end of Chapter 8)

Record Management Systems. Simple record management systems enable businesses to systematically capture and store documents. More modern electronic document

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and record management systems (EDRMs) extend such capabilities by helping organizations manage the workflow of electronic documents during document development, provide collaborative tools that enable several users to work on the same document, and allow organizations to create and store multiple versions of documents.
It is easy to understand why business and government organizations use EDRM tools.
For legal reasons, for example, businesses may need to retain both current and old policy manuals, contracts, or employment records. Similarly, it is convenient to automate the termination of documents when contracts expire, employees quit, or new policies replace old ones.

DATA COMMUNICATIONS AND NETWORKS
Data communications refers to transmitting data to and from different locations. Many accounting applications use data communications in normal business operations. For example, banking systems enable individual offices to transmit deposit and withdrawal information to centralized computer locations, airline reservation systems enable passengers to book flights from remote locations, and stock brokerage systems enable brokers to transmit buy and sell orders for their customers. Accountants must understand data communication concepts because so many AISs use them and also because so many clients acquire AISs that depend on them. In addition, auditors must sometimes audit the capabilities of a network—for example, evaluate its ability to transmit information accurately and to safeguard the integrity of the data during such transmissions.

Communication Channels and Protocols
A communication channel is the physical path that data take in data transmissions.
Examples include (1) the twisted-pair wires of telephone lines, (2) coaxial cables, (3) optical fibers, (4) microwaves, and (5) radio (satellite) waves. Local area networking applications
(discussed shortly) typically use the first three of these, while Internet applications often use all five of them.
To transmit data over these communications channels, the digital pulses of the sending computer must be translated into the sound patterns, light pulses, or radio waves of the communications channel. Over voice-grade telephone lines, this translation is performed by a modem (an acronym for ‘‘modulator-demodulator’’). The transmission rates are commonly measured in bits per second (bps).
Integrated services digital network (ISDN) is an international data communications standard that transmits data, voice message, or images at a standard rate of 128k bps over the Internet. A similar data transmission service is a digital subscriber line (DSL), which supports data communications rates up to 9 megabits per second. Finally, large data communications installations using fiber optic cables and similar wide-band channels can currently transmit data up to 266 million bps. Future optic fiber transmission rates will transmit data at speeds up to 2.2 billion bps—speeds high enough to transmit motion-picture images in real time.
In all data communications applications, the sending and receiving stations must use a compatible transmission format. A data communications protocol refers to the settings that provide this format. Two common protocols are TCP (transmission control protocol), which networks commonly use for e-mails, and HTTP (hypertext transmission protocol), which networks commonly use for Web pages.

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Local and Wide Area Networks
One important use of data communications is in local area networks (LANs). Figure 2-14 shows that a LAN consists of microcomputers, printers, terminals, and similar devices that are connected together for communications purposes. Most LANs use file servers to store centralized software and data files and also to coordinate data transmissions among the other LAN devices and users. Most local area networks occupy a single building, although
LANs covering several buildings are also common. In the past, installers hardwired LAN devices together. Today, many LANs are wireless—a convenience to users, who no longer need to worry about where to place computer equipment in their offices, but an added security hazard to network administrators.
LANs provide several users access to common hardware, software, and computer files, as well as to each other. The following are some advantages of LANs:
1. Facilitating communications. The number one reason why businesses install LANs today is to support e-mail.
2. Sharing computer equipment. For example, a LAN can provide users access to the same printers or Internet servers.
3. Sharing computer files. LANs enable several users to input or output data to or from the same accounting files.
4. Saving software costs. It is often cheaper to buy a single software package for a local area network than to buy individual packages for each of several workstations.
5. Enabling unlike computer equipment to communicate with one another. Not all computers use the same operating system or application software. LANs enable different computers using different software to communicate with one another.
Wide area networks (WANs) are computer networks spanning regional, national, or even global areas. For example, a WAN enables a national manufacturing company to connect several manufacturing, distribution, and regional centers to national headquarters, and therefore to each other, for communications purposes (Figure 2-15). WANs typically use a multitude of communication channels for this purpose, including leased phone lines, microwave transmitters, and perhaps even satellite transmissions. Rather than developing and maintaining their own WANs, many organizations employ public carriers, the Internet, or third-party network vendors to transmit data electronically.

Personal computer Internet with web services Personal computer File server Printer

Online storage FIGURE 2-14 A local area network with representative devices.

Personal computer Personal computer 52

PART ONE / An Introduction to Accounting Information Systems

Satellite

M

Headquarters

M

M
M
M

M

M Manufacturing plant

Transmission station

M

Local office and ground-based transmission line

FIGURE 2-15 A wide area network that a large organization might use to connect regional users and computers.

Case-in-Point 2.7 IGT is the world’s largest slot machine manufacturer, but nearly half its profits derive from its Megabucks® system—a wide-area network of progressive slot machines located on the floors of participating casinos in various states of the United States. In Nevada, the company links the machines together over private communications lines, enabling the company to both monitor its slot machines and display the growing jackpots in real time as customers play. (You can view the current jackpot in your home state by first selecting http://www.igt.com/play-igt.aspx and then selecting your state in the drop-down box.) To date,
Megabucks has created more than 1,000 millionaires and paid more than $3.8 billion in major jackpots. Only one lucky player has won the Megabucks jackpot twice—once for $4.6 million in 1989 and again for $21.1 million in 2005 (when he was 92).7
AISs use WANs to gather financial data from remote sites, distribute accounting information to and from headquarters, and support e-mail communications among users.
WANs are therefore typically complex, multifaceted systems that serve many users for many purposes. For example, the wide area networks of large Internet service providers (ISPs) such as America Online allow subscribers to access centralized databases through local phone lines. Similarly, regional supermarket chains use WANs to gather inventory data, cash receipts data, and sales information from the many stores in their chains. WANs can also be dedicated to specific tasks. For example, most bank ATM machines are connected to WANs for the purpose of centralizing account information.
Many WANs are organized in a hierarchy, in which the individual microcomputers of a specific branch office are connected to a file server on a local area network, the file servers of several LANs are connected to a regional computer, and several regional computers are
7

For more information about IGT’s Megabucks systems, go to http://www.igt.com.

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connected to a corporate mainframe. This hierarchical approach allows a large company to gather, store, and distribute financial and nonfinancial information at the appropriate geographic level of the company.

Client/Server Computing
Client/server computing is an alternative technology to mainframe and/or hierarchical networks. Depending on the type of client/server system, data processing can be performed by any computer on the network. The software application, such as a spreadsheet program, resides on the client computer—typically, a microcomputer. The database and related software are stored on networked file servers. Although mainframe systems normally centralize everything (including the control of the system), client/server applications distribute data and software among the server and client computers of the system.
As a result, client/server computing is a way to achieve the overall objective of an enterprise network. In so doing, more computing power resides in user desktops, yet all organizational computers are linked together.

Components of Client/Server Systems. Figure 2-16 shows that a client/server system may be viewed as a set of three interacting components: (1) a presentation component, (2) an application– logic component, and (3) a data-management component.
The presentation component of a client/server system is the user’s view of the system—that is, what the user sees onscreen. This view may resemble the familiar screens of the user’s home computer or may differ considerably from them. Simple client/server systems that focus on this presentation task are called distributed presentation systems. Most Internet applications illustrate this category.
The application– logic component of a client/server system refers to the processing logic of a specific application—for example, the logic involved in preparing payroll checks.
Thus, client/server computing differs from simple ‘‘host/terminal computing’’ in the user’s new ability to (1) query or manipulate the warehoused data on the server, (2) ask what-if questions of the server’s data, (3) process a transaction that may affect data stored on both client and server computers, or (4) alter data stored elsewhere on the network. Some systems enable users to write their own data queries (that ask for specific information from the server database) and also to store such queries on local files for later uses.

File server Mainframe computer or large server

Client

Local Server

Centralized System

Presentation component

Application component
(depending upon the system, also performs some of the logic and database services)

Data-management component FIGURE 2-16 Components of a client/server system.

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The processing tasks involved in each application are typically shared unequally between the client computer and the server, with the division of labor depending on the particular application. For example, in a payroll application, the client’s contribution may be limited to validating the data entered into the system, while in a word processing application, the client computer might perform nearly all the processing tasks required.
Finally, the data-management component of a client/server system refers to its databases and data-storage systems. Some applications rely on a centralized mainframe for this task. More typically, however, multiple copies of the databases reside on large, regional file servers, thereby speeding user access to the data they contain. These systems are also the most complex and therefore pose the greatest challenges to accountants for control and audit tasks.

Advantages and Disadvantages. The advantages of client/server computing include the flexibility of distributing hardware, software, data, and processing capabilities throughout a computer network. A further advantage can be reduced telecommunications costs—an advantage that enabled Avis Rent-a-Car to save a half minute on each of its 23 million annual customer calls, and therefore $1 million. A third advantage is the ability to install thin-client systems, which use inexpensive or diskless microcomputers, instead of more expensive models, to save money on system acquisition and maintenance costs. The managers of
Mr. Gatti’s, a Texas chain of 300 pizza restaurants, for example, estimate that it will save about 45% on its maintenance costs using such a system.
One disadvantage of a large client/server system is that it must maintain multiple copies of the same databases, which it then stores on its various regional servers. This makes backup and recovery procedures more difficult because multiple copies of the same file (or several parts of a single file) now exist on several different computers. This multiple-copy problem also causes difficulties in data synchronization (i.e., the need to update all copies of the same file when a change is made to any one of them).
Changing from one version of an application program to another is also more difficult in client/server systems because the system usually requires consistency in these programs across all servers. User access and security are also more difficult because access privileges may vary widely among employees or applications. Finally, the need for user training is often greater in client/server systems because employees must not only know how to use the data and application programs required by their jobs but must also understand the system software that enables them to access these databases and programs from local work stations.

Wireless Data Communications
A recent survey by Intuit revealed that over 70% of the small businesses in the United
States have mobile employees, and by all accounts, that number is growing. The term wireless communications, also called Wi-Fi (for ‘‘wireless fidelity’’), means transmitting voice-grade signals or digital data over wireless communication channels. Wi-Fi creates a wireless Ethernet network using access hubs and receiver cards in PCs, cell phones, and
PDAs, thereby turning cell phones and similar wireless devices into cordless, multifunction
‘‘web appliances.’’
Wireless devices have become important tools for business professionals, helping accountants in particular stay in touch with fellow employees, clients, and corporate networks. Early e-mailing uses of wireless communications have now been joined by

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job-dependent financial functions such as recording sales orders, entering time and billing information, and—as suggested by the following Case-in-Point—even preparing the payroll.

Case-in-Point 2.8 It wasn’t until the middle of his son’s little league game that Eddie
Elizando realized he hadn’t prepared the payroll for the employees at his small CPA company.
Mr. Elizando was nowhere near his corporate office, but this wasn’t a problem. Using his new iPhone, Mr. Elizando called his payroll service, entered data by clicking through the appropriate payroll program, and accomplished the task remotely between innings of the game. An added bonus: one of Mr. Elizando’s employees was his wife, who still wanted to be paid!8 The two key dimensions of Wi-Fi applications are ‘‘connectivity’’ and ‘‘mobility.’’ The connectivity advantage means the ability to connect to the Internet, LAN, or WAN without physical wires or cables. To accomplish this, Wi-Fi devices use wireless application protocol (WAP), a set of communication standards and wireless markup language (a subset of XML optimized for the small display screens typical of wireless, Internet-enabled appliances). Two important types of wireless communications are RFID applications and
NFC communications.

RFID. Radio frequency identification (RFID) enables businesses to identify pallets and even individual items without unpacking them from shipping crates. Passive RFID tags have no power source (and therefore cannot wear out) but can nonetheless ‘‘answer’’ inquiries from energized sources. Active RFID tags are actually chips with antennas, have their own power source, enjoy ranges of more than 100 meters, and are generally more reliable than passive tags.
Perhaps the most noticeable use of RFID tags is as user identifiers in transportation systems (Figure 2-17). For example, the subway systems of New York City, Moscow, and Hong Kong use them, as do some of the toll roads and parking lots in the states of
New York, New Jersey, Pennsylvania, Massachusetts, Georgia, Florida, and Illinois. Similar systems may be found in Paris, the Philippines, Israel, Australia, Chile, and Portugal. To toll-road travelers, RFID systems represent a convenient way of paying user fees and reducing wait times in tollbooth lines. To their operators, these systems are a convenient way of gathering accounting data and updating customer accounts.
Source
Reader

Receiver

Electronic tag

FIGURE 2-17 Reading an RFID tag at a toll booth.

8

Defelice, A. 2007. Working in a wireless world. Accounting Technology 23(10): 30–34.

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Case-in-Point 2.9 Recent RFID applications include employee ID badges, library books, credit cards, and even tire-tread sensors. Similarly, many retailers now require their suppliers to include tags that identify merchandise. Walmart and Target are two of a growing list of large retailers that now require their major suppliers to include RFID tags in the cases and pallets sent to their various distribution centers. The tags are superior to bar codes, which require a line of sight for reading, must appear on the outside of cartons, and can be lost or defaced.
Bank of America and Wells Fargo are two of the largest RFID users, with each tagging over
100,000 corporate assets. If your car has a keyless ignition system, you’re also using RFID technology.9 NFC. Near field communication (NFC) enables mobile devices such as cell phones,
PDAs, and laptop computers to communicate with similar devices containing NFC chips
(Figure 2-18). With NFC devices, for example, you can make travel reservations on your
PC, download airline tickets to your mobile phone or PDA, and check in at a departure gate kiosk with a swipe of your mobile device—all with no paper or printing.
In effect, NFC represents RFID communications for the masses. But the operating range of NFC devices is limited to 20 cm or about 8 inches—a limitation that helps avoid unintentional uses. The transit systems in China, Singapore, and Japan now use NFC systems, as do Visa International’s credit card system and chip-enabled posters of the
Atlanta Hawk’s basketball team.
NFC technology is a joint product development of Sony, Philips, and Nokia. Three possible communication modes are (1) active (bidirectional), (2) passive (one way), and
(3) transponder (batteryless and therefore powered only by an external communication source). Current NFC-standardized communication speeds are between 106 k and
424 kbps—considerably less than the 1 to 7 Mbps speeds of Bluetooth or Wi-Fi data transmissions. But passive NFC chips cost as little as 20 cents and are currently considerably cheaper than these alternate communication devices.

Cloud Computing
As noted in Chapter 1, the term cloud computing refers to a range of computing services on the Internet—for example, access to computer software programs, backup and recovery file services, and even Web page development and hosting. The term gets its name from the common use of a cloud symbol to represent the Internet itself—refer back to Figure 2-14.
Most commercial applications of cloud computing are types of outsourcing—that

FIGURE 2-18 Near field communication devices.
9

Desjardins, D. 2005. Implementation easier as No. 2. DSN Retailing Today 44(7): 34.

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is, situations in which one organization hires another to perform a vital service. An accounting application is the use of tax preparation software, which the customer accesses over the Internet from the vendor for a fee—an example of ‘‘software as a service’’ (SAAS). Many cloud service vendors have familiar names, including Amazon,
Google, Yahoo, IBM, Intel, Sun Microsystems, and Microsoft. The first cloud computing conference took place in May 2008 and attracted over 1,000 attendees. Chapters 1 and 14 discuss clouding computing in more detail.

COMPUTER SOFTWARE
As noted in the introduction to this chapter, it is impossible to discuss information technology without also recognizing the importance of computer software. Computer hardware serves as a base, or platform, upon which two types of computer software typically reside: (1) operating systems and (2) application software. This chapter concludes by briefly discussing each of these types of software.
It is difficult to overstate the importance of software to AISs. Both in industry and in private homes, computer software performs tasks such as computing spreadsheets, paying corporate bills, routing parcels on conveyor belts, answering telephones, or reserving airline seats. Automated AISs depend on software to function properly. But this dependency also presents important challenges to accountants. For example, every system that influences cash accounts or affects other corporate resources must also contain automated controls to ensure the reliability, completeness, and authenticity of computer inputs, processing, and outputs. Similarly, all AIS software must initially be designed, acquired, and installed by someone. These facts help explain why accountants are often such an integral part of the teams that shop for, test, and audit such systems.

Operating Systems
An operating system (OS) is a set of software programs that helps a computer, file server, or network run itself and also the application programs designed for it. Examples of operating systems for microcomputers include MacOS, Windows 7, and Linux. Operating systems for larger computers include UNIX, Windows.Net server, and OS2. Some of these operating systems are designed as single-user operating systems (e.g., Windows 7), while others are designed as multiuser operating systems for LANs (e.g., Microsoft Windows
Server and Novell Netware). Operating systems for very small systems such as PDAs and cell phones include Android, Windows Mobile, Blackberry, Bluetooth, Palm OS, and
Symbian OS. Most of these operating systems combine many convenient software tools in one package and use graphical user interfaces (GUIs) with menus, icons, and other graphics elements (instead of instruction commands) to identify system components and launch processing applications (apps).
On computers of any size, the operating system is typically the first piece of software loaded (booted) into primary memory when the computer powers up. System tasks for single-user OSs include testing critical components on boot-up, allocating primary memory among competing applications (i.e., managing the multitasking demands of several Windows sessions), managing system files (such as directory files), maintaining system security, and (in larger computers) gathering system performance statistics. The system tasks for multiuser OSs are even more complicated than for single-user systems

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because more users are involved and more coordination of system resources is required.
These multiuser OSs maintain job queues of programs awaiting execution, create and check password files, allocate primary memory to several online users, apportion computer time in time-sharing (multiprocessing) environments, and accumulate charges for resource usage.
Application (end-user) programs are designed to work with (‘‘run under’’) a particular operating system. An operating system helps run application programs by coordinating those programs’ input and output tasks, by managing the pieces of an application program that is too large to fit entirely in RAM, and by monitoring their execution.
The utility programs that come with operating systems help users perform tasks such as copying files, converting files from one format to another, compressing files, performing system diagnostics, and building disk directories. Another task is to manage virtual storage—that is, disk memory that a computer system uses to augment its limited primary memory. Finally, today’s operating systems also run antivirus software. As explained more fully in Chapter 11, a virus is a destructive program that, when active, damages or destroys computer files or programs. Today’s operating systems include antivirus software routines that guard against the virus programs a user might accidentally introduce into his or her computer system from external sources. However, because new viruses continue to appear, users should update this software at least monthly.

Application Software
The term application software refers to computer programs that help end users such as accountants perform the tasks specific to their jobs or relevant to their personal needs.
One category of application software is the personal productivity software familiar to most accountants—for example, word processing software (for creating documents and reports), spreadsheet software (for creating worksheets of rows and columns and also for graphing the data), database software (for creating files and databases of personal information), and personal finance software (for paying bills, creating personal budgets, and maintaining investment portfolio data).
Another category of application software is the personal productivity software designed for commercial uses. Examples include project management software (for coordinating and tracking the events, resources, and costs of large projects such as construction projects or office moves), computer-aided design (CAD) software (for designing consumer products, fashion clothing, automobiles, or machinery), and presentation graphics software
(for creating slides and other presentations).
A third category of application software is the accounting software that performs familiar tasks such as preparing payrolls, maintaining accounts receivable files, executing accounts payable tasks, controlling inventory, and producing financial statements. Often, developers integrate these tasks in complete accounting packages. Because of the particular relevance of such software to AISs, Chapter 9 discusses such packages in greater detail.
Yet a fourth type of application software is communications software that allows separate computers to transmit data to one another. Microcomputer examples include communications packages (for simple data transmissions between computers), Web browsers
(for accessing and displaying graphics information on the Internet), backend software (that enables Web servers to communicate with large, commercial databases of customer and

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product information), and e-mail software (for creating, transmitting, reading, and deleting e-mail messages).
Finally, a fifth type of application software is the relatively new enterprise resource management (ERP) software that enables businesses and government agencies to transmit and manipulate financial data on an organization-wide basis. An example is
SAP. These systems are particularly important to electronic commerce (e-commerce) applications—for example, because a simple sale over the Internet simultaneously affects accounts receivable, inventory, and marketing subsystems.

Programming Languages
To develop application software, developers must write detailed instructions in programming languages that computers can understand and execute. FORTRAN, COBOL, and RPG are examples of older programming languages that developers used to create minicomputer and mainframe AISs (i.e., the older but still viable legacy systems). Newer computer languages include C++ (favored for its ability to manipulate data at the bit level),
Visual Basic (favored for creating Windows-like user interfaces), HTML (an editing language favored for creating Web pages), and Java (favored for its ability to run on many different types of computers).
Most of the newer programming languages are object-oriented programming languages, meaning that they encourage programmers to develop code in reusable modules called objects, which are easier to develop, debug, and modify. Both Visual Basic and C++ are event-driven programming languages—that is, programming languages where code responds to events such as a user clicking on a menu item with a mouse.
Figure 2-19 illustrates how developers create application programs using these programming languages. The process begins when computer programmers write instructions in a source programming language such as Visual Basic. In a second step, the developers translate this source code into the machine language (object code) that a computer understands. Yet another computer program called a compiler performs this translation in a second step called a compilation. The output from the compilation is the object code, which a computer can then load and execute. When end users buy application software packages, they buy compiled computer programs in machine language that are ready to execute on their specific computers.

Step 1: Computer programmers create a program written in a highlevel programming language such as Java.

Step 2: Another computer program called a compiler treats the source code as input. It translates the source code into object code (machine language) that a computer can understand. Step 3: The object code is ready for execution.
This object code is the product that end users buy when purchasing application programs “off the shelf.”

Source Code

Compilation

Object Code

FIGURE 2-19 How computer programmers create application software.

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AIS AT WORK
Using iPads at the Mercedes-Benz Car Dealership10
Customers at a Mercedes-Benz dealership are now likely to talk to salespeople armed with iPads when they want to finance or lease their new cars or when they bring their older cars back at lease end. Why an iPad? Simple: The iPads let dealership employees stay close to the customer on the sales floor when discussing promotional incentives, financing terms, or leasing arrangements.

Source: © 2011 Mercedes-Benz Financial Services USA LLC. All rights reserved. Mercedes-Benz—are registered trademarks of Daimler, Stuttgart, Germany iPad is a registered trademark of Apple, Inc.

Once a pilot program but now corporate policy, iPad applications utilize Apple’s Safari
Web browser and customized MB Financial Advantage programs to allow employees to complete loan applications or the paperwork for end-of-lease turn ins on the spot—not in some back office. MB considers the iPad a better option than a smart phone application because the system displays more information on a single screen and both a salesperson and a customer can see the screen at the same time. This makes lease-end check-ins as simple as returning a rental car, for example, and the system can e-mail the customer a copy of the completed form.
Because customers buying cars like to close deals on the spot, perhaps the biggest problem Mercedes had to solve was obtaining customer signatures on completed electronic loan forms. As suggested by the accompanying picture, MB solved this problem in a particularly innovative way—by allowing customers to sign with their finger!

SUMMARY
It is useful to view an AIS as a collection of hardware, software, data, people, and procedures that work together to accomplish processing tasks.
Information technology will become even more important to accountants as AISs continue to incorporate technological advances and also as this technology becomes more important to them when performing their daily professional tasks.
To achieve their objectives, computerized AISs must input, process, store, and output information and, often, utilize data communications.
10

Murphy, C. 2010. 7 Tips for using the iPad in business. InformationWeek (November 1): 26.

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The starting point for most AIS data processing is either an electronic or a manual source document.
Electronic data eliminate many errors that are introduced by human input. POS devices, MICR readers, OCR readers, and magnetic strip readers enable AISs to capture data that are already in machine-readable formats.
Biometric scanners help AISs limit access to legitimate users. Two of the most reliable types of scanners read fingerprints or irises.
The central processing unit (CPU) performs the data-manipulating tasks of the computer system.
In order of increasing power, these units are micro- or personal computers, minicomputers, mainframe computers, and supercomputers. Newer systems include smart phones and computer tablets. All CPUs have primary memories and microprocessors. Most AISs are I/O bound, not process bound. Two major output devices are printers and video monitors. Three important types of printers are dot-matrix printers, ink-jet printers, and laser printers. Laser printers are often the most preferred because they are the fastest, have the highest print resolutions, and can now also print in color.
Secondary storage devices enable AISs to store and archive data on permanent media. Magnetic disks, CD-ROMs, DVDs, and flash memories are the most common secondary storage devices.
Image processing allows users to capture and store visual graphs, charts, and pictures in digital formats on such media.
Data communications enable AISs to transmit data over local and wide area networks. Many
AISs now use LANs or WANs for e-mail, sharing computer resources, saving software costs, gathering input data, or distributing outputs. Wi-Fi technology such as RFID and NFC applications significantly increases our ability to access information accurately as well as communicate efficiently with others.
Cloud computing refers to the use of service providers over the Internet. Applications include access to computer software programs, backup and recovery file services, and Web page development and hosting.
The software of an AIS performs the specific data processing tasks required. Operating systems enable computers to run themselves and also to execute the application programs designed for them. Application software enables end users to perform work-related tasks. Categories of such software include personal productivity software, integrated accounting packages, and communication packages. Programming languages enable IT professionals to translate processing logic into instructions that computers can execute.

KEY TERMS YOU SHOULD KNOW antivirus software application software bar code reader biometric scanner
Blu-ray disc
CD-ROM
central processing unit (CPU) client/server computing compiler computer record computer software computer tablet

data communications data communications protocol data transcription digital subscriber line (DSL) dot-matrix printer
DVD
electronic document and record management systems (EDRMs) enterprise network enterprise resource management (ERP) software event-driven programming languages

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file servers flash memory graphical user interfaces (GUIs) hard-copy output
I/O bound image processing ink-jet printers input-processing-output cycle integrated services digital network (ISDN) laser printers legacy systems local area networks (LANs) magnetic (hard) disk magnetic ink character recognition (MICR) mainframe computers mark-sense media microprocessor minicomputers modem (modulator-demodulator) multimedia multiprocessing near field communication (NFC) object-oriented programming languages operating system (OS) optical character recognition (OCR)

peripheral equipment personal data assistant (PDA) devices personal productivity software picture elements (pixels) point-of-sale (POS) devices primary memory programming languages radio frequency identification (RFID) redundant arrays of inexpensive disks (RAIDs) secondary storage soft-copy output software as a service (SAAS) source document supercomputers turnaround documents utility programs virtual storage virus volatile memory
Wi-Fi
wide area networks (WANs) wireless application protocol (WAP) wireless communications worm (write-once, read-many) media

TEST YOURSELF
Q2-1. All of the following are reasons why IT is important to accountants except:
a. Accountants often help clients make IT decisions
b. Auditors must evaluate computerized systems
c. IT questions often appear on professional certification examinations
d. The costs of IT are skyrocketing
Q2-2. Data transcription is best described as:
a. An efficient process
b. Always necessary in AISs
c. Labor intensive and time consuming
d. An important way to limit fraud and embezzlement
Q2-3. The acronyms POS, MICR, and OCR are most closely associated with:
a. Input devices

c. Output devices

b. Processing devices

d. Communication devices

Q2-4. Purchasing backup services from an Internet vendor is an example of:
a. OCR

c. Virtual storage

b. Modem services

d. Cloud computing

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Q2-5. The term ‘‘enrollment’’ is most closely associated with:
a. PDAs

c. Printers

b. Biometric scanners

d. Modems

Q2-6. The RAM of a computer is part of:
a. Primary memory

c. Arithmetic-logic unit

b. Secondary storage

d. Modem

Q2-7. The term ‘‘I/O bound’’ means that:
a. Computers must input and output data when executing accounting applications
b. AISs are headed for the land of I/O
c. Computers can ‘‘think’’ faster than they can read or write
d. Computers are obligated to make inferences and oversights
Q2-8. Video output can also be called:
a. Hard-copy output

c. Image output

b. Soft-copy output

d. Pixilated output

Q2-9. Which of these devices is capable of storing the most data?
a. CD-ROM disk

c. USB (flash memory) drive

b. DVD disk

d. Magnetic (hard) disk

Q2-10. All of these are components, or layers, of a client/server computing system except:
a. Presentation layer

c. Client layer

b. Application/logic layer

d. Data-management layer

Q2-11. All of these are terms associated with programming languages except:
a. Object oriented

c. Compiler

b. Event driven

d. Server

DISCUSSION QUESTIONS
2-1. Why is it important to view an AIS as a combination of hardware, software, people, data, and procedures? 2-2. Why is information technology important to accountants?
2-3. Why do most AISs try to avoid data transcription?
2-4. Name several types of computer input devices and explain in general terms how each one functions. 2-5. How do you feel about red-light cameras? Should cities be allowed to use them? Why or why not? 2-6. Identify the three sections of a CPU, and describe the functions of each component.
How are microprocessor speeds measured? Why are such speeds rarely important to
AISs?
2-7. Identify several types of printers. What are the advantages and disadvantages of each type? 2-8. What is the function of secondary storage? Describe three types of secondary storage media, and describe the advantages and disadvantages of each type.

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2-9. What is image processing? How is image processing used in AISs?
2-10. What are data communication protocols? Why are they important?
2-11. What are local area networks? What advantages do LANs offer accounting applications?
2-12. What is client/server computing? How does it differ from host/mainframe computing? What are some of the advantages and disadvantages of client/server systems?
2-13. What are the names of some current cloud computing vendors other than those discussed in the text? Do you think that all firms should use cloud vendors, or are there some reasons why they should be avoided?
2-14. What are windowing operating systems, multitasking operating systems, and graphical user interfaces? Why are they useful to AISs?
2-15. Name some general classes of application software. What tasks do each of your software classes perform?
2-16. What are computer programming languages? Name some specific languages and describe briefly an advantage of each.

PROBLEMS
2-17. Which of the following are input equipment, output equipment, CPU components, secondary storage devices, or data communications related?
a. ALU

f. POS device

b. CD-ROM

g. MICR reader

c. keyboard

h. laser printer

d. modem

i. flash memory

j. OCR reader
k. magnetic (hard) disk
l. ATM
m. primary memory

e. dot-matrix printer
2-18. All of the following are acronyms discussed in this chapter. What words were used to form each one and what does each term mean?
a. POS

i. OS

p. WAN

b. CPU

j. MHz

q. RFID

c. OCR

k. pixel

r. WAP

l. CD-ROM

s. Wi-Fi

d. MICR
e. ATM

m. worm

t. ppm

f. RAM

n. modem

u. dpi

g. ALU

o. LAN

v. NFC

h. MIPS
2-19. Which of the following holds the most data?
a. One DVD disk
b. One hard disk (capacity: 160 gigabytes)
c. Ten CD-ROMs
2-20. An advertisement for a desktop microcomputer says that it includes a 500-gigabyte hard drive.
Exactly how many bytes is this? (Hint: see the discussions on secondary storage.)
2-21. Brian Fry Products manufactures a variety of machine tools and parts used primarily in industrial tasks. To control production, the company requires the information listed below. Design an efficient record format for Brian Fry Products.
a. Order number (4 digits)
b. Part number to be manufactured (5 digits)

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c. Part description (10 characters)
d. Manufacturing department (3 digits)
e. Number of pieces started (always less than 10,000)
f. Number of pieces finished
g. Machine number (2 digits)
h. Date work started
i. Hour work started (use 24-hour system)
j. Date work completed
k. Hour work completed
l. Work standard per hour (3 digits)
m. Worker number (5 digits)
n. Foreman number (5 digits)
2-22. Go to the AICPA Web site at http://www.aicpa.org. What are the top ten information technologies for the current year? How do these items compare with the list in Figure 2-1? Is it common for new items to appear, or do you think this list is ‘‘stable’’ from year to year?
2-23. Your state has recently decided to install an RFID system for its toll roads. The current plan is to sell nonrefundable transponders for $20 and allow users to deposit up to $1,000 in their accounts. To assist the IT personnel, the system’s planners want to develop a list of possible accounting transactions and system responses. Using your skills from earlier accounting classes, what debit and credit entries would you make for each of the following activities? (Feel free to develop your own accounts for this problem.)
a. A user buys a new transponder for $20.
b. A user adds $100 to his account.
c. A user discovers that a data entry clerk charges his credit card $1,000 instead of $100 when adding $100 to his account.
d. An individual leaves the state, turns in his transponder, and wants a cash refund for the
$25.75 remaining in his account.
e. A good Samaritan turns in a transponder that he finds on the side of the road. There is a
$10 reward for this act, taken from the owner’s account.
2-24. Select a type of computer hardware that interests you and write a one-page report on three possible choices of it. Examples include monitors, USB drives, external hard drives, or even new laptops. Your report should include a table similar to the one shown here that includes:
(1) embedded pictures of your choices, (2) major specifications (e.g., storage capacities, pixel sizes, and data transfer rates), (3) the suggested retail price of each item, (4) the likely ‘‘street price’’ of the item, and (5) the name of the vendor that sells the item at the street price.
The major deliverable is a one-page report that includes (1) the table identified above, (2) an explanation of why you chose to examine the hardware you did, and (3) an indication of which particular item you would buy of your three choices.

Mickey Mouse USB

Octopus USB

Jack knife USB

spec

spec

spec

spec

spec

spec

Source: ADATA Technology (USA) Co., Ltd.

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CASE ANALYSES
2-25. Pucinelli Supermarkets (Validating Input Data)
Pucinneli Supermarkets is similar to most other grocery store chains that use the 12-digit
UPC code on packages to check out customers. For a variety of reasons, it is important that the computer systems using these codes validate them for accuracy and completeness. To perform this task, UPCs automatically include a ‘‘check digit’’ that can also be computed from the other digits in the code. Using the bar code shown in Figure 2-3 as an example, the system works as follows:
1. The UPC includes all numbers in the bar code, and therefore is 064200115896 for the example here. The length is 12 digits as required.
2. The check digit is the last digit in the code—for example, a ‘‘6’’ for this example.
3. Starting on the left, add the digits up to, but not including, the check digit in the oddnumbered positions (i.e., the numbers in the first, third, fifth, etc., position) together.
Multiply this sum by three.
4. Add the digits up to, but not including, the check digit in the even-numbered positions
(i.e., the second, fourth, sixth numbers, etc.).
5. Add the values found in steps 3 and 4.
6. Examine the last digit of the sum. If it is 0, the computed check digit is also 0. If the last digit of the result is not zero, subtract this digit from 10. The answer is the computed check digit and must equal the last number in the UPC code.
UPC code:
Length test:
Check digit is:
Sum of odd digits
Sum of even digits
Odd digits ×3
Sum
Last digit
Computed check digit
Conclusion

064200115896
Ok
6
19
17
57
74
4
6
Valid number

To illustrate, suppose the UPC barcode is 064200115896 as shown. The steps for this example are
1. The length is 12 as required.
2. The last value is ‘‘6’’ so this is the check digit.
3. Add the odd-position digits: 0 + 4 + 0 + 1 + 5 + 9 = 19. Multiply this sum by
3: 19 × 3 = 57.
4. Add the even-position digits: 6 + 2 + 0 + 1 + 8 = 17.
5. We add these two values together. The sum is 57 + 17 = 74.
6. The last digit in this sum is ‘‘4,’’ the check digit is not 0, and we therefore subtract 4 from 10 to get ‘‘6.’’ The computed value of ‘‘6’’ found in step 5 matches the check digit
‘‘6’’ in step 2, and we therefore conclude that this UPC code is valid.

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Requirements
Develop a spreadsheet to perform the tests described here and test your model with the following UPC codes. (1) 639277240453, (2) 040000234548, (3) 034000087884, (4)
048109352495, and (5) one UPC value of your own choosing (drawn from something you own or see). For each number, indicate whether the UPC number is valid or invalid.
Include a print out of all your work, plus a copy of the formulas for at least one of your tests. Hints: (1) You should enter your initial UPC code as ‘‘text’’—not a number. (2) You can use Excel’s LEN function to perform the desired length test and Excel’s IF function to test whether the entered value passes it. (3) You should use Excel’s MID function to parse each digit for these computations. (4) You can use Excel’s IF test again to reach the conclusion (e.g., ‘‘valid number’’).

2-26. Savage Motors (Software Training)
Savage Motors sells and leases commercial automobiles, vans, and trucks to customers in southern California. Most of the company’s administrative staff work in the main office. The company has been in business for 35 years, but only in the last 10 years has the company begun to recognize the benefits of computer training for its employees.
The company president, Arline Savage, is thinking about hiring a training company to give onsite classes. To pursue this option, the company would set up a temporary
‘‘computer laboratory’’ in one of the meeting rooms, and the trainers would spend all day teaching one or more particular types of software. You have been hired as a consultant to recommend what type of training would best meet the firm’s needs.
You begin your task by surveying the three primary corporate departments: sales, operations, and accounting. You find that most employees use their personal computers for only five types of software: (1) word processing, (2) spreadsheets, (3) database, (4) presentations, and (5) accounting. The accompanying table shows your estimates of the total number of hours per week used by each department on each type of software.

Department
(number of employees) Sales (112)
Operations (82)
Accounting (55)

Word Processing
1150
320
750

Spreadsheet
750
2450
3600

Database
900
650
820

Presentation Accounting
500
100
250

700
500
2500

Requirements
1. Create a spreadsheet illustrating each department’s average use of each application per employee, rounding all averages to one decimal point. For example, the average hours of word processing for the sales department is 1150/112 = 10.3 hours.
2. Suppose there were only enough training funds for each department to train employees on only one type of application. What training would you recommend for each department? 68

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3. What is the average number of hours of use of each application for all the employees in the company? What training would you recommend if funds were limited to only training one type of application for the entire company?
4. Using spreadsheet tools, create graphs that illustrate your findings in parts 1 and 2. Do you think that your graphs or your numbers better ‘‘tell your story’’?
5. What alternatives are there to onsite training? Suggest at least two alternatives and discuss which of your three possibilities you prefer.

2-27. Backwater University (Automating a Data Gathering Task)
Backwater University is a small technical college that is located miles from the nearest town. As a result, most of the students who attend classes there also live in the resident dormitories and purchase one of three types of meal plans. The ‘‘Full Plan’’ entitles a student to eat three meals a day, seven days a week, at any one of the campus’s three dining facilities. The ‘‘Weekday Plan’’ is the same as the Full Plan, but entitles students to eat meals only on weekdays—not weekends. Finally, the ‘‘50-Meal’’ plan entitles students to eat any 50 meals during a given month. Of course, students and visitors can always purchase any given meal for cash.
Because the school administration is anxious to attract and retain students, it allows them to change their meal plans from month to month. This, in fact, is common, as students pick plans that best serve their needs each month. But this flexibility has also created a nightmare at lunch times, when large numbers of students attempt to eat at the dining facilities simultaneously.
In response to repeated student complaints about the long lines that form at lunchtime,
Barbara Wright, the Dean of Students, decides to look into the matter and see for herself what is going on. At lunch the next day, she observes that each cashier at the entrance to the dining facilities requires each student to present an ID card, checks their picture, and then consults a long, hard-copy list of students to determine whether or not they are eligible for the current meal. A cashier later informs her that these tasks are regrettable, but also mentions that they have become necessary because many students attempt to eat meals that their plans do not allow.
The cashier also mentions that, at present, the current system provides no way of keeping a student from eating two of the same meals at two different dining facilities. Although
Barbara thinks that this idea is far-fetched, the cashier says that this problem is surprisingly common. Some students do it just as a prank or on a dare, but other students do it to smuggle out food for their friends.
Barbara Wright realizes that one solution to the long-lines problem is to simply hire more cashiers. She also recognizes that a computerized system might be an even more cost-effective solution. In particular, she realizes that if the current cashiers had some way of identifying each student quickly, the computer system could immediately identify a given student as eligible, or ineligible, for any given meal.

Requirements
1. Suggest two or more ‘‘technology solutions’’ for this problem.
2. What hardware would be required for each solution you named in part 1?
3. What software would be required for each solution you named in part 1? What would this software do?
4. How would you go about showing that your solutions would be more cost-effective than simply hiring more cashiers? (You do not have to perform any calculations to answer this question—merely outline your method.)

CHAPTER 2 / Information Technology and AISs

69

2-28. Bennet National Bank (Centralized versus Decentralized Data
Processing)
Bennet National Bank’s credit card department issues a special credit card that permits credit card holders to withdraw funds from the bank’s automated teller machines (ATMs) at any time of the day or night. These machines are actually smart terminals connected to the bank’s central computer. To use them, a bank customer inserts the magnetically encoded card in the automated teller’s slot and types in a unique password on the teller keyboard. If the password matches the authorized code, the customer goes on to indicate, for example,
(1) whether a withdrawal from a savings account or from a checking account is desired and
(2) the amount of the withdrawal (in multiples of $10). The teller terminal communicates this information to the bank’s central computer and then gives the customer the desired cash. In addition, the automated terminal prints out a hard copy of the transaction for the customer. To guard against irregularities in the automated cash transaction described, the credit card department has imposed certain restrictions on the use of the credit cards when customers make cash withdrawals at ATMs.
1. The correct password must be keyed into the teller keyboard before the cash withdrawal is processed.
2. The credit card must be one issued by Bennet National Bank. For this purpose, a special bank code has been encoded as part of the magnetic strip information.
3. The credit card must be current. If the expiration date on the card has already passed at the time the card is used, the card is rejected.
4. The credit card must not be a stolen one. The bank keeps a computerized list of these stolen cards and requires that this list be checked electronically before the withdrawal transaction can proceed.
5. For the purposes of making withdrawals, each credit card can be used only twice on any given day. This restriction is intended to hold no matter what branch bank(s) are visited by the customers.
6. The amount of the withdrawal must not exceed the customer’s account balance.

Requirements
1. What information must be encoded on the magnetic-card strip on each Bennet National
Bank credit card to permit the computerized testing of these policy restrictions?
2. What tests of these restrictions could be performed at the teller window by a smart terminal, and what tests would have to be performed by the bank’s central processing unit and other equipment?

2-29. Morrigan Department Stores (The Ethics of Forced Software Upgrading)
Morrigan Department Stores is a chain of department stores in Australia, New Zealand,
Canada, and the United States that sells clothing, shoes, and similar consumer items in a retail setting. The top managers and their staff members meet once a year at the national meeting. This year’s meeting took place in Hawaii—a geographical midpoint for them—and several accounting managers participated in a round-table discussion that went as follows:
Roberta Gardner (United States): One of our biggest problems in our Aukland office is the high cost and seemingly constant need to upgrade our hardware and software. Every time our government changes the tax laws, of course, we must acquire software that

70

PART ONE / An Introduction to Accounting Information Systems

reflects those changes. But why do we need new hardware too? All this discussion of
‘‘64-bit machines’’ is a mystery to me, but the IT department says the hardware in the old machines quickly become outdated.
Donalda Shadbolt (New Zealand): I’ll say! If you ask me, all these upgrades are costly, time consuming, and even counter-productive. I do a lot of work on spreadsheets, for example, and constantly ask myself: ‘‘Why do I have to spend hours relearning how to format a simple column of numbers in the newest version of Excel?’’ It takes time and effort, it’s frustrating, and in the end, I’ve spent hours relearning skills that I already know how to do in the older version.
Linda Vivianne (Canada): I know what you mean, but the newer hardware is faster, cheaper, and more capable than the old machines. Hard drives have moving parts in them, for example, and they eventually wear out. The newer software runs under the newer operating systems, which are also more competent and have more built in security such as antivirus software.
Ed Ghymn (Australia): I agree with you, Linda, but I think a lot of these new capabilities are more hype than real. If the security software was competent, we wouldn’t need all those patches and upgrades in the first place. And why must we upgrade so often, just to get newer capabilities that most of us don’t even need?
Alex McLeod (Australia): I don’t think anyone can stop the march of progress. I think the real problem is not the upgrades to new software, but the fact that our company expects us to learn it without proper training. Personally, I don’t buy my boss’s argument that ‘‘you’re a professional and should learn it on your own.’’
Linda Vivianne (Canada): I’m also beginning to realize just what advantages there are in outsourcing some of our accounting applications to cloud service providers. That won’t solve all our problems because we all still need word processing and spreadsheet capabilities, but at least we can let cloud providers deal with the software upgrades for our accounting software. Given how dispersed we are, that might also make it easier for us to consolidate our financial statements at year’s end too.

Requirements
1. Do you think that Roberta Gardner’s description of ‘‘64-bit machines’’ is accurate? Why or why not? Explain your reasons in detail, drawing upon additional Internet discussions to help you answer this question.
2. Summarize some of the arguments against upgrading hardware and software at the
Morrigan Department Stores. It is ok to mention additional, reasonable arguments that are not included in the case.
3. Summarize the arguments for upgrading hardware and software at the Morrigan
Department Stores. Again, it is ok to mention additional, reasonable arguments that are not included in the case.
4. Do you agree with Ed Ghymn’s argument that many upgrades are ‘‘more hype than real’’? Why or why not?
5. Many software vendors such as Microsoft, Adobe, and Apple ship software packages with both known and unknown defects in them. Do you feel that it is ethical for them to do so? Why or why not?
6. Do you agree or disagree with the argument made in this case that many hardware and/or software upgrades are unnecessary? Why or why not?

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71

7. Do you agree with Alex McLeod’s statement that a company should formally train its employees every time it upgrades its software? If not, do you agree with his boss that professionals should learn to use at least some software upgrades on their own? Explain your answer in detail.
8. Do you think it was necessary for the participants to physically meet at one location?
Couldn’t they simply hold a virtual meeting over the Internet? Explain your answer in detail. READINGS AND OTHER RESOURCES
Burnett, R., B. Daniels, A. Freidel, and M. Friedman. 2008. WiFi: Boon or Boondogle. Journal of
Corporate Accounting and Finance 19(5): 3–8.
Fineberg, S. 2010. Shadows on the cloud. Accounting Today 24(10): 4–37.
Fink, R., L. Gillet, and G. Grzeskiewicz. 2007. Will RFID change inventory assumptions? Strategic
Finance 89(4): 35–39.
Jackson, L. 2009. Biometric technology: The future of identity assurance and authentication in the lodging industry. International Journal of Contemporary Hospitality Management, 21(6/7):
892–905.
Jansen, D. 2010. Is it time to go blu? Tech Trader 2(4): 17–22.
Lin, P., and K. Brown. 2008. RFID deployment. CPA Journal 78(8): 68–71.
Martin, R., and J. Hoover. 2008. Guide to cloud computing. Information Week 1193 (June 21): 9.
Meall, L. 2009. Get your head in the clouds. Accountancy 144(December): 54–55.
Petravick, S., and S. Kerr. 2009. Protect your portable data always and everywhere. Journal of
Accountancy 207(6): 30–34.
Preston, R. 2011. Don’t dismiss tablets as only so much hype. Information Week 1295
(March 28): 48.
Ritchey, D. 2010. Tracking critical assets. Security: Solutions for Enterprise Security Leaders 47(2):
32–33.

Introduction to Cloud Computing: http://www.youtube.com/watch?v=ae_DKNwK_ms Cloud Computing Explained: http://www.youtube.com/watch?v=QJncFirhjPg What Is Flash Memory? http://www.break.com/usercontent/2009/1/What-is-Flash-Memory-646402 What Is a Local Area Network (LAN)? http://www.youtube.com/watch?v=_u3hNRZWMcc ANSWERS TO TEST YOURSELF
1. d

2. c

3. a

4. d

5. b

6. a

7. c

8. b

9. d

10. c

11. d

PART TWO
DATABASES

CHAPTER 3
Data Modeling
CHAPTER 4
Organizing and Manipulating the Data in Databases
CHAPTER 5
Database Forms and Reports

Accounting information systems collect, record, store, and manipulate financial and nonfinancial data and convert these data into meaningful information for management decision making. The chapters in Part Two discuss techniques for accomplishing these tasks using relational databases.
Chapter 3 discusses basic database concepts and the organizational structure of relational databases. The chapter explains how to use the REA framework to design database tables and relationships, and it describes how databases support important business functions.
The last section describes normalization of data in databases—a classical design approach compatible with the REA model. The chapter emphasizes how to design databases that efficiently and effectively store critical data.
Chapter 4 explains how to create a database using Microsoft Access 2010 and how to manipulate and extract data. The first section describes how to create database tables and relationships, and the second section illustrates how to enter and validate data.
Validating the data in databases involves implementing controls that safeguard the accuracy, completeness, and integrity of the data. The third section describes procedures for extracting data from existing database tables. This section explains how to create ‘‘select’’ queries in Access 2010 as well as other extraction techniques such as online analytical processing and data mining. The chapter concludes with a discussion of recent advances in database systems.
Chapter 5 focuses on the development of database forms and reports. The first section of the chapter explains why database forms are important and describes how to create simple and more complex database forms. The second section of the chapter explains why database reports are important, describes how to create simple reports as well as complex reports based on multitable queries using Access 2010, and it provides guidelines for creating professional outputs that are useful for decision making.

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Chapter 3
Data Modeling

INTRODUCTION

DISCUSSION QUESTIONS

AN OVERVIEW OF DATABASES

PROBLEMS

What Is a Database?

CASE ANALYSES

Significance of Databases

Carl Beers Enterprises (Understanding a Relational
Database)

Storing Data in Databases
Additional Database Issues

STEPS IN DEVELOPING A DATABASE USING
THE RESOURCES, EVENTS, AND AGENTS
MODEL

Martin Shoes, Inc. (Designing a Database Using REA and E-R Diagrams)
Souder, Oles, and Franek LLP (Data Modeling with
REA)

Step 1—Identify Business and Economic Events

Swan’s Supplies (Normalizing Data)

Step 2—Identify Entities

READINGS AND OTHER RESOURCES

Step 3—Identify Relationships Among Entities

ANSWERS TO TEST YOURSELF

Step 4—Create Entity-Relationship Diagrams
Step 5—Identify Attributes of Entities
Step 6—Convert E-R Diagrams into Database Tables

NORMALIZATION
First Normal Form
Second Normal Form
Third Normal Form

AIS AT WORK—NEW DATABASES FOR THE
GREEN ECONOMY
SUMMARY

After reading this chapter, you will:
1. Appreciate the importance of databases to AISs.
2. Be able to describe the concepts of the data hierarchy, record structures, and keys.
3. Be able to explain why design concerns such as processing accuracy, concurrency, and security are important to multi-user databases.
4. Be able to model a database with REA.
5. Be able to normalize database tables.

KEY TERMS YOU SHOULD KNOW
TEST YOURSELF

75

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PART TWO / Databases

In the process of designing a software artifact, one of the first steps is to construct a data model that represents users’ needs.
Fuller R., U. Murthy, and B. Schafer. 2010. The effects of data model representation method on task performance.
Information & Management 47(4): 208–218.

INTRODUCTION
Civilizations have collected and organized accounting data for at least 6,000 years. The ancient Babylonians, for example, stored clay tablets in their temples that recorded information such as inventory, payroll records, and real estate transactions. Modern AISs use computers rather than clay tablets, but many of the same basic requirements remain—the systematic recording of data, convenient and useful organization of data, ability to create useful reports from data, and easy access to required information. This chapter examines how to design a database that is efficient and effective, while the next two chapters examine at how to build and use a database. We begin by describing some database concepts and then discuss database design and data modeling techniques in more depth.

AN OVERVIEW OF DATABASES
Many requirements from the ancient Babylonian days remain today. Even the most basic
AIS needs to systematically record accounting data and organize accounting records in logical ways. Most often, these objectives are achieved by storing accounting data in a database. For this reason, it is essential for accountants to understand the basic principles of database-driven systems.

What Is a Database?
A database is a large collection of organized data that can be accessed by multiple users and used by many different computer applications. In many large firms, massive databases store all of the data used by almost every function in the organization. Data in databases are manipulated by specialized software packages called database management systems
(DBMSs). Databases are used to store the data that comprise nearly all accounting systems, such as inventory systems, general ledger systems, and production scheduling systems. Most accounting systems involve complex combinations of data stored in databases, processing software, and hardware that interact with one another to support specific storage and retrieval tasks. Most accounting databases are relational databases, which are groups of related, two-dimensional tables.
Technically, not every collection of data is a database. For example, time-card data from a weekly payroll system or budget data might be stored in single computer files, such as Excel files, that are generally too simplistic to be called databases. Most commercial databases are very large and complex collections of proprietary data that developers carefully design and protect and that form the core of accounting information systems.

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77

Significance of Databases
It is difficult to overstate the importance of computerized databases to AISs. Nearly every accounting system that influences financial reports involves the extensive use of databases.
For example, accounts receivable applications require vast amounts of information about customers’ accounts, accounts payable applications require information about suppliers, and payroll applications require information about employees. In many publicly traded firms, the databases needed to support accounting systems cost hundreds of millions of dollars to design and maintain, and firms rely on these databases to make key business decisions and conduct their day-to-day operations. The extensive use of databases in accounting systems makes it important to understand issues that databases can raise for companies and accounting professionals. These issues include:
• Critical information. The information stored in an organization’s databases is sometimes its most important and valuable asset. Equifax, for example, is one of the nation’s largest credit bureaus, maintaining credit information about millions of Americans. Its credit files are its business.
• Volume. Many firms’ databases are truly enormous. For example, Sprint keeps records on over 50 million customers and inserts about 70,000 records to its database every second.
Amazon.com has a database with more than 40 terabytes of data, and YouTube visitors watch more than 100 million video clips from its database every day. Designing, using, and maintaining databases of such great size requires substantial resources.
• Distribution. The databases of some organizations are centralized (i.e., data is stored in a single location). Many other databases, however, are distributed (i.e., duplicated in local or regional computers as processing needs dictate). Distributing data can make it difficult to (1) ensure data accuracy, consistency, completeness, and (2) secure information from unauthorized access.
• Privacy. Databases often contain sensitive information—for example, employee pay rates or customer credit card numbers. This information must be protected from those unauthorized to access it. The internal control procedures that protect databases from unwarranted access are often considered the most critical controls in an organization.

Case-in-Point 3.1 Heartland Payment Systems processes credit card transactions for many different credit and debit card companies. In 2009, hackers illegally accessed hundreds of millions of Heartland Payment Systems’ credit card transactions in what has been called the largest breach of credit card data in history. Heartland was required to pay substantial fines and settlement fees.1
• Irreplaceable data. The information contained in most accounting databases is unique to the organization that created it and is typically priceless. Many organizations would fail shortly after losing the information contained in their accounting databases. For this reason, the security of databases is critical to the organization.
• Need for accuracy. The data stored in databases must be complete, comprehensive, and accurate. The consequences of inaccurate data can be substantial. It is easy to imagine severe consequences of very small data errors. Consider a physician removing an incorrect limb during surgery because of one attribute in a database table (e.g., left versus right limb).
1

http://abcnews.go.com/Technology/Media/10-top-data-breaches-decade/story?id=10905634

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Case-in-Point 3.2 Studies of large medical databases indicate that as many as 60% of patient records in these databases contain errors, which makes it nearly impossible to accurately identify trends in medical care or the effectiveness of various treatment options.2
• Internet uses. As you might imagine, databases are critical components of both internal and external corporate Web systems. Databases store information related to product information for online catalog sales, e-mails, product registration data, employment opportunities, stock prices, and so on. Internet applications often store customer-entered data such as online product orders, credit card numbers, subscription information, airline reservations, and university-student registration data.

Storing Data in Databases
To be useful, the data in an organization’s databases must be stored efficiently and organized systematically. In order to understand how databases store information, it is important to first understand three database concepts: (1) the data hierarchy, (2) record structures, and
(3) database keys.

The Data Hierarchy. Storing accounting data in databases involves organizing the data into a logical structure. In ascending order, this data hierarchy is data field → record → file → database
The first level in the data hierarchy is a data field, which is information that describes a person, event, or thing in the database. In a payroll file, for example, data fields would include employee names, employee identification numbers, and pay rates for the employees. Other names for a data field are attribute, column, or simply field.
At the second level, data fields combine to form a complete record. A database record
(also called a tuple) stores all of the information about one entity (i.e., person, event, or thing). For example, all of the information about one inventory part in an inventory file, one employee in a payroll file, or one customer in a customer file. At this point, it may be helpful to liken the structure of a database to the data in a spreadsheet. Imagine that customer data is stored in a spreadsheet such that each row represents a customer and each column represents the various pieces of information that are stored for each customer.
Each column in this spreadsheet defines an individual data field, and each row defines a separate record.
At the third level of the data hierarchy, a set of common records forms a file, or using database and Microsoft Access terminology, a table. Thus, a file or table contains a set of related records—for example, a set of customer records or inventory records. Master files typically store permanent information—for example, part numbers, part descriptions, and location codes for the individual records in an inventory parts master file. Transaction files typically store transient information—for example, inventory disbursements and replenishments for a specific period.
Finally, at the highest level, several tables create a complete database (i.e., a collection of tables that contain all of the information needed for an accounting application). In an inventory application, for example, the database might contain a part-number master table, a supplier table, a price table, an order transaction table, and so forth, as well as several other tables that would help end users organize, access, or process inventory information efficiently. 2

Gallivan, S., and C. Pagel. 2008. Modelling of errors in databases. Health Care Management Science 11(1):
35–40.

CHAPTER 3 / Data Modeling

Social Security number

Last name First name Dept. code Pay rate Date of hire Overtime OK?

Other info. 575-64-5589

Smythe

Teri

A

12.85

10-15-2001

yes

79

....

FIGURE 3-1 Examples of data fields in an employee record.

Record Structures. The specific data fields in each record of a database table are part of what is called the record structure. In many accounting applications, this structure is fixed, meaning that each record contains the same number, same type, and same-size data fields as every other record in the file. This would likely be the case for the employee record illustrated in Figure 3-1. In other applications, the number of data fields in each record might vary, or the size of a given data field in each record might vary. For example, in a file of customer complaints, the memo field in each record might vary in length to accommodate different-size descriptions of customer problems.

Database Keys. The primary key is the data field in each record that uniquely distinguishes one record from another in a database table. Primary keys are required for every record in a database and they are unique. For the employee record in Figure
3-1, the primary key would be the employee’s Social Security number. End users and computer programs use primary keys to find a specific record—for example, the record for a particular employee, inventory item, or customer account. It is also possible for a record to have a primary key that consists of more than one data field.
Some accounting records contain data fields called foreign keys that enable them to reference one or more records in other tables. The foreign key in one table always matches the primary key of the related table. For example, in addition to the employee table in Figure
3-1, a firm might have a department table with the data fields shown in Figure 3-2. The primary key for the department table is the department code (e.g., ‘‘A,’’ ‘‘B,’’ and so forth). With this arrangement, the department code field in the employee record of Figure 3-1 would be a foreign key that the database system could use to reference the appropriate department record from the department table. These foreign keys enable a database system to combine the information from both tables to produce a report such as the one in Figure 3-3.
Note that each line of this report contains information from the records in two tables: the employee records in Figure 3-1 and the department records in Figure 3-2.

Additional Database Issues
Small database systems such as the types used by very small businesses or sole proprietorships tend to be fairly straightforward and manageable. However, large, multi-user databases pose special challenges for their designers and users because of their complexity. Here, we describe some database design concerns that are of special importance to accounting applications.
Department
code
(primary key)
A

Manager

Number of employees

Location

Secretary phone Other info. B. Wright

45

Bldg. 23

x8734

...

FIGURE 3-2 A sample record from a department file.

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PART TWO / Databases

Employee Roster
Friday, July 28, 20XX
Last
First
Name
Name

Dept.

Manager

Location

Secretary
Phone

Garadis
Gold
Hale
Smythe
Wright

B
A
C
A
A

Garadis
Wright
Hale
Wright
Wright

Bldg. 23
Bldg. 23
Bldg. 24
Bldg. 23
Bldg. 23

ext. 9330 ext. 8734 ext. 8655 ext. 8734 ext. 8734

Sue
Karen
Lois
Teri
Barbara

FIGURE 3-3 A formatted report that uses data from two tables.

Administration. Without an overall supervisor, a large commercial database is somewhat like a rudderless ship—that is, an entity without cohesion or direction. Similarly, it does not make sense to permit database designers to work unsupervised or to develop large databases without also creating accountability for subsequent changes. A database administrator supervises the design, development, and installation of a large database system, and is also the person responsible for maintaining, securing, and changing the database. As a result of the administrator’s many duties and powers, it is essential that the administrator be both skilled and trustworthy.
Case-in-Point 3.3 A database administrator at Certegy Check Services used his knowledge of the firm’s database to steal personal records from over 8 million customers. In another case, a database administrator for an oil and gas production firm created secret users in a database system that allowed him to access the system after he stopped working for the firm.
When the firm terminated his contract, he sabotaged the firm’s systems, which could have resulted in a serious environmental disaster. These cases highlight the powers of the database administrator and the critical importance of hiring highly qualified and trustworthy employees for this position.3

Documentation. Databases undergo changes throughout their design, development, and use. This makes documentation critical. Descriptions of database structures, contents, security features, E-R diagrams (discussed later in this chapter), and password policies are examples of important documentation materials. The data dictionary is a critical component of database documentation that describes the data fields in each database record. A data dictionary is basically a data file about the data itself.
Figure 3-4 identifies information that a data dictionary might contain (listed under the
Entry column) and an example of such information for a Social Security number data field
(listed under the Example column). In this figure, the data dictionary indicates that the
Social Security number data field must be nine characters, is a text data field (rather than a number data field because it is not manipulated mathematically), has no default value, and so forth. Entries in the data dictionary describe each data field in each record of each table
(file) of an AIS database. When developers add a new data field to the record structure of an existing table, they also add the appropriate information about the new field to the data dictionary. 3 http://www.computerworld.com/s/article/9129933/IT_contractor_indicted_for_sabotaging_offshore_rig_ management_system_

CHAPTER 3 / Data Modeling

Item
1
2
3
4
5
6
7
8
9
10
11

Entry

Example

Field name
Field size
Type of data field
Default value
Required?
Validation rule(s)
Range
Source document
Programs used to modify it
Individuals allowed access
Individuals not allowed access

81

Social Security number
9 characters text none yes all digits must be numeric characters none employee application form payroll X2.1 payroll personnel non-payroll personnel

FIGURE 3-4 Examples of information that might be stored in a data dictionary for the Social
Security number data field of a payroll database.
Data dictionaries contain metadata, or data about data, and have a variety of uses.
One use is as a documentation aid for those who develop, correct, or enhance either the database or the computer programs that access it. As suggested in items 10 and 11 of Figure 3-4, an organization can also use a data dictionary for security purposes—for example, to indicate which users can or cannot access sensitive data fields in a database.
Accountants can also make good use of a data dictionary. A data dictionary can help establish an audit trail because it identifies the input sources of data items, the potential computer programs that use or modify particular data items, and the management reports that use the data. When accountants help design a new computer system, a data dictionary can help them trace data paths in the new system. Finally, a data dictionary can serve as a useful aid when investigating or documenting internal control procedures.

Data Integrity. IT professionals estimate that it costs about ten times as much to correct information that is already in a database than it does to enter it correctly initially.
Even simple errors in databases can lead to costly mistakes, bad decisions, or disasters (think about air traffic controllers, for example). For these reasons, the software used to create databases should include edit tests that protect databases from erroneous data entries.
These data integrity controls are designed by database developers and are customized for different applications. Examples include tests for data completeness, conformance to the data type specified for the data field, valid code tests (e.g., a state code such as CA), and reasonableness tests (e.g., regular payroll hours worked must be between 0 and 40).
We will further discuss these issues in Chapter 10.
Processing Accuracy and Completeness. Within the context of database systems, transaction processing refers to the sequence of steps that a database system uses to accomplish a specific processing task. AISs need transaction controls to ensure that the database system performs each transaction accurately and completely.
To illustrate, imagine an inventory application with two types of inventory records: raw materials records and work-in-process records. An inventory manager wishes to subtract
200 units from a particular raw materials record and add the same number of units to a corresponding work-in-process record. Now suppose that the database system executes

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the first part of this transaction (i.e., subtracts 200 units from the raw materials record) and then stops operating for some reason. This is a problem because the transaction has not been executed completely and the balance-on-hand field in the current work-in-process record is incorrect. To overcome this problem, databases should process a transaction either entirely or not at all. Database systems maintain an auditable log of transactions to help achieve this goal. When a specific transaction only partially executes, the system is able to recover by verifying that a problem has occurred, reversing whatever entries were made, and starting anew. In accounting applications, the ability to audit any particular transaction to ensure processing accuracy and completeness is critical.

Concurrency. In multi-user systems, it is possible for more than one user to access the same database at the same time. Without concurrency controls, it is possible for two or more users to access the same record from the same table at the same time. This creates problems. To illustrate, suppose that User A and User B access the same inventory record at the same time. The initial balance-on-hand field for this record is 500 units. When User A accesses this record, the system transfers the entire record to A’s work area. User A wants to add 100 units to the balance-on-hand field. The result is a new balance of 600 units. User
A completes this transaction, the system writes the new record back to the disk, and the new balance on hand in this record is now 600 units.
When User B accesses this same record at the same time, the system also transfers the same initial record to B’s work area. User B wants to decrease the balance on hand by 200 units. The result is a balance of 300 units because this user also starts with an initial balance on hand of 500 units. Assuming that B completes this transaction after A is done, the system updates to reflect the transaction completed by B. The end result is an inventory record with a balance on hand of 300 units, not the correct value of 400 (= 500 + 100 − 200).
To guard against this problem, database systems include locking mechanisms that do not allow multiple users to access the same record at the same time. Rather, databases require that one user’s transaction is completed before the next user can make further changes to the database.

Backup and Security. As noted earlier, the information in many accounting databases is critical to the day-to-day operations of a company and is typically irreplaceable. Databases must be protected. A key security feature of any database, therefore, is a set of backup procedures that enable the organization to recreate its data if the original copies are lost or damaged. Case-in-Point 3.4 New Zealand experienced a massive earthquake in 2010 that destroyed a number of businesses and their data centers. Shortly after the quake, a partner from Ernst
& Young stated that businesses with recovery plans were much better able to survive than businesses without a plan. Many businesses struggled to even survive after the earthquake, but according to Ian Forrester, director of a large business continuity provider, ‘‘companies who had a detailed plan in place had a lot less stress and were able to continue work so customers didn’t notice the interruption, even where offices and premises had been destroyed.’’
In addition to backup security, an organization must also protect databases from unauthorized access. A system should have the ability to assign, maintain, and require employees to use passwords and guard against unwarranted intrusions. Similarly, database systems can use encryption techniques to scramble data into unintelligible formats, thereby protecting data even if an unauthorized user obtains access to the company’s database. This is especially important when database information resides on laptops, which can easily be lost or stolen.

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83

Case-in-Point 3.5 The Government Accountability Office (GAO) recently announced that
IRS computers and data are at risk because visitors and low-level users of systems can take advantage of weak access controls and lack of encryption to gain access to secured federal data. The IRS plans to correct these deficiencies by 2013.4
A final database security feature involves the use of view controls that limit each user’s access to information on a need-to-know basis. For example, a defense contractor will limit its employees’ access to many files that contain sensitive information. We cover intrusion detection systems and controls in Chapter 10.

STEPS IN DEVELOPING A DATABASE USING THE
RESOURCES, EVENTS, AND AGENTS MODEL
At a state department of social services, the director wants to know how many inquiries were made for a certain type of medical assistance last month. At the headquarters of a department store chain, a vice president wants to know how many credit customers made partial payments on their accounts last week. At a local university bookstore, a manager wants to know how many book orders went unfilled last year.
In each case above, a decision maker needs information. AISs must gather pertinent data and store the information in formats that enable managers to obtain timely answers to important questions. The challenges involved in creating large, useful databases include determining what data to collect and how to gather, record, organize, and store the data in ways that satisfy multiple objectives. Key goals include (1) identifying the reports desired by users of the system; (2) finding hardware and software solutions that can adequately perform the data-gathering, storage, and reporting tasks involved; (3) keeping the databases from becoming too large, complex, and unwieldy; (4) protecting the privacy of sensitive information; and (5) avoiding data redundancy, which means storing the same data repeatedly in different tables. To accomplish these and other goals, databases must be carefully designed to serve their intended uses.
When a company wants to create a database, it often hires a database consultant to help design a database that meets the organization’s needs. Based on the information obtained from managers and end users, the expert employs a process called data modeling to design the database. This can be the most challenging step in the process of creating a database because the designer must collect a considerable amount of information through investigation and interviews and must then determine the needs of all stakeholders as accurately and completely as possible. This process is both an art and a science.
Although there are a number of different models that may be used to design a database, the REA model has been demonstrated to be very effective for designing databases to be used in accounting systems. REA is an acronym for resources (R), events (E), and agents
(A). The basic assumption of this model is that business events affect firm resources and involve agents (i.e., people) who participate in the event. Many describe the REA model as event driven, meaning that it focuses on the important business events that managers must understand to make their decisions. Use of the REA model involves the following steps:
(1) identify business and economic events, (2) identify entities, (3) identify relationships among entities, (4) create entity-relationship diagrams, (5) identify the attributes of data entities, and (6) create database tables and records. The following discussions describe each of these steps in detail, using the sales process as an example.
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Step 1—Identify Business and Economic Events
Chapters 7 and 8 will discuss key business processes in accounting systems and describe the events involved in these processes. There are two main types of events: economic events and business events. Economic events typically affect an organization’s financial statements. An example of an economic event is a sale on account. This event increases an entity’s accounts receivable (balance sheet) and increases a sales revenue account (income statement). Critics of traditional financial accounting systems have stated that debit/credit systems often ignore organizational activities and events that are important to managers, investors, and creditors. Business events do not affect financial statements but can affect important aspects of an organization. One example of such an event is the discovery that a construction project will likely cost far more than was budgeted. While there is no journal entry for the event, this would certainly be important information that managers need to know. Other examples of business events include hiring a new CEO or making a valuable discovery during research and development. Again, these events do not require journal entries, but the information will affect critical decisions made by the firm.
When creating a database using an REA approach, a system designer will try to record all events that are relevant for management decision making in the database, whether they are business or economic events. By including both types of events in the database, users can access and obtain important information about both business and economic activities.

Step 2—Identify Entities
Databases contain data about objects of interest called entities. Database entities include business and economic events plus information about who and what were involved in those activities. Agents are the who associated with events. Agents are classified as either internal or external. Internal agents work within the firm for which a database is designed
(e.g., salespeople), while external agents are outside of the firm (e.g., customers). Most events involve both internal and external agents. For example, both a salesperson and a customer participate in a merchandise sale. The sale is made to a customer by a salesperson.
Events use, change, transfer, or generate resources. For example, a merchandise sale will transfer an inventory resource to a customer and generate a cash resource for the firm.
Resources represent things of economic value. Common examples of resources are cash, raw materials, and inventory.
The REA model helps designers identify database entities because each resource, event, and agent represents an entity in a relational database. Figure 3-5 provides several examples of each type of entity. You may notice that Figure 3-5 does not list accounts receivable

Resources

Events

Agents

Cash
Equipment
Inventory
Plant facilities

Sales
Purchase
Receive goods
Hire an employee

Customer (external)
Employee (internal)
Manager (internal)
Vendor (external)

FIGURE 3-5 Examples of resource, event, and agent entities.

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as a resource. This is because the REA model does not recognize receivables or payables as resources. Rather, receivables and payables represent claims to resources rather than resources themselves. Similarly, the REA model does not treat billing as a business or economic event because creating a paper bill replicates information about an economic event such as a sale. Similarly, a paper bill produced in a billing process is not a resource, as it does not have economic value. The bill represents a claim to cash, which is an economic resource. Step 3—Identify Relationships Among Entities
Entities are related to other entities. For instance, a sale involves the exchange of merchandise inventory to a customer. The relationship between a sale and inventory or between a sale and a customer is called a direct relationship. Inventory and customer also share a relationship, but it is an indirect relationship. The REA model helps database designers define the relationships between entities. In the REA model, events typically have direct relationships with resources and agents, and also with other events. The links between resources and agents are through events. The relationships between entities ultimately determine the ability to create reports from the data. Reports can logically combine data from any entities that are linked, either directly or indirectly.
Data modelers need to know about entity relationships in order to create links between database tables. Without these links, database users cannot access data from more than one table at a time. Before we can determine the best way to link database tables, we must first understand the nature of the relationships among entities. We describe relationships in terms of cardinalities. Cardinality describes how entities are related, and we often abbreviate the description of the cardinality between two entities as either one-to-one (1:1), one-to-many (1:N), or many-to-many (N:N). This terminology refers to the maximum number of one entity that can occur given its relationship to another entity.
We examine the relationships between two entities in two directions, and each direction of the relationship can yield a different maximum cardinality. For example, consider the relationship between a customer entity and a sale entity. The customer-sale relationship has a one-to-many cardinality. For a given customer, there can be many sale events (i.e., a single customer can be involved in many sales transactions over time). Thus, the sale has a maximum of many in this relationship. Examining this pair of entities from the other direction, we see that one sale involves just one customer. Thus, the maximum number of customers for a single sale is one, and we define the customer-sale relationship as one-to-many. Figure 3-6 depicts this relationship graphically, where | represents a maximum of 1, and > represents a maximum of many.
Cardinalities also have minimums. Considering the same example as above, one customer can be involved in many sales transactions, but some customers may not have been involved in any sales because they have never purchased anything from the firm.
As a result, we say that the minimum number of sales for a customer is 0, which is indicated with a ◦ . Reading this relationship in the other direction, we need to determine the minimum number of customers for a sale. Given that a sale cannot be made unless there

Sale

FIGURE 3-6 Maximum cardinality example.

Customer

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Sale

Customer

FIGURE 3-7 Maximum and minimum cardinality example.

Item

Sale

FIGURE 3-8 Cardinality example. is a customer, the minimum number of customers is 1. Figure 3-7 depicts the relationship with both minimum and maximum cardinalities.
To read this relationship, we start on one side of the relationship and assume that the initial entity is singular. Then, we read the minimum and maximum cardinalities of the related entity. We would read the cardinalities described above as (1) one sale is made to a minimum of one customer and a maximum of one customer and (2) one customer has a minimum of zero sales and a maximum of many sales.
Cardinalities are sometimes difficult to grasp at first, but they become easier to understand with practice. So let’s try another one. What does the cardinality notation in
Figure 3-8 tell us?
Part of the answer is that each type of inventory item (e.g., blue jeans) can be sold many times, but some inventory items (e.g., new brands that have not yet been marketed) have never been sold. Also note that cardinalities are not fixed across organizations but vary according to the rules or controls of a specific enterprise. For example, if the item being sold was unique and could be sold only one time, then the maximum cardinality for the item entity would change to 1, rather than many. The other half of this relationship indicates that each sale must be for at least one inventory item and may be for many inventory items.
For example, you would have to actually sell something in order to have a sale, and you could be selling a white shirt plus some jeans and a jacket as part of the same sale.
There are a three other points we want to make about cardinalities. First, you will often find that events involve single agents but that agents are involved in events many times. As a result, agent-event relationships are often one-to-many relationships. Second, in the case of a sequence of events, you will typically notice that the first event must occur before the next event can occur. Thus, the minimum cardinality for the first event will be
1. This would be the case between a Sale and a subsequent Cash Receipt (see Figure 3-9).
The Cash Receipt cannot occur unless there was first a sale. From the other direction, the cardinality says that a sale relates to a minimum of zero cash receipts (because some customers will not pay) and a maximum of many cash receipts (because some customers

Sale

Cash Receipt

FIGURE 3-9 Cardinality example for business events.

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may pay in installments). Again, plainly stated, this means that you cannot have a cash receipt without a sale, and you could receive several cash receipts for a sale. Finally, examination of cardinalities can also be helpful in understanding an organization and can tell us something about the controls for a given business event. Notice that Figure 3-9 tells us, for example, that this firm allows installment payments. Otherwise, the maximum cardinality for the cash receipts would be 1.

Step 4—Create Entity-Relationship Diagrams
Database designers use a graphical documentation technique called the entityrelationship (E-R) diagram to depict entities and their relationships. We have already introduced you to the basic elements of E-R diagrams in the preceding figures related to cardinalities. The diagram consists of three items: rectangles, connecting lines, and cardinality notations. Rectangles represent entities and connecting lines depict relationships.
E-R diagrams depict all of the entities and the relationships graphically. In addition, the diagrams are arranged as events that occur in temporal sequence when using the REA modeling approach. Therefore, a reader can quickly see the main business events and the order in which events occur. In addition, the resources are arranged on the left and people appear on the right (i.e., the diagram is ordered from left to right as resources, events, and agents). Recall that each event will be related to at least one resource, internal agent, and external agent. Figure 3-10 provides an example of an E-R diagram for a simple sales process.

Step 5—Identify Attributes of Entities
Eventually, the entities that the database designer identifies become tables in a database.
In other words, a database contains a table for every entity in the E-R diagram. The tables consist of records, each containing data fields that describe the entity’s attributes.
Figure 3-11 shows four database tables for our merchandise sale example: (1) an event
(Customer Order), (2) a resource (Inventory), (3) an external agent (Customer), and (4) an internal agent (Salesperson).
Entities have characteristics or attributes that describe them. The data within a table are based on the attributes of the entity. For example, a salesperson is an agent entity. The

Inventory

Customer
Order

Salesperson

Customer
Ship Goods

Shipping
Clerk

Cash

Receive
Payment

FIGURE 3-10 Sample E-R diagram for a sale process.

A/R Clerk

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Customer Order Table (Event)
Order #
1003
1004
1005
1006

Employee #

Customer #

Date

Comments

M24SP
R63SP
M24SP
W11SP

B104
P202
S200
C100

01/03/2011
01/03/2011
01/03/2011
01/03/2011

Ship ASAP

Inventory Table (Resource)
Item #
1400
1500
1600
1700
1800

Description

Unit Cost

Sales Price

Beg QOH

Goodie Bar
Almond Delight
Gummy Lions
Pecan Bar
Milky Bars

$0.20
$0.25
$0.60
$0.70
$0.18

$0.40
$0.45
$0.95
$1.09
$0.30

13025
5010
20109
4508
2207

Customer Table (Agent)
Customer #
A101
B104
C100
P202
S200

Name

Address

City

State

Zip Code

Amanda Wills
Boris Bailey
Carly Riccardi
Peggy Martin
Bill Safer

22 Yellow Ln.
321 Church St.
1899 Green St.
1260 Main St.
860 Broad St.

Charlotte
Oxford
Dayton
Columbus
Fairfax

NC
OH
OH
OH
VA

Credit Limit

79803
45056
43299
43320
22030

$20,000.00
5,000.00
10,000.00
10,000.00
5,000.00

Salesperson Table (Agent)
Employee #
A06SP
M24SP
R63SP
R73SP
W11SP

Name

Address

City

Sally Anderson
Randy Merit
Barry Rogers
Jim Rudolph
John Walker

3026 Skye Ln.
262 Main St.
80 N. Long St.
64 Lantern Ave.
1028 Fields Ln.

State Zip Code Dept ID Date Hired

Columbus
Bexley
Gahanna
Columbus
Lancaster

OH
OH
OH
OH
OH

43213
43209
43215
43213
43307

247
182
247
76
182

1/31/1989
7/2/1999
1/16/2001
8/15/2000
9/1/1992

FIGURE 3-11 Four sample tables in a relational database.

attributes are the data fields describing each salesperson. What data should you collect about a salesperson? First, it is necessary to include an attribute that uniquely identifies each salesperson within the Salesperson table. This is the primary key that we discussed earlier.
The salesperson’s identification number, which could be the employee’s Social Security number, is a good choice for the primary key. Other attributes to include in the table might be last name, middle name, first name, phone number, address, e-mail, date of birth, date hired, department assignment, salary, and so on. You do not want to include attributes that the system can calculate or that require manual updates. For example, you would not want to include an attribute for the number of years that the employee has worked for the organization, because you would need to update the attribute every year. Rather than store the number of years, it is better to include an attribute for the date hired and a formula that calculates the current number of years of service based on the current date.
It is not always easy to decide what attributes to include for an entity. There are, however, two guidelines you can use. First, the attributes should describe one entity and that entity only. For example, if you have an inventory table, you would not include

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information about the vendor in this table. You can reference the vendor, but the name, address, and other information about the vendor belongs in a separate Vendor table.
Second, you should only include entities that are singular. In other words, do not create attributes that are lists of data. An example of such a list would be an attribute for all of the children’s names for an employee. The database would not be able to store this attribute because there could be many names, but there is only space for one child’s name in the database table. We will discuss how to deal with such problems in this chapter’s section on normalization.

Step 6—Convert E-R Diagrams into Database Tables
Each entity in the E-R diagram becomes a table in the completed database. However, a database is likely to contain more tables than the total number of entities in the E-R diagram. This can occur because linking tables together sometimes requires the creation of additional tables. In databases, tables are linked using foreign keys as previously described.
For example, in Figure 3-11, the Customer # in the Customer Order table is a foreign key that references the primary key of a particular customer in the Customer table. The relationship between the primary key and foreign key enables the database software to link the two tables together. If you wanted to create a customer order report that shows the name of the customer associated with each order, the links allow the creation of this report.
Creating links between tables is simple when the relationship between the entities is one-to-one or one-to-many. In one-to-one relationships, the foreign key can be in either table. If entities occur in sequence, the foreign key will usually be in the second event.
In one-to-many relationships the foreign key will be on the many side of the relationship.
Looking at the sample E-R diagram for a sales process in Figure 3-10, for example, we see that the cardinality between a Salesperson and Customer Order is one-to-many. To create a foreign key, we would use the primary key from the Salesperson table as the foreign key in the customer order table. Looking at Figure 3-11, this is the case. The primary key for the
Salesperson table, Employee #, appears in the Customer Order table as an attribute. This is the link between the two tables.
Linking tables with foreign keys becomes problematic when there is a many-to-many relationship between two entities. New relationship tables are necessary when you have many-to-many relationships. The reason for this is that, without relationship tables, there would be fields in a database table that could contain many possible values. For example, there is a many-to-many relationship between Sale and Inventory in Figure 3-10.
If we placed the inventory item number in the Sale table as a foreign key, it would not be possible to input the value for the inventory item number, because there can be many items related to a single sale. Similarly, an item can be sold many times, making it impossible to input a single sale number for a given item. Figure 3-12 shows the relationship table that is necessary to join the Sales and Inventory Item entities.
How many tables, including relationship tables, will we have for a complete database of the Sales process described in Figure 3-10? Looking at the diagram, we see that there are nine entities, which will require nine tables. There are also three many-to-many relationships: (1) Inventory and Customer Orders, (2) Inventory and Sales, and (3) Sales and Receive Payment. Therefore, we would have twelve tables in the finished database: nine tables for entities and three additional ‘‘joining’’ tables.
Figure 3-13 lists all the database tables and their attributes for our sales process example.
Because data modeling is a creative process, there are other possible sets of database tables and other attributes that you might include in a database for a sales process. Figure 3-13 is one example.

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PART TWO / Databases

Sale #

Item #

Quantity

1003
1004
1005
1005
1005
1006
1006

1400
1400
1600
1800
1900
1400
1800

230
430
180
200
360
80
100

FIGURE 3-12 A relationship table joining the Customer Order and Inventory tables.

Inventory Table
Item#, Description, Unit Cost, Sales Price, Beginning Quantity on Hand, Beginning Quantity on Hand
Date
Cash Table
Account#, Account Type, Bank, Beginning Balance, Beginning Balance Date
Customer Order Table
Order#, [Employee#], [Customer#], Date, Comments
Sales Table
Sale#, [Employee#], [Customer#], Ship Date, [Order#]
Receive Payment Table
Cash Receipt#, Amount Received, Date, [Employee#], [Account#]
Employee Table
Employee#, First Name, Middle Name, Last Name, Address, City, State, Zip Code, [Department#], [Job
Classification Code], Date of Birth, Date Hired, Last Date of Review
Customer Table
Customer#, Company Name, Address1, City, State, Zip Code, Contact Person, Credit Limit
Inventory/Order Relationship Table
Order#, Item#2, Quantity
Inventory/Sale Relationship Table
Sale#, Item#, Quantity
Sale/Receive Payment Relationship Table
Sale#, Cash Receipt#
Order/Sale Relationship Table
Order#, Sale#
1 May

use multiple addresses for different departments or for shipping versus billing. tables require two fields together to represent a primary key. Either field alone would not be unique to a record.
2 Relationship

FIGURE 3-13 A schematic of database tables for the sales process. (Note: Underlining signifies a primary key and brackets denote foreign keys.)

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NORMALIZATION
Normalization is a methodology for ensuring that attributes are stored in the most appropriate tables and that the design of the database promotes accurate and nonredundant storage of data. The process of normalization can result in the creation of new tables to include in the database. There are multiple levels of normalization. We shall examine the first three levels—first normal form, second normal form, and third normal form—as these three normal forms address the vast majority of problems when designing database tables.

First Normal Form
A database is in first normal form (1 NF) if all of a single record’s attributes (data fields) are singular. That is, each attribute has only one value. Figure 3-14 shows a set of university parking ticket data with repeating groups in its rightmost four columns. (Real parking tickets will contain many more data fields than shown here, but we will keep things simple to focus on normalization tasks.) Databases cannot store more than one value in the same data field
(i.e., column) of the same record, so we must do something to overcome this limitation.
A solution to this problem is to use a separate record to store the information for each parking ticket. Figure 3-15 illustrates the results. For this file, the ticket number serves as the primary key. There are no repeating groups for any one column, and there is no longer a violation of the first normal form.
Although we now have corrected the problem associated with nonsingular attributes, several problems remain. One difficulty is a large amount of data redundancy (i.e., the fact that much of the information in this table is repetitive). Another problem is that we have created an insertion anomaly, which is a situation where desired data cannot be entered into the database. In particular, the current version of this database reveals that it only

Social
Security
Number
123-45-6789

Last
Name
Curry

First
Phone
License Plate
Ticket
Name
Number
State Number Number
Date
Code Fine
Dorothy (916)358-4448 CA 123 MCD 10151 10/15/10
A
$10
10152 10/16/10
B
$20
10121 11/12/10
B
$20
134-56-7783 Mason Richard (916)563-7865 CA
253 DAL
10231 10/23/10
C
$50
12051
12/5/10
A
$10

FIGURE 3-14 A set of unnormalized parking ticket data.

Ticket
Number
10151
10152
10121
10231
12051

Social
License
Security
Last
First
Phone
Plate
Number
Name Name
Number
State Number
Date
Code Fine
123-45-6789 Curry Dorothy (916)358-4448 CA 123 MCD 10/15/2010
A
$10
123-45-6789 Curry Dorothy (916)358-4448 CA 123 MCD 10/16/2010
B
$20
123-45-6789 Curry Dorothy (916)358-4448 CA 123 MCD 11/12/2010
B
$20
134-56-7783 Mason Richard (916)663-7865 CA
253 DAL 10/23/2010
C
$50
134-56-7783 Mason Richard (916)663-7865 CA
253 DAL
12/5/2010
A
$10

FIGURE 3-15 The data from Figure 3-14 in first normal form.

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PART TWO / Databases

stores information about students with parking tickets. Students with registered cars but no parking tickets will have no records in this file—a difficulty if school administrators also want to use this file for car registration purposes. A third problem is a deletion anomaly, which occurs when more data is deleted than is desired by the database user. When we delete records after students pay their tickets, we will no longer have car registration records on file for anyone who has paid all of his or her tickets.

Second Normal Form
To solve the problems described above, we now consider second normal form (2 NF).
A database is in second normal form if it is in first normal form and all the attributes in each record depend entirely on the record’s primary key. To satisfy this requirement for our student parking ticket example, let us split our student information into two files—a Car
Registration File and a Ticket File—as shown in Figure 3-16. This approach results in a more efficient design and also eliminates much of the first file’s data redundancy. Notice that the solution to both the insertion and deletion anomalies is the same—make more tables.
In our new Car Registration table, what should serve as the primary key? At first glance, you might guess ‘‘Social Security number.’’ If students are able to register only one car, then this choice might be satisfactory. If students can register more than one car, then it makes more sense to use the license plate number as the primary key. Remember: the primary key must uniquely identify a record, and this would not be possible if one person
(with one Social Security number) had two records in this table.
What about a primary key for our new Ticket table? In this table, the ticket number serves this purpose, while the student’s license plate number serves as the foreign key. The foreign key enables a database to link appropriate records together—for example, to trace

Car Registration File
Social
Security
Number
123-45-6789
134-56-7783
·
·
·

Last
Name
Curry
Mason
·
·
·

First
Name
Dorothy
Richard
·
·
·

Phone
Number
(916)358-4448
(916)563-7865
·
·
·

(primary key)
License Plate
State
Number
CA
123 MCD
CA
253 DAL
·
·
·
·
·
·

Ticket File
(primary key)
Ticket
Number
10151
10152
10231
10121
12051
·
·

(foreign key)
License Plate
State
Number
CA
123 MCD
CA
123 MCD
CA
253 DAL
CA
123 MCD
CA
253 DAL
·
·
·
·

Date
10/15/10
10/16/10
10/23/10
11/12/10
12/5/10
·
·

FIGURE 3-16 The data of Figure 3-15 in second normal form.

Code
A
B
C
B
A
·
·

Fine
$10
$20
$50
$20
$10
·
·

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93

a particular parking ticket to the car’s registered owner. It also enables database users to answer such questions as ‘‘Does a particular student have any outstanding parking tickets?’’

Third Normal Form
Although we are making headway in our database design, our goal is to create a database that is in third normal form (3 NF). A database is in third normal form if it is in second normal form and contains no transitive dependencies. This means that the same record does not contain any data fields where data field A determines data field B. The Ticket table in Figure 3-16 suffers from this problem because the ticket code data field (e.g., a code of
A) determines the amount of the fine (e.g., $10).
One way to solve this problem is to store the data for parking fines in a new Parking
Violations Code table as shown in Figure 3-17. This enables us to eliminate the redundant information (the fine data field) in the Ticket table of Figure 3-16 and streamline our data.
Figure 3-17 illustrates the results. The ticket codes (A, B, and so forth) in the Ticket table serve as a foreign key that links the information in the Ticket table to an entry in the Parking
Violations Code table. We now have a database in third normal form.

Car Registration File
Social
Security
Number
123-45-6789
134-56-7783
·
·
·

Last
Name
Curry
Mason
·
·
·

First
Name
Dorothy
Richard
·
·
·

Phone
Number
(916)358-4448
(916)563-7865
·
·
·

(primary key)
License Plate
State
Number
CA
123 MCD
CA
253 DAL
·
·
·
·
·
·

Ticket File
(primary key)
Ticket
Number
10151
10152
10231
10121
12051
·
·

(foreign key)
License Plate
State
Number
CA
123 MCD
CA
123 MCD
CA
253 DAL
CA
123 MCD
CA
253 DAL
·
·
·
·

Date
10/15/10
10/16/10
10/23/10
11/12/10
12/5/10
·
·

Parking Violations
Code File
(primary key)
Code
A
B
C
·
·

Fine
$10
$20
$50
·
·

Explanation meter expired parking in no-parking zone no parking sticker
·
·

FIGURE 3-17 The data of Figure 3-16 in third normal form.

(foreign key)
Code
A
B
C
B
A
·
·

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PART TWO / Databases

Large databases tend to become very complicated, with multiple tables that are linked together with foreign keys. The database in Figure 3-17, for example, is more complex than our original file in Figure 3-14, but it is also more efficient. For example, this database design will allow its users to (1) store the car registration information of all students, even if they do not have any parking tickets, (2) alter a student’s name, phone number, or license plate by altering only one record in the Car Registration file—not several of them, as would be required using the file in Figure 3-14, and (3) easily change the fine amount for a parking ticket. Finally, this database design allows us to eliminate redundant information and therefore makes file storage more efficient.

AIS AT WORK
New Databases for the Green Economy5
Databases are used to track firms’ financial performance throughout the world. Modern database systems store all of the data needed to produce financial statements and create the nonfinancial reports needed for strategic decision making. A new form of database system and related software applications are rapidly entering the market.
As firms and governments have become more aware of the risks associated with climate change, carbon emissions are beginning to be considered liabilities that should be reported on the balance sheet or at least disclosed. Keeping track of carbon, therefore, is becoming a priority. Firms are adopting new technology called Enterprise Carbon and
Energy Management (ECEM) systems to integrate with their existing business databases.
These new systems are designed to collect the data necessary to improve efficiency and reduce energy consumption, develop carbon reduction plans, improve relations with shareholders and the public, and comply with new regulations. Another goal for these systems is to reduce the risks associated with climate change. The concerns related to climate change risks have grown so rapidly that the Securities and Exchange Commission
(SEC) now requires publicly traded companies to assess climate change risks and estimate potential effects on financial results. Database technology will be essential for organizing the vast amounts of data needed to conduct such risk assessments.
According to Forrester research surveys, ECEM systems are being adopted at an astonishing rate. During a period of just 6 months in 2010, the number of companies who had adopted this technology nearly doubled. It may soon be commonplace for accounting databases to include complex climate predictions and emissions data.

SUMMARY
Almost every AIS uses databases to store accounting data.
Primary keys and foreign keys enable database systems to identify database records uniquely as well as link records to one another.
Large, multi-user accounting databases pose several concerns for accounting professionals. These include the administration and supervision of database development and maintenance; the need for documentation; the importance of data integrity, data processing accuracy, data completeness;
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database security and backup; and the need for concurrency controls to safeguard data when two users wish to access the same record.
The REA model is a methodology that enables database designers to model databases by focusing on resources, events, and agents.
Using E-R diagrams, the REA model graphically depicts the entities needed for a database and the types of relationships between them. The ultimate goal is to determine what data to store and how to organize the data.
Databases must be designed carefully. The process of normalization enables designers to minimize data redundancy, eliminate insertion and deletion anomalies, and remove transitive dependencies.
The goal is to develop a database that is at least in third normal form.

KEY TERMS YOU SHOULD KNOW agent attributes business event cardinalities concurrency controls data dictionary data field data hierarchy data integrity controls data modeling database database administrator database management system (DBMS) economic event entity entity-relationship (E-R) diagram first normal form (1NF)

foreign keys master files metadata normalization primary key
REA model record record structure relational databases relationship table resources second normal form (2NF) third normal form (3NF) transaction controls transaction file transitive dependencies view controls

TEST YOURSELF
Q3-1. Which of these does not characterize a typical database?
a. Large number of records

c. High need for accuracy

b. Irreplaceable data

d. Simple systems

Q3-2. The part of the data hierarchy that represents one instance of an entity is a:
a. Field

b. Record

c. File

d. Database

Q3-3. Which of these would not be a good primary key for a file of employee records?
a. Social Security number
b. Last name
c. Company employee number
d. All of these would make equally good primary keys

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Q3-4. In the REA model, the ‘‘A’’ stands for:
a. Agents

b. Additions

c. Accounts

d. Associations

Q3-5. In the REA model, which of these would not be classified as an event?
a. Cash sale

c. Hiring a new chief executive

b. Credit sale

d. Date of the office picnic

Q3-6. Which of these is not a cardinality between two database entities?
a. One-to-one

c. One-to-many

b. None-to-none

d. Many-to-many

Q3-7. What is the typical cardinality between a customer and a purchase event?
a. One-to-one

c. One-to-many

b. Many-to-many

d. None-to-one

Q3-8. An insert anomaly occurs when the database user cannot:
a. Delete data

c. View data

b. Modify data

d. Add new data

Q3-9. To link the records in a many-to-many relationship within a relational database:
a. You must create an intermediate ‘‘relationships’’ table
b. You must create a new database
c. You must use foreign keys and a spreadsheet system
d. You cannot link records together under these circumstances
Q3-10. Within the context of databases, the term concurrency refers to the possibility that:
a. A customer of one store might also be a customer of another store
b. Two database users might want to access the same record at the same time
c. A credit entry for a customer requires a debit entry for a matching account
d. None of these
Q3-11. A database is in third normal form (3NF) if it is second normal form and:
a. All the data attributes in a record are well defined
b. All the data attributes in a record depend on the record key
c. The data contain no transitive dependencies
d. The data can be stored in two or more separate tables

DISCUSSION QUESTIONS
3-1. Why are databases important for accounting information systems? Describe some concerns and explain why each one is important.
3-2. What is the hierarchy of data in databases? Provide an example for a particular accounting application. 3-3. What are primary keys in accounting databases and what purpose do they serve?
3-4. Name some specific accounting files and a potential primary key for each one.
3-5. Describe each of the following database issues that are relevant to accounting systems, and give an example of each: (1) data integrity, (2) transaction accuracy and completeness,
(3) concurrency processing, and (4) security.

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3-6. What is the REA model? How does REA differ from more traditional accounting views of data collection and storage? Hint: would a traditional accounting database store data about personnel matters?
3-7. What are database cardinalities? Give some examples of cardinalities for an accounting application other than sales.
3-8. What is an entity-relationship diagram? What can you determine about an organization from examining an E-R diagram?
3-9. Suppose that a data modeler creates a database that includes a Sales table and a Salesperson table. Would you be likely to need a relationship table to link these two entities? Why or why not? 3-10. What is the process of normalization? What levels are there, and why do database developers seek to normalize data?

PROBLEMS
3-11. An internal auditor should have a sound understanding of basic data processing concepts such as data organization and storage in order to adequately evaluate systems and make use of retrieval software.
a. Define the following terms as used in a data processing environment (all are nouns):
(1) field, (2) record, and (3) file.
b. Define a database. List two advantages and two disadvantages of a database system.
(CIA adapted)
3-12. What attributes (i.e., table columns) would you be likely to include in a Cash table? In a Cash
Receipts table?
3-13. Describe the meaning of each of the entity-relationship diagrams shown in Figure 3-18.
3-14. Draw an entity-relationship diagram for the following: Sales of inventory are made to customers by salespeople. After the sale, cash is received by cashiers.
3-15. Draw an entity-relationship diagram for the following: An accounting firm holds recruiting events for college students. At these events, recruiters are seeking students with particular skills. 3-16. Give some examples of attributes you would include in a Customer table. Would you use one data field or two for the customer name? Why?
3-17. Design tables to store the following attributes (make sure that all tables are in third normal form): customer name, customer address, customer phone, and names of customers’ children.
a.

Course

b.

Teach
Course

Patient

Surgery

Doctor

Nurse

FIGURE 3-18 Entity-relationship diagrams for Problem 3-13.

Teacher

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3-18. Design tables to store the following attributes (make sure that all tables are in third normal form): student name, student phone number, classes taken by student, student address, class number, class time, class room, and student’s grade for each class.
3-19. Bonadio Electrical Supplies distributes electrical components to the construction industry.
The company began as a local supplier 15 years ago and has grown rapidly to become a major competitor in the north central United States. As the business grew and the variety of components to be stocked expanded, Bonadio acquired a computer and implemented an inventory control system. Other applications such as accounts receivable, accounts payable, payroll, and sales analysis were gradually computerized as each function expanded. Because of its operational importance, the inventory system has been upgraded to an online system, while all the other applications are operating in batch mode. Over the years, the company has developed or acquired more than 100 application programs and maintains hundreds of files.
Bonadio faces stiff competition from local suppliers throughout its marketing area. At a management meeting, the sales manager complained about the difficulty in obtaining immediate and current information to respond to customer inquiries. Other managers stated that they also had difficulty obtaining timely data from the system. As a result, the controller engaged a consulting firm to explore the situation. The consultant recommended installing a
DBMS, and the company complied, employing Jack Gibbons as the database administrator.
At a recent management meeting, Gibbons presented an overview of the DBMS. Gibbons explained that the database approach assumes an organizational, data-oriented viewpoint as it recognizes that a centralized database represents a vital resource. Instead of being assigned to applications, information is more appropriately used and managed for the entire organization.
The operating system physically moves data to and from disk storage, while the DBMS is the software program that controls the data definition library that specifies the data structures and characteristics. As a result, both the roles of the application programs and query software, and the tasks of the application programmers and users are simplified. Under the database approach, the data are available to all users within security guidelines.
a. Explain the basic difference between a file-oriented system and a database management system. b. Describe at least three advantages and at least three disadvantages of the database management system.
c. Describe the duties and responsibilities of Jack Gibbons, the database administrator.
(CMA Adapted)

CASE ANALYSES
3-20. Carl Beers Enterprises (Understanding a Relational Database)
Carl Beers Enterprises manufactures and sells specialized electronic components to customers across the country. The tables in Figure 3-19 illustrate some of the records in its accounting databases. Thus, for example, the Sales by Inventory Number records show detailed sales data for each of the company’s inventory items, and the Customer Payments records indicate customer cash payments, listed by invoice number. Use the information in these tables to answer the following questions.

Requirements
1. The Sales by Inventory Number records are listed by inventory item number. How is this useful? Why might this information also be useful if it were listed by invoice number instead of inventory number?

CHAPTER 3 / Data Modeling

Sales by Inventory Number
Item
Number

Invoice
Number
V-1
V-3
V-6
V-5
V-6
V-3
V-1
V-5
V-3
V-7
V-2
V-4
V-5
V-7

I-1

I-2
I-3
I-4
I-5
I-6

Sales by Invoice Number

Quantity

Price
Each

Invoice
Number

1
1
3
2
10
6
2
2
2
3
2
2
2
2

2,000
2,000
1,575
3,000
3,500
1,000
600
300
4,000
3,000
5,000
5,000
5,000
7,000

V-1
V-2
V-3
V-4
V-5
V-6
V-7

Amount

Customer
Number

Date

7,200
10,000
16,000
10,000
16,600
35,000
23,000

C-1
C-2
C-5
C-2
C-5
C-3
C-4

July 1
July 12
July 22
July 26
July 31
Aug 1
Aug 2

Customer Payments

V-1
V-2
V-2
V-3
V-4
V-5

Salesperson
Number
S-12
S-10
S-10
S-10
S-10
S-10
S-11

Sales by Salesperson
Salesperson
Number

Quarterly
Sales

Commission
Rate

?
?
?
0

.10
.10
.12
.08

S-10
S-11
S-12
S-78

Invoice
Number

99

Customer Data

Remittance
Advice Number

Amount

R-3
R-1
R-5
R-4
R-2
R-4

7,200
1,666
1,666
16,000
10,000
16,600

Customer
Number
C-1
C-2
C-3
C-4
C-5

Customer
Name

Accounts
Receivable
Amount

Salesperson

Dunn, Inc.
J. P. Carpenter
Mabadera Corp.
Ghymn and Sons
D. Lund, Inc.

?
?
?
?
?

S-12
S-10
S-10
S-99
S-10

FIGURE 3-19 Sample of some of the records in the Beers Enterprises accounting databases.

2. In the Sales by Invoice Number, invoice V-3 shows a sales amount of $16,000. What was the name of the customer that made this purchase? What specific inventory items did this customer purchase? How much did this customer pay for each item?
3. Customers can choose among one of three payment options: (1) 5% discount if immediate cash payment, (2) 2% discount off list amount if total invoice paid by the fifteenth day of the month following purchase, or (3) deferred payment plan, using six monthly payments. Which option does J. P. Carpenter appear to be using for invoice V-2?
4. Using just the information provided, what are the quarterly sales amounts for salespeople
S-10, S-11, and S-12?
5. Assume that customers C-1 through C-5 began this quarter with net accounts receivable balances of zero. What are their balances now?

3-21. Martin Shoes, Inc. (Designing a Database Using REA and E-R Diagrams)
Martin Shoes, Inc. manufactures and distributes orthopedic footwear. To sell its products, the marketing department requires sales personnel to call on the shoe retailers within

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their assigned geographic territories. Each salesperson has a laptop computer, which he or she uses to record sales orders during the day and to send these sales orders to Martin’s network nightly for updating the company’s sales order file.
Each day, warehouse personnel review the current sales orders in its file, and where possible, pick the goods and ready them for shipment. (Martin ships goods via common carrier, and shipping terms are generally FOB from the shipping point.) When the shipping department completes a shipment, it also notifies the billing department, which then prepares an invoice for the customer. Payment terms vary by customer, but most are net 30. When the billing department receives a payment, the billing clerk credits the customer’s account and records the cash received.

Requirements
1. Identify the resources, events, and agents within Martin’s revenue process.
2. Develop an E-R diagram for this process.
3. With a particular DBMS in mind, design the tables for this revenue process. Note that you will need tables for each resource, event, and agent, as well as tables for each many-to-many relationship.

3-22. Souder, Oles, and Franek LLP (Data Modeling with REA)
Souder, Oles, and Franek LLP is an international consulting firm headquartered in Chicago,
Illinois. The E-R diagram in Figure 3-20 shows a simplified version of the company’s process for purchasing and paying for equipment and supplies.

Purchasing agent Order goods Merchandise inventory Vendor
Receive
goods
Receiving
clerk

Cash

Pay for goods Cashier or A/P clerk FIGURE 3-20 An E-R diagram for the purchasing system of Souder, Oles, and Franek LLP.

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Requirements
1. Insert appropriate cardinalities for the relationships in the E-R diagram developed with the REA data modeling approach.
2. Describe the database table attributes for this model. You will need a table for each entity, as well as one or more relationship tables. Identify first the table name, then indicate the primary key by underlining it. Show any foreign keys by framing them in brackets (e.g., [Vendor #]). Include at least three fields in each table. Below is an example for the Vendor table and the Order Goods table:
Vendor #: Name, Street Address 1, Street Address 2, City, State, Zip Code, Phone
Number, E-mail, Fax, Contact, Comments.
Order #: Date, [Vendor #], [Employee #], Shipping Instructions, Comments.

3-23. Swan’s Supplies (Normalizing Data)
Swan’s Supplies is a wholesaler of sporting goods equipment for retailers in a local metropolitan area. The company buys sporting goods equipment direct from manufacturers and then resells them to individual retail stores in the regional area. The raw data in
Figure 3-21 illustrate some of the information required for the company’s purchase order system. As you can see, this information is characteristic of accounting purchase order systems but is not well organized. In fact, because of the repeating groups in the rightmost columns, it cannot even be stored in a database system.

Requirements
Store this data in a spreadsheet to make it easy to manipulate. Then perform each of the following tasks in turn:
1. Reorganize the data in first normal form and print your spreadsheet. Why is your data in first normal form?
2. Reorganize the data from part 1 into second normal form and print your spreadsheet.
Why is your data in second normal form?
3. Reorganize the data from part 2 into third normal form and print your spreadsheet. Why is your data in third normal form?

Purchase
Order
Number

Date

Customer
Number

12345

01/03/2011 123-8209

12346

01/03/2011 123-6733

Customer
Name

Customer
Phone
Number

Charles Dresser, Inc.

Item
Item
Number Description

(752)433-8733 X32655
X34598
Z34523
Patrice Schmidt’s Sports (673)784-4451 X98673
X34598
X67453

FIGURE 3-21 Some purchasing data for Swan’s Supplies.

Unit
Cost

Unit

Baseballs
$33.69 dozen
Footballs
53.45 dozen
Bball Hoops 34.95 each
Softballs
35.89 dozen
Footballs
53.45 dozen
Soccer balls 45.36 dozen

Quantity
Ordered
20
10
20
10
5
10

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READINGS AND OTHER RESOURCES
Fuller, R., U. Murthy, and B. Schafer. 2010. The effects of data model representation method on task performance. Information & Management 47(4): 208– 218.
Gallivan, S., and C. Pagel. 2008. Modelling of errors in databases. Health Care Management Science
11(1): 35–40.
McCarthy, W. 1982. The REA accounting model: A generalized framework for accounting systems in a shared data environment. Accounting Review 57(3): 554–578.

Create an E-R Diagram with Visio: http://msdn.microsoft.com/en-us/data/ff628199 Introduction to Databases: http://www.youtube.com/watch?v=iKK3P11OCyM Introduction to Normalization: http://www.youtube.com/watch?v=uO80f642LCY ANSWERS TO TEST YOURSELF
1. d

2. b

3. b

4. a

5. d

6. b

7. c

8. d

9. a

10. b

11. c

Chapter 4
Organizing and Manipulating the Data in Databases

INTRODUCTION

DISCUSSION QUESTIONS

CREATING DATABASE TABLES IN MICROSOFT
ACCESS

PROBLEMS

Database Management Systems
An Introduction to Microsoft Access
Creating Database Tables
Creating Relationships

ENTERING DATA IN DATABASE TABLES
Creating Records
Ensuring Valid and Accurate Data Entry
Tips for Creating Database Tables and Records

EXTRACTING DATA FROM DATABASES: DATA
MANIPULATION LANGUAGES
Creating Select Queries

CASE ANALYSES
BSN Bicycles I (Creating a Database from Scratch with Microsoft Access)
Furry Friends Foundation I (Creating a New Database from Scratch)
Bonnie P Manufacturing Company (Data Validation
Using a DBMS)
Clifford Cohen University (Enforcing Referential
Integrity)
BSN Bicycles II (Creating Queries in Access)
Furry Friends Foundation II (Creating Queries for Databases)

READINGS AND OTHER RESOURCES

Creating Action Queries
Guidelines for Creating Queries

ANSWERS TO TEST YOURSELF

Structured Query Language
Sorting, Indexing, and Database Programming
Online Analytical Processing and Data Mining

RECENT DATABASE ADVANCES AND DATA
WAREHOUSES
Cloud Computing
Data Warehouses

AIS AT WORK—USING DATA MINING
TO PREDICT FINANCIAL DISASTERS
SUMMARY
KEY TERMS YOU SHOULD KNOW
TEST YOURSELF

After reading this chapter, you will:
1. Be familiar with database techniques for validating data inputs.
2. Know how to create tables, records, and relationships using Microsoft Access.
3. Understand the importance of extracting data from databases and AIS uses of this data.
4. Know how to create simple and multitable queries using Microsoft Access.
5. Be familiar with special purpose databases, data warehouses, cloud computing, and uses of these technologies in accounting applications.

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The WorldCom fraud was detected by an internal auditor running Access queries, highlighting just one reason for gaining advanced querying skills.
Loraas, T., and D. Searcy. 2010. Using queries to automate journal entry tests: Agile
Machinery Group, Inc. Issues in Accounting Education 25(1): 155–174.

INTRODUCTION
In theory, system developers should first design databases, using the techniques described in
Chapter 3, and then construct them later. In practice, organizations create many commercial databases from collections of preexisting manual files, nonintegrated computerized files, personal or informal files, or the databases of acquired companies. Thus, the key databases of a company are often in a state of continuous evolution, reevaluation, and revision.
The previous chapter introduced the concept of databases and discussed data modeling—the process of designing database tables. This chapter focuses on ways to use databases in AISs and the actual construction of a functioning database in Microsoft
Access. We begin with a discussion of the software used to create databases (i.e., database management systems) and then describe how to implement Access database tables in practice. Next, we discuss how to retrieve data from a database. Finally, we examine a few special types of databases and current advances in database technology.

CREATING DATABASE TABLES IN MICROSOFT ACCESS
After you have normalized your database tables, you are ready to actually create database tables and input records. Typically, these tasks are completed with a database management system. Database Management Systems
A database management system (DBMS) is a software system that enables users to create database records, delete records, query (i.e., select subsets of records for viewing or analysis), alter database information, and reorganize records as needed. This section of the chapter explains how to perform some of these tasks in greater detail.
A DBMS is not a database. Rather, a DBMS is a separate computer program that enables users to create, modify, and utilize a database of information efficiently, thus allowing businesses to separate their database system operations from their accounting system applications. This enables organizations to change record structures, queries, and report formats without also having to reprogram the accounting software that accesses these database items. It also enables businesses to upgrade either system independently of other systems. Examples of microcomputer DBMS packages include Microsoft Access, Alpha 5, dQuery, Filemaker Pro, and Lotus Approach. Examples of DBMSs that run on client/server systems or mainframes include ADABAS, Microsoft SQL Server, DB2, Oracle, MySQL, Sybase,
Ingrus, and Supra. Most microcomputer DBMSs are single-user systems, whereas others (for larger applications) are multi-user systems. Each system is limited in how many concurrent

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105

users it can support, the maximum number of transactions per hour it can process, and so forth. Also, not every accounting package can interface with every database, so managers should make sure that any new accounting software they acquire can also work with their existing databases, and vice versa.

Case-in-Point 4.1 Annual global spending on database management systems is approximately $30 billion, and the major database providers (e.g., MySQL, Oracle, and IBM DB2) are some of the largest software companies in the world.1

An Introduction to Microsoft Access
Microsoft Access is a popular database that many businesses and individuals use for small database applications. The procedures for creating tables and entering records in several alternative database systems are similar to those used in Access. This chapter assumes the use of Access 2010.
After launching Access 2010, click on the ‘‘Blank database’’ icon in the top portion of the screen in Figure 4-1, and you will launch the option to open a new blank database. A panel will appear on the right side of your screen asking you to name your database. The default name is ‘‘Database1.accdb.’’ You should rename your database to something more meaningful—for example, ‘‘Payroll Database’’ (blanks are permitted in Access database names). File name textbox

FIGURE 4-1 Opening screen for Access database program.

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Your next task is to decide where to store the database. To do this, look to the right of the File Name textbox (where you named your database from the previous step) and find the file folder with an arrow icon. Clicking on this icon will display a Microsoft ‘‘Save As’’ dialog box (not shown) that enables you to select where to store your database. After you have done this, click on the ‘‘Create’’ button in the lower-right portion of Figure 4-1.

Creating Database Tables
As you already know, database tables store data about specific entities—for example, customers, vendors, or employees. To illustrate how to create tables in Access, let’s create a table of employee payroll records similar to the one we previously described in
Figure 3-1.

Defining a Record Format. The ribbon across the top in Figure 4-2 shows seven tabs: File, Home, Create, External Data, Database Tools, Fields, and Table. The figure also shows two important components. First, Access assumes that your next job is to create a table of records and accordingly supplies the default name ‘‘Table1’’ in the left portion of the screen in Figure 4-2. Second, the system assumes that each record will have at least one data field with default name ‘‘ID.’’
Before you enter data in your new database, you must first define the record structure for your table. It is much easier to spend time developing this format prior to entering data than to spend hours changing it later. Figure 4-3 displays the form for developing the record fields and field properties for the tables in your database. To get to this screen, right click on the table name ‘‘Table1’’ from Figure 4-2 and select ‘‘Design View’’ from the set of choices. You will be asked to name and save the table. You should include the conventional tbl prefix in any name you create for a table. Thus, we will use the name
‘‘tblPayroll MasterFile’’ for our table name. The screen in Figure 4-3 will appear, and it is a template for creating the data fields of your records.
To define a record format, begin typing the name of the first data field you wish to create—for example, the term ‘‘SocSecNum’’—in the upper-left portion of the screen in
Figure 4-3. When you do, the following three columns will appear in that area of the screen:
(1) Field Name (which is required), (2) Data Type (also required), and (3) Description
(optional). Let’s look at each of these items separately.

FIGURE 4-2 Opening screen for creating a table in Access.

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107

FIGURE 4-3 Payroll MasterFile table displaying field name, data type, description, and field properties for
SocSecNum.

Field Name. Field names are the names you assign to the data fields in your record.
As illustrated in Figure 4-3, you can embed blanks in field names and capitalize selected letters in names as desired. Two general rules to follow when naming data fields are
(1) use mnemonic names (that help you remember their use such as ‘‘Zip code’’) and
(2) do not use excessively long names (which become cumbersome to use).
Although it isn’t obvious from Figure 4-3, you can use the same field name in each of two tables—the field names in tables are completely independent of one another. In fact, using the same field names for the same data—for example, ‘‘Vendor #’’—in both a Vendor table and a Vendor Invoices table often makes sense because this makes it easy to identify the data field that can link the tables together. We’ll look at this shortly.
Data Type. For each data field you create in a table, you must also specify a data type.
The data type tells Access how to store the data—for example, as text, a number, yes/no, memo, or a date/time. Several examples of such data are: text data types (e.g., employee’s
First Name and Last Name); currency data type (e.g., employee’s pay rate); date data type
(e.g., employee’s date of hire); yes/no data type (e.g., employee’s qualifications to earn overtime pay); and memo data type (that stores variable length text) for the Remarks data field. Each data field you specify in a table also includes a set of field properties, whose values appear in the lower portion of the screen in Figure 4-3. These include settings such as Field Size (e.g., a length of 9 bytes), Format (e.g., a number with a percent sign), and
Input Mask (e.g., a template for entering a phone number). Figure 4-3 shows the field properties for the SocSecNum field in our table. Note the Input Mask entry, which you can select from a drop down set of items if you click on this property. You might also be

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curious why we defined this as a text field rather than a number field. The reason is because this data value is not really a number that we can mathematically manipulate, but rather a code. Thus, we create it as a text field and limit its Field Size property to 9 characters (see the bottom portion of Figure 4-3).
Finally, if you use a number data type, you must also select the type of number you wish to use—for example, integer, long integer, single (a small decimal value), or double
(a large decimal value). These choices are important when using numeric data fields to link tables together—the fields must match exactly for the link to work.

Description. The last item that you can create for each data field in a table is its description. This is an optional field that you can ignore when defining record structures.
However, as you can see from the figure, data field descriptors help document the table itself and can also describe exception conditions or contain special notes.

Identifying a Primary Key. Recall that a primary key is the data field in each record that uniquely identifies the record. After you have defined the data fields in your table, you should designate a primary key. For our payroll file example, we will use the employee’s
Social Security number (SocSecNum) as the primary key. One way to designate this field as the primary key is to click on the name of this field and then select ‘‘Primary Key’’ icon ( ) from the banner at the top of the screen. An alternate way is to right click on the field with your mouse and select ‘‘primary key’’ from the set of choices in the drop-down list. The end result in either case will be the same—a little key icon appearing in the first column opposite the data field you selected, as illustrated in Figure 4-3. Note that relationship tables require a two-part primary key.
Saving a Table. You can save your current work at any time by clicking on the Save icon in the menu at the top of your screen. If you attempt to close your table at this point
(by clicking on the X in the upper-right portion of the screen), Access will prompt you to save the table.

Creating Relationships
After creating your tables, it is important to know how to create relationships between the tables. As you’ve seen from earlier discussions, these relationships link tables together.
They also enable users to create multitable reports, such as the one in Figure 3-3. To illustrate how to create relationships in Access, assume that you have created a department table with records similar to the one in Figure 3-2. Figure 4-4 illustrates the record structure for this table, which we named ‘‘tblDepartments.’’ The Department Code is the primary key for this table.
You now have two tables—‘‘tblDepartments’’ and ‘‘tblPayroll MasterFile.’’ They are related in a one-to-many relationship because each department has many employees, but each employee belongs to only one department. The department code is common to both tables, although its name differs slightly from one table to another. (We purposely used different names to demonstrate the fact that the names do not have to match exactly to link tables.) This field will act as the foreign key in the Payroll MasterFile table. To create a relationship between the two tables, follow these steps:
• Step 1—Select tables. Select ‘‘Relationships’’ from the ‘‘Database Tools’’ tab. From the tables listed on the left of your screen, right click on the table you wish to link (tblPayroll

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FIGURE 4-4 Departments table with properties for the department code.
Master File: Table), drag it into the Relationships window, and release the mouse. Now do the same with the tblDepartments: Table. You should now see boxes for the two tables in the Relationships window of Figure 4-5, but there will not be a line drawn between the two tables. That’s our next task.
• Step 2—Link the tables. To link the two tables together, drag and drop the Department
Code name from either table to the similar name in the other table. When you do, you should also see the Edit Relationships dialog window of Figure 4-5. This window enables you to enforce referential integrity. Check this box. In the context of this example, referential integrity is a control that prohibits users from creating employee records with references to nonexistent departments. (It does not affect your ability to create a department with no employees, however.)

FIGURE 4-5 Linking tables and enforcing referential integrity of table relationships.

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FIGURE 4-6 Showing subordinate data for multitable relationships.
If you follow these steps successfully, you should end up with a Relationships window with linked tables as shown in Figure 4-5. What you’ve done is link the tables together, using the Department Code as a foreign key. One dramatic way to see this linkage is to open the Departments table in run view (Figure 4-6). Note that there are now plus marks to the left of each department, indicating linked records. If you click on one of these plus marks with your mouse, you’ll be able to see these records, as illustrated in Figure 4-6. Although it isn’t obvious, the relationship you’ve created for your two tables will also enable you to create multitable reports. We’ll explain how to do that in Chapter 5.
The databases that we have constructed are simple, text-based databases (i.e., they include data that can be organized and categorized according to the values stored in text or numeric data fields). It is important to recognize that databases can handle a wide variety of data formats. Databases store text, hypertext links, graphics, video, sound, and so on. For example, real estate brokers store pictures and narrated tours of listed properties, police departments store mug shots and voiceprints of prisoners, and publishing houses enhance the descriptions of everything from cookbooks to encyclopedias. Your employer could use a database to store your picture in an employee file (Figure 4-7), or even your current location (Figure 4-8).

FIGURE 4-7 The employee records of this security database contain both text data and the picture of each employee.

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FIGURE 4-8 A database system with geotagging capability can record a user’s precise location.
Source: iStockphoto.

Case-in-Point 4.2 The U.S. Air Force recently warned that using social media sites such as Facebook could reveal servicemen’s and women’s position to enemies and threaten national security. Many sites have a feature called geotagging, which stores a user’s global position within the site’s database. Photographs taken with certain cell phones can also store geotags within the properties of the picture files. Location-based sites and files can reveal the precise locations of users. Indeed, many firms use geotagging capabilities to track raw materials and inventory.2 ENTERING DATA IN DATABASE TABLES
Creating Records
After specifying the names, data types, sizes, descriptions, and primary key for the data fields in our table, you can create individual records for it. To do so, you must switch to datasheet (or run) view. An easy way to do this is to close the design view of this table and then select the Datasheet view from the View menu in the upper-left portion of the Access screen in Figure 4-3.
After making these choices, you should see a screen similar to Figure 4-9. This is a table in datasheet view, and you are now free to input the data for individual records. Begin by entering data in the row with the asterisk (∗) and use the tab key to transition from data field to data field. Every time you complete the data entry for a new record, Access will save the record in the appropriate table automatically.
If you make a mistake while entering data, you can use your backspace key or delete key to correct it just as you would when correcting text in a word processor. Also, if you wish, you can delete an entire record by clicking on the first column to select an entire row (record) and then hitting the delete key. Because Access saves changes immediately, it will first remind you (via a small dialog box) that such a change will be permanent. If you indicate that this is your intent, Access will proceed to delete the record.
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FIGURE 4-9 Dataview sheet for Payroll MasterFile table.

Ensuring Valid and Accurate Data Entry
The data definition language (DDL) of a DBMS enables its users to define the record structure of any particular database table tab (i.e., the individual fields that each record will contain). Thus, DDL is the language that DBMSs use to create the data dictionaries that we described in Chapter 3. Well-conceived record structures can serve as controls over the accuracy of critical accounting data. For example, strong data definitions could prevent errors such as typing ‘‘4’’ instead of ‘‘40’’ for hours worked, ‘‘NU’’ instead of ‘‘NY’’ for the state code in a mailing address, or ‘‘UPC’’ instead of ‘‘UPS’’ for the shipper code. Although it is impossible to guard against every possible type of error, database designers can use the following tools found in typical DBMSs to catch many of them.

Proper Data Types for Fields. Using Microsoft Access, one input control is inherent in the data type that you assign to a particular data field. For example, if you create a data field as a number data type, Access will reject all character inputs that are not numbers.
Similarly, if you declare a data field as a date data type, Access will reject all input values
(including alphabetic letters or punctuation marks) that cannot be part of a date. This is why it is often better to use data types other than text for data fields.
Input Masks. Input masks limit users to particular types of data in specific formats—for example, ‘‘123-45-6789’’ for a Social Security number, ‘‘(123)456-7890’’ for a telephone number, or ‘‘8/9/10’’ for a date. Although system designers use special symbols for the mask, the DBMS interprets these symbols as input requirements and acts accordingly. At dataentry time, the user will see the formatted part of the mask—for example, ‘‘___-__-____’’ for a Social Security number. Input masks help users input data correctly in databases by indicating a general input format, thereby reducing data-entry errors. Such masks also enable the system to reject incompatible data—for example, a letter mistakenly input in a numeric field.

Default Values. A third control over the accuracy of data entry is to specify a default value for the data fields of new records. For example, a payroll program could include the number ‘‘40’’ in the hours-worked data field for all employees who typically work 40 hours each week. Again, default values help guard against input errors as well as speed data entry.

Drop-Down Lists. You have likely seen combo boxes on Web pages that contain drop-down lists of choices. Database systems such as Access 2010 enable you to use

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FIGURE 4-10 An example of a combo box at run time for the violation code of the Ticket File table. similar boxes for your tables or forms (Figure 4-10). Although such boxes are convenient alternatives to typing data manually, they also control input errors because they limit user entries to valid inputs. In Access, another advantage of using a combo box is that you can store the choices for it as the values of a separate table, adding to the flexibility of the database itself.

Validation Rules. One of the most versatile data-entry controls is the ability to create custom validation tests using a validation rule. Using Microsoft Access, for example, you create such rules as a record-structure property of a data field. Figure 4-11 illustrates an example for the ‘‘Fine Amount’’ data field of the Parking Violations Code table from
Chapter 3, Figure 3-17. This (numeric) data field shows the amount of money that a person must pay for a particular parking violation. In Figure 4-11, the expression Between 1 And
100 that appears in the properties window on the left side specifies the acceptable range of values. The error message in the message box on the right displays the ‘‘Validation Text’’ that you specify in this field’s properties window. This is what will appear in a message box when a user attempts to enter a value (such as ‘‘200’’) that falls outside the allowable range. FIGURE 4-11 (Left) The properties window for the fine amount data field of the Parking Violations table.
(Right) The error message that a user would see if he or she attempts to enter a value for this field that falls outside the specified range.

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Validation rules can be simple, such as the one in Figure 4-11, or much more complex.
For example, Access also enables you to use mathematical computations, predefined functions, and logical operators to create more complex validation rules. An example is
Between 1 And 100 AND Not 77, which means that the entry value must fall in the specified range and cannot be ‘‘77.’’ Another example is Between [fldStartDate] and [fldEndDate], which means that the date entered must be between an employee’s hire date and his or her termination date.

Case-in-Point 4.3 Validation rules can accomplish more than just reducing data-entry errors. Pacific Timesheet makes employees’ human resource data and related validation rules transparent to employees requesting time off. By making the validation rules transparent, employees are less likely to request time off when they fail to meet the requirements for the request. The system discourages requests for time off that will be denied, saving the valuable time of human resource personnel and helping employees understand why their requests are declined.3 Referential Integrity. A final data-entry control is to enforce referential integrity in relational database tables. This feature controls certain inconsistencies among the records in relational tables. Consider, for example, the possibility of deleting a Parking Violations
Code record from the third database table in Figure 3-17 (e.g., deleting the record for Code
A—meter expired). We can’t allow such a deletion because this would disrupt all of the references to that record in the Ticket table. For the same reason, we can’t allow new records in the Ticket table to reference nonexistent codes in the Parking Violations Code table—for example, a ticket with Code Z (if such a code didn’t exist). This would be a parking ticket for a nonexistent violation.
Database management systems make it easy to enforce referential integrity. In Access, for example, you simply check a box in the Edit Relationships dialog window at the time that you create the relationship—see Figure 4-12. This enforcement performs two

FIGURE 4-12 This dialog box appears when you first create a relationship in Microsoft Access.
Clicking the check box to Enforce Referential Integrity does just that.
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vital functions. First, it does not allow record deletions in the one table of a one-to-many relationship. Second, it does not allow a user to create a new record in the many table of a one-to-many relationship that references a nonexistent record on the one side. Case 4–23 illustrates these concepts in more detail.
In Figure 4-12, note that the Edit Relationships window in Access provides two additional boxes that you might check: one that allows Cascade Update Related Fields and one that allows Cascade Delete Related Records. These options enable you to override the referential integrity rules just described (although Access will warn you first). If you chose the first of these options, for example, you could delete a record in the Parking Violations
Code file, and Access would also delete the reference to that record in the records of the
Ticket file. (This would not be desirable here; however, it would leave you with tickets in the Tickets file with no violation code in them.) The second option allows you to delete a record from the one side of a one-to-many relationship, even if there are matching records on the many side. For example, if you delete a record in the Car Registration table, Access will then delete all the ticket records associated with that record (car) in the Ticket File table. Tips for Creating Database Tables and Records
The preceding discussions described how to create tables and records in a database. There are many things that can go wrong when performing these tasks. Here are some guidelines to help you avoid them.
1. Design first; create tables and records last. Some people don’t have time to do things right—only time to do things over. Don’t be one of them. A careful definition of database entities and their relationships can prevent many problems later.
2. Name tables systematically and use conventional tbl prefixes. Even small databases contain many tables, queries, forms, and reports. Using conventional prefixes such as ‘‘tbl’’ for tables and ‘‘qry’’ for queries enables database designers to distinguish among them. You may also find it useful to name related tables systematically—for example, use names such as ‘‘tblCustomer_MasterFile’’ or ‘‘tblCustomer_Returns’’ for different types of customer files.
3. Use mnemonic names for data fields. Each data field within a record must have a name, and mnemonic names help you remember what each field means. For example, the name ‘‘State’’ is better than ‘‘Address Line 3’’ to represent the data field for the customer’s state. Similarly, the names ‘‘State Abbreviation’’ or ‘‘State Code’’ may even be better if you allocate just 2 digits for this field.
4. Assign correct data types to data fields. If you plan to manipulate a data field mathematically, you must define this field as a number—not a text field. You should use text data types for fields such as Social Security, credit card, or phone numbers. These numbers are really codes that are too long to store as numbers, but ones that Access can store easily as text values.
5. Data fields that link tables together must be the same data type. If you use the data fields from separate tables to link two tables together, these fields must be of the exact same data type. Thus, you cannot link tables together if the foreign key in one table is a text field and the other is a date field. As noted earlier, when using ‘‘number’’ data fields, the type of number must also match—for example, each data field must be a long integer. Violating this rule is one of the most common errors novices make when creating database tables and relationships in Access.

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6. Limit the size of data fields to reasonable lengths. Access assigns a default size of
‘‘255’’ characters to text fields. If, for example, you designate a state code of only two digits, you should change the default size to two digits. This will limit users to entering no more than two digits. A similar guideline applies to Social Security numbers, telephone numbers, product numbers, and similar values of predetermined, fixed length.
7. Use input masks. As explained earlier, an input mask is a template that outlines the expected values for a data field. An example of a phone number input mask is
(999)000-0000, which limits the values in a phone number field to 10 numeric digits.
Input masks help ensure accurate data input and help reduce mistakes.

EXTRACTING DATA FROM DATABASES:
DATA MANIPULATION LANGUAGES
The totality of the information in a database and the relationships between its tables are called the database schema. Thus, the schema is a map or plan of the entire database.
Using the previous student parking example, the schema would be all the information that a university might store about car registrations and parking tickets.
Any particular user or application program will normally be interested in (or might be limited to) only a subset of the information in the database. This limited access is a subschema, or view. For example, one subschema for our parking database might be the information required by the university registrar—for example, the student’s name,
Social Security number, and outstanding parking tickets. Subschemas are important design elements of a database because they dictate what data each user needs, and also because they protect sensitive data from unauthorized access.
The terms schema and subschema describe a simple idea—the distinction between the design of a database on one hand and the uses of a database on the other. The goal is to design a database schema that is flexible enough to create all of the subschemas required by users. The following sections describe several ways to create subschemas.

Creating Select Queries
The purchasing agent of a manufacturing company needs to know what inventory balances are below their reorder points. A payroll manager wants to know which employees are eligible to receive year-end bonuses. A tax assessor is interested in those areas of the city that have experienced the most real estate appreciation.
What these individuals have in common is the need for specific information from one or more database tables. Queries allow database developers to create customized subschemas. For example, using the student car registration database, you might want to
(1) look up something about a specific student (e.g., the license plate number of his or her car), (2) change the information in a specific record (e.g., update a student’s phone number), (3) delete a record (e.g., because the person sells his or her car), or (4) list file information selectively (e.g., prepare a list of all students with California license plates).
A dynaset is a dynamic subset of a database that you create with such queries, and the purpose of a data manipulation language (DML) is to help you create such dynasets.

Case-in-Point 4.4 Internal auditors are charged with evaluating internal controls, operational efficiency, business risks, and other critical factors for success. The volume of data that internal auditors examine has expanded rapidly over the past decade, and internal auditors

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are developing new tools and testing procedures to detect risks and operational inefficiencies in complex environments. Conducting database queries is now a valuable and important skill for internal auditors. One example of modern application of queries by internal auditors involves employee phone records. Firms can analyze the phone calls made by their employees in order to reduce telecommunications costs and ensure compliance with policies related to telecommunications. Queries of long-distance call records allow internal auditors to detect misuse of phone services.4

One-Table Select Queries. A select query creates a dynaset of database information based on two types of user-specified criteria: (1) criteria that determine which records to include and (2) criteria that determine which data fields to include from those records.
Figure 4-13 illustrates a simple select query that displays particular information from a single table using Microsoft Access. This example asks the system to display the last name, first name, phone number, state licensed, and license plate number for all cars with California license plates.
You can create several types of queries with Access 2010. One is a simple filter query that references only one table. Another combines the information from several tables. A third type is an action query. We look at each of these queries next.

Single Criterion. To create a simple filter query, first click the Create tab on the main menu bar. In the Create menu, click ‘‘Query Design.’’ Access will display a small dialog box that allows you to select the table(s) on which to base your query. To create the query in
Figure 4-13, we need only the tbl Car Registrations File. The bottom portion of Figure 4-13 shows the layout in which to enter your data fields and the selection criteria for them.
Your next task is to select the data fields in each record you wish to display. One way to do this is to click on the first (left-most) cell in the Field row in the lower portion of the
Query panel. An arrow will appear in this cell. Click on this arrow and a drop-down list of

FIGURE 4-13 A simple query to select all car registrations with CA (California) license plates.
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Watson, M., and K. Dow. 2010. Auditing operational compliance: The case of employee long distance piracy.
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available data fields will appear. Select the field from this list that you wish to display in the current column (we selected Last Name in the figure). Continue across the panel until you have selected all the fields you need. Alternate methods of selecting data fields for queries in Access 2010 are (1) double clicking on the desired field name in the table list of the upper panel or (2) dragging the field name to the column.
Next, you must specify the selection criteria for the query. For example, to display only those records with California licenses enter ‘‘=CA’’ in the criteria box under ‘‘State
Licensed.’’ You will see CA is now enclosed with quotation marks, which Access automatically adds for you. Basic comparison operators are also available for setting criteria—that is, = (equals), < (less than), > (greater than), > = (greater than or equal to), < = (less than or equal to), and (not equal to).
You are now ready to run the filter. To do this, click the exclamation point with the word ‘‘Run’’ on the left portion of the main menu. The results of your query will appear as shown in Figure 4-14. You can toggle back and forth between design and run modes by clicking on the View option in the Results section of the left side of the main menu.
After you have created a query, most DBMSs enable you to save it in a separate file for later use, thus eliminating the need to rewrite it. This allows end users to run pre-made queries that are created by designers and database experts. The letters ‘‘qry’’ are the standard naming prefix for queries. Thus, as you can see in Figure 4-14, we named our query ‘‘qryCalifornia License Plates.’’

Multiple Criteria. It is also possible to specify multiple criteria in a query. For example, suppose you wanted a list of all car registrants whose cars had California license plates and whose last names were ‘‘Curry.’’ To create such a query in Access, simply type the name
‘‘Curry’’ in the ‘‘Last Name’’ column and in the same Criteria row as the ‘‘CA.’’ Access interprets criteria appearing in the same row as an ‘‘and’’ operation. The results will be all those records with last name ‘‘Curry’’ and whose license plate state is ‘‘CA.’’ Similarly, if you specify three criteria in the same row, then Access will find database records in the table satisfying all three requirements.
Sometimes, you might want to search for records that satisfy alternate requirements—for example, car registrants whose cars have California license plates or whose last names are ‘‘Curry.’’ To create such a query in Access, use multiple lines at the bottom of the Query dialog box in Figure 4-13. The result of this query will be all records that satisfy either requirement. (The system will also include records satisfying both requirements.)

FIGURE 4-14 The result of the query in Figure 4-13.

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FIGURE 4-15 A multiple-table query.

Multitable Select Queries. Many accounting applications require information that must be drawn from more than one database table. For example, suppose you wanted to create a report similar to the following:
Ticket
Number

License
Plate

Registered
Car Owner

Listed
Phone Number

Amount of Ticket

10151
10152
10231

CA 123 MCD
CA 123 MCD
CA 253 DAL

Dorothy Curry
Dorothy Curry
Richard Mason

(916) 358– 4448
(916) 358– 4448
(916) 563– 7865

$10.00
$20.00
$50.00

Notice that the information in this report comes from three different tables: the ticket number and license plate number come from the Tickets table, the registered car owner’s name and phone number come from the Car Registrations table, and the amount of each ticket comes from the Parking Violations Code table. To create such a report, you must first join the tables using the Relationships window as we described earlier in the chapter.
Your next step is to construct the query. Follow the steps outlined above for creating simple queries, being careful to select the data fields shown in Figure 4-15. The results should be similar to those shown in Figure 4-16.

FIGURE 4-16 The results of the multiple-table query in Figure 4-15.

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The tasks performed by a query such as the one shown in Figure 4-15 are nontrivial. To appreciate this, imagine that you had to create the report described above manually. Assume that there were over 100,000 parking tickets and millions of car registration records in the database. Sorting and organizing the records would take weeks. A computerized DBMS can accomplish this task and print the results almost instantly—an amazing accomplishment if you think about it!

Creating Action Queries
Although most queries simply extract information from database tables, some accounting tasks require users to update or delete multiple records in a single operation. Microsoft
Access supports the action queries listed below. You can create any of these queries by selecting the appropriate choice from the options that appear at the top of the screen after clicking on the Design tab while in the Query Tools menu (Figure 4-17).
• Delete queries. Enables you to delete table records selectively. Examples include the ability to delete employees who have left the organization, students who drop out of school or graduate from school, or inventory products no longer sold by the company.
• Append queries. Enables you to append records from one table to the end of another table. Accounting examples include the ability to add the payroll records for the current period to a year-to-date table or to consolidate the employees from two departments into a single table.
• Update queries. Enables you to alter selected table records systematically. Accounting examples include the ability to raise all suggested retail prices of a particular product line by 10%, lower the salaries of all those employees with a low performance rating by
5%, or add a fixed handling charge to all customer purchases over a set limit.
• Make-table queries. Enables you to create a new table from the records that you select in an existing table. For example, a university might want to create a separate table of all graduating seniors. Auditors might use this query is to create a separate table of all records that have been deleted in order to maintain an audit trail.
Some other queries available in the Access Query Wizard are:
• Simple query Wizard. Does the same thing as described previously under One-Table
Select Queries.
• Crosstab queries. Enables you to perform a statistical analysis of the data in a table and provide the cross-tabulation results in a row-and-column format similar to a pivot table in
Excel. For example, a crosstab query might show the average invoice amount for each vendor in a Vendor table or the average credit purchase amount for each customer living in a specified zip code.

FIGURE 4-17 The Query Wizard screen of options available in Access.

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• Find-duplicates queries. Enables you to find those records with duplicate entries in a specified field. Many common auditing tasks require such queries—for example, finding duplicate customer orders, finding employees with the same Social Security or employee number, or searching for different vendor records with the same address. Note that a simple select query might enable you to find one example of such duplicates. A find-duplicates query enables you to find all duplicates with a single query.
• Find-unmatched queries. Enables you to find the records in one table with no matching record in another table. For example, such queries enable auditors to identify those weekly payroll records with no matching master employee records or to identify vendor invoices with no matching supplier record.

Guidelines for Creating Queries
The preceding discussions described various kinds of select queries and action queries.
Here are some guidelines to help you create error-free queries using Microsoft Access:
1. Spell accurately and be sensitive to capitalization. The criteria for Access select queries are case sensitive. For example, you will not get matches if you specify California licenses as ‘‘Cal’’ or ‘‘Ca’’ in a criteria line if the entries in the underlying database table are
‘‘CA.’’
2. Specify AND and OR operations correctly. If you want a query to satisfy two conditions simultaneously (i.e., perform an AND operation), enter the criteria on the same line of your query. If you want a query to satisfy either of two conditions (i.e., perform an OR operation), place them on successive criteria lines.
3. Tables must be joined properly. If you wish to construct a multitable query, the tables should first be joined properly in the Access Relationships window.
4. Name queries systematically. Query names should begin with the standard ‘‘qry’’ prefix. It also helps to assign mnemonic query names—for example, ‘‘qryCustomers
_in_California’’ or ‘‘qryGraduating_Seniors.’’
5. Choose data fields selectively. Double clicking on the asterisk (∗) in the data field list of a table (e.g., the first symbol in each of the three table lists in Figure 4-15) enables you to include all the data fields from that table in your query. Because most commercial database tables have many data fields, using this option can result in a large number of data fields (i.e., columns in the lower portion of your query).

Structured Query Language
In addition to using a DML in a DBMS, you can also access selected information from a database using a data query language. The American National Standards Institute (ANSI) has adopted standards for one such query language: structured query language (SQL).
This language is important because most relational databases such as Access support it.
Figure 4-18 shows how you could construct the request for records with California license plates using SQL.
SQL is a useful tool for auditors because understanding SQL allows an auditor to retrieve data from many database systems, both small and large. In most contemporary business environments, an auditor can no longer retrieve data from paper reports. Instead, data must be acquired from the computerized accounting information system. SQL allows a user to

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SELECT (LastName, FirstName, PhoneNumber, LicPlateState, LicPlateNo)
FROM CarRegistrationFile
WHERE LicPlateState = CA;

FIGURE 4-18 An example of SQL instructions for the example of Figure 4-13. These instructions will list the last name, first name, phone number, license plate state, and license plate number of all cars with license plate state code ‘‘CA.’’

specify the table and fields that the user wants to retrieve, using commands such as FROM,
SELECT, and WHERE. FROM identifies the table source and SELECT chooses the data fields to include in the query. The WHERE command can specify criteria, such as selecting sales orders in excess of a specified dollar amount.

Sorting, Indexing, and Database Programming
In addition to accessing or listing records selectively, a DBMS also enables you to reorganize a table. One way to do this is by sorting records, which means physically rewriting records on a disk in the desired order. This is both time consuming and usually unnecessary. It is faster and easier to index your records (by setting the Indexed property to ‘‘Yes’’ in Figure 4-10), which simply creates a table of record keys and disk addresses that accomplishes the same purpose as sorting. Thus, when users specify ‘‘sort’’ in queries, Access does not physically reorder records but instead temporarily assembles the information in correct order for display purposes.
Finally, even the best DBMS software cannot anticipate every user’s processing needs.
For this reason, advanced DBMSs include programming tools that enable users to develop their own processing applications. Users commonly develop customized data-entry screens, which enable them to include better data descriptions and more detailed instructions for data-entry personnel on the input screens. Similarly, programming languages (such as VBA for Microsoft Access) enable users to create custom processing routines—for example, to create their own data-validation routines. This end-user programming is important because it enables users to perform their own data processing without the technical assistance of
IT professionals.

Online Analytical Processing and Data Mining
Online Analytical Processing (OLAP). OLAP involves using data-extraction tools to obtain complex information that describes what happened and also why it happened.
Several software developers now market OLAP packages. Examples include Integration
Server (Arbor Software), Holos (Seagate Technology), PowerDimensions (SyBase), Plato
(Microsoft), and WhiteLight (WhiteLight Systems). Some of these tools work only with specific databases, while others interface with several of them. Most allow end users to perform their own database analyses, including data mining (discussed shortly) and creating pivot tables, which are two-dimensional statistical summaries of database information (and similar to the pivot tables in Microsoft Excel).
Data Mining. Closely connected to OLAP is the concept of data mining, which means using a set of data analyses and statistical tools to detect relationships, patterns, or trends among stored data. For example, data mining tools might enable an auditor to find falsified

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invoices or overstated revenues. Data mining can help advertisers to cross-sell products or offer tie-in promotions, help retailers decide product placements in their stores (e.g., placing snacks near the frozen pizza section), and help sales managers increase customer satisfaction. Because data mining tools can sift through massive amounts of corporate data to detect patterns, they can be particularly effective tools for firms seeking to better understand their customers or their cost drivers.
A wide variety of software tools now provide data mining capabilities, and many data mining tools are included in OLAP software, database software, and artificial intelligence algorithms. In addition, users can purchase specific software packages for data mining tasks—for example, Darwin (Oracle), Intelligent Miner (IBM), Enterprise Miner (SAS), or
Clementine (SPSS).
Although the most popular uses of data mining are related to sales and marketing, there are many accounting applications as well. One possibility is for auditors to use data mining to detect credit card anomalies or suspicious behavior. For example, fraudulent credit card transactions may follow a pattern, such as an increase in the total amount of purchases immediately following a credit card theft or products with special characteristics (such as ones that can easily be sold). Another application is for investors to use data mining tools to predict corporate bankruptcies. The use of data mining is also expanding in the audit profession. Case-in-Point 4.5 Data mining can be employed to analyze the text in corporate e-mail and external communications. Recent psychology research demonstrates that employees’ and executives’ word choices can effectively detect lies and fraud. Future auditors are likely to employ advanced data mining techniques to analyze e-mails, corporate press releases, and minutes of board of director meetings.5

RECENT DATABASE ADVANCES AND DATA WAREHOUSES
Use of relational databases is widespread in business applications throughout the world.
Recent technological advances are changing the way firms design and use these database systems. Two of the most critical advances are cloud computing and XML.

Cloud Computing
Cloud computing is a form of Internet-based computing. Instead of applications being stored on individual workstations, software is provided through the Internet, processing occurs on a Web of computers, and information is ultimately sent to the user’s computer.
Cloud computing allows companies to expand their IT capabilities without investing in significant hardware, software, or training. All that is necessary is a subscription to a service that offers the software and processing capabilities that the firm needs.
The use of cloud computing is expanding rapidly in small businesses and large corporations because of its low costs, scalability, and simplicity relative to creating inhouse systems. Cloud services revenue was approximately $70 billion in 2010. Shifts toward cloud computing have major implications for modern database systems. New services called Database-As-A-Service (DAAS) are beginning to emerge. DAAS allows firms to outsource their databases to cloud service providers. For example, the databases behind consumer Web sites such as Amazon.com can be outsourced completely to
5

Hunton, J., and J. Rose. 2010. 21st century auditing: Advancing decision support systems to achieve continuous auditing. Accounting Horizons 24(2): 297– 312.

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providers who also manage Internet sales systems and Web interfaces. Enterprise Resource
Planning systems that contain all of the data for an entire organization can also be outsourced to cloud computing vendors. DAAS systems remove the need for firms to hire their own database administrators, design and maintain database systems, or purchase hardware. Thus, while the basic principles of databases will remain the same, the providers of database systems are changing. As databases move from within firms to ‘‘the cloud,’’ new considerations for accountants will emerge. In particular, controls over confidential firm data will be critical in the new cloud environment. Imagine the difficulty involved in protecting firm data that is no longer maintained on private servers within the firm, but is instead being managed on the Web.
Another common example of cloud computing involves backup services—that is, creating duplicate copies of critical data for security purposes. Just as individual users can backup files on synchronized external hard disks, businesses can contract with such vendors as Carbonite, Mozy, and SOS to create similar backups over the Internet. These vendors can often perform the same backup tasks less expensively and more reliably, and of course, such contracts shift the security responsibility from the database owner to the
Internet vendor. But such cloud computing also carries risks—in particular, the danger of relying upon an external party to protect sensitive data as well as properly maintaining the backups. Case-in-Point 4.6 Those companies maintaining large databases have at least one thing in common: the need to protect their data against intrusion, theft, and corruption. This is one reason why experts predict that, in the next few years, most businesses and government agencies will abandon onsite data storage and maintain all their critical databases on the media of online backup and storage service providers.6

Data Warehouses
Where feasible, it often makes sense to pool the data from separate applications into a large, common body of information called a data warehouse. The data in a data warehouse are rarely current. Rather, they are typically ‘‘older information’’ that was initially collected for other reasons during the conduct of normal operations and daily activities of an organization. For example, in recording a sale, an AIS collects data about the customer, the product, the timing of the sale, and so on. Extended histories of this information can be helpful in predicting things such as future sales of new products. In order to analyze large volumes of historical data, the data must first be amassed in a central location—the data warehouse. Case-in-Point 4.7 In 2010, researchers proposed a new application of data warehouses.
By using data warehouses to accumulate large amounts of information about security breaches both within a firm and across firms, organizations will be able to predict future attacks on their information systems. Predicting attacks will allow organizations to develop more effective security procedures and better allocate resources to technologies for protecting firm data.
These new data warehouses for security breaches will allow firms to detect patterns that would not be apparent in smaller data sets.7
6

http://ezinearticles.com/?Professionals,-Big-Businesses-Rely-on-Online-Backup-Services&id=5421978
Kim, P., and L. Steen, 2010. Can management predict information security threats utilizing a data warehouse?
Journal of Information Systems Applied Research 3(15).
7

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To be useful, the data in data warehouses should have the following characteristics:
(1) free of errors, (2) defined uniformly, (3) span a longer time horizon than the company’s transaction systems, and (4) optimized data relationships that allow users to answer complex questions—for example, queries requiring information from several diverse sources.
One advantage of a data warehouse is to make organizational information available on a corporate-wide basis. For example, the marketing representatives of a company can gain access to the company’s production data and thereby be better able to inform customers about the future availability of desired, but as yet unmanufactured, products. This idea is also central to the concept of an enterprise-wide database or enterprise resource planning (ERP) system (i.e., large repositories of organizational data that come from, and are available to, a wide range of employees).

Case-in-Point 4.8 With more than 9 million customers, KeyBank is the thirteenth largest bank in the United States. To help market financial products, the bank created a million-dollar
DB2 data warehouse that allows its managers to determine what investments its customers prefer (e.g., CDs or mutual funds) and how best to sell products (e.g., direct mail or Internet).
Bank officials credit the data warehouse, the decision tools that mine it, and the ability of different departments to share data, for increasing customer contacts by 200% and a 100% return on the investment in 14 months.8
Building a data warehouse is a complex task. The developers must first decide what data to collect, how to standardize and scrub (clean) the data to ensure uniform accuracy and consistency, and how to deal with computer records that are often not normalized. One reason for these difficulties is that the data in data warehouses may come from numerous sources. As a result, the same data element can have two different representations or values—for example, an eight-digit numeric product code in the AIS and a six-digit alphabetic character code in a production application. Similarly, one corporate division might capture sales daily while another collects the same data weekly. The developers must determine data standards in both cases, reconcile any discrepancies, and account for missing fields and misspellings. Another challenge is to build the data warehouse in such a way that users can access it easily and find answers to complex questions. Finally, data warehouses must be extremely secure, as they contain enterprise-wide data that must be protected. When corporate executives believe the rewards for building a data warehouse do not outweigh the costs, they can consider a data mart. Data marts are smaller than data warehouses, and they typically focus on just one application area—for example, marketing data. However, in most other ways, they are similar to data warehouses.

AIS AT WORK
Using Data Mining to Predict Financial Disasters9
Typically, we think about looking for patterns in numbers when talking about data mining.
For example, a firm might want to learn which products generate the most profits during different seasons, or it may seek to better understand its customers’ purchasing patterns. Data mining, however, can also be applied to text, such as stories in the popular
8

http://www.key.com
Cecchini, M., H. Aytug, G. Koehler, and P. Pathak. 2010. Making words work: Using financial text as a predictor of financial events. Decision Support Systems 50(1): 164–175.

9

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press, corporate e-mail, and even the financial statements themselves. Auditors, regulators, financial analysts, and investors may soon have a wide array of data mining tools available for predicting firms’ future performance.
The SEC requires all publicly traded firms to file electronically, which has created a huge volume of corporate filings that users can mine to discover patterns in data. A new data mining technique involves analyses of the Management Discussion and Analysis
(MD&A) section of the 10-K form, which the SEC requires. The MD&A is a narrative where management describes the prior year’s results and discusses future plans. The new data mining technique identifies firms that are likely to experience financial distress (such as bankruptcy) by studying the words in the MD&A section.
The main idea is to develop lists of keywords that are associated with firms that go bankrupt by examining the MD&A of all firms that go bankrupt during a period of time. Then, the system scans an individual firm’s MD&A and determines whether there is a pattern of key words that is similar to those found for bankrupt firms. When the similarity is high, the likelihood of bankruptcy is also high. According to its developers, the system accurately distinguishes between firms that go bankrupt versus those that do not go bankrupt with 80% accuracy. Again, this prediction is based solely on the statements made by management in the MD&A, without any examination of actual financial data. If analyzing only management statements can help predict bankruptcy, then advanced data mining systems that simultaneously analyze financial data, media coverage, MD&A, e-mails, and so on may prove to have substantial predictive accuracy.

SUMMARY
Database management systems (DBMSs) enable users to create their own databases using data definition languages (DDLs) and manipulate file data using data manipulation languages (DMLs).
Designers can integrate a variety of data-validation techniques to help ensure data integrity.
Examples include choosing data types carefully for data fields, using input masks, using default values, creating a wide variety of validation rules, and enforcing referential integrity.
Microsoft Access is a popular database management system that small businesses can use to create complete accounting systems. The chapter illustrated the techniques you can use to create database tables and records with this software.
An important use of databases is to extract selected information from it, and Access provides a number of tools for constructing select queries and action queries. These tools allow users to extract data from a single table or from multiple tables. Following the guidelines in this chapter can help you avoid errors when creating such queries.
Two additional ways of extracting information from databases are using structured query language
(SQL) and online analytical processing (OLAP) tools.
Users can also manipulate database information by sorting, indexing, using data mining tools, or performing specialized tasks with end-user programming languages.
Accountants are likely to need to extract data from a database or data warehouse at one time or another, using data manipulation languages such as queries, OLAP, or data mining tools.
Cloud computing and data mining are changing the design and delivery of database management systems. Data warehouses typically combine the information from separate databases into large sets of cross-functional data repositories that can help businesses increase data-retrieval efficiency, output productivity, and long-term profitability.

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KEY TERMS YOU SHOULD KNOW action query data definition language (DDL) data manipulation language (DML) data mart data mining data type data warehouse
Database-As-A-Service (DAAS) default value dynaset enterprise-wide database

field properties input masks online analytical processing (OLAP) pivot tables query referential integrity schema select query structured query language (SQL) subschema validation rule

TEST YOURSELF
Q4-1. What types of data can be stored in modern databases?
a. Text and graphics only
b. Text only
c. Text, graphics, video files, audio files, and programming code
d. None of the above can be stored in databases
Q4-2. The difference between a database management system (DBMS) and a database is:
a. Nothing—these terms are synonyms
b. The first is hardware, the second is software
c. The first is program software, the second is proprietary data and related files
d. The first refers to a complete accounting system, the second refers to a subset of that
Q4-3. An example of a validation rule is:
a. An input value must be an integer
b. An input value must also have a default value
c. An input value must be between 0 and 40
d. You cannot delete parent records that have child records associated with them
Q4-4. To construct a select query in Microsoft Access in which you want to satisfy two conditions simultaneously—that is, implement an And operation—you should:
a. Specify both criteria in separate fields of the Criteria line of the query
b. Specify both criteria in the same field of the Criteria line of the query
c. Specify each criterion in separate fields and in separate Criteria lines of the query
d. Give up; this is not possible in Microsoft Access
Q4-5. To adjust the minimum wage of all payroll employees to the current federal level, you should use a(n):
a. Update
b. Append query
c. Find minimums query
d. Tax expert

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Q4-6. To identify all those employees receiving payroll checks but who have no matching record in a payroll master file, you should:
a. Use an auditor
b. Find unmatched records query
c. Use cross-tabs query
d. Update query
Q4-7. All of the following are examples of DBMSs except:
a. Access

c. DB2

b. Oracle

d. SQL

Q4-8. All of the following are examples of action queries except:
a. Update query
b. Append query
c. Delete query
d. Find missing data query
Q4-9. The difference between using an update query and updating a single record is:
a. Nothing—both are the same
b. The first updates all selected records, the second affects only one record
c. The first updates more than one table, the second updates only one record
d. None of these is correct
Q4-10. SQL is an example of:
a. A tool to perform online analytical processing
b. A database management system
c. A query language
d. A multimedia database

DISCUSSION QUESTIONS
4-1. This chapter described how to create tables and records in Microsoft Access. What other database management systems are available? Use the Internet to learn more about these systems. 4-2. Identify the different data types available for creating data fields in Microsoft Access. Similarly, identify the different types of numbers (e.g., long integer) you can use if you define a field as a data type. (Hint: create a data field in a throwaway database table, assign it a number data type, and examine the possibilities for the Field Size property.)
4-3. Create a Salesperson table and a Customer Order table using the data in Figure 3-11. Create records for each table using the data provided. Add one more Salesperson record with your own name and an employee number of your choosing. Also add at least one customer order with your number as the salesperson. Finally, create a relationship for the two tables. Create hard-copy documentation of your work.
4-4. What are database management systems? Are they the same as databases? Why are DBMSs classified as software and not hardware?

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4-5. What are data definition languages (DDLs)? How are they related to DBMSs?
4-6. Why do database developers link tables together? How is this done using Access?
4-7. What is data validation? Why is it important? Give some examples of how to validate data inputs using Access.
4-8. What are data manipulation languages? How are these languages related to database management systems? How are these languages related to databases?
4-9. What is SQL? How is SQL like an Access query? How is it different?
4-10. What is online analytical processing? How is OLAP related to databases? What is a pivot table and how are pivot tables and OLAP related?
4-11. What is the difference between sorting records and indexing records in a database?
4-12. What is data mining? How is data mining useful to profit-seeking companies? What are some accounting uses of data mining?
4-13. What is cloud computing? How will it influence accounting systems?
4-14. What are data warehouses? How are they like databases? How do they differ from databases? 4-15. Why would a company be interested in creating a data warehouse? Why would a company not be interested in creating a data warehouse?

PROBLEMS
4-16. The Query Corporation employs the individuals listed in Figure 4-19. Use Access or another
DBMS required by your instructor to create a database of this information and then perform the following queries.
a. List all employees in Department 5. Print this list.
b. List all employees with first name Brenda. Print this list.
c. List all those employees with pay rates over $6.50. Print this list.
d. List all those employees eligible for overtime (T = yes; F = no). Print this list.
4-17. Use the Web to find current examples of data warehousing software. Why do companies create data warehouses and what are some accounting uses of such warehouses?
4-18. Use the Web to find current examples of online analytical processing (OLAP). Why do companies use OLAP? What is the connection between OLAP and databases?
4-19. The information in Figure 4-20 is for the employees of the Marcia Felix Corporation. Use a
DBMS software package to create a database for it.
a. What record structure did you design? Identify the names, widths, and other characteristics of each field in a typical record.
b. Sort these employees by department. Print this list.
c. Sort these employees by test score. Print this list.
d. Sort these employees by department and alphabetically by last name within department.
e. What is the average pay rate for these employees?
f. What is the average pay rate for females? What is the average for males?
g. What females scored over 70 on their examinations? What males scored over 50?

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Record
Number

Last
Name

First
Name

Social
Security
Number

Dept

Pay
Rate

Overtime

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

ADCOX
KOZAR
MCLEAN
CUNNINGHAM
DANIELS
MCGUIRE
REEDER
BLOOM
DAVIS
DUFFY
HARPER
MORGAN
WELSH
CHAPIN
FINN
HALPIN
LAURIN
MIAGLIO
TURNER
ZORICH

NORMAN
LINDA
KAY
TOM
PATRICIA
ANNE
BRENDA
BRENDA
DENISE
LESLIE
LINDA
MEREDITH
KAREN
GEORGE
JOHN
MARSHA
PHILIP
PEGGY
BRENDA
MILDRED

901795336
412935350
405751308
919782417
517351609
201891647
619294493
513321592
517351608
314532409
615824130
704563903
216253428
203767263
715386721
913541871
514484631
414224972
713589164
504455827

1
1
1
3
3
3
3
4
4
4
4
4
4
5
5
5
5
5
5
5

6.50
6.50
7.50
7.50
5.50
5.50
5.50
6.25
5.50
8.50
5.75
6.25
8.25
7.50
6.25
6.50
6.50
6.25
8.50
6.50

Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
Yes
No
Yes
Yes
No
Yes
Yes
Yes
Yes
Yes
No
Yes

FIGURE 4-19 Employees of the Query Corporation.

CASE ANALYSES
4-20. BSN Bicycles I (Creating a Database from Scratch with Microsoft Access)
Bill Barnes and Tom Freeman opened their BSN bicycle shop in 2005. Not counting Jake—a friend who helps out occasionally at the store—Bill and Tom are the only employees. The shop occupies a small commercial space that was once a restaurant. The former kitchen now stores spare parts and provides space for bicycles repairs while the former dining area in the front is now the retail sales area. The corporate office is just a desk and file cabinet in the back corner of the retail area.
Bill and Tom are more friends and bicycling enthusiasts than businessmen. They’ve pretty much sunk their life savings into the shop and are anxious that it succeed. In the first year of operations, they worked hard to convert the space into its present condition, which includes an old-timey sign above the door with their name ‘‘BSN Bicycles.’’
With all the other work that had to be done the first year, marketing efforts have been limited to chatting with friends, distributing flyers at bicycle races and similar sporting events, and placing a few advertisements in the local newspaper. Similarly, the owners haven’t paid much attention to accounting tasks. Who has time with all the other things that had to get done? But at least two things are now clear to the owners: (1) some of their loyal customers prefer to buy items on credit, and (2) all of their suppliers want to be paid on time.
Right now, BSN’s customer credit system is a box of 3 × 5 cards. Each handwritten card contains customer information on the front and invoice information on the back

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131

Personnel File
Date: October 10, 20xx

Employee
Number
BAKER, JEFFREY L.
BARRETT, RAYMOND G.
BLISS, DONALD W.
BOWERS, PAUL D.
BUCHANAN, CINDY
CHEUNG, WAI KONG
CONRAD, MARK E.
DAILY, REBECCA E.
DRISCOLL, DAVID M.
ERICKSON, KURT N.
FRANTZ, HEIDI L.
GARROW, SCOTT D.
HARDENBROOK, LISA A.
JACKSON, GREG W.
LANGLEY, JERRY W.
LUBINSKI, TRAVIS M.
LYNCH, SHERENE D.
MARKHAM, KYLE R.
MCGUIRE, TANA B.
MONACH, SHERI L.
MOORE, MICHAEL S.
NELSON, JOHN R.
PAPEZ, PETER M.
PETTINARI, DARIN M.

Score on
Aptitude
Test

Department
ID

Current
Pay Rate

Sex

1692
3444
6713
2084
3735
8183
8317
2336
5210
2217
6390
8753
7427
4091
3262
3865
7857
6766
4052
8082
2431
5873
7799
1222

73
53
55
42
41
55
58
45
47
53
55
61
40
67
86
37
66
62
55
48
67
46
41
56

A
B
D
B
E
C
D
D
D
B
A
A
C
D
E
D
D
A
A
B
E
B
E
B

$7.50
7.45
6.80
5.90
7.80
7.80
9.60
8.90
7.70
8.50
6.90
7.40
6.70
8.90
9.40
7.50
8.90
7.90
9.20
9.10
8.50
7.40
8.30
8.40

M
M
M
M
F
F
M
F
M
M
F
M
F
M
M
M
F
M
F
F
M
M
M
M

FIGURE 4-20 Employee data for the Marcia Felix Corporation.
(Figure 4-21). When a customer pays an invoice, one of the owners simply crosses off the invoice information on the card. The supplier accounts system is similar, except that the vendor box of 3 × 5 cards is green, whereas the customer box is grey.
Jake is a part-time student at the local community college. He recently completed a course on microcomputer applications that included a segment on Microsoft Access. He doesn’t know very much about database theory, but thinks that converting the shop’s current accounting systems to a DBMS might be a good idea. He thinks, for example, that
BSN needs a Customer table and a Vendor (supplier) table. He also thinks that BSN will need an Inventory table to keep track of inventory, but that even more tables might be required. Can you help them?

Requirements
1. Identify the resources, events, and agents for BSN’s accounting systems. Draw one or more E-R diagrams that illustrate the relationships between these items.
2. Identify the tables that you would need to create a working database for the company’s receivables, payables, and inventory.

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PART TWO / Databases

(a) The front of a 3x5 BSN customer card.

(b) The back of a 3x5 BSN customer card.

FIGURE 4-21 A customer record for the BSN company.
3. Using Access or another DBMS required by your instructor, create at least three records for each of the tables you identified in part 2. Hints: (1) Use the information on the front of the 3 × 5 card in Figure 4-21 for the customer record structure. (2) The data fields for the Vendors table should include the vendor ID, vendor name and address information, phone number, fax number, and contact person. (3) The data fields for the Inventory table should include item number, item description, units (e.g., dozen, each, etc.), unit cost, unit retail sales price, and quantity on hand.
4. Create relationships for your various tables.
5. Document your work by printing hard copies of each table in data sheet view and each relationship. 4-21. Furry Friends Foundation I (Creating a New Database from Scratch)
The Furry Friends Foundation is a nonprofit organization that finds homes for abandoned animals that are suitable for adoption. FFF began operations with a bequest from a wealthy gentleman who lived his life taking care of stray animals and wanted to be sure that such animals were looked after once he was gone. Although the amount the foundation started with was sufficient to set up an office and begin operations, it depends on continuing donations to run daily operations.

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FFF has been keeping their records on 4 × 6 cards. Over the years, the foundation has had requests for year-end statements that document their donations to the Foundation for tax purposes. (Usually, donations are given with a particular type of animal in mind—for example, ‘‘for dogs.’’)
Now that the number of contributors exceeds 500, the president has decided to develop a database to handle the foundation’s accounting and reporting needs. The following is a sample of some of the records at FFF.
FFF Contributor File
Contributor ID
13456
13480
13484

Last
Name

First
Name

Street
Address

City

Smythe
Jonathan 1845 Backpack Lane Franktown
Lawrence Marie
9190 Teepee Road
Doolittle
Funky
Robert
5815 Pearly Gate Lane Happiness

State
NV
NV
NV

Zip

Phone

55655 (501)666– 1234
54984 (501)767– 1114
53887 (501)995– 7654

FFF Donation File
Donation Date
September 30, 2009
September 20, 2009
October 15, 2009
October 15, 2009
October 31, 2009
October 31, 2009
November 30, 2009
November 15, 2009
December 1, 2009
December 10, 2009
September 10, 2009
October 10, 2009
November 11, 2009
December 14, 2009
September 5, 2009
October 10, 2009
November 8, 2009
December 15, 2009

Animal Code

Amount

Contributor ID

C
D
C
D
C
D
D
C
O
C
C
C
C
D
C
O
O
D

25
125
25
10
20
20
250
25
70
100
250
500
150
100
100
100
100
50

13456
13456
13456
13456
13456
13456
13456
13456
13456
13480
13480
13480
13480
13484
13484
13484
13484
13484

FFF Animal Code Table
Contribution for Code
Dogs
Cats
Hamster
Guinea Pig
Rabbit
Other

D
C
H
G
R
O

Requirements
1. Using Access or a similar relational database, create the tables needed to set up a database for contributors, contributions, and whether the contributions are to be used for dogs, cats, hamsters, guinea pigs, rabbits, or nonspecified.
2. What did you use for the primary record key of the FFF donation file table? Why did you use it?
3. Using Access or similar software as required by your instructor, add yourself as a contributor. 134

PART TWO / Databases

4. Create relationships for the tables.
5. Document your work by printing hard copies of each table in datasheet view and the relationships report that shows how they are related.

4-22. Bonnie P Manufacturing Company (Data Validation Using a DBMS)
The payroll department at the Bonnie P Manufacturing Company has defined the following record structure for employee records.
Date Field
Last name
First name
Social Security number
Home phone number
Work phone extension
Pay rate
Number of tax exemptions
Department

Data Type

Example

Text
Text
Text
Text
Number
Currency
Number
Text

Kerr
Stephen
123-45-6789
(987)456– 4321
123
$12.34
3
A

All fields are required. The employee’s Social Security number serves as the record key.
Work phone extensions are always greater than ‘‘100’’ and less than ‘‘999.’’ Pay rates are always at least $7.75 and no more than $29.85. The maximum number of tax exemptions allowed is ‘‘10.’’ Finally, there are only three departments: A, B, and C.

Requirements
1. Using a DBMS such as Access, create a record structure for the company.
2. Create data validation rules for as many data fields as you can. For each data validation rule, also create validation text that the system can use to display an appropriate error message. Create a list of such rules on a separate piece of paper.
3. Create employee records for yourself and employees with the last names Anderson,
Baker, and Chapman using data that you make up. Print this information.
4. Attempt to create one more record that violates a data validation rule. Create a screen capture of one or more violations, as suggested by your instructor.

4-23. Clifford Cohen University (Enforcing Referential Integrity)
Clifford Cohen University was founded as a small, liberal arts school just three years ago.
Since that time, the institution has grown to the point where parking on campus is difficult and parking in illegal areas is common. Accordingly, the Board of Directors has reluctantly approved a policy requiring campus police to issue parking tickets.
Currently, the university requires students and faculty to register their cars with the parking office, which issues them parking decals that registrants must display inside the front windshield of their cars. At present, all record keeping at the parking office is done manually, severely limiting the ability of office personnel to create reports or perform meaningful statistical analyses about parking on campus. For example, it is currently not

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known how many students of each class (freshman, sophomore, etc.) register their cars or how many full-time faculty, part-time faculty, or clerical staff register their cars. The new policy of writing parking tickets will only add to this problem because it will require office staff to match parking tickets to student or faculty names. In addition, the Board of
Directors would like an end-of-semester report indicating how many parking violations of each type (meter violation, invalid parking sticker, etc.) are issued by the campus police.
To help solve these problems, the University Board of Directors has hired you to create a computerized system for them. You realize that a database system might work for this, and accordingly propose a database of tables with record structures similar to those in
Figure 3-17. The Board of Directors approves your plan, but asks that you create a small system to demonstrate its features before creating a full-blown system.

Requirements
1. Use Microsoft Access (or an alternate DBMS designated by your instructor) to create the three tables illustrated in Figure 3-17. What data type did you specify for each data field in each table?
2. Create at least three records in the car registration table. Be sure to use your own name as one of the registrants. Also, create at least three records for the Parking Violations
Code File. Make up your own fine amounts instead of using the ones shown in the figure. 3. For each record you create in the car registration file in step 2 above, create at least three parking tickets and input this information to the Tickets File. Thus, you should have at least nine records in this file. Be sure that at least one record in the Tickets File contains a reference to each of the records in the Parking Violations Code File (i.e., at least one person breaks every possible parking violation). Print copies of the records in each table for your instructor.
4. Attempt to create a record in the Ticket File that contains a nonexistent ticket code in the parking Violations Code File. Were you successful?
5. Link the tables together. Be sure to check ‘‘enforce referential integrity.’’ When you finish, your relationships window should resemble the one shown in Figure 4-15. What are the relationships among the records in the three tables? Print a copy of this window as documentation for your project.
6. Now again attempt to create a record in the ticket file that contains a nonexistent ticket code in the parking Violations Code File. Were you successful this time?
7. Finally, attempt to delete a record in the Parking Violations Code File. Why can’t you do it?
8. If required by your instructor, create an example of the parking-violations-by-type report desired by the Board of Directors using the database you just created.

4-24. BSN Bicycles II (Creating Queries in Access)
Business has been growing at BSN Bicycles, and the store owners have been using their
Access database to store information about their customers. Now that the store is a little more established, the owners are thinking more about how best to attract more customers to their store. One idea is to see where their current customers live. The owners also want a complete list of their credit customers.

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Requirements
1. If you have not already done so, create a database for BSN and the Customer table described in Case 4–20. Be sure to create at least 10 customer records for the company, including one with your name. Several of the customers should also live in the state of Virginia (VA) and several customers should have zip code ‘‘12345.’’ The Virginia customers and the customers with zip code 12345 do not have to be the same.
2. If you have not already done so, create several invoices for your customers.
3. Create a query that selects all customers living in Virginia. Print your results.
4. Create a query that selects all customers living in zip code 12345. Print your results.
5. Create a query that selects all customers living in Virginia who also have zip code 12345.
6. Create a query that selects all credit customers. (Hint: use the word ‘‘Yes’’ for the criteria in this query.)

4-25. Furry Friends Foundation II (Creating Queries for Databases)
Recall from Case 4–21 that the Furry Friends Foundation is a nonprofit organization that finds homes for abandoned animals. The foundation has recently computerized some of its operations by storing its accounting data in a relational database. One reason for this was to enable it to more easily answer questions about donations. This portion of the case provides some examples of such questions and gives you practice creating database queries to answer them.

Requirements
1. If you have not already done so, create the tables and relationships described in
Case 4–21.
2. Using Access or similar software as required by your instructor, create three donations for yourself. You should be donating to dogs in one contribution, cats in the second contribution, and unspecified in the third contribution.
3. Create a query that selects all customers donating to cats. Print your results.
4. Create a query that selects all contributors who donated over $50. Print your results.
5. Create a query that selects all contributors who donated over $100 to dogs. Print your results. READINGS AND OTHER RESOURCES
Borthick, F., and M. Curtis. 2008. Due diligence on fast fashion inventory through data querying.
Journal of Information Systems 22(1): 77–93.
Cecchini, M., H. Aytug, G. Koehler, and P. Pathak. 2010. Making words work: Using financial text as a predictor of financial events. Decision Support Systems 50(1): 164–175.
Hunton, J., and J. Rose. 2010. 21st century auditing: Advancing decision support systems to achieve continuous auditing. Accounting Horizons 24(2): 297–312.

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Loraas, T., and D. Searcy. 2010. Using queries to automate journal entry tests: Agile Machinery Group,
Inc. Issues in Accounting Education 25(1): 155– 174.
Watson, M., and K. Dow. 2010. Auditing operational compliance: The case of employee long distance piracy. Issues in Accounting Education 25(3): 513–526.

Create a Pivot Chart Using Microsoft Access: http://office.microsoft.com/en-us/access-help/video-pivot-your-data-in-accessVA101842926.aspx Create a Simple Query: http://www.youtube.com/watch?v=WxGKLfWIJTU Create a Table Using Microsoft Access: http://www.youtube.com/watch?v=RD350qUlFdY&feature=related ANSWERS TO TEST YOURSELF
1. c

2. c

3. c

4. a

5. a

6. b

7. d

8. d

9. b

10. b

Chapter 5
Database Forms and Reports

INTRODUCTION
FORMS
Creating Simple Forms
Using Forms for Input and Output Tasks
Subforms—Showing Data from Multiple Tables
Concluding Remarks About Forms

A Listing of BSN Suppliers (Creating Simple Reports in Access)
Furry Friends Foundation III (Creating Forms and Reports)

READINGS AND OTHER RESOURCES
ANSWERS TO TEST YOURSELF

REPORTS
Creating Simple Reports
Creating Reports with Calculated Fields
Creating Reports with Grouped Data
Concluding Remarks About Reports

AIS AT WORK—MOTHER LODE BICYCLES
SUMMARY
KEY TERMS YOU SHOULD KNOW
TEST YOURSELF
DISCUSSION QUESTIONS
PROBLEMS
CASE ANALYSES

After reading this chapter, you will:
1. Understand how to create simple forms in
Access.
2. Understand the difference between a bound control and an unbound control on an Access form or report.
3. Know how to create advanced forms in Access with subforms.
4. Understand how to create simple reports in
Access.
5. Know how to create reports based on queries.
6. Know how to create reports that contain calculated fields and understand why databases do not store such fields in their tables.

A Form for BSN Suppliers (Creating a Simple Form in Access)
A Form and Subform for BSN Suppliers (Creating
Forms with Subforms in Access)

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Technical skills are an accountant’s best friend nowadays. It should be self-evident as to why. Data. Data. Data.
Devereaux, G. 2010. An argument for techie accountants. Going Concern.1

INTRODUCTION
The previous chapters illustrated how to design a database with several tables and also how to construct queries to select information from these tables. Two more important database tools are forms and reports. The first section of this chapter discusses how to create forms and also how to use forms for input and output tasks. The second section of this chapter discusses how to create reports. Both sections illustrate these tasks using Microsoft Access, but the skills discussed here are also applicable to other database software such as FoxPro or Oracle.

FORMS
Figure 5-1 illustrates an example of a database form—that is, a custom-designed screen for entering records or displaying existing records. As you can see in Figure 5-1, a form has three major sections: (1) a heading section, which appears at the top of the form;
(2) a detail section, which usually occupies the majority of the form and typically displays the record information; and (3) a navigation bar, which always appears at the bottom of the form.
Although there is no requirement to use a form for entering data into a database table, there are several reasons why using a form is better than using a datasheet screen such as

FIGURE 5-1 An example of a database form at run time.
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FIGURE 5-2 A portion of the Customers table (in datasheet view) from the BSN Database. the one in Figure 5-2 for this task. One advantage of forms is that a datasheet displays many records at once, making it possible to accidentally type over existing information instead of creating a new record. Another advantage is that a form can display all the data-entry textboxes for an entire record in one screen, whereas a datasheet typically requires users to keep tabbing to the right to enter data for off-screen items (Figure 5-2).
A third advantage of forms is that you can customize them. Figure 5-1 illustrates several examples of such customization, including (1) custom header information (e.g., the label with the words ‘‘BSN Customers’’) at the top of a form, (2) text, logos, artwork, and (as shown) pictures for graphic interest, (3) more complete names (instead of the default database names) to identify each field in the database table (e.g., ‘‘Customer Number’’ instead of ‘‘CustNo’’), (4) the ability to group similar fields together in the form (e.g., the phone numbers), (5) the ability to add explanations or special instructions in the form to help users understand how to enter data (e.g., see the label for the State field), and
(6) customized tab ordering that governs the order in which textboxes become active on the form.
Taken together, the various advantages of forms make them better for controlling and validating data input than datasheet screens. That is, forms help prevent data-entry errors, which is a critical component of the reliability of data and essential to strong internal control (which we discuss in more detail in Chapter 10).

Creating Simple Forms
To create a custom form for a database table in Access, you can design a form from scratch by selecting Blank Form from the Form menu in Figure 5-3, but it is often easier to use the
Form Wizard for this.
If you click on the Form Wizard icon, you will see dialog boxes similar to the ones in
Figure 5-4. Follow these steps to create a form in Access:

FIGURE 5-3 Create menu showing the Form Wizard in Access 2010.

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(a) First screen.

(b) Second screen.

(c) Third screen.

FIGURE 5-4 The three dialog boxes in the Form Wizard.

Step 1—Enter the appropriate settings in the Form Wizard dialog boxes. In the drop-down option on the left side of Figure 5-4a, select the table you want your form to reference (e.g., tbl BSN Customer Master Table). You will also need to select the fields you want to display on the form. Clicking on the button with the >> symbol selects all the fields from your table in your form—a typical choice. You can also click on individual field names with your mouse and then click on the > button to select data fields one by one.
Use the second dialog box in Figure 5-4b to select a layout for your form—typically
Columnar because this setting enables you to include all the data fields on one form.
Finally, in the third dialog box of the Form Wizard (Figure 5-4c), you will need to create a name for your form. As with many other database objects, you should use the conventional prefix for a form name—frm—and then create a name that helps you remember the form’s application.2 In Figure 5-4c, for example, we have named the form frmCustomers. At this point, you can click on the Finish button in the last dialog box and you’re done. The Form
2
In Chapters 4 and 5 we have recommended prefixing all files with tbl, frm, and rpt. Microsoft Access 2010 also includes icons on the left side of each file name that indicate the file type.

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Wizard will then create the form with the settings you’ve indicated and list the completed form among those available for use in the main menu for forms.

Step 2—Customize the form. If you open your form in design view, you will see something like the one in Figure 5-5. This figure helps make clear that a form has two modes—run mode, which looks similar to Figure 5-1, and design mode, which looks similar to Figure 5-5. In fact, the form in Figure 5-5 was the starting point for the completed form in Figure 5-1. This screen contains form objects such as labels and textboxes that you can delete (by first clicking on the object and then hitting the delete key on your keyboard), reposition (by clicking on and dragging them with your mouse), or customize in many other ways.
The objects such as textboxes and labels that appear on a form are examples of form controls. When customizing a form, it is important to distinguish between bound controls and unbound controls. Bound controls are textboxes, drop-down boxes, and similar controls that depend on the underlying data and therefore change from record to record.
In contrast, unbound controls are labels, pictures, and similar items that are consistent from record to record in a form and do not display underlying database information.
On Access forms, labels and textboxes typically appear in pairs, but they are, in fact, separate objects. Thus, you can delete the label for a particular data field on a form and the accompanying (bound) textbox will continue to display database information.
You can add additional controls to your form by selecting them from the Form Design
Tools (Figure 5-6a). Typical objects that you’ll use for this task are labels and picture boxes, but you can also add bound controls such as textboxes if you wish. You can view the Tools only when your form is in design mode.

FIGURE 5-5 The starting format for the form in Figure 5-1.

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(a) Selected controls in Design Tools.

(b) An example of a Properties window. Note the “Control Source” and “Input Mask” settings for this particular control—a textbox that displays a work phone number.

FIGURE 5-6 An example of (a) the Forms Controls window and (b) a Properties window.
To add a control to your form, left click on the control in the Toolbox and then use your mouse to draw the selected object on your form. For example, in Figure 5-1, you can see additional labels (e.g., the heading ‘‘BSN Customers’’ in the header portion of the form or the label ‘‘Phone Numbers’’ in the detail portion of the form) and also a picture of a bicycle (which we created with an Image object from the Toolbox). The size of the object depends on how large you drew it when you first created it, but you can resize any control on your form using the dots, or sizing handles, which appear on the border of your control when you click on it in the form.
Finally, to customize a control on a form, use the object’s Property Sheet window
(Figure 5-6b) to make individual settings for control objects. In effect, each form object has separate settings and its own Property Sheet window. To view the Property Sheet for a particular control, right click on an object in your form and select ‘‘Properties’’ from the drop-down list of choices that appears. This window allows you to change a wide range of settings—for example, the font size, font weight, or boldness of the text in labels.
Of particular importance is the Control Source property of an object, which you will find among the settings in the Data tab portion of the Property Sheet window and which links the control to an underlying data field. Bound controls have a Control Source setting, whereas unbound objects do not.

Step 3—Refine your design. You can toggle back and forth between run mode and design mode by clicking on the Form and Design options. Form (i.e., Run) mode allows you to see how your form looks at run time and reveals what further work you need to perform to complete your form’s design. In design mode, you can select multiple form objects at once (by depressing the control key and clicking on several objects successively) and then use the formatting options from the Format menu (on the main menu bar) to resize, align, and consistently space objects on your form.

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Step 4—Reset the tab order. If you rearrange objects in your form in design mode, there is a good chance you will also want to reset the tab order of your form controls—that is, the order in which each control becomes active in run mode. To do so, click on the
Design tab in Figure 5-6a. One of the options you will see there is ‘‘Tab Order.’’ If you click on this choice, Access will provide a small dialog window that enables you to reset this order. Here, you can create a custom order for the objects in your form or, more simply, click on the ‘‘Auto Order’’ button at the bottom of this window to have Access automatically reset the tab order. The new, auto-order sequence makes form controls become active sequentially from top to bottom and from left to right.

Using Forms for Input and Output Tasks
As noted earlier, database forms provide a convenient tool for entering data into database tables and displaying data from database tables. Both tasks require use of the navigation bar at the bottom of the form—that is, the portion of the screen that looks like this:

You can use this navigation bar for both the input and output tasks explained below.

Displaying Information. The number in the middle of the navigation bar (e.g., ‘‘2’’) indicates which record currently displays in your form. Clicking on the symbol causes
Access to display the first record in the underlying database table, while clicking on the symbol displays the last record in the table. Clicking on the symbol displays the previous record (the record just before the current one), while clicking on the symbol displays the next record (record just after the current one). You can also access the previous record or next record using the page up or page down keys on your keyboard.
Forms also enable you to change the information already in a database table. For example, if a customer moves to a new address or changes his or her phone number, you would want to alter this information in the appropriate table. It is a simple matter to enter the new information for the appropriate record using a form for this task. Changing data in a form causes Access to automatically update the information in the underlying table.
Using Forms to Create New Records. If you wish to add a new record, you can use a form for this task as well. First, click on the ∗ button in the navigation bar. The system will then display the first available empty record (i.e., the one at the end of the underlying table) and allow you to enter the information for a new table entity—for example, the data for a new customer.
A useful feature in Access is that any data field that you include in a form automatically inherits all properties that you set for that field in the underlying table. This means that the same edit tests and data restrictions apply to the field for data entry, whether you enter the data in datasheet view or in form view. For example, if you create an input mask for a phone number that looks like this: (999)000-0000, Access will display the mask for this data field when you start entering data in your form at run time. Similarly, if you restrict a certain field to Integer data (e.g., a zip code), the system will not allow you to enter alphabetic text for that field. Finally, if you create a range test in your form (e.g., limit input to values between ‘‘0’’ and ‘‘40’’ hours), Access will not allow you to enter a value of ‘‘50’’ for that field in your form. Thus, properties at the table level are powerful internal controls because they are also active in the forms used to update data or create new records.

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Case-in-Point 5.1 Database forms are all around you. For example, when you make a purchase on a Web site such as Amazon.com, you are interacting with a database form. The choices you select from menus and drop-down boxes are used to enter data into databases and query database tables.

Printing Forms. You can print a form just as easily as you print any other Microsoft document—that is, by using the ‘‘Print’’ option from the File tab.

Subforms—Showing Data from Multiple Tables
A subform is a form within a form that displays data related to the information in the main form. Figure 5-7 is an example—the original customer form from Figure 5-1 with a new subform showing an invoice for a particular customer. This explains why there are two navigation bars in the figure—the initial one at the bottom of Figure 5-1 and a new one in the subform of Figure 5-7. If you advance through the records of the customer table using the lower navigation bar, you will see the information for each customer in the main form.
Conversely, if you advance through the records of the subform, you will see the invoices for a particular customer—if they exist.

Creating Subforms. Subforms display subordinate information related to the information in the main form. This reflects the one-to-many relationship of the underlying data. In
Figure 5-7, for example, each customer might have several invoices, but each invoice is related to only one customer. To create a subform such as the one in Figure 5-7 requires that customers and invoices have a one-to-many relationship. To create a form with a subform in Access, your first task is to make sure that the data in the two tables are related via the Relationships window and verify that the relationship is one-to-many.

FIGURE 5-7 A form with a subform.

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In Access, there are two principal methods for creating a form with a subform. One approach is to identify the subform at the time you use the Form Wizard. First, you would use the dialog box in Figure 5-4a to select the data for the main form as explained above.
But before continuing to the next form, you would also click on the drop-down menu in this dialog box and select a second table from the list. If a one-to-many relationship exists between the two tables, the Form Wizard will recognize your wish to create a subform within your main form and will create one for you.
A second way to create a subform is to add one to an existing form after you’ve created the main form. To duplicate our form with a subform, open the form in Figure 5-1 in design view and use your mouse to extend the size of the details section of the form (to make room for the subform). Then, click on the Subform icon in the Toolbox shown in
Figure 5-6a and use your mouse to draw a rectangle in the detail section of your form. This procedure causes Access to launch the Subform Wizard, which will ask you for settings similar to those shown in Figure 5-4—for example, ‘‘which table do you want to use for the subform,’’ ‘‘how do you want the data to appear in the subform,’’ and so forth.
In design mode, your resulting form and subform will not look exactly like the one in Figure 5-7. For example, you will probably have to resize the outer dimensions of the subform to fit the data and perhaps reword the text in the label at the top of the subform.
With a little bit of work, however, you should be able to design the forms to look like
Figure 5-7. If you need to resize the column widths of your subform, however, you can do that at run time rather than at design time—a helpful advantage because you can see live data at run time.

Concluding Remarks About Forms
Database forms enable you to add records to a database table, modify the data in existing records of a table, or simply view the data in a table. Although forms are not needed for such tasks, the ability to customize a form, provide explanations for data-entry fields within forms, and create convenient tab orderings are especially useful features for ensuring valid data entry. In commercial environments, the database developer is rarely the same person who enters data in database tables on a daily basis. Anything that the developer can do to make this job more convenient and straightforward for data-entry personnel helps avoid errors, streamlines the data-entry process, and saves time. Experts estimate that it costs about 10 times as much to correct an error in a database as it does to enter the data correctly. Case-in-Point 5.2 Experian is a company that manages firm’s credit risks, helps firms prevent fraud, and processes firms’ payments. Experian recognizes the need for very strong validation controls within its database forms because its customers often enter data themselves.
Even one letter or digit entered incorrectly can result in a failed payment.3

REPORTS
Database reports provide custom information to database users. Reports can be simple documents that display only the contents of a table or complex outputs that combine the information from several tables and show selected subsets of database information useful
3

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for decision making. If you’re using Access to print something on paper, the chances are high that you are using a report to perform this task. This means that many items that you might not consider a ‘‘report’’ are treated as one by Access—for example, an invoice for a particular customer or a document that shows the name and address of a vendor.

Case-in-Point 5.3 The National Motor Vehicle Title Information System requires all insurance companies and salvage yards to forward the VIN numbers of vehicles that have been totaled to a national database. The reports from this database will enable consumers to obtain information such as a car’s odometer reading or theft report, as well as the reason for its condition—for example, a flood.4
Unlike forms, reports are strictly outputs and do not allow users to input data into databases. The next sections of the chapter explains how to create simple reports, how to create reports containing calculated fields, how to create reports based on queries instead of tables, and how to create reports containing grouped data.

Creating Simple Reports
Figure 5-8 illustrates the print preview of a simple report—a listing of selected information about the customers in BSN’s Customers table. The first step in creating such reports is not to use your database system at all, but rather to decide what information to include in the report and how best to display that information in a printed document. We stress again that spending a few minutes designing the general format of a report (even if on the back of an old envelope) may save you hours of redesign work later.
A typical report has seven major components: (1) report heading, (2) page header,
(3) group header, (4) detail lines or body, (5) group footer, (6) page footer, and (7) report footer. Figure 5-9 describes these items in greater detail. Perhaps the most important is the Detail Lines section, which is similar to the detail section of a form. The detail section displays information from the records of database tables. After you have a general idea of

FIGURE 5-8 A print preview of a portion of a simple Access report.
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Component

Where It Appears

Report header

First page of the report

Page header
Group header
Detail lines

Top of each page
Beginning of each group of records Body of the report

Group footer

End of each group

Page footer
Report footer

Bottom of each page
Last page of the report

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Typical Content
Company name and address, date prepared or relevant time period, company logo
Identification of each data field below it
Identification of a new group of data
The individual data fields of, and computed data fields from, underlying database tables
Control totals or other statistics such as maximums, minimums, or averages for the group Page number, report number
End-of-report identifier, grand totals

FIGURE 5-9 The components of a database report. the format for your report, you can develop the report itself using these components. An easy way to do so is by using the Report Wizard in Access, following these steps:

Step 1—Launch the Report Wizard. To launch the Report Wizard, select the Create option from the main menu and then select ‘‘Report Wizard’’ (see again Figure 5-3). The first dialog box you will see is the one in Figure 5-10a.
Step 2—Select the underlying data source and desired fields. You can base a report on a table, as we will do in this case, or on a query (which could integrate the data from several tables). To create the report in Figure 5-8, however, we will need only the
Customers table. Thus, to replicate our work, select tbl BSN Customer Master Table from the drop-down list in Figure 5-10a and then select the appropriate fields using the data field selector buttons (> and >>) as needed.
Notice that not all the information in the Customers table appears in the Customer report of Figure 5-8. For example, the customer’s home and cell phone numbers are missing. This is typical of output reports—only selected information from underlying tables appears in them. The more information you include, the more complete the report, but also the more difficult it becomes to interpret. As you know from Chapter 1, sometimes
‘‘less is more,’’ and this is one reason to ‘‘plan before you program.’’
Step 3—Indicate any grouping levels. When you click ‘‘Next’’ in Figure 5-10a, you will see the dialog box in Figure 5-10b. This is where you tell the Report Wizard how you would like to group your data. For example, you can group your customers by zip code.
For the simple report in Figure 5-8, however, we do not need any such groupings, and you can simply click the Next button in this dialog box.

Step 4—Indicate any sort fields and select the desired report format. The Report
Wizard also allows you to sort up to four different fields. For example, Figure 5-10c indicates the settings to create a report of customers sorted by customer last name within zip code.
After you have selected the sort fields, click Next in the dialog box. The fourth screen in the
Report Wizard appears (Figure 5-10d) and allows you to select a particular report layout.
For line-by-line listings—the typical choice in simple reports—select ‘‘Tabular.’’ You can also choose between ‘‘Portrait’’ or ‘‘Landscape’’ print options here.

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Step 5—Name the report. After clicking Next in the dialog box shown in Figure 5-10d, you will see the dialog box in Figure 5-10e. Here, you have the opportunity to name your report. The standard prefix for a report is rpt, which is the reason we’ve named our report rptCustomers_by_ZipCode. (a) The first screen in the Report Wizard.

(b) The second screen in the Report Wizard.

(c) The third screen in the Report Wizard.

(d) The fourth screen in the Report Wizard.

(e) The fifth screen in the Report Wizard.

FIGURE 5-10 The dialog boxes of the Report Wizard.

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Step 6—Modify the design of the report as desired. When you finish with the
Report Wizard, you may need to modify the report design still further. If you open your new report in design view, you will see a screen similar to the one in Figure 5-11. This interactive screen enables you to modify the height or width of labels or textboxes (using their sizing handles); change the font size and font characteristics (e.g., italic, bold) of headings (using the Properties window for each element); or reposition items (as we did for the second line of the address). You can also change your mind and delete any element in the report by left clicking on it and pressing the delete key on your keyboard.
In design view, the bar of any section of your report will darken to indicate which section of the report is active for design purposes. There are many additional things you can do to modify your report’s appearance. For example, you can cut and paste (or copy and paste) elements from one portion of your report to another. Thus, we moved the date
(with content ‘‘=Now()’’) from the footer section of the report to the header section using this cut-and-paste method. As with designing forms, you can also add charts, pictures, or logos to your report. To view these choices, click on the control’s drop-down menu within the Design tab.
Finally, you should be careful when moving anything into the ‘‘Detail’’ section of the report because the report will repeat any element in this section for each line of the report.
For this same reason, you should try to make the detail section of the report as simple as possible—it will save room on lengthy reports.

Creating Reports with Calculated Fields
A common task when creating reports is to include calculated fields. For example, a report of employee information might also include a field entitled ‘‘years of service,’’ which the system can calculate from the employee’s date of hire. Sometimes, you want a calculated field to appear in the detail section of a report, while at other times, you want group or grand totals to appear in the group footer or the report footer sections of your report. In this section of the chapter, we review the steps needed to accomplish the first task—creating a calculated field for the detail section of a report. In the following section, we review the steps needed to accomplish the second task—creating group summaries.
In AISs, a common task is to multiply prices by quantities in order to compute an extension (line total) in an invoice. There is no reason to store such values in the records

FIGURE 5-11 An Access report at design time.

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FIGURE 5-12 The print preview of a report that contains a calculated field (in the last column of the report). of a relational database because we can compute such values whenever we need them.
This is why we only stored prices and quantities in the Customer_Invoice_Details table.
However, when we print customer invoice information on a report, we need to show such computations. It is usually easiest to create calculated fields using queries rather than tables for the underlying data. To illustrate, suppose we wanted to create the report shown in
Figure 5-12—a report that shows invoice extensions for all current invoices for BSN. To create such a report, follow these steps:

Step 1—Create the query with a calculated field. Figure 5-13 shows the query for our report. To create this query, we begin by selecting the tables needed to calculate invoice totals. One such table is the Customer_Invoice_Details table. The records in this table contain the item number and the quantity ordered but not the name of the item purchased or its price. For this information, we need the Products_And_Services table.

FIGURE 5-13 A query with a calculated field.

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Figure 5-13 is the design view for our query. We have selected the two tables we need for our task and also the desired fields—that is, the item number, the description of the good or service (both taken from the tblProducts_And_Services table), and the quantity
(taken from the tblCustomer_Invoice_Details table). For convenience, it is a good idea to select these items in the order in which you want them to appear in your final invoice, but this isn’t required.
To create the calculated field, select the first available column in the query design screen and type the name of your calculated field. We chose the name ‘‘Extension,’’ but this choice is arbitrary. You can also choose a name with more than one word (e.g.,
‘‘Extension Calculation’’), but be careful not to choose a term with the same name as an existing data field.
Type a colon following your calculated field name and then input the formula for your calculated field. Use an asterisk for a multiplication sign and a forward slash (/) for a division sign. Also, be careful to spell the field names in your formulas exactly as they appear in your underlying database tables. (If you misspell a field name, Access will not indicate that you’ve made an error, but instead will assume you’re creating a parameter query and ask you for the data at run time.) Finally, place square brackets around your field names to indicate that you are referencing existing data fields.
When you have completed your query, you can test it by clicking on the Run button
(the exclamation point icon) in the main menu. If things work properly, you will see something like the screen in Figure 5-14. Note that although the data in Figure 5-14 is from a query, the screen in Figure 5-14 is interactive. Thus, for example, if you change the item number of a given line, Access will look up the new product description and the new price, change the new extension, and display everything as quickly as you can enter the new item number on the screen.

Step 2—Create the report based on your query. It now remains to create the report.
Using the steps outlined above, you can use the Report Wizard to create the final report in Figure 5-12. Base your report on the query you created in Step 1 above and select all available fields.
The second screen of the Report Wizard will ask you if you wish to group your data
(refer back to Figure 5-10b). Access will recognize that you have a one-to-many relationship between ‘‘invoice numbers’’ and ‘‘invoice details’’ and should show you this possibility by default. If it does not, however, select this option so that your invoice details for the same invoice will be grouped together. Then continue with the remainder of the Report

FIGURE 5-14 Partial results for the query in Figure 5-13 at run time.

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Wizard questions. Be sure to name your report something appropriate—for example, rptInvoice_Details. When you finish answering questions in the Report Wizard, you should then reformat your report as needed. The results should look similar to Figure 5-12.

Creating Reports with Grouped Data
The report in Figure 5-12 contains useful data, but obviously lacks some critical information.
What is the name of the customer associated with each invoice? What is his or her address?
What is the total for each invoice? A manager would likely want this information to appear in an invoice report. Finally, it might be useful to organize the report by customer last name rather than by invoice number.
A control break is the technical term for the point at which a group changes from one type to the next in a report. Examples of control breaks include a change in zip code for the addresses in customer listings, a change in the department number for a listing of employees, and a change in a service classification for the yellow pages of a phone book.
Control breaks are often the points at which managers want to see subtotals, maximums, minimums, averages, or similar subgroup summaries.
To create control breaks for the report in Figure 5-12, we need to modify its design to include group totals for each invoice. Figure 5-15 illustrates the format for the final report, which includes new information and provides totals for each invoice. To create it, we will follow the steps outlined above for creating reports with calculated fields—that is,
(1) create a query to generate the desired information, (2) use the Report Wizard to create an initial report based on this query, and (3) reformat our report as needed to achieve the desired end product. Here are the detailed steps:

Step 1—Create the underlying query. Our first task is to create the underlying query for this report. Figure 5-16 shows a portion of this query during its design.

FIGURE 5-15 The invoice report of Figure 5-12, expanded to include customer information and invoice totals.

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FIGURE 5-16 Part of the query used to create the report illustrated in Figure 5-15.
The upper portion of the query screen in Figure 5-16 identifies the four tables required to build the query. If you study the information contained in the final report of Figure 5-15, you will realize why we needed four tables for this task. We needed the Customers table to provide the name and address information for each customer. We needed the Invoice table to provide the customer number for each invoice. We needed the Customer Invoice
Details table to provide the item number and the order quantity for each detail line of an invoice. We needed the Products and Services table to provide the item description and sales price per unit for each item purchased. Finally, we had to create a calculated field—the extension of quantities times prices for each detail line—as described in the previous section of this chapter.
When queries become as complex as this one, it is a good idea to run them and make sure they work before using them in a report. Again, you can perform this task by clicking on the exclamation point (Run icon) in the main Access menu. (You must be working on a query, however, and not working on a form, table, or report.)

Step 2—Use the Report Wizard to create the initial report. After creating our initial query, we will then go to the Reports portion of Access and use the Report Wizard to create an initial report. You already know how to perform such a task, and we will not describe the process again here. The result is a report whose format will not look very much like the finished product in Figure 5-15, so we have additional work to do!

Step 3—Reformat the report as desired. It remains to reformat our report. Because we have also reviewed the activities for this step, we will not repeat them here. Again, it is useful to remember the following items: (1) you should expand the size of unbound labels so that their entire text shows, (2) you can delete any control you don’t need,
(3) you can move both bound and unbound controls from one part of a report to another, and (4) the Format menu enables you to resize, align, and reposition objects consistently on your report.

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Concluding Remarks About Reports
This section of the chapter illustrated how to create reports in Access, including reports that contain calculated fields and reports that calculate subtotals for grouped data. Reports are the desired end product of complex database systems. That is, managers need to convert vast amounts of data into useful information for decision making. This is the function of reports—they turn data into information. It is also important to remember at this point that reports cannot be created unless all of the needed data has been collected and appropriately organized. For this reason, database designers must speak with managers and other end users to determine what reports they need before designing the database.

AIS AT WORK
Mother Lode Bicycles5
Although the BSN Bicycle company is fictitious, Mother Lode Bicycles in Sparks, Nevada, is not. Founded in 1996 by two friends—Dave McDonald and Mark Kennedy—the 2,400square-foot shop sells road and mountain bikes to local customers as well as to out-oftowners visiting the area. Bike prices range from $200 to $5,000. Sales of bikes, clothing, and biking accessories are 90% of the store’s income; repairs make up the rest.
In many ways, running a bike shop is similar to running any small business. One partner manages the inventory, stocks the store shelves, and deals with the marketing and advertising parts of the business. The other partner deals with employees, supervises repairs, and interacts with customers. Their biggest problems are (1) making enough money to cover the overhead (especially during the months after Christmas and prior to spring cycling) and (2) the fact that the store must stay open seven days a week.
For accounting tasks, the store’s owners rely on QuickBooks™ from Intuit and the bookkeeping expertise of Mark’s wife. With the exception of employees, the store does not sell items on credit so there are no receivables. Mark personally supervises payables, taking advantage of cash discounts where possible and negotiating longer payment schedules with suppliers during the slower selling seasons of the year.
Most of the shop’s inventory consists of items that sit on shelves and racks in the retail portion of the store, with just a few parts and unassembled bikes stored in the back room—a combination storeroom-warehouse-office-dining room. Inventory control is also a combination of elements, including visual inspection, working with sales representatives to keep merchandise levels up, and the expertise of the owners for ordering or not ordering items for the slower or busier season to follow. Mark is considering acquiring a point-of-sale system with a backend database, which he thinks will help the company become better aware of its best sellers as well as keep closer tabs on stock on hand.

SUMMARY
Databases use forms to input data into, and to view data from, the records in tables.
If you use forms to create new records, the data fields in the customized forms automatically inherit the same properties, attributes, and input restrictions that were created for them in the design of the table.
5

From the authors.

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The navigation bar at the bottom of a form enables you to view the first, last, next, and previous record in the underlying table.
You can use subforms to display ‘‘many’’ records related to the record in the main form in a one-to-many relationship—for example, the outstanding invoices for a specific customer.
You typically design and develop reports to create hard-copy outputs. In Access, reports are based either directly on tables or on queries that reference tables.
A typical report has seven major components: (1) report heading, (2) page headings, (3) group headings, (4) detail or body, (5) group footer, (6) page footer, and (7) report footer.
You should name forms and reports systematically. The standard prefix for a form is frm, and the standard prefix for a report is rpt.
Most databases do not store calculated fields such as invoice line extensions (prices times quantities). Instead, we calculate these fields with queries.
Many reports contain data with grouped data—for example, a set of lines for a given invoice or a set of invoices for a given customer. It is also possible to require a report to show control totals, averages, maximum, or minimum values for each group. In Access, you can create such figures using the Report Wizard and its grouping options.

KEY TERMS YOU SHOULD KNOW bound control calculated field control break
Control Source property datasheet screen form form controls
Form Wizard

Property Sheet window report Report Wizard sizing handles subform tab order unbound control

TEST YOURSELF
Q5-1. In Access, you can use a form to perform all the following tasks except:
a. Create a new record in a specific table
b. Change the information in an existing record of a table
c. View the information from many different records sequentially
d. All of these are tasks that can be performed with an Access form
Q5-2. Each record in a database table of student records contains the name, address, total university credits, and total quality points for a specific student. The student’s grade point average
(GPA) is equal to total quality points divided by total university credits. Where would a database typically store a student’s GPA information?
a. In the same table as the student’s other information
b. In a new table of student details
c. In a report stored in the Reports section of the database
d. Nowhere. This is a calculated field that is typically created by a query at run time

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Q5-3. A form control that does not change from record to record is probably:
a. A design-time control
b. A bound control
c. An unbound control
d. A mistake
Q5-4. The database of a veterinary clinic has records for the pets it treats in one table, records for pet owners in another table, and records for employees in a third table. Which of these is most likely to describe a database form and subform for this application?
a. Employees in the main form and pets in the subform
b. Pets in the main form and owners in the subform
c. Owners in the main form and pets in the subform
d. Owners in the main form and employees in the subform
Q5-5. If the form onscreen appears with grid lines and you can view the Toolbox, this form is mostly likely in:
a. Design mode

c. Sleep mode

b. Run mode

d. Wizard mode

Q5-6. What happens when you click on this symbol

on a form’s navigation bar?

a. You will transition from run mode to design mode
b. You will transition from design mode to run mode
c. You will go to the first record in the table
d. You will go to the last record in the table
Q5-7. Which of these best identifies the underlying data source for an Access report?
a. Only tables
b. Only queries
c. Both tables and queries
d. Tables, queries, and forms
Q5-8. The term control break most closely associates with which of the following terms in Access?
a. Groups of data
b. Bathroom break
c. Form control
d. Report header
Q5-9. Which of these is not a typical part of a printed report using Access?
a. Report header
b. Report footer
c. Navigation bar
d. Detail line

DISCUSSION QUESTIONS
5-1. What are some of the advantages and disadvantages of database forms?
5-2. Would you rather use a form or a datasheet for entering data into a database table? Why?
5-3. To create a form, would you rather use the Form Wizard in Access or create the form from scratch? Why?

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5-4. What is a subform? Why do forms have subforms? How do you create subforms in Access?
5-5. Why do database developers customize forms? Why isn’t it sufficient to use the form as initially created by the Form Wizard?
5-6. What is the purpose of a database report? What information do such reports contain?
5-7. The chapter suggested that it is important to design the format of a report before creating the report itself. Do you agree with this suggestion? Why or why not?
5-8. Do you think that we will still use hard-copy reports in the future, or will they be replaced with soft-copy ones? Defend your answer.
5-9. Would you rather use the Report Wizard to create the format of a report or design one yourself from scratch? Why?
5-10. What is a calculated field in a report? Provide some examples. Why do reports contain calculated fields?
5-11. Why don’t databases store calculated fields as normal fields in database tables? Do you think they should?
5-12. Why are calculated fields created with database queries? Why not create them directly with reports? PROBLEMS
5-13. A form’s navigation bar has five symbols on it. Identify each one and indicate its use.
5-14. A database report has seven major sections in it.
a. Identify each one and provide a short explanation of each section.
b. Identify a report that might be generated in a database application and indicate what data might be found in each section of the report for your example.
5-15. Provide a short explanation of the difference between each of the following sets of terms:
a. Bound control versus unbound control
b. Design mode versus run mode
c.

Symbol versus

symbol on a form’s navigation bar

d. Form versus subform
e. Normal data field versus calculated data field
f. Page header versus page footer
g. Report header versus report footer
h. A report based on a table versus a report based on a query
5-16. Using the Customers table in the BSN database that accompanies this book and following the directions in this chapter, create the form in Figure 5-1. Make sure that you reformat the default positions of the various textboxes as shown in the figure.
a. Add a label in the heading portion of your form that contains the term ‘‘Prepared by:’’ and add your name. Print a single copy of your completed form.
b. Use the navigation bar at the bottom of your form. What is the first record? What is the last record? c. Add a new record to this form with your name as the customer. Print a copy of this form.
d. Close your form, go to the Tables portion of the database, and open the Customers table in datasheet view (see Figure 5-2). Verify that your new record is there. Now, add a second record with your name again. Are you surprised that you can do this?
5-17. If you have not done so already, use the Customers table in the BSN database that accompanies this book and the directions in this chapter to create the form in Figure 5-1. Make sure that you reformat the default positions of the various textboxes as shown in the figure. Now add

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a subform to your form so that it looks like Figure 5-7. To do this, open your initial form in design view, select the subform tool from the Toolbox Controls, and add a subform. Answer the questions for the Subform Wizard to select the Invoices table. When you have completed these tasks, also do the following:
a. Use the navigation bar of the main form to go to the last record in the Customers table.
Print the form for this record.
b. Use the navigation bar of the main form to find a record with invoices. Then use the navigation bar of the subform to select a particular invoice. Which one did you select? Print this form.
5-18. Using the Customers table in the BSN database that accompanies this book and following the directions in this chapter, create the report in Figure 5-8. Note that you will have to reformat and perhaps reposition several labels and add both labels and a graphic in the header portion of the report.
a. Add a label in the heading portion of your report that contains the term ‘‘Prepared by:’’ and add your name. Print a single copy of your completed report.
b. Who is the first customer in your report? Who is the last customer in your report?
5-19. Use the Customers table in the BSN database that accompanies this book and the Report
Wizard to create the report in Figure 5-15. Note that you will have to reformat and perhaps reposition several labels and add both labels and a graphic in the header portion of the report.
Note that you will first have to create the underlying query for this report. Use Figures 5-12 through 5–19 as guides for this task. Print the final report.

CASE ANALYSES
5-20. A Form for BSN Suppliers (Creating a Simple Form in Access)
The BSN Company requires a form with which to view its existing suppliers conveniently and also to create records for new suppliers. Figure 5-17 contains a suggested format for this form.

FIGURE 5-17 A form for entering and viewing vendor information in the BSN database.

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Requirements
1. Using the Vendors table in the BSN database that accompanies this book, create the initial form using the Form Wizard. Note that you will have to reposition some of the data fields in the form, add the term ‘‘Abbrev.’’ to the label for the State field, and add the following items in the heading of the form: (1) a label with text ‘‘BSN Vendors,’’
(2) a label with your name, and (3) a graphic (which can be different from the one shown in the figure).
2. Run your completed form to make sure it works. What is the first record that shows in your form? What is the last record?
3. While in run mode, tab through the individual data fields of any particular record and note that you do not tab through the data fields column by column. Return to design view and adjust the tab order by selecting View/Tab Order from the main menu and make the necessary adjustments. What is the correct Tab Order, and how did you make these adjustments?
4. Go back to run mode for your form and click on the ∗ symbol to add the information in Figure 5-17 to the Vendors table. Note that you should use your own name as the
Contact Person for this vendor.
5. Print just this form to document your work, following the steps in the text for this task.
6. Now that you have used your new form, what additional improvements would you make to further streamline data-entry tasks?

5-21. A Form and Subform for BSN Suppliers (Creating Forms with Subforms in Access)
Create the form in Figure 5-17 and then add a subform to it that shows purchase orders for each vendor. Figure 5-18 provides a suggested format. To accomplish this task, follow

FIGURE 5-18 A suggested format for the form and subform described in Case 5-21.

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these steps: (1) start with the Vendor form in design mode, (2) click on the subform control in the Toolbox, and (3) follow the steps in the Subform Wizard to complete your work.

Requirements
1. Run your new form to make sure it works properly and then print a copy of your new form to document your work. Make sure your name is in the header portion of the form.
2. Select a vendor for which there are outstanding purchase orders. Click on the symbol in the navigation bar of the main form. What happens?
3. Click on the symbol in navigation bar of the subform. What happens?
4. Create a new purchase order for your current vendor using your new subform. Do you think it makes sense to be able to create a new purchase order that has no detail lines?
Why or why not?

5-22. A Listing of BSN Suppliers (Creating Simple Reports in Access)
The BSN Company would like a hard-copy report of all the current vendors in its database.
Figure 5-19 provides a suggested format for the report. Note that your report header should include the company title, the current date, your name, and a graphic. Also note that the detail section contains multiple lines. Create a similar report for homework.

FIGURE 5-19 A suggested format for the report described in Case 5-22.

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Requirements
1. Print the complete report.
2. Who is the first supplier and who is the last supplier?

5-23. Furry Friends Foundation III (Creating Forms and Reports)
Recall from Cases 4–21 and 4–25 in Chapter 4 that the Furry Friends Foundation is a nonprofit organization that finds homes for abandoned animals. The foundation has created a relational database to help it store data more easily and answer questions about donations.
This portion of the case requires you to create database forms and reports.

Requirements
1. If you have not already done so, create the tables and relationships described in
Case 4–21.
2. Create an intake form for the Contributor’s Table. The form should be similar to
Figure 5-1 and contain two columns for data entry. Make sure that the system tabs properly, so that data entries proceed logically from left to right and from top to bottom.
To document your work, provide a screen capture of your report at run time, which includes your name as the entered contributor.
3. Create an intake form for the Donation’s Table. Again, the form should be similar to
Figure 5-1 and contain two columns for data entry. Make sure that the system tabs properly, so that data entries proceed logically from left to right and from top to bottom.
Provide a screen capture of your report at run time.
4. Create a report that contains a current list of contributors (including yourself as one of them). The report should include the following information in the header: Foundation’s title, a graphic of a furry pet, your name as the developer, and the current date. The body of the report should contain the name, address, and phone number of all contributors, listed alphabetically by contributor’s last name. The information for each contributor should all be on one line. Print the complete report.
5. Expand the set of donators to include at least 10 contributors and then change the entries in the donations file to include donations from all contributors. Create reports for both tables and then print complete lists. Finally, create a report that contains a complete list of all contributors who gave donations during the months of November and December 2009. (Hint: base your report on a query instead of a table.) The report should include a header with the foundation’s title, a graphic of furry pets, your name as the developer, and the current date. The body of the report should list donations in order of the donator’s last name and should include the donator’s address and phone number. An example set of lines is as follows:
Date
November 11, 2009

Contributor
Lawrence, Marie
9190 Teepee Road
Doolittle, NV
54984

Phone Number

Animal Code

Amount

(501)767– 1114

C

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READINGS AND OTHER RESOURCES
MacDonald, M. 2010. Access 2010: The Missing Manual. Sebastopol, CA: O’Reilly Media.
Conrad, J., and J. Viescas. 2010. Microsoft Access 2010 Inside Out. Sebastopol, CA: O’Reilly Media.

Forms and Reports in Microsoft Access 2010: http://office.microsoft.com/en-us/access-help/video-introduction-to-form-and-report-layoutsVA100405943.aspx Introduction to Microsoft Access 2010: http://office.microsoft.com/en-us/access-help/video-introduction-to-the-access-2010-userinterface-VA100680471.aspx Work More Efficiently with Microsoft Access 2010: http://office.microsoft.com/en-us/access-help/video-ten-quick-tips-to-help-work-moreefficiently-in-access-2010-VA101831095.aspx ANSWERS TO TEST YOURSELF
1. d

2. d

3. c

4. c

5. a

6. d

7. c

8. a

9. c

PART THREE
DOCUMENTING BUSINESS PROCESSES

CHAPTER 6
Documenting Accounting Information Systems
CHAPTER 7
Accounting Information Systems and Business Processes: Part I
CHAPTER 8
Accounting Information Systems and Business Processes: Part II

This section of the book is about documentation and business processes. Documentation refers to documents that describe how an information system works, what data an information system uses, and the outputs created by the system. Documenting an AIS is critical. Proper documentation helps managers, system designers, auditors, and system users understand the basic processes and functions of the system. Chapter 6 describes various tools and techniques for documenting AISs.
The next two chapters of the book are about business processes—what they are, why they are important, and what you need to know about these processes. First, we identify the fundamentals of a business process: journals, coding systems, and the basics of collecting and reporting accounting information. Chapter 7 identifies characteristics of two common business processes: the sales process and the purchasing process. Chapter 7 concludes with a discussion of a major trend called ‘‘business without boundaries’’ that is occurring as a result of networked enterprises and globalization. To support this trend, companies use
Business Process Management solutions to help maximize the efficiency and effectiveness of their processes.
Chapter 8 continues our discussion of core business processes. In this chapter we examine resource management processes, production processes, and financing processes, especially the events associated with these processes. Chapter 8 also considers the accounting information needs of specialized industries.

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Documenting Accounting
Information Systems

INTRODUCTION

DISCUSSION QUESTIONS

WHY DOCUMENTATION IS IMPORTANT

PROBLEMS

PRIMARY DOCUMENTATION METHODS

CASE ANALYSES

Data Flow Diagrams

Big Fun Toys (Data Flow Diagrams)

Guidelines for Drawing Data Flow Diagrams

The Berridge Company (Document Flowcharts)

Document Flowcharts

Classic Photography Inc. (Systems Flowcharts)

Guidelines for Drawing Document Flowcharts

The Dinteman Company (Document Analysis)

System Flowcharts

READINGS AND OTHER RESOURCES

Guidelines for Drawing System Flowcharts

ANSWERS TO TEST YOURSELF

Process Maps
Guidelines for Drawing Process Maps

OTHER DOCUMENTATION TOOLS
Program Flowcharts
Decision Tables
Software Tools for Graphical Documentation and SOX Compliance

END-USER COMPUTING AND
DOCUMENTATION
The Importance of End-User Documentation
Policies for End-User Computing and Documentation

AIS AT WORK—BETTER SYSTEM
DOCUMENTATION HELPS PROTECT
MINNESOTA’S ENVIRONMENT
SUMMARY

After reading this chapter, you will:
1. Understand why documenting an AIS is important.
2. Be able to draw simple data flow diagrams and document flowcharts and explain how they describe the flow of data in AISs.
3. Be able to draw simple system flowcharts and process maps and interpret these diagrams.
4. Know how program flowcharts and decision tables help document AISs.
5. Be able to explain the importance of end-user documentation. 6. Be aware of software available for documenting
AISs and helping companies comply with the
Sarbanes-Oxley Act and AS5.

KEY TERMS YOU SHOULD KNOW
TEST YOURSELF

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Business process modeling is a foundational requirement in many management and IS projects, yet it still represents a significant challenge to many organizations.
Indulska, M., J. Recker, M. Rosemann, and P. Green. 2009. Business process modeling: Current issues and future challenges. Lecture Notes in Computer Science 5565: 501–514.

INTRODUCTION
The previous three chapters introduced you to the importance of databases to accounting information systems and described how to design, build, and use databases. In these chapters you also learned how to create E-R diagrams, which are essential forms of documentation. This chapter describes other critical documentation methods that developers use to design and describe accounting systems.
Documentation explains how AISs operate and is therefore a vital part of any accounting system. For example, documentation describes the tasks for recording accounting data, the procedures that users must perform to operate computer applications, the processing steps that AISs follow, and the logical and physical flows of accounting data through systems.
This chapter explains in greater detail why accountants need to understand documentation and describes tools for diagramming complex systems.
Accountants can use many different types of logic charts to trace the flow of accounting data through an AIS. For example, document flowcharts describe the physical flow of order forms, requisition slips, and similar documents through an AIS. These flowcharts pictorially represent data paths in compact formats and save pages of narrative description. System flowcharts are similar to document flowcharts, except that system flowcharts usually focus on the electronic flows of data in computerized AISs. Other examples of documentation include process maps, data flow diagrams (DFDs), program flowcharts, and decision tables.
This chapter describes these documentation aids, as well as some computerized tools for creating them.
Today, many end users develop computer applications for themselves. This end-user programming is very helpful to managers, who consequently do not require IT professionals to develop simple word processing, spreadsheet, or database applications. But end-user programming can also be a problem because many employees do not know how to document their work properly or simply don’t do so. The final section of this chapter examines the topic of end-user programming and documentation in greater detail.

WHY DOCUMENTATION IS IMPORTANT
Accountants do not need to have the ability to program complex systems, but it is important for them to understand the documentation that describes how processing takes place.
Documentation includes the flowcharts, narratives, and other written communications that describe the inputs, processing, and outputs of an AIS. Documentation also describes the logical flow of data within a computer system and the procedures that employees must follow to accomplish application tasks. Here are nine reasons why documentation is important to AISs.

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Case-in-Point 6.1 A recent survey of practitioners found that system documentation has become increasingly important as organizations seek to better understand their own business processes and also comply with legislation that requires this understanding, such as the
Sarbanes-Oxley Act.1
1. Depicting how the system works. Observing large AISs in action is an impractical way to learn about them, even if they are completely manual. In computerized systems, it is impossible to understand systems without thorough documentation because the processing is electronic and therefore invisible. Examination of written descriptions and diagrams of the inputs, processing steps, and outputs is an efficient method for understanding key components of systems. This is one purpose of documentation—to help explain how an AIS operates. Documentation helps employees understand how a system works, assists accountants in designing controls for it, demonstrates to managers that it will meet their information needs, and assists auditors in understanding the systems that they test and evaluate.
The Internet contains many examples of flowcharts or logic diagrams that help individuals understand unfamiliar tasks or processes. For example, some universities use them to show students what classes to take and when they should take them to complete their majors in a timely manner. The University of Washington has flowcharts that show how to obtain grants and other types of funding. The University of Illinois at Urbana-Champaign uses elaborate diagrams to depict what happens when a faculty member’s employment terminates. Figure 6-1 is a logic diagram from the University of
Arizona Web site that shows employees how to file a claim for reimbursement. If the employee would like additional information for any step in the process, a click of the mouse on the appropriate flowchart symbol reveals additional information. The charts are intended to simplify long narratives describing how to file reimbursements.
2. Training users. Documentation also includes user guides, manuals, and similar operating instructions that help people learn how an AIS operates. Whether distributed manually in

Employee
Reimbursement

Allowable?

Yes

No

Yes

No

Explore Other
Reimbursement
Possibilities.

Business
Entertainment?

Prepare Check Request
Forward to Accounts Payable.
The reimbursement will be added to the employee’s net pay. No

Local
Account?

Yes
NOTE: Employee reimbursement must be signed by the employee and the employee’s supervisor, except at the dean and vice president level and above.

FIGURE 6-1 Example of a flowchart used at the University of Arizona to help employees file a reimbursement claim. For additional information, individuals simply click on the appropriate symbol.
1

Bradford, M., S. Richtermeyer, and D. Roberts. 2007. System diagramming techniques: An analysis of methods used in accounting education and practice. Journal of Information Systems 21(1): 173– 212.

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hard-copy format or electronically in help files or ‘‘get-started tours’’ of microcomputer applications, these documentation aids help train users to operate AIS hardware and software, solve operational problems, and perform their jobs better.
3. Designing new systems. Documentation helps system designers develop new systems in much the same way that blueprints help architects design buildings. We have seen how to create blueprints for databases with E-R diagrams. Professional IT personnel commonly hold structured walkthroughs in which they review system documentation to ensure the integrity and completeness of their designs and to identify design flaws. Well-written documentation and related graphical systems-design methodologies play key roles in reducing systems failures and decreasing the time spent correcting emergency errors. Conversely, poorly designed systems often lead to large-scale errors and expensive write-offs.
4. Controlling system development and maintenance costs. Personal computer applications typically employ prewritten, off-the-shelf software that is relatively reliable and inexpensive. In contrast, custom-developed business systems can cost millions of dollars and can be less reliable. Good documentation helps system designers develop object-oriented software, which is software that contains modular, reusable code.
This object-orientation helps programmers avoid writing duplicate programs and facilitates changes when programs must be modified later. If you have ever replaced a specialized part in your car, you have some idea of how frustrating, time consuming, and expensive nonstandardization can be, and therefore how useful object-oriented programming might be to business organizations.
5. Standardizing communications with others. The usefulness of narrative descriptions can vary significantly, and a reader can interpret such descriptions differently from what the writer intended. Documentation aids such as E-R diagrams, system flowcharts, and data flow diagrams are more standardized tools, and they are more likely to be interpreted the same way by all parties viewing them. Thus, documentation tools are important because they help describe an existing or proposed system in a common language and help users communicate with one another about these systems.
6. Auditing AISs. Documentation helps depict audit trails. When investigating an AIS, for example, the auditors typically focus on internal controls. In such circumstances, documentation helps auditors determine the strengths and weaknesses of a system’s controls and therefore the scope and complexity of the audit. Similarly, auditors will want to trace sample outputs to the original transactions that created them (e.g., tracing inventory assets back to original purchases). System documentation helps auditors perform these tasks.
7. Documenting business processes. Understanding business processes can lead to better systems and better decisions. Documentation helps managers better understand how their businesses operate, what controls are involved or missing from critical organizational activities, and how to improve core business activities.
8. Complying with the Sarbanes-Oxley Act. Section 404 of the Sarbanes-Oxley Act of 2002
(SOX) requires publicly traded companies to identify the major sources of business risks, document their internal control procedures, and hire external auditors to evaluate the validity and effectiveness of such procedures. Documentation is therefore crucial for analyzing the risks of errors, frauds, omissions, and problems with important business processes, as well as helping auditors evaluate the controls used to mitigate such risks—that is, some of the major tasks required by SOX.

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Almost everyone acknowledges that the costs of complying with SOX are enormous, and many also believe that SOX gave documentation a new life. To save money, many companies now use software packages to help them automate SOX documentation tasks. We describe some examples of such software in a later section of this chapter.
While Auditing Standard No. 5 (AS5) has reduced some of the documentation burdens created by SOX, documentation requirements for internal controls and risk assessments remain much more substantial than during periods prior to the enactment of SOX.
9. Establishing accountability. Manual signatures on business and government documents allow employees and government agents to execute their responsibilities, create audit trails, and establish accountability for their actions. An example is a signed checklist that outlines the month-end journal entries an accountant must perform. Such checklists verify that an accountant performed these tasks, that a reviewer approved them, and that both individuals are accountable for the accuracy of the work. Similar comments apply to the checklists for preparing financial statements, tax returns, auditing papers, budgets, and similar accounting documents. Including such checklists with the statements themselves documents the work that the employees performed as well as the procedures and controls involved in the work. Signed approvals (e.g., manager-approved purchase requests) create similar levels of accountability for large expenditures.

Case-in-Point 6.2 Quality documentation, clear evidence of proper authorization, and the establishment of accountability can yield benefits in addition to improved systems design and better internal control. During recent and challenging economic times, layoffs are at a record high. As a result, wrongful termination lawsuits are also on the rise.
Lawyers suggest that an employer’s best defense in these lawsuits is clear documentation of employee duties and the procedures that they should follow. When managers fail to clearly document business processes and employees’ responsibilities and actions related to the business, employers have difficulties defending their termination or promotion decisions.2 PRIMARY DOCUMENTATION METHODS
Despite the many reasons that documentation is important, most organizations find that they document less than they should. One explanation for this deficiency is that organizations often create or implement large AISs under tight deadlines. In such cases, the urgency to develop a system that works overrides the need for a system that is well documented. Another reason is that most IT professionals prefer creating systems more than documenting them. Thus, many developers actively resist it, arguing that they will
‘‘get around to it later’’ or that documenting is a job for nonexistent assistants.
Insufficient and deficient documentation costs organizations time and money, and good documentation can be as important as the software it describes. We next describe the methods that are available to document AISs. Chapter 3 described E-R diagrams. Four other common documentation methods are data flow diagrams, document flowcharts, system flowcharts, and process diagrams.
2

http://www.theledger.com/article/20090427/COLUMNISTS/904275005

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Data Flow Diagrams
System designers primarily use data flow diagrams (DFDs) in the development process—for example, as a tool for analyzing an existing system or as a planning aid for creating a new system. Because documented data flows are important for understanding an AIS, many of the remaining chapters of this book use DFDs to illustrate the flow of data in the AISs under discussion.
Different types of diagrams give different views of systems, which is why reviewers may need multiple diagrams to fully comprehend a system. For example, an E-R diagram indicates the resources, events, and agents about which the business collects data and stores in a database. A DFD describes the sources of data stored in a database and the ultimate destinations of these data.

Data Flow Diagram Symbols. Figure 6-2 illustrates the four basic symbols used in
DFDs. A rectangle or square represents an external data source or data destination—for example, a customer. To show this, a DFD would include the word ‘‘customer’’ inside a data source or destination symbol. In Figure 6-2, the term external entity (an entity outside the system under study) does not necessarily mean that it is an entity external to the company. Thus, for example, a ‘‘customer’’ might be another division of the same company under study.
Data flow lines are lines with arrows that indicate the direction that data flow in the system. For this reason, every data source symbol will have one or more data flow lines leading away from it, and every data destination symbol will have one or more data flow lines leading into it. For clarity, you should label each data flow line to indicate exactly what data are flowing along it.
A circle or bubble in a DFD indicates a system entity or process that changes or transforms data. (Some authors prefer to use squares with rounded corners for this symbol.) In physical DFDs (discussed shortly), the label inside a bubble typically contains the title of the person performing a task—for example, ‘‘cashier.’’ In logical DFDs (also discussed shortly), the label inside the bubble describes a transformation process—for example, ‘‘process cash receipts.’’

External entity (data source or data destination)

Data flow

Internal entity (physical DFDs) or transformation process (logical DFDs)

or

Data store (file)

FIGURE 6-2 Symbols for data flow diagrams.

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Finally, DFDs use a set of parallel lines or an open rectangle to represent a store or repository of data. This is usually a file or database table. If data are permanently stored, a data store symbol is mandatory. If data are collected over time and stored in some temporary place, you are not required to use a file symbol for this (although experts recommend including one for clarity).

Context Diagrams. We typically draw DFDs in levels that show increasing amounts of detail. Designers first prepare a high-level DFD called a context diagram to provide an overview of a system. Figure 6-3 is an example of a context diagram for payroll processing.
The DFD in Figure 6-3 shows the inputs and outputs of the application (payroll processing) as well as the data sources and destinations external to the application. Thus, this context diagram uses rectangles to identify Timekeeping and Human Resources as external entities, despite the fact that these departments are internal to the company. This is because these entities are external to the payroll processing system under study. The data flow lines connecting these entities to and from the system (e.g., time card data) are system interfaces.
Physical Data Flow Diagrams. A context diagram shows very little detail. For this reason, system designers usually elaborate on the elements in context DFDs by decomposing them into successively more detailed levels. These subsequent DFDs show more specifics, such as processing details or the inputs and outputs associated with each processing step.
The first level of detail is commonly called a physical data flow diagram. Figure 6-4 is an example for our payroll illustration. The circles in the physical DFD of Figure 6-4 identify the data-entry clerk who enters payroll information into the computer, the payroll cashier who distributes paychecks to employees, and the tax accountant who sends tax information to the Internal Revenue Service.
Figure 6-4 illustrates several important characteristics of physical DFDs. First, we observe that each circle contains a number as well as a title. Including a number in each circle makes it easier to reference it later. This also assists designers in the decomposition tasks discussed shortly. Second, we notice that a physical DFD includes the same inputs and outputs as its predecessor context diagram in Figure 6-3—that is, the context DFD and the physical DFD are balanced. This balancing is important because unbalanced DFDs are inconsistent and likely contain errors. Third, we find that all circles in the physical
DFD contain the names of system entities (i.e., the titles of employees). These titles should correspond to the titles in an official organization chart.

Paychecks
Timekeeping

Human
Resources

Employees

Time Card Data

Payroll Change
Data

Payroll
Processing
System

Payroll Summaries

Tax Information

FIGURE 6-3 A context diagram for a payroll processing system.

Management

Government
Agencies

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PART THREE / Documenting Business Processes

Timekeeping

Time Card Data
Weekly payroll data and changes

1.0
Data
Entry Clerk
Human
Resources

Payroll master file Payroll Change
Data

Paycheck

Payroll
Data

2.0
Payroll
Cashier

Payroll tax
Information

3.0
Tax
Accountant

Employee

Payroll Summary
Information

Management

Payroll tax
Information

Government
Agencies

FIGURE 6-4 A physical data flow diagram.

Finally, we see that a physical DFD lists the job title of only one typical employee in an entity symbol, despite the fact that several employees may perform the same task—for example, several data-entry clerks or payroll cashiers. This last characteristic also applies when several employees perform the same task at different locations—for example, a company has several payroll cashiers who distribute paychecks at each of its manufacturing facilities. Representing types of employees, rather than individual employees, keeps DFDs simple and makes them easier to interpret.

Logical Data Flow Diagrams. A physical DFD illustrates the internal and external entities that participate in a process but does not give the reader a good idea of what these participants do. For this task, we need logical data flow diagrams.
Figure 6-5 is a logical DFD for the payroll illustration in Figure 6-4. In Figure 6-5, note that each circle no longer contains the name of a system entity, but instead contains a verb that indicates a task the system performs. For example, instead of a single circle with the title ‘‘Data-Entry Clerk,’’ as in Figure 6-4, the logical DFD in Figure 6-5 shows two circles with the titles ‘‘Process employee hours worked’’ and ‘‘Process payroll change data’’—because these are separate data processing tasks that clerks perform.
From the standpoint of good system design and control, describing system processes is important because understanding how a system performs tasks can be more important than knowing what tasks the system performs. For example, all payroll systems prepare paychecks, but not all payroll systems do this exactly the same way. The differences may require different hardware, software, procedures, or controls. Logical DFDs help designers

CHAPTER 6 / Documenting Accounting Information Systems

Timekeeping

Time card data 1.0
Process
employees hours worked

Employee hours data
Payroll
Master File

Status and rate data

Human
Resources

Paycheck

3.0
Process
paycheck

Payroll information yc he Pa

2.0
Process
payroll change data

ck d at a Payroll change data

Employee

175

l ol yr pa n d io t se es rma c ro nfo
P
i

Tax information Government

4.0
Process
payroll reports Payroll summaries Management

FIGURE 6-5 A logical data flow diagram for a payroll processing system.

decide what system resources to acquire, what activities employees must perform to run these systems, and how to protect and control these systems after they are installed.
Figure 6-5 is called a level 0 data flow diagram because it shows only in broad terms what tasks a system performs. Most systems are more complex than this and therefore require more detail to describe them completely. The task of creating such detail is called decomposition, which becomes necessary because DFD designers try to limit each level diagram to between five and seven processing symbols (circles).
Figure 6-6 shows an example of a level 1 data flow diagram—an ‘‘explosion’’ of symbol 3.0 (in Figure 6-5) with the caption ‘‘process paycheck.’’ Here, we see that ‘‘process paycheck’’ entails computing gross pay, payroll deductions, and net pay. If necessary, you can also show ancillary computer files at this level.
To fully document the system, you would continue to perform these decomposition tasks in additional DFDs. For example, you might decompose the procedure ‘‘compute payroll deductions’’ in circle 3.2 of Figure 6-6 into several additional processes in lower-level
DFDs—for example, create separate DFDs for ‘‘compute medical deductions,’’ ‘‘compute savings plan deductions,’’ ‘‘compute tax deductions,’’ and so forth. In this way, a set of
DFDs become linked together in a hierarchy.

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PART THREE / Documenting Business Processes

Payroll
Master File
Paycheck data
3.1
Compute gross pay
Processed
payroll information Summary paycheck data

Paycheck data with gross pay
3.2
Compute payroll deductions
3.3
Compute net pay

Paycheck data with gross pay and deductions

3.4
Prepare
paycheck
Paycheck
Employee

FIGURE 6-6 An exploded view of the ‘‘process paycheck’’ bubble of Figure 6-5.

Guidelines for Drawing Data Flow Diagrams
Creating DFDs is as much art as science. The following rules can help you make them easier to interpret and assist you in avoiding simple errors.
1. Avoid detail in high-level DFDs (i.e., in levels 0 and 1). Where appropriate, combine activities that are performed at the same place or same time or that are logically related.
2. As a general rule, each logical DFD should contain between five and seven processing circles (or bubbles). This guideline helps you simplify the diagrams and avoid showing too much detail in high-level DFDs.
3. Different data flows should have different names to avoid confusion related to the data produced and used by different processes.
4. Unless they are outside the system or used for archiving, all data stores should have data flows both into and out of them. Thus, an internal file symbol that lacks both of these data flow lines typically involves a diagramming error.
5. Even if a file is temporary, it is usually desirable to include it in a DFD.
6. Classify most of the final recipients of system information as external entities.
7. Classify all personnel or departments that process the data of the current system as internal entities.

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8. Display only normal processing routines in high-level DFDs. Avoid showing error routines or similar exception tasks.
9. Where several system entities perform the same task, show only one to represent them all. This rule also applies when system personnel perform the same task at different locations of the organization—for example, at different plants.

Document Flowcharts
A document flowchart traces the physical flow of documents through an organization—that is, the flow of documents from the departments, groups, or individuals who first created them to their final destinations. Document flowcharts provide more details about documents than do DFDs. Figure 6-7 illustrates common document flowcharting symbols, and the examples below illustrate how to use them to create basic document flowcharts.
Constructing a document flowchart begins by identifying the different departments or groups that handle the documents for a particular system. The flowchart developer then uses the symbols in Figure 6-7 to illustrate the document flows. Let us first examine two simple cases and then discuss general flowcharting guidelines.

Document

1

2

3

Multiple copies of a specific document

Keying operation

A

Permanent file of manual documents
(letter inside symbol indicates file sequence order)
A = alphabetically
N = numerically
D = chronologically
(year, month, day)

Document flow

Information flow
(without document flow) Journal or ledger

Flow of physical goods (inventory, etc.)

Envelope for mailing or distributing bills, checks, etc.

Adding machine tape total utilized for batch control

Manual operation

On-page connector between two points on a flowchart
Off-page connector between two points on a flowchart
Annotation symbol for comments or further descriptions
Electronic data communication FIGURE 6-7 Common document flowcharting symbols.

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PART THREE / Documenting Business Processes

Requesting Department

Central Supplies Department

A
2
Goods
Requisition
Form
(GRF)

Goods
Requisition
Form
(GRF)

1

1

A
File

FIGURE 6-8 A simple document flowchart.

Example 1. Your boss asks you to document the paperwork involved in acquiring office supplies from your company’s Central Supplies Department. Your administrative assistant explains the process as follows:
Reordering supplies requires a requisition request. When I need more stationery, for example, I fill out two copies of a goods requisition form (GRF). I send the first copy to central supplies and file the second copy here in the office.
There are two departments involved in this example—your department (which we will call the Requesting Department) and the Central Supplies Department. Thus, you should begin by naming these departments in the headings on your document flowchart
(Figure 6-8). Next, you draw two copies of the GRF under the heading for the Requesting
Department because this is the department that creates this form. You number these copies
1 and 2 to indicate two copies.
Finally, you indicate where each document goes: copy 1 to the Central Supplies
Department and copy 2 to a file in the Requesting Department. A document’s first appearance should be in the department that creates it. A solid line or the on-page connectors shown here indicate its physical transmittal from one place to another. You then redraw the transmitted document to indicate its arrival at the department that receives it. Figure 6-8 illustrates the completed flowchart for this narrative.

Example 2. Now consider a slightly more complex example—the task of hiring a new employee at your company. The process begins when a department develops a vacancy.
The Human Resources (HR) director explains the process as follows:
The department that develops a vacancy must first complete a job vacancy form, which it forwards to my department. We then advertise for the position and, with the help of the requesting department, interview applicants. When the vacancy is filled, the HR Department prepares a position hiring form (PHF) in triplicate. We file the first copy in a manual file, which is organized by employee Social Security number. We staple the third copy to the job vacancy form and return it to the
Requesting Department, where clerks file it alphabetically by employee last name.

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The HR Department forwards the second copy of the PHF to the Payroll
Department. The Payroll Department uses the form as an authorization document to create a payroll record for the new employee. Thus, the information on the form is keyed directly into the company’s computer system using an online terminal located in the payroll office. This copy of the PHF is then filed numerically for reference and also as evidence that the form has been processed.
Figure 6-9 is a document flowchart for this example. To draw it, your first step is the same as before—to identify the participants. In this case there are three of them:
(1) the department with the job vacancy (i.e., the Requesting Department), (2) the
Human Resources Department, and (3) the Payroll Department. You identify each of these departments in separate columns at the top of the document flowchart.
Your next step is to identify the documents involved. There are two major ones:
(1) the Job Vacancy form, which we presume is prepared as a single copy, and (2) the
Position Hiring form, which we are told is prepared in triplicate. In practice, multiplecopy forms are usually color-coded. However, in document flowcharts, these are simply numbered and a separate page is attached to explain the color–number equivalencies.
Your third step is to indicate where the documents are created, processed, and used.
This is probably the most difficult task, and a document flowchart designer must often use considerable ingenuity to represent data flows and processing activities accurately.
Figure 6-9 illustrates these flows for the hiring procedures just described. Where there are a large number of document transmittals, you can use on-page connectors (circles) to connect document flows from one place on a page to another and avoid complicated flow lines. Thus, Figure 6-9 uses several on-page connectors (with letters A, B, and C) to avoid cluttering the chart. You should use a unique identifier in each connector (such as a letter)
Requesting Department

Job
Vacancy
form

Job Vacancy form C
A

Human Resources

Position 3
Hiring form

A

B

prepare
Position
Hiring form Job Vacancy form A

Payroll Department

Position
Hiring form

2

key data using online terminal

3
2

filed alphabetically by employee last name

Position 1
Hiring
form

C
B

Position 2
Hiring
form

N
N

filed by employee Social
Security
number

FIGURE 6-9 A document flowchart illustrating the flow of documents involved in the hiring of a new employee.

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PART THREE / Documenting Business Processes

for identification purposes. You can also use off-page connectors (to connect data flows to other pages) if necessary.
When constructing document flowcharts, some analysts also include the movement of physical goods—for example, moving inventory from a receiving department to an inventory storeroom. Document flowcharts typically use hand-truck symbols for this task. Some document flowcharts also illustrate information flows that do not involve documents (for example, a sales clerk telephoning to check a customer’s account balance before approving a credit sale). Thus, the term ‘‘document’’ broadly includes all types of organizational communications and data flows. It is also important to recognize that document flowcharting symbols are not standardized across all firms.

Guidelines for Drawing Document Flowcharts
You can use the following guidelines to simplify the process of creating document flowcharts. 1. Identify all the departments that create or receive the documents involved in the system. Use vertical lines to create ‘‘swim lanes’’ to separate each department from the others.
2. Carefully classify the documents and activities of each department, and draw them under their corresponding department headings.
3. Identify each copy of an accounting document with a number. If multiple-copy documents are color-coded, use a table to identify the number–color associations.
4. Account for the distribution of each copy of a document. In general, it is better to over-document a complicated process than to under-document.
5. Use on-page and off-page connectors to avoid diagrams with lines that cross one another. 6. Each pair of connectors (a from and a to connector in each pair) should use the same letter or number.
7. Use annotations if necessary to explain activities or symbols that may be unclear. These are little notes to the reader that help clarify your documentation.
8. If the sequence of records in a file is important, include the letter ‘‘A’’ for alphabetical,
‘‘N’’ for numeric, or ‘‘C’’ for chronological in the file symbol. As indicated in guideline
7, you can also include a note in the flowchart.
9. Many flowcharts in practice use acronyms (e.g., GRF or PHF in the preceding examples). To avoid confusion, use full names (possibly with acronyms in parentheses) or create a table of equivalents to ensure accuracy in identifying documents.
10. Consider using automated flowcharting tools. See the section of this chapter on CASE tools for more information.

Case-in-Point 6.3 Some accountants disagree about the usefulness of document flowcharts relative to other documenting tools, but one manuscript reviewer of this book wrote: ‘‘Flowcharting is one of the most essential skills, in my opinion, for a student to learn in a systems course. During my tenure at a CPA firm, I had the opportunity to document several accounting information systems, and document flowcharting was the key skill. When word got around the office that I was a good flowcharter, I got placed on more important clients, furthering my career.’’

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System Flowcharts
Whereas document flowcharts focus on tangible documents, system flowcharts concentrate on the computerized data flows of AISs. Thus, a system flowchart typically depicts the electronic flow of data and processing steps in an AIS. Figure 6-10 illustrates some common system flowcharting symbols. Most of these symbols are industry conventions that have been standardized by the National Bureau of Standards (Standard ×3.5), although additional symbols are now necessary to represent newer data transmission technologies—for example, wireless data flows.
Some system flowcharts are general in nature and provide only an overview of the system. These are high-level system flowcharts. Figure 6-11 is an example. The inputs and

Start

Terminator (start or stop)

Yes

Hours
>=40?

Decision point

No
Computer
running payroll program Processing function

Input time card data for an employee Payroll processing report

Payroll master file

Input or output, using any type of medium or data

Hard-copy document (e.g., a report, payroll check, customer letter, etc.)

or

Payroll master file

Airport departures screen

Transcribe time card data

Online storage, especially disk storage

Screen display (output only)

Manual keying operation using an online terminal or microcomputer (typically assumes the presence of a dedicated display screen)
Communications link (e.g., a satellite connection)

Time card must be signed by supervisor Annotation symbol (contains notes and explanations) FIGURE 6-10 Some common system and programming flowcharting symbols.

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Time Cards and
Payroll Changes

Computer Using
Payroll
Program

Payroll
Master File

Paychecks and
Reports

FIGURE 6-11 A high-level system flowchart for payroll processing.

outputs of the system are specified by the general input and output symbol, a parallelogram.
In more detailed system flowcharts, the specific form of these inputs and outputs would be indicated—for example, by magnetic disk symbols.
Figure 6-11 refers to only one process—processing payroll. A more detailed system flowchart would describe all the processes performed by the payroll program and the specific inputs and outputs of each process. At the lowest, most detailed level of such documentation are program flowcharts that describe the processing logic of each application program. We will examine program flowcharts later in this chapter.
Like document flowcharts, the process of drawing system flowcharts is probably best understood by studying an illustration. Figure 6-12 is a system flowchart for the following example. The Sarah Stanton Company is a magazine distributor that maintains a file of magazine subscribers for creating monthly mailing labels. Magazine subscribers mail change-of-address forms or new-subscription forms directly to the company, where input personnel key the information into the system through online terminals. The computer system temporarily stores this information as a file of address change or new-subscription requests. Clerical staff key these data into computer files continuously, so we may characterize it as ‘‘daily processing.’’
Once a week, the system uses the information in the daily processing file to update the subscriber master file. At this time, new subscriber names and addresses are added to the file, and the addresses of existing subscribers who have moved are changed. The system also prepares a Master File Maintenance Processing Report to indicate what additions and modifications were made to the file. Once a month, the company prepares postal labels for the magazine’s mailing. The subscriber master file serves as the chief input for this computer program. The two major outputs are the labels themselves and a Mailing Labels Processing Report that documents this run and indicates any problems.
The system flowchart in Figure 6-12 documents the flow of data through the company’s computerized system. Thus, it identifies sources of data, the places where data are temporarily stored, and the outputs on which processed data appear. In Figure 6-12, for example, the system flowchart begins with the subscriber request forms and documents

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183

New Subscriber
Forms
Subscriber
Address Change
Request Forms

Online
Terminal

Computer, using
“Subscriber File
Maintenance”
Program
(Daily Processing)

Change
Request
Records

Subscriber
Master
File

Computer, using
“Master File
Maintenance”
Program
(Weekly Processing)

Computer, using
“Prepare Mailing
Labels” Program
(Monthly Processing)

Master File
Maintenance
Processing
Report

Mailing Labels
Processing
Report

Subscriber
Mailing
Labels

FIGURE 6-12 A system flowchart illustrating the computer steps involved in maintaining a subscriber master file and creating monthly mailing labels.

the flow of data on these forms through the keying phase, master-file-maintenance phase, and finally, the monthly mailing phase.
Indirectly, system flowcharts also indicate processing cycles (daily, weekly, or monthly), hardware needs (e.g., disk drives and printers), areas of weak or missing application controls, and potential bottlenecks in processing (e.g., manual data entry). In
Figure 6-12, we can also identify the major files of the system (a temporary log file of change-request records and a subscriber master file) and the major reports of the system.

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PART THREE / Documenting Business Processes

Finally, note that each processing phase of a system flowchart usually involves preparing one or more control reports. These reports provide processing-control information (e.g., counts of transactions processed) for control purposes and exceptions information
(e.g., the identity of unprocessed transactions) that helps employees correct the errors detected by the system.

Guidelines for Drawing System Flowcharts
System flowcharts depict an electronic job stream of data through the various processing phases of an AIS and therefore also illustrate audit trails. Each time the records of a file are sorted or updated, for example, a system flowchart should show this in a separate processing step. Recognizing the usefulness of system flowcharts, both the American Institute of
Certified Public Accountants (AICPA) and the Institute of Management Accountants (IMA) consistently include test questions in their professional examinations that require a working knowledge of system flowcharts.
Although no strict rules govern exactly how to organize a system flowchart, the following list provides some guidelines.
1. System flowcharts should read from top to bottom and from left to right. In drawing or reading such flowcharts, you should begin in the upper-left corner.
2. Because system flowcharting symbols are standardized, you should use these symbols when drawing your flowcharts—do not make up your own.
3. A processing symbol should always be found between an input symbol and an output symbol. This is called the sandwich rule.
4. Use on-page and off-page connectors to avoid crossed lines and cluttered flowcharts.
5. Sketch a flowchart before designing the final draft. Graphical documentation software tools (discussed shortly) make this job easier.
6. Add descriptions and comments in flowcharts to clarify processing elements. You can place these inside the processing symbols themselves, include them in annotation symbols attached to process or file symbols, or add them as separate notes in your systems documentation.

Process Maps
A business process is a natural group of business activities that create value for an organization. Process maps document business processes in easy-to-follow diagrams. Did you understand the logic diagram in Figure 6-1 at the beginning of the chapter? It’s an example of a process map. Studies suggest that process maps are among the easiest to draw and are also among the easiest for novices to follow.
In businesses, a major process is usually the sales or order fulfillment process. A process map for this process (Figure 6-13) shows activities such as customers placing orders, warehouse personnel picking goods, and clerks shipping goods. Managers can create similar maps that show just about any other process—for example, how an organization processes time cards for a payroll application, how a business responds to customer returns, or how a manager deals with defective merchandise.

Case-in-Point 6.4 Increased competition and tighter profit margins have forced companies to look for places where they might be able to save money. One large accounting firm has

CHAPTER 6 / Documenting Accounting Information Systems

CUSTOMER

Order
Goods

SALES DEPT.

Submit
Order

CREDIT &
BILLING

Check
Credit

185

Prepare
Payment

Send
Invoice

Credit
OK?
yes

SHIPPING

Check
Inventory

On
Hand?

yes

Pick and
Ship Goods

FIGURE 6-13 A process map for the order fulfillment process (created with Microsoft Word). used process mapping software to assist clients in evaluating and redesigning their business processes. For example, the firm’s business reengineering practice helped a financial services company cut its costs and become more efficient. The company was able to cut in half the time it took to approve a loan—and it needed 40% fewer staff to do it.

Internal and external auditors can use process maps to help them learn how a department or division operates, document what they have learned, and identify internal control weaknesses or problems in existing operations. An additional benefit is to use such maps as training aids. Consultants frequently use process maps to help them study business processes and redesign them for greater productivity. Accountants and managers can also use this tool to help them describe current processes to others.
Like most other types of documentation, you can draw process maps in multilevel versions called hierarchical process maps that show successively finer levels of detail. Such maps are especially popular on the Web because viewers can click on individual symbols to see more information for any given process or decision. Figure 6-14, for example, illustrates a second-level process map for checking credit that might link to the ‘‘Check Credit’’ box in Figure 6-13.

Guidelines for Drawing Process Maps
Process maps vary considerably across firms, and the symbols found in Web versions are remarkably inconsistent. Nonetheless, it is possible to use the flowchart symbols that you already know to create process maps, including (1) a rectangle (to represent a process),
(2) a diamond (to represent decisions), (3) an oval (to depict the starting and ending points for a process), (4) an off-page connector, and (5) a document symbol. Creating a good process map requires a blend of art, science, and craftsmanship, all of which mostly comes with practice. Here are some guidelines to use when drawing process maps.
1. Identify and define the process of interest. The goal is to stay focused on the scope of the process you are trying to map.

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SALES
DEPARTMENT

Submit
Order

Reject order no

CREDIT &
BILLING

Customer approved for credit?

SHIPPING

Customer account current?

New order falls within credit limit?

Credit
OK?

yes
Approve
for shipping FIGURE 6-14 A second-level process map for the credit approval process of Figure 6-13.
2. Understand the purpose of each process map. Is it to identify bottlenecks? Discover redundancies? 3. Meet with employees to get their ideas, suggestions, and comments. Don’t hesitate to ask challenging or probing questions.
4. Remember that processes have inputs, outputs, and enablers. An example input is an invoice; an output could be a payment check for a supplier, and an enabler helps a process achieve results. In AISs, information technology is a common enabler.
5. Show key decision points. A process map will not be an effective analytical tool without decision points (the intellectual or mental steps in a process).
6. Pay attention to the level of detail you capture. Did you capture enough detail to truly represent the process and explain it to others?
7. Avoid mapping the should-be or could-be. Map the process that is in place.
8. Practice, practice, practice.

OTHER DOCUMENTATION TOOLS
There are many other tools for documenting AISs besides data flow diagrams, document flowcharts, system flowcharts, and process maps. Two of them are (1) program flowcharts and (2) decision tables. Because these tools are used mostly by consultants and IT professionals rather than accountants, we will describe them only briefly. Accountants should have some familiarity with these tools, however, because they may see them—for example, when reviewing the design for a revised accounting system.

Program Flowcharts
Because large computer programs today involve millions of instructions, they require careful planning and the coordinated work of hundreds of systems analysts and programmers.
Typically, organizations use structured programming techniques to create these large programs in a hierarchical fashion, that is, from the top down. This means that the developers design the main routines first and then design subroutines for subsidiary processing as major processing tasks become clear.

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Initialize control total to zero

Start

Read a record Compute sales amount = price × quantity

Add sales amount to control total

Print an output line

No

Last account? Yes

Print final output line with control total

Stop

FIGURE 6-15 A program flowchart for a sales application.
To help them plan the logic for each processing routine, IT professionals often create program flowcharts (Figure 6-15) that outline the processing logic of computer programs as well as the order in which processing steps take place. After designing such program flowcharts, the developers typically present them to colleagues in a structured walkthrough or formal review of the logic. This process helps the reviewers assess the soundness of the logic, detect and correct design flaws, and make improvements. On approval, the program flowcharts become blueprints for writing the instructions of a computer program as well as documenting the program itself.
Program flowcharts use many of the same symbols as system flowcharts (refer back to
Figure 6-10). A few specialized symbols for program flowcharts are the diamond symbol
(which indicates a decision point in the processing logic) and the oval symbol (which indicates a starting or stopping point).
Like system flowcharts and data flow diagrams, program flowcharts can be designed at different levels of detail. The highest-level program flowchart is sometimes called a macro program flowchart, which provides an overview of the data processing logic. A lower-level program flowchart would indicate the detailed programming logic necessary to carry out a processing task. Figure 6-15 is a detailed (lower-level) program flowchart for a sales report application. Decision Tables
When a computer program involves a large number of conditions and subsequent courses of action, its program flowchart tends to be large and complex. A decision table (Figure 6-16)

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Rules
1

Condition stub Action stub Conditions
Account balance less than $5
Account balance less than $1,000
Account 1 year old or less
Actions
Pay no interest
Pay 5 percent interest
Pay 5.5 percent interest

2

3

4

Y

N
Y

N

N
N
N

*
*

*

*
Y

X

X

X
X

Condition entries Action entries FIGURE 6-16 This is a decision table to help a credit union decide how much interest to pay each account. An asterisk (∗) means that the condition does not affect the course of action.

is a table of conditions and processing tasks that indicates what action to take for each possibility. Sometimes, decision tables are used as an alternative to program flowcharts.
More commonly, they are used in conjunction with these flowcharts. To illustrate a decision table, consider the following scenario:
A credit union pays interest to its depositors at the rate of 5% per year. Accounts of less than $5 are not paid interest. Accounts of $1,000 or more that have been with the credit union for more than one year get paid the normal 5%, plus a bonus of
0.5%.
Figure 6-16 presents a decision table for the credit union that shows how much interest to pay each account. Note that the decision table consists of four parts: (1) the condition stub outlines the potential conditions of the application, (2) the action stub outlines the available actions that can be taken, (3) the condition entries depict the possible combinations of conditions likely to occur, and (4) the action entries outline the action to be taken for each combination of conditions.
The rules at the top of the decision table set forth the combination of conditions that may occur and the action entries show what to do for each condition. For the illustration at hand, three conditions affect the data processing of each account: (1) an account balance less than $5, (2) an account balance less than $1,000, and (3) an account 1 year old or less. As defined, each of these conditions can now be answered ‘‘yes’’ or ‘‘no.’’ Figure 6-16 is a decision table for the illustration at hand, in which Y stands for ‘‘yes’’ and N stands for ‘‘no.’’ The combination of Y’s and N’s in each column of the table illustrates each possible condition the system might encounter. Using X’s, the decision table also shows what course of action should be taken for each condition (i.e., how much interest should be paid to each account).
The major advantage of decision tables is that they summarize the processing tasks for a large number of conditions in a compact, easily understood format. This increases system understanding, resulting in fewer omissions of important processing possibilities. Decision tables also serve as useful documentation aids when new data processing conditions arise or when changes in organizational policy result in new actions for existing conditions. This advantage is particularly important to AISs because of organizational concern for accuracy and completeness in processing financial data.

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One drawback of decision tables is that they do not show the order in which a program tests data conditions or takes processing actions, as do program flowcharts.
This is a major deficiency because the order in which accounting data are tested or processed is often as important as the tests or processes themselves. A second drawback is that decision tables require an understanding of documentation techniques beyond flowcharting. Finally, decision tables require extra work to prepare, and this work may not always be cost-effective.

Software Tools for Graphical Documentation and SOX Compliance
Accountants, consultants, and system developers can use a variety of software tools to create graphical documentation of existing or proposed AISs. The simplest tools include presentation software, such as Microsoft PowerPoint, as well as word processing and spreadsheet software such as Microsoft Word and Excel. The advantages of using such tools closely parallel those of using word processing software instead of typewriters (e.g., easily revised documents, advanced formatting capabilities and coloring options, and a variety of reproduction capabilities). For example, the authors used Microsoft Word to create the process maps in Figures 6-13 and 6-14.

Microsoft Word, Excel, and PowerPoint. Using the ‘‘AutoShapes’’ option in the
Drawing Toolbar of Microsoft Word, Excel, or PowerPoint, you can reproduce most of the graphics symbols and logic diagrams in this chapter. (The connectors in Excel are different from, as well as better than, simple lines because they adjust automatically when you reposition symbols in your charts.) Two additional advantages of using Excel to create graphical documentation are the ability to create large drawings (that exceed the margins of word processing documents) and the option to embed computed values in flowcharting symbols. Problem 6–21 at the end of the chapter describes how to use Excel to create such graphical documentation.
CASE Tools. The capabilities of specialized graphical documentation software exceed those of word processing or spreadsheet packages. These CASE (computerassisted software engineering) tools automate such documentation tasks as drawing or modifying flowcharts, drawing graphics and screen designs, developing reports, and even generating code from documentation. Thus, CASE tools are to flowcharts what word processors are to text documents. Figure 6-17 is an example of a CASE package being used to draw a data flow diagram.
Most CASE products run on personal computers. Examples include iGrafx (Micrografx,
Inc.), allCLEAR (Proquis, Inc.), SmartDraw (SmartDraw LLC.), and Visio (Microsoft Corp.).
These products are especially popular with auditors and consultants who use them to document AISs using the techniques discussed above, as well as to analyze the results.
Graphical documentation software enables its users to create a wide array of outputs, including data flow diagrams, entity-relationship diagrams (described in Chapter 3), system flowcharts, program flowcharts, process maps, and even computer network designs.
Front-end CASE tools focus on the early (front-end) tasks of systems design—for example, requirements-design activities. Backend CASE tools automate the detailed design tasks required in the later stages of a project—for example, developing detailed program

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0.0 OIS SYSTEM DIAGRAM
File
R

Options

Help

Toolbox
REQUEST FOR
CREDIT APPROVAL

1.0

I

ACT

APPROVED
CUSTOMER

PROCESS
ORDER

ACCOUNTING

ORD
ORDER
ENTRY
DEPARTMENT

Map
...
...
...
...

G

ORDER
ENT
MARKETING

ORDER ENTRY SIGNALS

ORDER/
INVENTORY
DETAIL

CUSTOMER DETAIL

A A
BC BC

INVENTORY
DETAIL

ORDER/INVENTORY
DATA

3.0

CATALOGUE
CHANGE

MAINTAIN
INVENTORY
GOODS
RECEIVED
DETAIL

SED
OPEN
ORDER
RELEASED
MAIL
ORDER
INVENTORY
DETAIL
2.0

5.0-P

FULFILL

RECEIVE

REC
RECEIVING

Level: 1 Select command:

FIGURE 6-17 This CASE tool is a software program called Excelerator™, which is used here to create a data flow diagram. The toolbox on the left contains symbols that the user can select for his or her diagram. flowcharts. Integrated CASE (I-CASE) packages enable users to perform both types of tasks and can even generate computer code directly from logic diagrams. As a result, these tools support rapid application development (RAD) and help organizations reduce development costs.
Graphical documentation software tools enable their users to generate documentation quickly and consistently, as well as to automate modifications to this documentation later as changes are required. They include templates and models that allow users to document almost any business and system environment. But these packages only create what they are told to create. Like word processors, they lack imagination and creativity, and they also require training to use them effectively.

SOX and AS5 Compliance. Many businesses now use specialized software packages to automate the tasks required by Section 404 of the Sarbanes-Oxley Act of 2002 and standards of the Public Company Accounting Oversight Board (PCAOB). Since the adoption of Auditing Standard No. 5 (AS5) by the PCAOB, companies are placing more emphasis on entity-level controls (such as the tone at the top, management override of internal controls, and the overall control environment) than in prior years. Just as word processing software makes document revisions easier, these ‘‘compliance software packages’’ enable businesses to reduce the time and costs required to satisfy legal requirements.
Symantec Control Compliance Suite (Symantec Corporation), for example, automates processes required by SOX that are intended to reduce IT risks. OpenPages FCM

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(OpenPages, Inc.) and BizRights (Approva Corp.) provide somewhat similar capabilities.
OpenPages FCM includes a compliance database and workflow management tools and provides a software dashboard that enables executives to verify that specific managerial controls are now in place as well as to identify control deficiencies that might affect financial reports. BizRights software enables firms to reduce the risk of fraud by continuously testing and monitoring controls.

END-USER COMPUTING AND DOCUMENTATION
End-user computing refers to the ability of non-IT employees to create computer applications of their own. Today, we take much of this computing for granted—for example, when employees manipulate data with word processing, spreadsheet, database management systems, or tax packages—because all of these programs were developed to allow end users to develop applications for themselves.

The Importance of End-User Documentation
End-user applications often perform mission-critical functions for busy organizations. In many cases, the outputs of user-developed spreadsheets and database applications find their way into financial systems and ultimately influence an organization’s financial statements.
Thus, end users should document their applications for many of the same reasons that professionals must document applications. Managers, auditors, and other system users need to understand how user-developed systems work in order to prevent errors created by these systems. In addition, if an employee leaves an organization, other employees need to be able to use these applications and interpret their outputs.
Unfortunately, documentation of end-user applications is often overlooked or is performed so poorly that it might as well be overlooked. Such oversight can be costly.
For example, time is wasted when other employees must alter the system but lack the basic documentation to accomplish this task. Thus, even if the developer is the only one in the office who uses a particular application, managers should insist that he or she document it.

Case-in-Point 6.5 The Institute of Internal Auditors (IIA) released a white paper in 2010 that guides internal auditor’s evaluations of end-user applications. Because nearly all organizations use employee-developed software such as spreadsheets, the IIA observes that such software may pose threats to organizations (including honest mistakes, noncompliance with regulations, and fraud). As a result, the IIA states that it is critical to evaluate and document these systems.3
The specific items that should be used to document any particular end-user application will, of course, vary with the application. For example, businesses often find it convenient to use systematic file names to identify word processing documents and to embed these

3

The Institute of Internal Auditors. 2010. Global Technology Audit Guide (GTAG) 14: Auditing UserDevelopment Applications. The Institute of Internal Auditors. Altamonte Springs, Florida.

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1. Name of the developer.
2. Name of the file where the application is stored.
3. Name of the directories and subdirectories where the application is stored.
4. Date the application was first developed.
5. Date the application was last modified, and the name of the person who modified it.
6. Date the application was last run.
7. Name and phone number of person to call in case of problems.
8. Sources of external data used by the system.
9. Important assumptions made in the application.
10. Important parameters that must be modified in order to change assumptions or answer ‘‘what-if’’ questions. 11. Range names used in the application and their locations in the spreadsheet.

FIGURE 6-18 Examples of information to include when documenting spreadsheets. file names within the reports to help others find them later. Figure 6-18 provides some ideas for documenting spreadsheet applications.

Policies for End-User Computing and Documentation
To avoid the creation of redundant or ineffective systems and poor documentation of systems developed by employees, businesses should establish and follow the guidelines outlined here to control end-user applications development:
1. Formally evaluate large projects. Employees should be allowed to create a large application only after it has withstood the scrutiny of a formal review of its costs and benefits. When projects are large, higher-level management should be involved in the go-ahead decision.
2. Adopt formal end-user development policies. Employees usually do not develop poor applications because they wish to do so but because no organizational policies exist that restrict them from doing so. Policy guidelines should include procedures for testing software, examining internal controls, and periodically auditing systems.
3. Formalize documentation standards. At this point in the chapter, the importance of formal documentation should be self-evident. What may be less obvious is the need to create procedures for ensuring that employees meet these documentation standards.
4. Limit the number of employees authorized to create end-user applications. This restricts applications development to those employees in whom management has confidence, or perhaps who have taken formal development classes.
5. Audit new and existing systems. The more critical an end-user system is to the functioning of a department or division, the more important it is for organizations to require formal audits of such systems for compliance with the guidelines outlined previously. CHAPTER 6 / Documenting Accounting Information Systems

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AIS AT WORK
Better System Documentation Helps Protect
Minnesota’s Environment4
The Minnesota Pollution Control Agency is charged with protecting Minnesota’s environment. The agency recently realized that it has collected vast amounts of data for nearly
40 years, but it still does not have reliable methods for assessing many of its functions and their effectiveness. To enhance the agency’s effectiveness, the CIO decided that the agency needs detailed business process mapping and documentation. The purpose of the new documentation is to help the agency better understand their existing business processes and identify the current bottlenecks.
The agency undertook four main steps in its documentation efforts. First, they identified the critical business processes and defined these processes. Next, the agency gathered information about the processes by interviewing key personnel and performing walkthroughs of processes. Third, processes were graphically mapped using the forms of documentation described in this chapter. Finally, experts within the agency analyzed the existing processes in order to identify opportunities for improvement.
While the business process modeling task is still ongoing, some of the initial benefits of the new documentation are a reduction in the percentage of backlogged permits from 40% to 9%, streamlined reporting processes to the federal government, and better understanding of the key risks involved in business processes.

SUMMARY
Nine reasons to document an AIS are (1) to explain how the system works, (2) to train others,
(3) to help developers design new systems, (4) to control system development and maintenance costs, (5) to standardize communications among system designers, (6) to provide information to auditors, (7) to document a business’s processes, (8) to help a company comply with the
Sarbanes-Oxley Act of 2002 and AS5, and (9) to establish employee accountability for specific tasks or procedures.
Data flow diagrams provide both a physical and a logical view of a system, but concentrate more on the flow and transformation of data than on the physical devices or timing of inputs, processing, or outputs.
A document flowchart describes the physical flow of documents through an AIS, for example, by providing an overview of where documents are created, sent, reviewed, and stored, and what activities they trigger.
A system flowchart describes the electronic flow of data through an AIS, indicates what processing steps and files are used and when, and provides an overview of the entire system.
Process maps also describe the flow of information through an organization, use only a few symbols, and (to many) are among the easiest to draw and understand.
4

http://www.theusdaily.com/articles/viewarticle.jsp?id=1264630&type=TechnologyComm

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Two additional documentation tools are program flowcharts and decision tables. Accountants do not need to be programmers to evaluate or design an accounting information system, but they should understand in general terms how these tools work.
A variety of software tools exist for documenting AISs. These include standard personal productivity tools such as word processing and spreadsheet software, specialized CASE tools, and software packages designed to help companies comply with SOX and AS5.
End-user computing is important because it is used extensively and also because such applications often contribute significantly to the efficiency of specific departments or divisions. But many employees do not document their applications very well, and this often costs time and money.

KEY TERMS YOU SHOULD KNOW
CASE (computer-assisted software engineering) tools context diagram data flow diagrams (DFDs) decision table decomposition document flowchart documentation end-user computing graphical documentation job stream

level 0 data flow diagram level 1 data flow diagram logical data flow diagrams object-oriented software physical data flow diagram process maps rapid application development (RAD) sandwich rule signed checklist structured programming system flowcharts

TEST YOURSELF
The first three questions refer to this diagram:

office supplies requisition form

Q6-1. The diagram here is most likely a:
a. Document flowchart
b. System flowchart
c. Data flow diagram
d. Program flowchart
Q6-2. In the diagram here, the symbol with the letter ‘‘A’’ represents:
a. An on-page connector
b. An off-page connector
c. A file
d. An answering machine
Q6-3. In this diagram, the arrow represents:
a. A wireless transmission
b. A telephone call
c. An information flow
d. A management order to a subordinate

A

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Q6-4. Document flowcharts would not be able to represent:
a. The flow of information when ordering office supplies
b. The flow of information when hiring new employees
c. The flow of information when creating orders for new magazine subscriptions
d. The logic in performing payroll processing
Q6-5. Which of the following is not true about system flowcharts?
a. They can depict the flow of information in computerized AISs
b. They use standardized symbols
c. They cannot show how documents flow in an AIS
d. They often document an audit trail
Q6-6. Which of the following is not true about process maps?
a. They depict the flow of information in computerized AISs
b. They use standardized symbols
c. Government agencies as well as businesses often use them
d. Web pages often depict hierarchical versions of them
Q6-7. The sandwich rule states that:
a. You should only create logic diagrams that have some ‘‘meat’’ in them
b. Every diagram should have a cover page and a summary page
c. A processing symbol should be between an input and an output symbol
d. In DFDs, there should always be data flow lines leading to and from files
Q6-8. Which of these is not a good guideline to follow when creating DFDs?
a. Avoid detail in high-level DFDs
b. Avoid drawing temporary files in DFDs
c. Classify most of the final recipients of system outputs as external entities
d. Avoid showing error routines or similar exception tasks
Q6-9. A data flow diagram helps readers to understand:
a. The data structure of tables
b. The resources involved in transactions
c. The destinations of important reports
d. The logical operations of programs
Q6-10. A decision table shows:
a. The possible conditions and processing alternatives for a given situation
b. Who sat where at a board meeting
c. The rules for drawing DFDs
d. The local outsourcing vendors in the area for documentation tasks

DISCUSSION QUESTIONS
6-1. Why is documentation important to accounting information systems? Why should accountants be interested in AIS documentation?
6-2. Distinguish between document flowcharts, system flowcharts, data flow diagrams, and program flowcharts. How are they similar? How are they different?

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PART THREE / Documenting Business Processes

6-3. What are document flowcharts? How does a document flowchart assist each of the following individuals: (1) a systems analyst, (2) a systems designer, (3) a computer programmer, (4) an auditor, and (5) a data security expert?
6-4. Flowcharting is both an art and a science. Guidelines can be used to make better flowcharts.
What are these guidelines for document, system, and data flow diagram flowcharts?
6-5. What are the four symbols used in data flow diagrams? What does each mean?
6-6. Why are data flow diagrams developed in a hierarchy? What are the names of some levels in the hierarchy?
6-7. Look at the process map in Figure 6-5. Trace the steps in the order fulfillment process. Do you think this figure is more helpful than a narrative would be in understanding the flow of events in the process?
6-8. What is the purpose of a decision table? How might decision tables be useful to accountants?
6-9. What are CASE tools? How are they used? How do CASE tools create documentation for AISs?
If you were a systems analyst, would you use a CASE tool?
6-10. What is end-user computing? Why is documentation important to end-user computing? What guidelines should companies develop to control end-user computing?

PROBLEMS
6-11. To view the flowchart shapes in Microsoft Excel, select the following options from the main menu: Insert\Shapes. There should be approximately 28 of them (using Excel 2010). If you allow your mouse to hover over a specific symbol, its title and meaning will appear in a tool-tip box. Finally, if you click on a specific symbol, your mouse icon will change to a cross-hair and you will be able to draw this symbol on your spreadsheet. Create a list with items similar to the one below that contains all the symbols in your version of Excel.
Predefined Process

6-12. Draw a document flowchart to depict each of the following situations.
a. An individual from the marketing department of a wholesale company prepares five copies of a sales invoice, and each copy is sent to a different department.
b. The individual invoices from credit sales must temporarily be stored until they can be matched against customer payments at a later date.
c. A batch control tape is prepared along with a set of transactions to ensure completeness of the data.
d. The source document data found on employee application forms are used as input to create new employee records on a computer master file.
e. Delinquent credit customers are sent as many as four different inquiry letters before their accounts are turned over to a collection agency.
f. Physical goods are shipped back to the supplier if they are found to be damaged upon arrival at the receiving warehouse.
g. The data found on employee time cards are keyed onto a hard disk before they are processed by a computer.

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h. The data found on employee time cards are first keyed onto a floppy diskette before they are entered into a computer job stream for processing.
i. A document flowchart is becoming difficult to understand because too many lines cross one another. (Describe a solution.)
j. Three people, all in different departments, look at the same document before it is eventually filed in a fourth department.
k. Certain data from a source document are copied into a ledger before the document itself is filed in another department.
6-13. Develop a document flowchart for the following information flow. The individual stores in the
Mark Goodwin convenience chain prepare two copies of a goods requisition form (GRF) when they need to order merchandise from the central warehouse. After these forms are completed, one copy is filed in the store’s records and the other copy is sent to the central warehouse.
The warehouse staff gets the order and files its copy of the GRF form in its records. When the warehouse needs to restock an item, three copies of a purchase order form (POF) are filled out. One copy is stored in the warehouse files, one copy goes to the vendor, and the third copy goes to the accounts payable department.
6-14. The Garcia-Lanoue Company produces industrial goods. The company receives purchase orders from its customers and ships goods accordingly. Assuming that the following conditions apply, develop a document flowchart for this company:
a. The company receives two copies of every purchase order from its customers.
b. On receipt of the purchase orders, the company ships the goods ordered. One copy of the purchase order is returned to the customer with the order, and the other copy goes into the company’s purchase order file.
c. The company prepares three copies of a shipping bill. One copy stays in the company’s shipping file, and the other two are sent to the customer.
6-15. The data-entry department of the Ron Mitchell Manufacturing Company is responsible for converting all of the company’s shipping and receiving information to computer records.
Because accuracy in this conversion is essential, the firm employs a strict verification process.
Prepare a document flowchart for the following information flow:
a. The shipping department sends a copy of all shipping orders to the data-entry department.
b. A data-entry operator keys the information from a shipping order onto a diskette.
c. A supervisor checks every record with the original shipping order. If no errors are detected, the diskette is sent to the computer operations staff and the original shipping order is filed.
6-16. Amanda M is a regional manufacturer and wholesaler of high-quality chocolate candies. The company’s sales and collection process is as follows. Amanda M makes use of an enterprise-wide information system with electronic data interchange (EDI) capability. No paper documents are exchanged in the sales and collection process. The company receives sales orders from customers electronically. On receipt of a sales order, shipping department personnel prepare goods for shipment and input shipping data into the information system. The system sends an electronic shipping notice and invoice to the customer at the time of shipment. Terms are net
30. When payment is due, the customer makes an electronic funds transfer for the amount owed. The customer’s information system sends remittance (payment) data to Amanda M.
Amanda M’s information system updates accounts receivable information at that time.
Draw a context diagram and a level 0 logical data flow diagram for Amanda M’s sales and collection process.
6-17. The order-writing department at the Winston Beauchamp Company is managed by Alan Most.
The department keeps two types of computer files: (1) a customer file of authorized credit customers and (2) a product file of items currently sold by the company. Both of these files are direct-access files stored on magnetic disks. Customer orders are handwritten on order forms with the Winston Beauchamp name at the top of the form, and item lines for quantity, item number, and total amount desired for each product ordered by the customer.

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When customer orders are received, Alan Most directs someone to input the information at one of the department’s computer terminals. After the information has been input, the computer program immediately adds the information to a computerized ‘‘order’’ file and prepares five copies of the customer order. The first copy is sent back to Alan’s department; the others are sent elsewhere. Design a system flowchart that documents the accounting data processing described here. Also, draw a data flow diagram showing a logical view of the system. 6-18. The LeVitre and Swezey Credit Union maintains separate bank accounts for each of its 20,000 customers. Three major files are the customer master file, the transaction file of deposits and withdrawal information, and a monthly statement file that shows a customer’s transaction history for the previous month. The following lists the bank’s most important activities during a representative month:
a. Customers make deposits and withdrawals.
b. Employers make automatic deposits on behalf of selected employees.
c. The bank updates its master file daily using the transaction file.
d. The bank creates monthly statements for its customers, using both the customer master file and the transactions file.
e. Bank personnel answer customer questions concerning their deposits, withdrawals, or account balances.
f. The bank issues checks to pay its rent, utility bills, payroll, and phone bills.
Draw a data flow diagram that graphically describes these activities.
6-19. The Jeffrey Getelman Publishing Company maintains an online database of subscriber records, which it uses for preparing magazine labels, billing renewals, and so forth. New subscription orders and subscription renewals are keyed into a computer file from terminals. The entry data are checked for accuracy and written on a master file. A similar process is performed for change-of-address requests. Processing summaries from both runs provide listings of master file changes.
Once a month, just prior to mailing, the company prepares mailing labels for its production department to affix to magazines. At the same time, notices to new and renewal subscribers are prepared. These notices acknowledge receipt of payment and are mailed to the subscribers.
The company systems analyst, Bob McQuivey, prepared the system flowchart in Figure 6-19 shortly before he left the company. As you can see, the flowchart is incomplete. Finish the flowchart by labeling each flowcharting symbol. Don’t forget to label the processing runs marked computer.
6-20. The Bridget Joyce Company is an office products distributor that must decide what to do with delinquent credit-sales accounts. Mr. Bob Smith, the credit manager, divides accounts into the following categories: (1) accounts not past due, (2) accounts 30 days or less past due,
(3) accounts 31 to 60 days past due, (4) accounts 61 to 90 days past due, and (5) accounts more than 90 days past due. For simplicity, assume that all transactions for each account fall neatly into the same category.
Mr. Smith decides what to do about these customer accounts based on the history of the account in general and also the activity during the account’s delinquency period. Sometimes, for example, the customer will not communicate at all. At other times, however, the customer will either write to state that a check is forthcoming or make a partial payment. Mr. Smith tends to be most understanding of customers who make partial payments because he considers such payments acts of good faith. Mr. Smith is less understanding of those customers who only promise to pay or who simply ignore follow-up bills from the company.
Mr. Smith has four potential actions to take in cases of credit delinquency. First, he can simply wait (i.e., do nothing). Second, he can send an initial letter to the customer, inquiring about the problem in bill payment and requesting written notification of a payment schedule if payment has not already been made. Third, he can send a follow-up letter indicating that a collection agency will be given the account if immediate payment is not forthcoming. Fourth, he can turn the account over to a collection agency. Of course, Mr. Smith prefers to use one

CHAPTER 6 / Documenting Accounting Information Systems

New subscription orders, renewals, and checks

Change of address forms

Computer

199

Computer
MF

Computer
(monthly
processing)

Mailing labels

?

To new subscribers and renewal subscribers

FIGURE 6-19 System flowchart for processing the subscription orders and changes for the
Jeffrey Getelman Company. of the first three actions rather than turn the account over to a collection agency because his company receives only half of any future payments when the collection agency becomes involved. a. Create a decision table for the Bridget Joyce Company and provide a set of reasonable decision rules for Mr. Smith to follow. For now, ignore the influence of a customer’s credit history. b. Expand the decision table analysis you have prepared in question ‘‘a’’ to include the credit history of the customer accounts. You are free to make any assumptions you wish about how this history might be evaluated by Mr. Smith.
6-21. Follow the directions in Problem 6–11 to access Excel’s drawing tools and then re-create the two program flowcharts shown in Figure 6-20. Draw each flowchart on a separate work sheet.
Rename the first sheet ‘‘Main’’ and the second sheet ‘‘Sub.’’ To embed text inside a symbol, right click on that symbol with your mouse and then choose ‘‘Edit Text’’ from the drop-down menu that appears. To center text inside a symbol, highlight the text and then click on the centering icon in the main toolbar.
Create the words ‘‘Yes’’ and ‘‘No’’ that appear in this flowchart using Text Box selection from the Insert menu. To eliminate the black (default) borders around these words, right click on a Text Box and select Format Shape. Select the line color option and choose ‘‘No line’’ from the ‘‘Line Color’’ options on the right. Finally, you can fine-tune the position of any object by clicking on its border, holding the left button, and dragging the text box.

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Start

Read a record Compute gross wages

Process record Compute withholding at
20%

Print output line

No

Start

Compute net
= gross – withholding Stop
EOF?
Yes
Stop

FIGURE 6-20 Draw the flowchart on the left on one Excel sheet and the flowchart on the right on a second sheet.

Linking Flowcharts
After drawing these two flowcharts, we want to link them together. In this case, we want the user to click on the ‘‘Process Record’’ symbol in the main flowchart and then be able to view the second spreadsheet you’ve created on the alternate sheet. To create this link, right click on the ‘‘Process
Record’’ symbol and then select Hyperlink from the main menu.
When the Hyperlink dialog box appears, first select ‘‘Place in this Document’’ from the choices on the left side of the box and then click on the name of the sheet in which you’ve drawn the second flowchart (‘‘Sub’’) in the lower box on the right. If you wish, you can also select a particular cell for linking in the top box—a handy feature if you’ve drawn your flowchart in a lower portion of the Sub sheet. That’s it! Now, when you move your mouse over the ‘‘Process Record’’ symbol in the ‘‘Main’’ sheet, your mouse icon should turn into a hand, indicating that clicking on this symbol links you to the supporting document’s sheet.
Using Excel software and the skills described above, re-create the documents from the list below or the ones required by your instructor:
a. The context diagram in Figure 6-3
b. The physical DFD in Figure 6-4
c. The logical data flow diagram shown in Figure 6-5
d. Link the DFD in part b to a new DFD similar to Figure 6-6
e. The document flowchart in Figure 6-8
f. The system flowchart in Figure 6-11
g. The process map in Figure 6-13
h. The program flowchart shown in Figure 6-15

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201

CASE ANALYSES
6-22. Big Fun Toys (Data Flow Diagrams)
Big Fun Toys is a retailer of children’s toys. The accounts payable department is located at company headquarters in Boston, MA. The department consists of two full-time clerks and one supervisor. They are responsible for processing and paying approximately 2,000 checks each month. The accounts payable process begins with receipt of a purchase order from the purchasing department. The purchase order is held until a receiving report and the vendor’s invoice have been forwarded to accounts payable.
At that time, the purchase order, receiving report, and invoice are matched together by an accounts payable clerk, and payment and journal entry information are input to the computer. Payment dates are designated in the input, and these are based on vendor payment terms. Company policy is to take advantage of any cash discounts offered. If there are any discrepancies among the purchase order, receiving report, and invoice, they are given to the supervisor for resolution. After resolving the discrepancies, the supervisor returns the documents to the appropriate clerk for processing. Once documents are matched and payment information is input, the documents are stapled together and filed in a temporary file folder by payment date until checks are issued.
When checks are issued, a copy of the check is used as a voucher cover and is affixed to the supporting documentation from the temporary file. The entire voucher is then defaced to avoid duplicate payments. In addition to the check and check copy, other outputs of the computerized accounts payable system are a check register, vendor master list, accrual of open invoices, and weekly cash requirements forecast.

Requirements
Draw a context diagram and data flow diagram similar to those in Figures 6-3 and 6-4 for the company’s accounts payable process, using the symbols in Figure 6-2.

6-23. The Berridge Company (Document Flowcharts)
The Berridge Company is a discount tire dealer that operates 25 retail stores in a metropolitan area. The company maintains a centralized purchasing and warehousing facility and employs a perpetual inventory system. All purchases of tires and related supplies are placed through the company’s central purchasing department to take advantage of the quantity discounts offered by its suppliers. The tires and supplies are received at the central warehouse and distributed to the retail stores as needed. The perpetual inventory system at the central facility maintains current inventory records, which include designated reorder points, optimal order quantities, and balance-on-hand information for each type of tire or related supply.
The participants involved in Berridge’s inventory system include (1) retail stores,
(2) the inventory control department, (3) the warehouse, (4) the purchasing department,
(5) accounts payable, and (6) outside vendors. The inventory control department is responsible for maintenance of the perpetual inventory records for each item carried in inventory. The warehouse department maintains the physical inventory of all items carried by the company’s retail stores.

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All deliveries of tires and related supplies from vendors are received by receiving clerks in the warehouse department, and all distributions to retail stores are filled by shipping clerks in this department. The purchasing department places every order for items needed by the company. The accounts payable department maintains the subsidiary ledger with vendors and other creditors. All payments are processed by this department. The documents used by these various departments are as follows:

Retail Store Requisition (Form RSR). The retail stores submit this document to the central warehouse whenever tires or supplies are needed at the stores. The shipping clerks in the warehouse department fill the orders from inventory and have them delivered to the stores. Three copies of the document are prepared, two of which are sent to the warehouse, and the third copy is filed for reference.

Purchase Requisition (Form PR). An inventory control clerk in the inventory control department prepares this document when the quantity on hand for an item falls below the designated reorder point. Two copies of the document are prepared. One copy is forwarded to the purchasing department and the other is filed.
Purchase Order (Form PO). The purchasing department prepares this document based on information found in the purchase requisition. Five copies of the purchase order are prepared. The disposition of these copies is as follows: copy 1 to vendor, copy
2 to accounts payable department, copy 3 to inventory control department, copy 4 to warehouse, and copy 5 filed for reference.

Receiving Report (Form RR). The warehouse department prepares this document when ordered items are received from vendors. A receiving clerk completes the document by indicating the vendor’s name, the date the shipment is received, and the quantity of each item received. Four copies of the report are prepared. Copy 1 is sent to the accounts payable department, copy 2 to the purchasing department, and copy 3 to the inventory control department; copy 4 is retained by the warehouse department, compared with the purchase order form in its files, and filed together with this purchase order form for future reference. Invoices. Invoices received from vendors are bills for payment. The vendor prepares several copies of each invoice, but only two copies are of concern to the Berridge Company: the copy that is received by the company’s accounts payable department and the copy that is retained by the vendor for reference. The accounts payable department compares the vendor invoice with its file copy of the original purchase order and its file copy of the warehouse receiving report. On the basis of this information, adjustments to the bill amount on the invoice are made (e.g., for damaged goods, for trade discounts, or for cash discounts), a check is prepared, and the payment is mailed to the vendor.

Requirements
1. Draw a document flowchart for the Berridge Company using the symbols in Figure 6-7.
2. Could the company eliminate one or more copies of its RSR form? Use your flowchart to explain why or why not.

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203

3. Do you think that the company creates too many copies of its purchase orders? Why or why not?

6-24. Classic Photography Inc. (Systems Flowcharts)
Jenny Smith owns Classic Photography Inc., a company that restores photos for its clients and creates electronic images from the restored photos. The company also frames restored photos and creates sophisticated custom artworks. Artworks include materials such as glass and frames that are purchased from local suppliers. In addition to supplies for displays, the company purchases office supplies and packaging materials from several vendors.
Classic Photography uses an off-the-shelf accounting software package to prepare internal documents and reports. As employees note a need for supplies and materials, they send an e-mail to Jenny, who acts as the office manager and company accountant. Either Jenny or her assistant Donna enters order information into the accounting system and creates a purchase order that is faxed to the supplier. Jenny or Donna may also call the supplier if there is something special about the product ordered.
When ordered materials and supplies arrive, either Jenny or Donna checks the goods received against a copy of the purchase order and enters the new inventory into the computer system. Jenny pays bills twice each month, on the first and the fifteenth. She checks the computer system for invoices outstanding and verifies that the goods have been received. She then enters any information needed to produce printed checks from the accounting system. Classic Photography mails checks and printed remittance advices
(portions of the vendor bill to be returned) to suppliers.

Requirements
1. Create a systems flowchart for the purchase and payment processes.
2. Comment on the value, if any, that having a systems flowchart describing this process would have to Jenny.

6-25. The Dinteman Company (Document Analysis)
The Dinteman Company is an industrial machinery and equipment manufacturer with several production departments. The company employs automated and heavy equipment in its production departments. Consequently, Dinteman has a large repair and maintenance department (R&M department) for servicing this equipment.
The operating efficiency of the R&M department has deteriorated over the past two years. For example, repair and maintenance costs seem to be climbing more rapidly than other department costs. The assistant controller has reviewed the operations of the R&M department and has concluded that the administrative procedures used since the early days of the department are outmoded due in part to the growth of the company. In the opinion of the assistant controller, the two major causes for the deterioration are an antiquated scheduling system for repair and maintenance work and the actual cost to distribute the R&M department’s costs to the production departments. The actual costs of the R&M department are allocated monthly to the production departments on the basis of the number of service calls made during each month.
The assistant controller has proposed that a formal work order system be implemented for the R&M department. With the new system, the production departments will submit

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a service request to the R&M department for the repairs and/or maintenance to be completed, including a suggested time for having the work done. The supervisor of the
R&M department will prepare a cost estimate on the service request for the work required
(labor and materials) and estimate the amount of time for completing the work on the service request. The R&M supervisor will return the request to the production department that initiated the request. Once the production department approves the work by returning a copy of the service request, the R&M supervisor will prepare a repair and maintenance work order and schedule the job. This work order provides the repair worker with the details of the work to be done and is used to record the actual repair and maintenance hours worked and the materials and supplies used.
Production departments will be charged for actual labor hours worked at a predetermined standard rate for the type of work required. The parts and supplies used will be charged to the production departments at cost. The assistant controller believes that only two documents will be required in this new system—a Repair/Maintenance Service Request initiated by the production departments and a Repair/Maintenance Work Order initiated by the R&M department.

Requirements
1. For the Repair/Maintenance Work Order document
a. Identify the data items of importance to the repair and maintenance department and the production department that should be incorporated into the work order.
b. Indicate how many copies of the work order would be required and explain how each copy would be distributed.
2. Prepare a document flowchart to show how the Repair/Maintenance Service Request and the Repair/Maintenance Work Order should be coordinated and used among the departments of Dinteman Company to request and complete the repair and maintenance work, to provide the basis for charging the production departments for the cost of the completed work, and to evaluate the performance of the repair and maintenance department. Provide explanations in the flowchart as appropriate.
(CMA Adapted)

READINGS AND OTHER RESOURCES
Bradford, M., S. Richtermeyer, and D. Roberts. 2007. System diagramming techniques: An analysis of methods used in accounting education and practice. Journal of Information Systems 21(1):
173–212.
McDonald, M. 2010. Improving Business Processes. Harvard Business School Press. United States.
Indulska, M., J. Recker, M. Rosemann, and P. Green. 2009. Business process modeling: Current issues and future challenges. Lecture Notes in Computer Science 5565: 501–514.

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205

The Institute of Internal Auditors. 2010. Global Technology Audit Guide (GTAG) 14: Auditing
User-Development Applications. The Institute of Internal Auditors. Altamonte Springs, Florida.

Create Data Flow Diagrams (DFDs): http://www.youtube.com/watch?v=N76olMe_IY0 Create a Flowchart Using Microsoft Word: http://www.ehow.com/video_4871932_create-flowchart-word.html Create Process Maps with TaskMap: http://www.youtube.com/watch?v=eQOn9O6PKUg Using Visio to Create Process Maps: http://www.youtube.com/watch?v=Gt1XNidTUgA&p=378CD823771BBCE1 ANSWERS TO TEST YOURSELF
1. a

2. c

3. c

4. d

5. c

6. b

7. c

8. d

9. c

10. a

Chapter 7
Accounting Information Systems and Business Processes: Part I

INTRODUCTION

DISCUSSION QUESTIONS

BUSINESS PROCESS FUNDAMENTALS

PROBLEMS

Overview of the Financial Accounting Cycle

CASE ANALYSES

Coding Systems

Food Court Inc. (Sales Process)

COLLECTING AND REPORTING ACCOUNTING
INFORMATION

Larkin State University (Purchasing Process)

Designing Reports

The Caribbean Club (Customer Relationship
Management)

From Source Documents to Output Reports

READINGS AND OTHER RESOURCES

THE SALES PROCESS

ANSWERS TO TEST YOURSELF

Objectives of the Sales Process
Inputs to the Sales Process
Outputs of the Sales Process

THE PURCHASING PROCESS
Objectives of the Purchasing Process
Inputs to the Purchasing Process
Outputs of the Purchasing Process

CURRENT TRENDS IN BUSINESS PROCESSES
Business Processes Outsourcing (BPO)
Business Process Management Software

AIS AT WORK—ECONOMIC DOWNTURN
PROMOTES ONSHORING
SUMMARY

After reading this chapter, you will:
1. Know the steps in the financial accounting process. 2. Understand the use of journals and ledgers in processing accounting transactions.
3. Recognize different types of coding systems used by AISs.
4. Understand why planning an AIS begins with the design of outputs.
5. Recognize the objectives, inputs, and outputs of the sales and purchasing processes.
6. Understand why businesses choose outsourcing and offshoring of business processes.

KEY TERMS YOU SHOULD KNOW
TEST YOURSELF

207

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Business is no longer just about increasing sales. It’s about increasing profitability from sales. It is not enough simply to measure gross margin profitability for sales of products and standard service lines.
Cokins, G. 2009. The CFO’s new mission—supporting marketing and sales. The
Journal of Corporate Accounting & Finance (March/April): 35–42.

INTRODUCTION
In this chapter and the following chapter, we introduce the fundamentals of business processes and then focus on several core business processes that are common to many businesses. We begin with a brief refresher of the basics of financial accounting. Although you may be wondering why we talk about the bookkeeping process in this textbook, these concepts are actually at the heart of an AIS. That is, fundamental elements of accounting are embedded in modern accounting information systems, and they are the basis for a company’s annual financial statements. These fundamental elements include journals, ledgers, accounts, trial balances, and financial statements. We discuss these concepts from the perspective of simple, paper journals and records because this simplifies the discussion of the key business processes. It is important to recognize, however, that business processes in firms with large, database driven AISs will often not involve paper source documents or traditionally formatted journals or ledgers.
The nature and types of business processes vary, depending on the information needs of a specific organization. Nevertheless, a number of business processes are common to most organizations. In this chapter, we examine business transactions related to the sales process (sales and cash collection) and the purchasing process (expenditures for materials and supplies and cash payment).
Businesses are under tremendous pressure to cut costs, reduce capital expenditures, and become as efficient as possible at their core competencies. As a result, companies search globally to achieve efficiencies—it’s called business without boundaries. In the final portion of this chapter, we give examples of business processes that are commonly outsourced or offshored. We then examine some business process management solutions that are available to improve business processes regardless of their location.

BUSINESS PROCESS FUNDAMENTALS
An accounting cycle can begin in a number of different ways. For instance, accounting personnel can create a transaction from a source document, or a customer may order products online. Regardless of how the process starts, at the end of the process we issue annual financial reports and close the temporary accounts in preparation for a new cycle.

Overview of the Financial Accounting Cycle
An AIS records each transaction or business event affecting an organization’s financial condition in journals or ledgers.

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209

Journals. Accounting personnel record transactions in a journal. Of course, this is rarely an actual paper journal anymore—it’s more likely an electronic entry in an accounting information system. In many cases, these entries are made directly into database tables.
The journal is a chronological record of business events by account. A journal may be a special journal or a general journal. Special journals capture a specific type of transaction.
They are usually reserved for transactions occurring frequently within an organization. In a computerized system, special journals may take the form of special modules with their own files. For example, an accounting clerk would likely record a credit sale in an accounts receivable module. In more automated systems, entries into the accounting system may be entirely electronic, such as through scanning a bar code.
Companies can set up a special journal for virtually any type of transaction. Common ones are sales journals, purchase journals, cash receipts journals, and cash disbursements journals. If you think about it, almost all accounting transactions a business organization records fall into one of these categories. Special journals include entries for all but a few types of transactions and adjusting journal entries, such as for depreciation. The general journal records these entries.
Ledgers. Journal entries show all aspects of a particular transaction. Each entry shows debit and credit amounts, the transaction date, the affected accounts, and a brief description of the event. Once an AIS records a journal entry, it next posts the entry in the general ledger. Within an AIS, a general ledger is a collection of detailed monetary information about an organization’s various assets, liabilities, owners’ equity, revenues, and expenses.
The general ledger includes a separate account (often called a T account because of its shape) for each type of monetary item in an organization. While journal entries record all aspects of business transactions, an AIS separately posts the monetary amounts in each account to the various accounts in the general ledger. A company’s chart of accounts provides the organizational structure for the general ledger. The chart of accounts makes use of a block coding structure (discussed later in this chapter).

Trial Balances and Financial Statements. Once an AIS records journal entries and posts them to the general ledger, it can create a trial balance. The trial balance is a listing of all accounts and their debit and credit balances. After debit and credit dollar amounts in this trial balance are equal, an accountant will record any necessary adjusting journal entries. Adjusting entries include journal entries for depreciation and other unrecorded expenses, prepaid expenses, unearned revenues, and unrecorded revenue. Once the debit and credit amounts in this adjusted trial balance are equal, an AIS is ready to produce financial statements.
Financial statements are the primary output of a financial accounting system. These financial statements include an income statement, balance sheet, statement of owners’ equity, and cash flow statement. The accounting cycle does not end when an AIS generates financial statements. The computerized system must close temporary accounts, such as revenue and expense accounts, so that a new cycle can begin. This is necessary because users are interested in income information for a specific period of time. Because balance sheet accounts show financial performance at a specific point in time, they are permanent and need not be closed. Thus, an AIS will carry these amounts forward to the next accounting cycle. Figure 1-7 shows an illustration of the accounting cycle and Figure 7-1 summarizes the steps in the accounting cycle.

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1.
2.
3.
4.
5.
6.
7.
8.

Record transaction in a journal.
Post journal entries to a ledger.
Prepare an unadjusted trial balance.
Record and post adjusting journal entries.
Prepare an adjusted trial balance.
Prepare financial statements.
Record and post closing journal entries.
Prepare a post-closing trial balance.

FIGURE 7-1 A summary of the steps in the accounting cycle.

Coding Systems
Accounting information systems depend on codes to record, classify, store, and retrieve financial data. Although it is possible in a manual system to use simple alphabetic descriptions when preparing journal entries, computerized systems use numeric codes
(codes that use numbers only) or alphanumeric codes (codes that use numbers and letters) to record accounting transactions systematically. For example, a manual journal entry might include a debit to the ‘‘Direct Materials Inventory’’ account. In a computerized system, the debit might be to account ‘‘12345.’’ Alphanumeric codes are important in computerized systems, as they help to ensure uniformity and consistency. Suppose that a clerk entered a debit to ‘‘Direct Materials Inventory’’ one time and another time entered the debit to ‘‘Dir. Materials Inventory.’’ A computer would set up a new account the second time, rather than recognizing the intended account.

Types of Codes. AISs typically use several types of codes: (1) mnemonic codes,
(2) sequence codes, (3) block codes, and (4) group codes. Mnemonic codes help the user remember what they represent. The product codes S, M, L, and XL are examples of mnemonic codes describing apparel sizes. As the name implies, a sequence code is simply a sequential set of numbers used to identify customer accounts, employee payroll checks, customer sales invoices, and so forth. Block codes are sequential codes in which specific blocks of numbers are reserved for particular uses. In a typical application, the lead digit, or two lead digits, in the sequence code acts as the block designator and subsequent digits are identifiers. AISs use block codes to create a chart of accounts (Figure 7-2). Combining two or more subcodes creates a group code, which is often used as product codes in sales catalogs.
Design Considerations in Coding. There are a number of important factors to consider when designing an accounting code. First, it must serve some useful purpose. For example, if a product code in a manufacturing firm is part of a responsibility accounting system, at least one portion of the code must contain a production department code.
Second, it must be consistent. Using Social Security numbers as employee identifiers is a good example of this design consideration. Third, managers must plan for future expansion
(e.g., the creation of extra accounts).

COLLECTING AND REPORTING ACCOUNTING
INFORMATION
As you might imagine, most of the accounting data collected by an organization ultimately appear on some type of internal and/or external report. Thus, the design of an effective AIS

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211

Current Assets Detail

Major Accounts
100-199

Current assets

100

Cash

200-299

Noncurrent assets

110

Marketable securities

300-399

Current liabilities

120

Common stock

400-499

Long-term liabilities

121

Preferred stock

500-599

Owners’ equity

122

Bonds

600-699

Revenue

123

Money market certificates

700-799

Cost of goods sold

124

Bank certificates

800-899

Operating expenses

125

Accounts receivable

900-999

Nonoperating income & expenses 130

Prepaid expenses

140

Inventory

150

Notes receivable

FIGURE 7-2 A block code used for a companys chart of accounts. usually begins with the outputs (reports) that users will expect from the system. Although this might seem counterintuitive, we discuss the reasons for this in Chapter 13.
Among the outputs of an AIS are: (1) reports to management, (2) reports to investors and creditors, (3) files that retain transaction data, and (4) files that retain current data about accounts (e.g., inventory records). Perhaps the most important of these outputs are the reports to management because these reports aid decision-making activities. As you might imagine, the formats of these various reports might be very different. These reports might be hard-copy (paper) reports, soft-copy (screen) reports, e-copy (CD and other electronic media) reports, or audio outputs. If a manager queries a database system, the monitor shows the requested data and the system produces a hard-copy report only upon demand.
Graphics enhance reports in any form. Many reports today appear on company Web sites.
While Web page design is beyond the scope of this book, it is important to recognize that the rules for preparing good reports apply to Web page reports as well as hard-copy and other multimedia reports.

Designing Reports
Users need many different types of accounting reports—some might be every hour and others not as often. An AIS might issue some reports only when a particular event occurs.
For example, an AIS might issue an inventory reorder report only when the inventory for a certain product drops below a specified level. Such an event would probably result in an exception report, which is a list of exceptional conditions. As another example, suppose that a purchase order has an authorization signature but contains some inaccurate or missing information. In this case, the AIS would generate an exception report. The report would include a table that identifies the error or errors and would suggest a possible solution to fix the error. After correcting the error, the purchase order would require a new authorization signature. This signature would clear the exception from the report.

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The Lu Company Sales by Product Line for the Month of January 2011
Sports Hats
22%

Baseballs
27%

Golf Balls
5%

Baseballs
Baseball Bats
Basketballs
Golf Balls
Sports Hats

Baseball Bats
11%
Basketballs
35%

FIGURE 7-3 A pie chart showing the percentage of sales from various product lines.

Characteristics of Good Reports. Good output reports share similar characteristics regardless of their type, such as (1) useful, (2) convenient format, (3) easy to identify, and
(4) consistent. For example, summary reports should contain financial totals, comparative reports should list related numbers (e.g., budget versus actual figures) in adjacent columns, and descriptive reports (e.g., marketing reports) should present results systematically.
Sometimes the most convenient format is graphical, such as a pie chart (Figure 7-3). Other graphical formats include bar charts and trend lines.

Identification and Consistency. Good managerial reports always contain fundamental identification, including headings (company name, organizational division or department, etc.), page numbers, and dates. For example, a report loses its information value if you do not know the time period it covers. Balance sheets and similar reports should show the date as of a specific point in time. Reports such as lists of current employees, customers, and vendors should also indicate a specific date. Income statements and similar reports should show a span of dates for the reporting period (e.g., for the month ended January 31, 2012).
AIS reports should be consistent: (1) over time, (2) across departmental or divisional levels, and (3) with general accounting practice. Consistency over time allows managers to compare information from different time periods. For example, a manager might want to compare a sales report for June with a similar report for the month of May of the same year. This manager might also look at sales for June of prior years to evaluate whether performance is improving or deteriorating. Similarly, reports should be consistent across departmental levels so that supervisors may compare departmental performance. Finally, report formats should be consistent with general accounting practice so that managers and investors can understand and use these reports.

From Source Documents to Output Reports
Companies use a variety of source documents to collect data for the AIS. The chief concerns in the data collection process are accuracy, timeliness, and cost-effectiveness. An example of a source document is the purchase order in Figure 7-4. This source document represents a purchase order (number 36551) generated from the BSN Bicycles’ database system to purchase goods from the Lu Company, a sporting goods distributor. In a paperbased environment, employees typically prepare several copies of a purchase order for

CHAPTER 7 / Accounting Information Systems and Business Processes: Part I

ORDERED BY
BSN BICYCLES
1 Sports Lane
Sports Shop, XX 12345

213

Purchase
Purchase Order No:
36551

To:
Lu Company
222 Main Street
Pleasantville, XX 23456
Date

Good Through

3/1/2012

3/30/2012

Item
G124-464
G453-324

Description
Hot Rider Gloves-Women
Mogul Tire Pumps

Account No.

Terms
2/10, n/30

Quantity
15.00
20.00

Unit Price

Total

24.95
34.95

374.25
699.00

Total

$1,073.25

Authorized Signature

FIGURE 7-4 A sample purchase order.

internal use (these may be hard copies or computer images). For instance, the purchasing department keeps one copy to document the order and to serve as a reference for future inquiries. Accounting and receiving departments also receive copies. Purchase orders are normally sequentially numbered for easy reference at a later date.
Based on this purchase order, the Lu Company ships merchandise and sends a sales invoice to BSN Bicycles. Figure 7-5 illustrates the sales invoice document. The sales invoice duplicates much of the information on the original purchase order. New information includes the shipping address, a reference to the purchase order number, the shipping date, due date, the sales invoice number, and the customer identification number. The
Lu Company might produce as many as six copies of the sales invoice. Two (or more) copies are the bill for the customer. The shipping department keeps a third copy to record that it filled the order. A fourth copy goes to the accounting department for processing accounts receivable. The sales department retains a fifth copy for future reference. Finally, the inventory department receives a sixth copy to update its records related to the specific inventory items sold.
Source documents of the types illustrated here help manage the flow of accounting data in several ways. First, they dictate the kinds of data to be collected and help ensure consistency and accuracy in recording data. Second, they encourage the completeness of accounting data because these source documents clearly enumerate the information

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PART THREE / Documenting Business Processes

Invoice
Invoice Number:
15563
Invoice Date:
3/5/2012
Page:
1

Voice:
Fax:
Duplicate
Sold To:
BSN BICYCLES
1 Sports Lane
Sports Shop, XX 12345

Ship To:
BSN BICYCLES
1 Sports Lane
Sports Shop, XX 12345

Customer ID

Customer PO

BSN001

36551

Sales Rep

Shipping Method

Ship Date

Due Date

W. Loman

Rail

3/30/2012

4/2/2012

Quantity
15.00
20.00

Item
G124-464
G453-324

Payment Terms
2/10, n/30

Description

Unit Price

Total

Hot Rider Gloves-Women
Mogul Tire Pumps

$24.95
$34.95

374.00
699.00

Check No.

Subtotal
Sales Tax
Total Invoice Amount
Payment Received
TOTAL

$1,073.25
$1,073.25
0.00
$1,073.25

FIGURE 7-5 A sample sales invoice. required. Third, they serve as distributors of information for individuals or departments.
Finally, source documents help to establish the authenticity of accounting data. This is useful for purposes such as establishing an audit trail, testing for authorization of cash disbursement checks or inventory disbursements, and establishing accountability for the collection or distribution of money. Many source documents are actually database- or
Internet-based forms that are used to input data electronically. Reducing the use of paper forms can create significant efficiencies.

Case-in-Point 7.1 Woerner Turf is a company that produces turf grass and sod for landscaping. The company recently implemented a new software package by Microsoft Great
Plains Business Solutions that consolidated its sales order screen. It eliminated or condensed data-entry fields to create a single screen. It is not uncommon for a sales person to enter orders as often as 50 to 100 times each day. The new design, which is similar to the paper

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215

form used previously, reduces order entry time from three minutes to one. This increased efficiency allows sales staff to spend more time selling and less time entering data.1

Both manual and computerized AISs use source documents extensively. In many AISs, source documents are still written or printed on paper. However, large companies (such as publicly traded firms) rely heavily on integrated database systems that handle many transactions virtually (i.e., electronically with no paper).

THE SALES PROCESS
A business process is a collection of activities and work flows in an organization that creates value. An AIS collects and reports data related to an organization’s business processes. The nature and type of business processes might vary from industry to industry, but most businesses and government agencies have some common core processes. Two core business processes that are common to many businesses are sales and purchasing.
Information processing requires recording, maintaining, grouping, and reporting business and economic activities that make up a business process. For example, the sales process includes activities such as taking sales orders, filling orders, managing customer inquiries, and receiving payment. The AIS collects and stores data for each of these activities as part of the sales process. We have seen how many of these activities or events are depicted in E-R diagrams. Now we will describe the sales process and its component events in more detail.
An economic event is an activity that involves an increase and/or decrease in dollar amounts on the financial statements. An example would be collecting cash from a customer on account. Since economic events affect financial statements, they are often called accounting transactions. A business event is an activity that does not affect the financial statements but is nevertheless important to the business. A sales order from a customer is an example of a business event. While accountants do not record all business events in journals, they most likely record this information to support decision making
(e.g., customer relationship management, discussed later in this chapter).
The sales process begins with a customer order for goods or services and ends with the collection of cash from the customer. Figure 7-6 summarizes the AIS objectives, inputs, and outputs related to the sales process, assuming that sales are on credit and for merchandise rather than services.

Objectives of the Sales Process
Revenues result from an organization’s sale of goods or services. They may also result from donations or gifts, as in the case of many not-for-profit organizations. An organization that generates revenues but fails to collect these revenues regularly may find it cannot pay its bills. Many people unfamiliar with accounting make the incorrect assumption that companies with positive incomes cannot go out of business. The reality is that bankruptcy results from inadequate cash flow, not from insufficient income. A primary objective in processing revenues is to achieve timely and efficient cash collection.
To process sales in a timely manner, an organization must be able to track all revenues that customers owe the firm. Once the AIS recognizes these revenues, the system needs to monitor the resulting cash inflows. A good AIS matches each revenue with a valid transaction. Maintaining customer records is an important function of the AIS for the
1

http://www.greatplains.com/solutions

216

PART THREE / Documenting Business Processes

The Sales Process
Objectives
Tracking sales of goods and/or services to customers
Filling customer orders
Maintaining customer records
Billing for goods and services
Collecting payment for goods and services
Forecasting sales and cash receipts
Inputs (Source documents)
• Sales order
• Sales invoice
• Remittance advice
• Shipping notice
• Debit/credit memoranda

Outputs (Reports)








Financial statement information
Customer billing statement
Aging report
Bad debt report
Cash receipts forecast
Customer listing
Sales analysis reports

FIGURE 7-6 Objectives, inputs, and outputs associated with processing revenue transactions. revenue process. This includes validating a customer’s bill-paying ability and payment history, assigning credit limits and ratings to customers, and tracking all customers’ outstanding invoices. Processing revenues includes filling customers’ orders, and this requires an interface with the inventory control function. The AIS should bill customers only for products shipped. The sales process must also allow for certain exceptions—for example, sales returns.
Forecasting is another objective of the AIS to help management in its planning function. The AIS must analyze sales orders, sales terms, payment histories, and other data.
For example, sales orders are a good indicator of future revenues, and the terms of sale provide information about likely dates of collection on accounts.

Events in the Sales Process. Figure 7-7 illustrates an AIS for the sales process in a systems flowchart. This view assumes an online sales order. Notice that e-mails and electronic images replace many of the paper documents. The flowchart also assumes that the AIS uses a centralized database that integrates all data files (discussed in Chapters 3, 4, and 5). The following fictitious example describes the sales process shown in Figure 7-7.
Example. Hiroshi Ajas needs to purchase books for his classes this semester. He decides to buy the books online from Textbooks.com. In verifying the order, Textbooks.com’s
AIS also verifies Hiroshi’s credit card and checks its inventory to make sure the books are available. The company then sends Hiroshi an e-mail confirmation, verifying the transaction.
Textbooks.com’s AIS notifies its warehouse via e-mail to pack and ship the books. The warehouse processes the shipment information and creates a packing slip. Warehouse personnel then package the packing slip with the books and send them to Hiroshi. The day that Textbooks.com ships the books, it also charges Hiroshi’s credit card.
The major events in Textbooks.com’s sales process are the sales order, the shipment of goods, and the customer payment. The company will record information about each of these events. This information allows them to produce a variety of reports—such as book sales by regions of the country. The next two sections describe the information inputs and outputs of the sales process.

CHAPTER 7 / Accounting Information Systems and Business Processes: Part I

Customer places online order System checks inventory and credit Inventory, sales order, & customer files

Send email order confirmation to customer

Payment & customer files

Process customer payment information Send email notice to warehouse to pick and ship

Process shipping information

Inventory & sales files

Create and print packing slip Send packing slip to customer with goods

Packing slip Process and print reports

Financial statements Cash receipts forecast

Customer listing Management reports FIGURE 7-7 High-level systems flowchart of the sales process in an online environment.

217

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PART THREE / Documenting Business Processes

Inputs to the Sales Process
Figure 7-8 shows a data flow diagram of the sales process, which identifies the data inputs and information outputs of the process. As noted in the example, an AIS typically creates a sales order at the time a customer contracts goods or services. In this example, an accounts receivable clerk uses this sales order to prepare a sales invoice or the customer might generate one herself using the Web page of an online retailer. The sales invoice reflects the product or products purchased, the price, and the terms of payment. When the customer makes a payment, a remittance advice may accompany the payment. When you pay your
Visa or MasterCard bill, for example, the portion of the bill you return with your check is a remittance advice.
In addition to sales orders, sales invoices, checks, and remittance advices, shipping notices are another input to sales processing. When the warehouse releases goods for shipment, the warehouse clerk prepares a shipping notice. A copy of this notice may serve as a packing slip and would be included in the package with the goods. A copy of this document is also sent to the accounts receivable department and is used as a prompt for the department to bill the customer.
Debit/credit memoranda are source documents affecting both the sales and purchasing processes. An organization issues these memoranda to denote the return of damaged goods or discrepancies in the amount owed. For example, let’s assume that Hiroshi’s package with the textbooks arrived, but two of the books were damaged and two were the wrong textbooks. Hiroshi would return the four books (worth $400) to Textbooks.com.
However, Hiroshi must wait until the company receives the books and processes the return before he will be issued a credit to his account (credit card) for the $400.

Management

Sales Analysis Reports

Invoice Data

Billing

Cash Receipts Forecast

Invoice

Sales
Order

Accounts Receivable
Master File

Customers
Receive
Payment
Debit/Credit
Memo
Aging Reports
Bad Debt Reports

Manage
Customer
Accounts

Sales Return Notification

Receiving
Department

FIGURE 7-8 Data flow diagram of the sales process.

Customer Data
Check and
Remittance
Advice

Customers

Deposit Slips and Checks

Banks

CHAPTER 7 / Accounting Information Systems and Business Processes: Part I

219

If a company finds that it has charged a customer too little for goods sold, the company would issue a debit memorandum. This debit memorandum signifies a debit to the customer’s account receivable with the company to reflect the amount not charged originally. The customer now owes more to the company.
Business organizations use the data they collect about their customers and sales transactions to improve customer satisfaction and increase profitability. As a result, firms are purchasing or developing customer relationship management (CRM) software to gather, maintain, and use customer data to provide better customer service and enhance customer loyalty. However, think broadly here about potential uses of CRM software. For example, many universities are now purchasing CRM solutions to help them better manage their current and potential customers (i.e., students). These software packages help various schools and colleges within a university manage course enrollments, communications, invoice and payment processing, and perhaps most importantly, to stay connected with graduates who will potentially become donors.

Case-in-Point 7.2 Even public accounting firms benefit from CRM systems. CPA firms now collect detailed data about their clients and client’s industries. Understanding clients makes it less likely that clients will be lost to competitor firms. CPA firms also store data about potential clients in order to identify new prospects and market opportunities.2

Outputs of the Sales Process
Processing sales transactions creates several outputs. An AIS uses some of these outputs to produce external accounting reports (such as financial statements) as well as internal reports (such as management reports). Management reports can be in any format and contain the information managers need for decision making. In this and the following sections of the chapter, we discuss a few of the many reports that may be created by AISs.
One output of the sales process is a customer billing statement. This statement summarizes outstanding sales invoices for a particular customer and shows the amount currently owed. Other reports generated by the sales revenue process include aging reports, bad debt reports, cash receipts forecasts, approved customer listings, and various sales analysis reports. The aging report shows the accounts receivable balance broken down into categories based on time outstanding (see Figure 7-9). The bad debt report contains
Accounts Receivable Aging Report
Current
A/R Balance
($)
Customer #
Current ($)
1106
15,460.00
1352
6,453.00
6,453.00
1743
18,684.00 13,454.00
1903
2,349.00
2258
6,530.00
4378
5,434.00
2,400.00
4553
173.00
173.00
4623
389.00
5121
4,189.00

-------------------------0-30 days ($)

31-60 days ($)

10,000.00

Past Due
61-90
days ($)

-------------------------91-120 days ($)

over 120 days ($)

5,460.00
5,230.00
6,530.00

1,235.00

1,799.00

2,356.00

389.00
1,833.00

FIGURE 7-9 A sample accounts receivable aging report.
2 Lassar, W., S. Lassar, and N. Rauseo. 2008. Developing a CRM strategy in your firm. Journal of Accountancy
206(2): 68– 73.

220

PART THREE / Documenting Business Processes

information about collection follow-up procedures for overdue customer accounts. In the event that a customer’s account is uncollectible, the account is written off to an allowance account for bad debts. A detailed listing of the allowance account may be another output of the sales process.
All of the data gathered from source documents in processing sales transactions serve as inputs to a cash receipts forecast. Data such as sales amounts, terms of sale, prior payment experience for selected customers, and information from aging analysis reports and cash collection reports are all inputs to this forecast.
We previously indicated that maintaining customer records is an important function of the AIS in the sales process. The billing or accounts receivable function should approve new customers, both to ensure that the customers exist and to assess their bill-paying ability. This may require obtaining a credit report from a reputable credit agency. The billing function assigns each new customer a credit limit based on credit history. From time to time, the AIS produces an approved customer listing report. This report is likely to show customer ID numbers (for uniquely identifying each customer), contact name(s), shipping and billing addresses, credit limits, and billing terms.
If an AIS captures (or converts) appropriate sales data electronically, it can also produce various sales analysis reports. These include sales classified by product line, type of sale
(cash, credit, or debit card), or sales region. However, the sales process can produce effective sales analysis reports only if the AIS captures appropriate sales data. Again, customer relationship management solutions help managers take advantage of this data to maximize revenue and to provide better customer service.

THE PURCHASING PROCESS
The purchasing process begins with a request (or an order) for goods or services and ends with payments to the vendor. Figure 7-10 shows the objectives, inputs, and outputs associated with purchasing events. Our discussion assumes that credit purchases are for

The Purchasing Process
Objectives
Tracking purchases of goods and/or services from vendors
Tracking amounts owed
Maintaining vendor records
Controlling inventory
Making timely and accurate vendor payments
Forecasting purchases and cash outflows
Inputs (Source documents)
• Purchase requisition
• Purchase order
• Vendor listing
• Receiving report
• Bill of lading
• Packing slip
• Debit/credit memoranda

Outputs (Reports)
• Financial statement information
• Vendor checks
• Check register
• Discrepancy reports
• Cash requirements forecast
• Sales analysis reports

FIGURE 7-10 Objectives, inputs, and outputs associated with the purchasing process.

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221

goods (i.e., inventory) rather than for services. But in general, purchases may be for either goods or services and for cash or on credit.

Objectives of the Purchasing Process
Credit transactions create accounts payable. Accounts payable processing closely resembles accounts receivable processing; it is the flip side of the picture. With accounts receivable, companies keep track of amounts owed to them from their customers. An accounts payable application tracks the amounts owed by a company to vendors. The objective of accounts payable processing is to pay vendors at the optimal time. Companies want to take advantage of cash discounts offered and also avoid finance charges for late payments.
Maintaining vendor records is as important to the purchasing process as maintaining customer records is for the sales process. The purchasing department is responsible for maintaining a list of authorized vendors. This entails ensuring the authenticity of vendors as well as finding reputable vendors who offer quality goods and services at reasonable prices.
Vendor shipping policies, billing policies, discount terms, and reliability are also important variables in the approval process. Businesses today are strengthening their relationships with their vendors or suppliers, recognizing that they are partners in a supply chain.
One of the most successful supply chain management partnerships is that of Walmart and
Procter & Gamble.

Case-in-Point 7.3 There is a long-standing supply chain partnership between Procter &
Gamble (P&G) and Walmart. When P&G’s products run low at Walmart distribution centers,
Walmart’s information system sends an automatic alert to P&G to ship more inventory. In some cases, the system communicates at the individual store level, which allows P&G to monitor the shelves through real-time satellite link-ups. Both firms are recognized as leaders in supply chain management.3
The purchase of goods affects inventory control. The objective of inventory control is to ensure that an AIS records all goods purchased for, and dispensed from, inventory.
The inventory control component of the purchasing process interfaces with production departments, the purchasing department, the vendor, and the receiving department.
A final objective of the purchasing process is forecasting cash outflows. The addition of outstanding purchase requisitions, purchase invoices, and receiving reports provides an estimate of future cash requirements. With the forecast of cash receipts produced by the sales process, this estimate allows an organization to prepare a cash budget.

Events in the Purchasing Process. Figure 7-11 shows a systems flowchart that describes the purchasing process. As with the sales process, the flowchart assumes a centralized database and a mix of paper documents and electronic images. The following fictitious example describes the purchasing process shown in Figure 7-11.
Example. Sandra Michaels is an employee at Textbooks.com who needs to purchase a new computer. She pulls up the purchase requisition form from the company’s intranet and fills in the appropriate information. She then sends the completed form to her supervisor for approval, who approves the request and clicks the ‘‘Submit’’ button to forward Sandra’s request electronically to the purchasing department. A purchasing agent creates an electronic purchase order based on the information Sandra provided. The agent consults the vendor file to locate an authorized vendor for the requested computer. The
3

http://www.gartner.com/DisplayDocument?doc_cd=213740

222

PART THREE / Documenting Business Processes

Employees key in requests or automated requests for raw materials

Request for goods or services Process requisition Inventory and purchase requisition files Electronic requisition to purchase department

Purchasing agent creates electronic purchase order

Electronic purchase order to receiving Vendor & purchase order files

Electronic purchase order to vendor Receiving creates electronic receiving report

Purchase order & receiving files

A/P system matches electronic documents & sends payment

Vendor sends electronic invoice Process and print reports

Financial statements Cash payment forecast

Vendor listing Management reports FIGURE 7-11 High-level systems flowchart of the purchasing process in an online environment.

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223

AIS then sends an electronic version of the order to the receiving department and another copy to the vendor. When the computer arrives from the vendor, a receiving clerk consults the AIS system to verify that a purchase order exists for the goods received. The clerk then enters information about the receipt (e.g., date, time, count, and condition of merchandise) to create an electronic receiving report. On receipt of an electronic vendor invoice and the receiving report, the accounts payable system remits payment to the vendor.
The economic and business events in Textbooks.com’s purchasing process are the purchase request, purchase order, receipt of goods, and payment to the vendor. The company’s AIS records information about each of these events and produces a variety of reports. The next two sections describe the information inputs and some of the reports associated with the purchasing process

Inputs to the Purchasing Process
As explained earlier, the purchasing process often begins with a requisition from a production department for goods or services. Sometimes, an AIS triggers purchase orders automatically when inventories fall below prespecified levels. The purchase requisition shows the item requested and may show the name of the vendor who supplies it.
In Figure 7-12, the accounts payable system matches three source documents before remitting payment to the vendor: the purchase order, the receiving report, and the purchase invoice. A purchase invoice is a copy of the vendor’s sales invoice. The purchasing organization receives this copy as a bill for the goods or services purchased.
The purpose of matching the purchase order, receiving report, and purchase invoice is to maintain the best possible control over cash payments to vendors. For example, the

Receive
Goods or
Services

Inventory
Control

Materials
Requisition
Form

Shipping Notice

Receiving Report
Receiving Report
Purchase Requisition

Production
Departments

Purchase
Goods or
Services

Purchase Order

Vendor

Purchase Order
Payment

Notice of Receipt
Maintain
Accounts
Payable

Invoice and Payment Data

Acco
Accounts Payable
Master File

ta

e Da

yabl

Pa unts Purchase Invoice

Cash Requirement Forecast

FIGURE 7-12 Data flow diagram of the purchasing process.

Purchase Analysis

Management

224

PART THREE / Documenting Business Processes

absence of one of these documents could signify a duplicate payment. A computerized AIS can search more efficiently for duplicate payments than a manual system. For example, auditors can instruct an AIS to print a list of duplicate invoice numbers, vendor checks for like dollar amounts, and similar control information.
The purchase requisition initiates the purchase order. Besides the information on the requisition, the purchase order includes vendor information and payment terms
(Figure 7-4). The purchasing department typically prepares several copies (or images) of the purchase order. In a paper-based system, the purchasing clerk sends one copy of the purchase order to the receiving department to serve as a receiving report or, preferably, to prompt the receiving department to issue a separate receiving report. This copy of the purchase order is specially coded (or color-coded) to distinguish it from other copies of the purchase order if there is no separate receiving report. The receiving department copy might leave out the quantities ordered that are identified in the purchase order. This is done for control purposes, so that workers receiving the goods must do their own counts, rather than simply approving the amounts shown on the purchase order.
Another source document, a bill of lading, accompanies the goods sent. The freight carrier gives the supplier a bill of lading as a receipt, which means the carrier assumes responsibility for the goods. It may contain information about the date shipped, the point of delivery for freight payment (either shipping point or destination), the carrier, the route, and the mode of shipment. The customer may receive a copy of the shipping notice with the purchase invoice. This is important to the accounts payable subsystem, since accounts payable accruals include a liability for goods shipped free on board (FOB) from the shipping point. Goods shipped this way have left the vendor, but the customer has not yet received them. Another source document, the packing slip, is sometimes included in the merchandise package. This document indicates the specific quantities and items in the shipment and any goods that are on back order. The next time you order goods through a catalog or over the Internet, look for a packing slip, such as the one shown in Figure 7-13, in the container with your merchandise.

Outputs of the Purchasing Process
Typical outputs of the purchasing process are vendor checks and accompanying check register, discrepancy reports, and a cash requirements forecast. The check register lists all checks issued for a particular period. Accounts payable typically processes checks in batches and produces the check register as a by-product of this processing step. Discrepancy reports are necessary to note any differences between quantities or amounts on the purchase order, the receiving report, and the purchase invoice.
The purpose of a discrepancy report is to ensure that no one authorizes a vendor check until the appropriate manager properly reconciles any differences. For example, assume that a receiving report indicates the receipt of 12 units of product, whereas the purchase order shows that a company ordered 20 units and the purchase invoice bills the company for these 20 units. The accounts payable function records the liability for 20 units and notes the situation on a discrepancy report for management. This report would trigger an investigation. For example, it is possible that the vendor made two shipments of merchandise and one shipment has yet to be received. If this is the case, receipt of the second shipment clears this discrepancy from the next report. However, if this is not the case, it is important for management to determine the cause of the discrepancy as soon as possible. The purchasing process produces a cash requirements forecast in the same manner that the sales process produces a cash receipts forecast. By looking at source documents

225

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This shipment completes your order.

Hardcover

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Format

Order Total:
Paid:
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Subtotal:
Shipping & Handling:

Weight Watchers

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Description

FIGURE 7-13 A sample packing slip.

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Item

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http://www.bluebooks.com orders@bluebooks.com BlueBooks.com
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226

PART THREE / Documenting Business Processes

such as outstanding purchase orders, unbilled receiving reports, and vendor invoices, an
AIS can predict future cash payments and their dates. Naturally, this forecast is easier to make with a computerized system than with a manual system.

Information Technology (IT) Used in the Sales and Purchasing Processes.
Much of the input and output related to business processes is now electronic, and that includes the sales and purchasing processes. For instance, inputs (sales order or purchase requests) can be voice inputs, touch-tone telephone signals, bar codes, video signals, magnetic ink characters (as on checks), scanned images, or key strokes from a computer.
Salespeople in the field typically use laptop computers, handheld devices, portable bar code scanners, or other types of input devices to enter data. With wireless capability, they can enter information in real time.

Case-in-Point 7.4 If you have moved lately, you probably watched a moving company representative walk through your home with a bar code scanner and a sheet of paper with various bar codes for different pieces of furniture and other items in your home. After the walk through, the representative can quickly download the information to a laptop, print out an estimate of the cost of your move, and discuss the estimate with you—all in the same visit!
Automated data-entry technology helps companies reduce costs and provide better customer service. For example, bar code scanners that are commonly used in most retail stores gather essential inventory data (and help to avoid human error) for the retailer, and they also help expedite the check out process for customers. In addition, some retailers are using biometric technology that offers customers convenience and faster checkouts, and offers retailers savings in transaction costs. Here’s how biometric payment works: to set up an account, customers scan their fingerprint at an in-store kiosk, enter their phone number, and then submit checking and credit card account information. To make a purchase, they place their finger on a scanner at the register, enter their phone number, and choose how they want to pay (credit, debit, or checking).4

Case-in-Point 7.5 In 1916, Clarence Saunders (a very innovative businessman in Memphis, TN) opened the first Piggly Wiggly® grocery store—the very first self-service grocery store. Saunders recently decided to be innovative again and started a pilot program to test the use of biometric payments. Within three months of starting the pilot program at four Piggly
Wiggly grocery stores, 15% of its customers who normally did not pay by cash enrolled in the
Pay By Touch system. Those users increased their store visits by 15%, which translates into an additional 7,350 transactions a year. Not only did they come more often, those shoppers also spent 12% more on groceries.5
IT supports the purchasing process in a variety of ways. For example, an organization might determine that some inventory items can be reordered automatically and electronically when the company reaches a predetermined minimum quantity of those inventory items. An automatic reorder can be generated by the computer system, sent electronically to the vendor, and the vendor can be paid electronically by using EDI. We discuss this aspect of e-Commerce more in depth in Chapter 14. After purchases arrive, our next concern is inventory management. To effectively manage inventory, we might use different technologies. Below, we describe two cases where organizations decided to use RFID tags (a computer chip with a tiny antenna) to manage inventory. The first
4

http://money.cnn.com/2006/01/24/magazines/fortune/pluggedin_fortune_biometrics http://www.pigglywiggly.com/cgi-bin/customize?aboutus.html and http://money.cnn.com/2006/01/24/ magazines/fortune/pluggedin_fortune_biometrics 5

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is the Boeing Company, and the second is ConocoPhillips. In both cases, the vendors of the manufactured goods place the RFID tags on the items. The interesting point about
RFID tags is that they can contain a complete history of the individual part, and then the purchaser can add or delete information to or from the tag as the part proceeds through the supply chain.

Case-in-Point 7.6 The Boeing Co. uses RFID tags to track between 1,700 and 2,000 mission-critical parts on each of its 747 jetliners, but that’s really not very many when you consider that each of these jetliners has about 6 million parts. The parts that are tagged with RFID are those that are either very expensive or frequently require maintenance and replacement. Information stored on the RFID tag helps trace parts and reduces cycle time to solve service problems. For example, before RFID, if one of the three computers in the cockpit of a 747 needed to be replaced, a mechanic would have to get on his back with a flashlight and a mirror to search for a serial number. Now, the mechanic can walk into a cockpit with an
RFID reader and locate the faulty computer with just a couple of clicks.6
Case-in-Point 7.7 ConocoPhillips uses RFID tags to track employees on offshore oil rigs.
The tags allow the firm to identify the exact location of every employee in case of an emergency and to ensure that employees only enter areas where they have authorization to work.7

CURRENT TRENDS IN BUSINESS PROCESSES
Organizations frequently divide business processes into ‘‘core processes’’ and ‘‘other processes.’’ In the past, managers and management accountants focused on cost management, while managers and internal auditors primarily focused on improving core processes. In all cases, the goal was typically to make these processes as efficient as possible. Now, organizations are critically examining their processes to determine which ones to keep and which ones to outsource. Results from a 2008 Accenture survey suggest that companies outsource for strategic advantages as much as for cost savings, as we highlight in the following Case-in-Point.

Case-in-Point 7.8 The senior executives who responded to a recent Accenture survey credit outsourcing with increasing their sense of control over business performance, and the most common control gains that they mentioned are
• Improved planning (47%)
• Greater reliability of business information (39%)
• A stronger grasp of business outcomes (37%)
• More effective implementation of ideas (33%)
• Increased revenue (32%)8

Business Processes Outsourcing (BPO)
Companies outsource business processes such as human resources, finance and accounting, customer services, learning services and training, and information technology. A recent
6

http://epsfiles.intermec.com/eps_files/eps_cs/Boeing_cs_web.pdf http://www.rfidjournal.com/article/view/8000 8 http://www.accenture.com/us-en/Pages/insight-outsourcing-control-travel-tourism-summary.aspx
7

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survey estimated the global business process outsourcing (BPO) market for human resources services to be approximately $450 billion.

Case-in-Point 7.9 CNA is one of the largest insurance companies in the United States, providing services (core processes) such as risk management, information services, underwriting, and claims administration. Rather than develop training programs for their employees, CNA outsourced this business process to another company. Similarly, many universities outsource a number of operations they used to perform themselves—for example, landscaping, food services, or janitorial services—so that they can focus on core functions more directly related to educating students.
Today’s combination of networked enterprises and globalization has given rise to a business model called business without boundaries. Companies no longer have all of their employees in one location, working on various business processes such as HR, accounting, production, and others. Employees may be located anywhere in the world, and they are. The result is a new dimension to outsourcing called offshoring—moving jobs offshore—to countries such as India, China, Canada, Mexico, or Malaysia.
Of course, not all outsourced business processes are accomplished by employees in foreign countries. Many of these processes are still accomplished by businesses in the
United States. Nevertheless, all business processes are under a great deal of scrutiny by managers and management accountants as companies become more strategically oriented toward revenue generation and more vigilant about managing costs.
The important point for accountants is that, at some point, you will most likely be on a team of professionals in your organization that will study the costs and benefits of either keeping a business process in-house or outsourcing the function. If the team decides that the organization should keep the process, then the next task might be to decide what business process management (BPM) software the company should use to automate that process. Software companies are developing a wide variety of business process solutions to help managers integrate their existing data and applications into efficient and effective business systems. If the decision is to outsource the process, then accountants will most certainly be involved in analyzing the many costs and benefits/concerns associated with the decision.

Business Process Management Software
Business Process Management (BPM) software packages help companies collect corporate knowledge, data, and business rules into a business system to improve core business processes. Think of BPM as a combination of software tools and management practices that enable entities to accomplish business processes more efficiently. As a result, managers have timely access to performance data related to clients, projects, financials, and people to improve company performance—and these benefits are available even to smaller businesses, as the following Case-in-Point describes.

Case-in-Point 7.10 The Sleeter Group is a nationwide community of experts who provide
QuickBooks consulting services to small business owners—and they also announce their
Annual Award List of ‘‘Awesome Add-ons for QuickBooks.’’ For 2011, this list includes
ViewMyPaycheck (a cloud where employees can access paychecks), SmartVault V3 (a document management system), ShipGear (for integrating accounting and shipping), and a number of other very innovative BPM solutions!9
9

http://www.sleeter.com/awesomeaddons

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AIS AT WORK
Economic Downturn Promotes Onshoring10
For the past decade, we read one story after another of yet another company that had outsourced or offshored a business process to another firm. Most troubling to Americans were the business processes and the many jobs associated with those functions that were moved to other countries, especially India, China, and the Philippines. Management of these firms claimed that such business decisions were necessary for their companies to remain competitive and to generate value for shareholders. Recent downturns in the economy, an increased labor pool, and decreased real estate prices may have changed the equation, however.
Many experts suggest that offshoring has now reached a plateau. Companies are beginning to reconsider earlier decisions to offshore—and are bringing jobs back to the
United States or choosing not to offshore new jobs. One such company, DESA Heating
Products (DHP) of Bowling Green, Kentucky, announced in 2008 that the company would move their manufacturing production from China back to Bowling Green. Although DHP had outsourced hundreds of manufacturing jobs to China, management decided to reverse that decision and bring those jobs back to its Kentucky factory. The rationale for this decision focuses on two factors: quality and cost. And when you think about it, these are both critical factors for a company’s success because today’s customers demand the best quality products at the lowest price.
The Governor of Kentucky claimed that DHP’s decision to bring their production back to the United States is a strong indicator of evolving outsourcing trends in the global economy. So what exactly are these trends? A recent report from a global consulting firm contains a number of clues: transportation costs, wage inflation, currency fluctuations, and quality issues.
Perhaps DHP’s experience with offshoring can help us understand the Governor’s claim. First, Chinese workers are now demanding higher wages for their labor, which means that Chinese workers are no longer an economical solution to labor costs in the United States (19% increase in China compared to 3% in the United States since
2003). Second, significant fluctuations in oil prices cause great difficulty in budgeting the costs of transportation of goods produced in China—especially for the large, heavy products that DHP produces.
Third, Kentucky’s central location in the United States means that DHP is only one day’s drive from 70% of the population in the United States. That translates to products in the hands of DHP’s customers in 12 hours instead of the 6 to 8 weeks to ship from
China. And finally, DHP expects to save money in warranty repairs and replacement costs—manufacturing costs that tripled on the products made in China.

SUMMARY
The fundamentals of any business process include journals, ledgers, accounts, trial balances, and financial statements.
10

http://www.networkworld.com/news/2007/081707-study-onshoring.html; http://www.bgchamber.com/ media_room/blog/2008/07/desa-to-expand-bowling-green.php 230

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When planning a new AIS, developers usually start by designing the outputs from the system.
The fundamental instrument for collecting data in a typical AIS is the source document.
Two business processes that are common to many business organizations are the sales process and the purchasing process.
The sales process begins with a customer order and ends with the collection of cash from the customer. Important source documents associated with the sales process are sales orders, sales invoices, remittance advices, shipping notices, and customer checks.
The primary outputs of the sales process are reports such as a cash receipts report, a bad debt report, and a customer listing report.
For the purchasing process, the AIS is concerned with timely payment for purchased goods and services. Source documents common to the purchasing process include purchase requisitions, purchase orders, receiving reports, purchase invoices, and bills of lading.
Although companies still outsource to better manage costs, they now outsource and offshore business processes for strategic advantages.
Some of the business processes that are most likely to be outsourced or offshored are human resources, finance and accounting, customer services, learning services and training, and information technology.

KEY TERMS YOU SHOULD KNOW alphanumeric code block code business process
Business Process Management (BPM) software business process outsourcing (BPO) business without boundaries customer relationship management (CRM) discrepancy reports exception report

group code mnemonic code numeric code offshoring purchasing process
RFID tags sales process sequence code supply chain

TEST YOURSELF
Q7-1. Which of the following provides the organizational structure for the general ledger?
a. Special journals

c. General journals

b. A source document

d. The chart of accounts

Q7-2. AISs often depend on codes to record, classify, store, and retrieve financial data. Which of the following codes is a group of numbers reserved for particular uses?
a. Block codes
b. Mnemonic codes
c. Alphanumeric codes
d. Numeric codes

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Q7-3. AIS reports should be consistent in at least three ways. Which of the following is not one of those ways?
a. Over time
b. Across firms
c. Across departmental or divisional levels
d. With general accounting practice
Q7-4.

is (are) a collection of activities or flow of work in an organization that creates value. a. An economic event
c. A business process
b. Accounting transactions

d. A chart of accounts

Q7-5. Which of the following is not an objective of the sales process?
a. Controlling inventory
b. Tracking sales of goods and/or services to customers
c. Billing for goods and services
d. Forecasting sales and cash receipts
Q7-6. Which of the following report(s) is (are) common to both the sales and the purchasing processes? a. Cash receipts forecast and cash requirements forecast
b. Financial statement information
c. Discrepancy reports and bad debt report
d. None of the above
Q7-7. Which of the following source document(s) is (are) common to both the sales and the purchasing processes?
a. Debit/credit memoranda
b. Financial statement information
c. Discrepancy reports and bad debt report
d. None of the above
Q7-8. Which of the following business processes is most often targeted for offshoring?
a. Janitorial services
b. Landscaping maintenance
c. Information technology
d. Employee training
Q7-9. If a manager wanted to sort out any differences between quantities or amounts on the purchase order, the receiving report, and the purchase invoice, which of the following AIS reports would be most useful?
a. A purchase analysis report
b. An inventory control report
c. A check register report
d. A discrepancy report
Q7-10. Which of the following would be most helpful for a university to manage course enrollments? c. BPO
a. A supply chain report
b. CRM software

d. BPM software

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Q7-11. Which of the following is a relatively new way to manage inventory?
a. A purchase analysis report
b. RFID tags
c. BPM software
d. An inventory register

DISCUSSION QUESTIONS
7-1. As you might imagine, the chart of accounts for a manufacturing firm would be different from that of a service firm. Not surprisingly, service firms differ so much that software now exists for almost any type of firm that you could name. Think of yourself as an entrepreneur who is going to start up your own business. Now, go to Office Depot, Staples, or a similar office supply store (or search online) to find at least two different software packages that you might use for the type of firm you are going to start up. What does the Chart of Accounts include?
Are both software packages the same? What are the differences between the packages?
7-2. What are the purposes of accounting codes? How are they used? Bring to class some examples of codes used by manufacturing firms, accounting firms, and merchandising firms.
7-3. What are some typical outputs of an AIS? Why do system analysts concentrate on managerial reports when they start to design an effective AIS? Why not start with the inputs to the system instead? 7-4. What are some criteria that systems designers should consider when developing managerial reports for an AIS? How do system designers know what to include on reports?
7-5. Visit a local business and collect some examples of source documents used in an AIS. For each source document you collect, discuss its purpose(s). Are different source documents required for manufacturing firms versus merchandising organizations? Are all the business source documents paper based?
7-6. This chapter discussed many inputs to an organization’s sales process. What are the specific data items needed to add a new customer and record a sales order?
7-7. How does a data flow diagram for the sales process differ from a system flowchart describing that process?
7-8. How are the inputs and outputs of the purchasing process likely to be different for a restaurant versus an automobile manufacturer?
7-9. Explain the term business without boundaries. How is this changing the nature of organizations and who accomplishes various business processes?
7-10. What do we mean when we say companies are offshoring business processes?
7-11. Some businesses choose offshoring to solve the issue of expertise, especially for IT personnel. These companies claim they simply cannot find enough qualified employees in the
United States to do certain technology jobs. Do you agree with this assessment? Why or why not?
7-12. Search the Web for unusual and interesting uses of RFID tags. Find at least two that are unusual and share those with your classmates.
7-13. Discuss the privacy issues created by the use of RFID tags. Do you support the use of RFID tags for personal ID, customer relationship management, and inventory tracking? Why or why not?

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PROBLEMS
7-14. Listed below are several types of accounting data that might be coded. For each data item, recommend a type of code (mnemonic, sequence, block, or group) and support your choice.
a. Employee identification number on a computer file
b. Product number for a sales catalog
c. Inventory number for the products of a wholesale drug company
d. Inventory part number for a bicycle manufacturing company
e. Identification numbers on the forms waiters and waitresses use to take orders
f. Identification numbers on airline ticket stubs
g. Automobile registration numbers
h. Automobile engine block numbers
i. Shirt sizes for men’s shirts
j. Color codes for house paint
k. Identification numbers on payroll check forms
l. Listener identification for a radio station
m. Numbers on lottery tickets
n. Identification numbers on a credit card
o. Identification numbers on dollar bills
p. Passwords used to gain access to a computer
q. Zip codes
r. A chart of accounts for a department store
s. A chart of accounts for a flooring subcontractor
t. Shoe sizes
u. Identification number on a student examination
v. Identification number on an insurance policy
7-15. Novelty Gadgets is a marketer of inexpensive toys and novelties that it sells to retail stores, specialty stores, and catalog companies. As an accountant working for the company, you have been asked to design a product code for the company. In analyzing this problem, you have discovered the following:
a. The company has three major product lines: (1) toys and games, (2) party and magic tricks, and (3) inexpensive gifts. There are major subproducts within each of these product lines, and the number of these categories is 25, 18, and 113, respectively.
b. The company has divided its selling efforts into five geographic areas: (1) the United States,
(2) the Far East, (3) Europe and Africa, (4) South America, and (5) International (a catchall area). Each major geographic area has several sales districts (never more than 99 per area).
Between 1 and 20 salespeople are assigned to each district.
c. As noted earlier, there are three major categories of customers, and certain customers can also purchase goods on credit. There are five different classes of credit customers, and each rating indicates the maximum amount of credit the customer can have. Design a group code that Novelty Gadgets could use to prepare sales analysis reports. Be sure to identify each digit or position in your code in terms of both use and meaning.

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New vendor authorization form

New product authorization form

Key

Key

Add new vendors to vendor master file Add new products to products master file

Vendor master file

Product master file

Key
Authorized
purchase recquisitions Purchase orders (to vendors) Prepare purchase order

Purchase order pending file Purchase order summary

FIGURE 7-14 System flowchart illustrating the preparation of purchase orders for P. Miesing and Company.

7-16. Figure 7-14 is a system flowchart for P. Miesing and Company’s purchase order event. Prepare a narrative to accompany the flowchart describing this purchase order event. Include in your narrative the source documents involved, the computerized data processing that takes place, data inputs used to prepare purchase orders, and the outputs prepared from the processing function. 7-17. SSR-Save is a national discount retail store chain with annual revenues of more than $1 billion.
It’s a typical bricks-and-mortar operation with accounting software that records sales transactions in real time and tracks inventories on a perpetual basis. Management is considering an online store and will sell the same products as in the stores. Customers will be able to use credit cards only for online payments (versus cash, credit card, or debit card in the stores).
The marketing manager is interested in learning about customers and using the information to improve both in-store and online sales.

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a. Contrast the sales process of their retail store operation with the sales process in an online store environment. Would any of the events in the process change?
b. At what points do you collect data about customers and sales transactions in the retail store? In the online environment?
c. What data might you collect about retail store and online customers to improve your profitability? What data might you collect to improve customer satisfaction?
d. How is the sales process different for a public accounting firm? What data can they collect to improve customer relationships and grow revenues?

CASE ANALYSES
7-18. Food Court Inc. (Sales Process)
Food Court Inc. (FCI) is a business in Boston, MA, that offers meal plans to college students. Students, or their families, buy debit cards with fixed amounts that they can use to purchase food at more than 50 local restaurants. FCI sells the cards to students using an online storefront and in several locations near major college campuses. The following paragraph describes the online card sale process.
Customers enter their credit card information online and then the amount of purchase.
FCI’s software automatically checks the card number to determine that it is a valid credit card number; for instance, there are certain digits that indicate Visa cards. The software displays an error message if the number is not valid. The usual cause of these errors is typographical. Once the customer completes the card order screen, the software sends the data in an encrypted form to FCI’s host computer. Periodically, the FCI accountant retrieves transactions from the server. This is done by clicking on the ‘‘Get Transactions’’ screen button.
For each online transaction, the accountant manually copies down the credit card number on a scrap of paper, walks across the office to the credit card machine, and keys in the credit card number, the amount, and the numerical portion of the address. The credit card software checks to see if the card is valid and charges it for the amount. The accountant next writes down the validation number, returns to the host computer, and enters it. The accountant prints a receipt for the transaction and puts it in a file. The customer database now reflects the new customer. When a customer purchases a card off-line with a credit card, the accountant swipes the card directly, checks its validity, charges the card, and then writes down the validation number and enters it in the host computer.
FCI is considering the purchase of credit card software that can reside on the host computer and interact with their accounting software. The credit card software costs about $400. The credit card company rates are likely to increase by about 0.5% because cards could no longer be swiped directly—all credit card purchases would need to go through the online software. The rate FCI has to pay the credit card company is based on this mix. Credit card companies typically charge more if card numbers are punched rather than swiped because they have more chance of invalid transactions due to theft. It’s easier to steal a number than a card. Currently about half of FCI’s sales transactions arise from online sales; the other half result from sales through the office.

Requirements
1. Should FCI buy the credit card software?

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2. Use the skills you developed from Chapter 6 to develop a flowchart for FCI’s online sales process.
3. What are the business risks associated with this process?

7-19. Larkin State University (Purchasing Process)
Larkin State University is a medium-size academic institution located in the Southeastern
United States. The university employs about 250 full-time faculty and 300 staff personnel.
There are 12,000 students enrolled among the university’s four colleges.

The Purchase Process
The university’s budget for purchases of equipment and supplies is about $25 million annually. Peter Reese is in charge of the Purchasing Department. He reports directly to the
Vice President of Finance for the university. Pete supervises four purchasing clerks and three receiving personnel. The office is responsible for purchases of all equipment and supplies except for computer equipment and software and plant purchases or additions.

The Payment Process
The various departments across campus manually fill out hard-copy purchase requisition forms when there is a need for equipment/supplies. Each department forwards these forms to the Purchasing Department. If the request is for computer equipment or software, the requisition is forwarded to the Department of Information Technology for action.
Purchase requisitions are assigned to one of the three purchasing clerks by department.
For instance, one purchasing clerk makes purchases for all university departments beginning with the letters A through G (Accounting–Geology). Purchasing clerks check the requisition to make sure it is authorized and then consult the Approved Vendor Listing to find a supplier. The clerk may contact a supplier for pricing and product specification.
Once this task is complete, the purchasing clerk enters the purchase requisition and vendor and price information into the computer system, which prints out a multiple-part purchase order. Clerks send copies of the purchase order to Central Receiving, to the vendor, and to the Accounts Payable Department. (The university considered using EDI for its purchases, but chose not to adopt it because of the large number of vendors used.)
When Central Receiving receives an order, a receiving clerk consults the Purchase Order file to make sure the correct product and quantity have been delivered. The clerk also checks the product for damage. Central receiving does not accept any overshipments.
Receiving clerks forward accepted shipments to the adjacent warehouse for distribution to the appropriate department. Clerks file one copy of the Receiving Report, send one copy to the Purchasing Department, and forward a third copy to Accounts Payable.
George Vaughn is the Supervisor of Accounts Payable. Two accounting clerks report to him. He assigns invoices to them for payment based on vendor name. One clerk processes payments for vendors A through M, and the other clerk handles payments to all vendors with names beginning with letters N through Z. The clerks match each vendor invoice with a copy of the receiving report and purchase order before entering it into the computer for payment by due date. There are often discrepancies among the three documents. This requires frequent phone calls to the vendor, the Receiving Department, or Purchasing for resolution. As a result, the company frequently makes payments late and loses out on cash discounts. CHAPTER 7 / Accounting Information Systems and Business Processes: Part I

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Requirements
1. Identify the important business events that occur within Larkin’s purchase/payment process. 2. What changes would you suggest to the current process to take advantage of information technology? 7-20. The Caribbean Club (Customer Relationship Management)
The Caribbean Club is one of Virgin Island’s hottest night spots. It’s a great place for locals to meet after work and relax with friends, it’s a popular destination for tourists who stay on the island, and it’s always on the list of fun entertainment choices for the crowds from the cruise ships that dock in the harbor.
The reason the club is so popular with such a variety of customers is because the founder of the club, Ross Stewart, always has such innovative and visionary ideas that delight the patrons. For example, every night of the week the club features different activities or shows, including beach volleyball, Caribbean shows with calypso singers, world-class musicians who play steel drums, and other island delights.
Since Ross was a former accountant and auditor with one of the largest public accounting firms in New Zealand, he is very accustomed to brainstorming sessions to generate ideas and surface concerns. He brought this practice with him to the Caribbean and holds brainstorming sessions with his ‘‘club associates’’ (which is what he calls all of the employees at the club) once every month to identify new and novel ideas to increase the popularity and profitability of the club.
As you might imagine, the patrons of a night club are there to relax and enjoy themselves.
So, the associates thought it would be a great idea to somehow be able to recognize their regular patrons so that they wouldn’t have to trouble them with a bill every time a server came to their table with another round of drinks. After all, if the Club wanted these people to ‘‘feel like they were at home with friends,’’ the patrons shouldn’t have to bother with trying to decide who owed what to pay the bill. What a nuisance!
So Ross and his associates came up with the idea to implant their regular customers with an implantable microchip. The idea was to make the chip fun—to give it an elite status so that their regular patrons would want to be implanted. To dramatize the elite status of the chip, Ross decided that the Club would have a special area where only those with chips, the VIPs, would be admitted. And of course, this area would have various exclusive services for these members. The chip would allow the VIPS to be recognized and to be able to pay for their food and drinks without any ID—they would simply pass by a reader and the Club would know who they are and their credit balance. Ross also wanted the information system supporting the chip to be a customer relationship management tool.

Requirements
1. What do you think of this idea? That is, what are the advantages and disadvantages of this idea for the Caribbean Club?
2. If you were Ross, what information would you want the CRM to collect? Search the
Internet to see if you can find a CRM software package that seems appropriate for the Club. Why did you select this particular software?

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3. What are the advantages and disadvantages for the patrons?
4. If you were a passenger on a cruise ship, or staying at a resort on the island, would you get the chip implanted? Why or why not?

READINGS AND OTHER RESOURCES
Daugherty, B., and D. Dickins. 2009. Offshoring the independent audit function. The CPA Journal
79(1): 60–65.
Lassar, W., S. Lassar, and N. Rauseo. 2008. Developing a CRM strategy in your firm. Journal of
Accountancy 206(2): 68–73.
Lin, P. 2010. SaaS: What accountants need to know. The CPA Journal 80(6): 68–72.
Stambaugh, C., and F. Carpenter. 2009. RFID: Wireless innovations in inventory monitoring and accounting. Strategic Finance 91(6): 35–40.

Introduction to CRM (this site graphically depicts advantages and features of CRM): http://www.commence.com/crm/crm-software/landing.aspx?gclid= CNXi2Yyl_qcCFQhy5QodrwgBsQ
Introduction to Outsourcing: http://www.outsourcingmonitor.eu/videos/index.html Key Steps of the Purchasing Process: http://www.youtube.com/watch?v=Ph4tr_RtoJM&feature=related RFID Tags and Inventory Management: http://www.rfident.org/rfidvideo.htm ANSWERS TO TEST YOURSELF
1. d

2. a

3. b

4. c

5. a

6. b

7. a

8. c

9. d

10. b

11. b

Chapter 8
Accounting Information Systems and Business Processes: Part II

INTRODUCTION

CASE ANALYSES

THE RESOURCE MANAGEMENT PROCESS

Public Accounting Firm (Modeling Human Resource
Management)

Human Resource Management
Fixed Asset Management

THE PRODUCTION PROCESS
Objectives of the Production Process

Hammaker Manufacturing I (AIS for New
Manufacturing Firm)
Hammaker Manufacturing II (Business Process
Reengineering or Outsourcing)

Outputs of the Production Process

Hammaker Manufacturing III (Lean Production/Lean
Accounting)

THE FINANCING PROCESS

READINGS AND OTHER RESOURCES

Objectives of the Financing Process

ANSWERS TO TEST YOURSELF

Inputs to the Production Process

Inputs to the Financing Process
Outputs of the Financing Process

BUSINESS PROCESSES IN SPECIAL
INDUSTRIES
Professional Service Organizations
Not-for-Profit Organizations
Health Care Organizations

BUSINESS PROCESS REENGINEERING
Why Reengineering Sometimes Fails

AIS AT WORK—REENGINEERING HEALTH
CARE SYSTEMS
SUMMARY
KEY TERMS YOU SHOULD KNOW
TEST YOURSELF
DISCUSSION QUESTIONS
PROBLEMS

After reading this chapter, you will:
1. Appreciate the many ways technology is changing management’s ability to monitor and control business processes across the organization.
2. Know the objectives, inputs, and outputs of the resource management, production, and financing processes.
3. Understand how business strategy affects the data that are collected in the firm’s AIS and how that affects performance measures.
4. Be able to explain why some organizations have special accounting information needs.
5. Recognize the special information needs of several different types of organizations.
6. Understand how companies use business process reengineering (BPR) to cut costs and improve their operational efficiency.

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When dieting, standard cost accounting would advise you to weigh yourself once a week to see if you’re losing weight. Lean accounting would measure your calorie intake and your exercise and then attempt to adjust them until you achieve the desired outcome. . .
Lean accounting attempts to find measures that predict success.
Woods, D. 2009. Lean accounting’s fat problem. Forbes.com.1

INTRODUCTION
In the previous chapter we identified two processes that are common to most organizations: the sales process and the purchasing process. This chapter continues the discussion of business processes by exploring three additional processes: resource management, production, and financing. The resource management process includes human resources and fixed assets. The production manufacturing cycle entails the conversion of raw materials (another resource) into finished goods available for sale. Finally, the financing process involves the ways that organizations fund their operations (i.e., through borrowing or by selling shares of ownership).
Many organizations, such as government agencies, have specialized information needs, apart from the typical AIS requirements for information about revenues, purchases, and resources. The second section of this chapter considers some unique accounting information needs of organizations.
Maximizing the efficiency of every business process is critical to business success in today’s business without boundaries operating environment. Sometimes managers decide that a current business process isn’t working and must be reengineered. This is usually the case, for example, when a firm decides to implement a new enterprise-wide IT system. As a result, they turn to business process reengineering, which is the topic of the final section of this chapter.

THE RESOURCE MANAGEMENT PROCESS
Two resources that managers must closely manage, and require appropriate data, are an organization’s human resources and its fixed assets. Because the inputs, processing, and outputs for human resources and fixed assets are quite different, we examine them separately (Figure 8-1).

Human Resource Management
The ‘‘economic meltdown’’ in the fall of 2008 has been one of the most challenging times for resource managers as they try to deal with cash flow problems, bankruptcies, plant closings, and layoffs. An organization’s human resource (HR) management activity includes the personnel function, which is responsible for hiring or laying off employees.
HR must properly maintain the personnel and payroll records for employees, as well as handle the many actions associated with employee terminations. Nevertheless, the primary
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Human Resource Management Process
Objectives
Hiring, training, and employing workers
Maintaining employee earnings records
Complying with regulatory reporting requirements
Reporting on payroll deductions
Making timely and accurate payments to employees
Providing an interface for personnel and payroll activities
Inputs (Source documents)
• Personnel action forms
• Time sheets
• Payroll deduction authorizations
• Tax withholding forms

Outputs (Reports)
• Financial statement information
• Employee listings
• Paychecks
• Check registers
• Deduction reports
• Tax (regulatory) reports
• Payroll summaries

FIGURE 8-1 Objectives, inputs, and outputs for the human resource management process. objective of the personnel function is to hire, train, and employ appropriately qualified people to do an organization’s work.
In the past, HR professionals used technology to handle administrative tasks such as time clocking and payroll. However, many business process management (BPM) software packages are now available to automate the core processes that normally occur in an HR office. For example, HR departments are increasingly turning to technology to help with such diverse responsibilities as recruitment, oversight of legal and regulatory compliance, benefits administration, training, performance evaluation, and safeguarding confidential employee information.

Case-in-Point 8.1 Merix, a global supplier of advanced technology and printed circuit boards, focuses on the financial performance of its recruiting process. Using a cost-per-hire calculation, Merix determines whether its recruiting process is functioning at peak efficiency.
Goals for this measure are set to assure that HR is financially responsive to the organization and is an efficient support service. Further, tracking this measure allows Merix to more effectively budget human resources expenditures for the coming year based on projections of staffing needs.2
Although the main purpose of payroll processing information systems is to pay employees for their work, such systems also maintain employee earnings records (a payroll history), comply with various government tax and reporting requirements, report on various deduction categories (e.g., pension funds and group insurance), and interact with other personnel functions. Figures 8-2 and 8-3 show sample system flowcharts for the personnel function and for the payroll function.

Inputs to Human Resource Management Processing. The source documents used in payroll processing are personnel action forms, time sheets, payroll deduction authorizations, and tax-withholding forms. The personnel department sends personnel
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Hire
Employee

Process New
Employee

Record personal, tax, and payroll data Maintain
Employee
Records

Update personal, tax, and payroll data Personnel and Payroll
Files

Various
Personnel
Reports

FIGURE 8-2 Systems flowchart of the AIS for the personnel function.

action forms to payroll that document the hiring of new employees or changes in employee status. For example, payroll receives a personnel action form when an employee receives a salary increase. This document is very important for control purposes. For example, auditors will detect an employee who increases his or her own salary when they fail to find a personnel action form authorizing the increase.
Many companies use time sheets to track the hours that employees work. The source of information for these time sheets varies widely with the level of technology that

Employee
Performs
Services

Record
Employee
Time

Create
Employee
Pay Checks
& Reports

Various
Payroll
Reports

Personnel and Payroll
Files

Paychecks

FIGURE 8-3 Systems flowchart of the AIS for the payroll function.

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the organization employs. For example, some companies use a time clock that requires employees to punch in (on time cards) when they arrive for work. Others use picture
ID cards or RFID-enabled ID cards that serve to verify the identity of an employee and record the time when employees enter and leave the workplace or a specific location within the firm. To guard against employees having their friends punch in for them, some organizations now use various biometric devices (e.g., fingerprints or iris scans) to identify employees and capture their entry and departure from workplaces.
At the end of the pay period, the employee’s supervisor verifies the number of hours worked and authorizes payment. Next, either a payroll clerk or an internal control embedded in the payroll processing information system checks for the appropriate authorization before processing these hours. Companies that use a job cost information system can cross-reference employee time sheets with time recorded on individual jobs.
Employees fill out payroll deduction authorizations that direct the payroll processing system to deduct amounts from gross pay for items such as health and life insurance, parking fees, retirement plan contributions, and union dues. An authorization form should document each deduction. In the United States, every employee must also complete tax-withholding forms, which authorize the payroll system to reduce gross pay by the appropriate withholding tax. The information system uses each employee’s W-4 withholding form to calculate the correct withholding for federal income taxes.

Outputs of Human Resource Management Processing. The outputs of human resource management processing include employee listings, check registers, paychecks, deduction reports, tax reports, and payroll summaries. As you might imagine, the processing of paychecks should include very strict internal control procedures (covered in Chapters 9 and 10). Employee listings show current employees and may contain addresses and other demographic information. Check registers accompany each printing of paychecks and list gross pay, deductions, and net pay. Payroll clerks use the check register information to make journal entries for salary and payroll-tax expenses. Deduction reports can contain summaries of deductions for all employees in a department, a division, or company wide.
Finally, the payroll function issues various payroll summaries that help managers analyze expenses. A typical payroll summary report might classify payroll expenses by department or job or show total overtime hours worked in each department.
Case-in-Point 8.2 The city of Reno, Nevada, is one of many cities in the United States seeking ways to lower its expenditures. Recently, the issue of overtime pay for firemen came to the attention of the city council because reports indicated that there were excessive amounts of overtime. Apparently, the number of firemen that the city could hire was limited, but not the amount of overtime pay these individuals could earn.3
The U.S. government requires various tax reports for income tax, Social Security tax, and unemployment tax information. Employees pay some taxes in their entirety, but employers share others. For instance, both the employee and the employer pay equal amounts of Social Security taxes. The payroll system allocates shared taxes to the appropriate accounts. Taxes paid by employees are allocated to payroll expense, but employer taxes are part of the employer’s tax expense.
Because manual payroll processing can be tedious, repetitive, and error-prone, the payroll function was one of the first accounting activities to be computerized in many organizations. Today, many companies find it cost-effective to outsource the process for paychecks and payroll reports.
3

From the authors.

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Case-in-Point 8.3 Automatic Data Processing, Inc., or ADP, is the world’s largest payroll service provider. More than 500,000 companies in 15 countries outsource their payroll processing and, in some cases, their human resource administration to ADP. The company has been in business for over 50 years and pays more than one in six private sector employees in the United States.4

Fixed Asset Management
Even small organizations generally own many fixed assets, which management must track as they are purchased and used. The objective of the fixed asset management (FAM) function is to manage the purchase, maintenance, valuation, and disposal of an organization’s fixed assets (also called ‘‘long-term assets’’ because they last more than one year).
In thinking about how complex it might be to track fixed assets, imagine the endless number of fixed assets that are owned by a large, publicly traded firm such as Boeing
(which has about $23 billion in fixed assets on its balance sheet). A firm must record each fixed asset on its books when it purchases the asset. In addition, the firm must maintain depreciation schedules for its fixed assets. Many large firms will calculate depreciation using five or more different depreciation methods because of different calculation requirements for financial statements prepared according to Generally Accepted Accounting Principles
(GAAP), federal income tax reporting, Alternative Minimum Tax (AMT), state tax reporting, and so forth. Employees often move fixed assets around within an organization, and although an AIS should keep track of all asset locations, this can be quite difficult in practice. Bar codes affixed to physical assets make this job easier.
Because fixed assets often require repairs, an AIS should also track repair costs and distinguish between revenue expenditures and capital expenditures. Revenue expenditures are ordinary repair expenses, whereas capital expenditures add to the value of assets. Finally, the AIS calculates the amount of gain or loss upon disposal of individual fixed assets. By comparing the amount received for the asset with the asset’s book value, the AIS can compute a gain or loss. Fortunately, software companies offer a variety of solutions to help managers and automate these processes.

Case-in-Point 8.4 BNA Software offers a fixed assets system for small and midsize firms that handles inventory reporting, management, regulatory compliance, estate planning, and even auditing of the inventory account. The software also allows for tracking of mobile inventory and integrates with ERP packages.5
Increasingly, organizations are adopting enterprise asset management (EAM) systems to automate the management of a broad spectrum of assets. For example, Green
Bay Packaging, Inc. is using an EAM solution to streamline purchasing, reduce inventory, and trim machine downtime and maintenance costs. Because of reduced overall operating expenses, the company expects the software to pay for itself in six months. Avantis makes a global EAM solution that focuses on maintenance, inventory, procurement, and invoicing efficiencies. Finally, the U.S. government purchased a $1.9 million EAM system to integrate data and coordinate logistics for the 5,000-plus major rebuilding projects underway in Iraq.

Inputs to Fixed Asset Management Processing. Fixed asset processing begins with a request for a fixed asset purchase. The individual making the request enters the appropriate information on a purchase requisition form (typically an e-form). Fixed asset
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requests usually require approval by one or more managers, especially where purchases require substantial investments. Other documents associated with fixed asset purchases are receiving reports, supplier invoices, and repair and maintenance records. The receiving department either scans in the information electronically to the AIS or fills out a receiving report on receipt of a fixed asset. The asset’s supplier sends an invoice when it ships the asset. Sometimes a company builds a fixed asset, for example, a warehouse, rather than acquiring it from an outside vendor. Here, processing fixed assets requires a work order detailing the costs of construction.
Those responsible for a particular fixed asset should complete a fixed asset change form when transferring fixed assets from one location to another. The fixed asset change form also records the sale, trade, or retirement of fixed assets. Fixed asset management requires maintaining repair and maintenance records for each asset individually or for categories of fixed assets. The department performing this service should record these activities on a repair and maintenance form. This form notifies the AIS to update expense or asset accounts. Figure 8-4 is a systems flowchart that shows fixed asset acquisition, maintenance, and disposition.

Outputs of Fixed Asset Management Processing. One output of the fixed asset processing system is a listing of all fixed assets acquired during a particular period. A fixed asset register lists the identification number of all fixed assets held by a company and each asset’s location. The depreciation register shows depreciation expense and accumulated depreciation for each fixed asset. Repair and maintenance reports show the current period’s repair and maintenance expenses, as well as each fixed asset’s repair and maintenance history. Finally, a report on retired assets reflects the disposition of fixed

Invest in
Fixed Assets

Record New
Asset
Fixed
Asset
Files

Maintain
Fixed Asset
Records

Update for depreciation, maintenance, repair, betterment, disposal

Create Fixed
Asset
Reports

Various Fixed
Asset Reports

FIGURE 8-4 Systems flowchart of the AIS for the fixed asset management function.

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Fixed Asset Management Process
Objectives
Tracking purchases of fixed assets
Recording fixed asset maintenance
Valuing fixed assets
Allocating fixed asset costs (recording depreciation)
Tracking disposal of fixed assets
Inputs (Source documents)
• Purchase requisition
• Receiving reports
• Supplier invoices
• Construction work orders
• Repair and maintenance records
• Fixed asset change forms

Outputs (Reports)
• Financial statement information
• Fixed asset register
• Depreciation register
• Repair and maintenance reports
• Retired asset report

FIGURE 8-5 Objectives, inputs, and outputs for the fixed asset management process. assets during the current period. Figure 8-5 summarizes the objectives, inputs, and outputs of the fixed asset management process.

THE PRODUCTION PROCESS
The production process (sometimes called the conversion process) begins with a request for raw materials and ends with the transfer of finished goods to warehouses.

Objectives of the Production Process
The objective of a manufacturing organization’s production process is to convert raw materials into finished goods as efficiently as possible. Today’s production of goods and services often requires expensive factory machinery, such as computer-assisted design
(CAD) technology or robotics (used in the manufacture of automobiles).
Accounting for the acquisition and use of production machinery is part of the fixed asset management process described in the previous section of this chapter. Another important objective of an AIS’s production process is collecting cost accounting data for operational managers, who then can make informed decisions with respect to the products produced in their departments. Figure 8-6 identifies the objectives, inputs, and outputs associated with the production of goods and services.

Cost Accounting Subsystem. Because the cost of goods sold is likely to be the largest expense on a manufacturing firm’s income statement, a critical part of the production process is an AIS’s cost accounting subsystem. The cost accounting subsystem provides important control information (e.g., variance reports reflecting differences between actual and standard production costs) and varies with the size of the company and the types of product produced. As you might guess, a bakery producing baked goods would collect very different data in its AIS than that of an automobile manufacturer. Cost accounting subsystems for manufacturing organizations are commonly job costing, process costing, or activity-based costing systems.

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Production Process
Objectives
Track purchases and sales of inventories
Monitor and control manufacturing costs
Control inventory
Control and coordinate the production process
Provide input for budgets
Inputs (Source documents)
• Materials requisition form
• Bill of materials
• Master production schedule
• Production order
• Job time cards

Outputs (Reports)
• Financial statement information
• Material price lists
• Periodic usage reports
• Inventory status reports
• Production cost reports
• Manufacturing status reports

FIGURE 8-6 Objectives, inputs, and outputs commonly associated with the production process.
A job costing information system keeps track of the specific costs for raw materials, labor, and overhead associated with each product or group of products, called a ‘‘job.’’
This type of costing system is most appropriate for manufacturers of large-scale or custom products, such as home builders or book publishers. Manufacturers of homogeneous products (such as soft drinks or toothbrushes) that are produced on a regular and continuous basis use a process costing information system. In this system, it is not feasible or practical to keep track of costs for each item or group of items produced.
Instead, process costing systems use averages to calculate the costs associated with goods in process and finished goods produced.
Activity-based costing (ABC) systems help managers describe processes, identify cost drivers of each process, and then determine the unit costs of products created in each process. By studying their business processes, managers are in a better position to recognize opportunities to improve those processes. Thus, activity-based costing gives managers a better understanding of their processes, an improved ability to allocate indirect costs to those processes, and a better understanding of the true cost of each product.
The systems flowchart in Figure 8-7 shows a typical information flow for production in a manufacturing firm.

Just-in-Time (JIT) Inventory Systems. Inventory control ensures that the production process handles inventory transactions appropriately so that the financial statements correctly state the value of the inventory and cost of goods sold. Carrying inventory has a number of costs associated with it, including storage, obsolescence, shrinkage, or reduction in sales value.
Toyota (of Japan) popularized the use of just-in-time (JIT) inventory systems. Some managers refer to a JIT system as a ‘‘make-to-order inventory system.’’ This phrase indicates that the organization produces goods to fill an order rather than to fill inventory. The objective of a JIT system is to minimize inventories at all levels. Each stage in the production operation manufactures (or acquires) a part just in time for the next process to use it. While the best possible JIT system would maintain zero inventory balances, this is often not practical in real-world applications. Manufacturing organizations need some inventories to protect against interruptions in supply from manufacturers and fluctuations in demand for their finished goods that are beyond the manufacturer’s control.

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Orders For
Finished Goods

Raw Materials
Review

Purchase Orders
For Required
Raw Materials

Raw
Materials
Inventory
File

Personnel
Files

Create Labor
Schedules

Labor
Schedules

Production
Schedule
Files

Produce Cost
Accounting
& Production
Reports

Resource
Usage &
Cost Reports

Production
Status
Reports

Miscellaneous
Management
Reports

FIGURE 8-7 Systems flowchart of the AIS for the production process in a manufacturing organization.

A JIT system requires a reliable and high-quality AIS. If the AIS does not process transactions on a timely and accurate basis, manufacturing processes may lack the raw materials inventory necessary to maintain a constant work flow. Inefficient processing of transactions can also lead to shortages of finished goods that in turn translate into lost sales.
This leads some organizations to be proactive and reengineer the process.

Case-in-Point 8.5 JIT is a great concept for a company that is intent on efficiently managing stock, but it makes life difficult for the accounts payable department, which is responsible for paying many JIT invoices. For example, Dell Computer Company found itself ordering certain parts as frequently as 12 times a day. The A/P department was inundated with paper invoices. GE Capital dispatched several of its Six Sigma analysts, known as black belts, to Dell to analyze its A/P process. The consultants mapped out the entire process (using documentation procedures similar to those described in Chapter 6) and then recommended that Dell change to an Internet-based electronic filing process. The move saves Dell over
$2 million per year.6
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Lean Production/Manufacturing. Although JIT inventory systems are an important step for manufacturing companies to control costs associated with inventory, the truth is that companies must learn to eliminate waste throughout the manufacturing process—indeed, throughout the organization—if they hope to become a world class organization. Lean manufacturing involves making the commitment to eliminate waste throughout the organization (not just in production), which is a philosophy that is often attributed to the Toyota Production System (TPS). The TPS essentially focuses on elimination or reduction of non-value-added waste to improve overall customer value and to increase the profitability of the products or services that the organization offers. So we might say that lean manufacturing developed through the concepts of JIT as well as Total
Quality Management.
Figure 8-8 depicts eight different categories of waste that companies hope to reduce or eliminate. In the figure, overproduction means producing more than your customers want to purchase. Waiting refers to the time that is lost when employees, products, services, or machines wait for the next step in a process to occur. Transportation identifies the unnecessary movement of materials or information around a firm or organization. Excessive processing can be the result of an organization that has poor products, defective inputs, or an inefficient business process. From JIT principles, we know that it is wasteful to store more inventory than the minimum required to produce the goods or services of the company. Excess (or unnecessary) motion of people, materials, products, or anything should be avoided. Whenever substandard products are produced, companies end up with defects, scrap, rework, and/or paperwork errors. Finally, when organizations do not fully engage the skills, talents, and abilities of their employees, they lose some of the human potential that is available to the firm.
Lean Accounting. Accountants are quick to point out that you cannot have lean manufacturing without lean accounting. A company that follows lean manufacturing concepts must identify value from the perspective of their customers, organize production
(and data collection) in value streams, empower employees to make decisions, and then continually pursue excellence in all areas of the organization. Thus, you can’t use the same old performance measures—you need new ones. Why is that the case? Because the goal of performance measures is to communicate, motivate, clarify, and evaluate. Management accountants use performance measures to give managers information and feedback for decision making. Traditional performance measures typically support only top managers

Types of non-value-added waste
• Human potential
• Defects
• Motion
• Inventory
• Processing
• Transportation
• Waiting
• Overproduction

FIGURE 8-8 Categories of waste that are the focus of lean operations management. Source:
Burton, T., and S. Boeder, The lean extended enterprise: Moving beyond the four walls to value stream excellence (2003), Boca Raton, FL: J. Ross Publishing.

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as decision makers. Lean manufacturing requires that many leaders (i.e., employees other than high-level managers) be empowered as decision makers, which means they also need timely information to be effective.
While reengineering the traditional performance measures would be ideal, this is often not possible. However, management accountants, managers, and empowered team members can work together to identify critical data that the AIS must collect to support lean production. At a minimum, these data should include metrics that will help managers and team members make wise decisions regarding methods to reduce or eliminate waste that is identified in Figure 8-8 (overproduction, waiting, transportation, processing, inventory, motion, defects, and human potential).
Jan Brosnahan, the controller for Watlow Electric Manufacturing Co. (WEM) describes how her team adopted lean accounting, which means measuring and evaluating results by value stream management rather than by traditional departments (such as customer service, purchasing, etc.). For example, an order fulfillment value stream includes all metrics from the sales/order entry point, through manufacturing, all the way to after-sales support. Each value stream has a leader who is responsible for coaching and profitability of the specific metrics identified for that value stream. Standard costs, variances, and overhead allocations are not the drivers of decisions—rather, only directly incurred costs are used for decision making.
Lean accounting will have many implications throughout organizations of the future.
On the basis of the many changes that WEM implemented in their company to support lean accounting, there are two areas that may need to be evaluated by management accountants—the collection of data in the AIS and the chart of accounts that the company uses. Fortunately, AISs that are built upon a relational database (see Chapters 3, 4, and 5) can be modified to support lean accounting. Regarding the chart of accounts (covered in
Chapter 7), the accountants at each organization will need to work with managers and team leaders to determine the most appropriate coding system to use, based on the value streams that are identified.

Inputs to the Production Process
When a production manager needs raw materials, he or she issues a materials requisition form to acquire more material from a storeroom or warehouse where the raw materials are kept. If the level of inventory falls below a certain predetermined level, the inventory control clerk issues a purchase requisition to the purchasing department (probably an e-form, and this might be an automatic determination that is transmitted electronically to the vendor). Finished goods consist of a complex array of parts or subassemblies.
For example, an armchair consists of four legs, a seat, two arms, and a back. The bill of materials shows the types and quantities of parts needed to make a single unit of product. An important input to the production process is the master production schedule, which shows the quantities and the timing of goods needed to meet quantities required for anticipated sales. The marketing department’s sales projections, combined with desired inventory levels, are inputs to the production order, which authorizes the manufacture of goods and dictates the production schedule. Tracking labor time is important to a job costing system because one employee may work on many jobs and one job might require the work of many employees. An input to a job costing system is the job time card.
This card shows the distribution of labor costs to specific jobs or production orders. Each worker completes a job time card (usually daily or weekly), detailing the hours worked on specific operations and jobs.

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Typically, large and medium-size firms use enterprise resource planning (ERP) systems to collect essential data about their production operations so that they can better manage these processes. ERPs are multimodule software packages backed by large databases that help a manufacturer effectively track, monitor, and manage product planning, parts purchasing, maintaining inventories, interacting with suppliers, providing customer service, and tracking orders. We discuss ERP software in more depth in Chapter 15.
In conjunction with ERPs, manufacturers have often replaced manual data entry with automated technologies such as bar code readers, radio frequency (RF) technology, RFIDs, handheld devices, GPS locators, and other advanced technologies. These input technologies can be used individually or combined in innovative ways to significantly reduce input errors
(compared to human data entry) and support fast, accurate, real-time production and data collection. Case-in-Point 8.6 Mail-order fulfillment of drug prescriptions is a booming business for the U.S. Veteran’s Administration, CVS, Kaiser Permanente, and others. When mail-order prescription centers first started, a worker would stand next to a printer, wait for a label to be printed, wrap the label around the bottle, and put it in a box. The box traveled to the next worker who read the label, found the correct pill-counter station, held the bottle under the counter as the bottle filled, replaced the lid on the bottle and sent the prescription down the line for final packing. It took 20–30 people to complete the operation. Now, a computer system using plastic transport carriers (called ‘‘pucks’’) with RFID tags in the base automates this entire process. The prescription and the puck are linked in the system and travel along the conveyor automatically, eliminating the need for human intervention until the prescription is ready to be placed in the mailing envelope.7
Other technologies are being combined in innovative ways to improve management’s ability to track and monitor production. For example, United Parcel Service
(UPS) uses combinations of technology to manage the efficiency of their deliveries and control costs.

Case-in-Point 8.7 UPS deployed a new fleet tracking system in 2010. The system combines
GPS technology, telematics, and Bluetooth technology to record data about trucks. The system analyzes information such as the number of times a truck is put into reverse, the number of minutes a truck idles, whether or not the driver wears a seatbelt, and over 200 other pieces of information. Using this information, UPS has already found methods for reducing fuel usage by over 1.4 million gallons per year.8

Outputs of the Production Process
Examples of output reports for the production process include materials price lists, periodic usage reports, inventory reconciliation reports, detailed inventory status reports, production cost reports, and manufacturing status reports. The materials price list shows the prices charged for raw materials. The purchasing department updates this list. Cost accountants use price lists to determine the standard costs needed to budget production costs. Periodic usage reports show how various production departments use raw materials.
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Managers scrutinize these reports to detect waste by comparing raw material usage to output (finished goods) produced.
A company using a perpetual inventory system issues an inventory reconciliation report. When auditors take a physical inventory, the accounting subsystem compares the physical inventory results with book balances and notes discrepancies on this inventory reconciliation report. Another report important for inventory control purposes is the periodic detailed inventory status report. This report allows purchasing and production managers to monitor inventory levels.
Cost accountants use production cost reports to calculate budget variances. Some manufacturing organizations use standard costing systems that allow them to compare standard costs with actual costs and compute variances for materials, labor, and overhead.
The production cost report details the actual costs for each production operation, each cost element, and/or each separate job. Manufacturing status reports provide managers with information about the status of various jobs. Because manufacturing a product usually requires coordination of many operations, it is important to report on production status regularly. Of course, as more companies move to lean production and manufacturing methods, some of these production reports will be replaced with value stream management metrics that may be more useful for decision making.

THE FINANCING PROCESS
The financing process describes how a company acquires and uses financial resources such as cash, other liquid assets, and investments. Cash and liquid assets are an organization’s working capital. The financing process interfaces with the revenue, purchasing, fixed asset, and human resource processes. Much of the capital available in an organization comes from sales revenue and is used to pay expenses and personnel and to buy fixed assets.
Besides obtaining financial resources through the sales of goods and services, most organizations also acquire funds by borrowing cash or selling ownership shares. The financing process includes managing these activities. Figure 8-9 is a data flow representation of the financing process.

Objectives of the Financing Process
The financing process has a number of objectives. These include managing cash effectively, minimizing the cost of capital, investing for maximum returns, and projecting cash flows.
Effective cash management requires collecting cash as soon as possible and spending it carefully. To collect cash quickly, an organization’s AIS can provide useful information about how quickly customers pay their bills. An AIS can also show trends in cash collections.
Organizations can use lock-box systems to reduce the float period during which checks clear the bank. A lock-box system is an effective cash management tool because banks typically require several days, and sometimes a full week, to provide an organization with credit for out-of-state checks. With a lock-box system, a company directs its customers to mail their checks on account to a lock-box in their home state. A local bank collects the checks in the lock-box, clears the checks, sends the customer payment data in an electronic format, and deposits the cash into the company’s account. In this way, cash is available for use more quickly. Figure 8-10 identifies additional benefits that companies might realize by using a lock-box system.

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Investment
Services

Fin'l Instit.
Profiles

Loan
Requests

Management and
Board of Dirs.

Debt and
Interest Reports
Market
Data

253

Track
Borrowed
Funds

Authorization to Sell Shares

Maintain
Investment
Accounts

Record Stock
Sales

Cash
Bank
Statements
Record Stock
Sales
Banks/Lending
Institutions

General Ledger
Deposit Slips
Stock Certifs.
Other Fin'l. Paper

Stock
Certificates

Cash

Investments

Shareholders

FIGURE 8-9 A data flow diagram of the financing process. This data flow diagram does not include cash management related to sales revenue, purchases, payroll, or fixed assets.

Electronic funds transfer (EFT), or electronic payment, is another cash management technique that is very common. Using EFT, business organizations eliminate paper documents and instead transfer funds electronically. Similarly, most companies today pay their employees electronically by directly depositing the funds to each employee’s bank account directly rather than issuing a paper check.
Managing cash on the expenditure side means paying cash as bills come due and taking advantage of favorable cash discounts. While an organization wants to make sure there is cash available for timely payments to vendors and employees, it is also possible to have too much cash on hand. Idle cash is an unproductive asset, and short-term investments often earn less return than long-term investments. Effective cash management means cash balances are not unreasonably high and managers invest excess cash wisely. Managers in

Benefits of a Lock-Box System







Better-managed large-volume deposit customers
Capture market share with lock-box services
Process any coupon payment format
Reduce operating costs
Increase efficiencies
Cross-selling opportunities through daily access







Online home page marketing capabilities
Flexible implementation options
Archive all check payment information online
Research images for all lock-box transactions
Capture greater share of wallet

FIGURE 8-10 Additional benefits firms may realize by using a lock-box system. Source: Web site for ImageWay® Payment Processing.

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large companies monitor excess cash and invest it for very short time periods, sometimes less than a day.
Minimizing the cost of capital (i.e., the cost of obtaining financial resources) requires management to decide how much cash to borrow and how many shares of ownership
(stock) to sell. Borrowed funds require interest payments. While businesses do not pay interest to shareholders, they do pay dividends. Financial managers frequently use financial planning models to help them select an optimal strategy for acquiring and investing financial resources. These models require an information system that can make complex calculations and consider alternative investment, borrowing, and equity (sales of stock) strategies.
A final objective of the financing process is to project cash flows. An output of the revenue process is a cash receipts forecast, and the purchasing and human resource processes contribute to a forecast of cash disbursements. The financing process makes use of these forecasts to invest excess funds and determine debt and equity strategies. The AIS for the financing process contributes to cash flow predictions through estimates of interest and dividend payments and receipts. Figure 8-11 summarizes the objectives, inputs, and outputs of this process.

Inputs to the Financing Process
Many inputs to the financing process originate outside an organization. Externally generated data or source documents might include remittance advices, deposit slips, checks, bank statements, stock market data, interest data, and data about financial institutions. Chapter 7 explained that a remittance advice accompanies a customer’s payment on account. Banks provide deposit slips to document account deposits. For example, you receive a deposit slip when you make a cash deposit to your account through an automated teller machine and a credit slip when you purchase gasoline with your debit card.
Regardless of whether companies transfer funds electronically or receive/issue paper checks, accountants use the company’s bank statement to reconcile any account discrepancies and as proof of payment. Accountants use bank statements to reconcile the cash account balance in the company’s ledger against the cash balance in the bank account.

Financing Process
Objectives
Effective cash management
Cost of capital optimization
Earn maximum return on investments
Project cash flows
Inputs (Source documents)
• Remittance advices
• Deposit slips
• Checks
• Bank statements
• Stock market data
• Interest data
• Financial institution profiles

Outputs (Reports)
• Financial statement information
• Cash budget
• Investment reports
• Debt and interest reports
• Financial ratios
• Financial planning model reports

FIGURE 8-11 Objectives, inputs, and outputs associated with the financing process.

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Discrepancies between these two accounts arise from outstanding checks, deposits in transit, and various other transactions. Sometimes, of course, discrepancies are due to errors or even fraud. Because cash is a company’s most liquid asset, AISs use control procedures to help protect against misappropriations.

Outputs of the Financing Process
Like all other business processes, the financing process provides general ledger information to help an AIS produce periodic financial statements. Examples include interest revenue and expense, dividend revenue and expense reports, and summaries of cash collections and disbursements. It also provides information about balances in debt, equity, and investment accounts. Besides providing general ledger information, the financing process of an AIS produces a cash budget showing projected cash flows.
The AIS for the financing process can produce a variety of reports about investments and borrowings. Investment reports may show changes in investments for a period, dividends paid, and interest earned. Reports on borrowings could show new debt and retired debt for a period. These reports should list the lending institutions, interest rates charged, and payments of principal and/or interest for the period.
Managers perform ratio analyses to manage an organization’s capital effectively.
Significant ratios, such as return on investment and debt to equity, help management make decisions regarding investment and borrowing strategies. A company’s financial planning model calculates and reports these ratios. The planning model also prepares recommendations regarding the appropriate mix of debt versus equity financing, and shortversus long-range investments. Figure 8-12 is a sample systems flowchart for the financing process. Cash
Forecasts

External
Data

Cash
Management
System

Financial
Planning
Models

Various
Financial
Reports

Various
AIS Files

Financial
Statement
Information

Various
Reports

FIGURE 8-12 Systems flowchart of the AIS for the financing process.

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BUSINESS PROCESSES IN SPECIAL INDUSTRIES
The term vertical market refers to markets or industries that are distinct in terms of the services they provide or the goods they produce. When you think about it, most organizations fit into a vertical market category. For example, an accounting firm is a professional service organization while a grocery store is in the retail industry. However, large conglomerates may operate in several different vertical markets—for instance, many large manufacturers have branched out to also provide professional and financial services.
The same is true of retail firms. Consider, for example, Sears, Roebuck and Co. While still known primarily as a retailer, a large share of the company’s profit comes from providing consumer credit.
Vertical markets with specialized AIS-related needs include professional services; notfor-profit, health care, retail, construction, government, banking, and financial services; and hospitality. This section describes a few of these types of organizations in terms of their unique characteristics and AIS needs.

Professional Service Organizations
Professional service organizations are business establishments providing a special service to customers such as accounting, legal services, engineering, consulting, and architectural services. Compared with organizations that provide tangible goods (such as automobile manufacturers), professional service organizations have several unique operating characteristics: (1) no merchandise inventory, (2) emphasis on professional employees, (3) difficulty in measuring the quantity and quality of output, and (4) small size. These are common characteristics, although not every organization in this industry segment has all of them. For instance, some accounting and consulting firms are relatively large. They have hundreds of partners and international offices in cities throughout the world.
Because professional service organizations do not maintain a product inventory, they do not need an AIS that tracks inventory levels. Instead, the primary accounting information needed by professional service organizations relates to time and billing for their professional staff. Time and billing information systems are similar to job order costing systems—they track hours and costs associated with each job (i.e., each client) and each employee (i.e., professional staff). There are two major outputs of the time and billing system: (1) the client bill and (2) the professional staff member’s record of billable hours
(hours actually spent working on client business).
Figure 8-13 shows an example of a software consulting firm’s client bill. The client bill may detail the number of hours worked by every professional staff member and the rate charged by each. For example, an audit client might incur charges for audit staff, supervisors or seniors, managers, and partners. An AIS multiplies the hours worked by each staff member by his or her respective billing rate to compute the total charge. Time and billing systems can also show other charges on the bill or client invoice—for example, charges for overhead and detailed charges for phone, fax, mail, support staff, and copy costs.
Billable hours are important in a professional service organization. Law firms, for example, stress the importance of accumulating an accurate accounting of the number of billable hours. Nonbillable hours are hours spent on training, marketing, and general research. While these activities are important, they do not directly generate revenue for a law firm. A time and billing system can track each staff member’s hours in many ways.
The increments of time recorded vary by firm. Some professional service firms record

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Smith & Smith Partners
8888 Newbury Rd.
Glenwood, NC 00301
Office: 634/344-9845
Fax: 634/344-5468

Invoice #:
Invoice Date:
Terms:
Due Date:
Customer #:

Mr. Bob Townsend
234 Bayberry St.
Rocktown, NC 12093

2309
July 26, 2011
Net 15 Days
August 26, 2011
12088
FOR SERVICES RENDERED

Work Type

Date

Description

Employee

Time

Chargeable
No Charge
Chargeable

3/17/11
3/19/11
3/20/11

Planning
Issues/Resolves
Processing Error & Corrections

MAS
SBC
MAS
Total Hours:
Not Charged Hours:
Chargeable Hours:
Invoice Dollar Total:

0.60
0.25
0.60
1.20
0.25
1.20
$200.00

FIGURE 8-13 A sample client bill for a software consulting firm. every 15 minutes spent working on a client job. Some law firms even record time in six-minute increments. Because time is literally money, it is important to keep records that are as detailed and accurate as possible.
Automation helps professional service organizations keep accurate records of billable hours. For example, phone systems can record the amount of time spent on calls to and from clients, and the phone system can enter values directly into the time and billing system. A copy machine in which users enter client numbers for each job is another tool that helps assign copy costs to client accounts. Finally, as professional staff members rely increasingly on their computers for their work, special computer programs can automatically record the time spent on each job as the staff member logs on to different programs with client-oriented passwords.

Not-for-Profit Organizations
Not-for-profit organizations provide services for the protection and betterment of society.
Examples include public schools, museums, churches, and governmental agencies. Notfor-profit organizations differ from for-profit businesses in that they (1) are usually staffed by volunteers as well as professional employees, (2) do not emphasize maximizing net

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income, (3) are usually not as affected by market forces as are for-profit organizations, and
(4) sometimes have a political emphasis.
As with other organizations in vertical markets, not-for-profit organizations have special accounting information needs that reflect their unique characteristics. For example, public schools (such as a university) must keep records of students’ schedules, grades, health records, and so on. Religious organizations, on the other hand, must track members and account for donations. The federal government (certainly the largest not-for-profit organization) must value various unique assets that are not traded in a public market. How much, for instance, is the Lincoln Memorial or Interstate 95 worth, and how would you determine the annual depreciation for these assets?
In general, it is the lack of a profit goal that most influences the special AIS needs of not-for-profit organizations. Accounting standards, such as the Financial Accounting
Standards Board’s Statement No. 117, Financial Statements of Not-for-Profit Organizations, now require the financial statements to more closely resemble those of profit-seeking entities. However, the internal reporting systems of not-for-profit organizations focus on funds, rather than income. Fund accounting systems show the resources available for carrying out an organization’s objectives. Funds may be restricted for special purposes
(e.g., funds donated to a university for student scholarships) or available for general use. To reconcile the internal and external accounting systems, an AIS of a not-for-profit institution must be able to reconcile between these two different reporting structures.
Although the effectiveness of not-for-profit organizations cannot be evaluated using profit measures, some mechanism for performance evaluation is still desirable. A frequently used mechanism is a budgetary AIS. By comparing actual performance against planned activity, the managers in not-for-profit entities can determine how well they met their goals. Many not-for-profit entities (especially governmental organizations) employ formal long-range budgetary techniques. These budgets include projections of future activity that may serve as performance measures when compared with actual data. One difficulty often encountered in not-for-profit budgetary systems is the lack of a monetary measure of performance output. Consequently, managers must often use process measures (i.e., nonmonetary measures) to measure performance. In a police department, for example, the process measures might be number of arrests, number of homicides, or burglary rates.
Public universities might use the number of students graduating each academic year or retention rates.
A good short-range budgetary planning and controlling system is typically more important to a not-for-profit entity than to a profit-oriented company. The reason is the fixed, rather than flexible, nature of these organizations’ annual budgets. In a not-forprofit organization, budgetary revisions are difficult, if not impossible, to carry out once the budget year begins. For example, at publicly financed state universities, biannual state legislators approve annual operating budgets years in advance, which cannot be changed in off years. Thus, in those not-for-profit organizations subject to fixed or static budgets, good short-range planning is necessary to obtain accurate budget projections for the coming year.

Health Care Organizations
The dollars spent on health care have made this vertical market segment the target of much controversy and concern as the United States struggles to contain health care costs.
As a result, health care reform remains a very important political issue. Interestingly, the
AISs associated with health care are a large part of the controversy. Paperwork has been a

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• Patient Census
Patient Control
• Patient Registration A - D - T
Subsystem

Materials
Management
Subsystem

MHS
(Mini-based
hospital system)

Patient
Accounting
Subsystem





• Inventory Control
• Fixed Assets
• Preventative Maintenance

Patient Account Management
Patient and Insurance Billing
Accounts Receivable
Revenue Control

General
Accounting
Subsystem





Payroll and Personnel
Accounts Payable
General Ledger
Responsibility Reporting

FIGURE 8-14 Mini-based hospital system.

bottleneck in delivering efficient health care, and it is also an important cost. Figure 8-14 shows examples of the many subsystems in a health care organization’s AIS.
Health care entities share many characteristics with professional service organizations and not-for-profit institutions. Like these entities, health care organizations do not provide tangible goods to their customers (except for drugs). In addition, health care organizations also count professional staff as their most important asset resource. Some health care organizations are public and operate on a not-for-profit basis. Finally, output is exceptionally difficult to measure for this industry. For example, a patient may get well due to the quality of health care received, or the patient may simply get well due to his or her body’s ability to overcome an illness. On the other hand, some patients die despite excellent health care and heroic measures.
The special accounting information needs of health care organizations primarily relate to third-party billing. Health care organizations usually do not bill their customers directly for services received. Rather, they bill insurance companies or government agencies who in turn reimburse these service providers. Typically, bills to third-party payers (insurance companies) use standardized codes for both the medical diagnosis and the procedures performed by medical personnel. Although standardized codes promote efficiency in processing information, coding can still be difficult. For example, sometimes a diagnosis is hard to pinpoint, and medical personnel often do procedures for multiple purposes.
Reimbursement from an insurance company depends on the codes used. In addition, one plan may cover a particular procedure, and another may not. Because doctors often have discretion in making a diagnosis or prescribing a procedure, the accounting staff needs to

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understand the nuances of the codes and general classifications. Errors in coding can be costly, and not just in terms of the processing costs associated with them. Errors can lead to a patient’s inability to obtain coverage for charges and also potentially be viewed as fraud by insurance carriers.
Payment policies and filing forms may vary among third-party insurers. Government insurance (Medicare and Medicaid) presents another problem in terms of claim forms. These health care programs are state administered and each state has special filing requirements.
The several hundred medical insurance carriers in the United States all use the same coding base. However, clerical personnel and AISs do not uniformly apply these codes.
As previously mentioned, special AIS needs for the health care industry relate mostly to third-party billing, but other features of the industry also require special processing.
Health care AISs generally need to maintain patient information. Hospitals, doctors’ offices, and nursing homes all need systems to efficiently schedule patients. Home health care services need to keep track of travel costs for employees. Information needs may be unique to very specific industry segments. Physical therapy offices, chiropractic practices, ophthalmologists, optometrists, and dental offices each have some very special information needs. For example, physical therapy offices are different from other medical offices in that a patient may spend an hour in therapy on many different kinds of equipment. An AIS might charge differently for 10 minutes spent in the whirlpool versus 10 minutes on exercise equipment. The following case describes one specialized health care software program.

Case-in-Point 8.8 Chiropractic software programs help chiropractors with many of their business processes. For example, Advantage Software includes scheduling, medical records management, accounting, insurance claims, and other features that are desirable for this industry. The software tracks patient histories, treatments, payments, appointments, and claims.9 BUSINESS PROCESS REENGINEERING
Business process reengineering (BPR) is about redesigning business processes that are no longer efficient or effective. BPR is a continuous process that involves the analysis of an existing process to find areas for improvement (Figure 8-15). As an example, consider an order process that begins with inquiries from a customer about the products available for sale and ends when the customer pays cash to complete a sale. In many organizations, several individuals handle the order process. Each person has responsibility for a particular function: a receptionist or secretary may handle inquiries, a salesperson follows up on product inquiries, warehouse personnel assume responsibility for filling the order, an accounts receivable clerk bills the customer, and so on. This division of responsibility can make it difficult for some organizations to fill customer orders quickly. The result: dissatisfied customers. Through BPR, inefficient processes such as the one described above are identified and then either improved or replaced with a new process.
Reengineering the order process may result in an integration of functional activities so that one specified individual handles customers from start to finish. This redesign means a customer knows who to talk to when an order is late and the customer is not passed
9

http://www.advantagesoftware.com/chiropractic.html

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Identify
Business
Processes

Test
Processes

Document
Business
Processes

Create
New
Processes
Improve
and Update
Processes

FIGURE 8-15 The business process reengineering cycle. around from one person to another when problems occur. As we discussed earlier in this chapter, this might be an opportunity for the firm to evaluate the possibility of value stream management.

Case-in-Point 8.9 Approving an insurance application at Mutual Benefit Life previously included 30 steps performed by 19 people in 5 departments. Because paperwork moved among so many workers, an approval took from 5 to 25 days. When the insurance company reengineered its system, it abolished existing job descriptions and departmental boundaries.
In their place, the company created the position of ‘‘case manager’’ and provided each manager with the authority to perform all application approval tasks. Because every case manager is in charge of the entire process associated with approving applications, files are not passed around. The results have been fewer errors, decreased costs, and a significantly reduced turnaround time for approval. A new application can now be processed in approximately
4 hours, with an average approval turnaround time of 2 to 5 days.

Why Reengineering Sometimes Fails
Despite the best efforts of managers, some BPR initiatives fail. There are several reasons for these failures, including unrealistic expectations, employee resistance, and lack of top management support. Some organizations that contract with consultants for BPR services expect significant improvements in their products and services and expect significantly lower costs. Successful BPR projects can result in increased profit and more satisfied customers, but often not to the extent envisioned. Employees frequently dread hearing the term ‘‘BPR’’ because it has become synonymous with ‘‘downsizing.’’ It is often a challenge to get employees to embrace change, especially change that may make what they do more difficult or potentially unnecessary.
While employee resistance is often fatal to BPR efforts, management support can help overcome some of the obstacles. BPR needs champions in top management. Successful
BPR efforts also need top managers who are good communicators and are willing to give employees both good and bad news. Managers who try to mask the downside of change are likely to run into difficulty. Finally, managers should consider the professional help of change management consultants to facilitate this complex process and overcome potential negative reactions.

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AIS AT WORK
Reengineering Health Care Systems10
Imagine if you still went to the grocery store and the clerk at the register had to manually enter the price of every item you purchased. Imagine if airlines still used only paper tickets—the ones with the carbon paper on the back of each flight segment. Imagine . . . well, you get the point. But, isn’t that still the way business is accomplished at many doctors’ offices? At almost every visit, you’re handed a clipboard with a form (or several forms) and must fill out the exact same information you did the last time you came for an appointment! Estimates suggest that fewer than 25% of all hospitals and health care providers in the United States use electronic medical records or digitized clinical systems.
Even fewer physician practices use such technology.
The U.S. government plans to spend approximately $20 billion to support the expansion of medical record systems. The purpose is to give your doctors and the administrators of hospitals more information. Improving the collection, organization, accuracy, and accessibility of information should lead to improved health care and reduced costs.
Imagine, for example, that your personal physician has prescribed a medication that cannot be taken with many other common medications because of dangerous interactions.
If you are admitted to the emergency room as a result of an accident, high-quality medical records will prevent emergency room doctors from giving you medication that will interact with your current prescription. One study estimated that over 100,000 people in the United
States die each year because of preventable medical errors that digital medical records can help eliminate. For example, if a particular drug is pulled off the market, a doctor could quickly and easily identify the patients who need to be notified. These are very tangible benefits that result from reengineering medical records!

SUMMARY
This chapter discusses three additional business processes: resource management, production, and financing.
The resource management process includes two areas of interest: human resource management and fixed asset management. Human resource management encompasses both the personnel activities in an organization and the payroll events.
The production process includes the events related to converting raw materials into finished goods inventories.
The concept of lean manufacturing is a commitment to eliminate waste throughout the organization
(not just in production).
A company that follows lean manufacturing concepts must identify value from the perspective of their customers, organize production (and data collection) in value streams, empower employees to make decisions, and then continually pursue excellence in all areas of the organization.
To support lean manufacturing concepts, the firm must also adopt lean accounting concepts, which means measuring and evaluating results by value stream management rather than by traditional departments.
10

MacKinnon, W., and M. Wasserman. 2009. Implementing electronic medical record systems. IT Professional
11(6): 50–53.

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The financing process overlaps all the other processes since it is concerned with the acquisition and use of funds needed for operations.
The financing process also includes investing, borrowing, and stock-selling activities.
Cash management is an important part of the financing process. Sound cash management requires companies to constantly monitor cash balances, investing any excess and covering temporary shortfalls with bank loans.
There are many other business processes unique to specific industries. Each industry, or vertical market segment with specialized processes, has associated custom AIS needs.
Current technology, combined with management scrutiny of business processes, provides opportunities to reengineer business processes in ways that help organizations achieve their objectives.
Business process reengineering (BPR) is the practice of examining business processes and redesigning them from scratch.
Many companies today are engaged in BPR as a way to improve customer service and satisfaction, increase profitability, and decrease costs.

KEY TERMS YOU SHOULD KNOW business process reengineering (BPR) change management consultants cost accounting subsystems electronic funds transfer (EFT) enterprise asset management (EAM) systems financial planning model financing process fixed asset management (FAM) human resource (HR) management job costing information systems just-in-time (JIT) inventory

lean accounting lean production/manufacturing lock-box systems non-value-added waste payroll processing information system process costing information systems production process third-party billing time and billing information systems value stream management vertical markets

TEST YOURSELF
Q8-1. All of the following activities are common to the Human Resource Management function except: a. Hiring, training, and employing workers
b. Reporting on payroll deductions
c. Maintaining employee earnings records
d. Certified financial planning for employees
Q8-2. Which of the following outputs (reports) is common to all of the processes described in this chapter? a. Financial statement information
b. Deduction reports
c. Supplier invoices
d. Budget reports

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Q8-3. What is the objective of the fixed asset management function?
a. To track purchases of fixed assets
b. To manage the purchase, management, valuation, and disposal of an organization’s fixed assets c. To record maintenance and depreciation of fixed assets
d. To keep a current listing of approved vendors
Q8-4. Why do companies use BPM solutions for the fixed asset management function?
a. Decrease machine downtime and maintenance costs
b. Reduce inventory
c. Integrate data and coordinate logistics
d. All of the above
Q8-5. Which of the following automated systems help minimize inventory costs?
a. JIT systems
b. ABC systems
c. Job order costing systems
d. Process costing systems
Q8-6. Automated point-of-sale technology offers many advantages to retailers as well as customers.
Which of the following is the most commonly used POS technology?
a. Cell phones
b. RFID
c. Bar code scanners
d. None of these
Q8-7. The concept of lean production or manufacturing includes all of the following, except:
a. Commitment to eliminate ‘‘waste’’ throughout the manufacturing process
b. Eliminate or reduce non-value-added waste
c. Improve overall customer value and the profitability of products or services
d. There are 12 categories of waste that companies hope to reduce or eliminate
Q8-8. Lean accounting is:
a. An AIS that is generally considered low cost (i.e., an entry-level system)
b. Designed to support traditional financial performance measures
c. New performance measures that support decision making by managers and operational improvement leaders
d. None of these
Q8-9. Business process reengineering:
a. Is an incremental approach to redesigning business processes
b. Involves redesigning business processes from scratch
c. Is rarely successful in cutting an organization’s costs
d. Is usually welcomed by an organization’s employees

DISCUSSION QUESTIONS
8-1. The resource management process includes events associated with both personnel and payroll functions. Describe four data items that could be used by both functions. Describe two data

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items for each function that would not necessarily be needed by the other (e.g., spouse name for personnel but not payroll).
8-2. Why are accounting transactions associated with payroll processing so repetitive in nature?
Why do some companies choose to have payroll processed by external service companies rather than do it themselves?
8-3. In this chapter, we discussed many data inputs to an organization’s production process. What are the specific data items to input to a system when adding a new raw materials inventory item? What specific data items need to be input when a worker records time spent on the production line?
8-4. What nonfinancial information would be important for an AIS to capture about a manufacturing firm’s production process?
8-5. What are the basic concepts of lean manufacturing? What concepts are the root of lean production and lean manufacturing?
8-6. Find an example of a firm that is using lean manufacturing concepts. Has the company realized any improvements? What are they?
8-7. Can you find an example of a firm that is using lean production concepts that are supported by lean accounting? How are they doing?
8-8. Are the inputs and outputs of a production process likely to be different for a home builder than for a cement company? How?
8-9. There are many vertical market industries with special accounting information needs apart from the industries discussed in this chapter. Identify three additional vertical market industries.
What are the unique characteristics of these industries that affect their AISs?
8-10. Discuss specific steps you would take as a manager to ensure that a business process reengineering effort is successful.

PROBLEMS
8-11. Choose an industry described in this chapter and find out what vertical market accounting software is available for that industry. You may use resources such as the library, trade associations, interviews with organizations within the industry, or interviews with software consultants. 8-12. Literally thousands of business process management (BPM) solutions are available to help managers accomplish tasks in a more effective, efficient manner. Assume that you work in a payroll processing function and your supervisor asked you to select a BPM solution for your company. Which BPM software would you select and why? Identify the vendor, the name of the software package, and several of the features that you thought would be most beneficial to your company.
8-13. Now, assume that you work in the internal audit function at a company that is considering a software package to help automate the process of complying with the requirements of the
Sarbanes-Oxley Act of 2002. Which BPM software would you select and why? Identify the vendor, the name of the software package, and several of the features that you thought would be most beneficial to your company.
8-14. Assume that you started your own law practice 10 years ago, specializing in estate planning, and you currently employ five attorneys, two legal assistants, one legal secretary, and a bookkeeper/receptionist. The firm has always used a manual accounting system, which includes procedures for time and billing. How could an automated time and billing system help your firm? Search the Internet for a specific technology to automatically capture a professional employee’s time spent on a particular client engagement. What is the name of the software package and what are the primary features of this BPM software?

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CASE ANALYSES
8-15. Public Accounting Firm (Modeling Human Resource Management)
Draw an E-R diagram using the REA approach for the recruiting process at a typical public accounting firm. Assume that there are three main events: hold recruiting events, hire new employees, train employees.

8-16. Hammaker Manufacturing I (AIS for New Manufacturing Firm)
Dick Hammaker has been fascinated with Corvette cars, especially convertibles, since he was a teenager. Dick grew up in Michigan and worked part-time through his high school and college years at a car manufacturer, so he knew the business well. Not surprisingly, when he graduated from college he bought his first car, a used Corvette convertible, and became a member of the local Corvette Club of America.
As an accounting graduate, Hammaker was hired by one of the large automobile manufacturers in Michigan and was selected for the ‘‘fast-track’’ management training program. After 5 years, Hammaker decided to leave Michigan and start a specialty parts manufacturing company strictly for Corvettes. Before he even left Michigan, a potential customer contacted him—the repair shop was replacing the black convertible top on a
1967 Corvette that the owner was going to sell for $76,995!
Hammaker decided to locate his company, Hammaker Manufacturing Co. (HMC), in
Northern Virginia since this is the site of the oldest Corvette Club of America. Dick knows he will need the appropriate technology to support his company, so he decided to focus on this aspect of his company prior to starting any production activities. His first action was to hire a CFO (Denise Charbonet) who could work with Lloyd Rowland (a software consultant) to determine the inputs and outputs needed for an AIS for the new company.
Of particular concern is the data the AIS will need to collect regarding inventories. As Dick,
Denise, and Lloyd know, inventory management will be a key factor for the success of
HMC since Corvette cars are unique—parts are needed for cars from the 1960s!
Dick believes that an AIS will give him the data and information needed for good decision making—especially to manage inventory investments. HMC’s customers are primarily Corvette specialty repair shops, and they typically demand parts only as needed but exactly when needed. Inventory can be very costly for HMC if they must stockpile many specialty parts to be able to quickly meet customer orders.
Hammaker knows from his work experience in Michigan that there are a number of costs associated with holding inventories (warehousing, obsolescence, and insurance costs)—money that could be put to better use elsewhere. Dick knows that he will need to buy raw materials from suppliers and hold raw materials inventories plus make-to-stock parts, or customers will find other parts suppliers.
Denise and Lloyd meet to discuss the issues. They decide that they need to do two things. First, they need to determine what AIS software package would be best for the new company, one that is particularly focused on inventory control (or one with an inventory control module that would be well-suited for HMC). Second, they need to decide what data elements they need to capture about each inventory item to optimize inventory management and control. Denise notes that while some inventory descriptors are easy to determine, such as item number, description, and cost, others are more difficult. For

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instance, inventory on hand and inventory available for sale could be two different data items since some of the inventory on hand might be committed but not yet shipped.

Requirements
1. Explain how an AIS could help HMC optimize inventory management and control.
2. What data elements should HMC include in the new AIS to describe each inventory item? 8-17. Hammaker Manufacturing II (Business Process Reengineering or Outsourcing)
Implementation of a new AIS went smoothly, for the most part. It is 15 years later, and now HMC is interested in mapping a variety of their business processes to determine whether improvements can be made and whether business process reengineering should be considered. Hammaker asked Denise to work with the consulting firm analysts to determine the feasibility of these two options and also to consider the possibility of outsourcing. Denise does not know much about outsourcing and she is not sure which process (or processes) Dick might want to outsource.
Denise discovers that a number of developing countries have the capacity and the labor to make the parts that HMC is currently producing and at much cheaper prices.
Further, Denise discovers that many companies are outsourcing and offshoring a number of processes that used to be accomplished by company employees. Denise makes a note to herself to check the number of employees in each of the following departments:
HR, computer support, accounting, and janitorial services. She also decides to query the
AIS to determine what performance measures are available to assess the efficiency and effectiveness of each of these departments. Denise places a call to Lloyd Rowland to discuss this issue with him.
HMC is not unionized, but Denise ponders the legal and social issues associated with outsourcing jobs, since many of the 365 employees at Hammaker Manufacturing have been with the company for well over a decade.

Requirements
1. Identify tools that would help Denise and Rowland map HMC’s business processes.
Which processes do you think they should work on first? Why those processes?
2. Identify at least six reasons why companies choose to outsource a business process.
Which of these reasons might Dick use to make his decision to outsource or to attempt
BPR?
3. Is producing automotive parts a ‘‘core’’ business process for HMC? Explain.
4. Do companies ever outsource ‘‘core’’ business processes? Search the Internet to see if you can find an example of a company or an industry that outsources core business processes. What are they? Why are they doing this?
5. What social or legal issues might Denise consider? Be specific and explain why these issues might be important to HMC.

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6. What would you recommend if you were one of the analysts at the consulting firm?
Explain.

8-18. Hammaker Manufacturing III (Lean Production/Lean Accounting)
HMC continues to be profitable. Although Denise and Lloyd Rowland mapped several business processes 5 years ago to determine whether HMC should work on process improvements or consider business process reengineering, they never really finished that effort nor did HMC decide whether to outsource any processes. Hammaker still thinks that HMC could be more efficient and more profitable, but he’s not really sure how the company can achieve this next level of excellence.
About a year ago, Denise started reading books and trade journals on the topics of business strategy, lean production, and lean manufacturing. So when Dick approached her regarding his intent to improve the company, she began to share with him some of the insights she had gained over the past year on business strategy and how their current
AIS might not be capturing the most useful metrics for optimal decision making. Denise mentioned that the next Lean Accounting Summit will be in September and suggested that she and her three financial analysts go to the 4-day conference to gain a better understanding of lean production and accounting concepts to determine how they might be able to better support HMC and Dick’s goal of improving the company.

Requirements
1. If Dick decided to adopt the business strategy of lean production, what changes might he and his managers consider?
2. Explain how HMC might benefit from implementing lean production/manufacturing concepts. 3. Why would it be important for Denise and her financial analysts to attend the Lean
Accounting Summit? What benefits would you expect them to acquire from this conference that would be useful at HMC?

READINGS AND OTHER RESOURCES
Brosnahan, J. 2008. Unleash the power of lean accounting. Journal of Accountancy 206(1): 60–66.
Johnson, D., J. Sun, and M. Johnson. 2007. Integrating multiple manufacturing initiatives: Challenge for automotive suppliers. Measuring Business Excellence 11(3): 41–56.
Kennedy, F., L. Owens-Jackson, L. Burney, and M. Schoon. 2007. How do your measurements stack up to lean? Strategic Finance 88(11): 32–41.
Maskell, B., and F. Kennedy. 2007. Why do we need lean accounting and how does it work? The
Journal of Corporate Accounting & Finance (March/April): 59–73.
Tracy, D., and J. Knight. 2008. Lean operations management: Identifying and bridging the gap between theory and practice. Journal of American Academy of Business (March): 8–14.

CHAPTER 8 / Accounting Information Systems and Business Processes: Part II

Basics of Activity-Based Costing: http://www.youtube.com/watch?v=SaJ82WEpuIw Business Process Reengineering (five videos): http://www.ovguide.com/business-process-reengineering9202a8c04000641f8000000000585bad Change Management Example: http://www.youtube.com/watch?v=bG5na7JD7rE ANSWERS TO TEST YOURSELF
1. d

2. a

3. b

4. d

5. a

6. c

7. d

8. c

9. b

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INTERNAL CONTROL SYSTEMS AND COMPUTER
CRIME, ETHICS, AND PRIVACY

CHAPTER 9
Introduction to Internal Control Systems
CHAPTER 10
Computer Controls for Organizations and Accounting Information Systems
CHAPTER 11
Computer Crime, Fraud, Ethics, and Privacy

Managers have many responsibilities within an organization and one of the most important is to safeguard the assets of the firm. This is no small task. Although people normally think first about safeguarding cash and other physical assets, think about the huge electronic data repositories of most firms. This might well be the most valuable asset the firm possesses and protecting this sensitive information, both proprietary and client data, is critical.
Chapter 9 introduces the subject of internal control using the 1992 COSO Report which identifies the five components of an internal control system. Next we offer updates and additional guidance that COSO has published since the 1992 Report. We also expand upon the concept of enterprise-wide risk management, which must be considered first to determine what controls are necessary to mitigate the risks that are identified.
Chapter 10 examines various types of computer controls that are commonly used within
AISs: enterprise level controls, general controls for IT, and application controls for transaction processing. This chapter also includes a discussion of business continuity planning.
In light of the fact that natural and man-made disasters are becoming more frequent, firms and organizations of all sizes must now become more intentional about developing and testing a disaster recovery plan in support of general controls.
Chapter 11 discusses the important topic of computer crime and fraud. This is a growing problem that requires the attention of management at all levels in an organization. In this chapter, we include examples of real world cases of computer crime and also describe procedures that organizations can implement to protect their assets. For example, to prevent and detect fraudulent acts within the environment of computerized AISs, firms can perform audit procedures, train employees to recognize symptoms of fraud, and implement stronger security measures.

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Chapter 9
Introduction to Internal Control
Systems

INTRODUCTION
Internal Control Defined

AIS AT WORK—USING THE COMPANY CREDIT
CARD AS A NEST EGG?

Internal Control System

SUMMARY

1992 COSO REPORT

KEY TERMS YOU SHOULD KNOW

Control Environment

TEST YOURSELF

Risk Assessment
Control Activities

DISCUSSION QUESTIONS

Information and Communication

PROBLEMS

Monitoring

CASE ANALYSES

Status of 1992 COSO Report

Gayton Menswear (Risk Assessment and Control
Procedures)

UPDATES ON RISK ASSESSMENT
2004 Enterprise Risk Management Framework
COSO’s 2010 Report on ERM

Cuts-n-Curves Athletic Club (Analyzing Internal
Controls)

EXAMPLES OF CONTROL ACTIVITIES

Emerson Department Store (Control Suggestions to
Strengthen a Payroll System)

Good Audit Trail

READINGS AND OTHER RESOURCES

Sound Personnel Policies and Procedures

ANSWERS TO TEST YOURSELF

Separation of Duties
Physical Protection of Assets
Reviews of Operating Performance

UPDATE ON MONITORING
Guidance on Monitoring Internal Control Systems
Reviews of Operating Performance versus Monitoring

2011 COBIT, VERSION 5
TYPES OF CONTROLS
Preventive Controls
Detective Controls
Corrective Controls

EVALUATING CONTROLS
Requirements of the Sarbanes-Oxley Act
Cost-Benefit Analysis

After reading this chapter, you will:
1. Be familiar with the primary control frameworks commonly used in organizations.
2. Be familiar with an internal control system and the components of this system.
3. Understand the importance of enterprise-wide risk assessment and the impact this has on internal controls.
4. Understand the importance of COSO and
COBIT with respect to internal control systems.
5. Be able to identify the differences between preventive, detective, and corrective controls.
6. Understand various methods used to analyze internal control decisions.

A Risk Matrix

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Ultimately, all stakeholders in the company should share the same high-level goal of establishing a strong system of internal controls.
Mueller, R. 2008. Mending broken controls.
Internal Auditor 65(4): 84–85.

INTRODUCTION
Protecting the assets of an organization has always been an important responsibility of management. However, the incredible advancements in IT as well as the pervasive use of IT across organizations of all sizes have dramatically changed how managers establish and monitor internal controls. Indeed, the pervasiveness of IT also has a profound impact on internal and external auditors and how they assess the strength of the internal control environment. Protecting such assets requires organizations to develop and implement an effective internal control system—a system that can also perform other functions such as helping ensure reliable data processing and promoting operational efficiency in an organization. This chapter and the next cover the topic of internal controls—that is, the controls established to protect the assets of an organization. This chapter defines internal control, corporate governance, and IT governance within organizations. We also identify the components of an internal control system, the importance of enterprise risk management as it relates to internal controls, as well as the different types of internal controls. Finally, we discuss methods used in organizations to evaluate controls and to determine which control procedures are cost-effective.

Internal Control Defined
Internal control describes the policies, plans, and procedures implemented by the management of an organization to protect its assets, to ensure accuracy and completeness of its financial information, and to meet its business objectives. Usually the people involved in this effort are the entity’s board of directors, the management, and other key personnel in the firm. The reason this is important is that these individuals want reasonable assurance that the goals and objectives of the organization can be achieved
(i.e., effectiveness and efficiency of operations, reliability of financial reporting, protection of assets, and compliance with applicable laws and regulations).1 Figure 9-1 identifies key laws, professional guidance, and reports that focus on internal controls.
In 2001, the AICPA issued Statement on Auditing Standards (SAS) No. 94, ‘‘The Effect of Information Technology on the Auditor’s Consideration of Internal Control in a Financial
Statement Audit.’’ This SAS cautions external auditors that the way firms use IT might impact any of the five internal control components, which we discuss later in this chapter.
That is, auditors must realize that internal controls are both manual and automated, and therefore, auditors might need to adopt new testing strategies to obtain sufficient evidence that an organization’s controls are effective. Because of the complexity of IT environments, auditors will most likely need to use computer-assisted auditing techniques (CAATs) to
1

http://www.coso.org

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Date

Act/Report

Significant Provisions Pertaining to Internal Controls

1977

Foreign Corrupt
Practices Act

• Requires publicly owned companies to implement internal control systems; Only applies to publicly owned corporations registered under
Section 12 of the 1934 Securities and Exchange Act

1977

Treadway
Commission
Report

1992

1992

2001

2002

2004

2005

2006

2007
2009
2010

• Recommends development of common definition for internal control, guidance for judging effectiveness of internal control, methods to improve internal controls
• Title: Internal Control—Integrated Framework; Defines internal control
Committee of and describes its components; Presents criteria to evaluate internal
Sponsoring
control systems; Provides guidance for public reporting on internal
Organizations
controls; Offers materials to evaluate internal control system
(COSO) Report
• A framework for IT management; Provides managers, auditors, and
COBIT—Control
IT users a set of generally accepted measures, indicators, processes,
Objectives for best practices to maximize benefits of IT and develop appropriate IT
Business and IT governance and control
• Guidance to auditors about information technology on internal controls;
SAS No. 94
Describes benefits/risks of IT to internal controls and how IT affects the components of internal controls
• Requires publicly traded companies to issue ‘‘internal control report’’
Sarbanes-Oxley
that states management is responsible for establishing and maintaining
Act, Section 404 adequate internal control structure; Management must annually assess effectiveness of internal controls; Independent auditor for firm must attest to/report on managements’ assessment
Committee of Spon- • Focuses on enterprise risk management; Includes five components of soring Organizations COSO 1992 Report; Adds three components: objective setting, event identification, risk response
(COSO) Report
• Includes 34 high-level objectives that cover 215 control objectives cateCOBIT, Ver. 4.0 gorized in 4 domains: Plan and Organize, Acquire and Implement, Deliver and Support, and Monitor and Evaluate
• Establishes standards/provides guidance to auditors of nonpublic entiSAS No. 112 ties on communicating matters related to entity’s internal control over financial reporting observed during a financial statement audit; auditor must have working knowledge of COSO framework
• Better definitions of core concepts; Improved control objectives; AppliCOBIT, Ver. 4.1 cation controls reworked; Business and IT goals improved
COSO Guidance on • Identifies three broad principles for monitoring: establish baseline, design and execute procedures, assess and report results
Monitoring
• Survey of 460 senior executives: state of ERM relatively immature; noted
Report on ERM dissatisfaction with oversight of ERM; limited processes for identifying
(Commissioned
and tracking risks; 2004 COSO Report used by most organizations by COSO)

FIGURE 9-1 Background information on internal controls.

test the automated controls in an organization. We discuss these techniques in depth in
Chapter 12.
An important piece of legislation with respect to internal controls is the
Sarbanes-Oxley Act of 2002. One key provision of this law is Section 404, which reaffirms that management is responsible for establishing and maintaining an adequate internal control structure. At the end of each fiscal year, corporate officers must attest to the effectiveness and completeness of the internal control structure, thus making them personally liable for this structure within the firm. We cover the Sarbanes-Oxley Act in more depth in Chapter 12.

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Internal Control System
An internal control system consists of the various methods and measures designed into and implemented within an organization to achieve the following four objectives: (1) safeguard assets, (2) check the accuracy and reliability of accounting data, (3) promote operational efficiency, and (4) enforce prescribed managerial policies. An organization that achieves these four objectives is typically one with good corporate governance.
This means managing an organization in a fair, transparent, and accountable manner to protect the interests of all the stakeholder groups.2 The 1992 COSO Framework is widely used by managers to organize and evaluate their corporate governance structure. This framework was developed to improve the quality of financial reporting through business ethics, effective internal controls, and corporate governance.3

1992 COSO REPORT
The 1992 COSO Report is important because it established a common definition of internal control for assessing control systems, as well as determined how to improve controls. According to the report, controls can serve many important purposes, and for this reason, many businesses look at internal control systems as a solution to a variety of potential problems (such as dealing with rapidly changing economic and competitive environments, as well as shifting customer demands and priorities). According to the
COSO report, an internal control system should consist of these five components: (1) the control environment, (2) risk assessment, (3) control activities, (4) information and communication, and (5) monitoring. We discuss each one below.

Control Environment
The control environment establishes the ‘‘tone at the top’’ of a company and influences the control awareness of the company’s employees. It is the foundation for all the other internal control components and provides discipline and structure. There are a number of factors that are included in the control environment. First, and usually the most important, is top management’s oversight, integrity, and ethical principles that guide the organization.
This includes the attention and direction provided by the board of directors, as well as top management’s philosophy and operating style. Equally important are the policies and procedures that management develops to assign authority and responsibility across the organization, as well as the policies for developing its employees.
The management of most large and medium-size enterprises have separate internal audit departments, whose internal auditors are responsible for operational reviews within the organization. Small enterprises usually cannot afford their own internal audit departments, but they can hire outside consultants or ask managers to test compliance with operating policies. Regular reviews are important to organizations of all sizes to ensure that top management is fully informed regarding operational effectiveness and efficiency.

Case-in-Point 9.1 A commonly used source of information on reported cases of material weaknesses for publicly traded companies is Audit Analytics. One of the categories in this
2
3

http://www.us.kpmg.com/microsite/Attachments/corp_govern_newstrat.pdf http://www.coso.org CHAPTER 9 / Introduction to Internal Control Systems

277

database is ‘‘senior management, tone, or reliability.’’ A recent study of this particular category shows that audit firms issued adverse internal control opinions to 93 public companies because of weaknesses in tone at the top.4

Risk Assessment
It is not possible or even desirable to install controls for every possible risk or threat. The purpose of risk assessment is to identify organizational risks, analyze their potential in terms of costs and likelihood of occurrence, and implement only those controls whose projected benefits outweigh their costs. A general rule is the more liquid an asset, the greater the risk of its misappropriation. To compensate for this increased risk, stronger controls are required. The COSO report recommends the use of a cost-benefit analysis
(discussed and illustrated later in this chapter) to determine whether the cost to implement a specific control procedure is beneficial enough to spend the money.

Control Activities
These are the policies and procedures that the management of a company develops to help protect all of the different assets of the firm, based on a careful risk assessment.
Control activities include a wide variety of activities throughout the firm and are typically a combination of manual and automated controls. Some examples of these activities are approvals, authorizations, verifications, reconciliations, reviews of operating performance, and segregation of duties. Through properly designed and implemented control activities, management will have more confidence that assets are being safeguarded and that the accounting data processed by the accounting system are reliable.

Information and Communication
Managers must inform employees about their roles and responsibilities pertaining to internal control. This might include giving them documents such as policies and procedures manuals (discussed later) or posting memoranda on the company’s intranet. This could also include training sessions for entry-level personnel and then annual refresher training for continuing employees. Regardless of the method, all employees need to understand how important their work is, how it relates to the work of other employees in the firm, and how that relates to strong internal controls. It is equally important that management understand the importance of keeping good working relationships between all layers of management so that employees feel safe communicating any possible problems they may find. When this is the case, employees at all levels can actually enhance the effectiveness of good internal controls. Also, they will be much more likely to point out any problems they may detect, and corrective action can be initiated.

Case-in-Point 9.2 Whistle-blowing systems help employees feel safe communicating problems or suspected wrongdoing to management. However, some employees struggle with reporting problems because they are not sure how to report what they know or fear possible consequences of doing so. One solution to this problem is to outsource the whistle-blower system. A recent survey of Chief Audit Executives reports that 60% of the organizations in the survey had outsourced their reporting systems.5
4
5

Hermanson, D., D. Ivancevich, and S. Ivancevich. 2008. Tone at the top. Internal Auditor (November): 39–45.
Baker, N. 2008. See no evil, hear no evil, speak no evil. Internal Auditor (April): 39– 43.

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Monitoring
The evaluation of internal controls should be an ongoing process. Managers at various levels in the organization must evaluate the design and operation of controls and then initiate corrective action when specific controls are not functioning properly. This could include daily observations and scrutiny, or management might prefer regularly scheduled evaluations. The scope and frequency of evaluations depend, to a large extent, on management’s assessment of the risks the firm faces.

Status of 1992 COSO Report
In recognition of the increasingly complex business environment, COSO commissioned
PwC to update the 1992 COSO Framework. The project is not intended to change how internal controls are designed, assessed, or managed. Instead, the intent of the update effort is to provide more comprehensive and relevant conceptual guidance and practical examples. For example, COSO said they need to refine certain concepts and guidance in the 1992 framework to reflect the evolution of the operating environment as well as the changed expectations of regulators and other stakeholders. COSO also intends to improve guidance on operations and compliance beyond financial reporting. The revised framework will most likely be published in 2012.6

UPDATES ON RISK ASSESSMENT
2004 Enterprise Risk Management Framework
COSO determined that additional guidance should be published to help organizations do a more comprehensive assessment of risk. The result was the 2004 COSO Enterprise Risk
Management—Integrated Framework, which focuses on enterprise risk management
(ERM) and builds upon the 1992 COSO Internal Control—Integrated Framework (ICIF).
The ERM Framework (Figure 9-2) includes the five components of ICIF (control environment, risk assessment, control activities, information and communication, and monitoring) and adds three additional components: objective setting, event identification, and risk response. Objective Setting. ERM offers management a process for setting objectives for the firm—that is, the purposes or goals the firm hopes to achieve. ERM helps an organization determine if the objectives are aligned with the organizational strategy and that goals are consistent with the level of risk the organization is willing to take. An enterprise’s objectives are viewed from four perspectives: (1) strategic: the high-level goals and the mission of the firm; (2) operations: the day-to-day efficiency, performance, and profitability of the firm;
(3) reporting: the internal and external reporting of the firm; and (4) compliance: with laws and regulations.
6

http://www.complianceweek.com/coso-commissions-update-for-internal-control-framework/article/192017/

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E
C

G
O
M
P

LI
A

N

N
E
R

C

O
R
TI
P

R
E
O
P

S

TR

A
TE

A
TI
O
N

G
IC

S

RISK CUBE

Internal Environment

Event Identification
Risk Assessment
Risk Response
Control Activities

SUBSIDIARY
BUSINESS UNIT
DIVISION
ENTITY-LEVEL

Objective Setting

Information & Communication
Monitoring

FIGURE 9-2 2004 COSO Enterprise Risk Management—Integrated Framework. Source: COSO
Enterprise.

Event Identification and Risk Response. Organizations must deal with a variety of uncertainties because many events are beyond management control. Examples include natural disasters, wars, unexpected actions of competitors, and changing conditions in the marketplace. However, it is critical for management to identify these external risks as quickly as possible and then consider internal and external factors regarding each event that might affect its strategy and achievement of objectives. Depending on the type or nature of events, management might be able to group some of them together and begin to detect trends that may help with risk assessment.

Case-in-Point 9.3 The responsibility of the Director of the Arkansas Department of
Finance and Administration (DFA) is to ensure that state agencies operate uniformly and efficiently. To help the Director achieve these DFA objectives, each state agency is required to perform a risk assessment once every 2 years and to complete a ‘‘Risk Assessment and
Control Activities Worksheet.’’ This worksheet (Figure 9-3) helps department managers across the state to think about their operations through a risk assessment lens.7

The objective of risk assessment is to manage and control risk by identifing threats, analyzing the risks, and implementing cost-effective countermeasures to avoid, mitigate, or transfer the risks to a third party (through insurance programs or outsourcing). As they identify and categorize risks, managers will be in a better position to determine the probable effects on the organization. They can then formulate and evaluate possible response options for the organization. In developing options, managers need to consider the level of risk they are willing to assume, as well as the trade-offs between costs and benefits of each choice. A number of computerized risk assessment software tools already exist to help managers with this task.
7

http://www.arkansas.gov/dfa/accounting/acc_ia_risk.html

280
Risks

For each risk, assess the likelihood of the risk occurring. Use probable, reasonably possible, or remote. Alternatively use High, Medium of Low.
For each risk with large or moderate impact and probable (high) or reasonable (medium) likelihood of occurrence, list both the actions to mitigate the risk to an acceptable level and the control activities that help ensure that those actions are carried out properly and in a timely manner. If no action is present to manage the risk and/or no control activity is present, an action plan to address the risk and an associated timeline should be included.

4

5

(5)

FIGURE 9-3 An example of a risk assessment and control activities worksheet. Source: http://www.arkansas.gov/dfa/ accounting/acc_ia_risk.html. For each risk, estimate the potential impact on operations, financial reporting or compliance with laws and regulations, assuming that the risk occurs. Consider both quantitative and qualitative costs. Use Large, Moderate or Small.

3

(4)

Actions to Manage Risks/
Control Activities

List all identified risks to the achievement of each goal and objective. Consider both internal and external risk factors.
For each goal and objective, several different risks can be identified.

(3)

Likelihood

2

(1)

Significance/Impact

List all operations, financial reporting and compliance objectives associated with the activity. Goals should be clearly defined, measurable and attainable.

(2)

Goals & Objectives

Risk Assessment

Date Prepared:

Prepared By:

1

Activity:

Department:

Risk Assessment and Control Activities Worksheet

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Case-in-Point 9.4 Managers need to ask themselves about the possible impact of certain risks—would it be minimal, significant, serious, or catastrophic? RiskPAC is an example of a business risk software system that organizations can use to detect and eliminate vulnerabilities in information systems and data security. CPACS, the company that developed
RiskPAC, defines ‘‘risk assessment’’ as identification of the major risks and threats to which an organization’s reputation, business processes, functions, and assets are exposed. RiskPAC helps organizations determine the possibility that a harmful incident will occur (very likely, possible, probable, or very unlikely).8

COSO’s 2010 Report on ERM9
To better understand the use of, consideration of, or reliance on the COSO ERM Framework,
COSO decided to commission North Carolina State University to conduct a survey in the summer of 2010. The survey, called the Enterprise Risk Management Initiative, targeted individuals who are involved in leading ERM related processes—or individuals who are knowledgeable about those efforts—within their organization. Responses were collected from 460 individuals who answered questions that addressed both risk management practices and perceptions about the strengths and weaknesses of COSO’s ERM Framework.
Several of the key findings are the following:
1. Most believe that the ERM Framework is theoretically sound and clearly describes key elements of a robust ERM process.
2. Almost 65% of respondents were fairly familiar or very familiar with COSO’s ERM
Framework.
3. In over half of the organizations, the Board of Directors had not formally assigned risk oversight responsibilities to one of its subcommittees.
4. The state of ERM appears to be relatively immature.

EXAMPLES OF CONTROL ACTIVITIES
Because each organization’s accounting system is unique, there are no standardized control policies and procedures that will work for every company. This means that each organization designs and implements specific controls based on its particular needs.
However, certain control activities are common to every organization’s internal control system. The ones that we will examine here are (1) a good audit trail, (2) sound personnel policies and practices, (3) separation of duties, (4) physical protection of assets, (5) reviews of operating performance, and (6) timely performance reports. We describe each of these in more detail below.

Good Audit Trail
The basic inputs to an AIS are usually business transactions that it records and measures monetarily. A good audit trail enables auditors to follow the path of the data from the initial
8
9

http://www.cpacsweb.com/riskpac.html (business continuity planning software products). http://www.coso.org/documents/COSOSurveyReportFULL-Web-R6FINALforWEBPOSTING111710.pdf 282

PART FOUR / Internal Control Systems and Computer Crime, Ethics, and Privacy

source documents (for instance, a sales invoice) to the final disposition of the data on a report. In addition, managers and auditors can trace data from transactions on reports (such as expenses on an income statement) back to the source documents. In both instances, an auditor can verify the accuracy of recorded business transactions. Without a good audit trail, errors and irregularities are more likely to happen and not be detected.
To establish its audit trail, a company needs a policies and procedures manual that includes the following items:
• A chart of accounts that describes the purpose of each general ledger account so that employees enter the debits and credits of accounting transactions in the correct accounts. • A complete description of the types of source documents individuals must use to record accounting transactions. Also, include the correct procedures to prepare and approve the data for these documents.
• A comprehensive description of the authority and responsibility assigned to each individual—for example, the person who sets credit limits for customers.

Sound Personnel Policies and Procedures
Employees at every level of a company are a very important part of the company’s system of internal control. This is becoming increasingly obvious as managers downsize and right-size their organizations to streamline operations and cut costs. Consequently, there are fewer employees, and these employees have more responsibility and oversight than in the past.
The obvious result is that the opportunity for misappropriation is greater than before.
In addition, the capabilities of a company’s employees directly affects the quality of the goods and services provided by the company. In general, competent and honest employees are more likely to help create value for an organization. Employees work with organizational assets (e.g., handling cash, producing products, acquiring and issuing inventory, and using equipment). Competent and honest employees, coupled with fair and equitable personnel policies, lead to efficient use of the company’s assets. Most organizations post their personnel policies and procedures on their Web site so that they are easily accessible to all employees at any time.

Case-in-Point 9.5 Employees at the University of Arizona have ready access to a wealth of information regarding the university’s personnel policies by searching the Human Resources
Policy Manual (HRPM). The HRPM is available on the university Web site and includes policies on employment, benefits, compensation, employee relations, training and employee development, and additional university policies (e.g., conflict of interest, code of research ethics, and others).10
In general, little can be done to stop employees who are determined to embarrass, harm, or disrupt an organization. For example, several employees may conspire (collude) to embezzle cash receipts from customers. But, companies can encourage ethical behavior among employees in several ways. First, review the rules and the Code of Conduct. A number of organizations have too many ‘‘picky’’ rules that employees do not understand. To avoid this type of problem, managers should create rules that make a positive contribution to the productivity and effectiveness of a company and then explain the rationale for
10

http://www.hr.arizona.edu/09_rel/clsstaffmanual.php

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1. Specific procedures for hiring and retaining competent employees.
2. Training programs that prepare employees to perform their organizational functions efficiently.
3. Good supervision of the employees as they are working at their jobs on a daily basis.
4. Fair and equitable guidelines for employees’ salary increases and promotions.
5. Rotation of certain key employees in different jobs so that these employees become familiar with various phases of their organization’s system.
6. Vacation requirement that all employees take the time off they have earned.
7. Insurance coverage on those employees who handle assets subject to theft (fidelity bond).
8. Regular reviews of employees’ performances to evaluate whether they are carrying out their functions efficiently and effectively, with corrective action for those employees not performing up to company standards. FIGURE 9-4 Examples of personnel policies that firms might adopt. Source: www.hr
.arizona.edu.

these rules to employees. Secondly, managers should always lead by example. Figure 9-4 identifies some examples of personnel policies that firms might adopt.
All employees should be required to take their earned vacations (personnel policy 6 in Figure 9-4). This is important for two reasons. First, if employees are embezzling assets from an organization, they will not want to take a vacation—someone else will do their jobs, increasing the likelihood of detection. Second, required vacations help employees to rest, enabling them to return refreshed and ready to perform their job functions more efficiently. For employees who handle assets susceptible to theft, such as a company’s cash and inventory of merchandise, it is a good personnel policy (number 7 in Figure 9-4) to obtain some type of insurance coverage on them. Many organizations obtain fidelity bond coverage from an insurance company to reduce the risk of loss caused by employee theft of assets. The insurance company investigates the backgrounds of the employees that an organization wants to have bonded. When an insurance company issues one of these bonds, it assumes liability (up to a specified dollar amount) for the employee named in the bond.

Case-in-Point 9.6 Fidelity bonds are also called employee dishonesty bonds and are intended to cover your company when the unthinkable happens—you have a dishonest employee! For example, if you operate a home cleaning service and have employees in other people’s homes, an employee dishonesty bond will cover your company in case one of your employees steals from your customers.11

Separation of Duties
The purpose of separation of duties is to structure work assignments so that one employee’s work serves as a check on another employee (or employees). When managers design and implement an effective internal control system, they must try to separate certain responsibilities. If possible, managers should assign the following three functions to different employees: authorizing transactions, recording transactions, and maintaining custody of assets.
11

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Authorizing is the decision to approve transactions (e.g., a sales manager authorizing a credit sale to a customer). Recording includes functions such as preparing source documents, maintaining journals and ledgers, preparing reconciliations, and preparing performance reports. Finally, custody of assets can be either direct (such as handling cash or maintaining an inventory storeroom) or indirect, such as receiving customer checks through the mail or writing checks on a company’s bank account. If two of these three functions are the responsibility of the same employee, problems can occur. We describe three real-world cases that demonstrate the importance of separating duties. Immediately following each case is a brief analysis of the problem.

Case-in-Point 9.7 The controller of a Philippine subsidiary confessed to embezzling more than $100,000 by taking advantage of currency conversions. The controller maintained two accounts—one in Philippine pesos to deposit funds collected locally and the other account in
U.S. dollars so he could transfer funds from the Philippine account to the U.S. account. The auditor became suspicious when he noticed that each transfer was rounded to the nearest thousand in pesos and dollars. For example, one day the statements showed an $885,000
(pesos) transfer from the local currency account and a transfer of exactly $20,000 into the U.S. dollar account. Further investigation revealed that the controller was actually withdrawing cash from the peso account, keeping some of the money, and depositing only enough pesos in the U.S. currency account to show a transaction of exactly $20,000. Because the withdrawal and the deposit took place almost simultaneously, the U.S. controller never suspected any wrongdoing.12 Analysis. The control weakness here is that the controller had responsibility for both the custody of the cash (depositing the locally collected funds in pesos) and the recording of the transactions (the deposit of the funds in the local account and the transfer of funds to the U.S. account). Consequently, he had control of the money throughout the process and was able to manipulate cash transfers to embezzle small amounts of money each time and then falsify the transactions that were recorded in each of the bank accounts to conceal the embezzlement activity.
Case-in-Point 9.8 The utilities director of Newport Beach, California, was convicted of embezzling $1.2 million from the city of Newport Beach over an 11-year period. The utilities director forged invoices or easement documents that authorized payments—for example, to real or fictitious city property owners for the rights to put water lines through their land.
Officials within the Finance Department gave him the checks for delivery to the property owners. The utilities director then forged signatures, endorsed the checks to himself, and deposited them in his own accounts.

Analysis. The control weakness here is that the utilities director had physical custody of checks for the transactions he previously authorized. Due to the lack of separation of duties, the director could authorize fictitious transactions and subsequently divert the related payments to his own accounts.

Case-in-Point 9.9 The executive assistant (EA) to the president of a home improvement company used a corporate credit card, gift checks, and an online payment account to embezzle $1.5 million in less than 3 years. The EA arranged hotel and airline reservations and coordinated activities for the sales team. She was also responsible for reviewing the corporate credit card bills and authorizing payment. The president gave her the authority to approve
12

Jacka, J. 2001. Rounding up fraud. Internal Auditor (April): 65.

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amounts up to $100,000. When the EA realized that no one ever asked to look at the charges on the corporate credit card bill, she began making personal purchases with the card.13

Analysis. The control weakness here is that the EA was responsible for both recording the expenses and then authorizing payment of the bills. As a result, she quickly realized that she had nearly unlimited access to a variety of sources of funds from the company—and then found other ways to have the company pay for the things she wanted (i.e., gift checks and a PayPal account that she set up).
The separation of duties concept is very important in IT environments. However, the way this concept is applied in these environments is often different. In today’s information systems, for example, a computer can be programmed to perform one or more of the previously mentioned functions (i.e., authorizing transactions, recording transactions, and maintaining custody of assets). Thus, the computer replaces employees in performing the function (or functions). For example, the pumps at many gas stations today are designed so that customers can insert their debit or credit cards to pay for their gas. Consequently, the computer performs all three functions: authorizes the transaction, maintains custody of the ‘‘cash’’ asset, and records the transaction (and produces a receipt if you want one).

Physical Protection of Assets
A vital control activity that should be part of every organization’s internal control system is the physical protection of its assets. Beyond simple protection from the elements, the most common control is to establish accountability for the assets with custody documents.
Three application areas for this are (1) inventory controls, (2) document controls, and (3) cash controls.

Inventory Controls. To protect inventory, organizations keep it in a storage area accessible only to employees with custodial responsibility for the inventory asset. Similarly, when purchasing inventory from vendors, another procedure is to require that each shipment of inventory be delivered directly to the storage area. When the shipment arrives, employees prepare a receiving report source document. This report, as illustrated in Figure 9-5, provides documentation about each delivery, including the date received, vendor, shipper, and purchase order number. For every type of inventory item received, the receiving report shows the item number, the quantity received (based on a count), and a description.
The receiving report also includes space to identify the employee (or employees) who received, counted, and inspected the inventory items as well as space for remarks regarding the condition of the items received. By signing the receiving report, the inventory clerk
(Roger Martin in Figure 9-5) formally establishes responsibility for the inventory items. Any authorized employee can request inventory items from the storage area (for instance, to replenish the shelves of the store) and is required to sign the inventory clerk’s issuance report, which is another source document. The clerk is thereby relieved of further responsibility for these requisitioned inventory items.

Document Controls. Certain organizational documents are themselves valuable and must therefore be protected. Examples include the corporate charter, major contracts with other companies, blank checks (the following Case-in-Point), and registration statements required by the Securities and Exchange Commission. For control purposes, many organizations keep such documents in fireproof safes or in rented storage vaults off-site.
13

Sutphen, P. 2008. Stealing funds for a nest egg. Internal Auditor (August): 87–91.

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Sarah's Sporting Goods

No. 7824

Receiving Report
Vendor: Richards Supply Company

Date Received:
March 14, 2012

Shipped via: UPS

Purchase Order
Number: 4362

Item
Number

Quantity

Description

7434
7677
8326
8687

100
120
300
600

Spalding basketballs
Spalding footballs
Spalding baseballs
Penn tennis balls

Remarks:
Container with footballs received with water damage on outside, but footballs appear to be okay.
Received by:

Inspected by:

Delivered to:

FIGURE 9-5 Example of receiving report (items in boldface are preprinted).

Case-in-Point 9.10 The Finance Office in Inglewood, California, did not have adequate controls over important documents. As a result, a janitor who cleaned the Finance Office had access to blank checks that were left on someone’s desk. The janitor took 34 blank checks, forged the names of city officials, and then cashed them for amounts ranging from $50,000 to
$470,000.
Organizations that maintain physical control over blank checks may still be at risk of embezzlement by using a method known as a demand draft. If you write a check to your 12-year-old babysitter, she has all the information needed to clean out your account, since all she needs is your account number and bank routing number. Originally, demand drafts were used to purchase items over the phone (i.e., from telemarketers). Now, they’re commonly used to pay monthly bills by having money debited automatically from an individual’s checking account. Not surprisingly, due to the limited amount of information needed to make a demand draft, the potential for fraud is substantial. The irony of the demand draft system is that it may mean that paper checks are ultimately more risky to use than e-payments.

Case-in-Point 9.11 The Urban Age Institute, a nonprofit organization that focuses on planning new urban sustainability initiatives, received an e-mail from a would-be donor who asked for instructions on how to wire a $1,000 donation into the agency’s account. Not thinking anything unusual about the request, the group sent its account numbers. The donor used this information to print $10,000 worth of checks, which the donor cashed and then used Western
Union to wire the money to her new Internet boyfriend in Nigeria. The Director at the Institute

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later discovered that the donor used the Institute’s account number and bank routing number to obtain checks at Qchex.com. Fortunately, the Institute discovered the fraud and was able to close its checking account before money was withdrawn to cover the $10,000 in checks, which had already been deposited into the donor’s Bank of America account.14

Cash Controls. Probably the most important physical safeguards are those for cash.
This asset is the most susceptible to theft by employees and to human error when employees handle large amounts of it. In addition to fidelity bond coverage for employees who handle cash, companies should also (1) make the majority of cash disbursements for authorized expenditures by check rather than in cash and (2) deposit the daily cash receipts intact at the bank.
If a company has various small cash expenditures occurring during an accounting period, it is usually more efficient to pay cash for these expenditures than to write checks.
For good operating efficiency, an organization should use a petty cash fund for small, miscellaneous expenditures. To exercise control over this fund, one employee, called the petty cash custodian, should have responsibility for handling petty cash transactions. This employee keeps the petty cash money in a locked box and is the only individual with access to the fund.

Cash Disbursements by Check. A good audit trail of cash disbursements is essential to avoid errors and irregularities in the handling of cash. Accordingly, most organizations use prenumbered checks to maintain accountability for both issued and unissued checks.
When paying for inventory purchases, there are two basic systems for processing vendor invoices: nonvoucher systems and voucher systems. Under a nonvoucher system, every approved invoice is posted to individual vendor records in the accounts payable file and then stored in an open-invoice file. When an employee writes a cash disbursement check to pay an invoice, he or she removes the invoice from the open-invoice file, marks it paid, and stores it in the paid-invoice file. Under a voucher system, the employee prepares a disbursement voucher that identifies the specific vendor, lists the outstanding invoices, specifies the general ledger accounts to be debited, and shows the net amount to pay the vendor after deducting any returns and allowances as well as any purchase discount.
Figure 9-6 illustrates a disbursement voucher. Like the receiving report (Figure 9-5), we depict paper copies, but both of these processes are most likely electronic in today’s organizations. As Figure 9-6 discloses, the disbursement voucher summarizes the information contained within a set of vendor invoices. When the company receives an invoice from a vendor for the purchase of inventory, an employee compares it to the information contained in copies of the purchase order and receiving report to determine the accuracy and validity of the invoice. An employee should also check the vendor invoice for mathematical accuracy. When the organization purchases supplies or services that do not normally involve purchase order and receiving report source documents, the appropriate supervisor approves the invoice.
A voucher system has two advantages over a nonvoucher system: (1) it reduces the number of cash disbursement checks that are written, since several invoices to the same vendor can be included on one disbursement voucher and (2) the disbursement voucher is an internally generated document. Thus, each voucher can be prenumbered to simplify the tracking of all payables, thereby contributing to an effective audit trail over cash disbursements. 14

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Sarah's Sporting Goods

No. 76742

Disbursement Voucher
Date Entered: August 9, 2012

Debit Distribution

Prepared by:

Account No.

Amount

27-330
27-339
28-019
29-321

$750.00
450.00
300.00
425.00

Vendor Number: 120
Remit to:
Valley Supply Company
3617 Bridge Road
Farmington, CT 06032
Vendor Invoice
Number
4632
4636

Date
6/28/2012
7/10/2012

Voucher Totals:

Amount

Returns &
Allowances

Purchase
Discount

Net
Remittance

$1250.00
675.00

$150.00
0.00

$22.00
13.50

$1078.00
661.50

$1925.00

$150.00

$35.50

$1739.50

FIGURE 9-6 Example of disbursement voucher (items in boldface are preprinted).

Cash Receipts Deposited Intact. It is equally important to safeguard cash receipts.
As an effective control procedure, an organization should deposit intact each day’s accumulation of cash receipts at a bank. In the typical retail organization, the total cash receipts for any specific working day come from two major sources: checks arriving by mail from credit-sales customers and currency and checks received from retail cash sales.
When cash receipts are deposited intact each day, employees cannot use any of these cash inflows to make cash disbursements. Organizations use a separate checking account for cash disbursements. When organizations ‘‘deposit intact’’ the cash receipts, they can easily trace the audit trail of cash inflows to the bank deposit slip and the monthly bank statement. On the other hand, if employees use some of the day’s receipts for cash disbursements, the audit trail for cash becomes quite confusing, thereby increasing the risk of undetected errors and irregularities.

Reviews of Operating Performance
As a result of the Sarbanes-Oxley Act (SOX), the internal audit function of an organization typically reports directly to the Audit Committee of the Board of Directors. This makes the internal audit department independent of the other corporate subsystems and enhances objectivity when reviewing the operations of each subsystem. The internal audit staff makes periodic reviews called operational audits of each department or subsystem within its organization. These audits focus on evaluating the efficiency and effectiveness of operations within a particular department. On completion of such an audit, the internal auditors make recommendations to management for improving the department’s operations.

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In performing operational reviews, the internal auditors may find that certain controls are not operating properly. For example, the corporate policy manual might state that separate individuals should receive and record customer payments. But there is no guarantee that this is what actually happens. If practice is not according to policy, it is the internal auditor’s job to identify such problems and inform management.

UPDATE ON MONITORING
Guidance on Monitoring Internal Control Systems
Since publishing the 1992 COSO Report, COSO observed that many organizations did not fully understand the benefits and potential of effective monitoring. As a result, organizations were not effectively using their monitoring results to support assessments of their internal control systems. Accordingly, in 2009, COSO published a more comprehensive report called Guidance on Monitoring Internal Control Systems (GMICS).15 This guidance more carefully explains the monitoring component of the 1992 COSO Report.
The 2009 Report rests on two principles: (1) Ongoing and/or separate evaluations of internal controls help management determine whether the internal control system continues to function as expected over time. (2) Internal control deficiencies or weaknesses should be identified and communicated to the proper individuals in a timely fashion so that management can make corrections promptly. Thus, the GMICS suggests that these two principles can be achieved most effectively when monitoring is based on these three broad elements (Figure 9-7):

Establish
Foundation for
Monitoring

• Proper tone at the top
• Organizational structure that assigns monitoring roles
• Baseline for ongoing monitoring and evaluations

Design and Execute
Monitoring
Procedures






Assess and Report
Results

• Evaluate identified weaknesses or deficiencies in controls
• Report results to appropriate personnel and Board of Directors
• Follow up if needed

Prioritized organizational risks
Identify current internal controls
Focus on persuasive information about operation of key controls
Execute effective, efficient monitoring

Conclusions About Effectiveness of Controls Are Supported
FIGURE 9-7 Overview of 2009 COSO Guidance on Monitoring. Source: COSO Enterprise.
15

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1. Establish a foundation for monitoring (e.g., determine the current baseline).
2. Design and execute monitoring procedures (e.g., collect persuasive information about risks that might affect organizational objectives and the key controls that are intended to mitigate such risks).
3. Assess and report the results of monitoring those key controls.
The following figure shows these broad elements in a graphical format, indicating that they are interconnected and can help the management of an organization to effectively monitor the control system and persuasively document that effectiveness.

Reviews of Operating Performance versus Monitoring
While ‘‘reviews’’ and ‘‘monitoring’’ might sound like the same thing, there is a subtle difference between them. Organizations rarely have enough time or internal auditors to audit every department or division every year. Consequently, some areas of the company may have an internal audit review only once every 3 to 5 years. So, an operational audit is a review of the operations of a department or a subunit of the organization and occurs on a regular basis, but not every year. One of the tasks during the operational audit is to test the internal controls that are in place.
On the other hand, effective monitoring within the context of the COSO Framework is both risk based and principles based and considers all five components of internal control. Monitoring is a high-level, comprehensive review of firm-wide objectives and risks.
With such information, managers can identify critical controls to mitigate identified risks and then develop appropriate tests of those controls to be persuasively convinced that the controls are operating as expected. And as we know, many different types of events can happen in one part of the world that suddenly (and unexpectedly) cause a risk for companies in other parts of the world.

2011 COBIT, VERSION 516
ISACA is an audit and control association that issued the first version of Control Objectives for Information and related Technology (COBIT) in 1996. It released Version 5 of
COBIT in 2011, which was driven by a major strategic effort to ‘‘tie together and reinforce all ISACA knowledge assets.’’ The resulting version consolidates and integrates COBIT 4.1,
Val IT 2.0, Risk IT frameworks, as well as the Business Model for Information Security
(BMIS) and the IT Assurance Framework (ITAF).
ISACA created the COBIT framework to be business focused, process oriented, controls based, and measurement driven. If we examine the mission statement for COBIT, we can quickly understand why corporations commonly use this framework:
To research, develop, publicize and promote an authoritative, up-to-date international set of generally accepted information technology control objectives for dayto-day use by business managers, IT professionals and assurance professionals.17
The COBIT framework takes into consideration an organization’s business requirements, IT processes, and IT resources to support COSO requirements for the IT control
16
17

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environment. This suggests that managers must first tend to the requirements outlined in the 1992 COSO Report and set up an internal control system that consists of these five components: (1) the control environment, (2) risk assessment, (3) control activities, (4) information and communication, and (5) monitoring. The next step managers should take is to work through the guidelines contained in the 2004 COSO Report (perhaps using a worksheet like the one in Figure 9-3 to set objectives, identify possible risk events, and consider appropriate risk responses the organization might need to take should an event occur). Once the internal control system is in place (i.e., managers have worked through the
1992 and the 2004 COSO Frameworks), IT managers work with operational managers throughout the organization to determine how IT resources can best support the business processes. To achieve appropriate and effective governance of IT, senior managers of the organization will typically focus on five areas. First, managers need to focus on strategic alignment of IT operations with enterprise operations. Second, they must determine whether the organization is realizing the expected benefits (value) from IT investments.
Third, managers should continually assess whether the level of IT investments is optimal.
Fourth, senior management must determine their organization’s risk appetite and plan accordingly. Finally, management must continuously measure and assess the performance of IT resources. Here again is an opportunity for managers to consider a ‘‘dashboard’’ to have access to key indicators of these five focus areas to support timely decision making.
Perhaps it was the Sarbanes-Oxley Act, and the many governance lapses prior to the enactment of this legislation, that prompted the IT Governance Institute (ITGI) to recognize a need for and to develop a framework for IT governance. This governance framework, called Val IT, is a formal statement of principles and processes for IT management. Val IT is tightly integrated with COBIT. While COBIT helps organizations understand if they are doing things right from an IT perspective, Val IT helps organizations understand if they are making the right investments and optimizing the returns from them. So, COBIT focuses on the execution of IT operations, and Val IT focuses on the investment decision. Figure 9-8

Strategic Question
From a strategic perspective, are we doing the right things to obtain maximum value from our IT investment? Value Question
Are the right metrics in place to ensure that the company achieves the expected benefits from the
IT investment?

Architecture Question
Is our IT investment consistent with our IT architecture (business processes, data, information flows, software, hardware, technology)?

Delivery Question
Do we have the resources
(effective management, change management) to get the most from our IT investment?

FIGURE 9-8 The integration of COBIT and Val IT. Source: Adapted from the ISACA Website
(http://www.isaca.org).

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diagrams the integration of COBIT and Val IT, which is described in considerable depth in ‘‘The Val IT Framework 2.0 Extract.’’18 In essence, this is also a model for continuous improvement for an organization’s IT governance program.
To better understand the importance and value of COBIT and Val IT, there are three helpful publications that you can download for free at the ISACA Web site
(http://www.isaca.org). These are (1) Val IT Framework 2.0, (2) Val IT Getting Started with
Value Management, and (3) Val IT The Business Case.

TYPES OF CONTROLS
We can classify a company’s control procedures into three major types: preventive controls, detective controls, and corrective controls. This section examines each of these types of control procedures in more detail.

Preventive Controls
Preventive controls are controls that management puts in place to prevent problems from occurring. For example, a company might install a firewall to prevent unauthorized access to the company’s network, thereby safeguarding the disclosure, alteration, or destruction of sensitive information from external hackers. ERM (discussed earlier in this chapter) helps managers identify areas where preventive controls should be in place. Under the section called ‘‘Event Identification,’’ we said that management must identify possible events that represent a problem to the firm and then identify appropriate safeguards for those problems.
James Cash calls this scenario planning, and it means that management identifies various scenarios that range from minor concerns to major disasters that could occur.19
Management should include a number of informed individuals in these brainstorming sessions, such as the IS team, IT auditors, external auditors, and perhaps risk-management consultants. First, management documents each scenario. Then, it must establish preventive controls to minimize the likelihood of each problem they identify.

Detective Controls
Because preventive controls cannot stop every possible problem from occurring, organizations also need strong detective controls that alert managers when the preventive controls fail. As an example, assume that a company’s information system prepares daily responsibility accounting performance reports for management that computes variations of actual production costs from standard production costs. If a significant variance occurs, a manager’s report signals this problem, and the manager can initiate corrective action.
Examples of detective security controls are log monitoring and review, system audits, file integrity checks, and motion detection.
18
19

http://www.isaca.org
Cash, J. 1997. It’s reasonable to prepare. Information Week 654 (October): 142.

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Corrective Controls
Corrective controls are procedures a company uses to solve or correct a problem.
Organizations can initiate corrective action only if corrective controls are in place. A company establishes corrective controls to remedy problems it discovers by the detective controls. An example of a corrective control procedure might be to change the company’s procedures for creating backup copies of important business files. More than ever before, companies realize the importance of corrective controls, based on the incredible economic and physical impact of natural disasters over the past decade.

Case-in-Point 9.12 The recent BP oil spill in the Gulf of Mexico, labeled as the worst oil disaster in U.S. history, focuses a spotlight on the impact of control failures and reinforces the responsibility of internal auditors to constantly monitor the internal control systems of an organization. While estimates vary regarding the total amount of oil that spilled into the Gulf, the fact remains that the clean-up efforts (corrective controls) are extensive and evolving.20

EVALUATING CONTROLS
Once controls are in place, it is a wise practice for management to evaluate them. We introduced several frameworks at the beginning of this chapter that companies might use to evaluate their internal controls, but regardless of how management chooses to evaluate their internal controls, it is clear that they must do this. On the basis of the requirements contained in SOX, the New York Stock Exchange (NYSE) adopted rules that require all companies listed on this exchange to maintain an internal audit function to provide management and the audit committee ongoing assessments of the company’s risk management processes and system of internal control for financial reporting.

Requirements of the Sarbanes-Oxley Act
As previously discussed, the Sarbanes-Oxley Act of 2002 significantly changed the way internal auditors and management view internal controls within an organization. In particular, Section 404 contains very specific actions that the management of a publicly traded company must perform each year with respect to the system of internal controls within the organization. Specifically, the annual financial report of the company must include a report on the firm’s internal controls. This report must include the following:
• A statement that management acknowledges its responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting.
• An assessment, as of the end of the fiscal year, of the effectiveness of the internal control structure and procedures for financial reporting.
• An attestation by the company’s auditor that the assessment made by the management is accurate. 20

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A number of experts believe that some interesting synergies may have happened as a result of companies becoming SOX compliant. Recall that the purpose of SOX was to improve transparency and accountability in business processes and financial accounting.
For this to happen, internal auditors and the management of companies had to study their processes very carefully. However, if these same firms already implemented an ERP system, then most likely they already have reengineered some of their business processes.
During the evaluation of those processes, it is likely that the appropriate internal controls were considered and included, enabling SOX compliance. In addition, for management to comprehensively consider the requirements of SOX, they most likely used the Enterprise
Risk Management framework in the 2004 COSO Report.

Cost-Benefit Analysis
Companies develop their own optimal internal control package by applying the cost-benefit concept. Under this concept, employees perform a cost-benefit analysis on each control procedure considered for implementation that compares the expected cost of designing, implementing, and operating each control to the control’s expected benefits. Only those controls whose benefits are expected to be greater than, or at least equal to, the expected costs are implemented.
To illustrate a cost-benefit analysis, assume that the West End Boutique sells fashionable high-end ladies’ clothing, jewelry, and other accessories. The owner is concerned about how much inventory customers have shoplifted during the last several months and is considering some additional controls to minimize this shoplifting problem. If no additional controls are implemented, the company’s accountant estimates that the total annual loss to the boutique from shoplifting will be approximately $120,000. The company is considering two alternative control procedures to safeguard the company’s inventory (Figure 9-9).
Based on the owner’s goal of reducing shoplifting, alternative #1 (hiring six security guards) is the ideal control procedure to implement. Shoplifting should be practically zero, assuming that the guards are properly trained and perform their jobs in an effective manner. Even if shoplifting is completely eliminated, however, alternative #1 should not be implemented. Why not? It costs too much. The control’s expected cost ($240,000 a year) is greater than the control’s expected benefit ($120,000 a year, which is the approximate annual shoplifting loss that would be eliminated).

Alternative #1
Hire six plain-clothed security guards to patrol the boutique.
Based on the annual salaries that would have to be paid to the security guards, this control would cost West End Boutique an estimated $240,000 a year.

Alternative #2
Hire two plain-clothed security guards who would patrol the aisles, and install several cameras and mirrors throughout the company’s premises to permit managers to observe any shoplifters. The estimated annual cost of this control would be $80,000.

FIGURE 9-9 Internal control alternatives for West End Boutique.

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If the owner implements alternative #2 (hiring two security guards plus installing cameras and mirrors), the boutique’s accountant estimates that the total annual loss from shoplifting could be reduced from $120,000 to $25,000. The net benefit is $95,000 (=
$120,000−$25,000). Because the second alternative’s expected benefit ($95,000 a year reduction of shoplifting) exceeds its expected cost ($80,000 a year), the boutique’s owner should select alternative #2.
The point of this cost-benefit analysis example is that in some situations, the design and implementation of an ideal control procedure may be impractical. We are using the term ideal control to mean a control procedure that reduces to practically zero the risk of an undetected error (such as debiting the wrong account for the purchase of office supplies) or irregularity (such as shoplifting). If a specific control’s expected cost exceeds its expected benefit, as was true with the alternative #1 control procedure discussed above, the effect of implementing that control is a decrease in operating efficiency for the company. From a cost-benefit viewpoint, therefore, managers are sometimes forced to design and implement control procedures for specific areas of their company that are less than ideal. These managers must learn to live with the fact that, for example, some irregularities may occur in their organizational system, and these problems will not be detected by the internal control system.
Another approach to cost-benefit analysis attempts to quantify the risk factor associated with a specific area of a company. Risk assessment, as discussed earlier, is an important component of an internal control system. In general, the benefits of additional control procedures result from reducing potential losses. A measure of loss should include both the exposure (that is, the amount of potential loss associated with a control problem) and the risk (that is, the probability that the control problem will occur). An example of a loss measure is expected annual loss computed as follows:
Expected annual loss = risk × exposure per year
The expected loss is based on estimates of risk and exposure. To determine the costeffectiveness of a new control procedure, management estimates the expected loss both with and without the new procedure. After completing these calculations, the estimated benefit of the new control procedure is equal to the reduction in the estimated expected loss from implementing this procedure. Employees compare the estimated benefit to the incremental cost of the new control procedure. Whenever the estimated benefit exceeds this incremental cost, the company should implement the newly designed control procedure. To demonstrate this method of cost-benefit analysis, assume that a company’s payroll system prepares 12,000 checks biweekly. Data errors sometimes occur, which require reprocessing the entire payroll at a projected cost of $10,000. The company’s management is considering the addition of a data validation control procedure that reduces the error rate from 15% to 1%. This validation control procedure is expected to cost $600 per pay period.
Should the data validation control procedure be implemented? Figure 9-10 illustrates the analysis to answer this question.
Figure 9-10 indicates that the reprocessing cost expected (= expected loss) is $1,500 without the validation control procedure and $100 with the validation control procedure.
Thus, implementing this control procedure provides an estimated reprocessing cost reduction of $1,400. Because the $1,400 estimated cost reduction is greater than the $600 estimated cost of the control, the company should implement the procedure: the net estimated benefit is $800.

PART FOUR / Internal Control Systems and Computer Crime, Ethics, and Privacy

Without Control
Procedure

With Control
Procedure

Net Expected
Difference

Cost of payroll reprocessing

$10,000

$10,000

Risk of data errors
Reprocessing cost expected
($10,000 × risk)
Cost of validation control procedure (an incremental cost)
Net estimated benefit from validation control procedure

15%
$ 1,500

$

1%
100

$1,400

$0

$

600

$ (600)
$ 800

FIGURE 9-10 Cost-benefit analysis of payroll validation control procedure.

A Risk Matrix
Cost-benefit analyses suffer from at least three problems. One is that not all cost considerations can be expressed easily in monetary terms and that nonmonetary (or qualitative) items are often as important in evaluating decision alternatives in a cost-benefit analysis. For example, when an airport contemplates whether or not to install a control that might save lives, it might be difficult to quantify the benefits. Admittedly, this is an extreme example, but the point remains: often qualitative factors exist in a decision-making situation, which requires a degree of subjectivity in the cost-benefit analyses.
Another problem with cost-benefit analyses is that some managers are not comfortable with computations involving probabilities or averages. What does it mean, for example, to state that on average 2.5 laptops are lost or stolen each year? Finally, a third problem with cost-benefit analyses is that it requires an evaluation of all possible risks and a case-bycase computation of possible safeguards. Typically, companies will run out of money for controls long before they run out of risks to mitigate.
A possible solution to this third problem is to develop a risk matrix, which is a tool especially useful for prioritizing large risks. As you can see in Figure 9-11, a risk matrix classifies each potential risk by mitigation cost and also by likelihood of occurrence. As a

Cost to Organization

Negligible
Likelihood of Occurrence

296

Certain

Marginal

Critical

Catastrophic

Busy Street

Likely

Hit by car

Possible

Hit by piano

Unlikely

Burst Dam

Rare

Locust
Swarm

FIGURE 9-11 Example of a risk matrix.

Stampede

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result, highly likely, costly events wind up in the upper-right corner of the matrix, while events with small likelihoods of occurrence or negligible costs wind up in the lower left corner. This helps managers see which events are most important (the upper-right ones), and therefore how to better prioritize the money spent on internal controls.

AIS AT WORK
Using the Company Credit Card as a Nest Egg?21
Laura Jones, 22 years old, was very excited! She just got hired at a regional home improvement company as the executive assistant to the president. The company was eagerly planning an aggressive expansion of operations and was looking for ambitious and eager employees—willing to work hard as team players. To realize growth, the president knew the company had to be very active in the industry. Thus, the company sponsored booths at trade shows, attended industry conferences, and had morale-building events for its sales team in exciting places such as Hawaii.
Laura’s responsibilities included making all the arrangements for these activities. She made hotel and airline reservations and coordinated activities for the sales team. She was also responsible for reviewing the corporate credit card bills and authorizing payments.
The president gave her the authority to approve amounts up to $100,000. However, when
Jones realized that no one ever asked to look at the charges on the corporate credit card bill, she began making personal purchases with the card. If total charges exceeded $100,000, she simply forged the president’s signature on the approval form. When she learned that the accounts payable department accepted approvals from the president by e-mail, she would slip into his office when he was at a meeting or out of town, access his computer, and send herself an approval e-mail.
The temptation was so great that she began to find additional ways the company could pay for things she wanted. For example, she soon discovered that she could also purchase gift checks with the corporate credit card, and over a 2-year period she bought more than
$150,000 in gift checks to buy items for herself, her family, and some friends.
When Laura had been with the firm for slightly less than 3 years, her scheme was discovered. An agent at the credit card company noticed some questionable transactions involving Jones and the corporate credit card. When the internal auditors investigated the transactions, they discovered that Jones had embezzled more than $1.5 million.

SUMMARY
An organization’s internal control system has four objectives: (1) to safeguard assets, (2) to check the accuracy and reliability of accounting data, (3) to promote operational efficiency, and (4) to encourage adherence to prescribed managerial policies.
It is management’s responsibility to develop an internal control system.
The control environment, risk assessment, control activities, information and communication, and monitoring are the five interrelated components that make up an internal control system.

21

Sutphen, P. 2008. Stealing funds for a nest egg. Internal Auditor (August): 87–91.

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Six control activities to include in each organization’s internal control system are: (1) a good audit trail, (2) sound personnel policies and practices, (3) separation of duties, (4) physical protection of assets, (5) internal reviews of controls by internal audit subsystem, and (6) timely performance reports. Within these six activities, specific control procedures should be designed and implemented for each company based on its particular control needs.
There are three types of controls: preventive, detective, and corrective.
To develop an optimal internal control package, management should perform a cost-benefit analysis on each potential control procedure or consider a risk matrix if there are qualitative considerations that cannot be ignored.
A company should implement only those controls whose expected benefits exceed, or at least equal, their expected costs.

KEY TERMS YOU SHOULD KNOW
1992 COSO Report control environment
Control Objectives for Information and related
Technology (COBIT) corporate governance corrective controls demand draft detective controls enterprise risk management (ERM) expected loss fidelity bond ideal control

internal control internal control system operational audits preventive controls risk assessment risk matrix
Sarbanes-Oxley Act of 2002
(SAS) No. 94 scenario planning
Section 404 separation of duties
Val IT

TEST YOURSELF
Q9-1. This term describes the policies, plans, and procedures implemented by a firm to protect the assets of the organization.
a. Internal control
b. SAS No. 94
c. Risk assessment
d. Monitoring
Q9-2. Which of the following is not one of the four objectives of an internal control system?
a. Safeguard assets
b. Promote firm profitability
c. Promote operational efficiency
d. Encourage employees to follow managerial policies

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Q9-3. Section 404 affirms that management is responsible for establishing and maintaining an adequate internal control structure. This Section may be found in which of the following?
a. The 1992 COSO Report
b. The 2004 COSO Report
c. The Sarbanes-Oxley Act of 2002
d. COBIT
Q9-4. Which of the following would a manager most likely use to organize and evaluate corporate governance structure?
a. The 1992 COSO Report
b. The 2004 COSO Report
c. The Sarbanes-Oxley Act of 2002
d. COBIT
Q9-5. Which of the following would a manager most likely use for risk assessment across the organization? a. The 1992 COSO Report
b. The 2004 COSO Report
c. The Sarbanes-Oxley Act of 2002
d. COBIT
Q9-6. An internal control system should consist of five components. Which of the following is not one of those five components?
a. The control environment
b. Risk assessment
c. Monitoring
d. Performance evaluation
Q9-7. COSO recommends that firms specific control.

to determine whether they should implement a

a. Use cost-benefit analysis
b. Conduct a risk assessment
c. Consult with the internal auditors
d. Identify objectives
Q9-8. Which of the following is not one of the three additional components that was added in the
2004 COSO Report?
a. Objective setting

c. Event identification

b. Risk assessment

d. Risk response

Q9-9. Separation of duties is an important control activity. If possible, managers should assign which of the following three functions to different employees?
a. Analysis, authorizing, transactions
b. Custody, monitoring, detecting
c. Recording, authorizing, custody
d. Analysis, recording, transactions
Q9-10. Which of these is not one of the three major types of controls?
a. Preventive

c. Objective

b. Corrective

d. Detective

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Q9-11. To achieve appropriate, effective IT governance, senior managers of an organization will typically use which of the following:
a. COBIT and VAL IT
b. A good audit trail and COSO 1998
c. COSO 1998 and monitoring
d. COBIT and ERM
Q9-12. When the management of the sales department has the opportunity to override the system of internal controls of the accounting department, a weakness exists in:
a. Risk management
b. Information and communication
c. Monitoring
d. The control environment
Q9-13. Segregation of duties is a fundamental concept in an effective system of internal control. But, the internal auditor must be aware that this safeguard can be compromised through:
a. Lack of training of employee
b. Collusion among employees
c. Irregular employee reviews
d. Absence of internal auditing
Q9-14. Which one of the following forms of audit is most likely to involve a review of an entity’s performance of specific activities in comparison to organizational specific objectives?
a. Information system audit
b. Financial audit
c. Operational audit
d. Compliance audit

DISCUSSION QUESTIONS
9-1. What are the primary provisions of the 1992 COSO Report? The 2004 COSO Report?
9-2. What are the primary provisions of COBIT?
9-3. Why are the COSO and COBIT frameworks so important?
9-4. Briefly discuss the interrelated components that should exist within an internal control system.
In your opinion, which component is the most important and why?
9-5. Why are accountants so concerned about their organization having an efficient and effective internal control system?
9-6. Discuss what you consider to be the major differences between preventive, detective, and corrective control procedures. Give two examples of each type of control.
9-7. Why are competent employees important to an organization’s internal control system?
9-8. How can separation of duties reduce the risk of undetected errors and irregularities?
9-9. Discuss some of the advantages to an organization from using a voucher system and prenumbered checks for its cash disbursement transactions.
9-10. What role does cost-benefit analysis play in an organization’s internal control system?

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9-11. Why is it important for managers to evaluate internal controls?
9-12. Why did COSO think it was so important to issue the 2009 Report on monitoring?

PROBLEMS
9-13. You have been hired by the management of Alden, Inc. to review its control procedures for the purchase, receipt, storage, and issuance of raw materials. You prepared the following comments, which describe Alden’s procedures.
• Raw materials, which consist mainly of high-cost electronic components, are kept in a locked storeroom. Storeroom personnel include a supervisor and four clerks. All are well trained, competent, and adequately bonded. Raw materials are removed from the storeroom only upon written or oral authorization from one of the production foremen.
• There are no perpetual inventory records; hence, the storeroom clerks do not keep records of goods received or issued. To compensate for the lack of perpetual records, a physical inventory count is taken monthly by the storeroom clerks, who are well supervised.
Appropriate procedures are followed in making the inventory count.
• After the physical count, the storeroom supervisor matches quantities counted against a predetermined reorder level. If the count for a given part is below the reorder level, the supervisor enters the part number on a materials requisition list and sends this list to the accounts payable clerk. The accounts payable clerk prepares a purchase order for a predetermined reorder quantity for each part and mails the purchase order to the vendor from whom the part was last purchased.
• When ordered materials arrive at Alden, they are received by the storeroom clerks. The clerks count the merchandise and see that the counts agree with the shipper’s bill of lading. All vendors’ bills of lading are initialed, dated, and filed in the storeroom to serve as receiving reports.
a. List the internal control weaknesses in Alden’s procedures.
b. For each weakness that you identified, recommend an improvement(s).
9-14. Listed below are 12 internal control procedures or requirements for the expenditure cycle
(purchasing, payroll, accounts payable, and cash disbursements) of a manufacturing enterprise.
For each of the following, identify the error or misstatement that would be prevented or detected by its use.
a. Duties segregated between the cash payments and cash receipts functions.
b. Signature plates kept under lock and key.
c. The accounting department matches invoices to receiving reports or special authorizations before payment.
d. All checks mailed by someone other than the person preparing the payment voucher.
e. The accounting department matches invoices to copies of purchase orders.
f. Keep the blank stock of checks under lock and key.
g. Use imprest accounts for payroll.
h. Bank reconciliations performed by someone other than the one who writes checks and handles cash.
i. Use a check protector.
j. Periodically conduct surprise counts of cash funds.

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k. Orders placed with approved vendors only.
l. All purchases made by the purchasing department.
9-15. Rogers, North, & Housour, LLC is a large, regional CPA firm. There are 74 employees at their
Glen Allen, SC office. The administrative assistant at this office approached Mr. Rogers, one of the partners, to express her concerns about the inventory of miscellaneous supplies (e.g., pens, pencils, paper, floppy disks, and envelopes) that this office maintains for its clerical workers. The firm stores these supplies on shelves at the back of the office facility, easily accessible to all company employees.
The administrative assistant, Sandra Collins, is concerned about the poor internal control over these office supplies. She estimates that the firm loses about $350 per month because of theft of supplies by company employees. To reduce this monthly loss, Sandra recommends a separate room to store these supplies and that a company employee be given full-time responsibility for supervising the issuance of the supplies to those employees with a properly approved requisition. By implementing these controls, Sandra believes this change might reduce the loss of supplies from employee misappropriation to practically zero.
a. If you were Mr. Rogers, would you accept or reject Sandra’s control recommendations?
Explain why or why not.
b. Identify additional control procedures that the firm might implement to reduce the monthly loss from theft of office supplies.
9-16. Ron Mitchell is currently working his first day as a ticket seller and cashier at the First Run
Movie Theater. When a customer walks up to the ticket booth, Ron collects the required admission charge and issues the movie patron a ticket. To be admitted into the theater, the customer then presents his or her ticket to the theater manager, who is stationed at the entrance. The manager tears the ticket in half, keeping one half for himself and giving the other half to the customer.
While Ron was sitting in the ticket booth waiting for additional customers, he had a brilliant idea for stealing some of the cash from ticket sales. He reasoned that if he merely pocketed some of the cash collections from the sale of tickets, no one would ever know. Because approximately 300 customers attend each performance, Ron believed that it would be difficult for the theater manager to keep a running count of the actual customers entering the theater.
To further support his reasoning, Ron noticed that the manager often has lengthy conversations with patrons at the door and appears to make no attempt to count the actual number of people going into the movie house.
a. Will Ron Mitchell be able to steal cash receipts from the First Run Movie Theater with his method and not be caught? Explain.
b. If you believe he will be caught, explain how his stealing activity will be discovered.
9-17. The Palmer Company manufactures various types of clothing products for women. To accumulate the costs of manufacturing these products, the company’s accountants have established a computerized cost accounting system. Every Monday morning, the prior week’s production cost data are batched together and processed. One of the outputs of this processing function is a production cost report for management that compares actual production costs to standard production costs and computes variances from standard. Management focuses on the significant variances as the basis for analyzing production performance.
Errors sometimes occur in processing a week’s production cost data. The cost of the reprocessing work on a week’s production cost data is estimated to average about $12,000.
The company’s management is currently considering the addition of a data validation control procedure within its cost accounting system that is estimated to reduce the risk of the data errors from 16% to 2%, and this procedure is projected to cost $800 per week.
a. Using these data, perform a cost-benefit analysis of the data validation control procedure that the management is considering for its cost accounting system.
b. On the basis of your analysis, make a recommendation to the management regarding the data validation control procedure.

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CASE ANALYSES
9-18. Gayton Menswear (Risk Assessment and Control Procedures)
The Gayton Menswear company was founded by Fred Williams in 1986 and has grown steadily over the years. Fred now has 17 stores located throughout the central and northern parts of the state. Since Fred was an accounting major in college and worked for a large regional CPA firm for 13 years prior to opening his first store, he places a lot of value on internal controls. Further, he has always insisted on a state-of-the art accounting system that connects all of his stores’ financial transactions and reports.
Fred employs two internal auditors who monitor internal controls and also seek ways to improve operational effectiveness. As part of the monitoring process, the internal auditors take turns conducting periodic reviews of the accounting records. For instance, the company takes a physical inventory at all stores once each year, and an internal auditor oversees the process. Chris Domangue, the most senior internal auditor, just completed a review of the accounting records and discovered several items of concern. These were:
• Physical inventory counts varied from inventory book amounts by more than 5% at two of the stores. In both cases, physical inventory was lower.
• Two of the stores seem to have an unusually high amount of sales returns for cash.
• In 10 of the stores gross profit has dropped significantly from the same time last year.
• At four of the stores, bank deposit slips did not match cash receipts.
• One of the stores had an unusual number of bounced checks. It appeared that the same employee was responsible for approving each of the bounced checks.
• In seven of the stores, the amount of petty cash on hand did not correspond to the amount in the petty cash account.

Requirements
1. For each of these concerns, identify a risk that may have created the problem.
2. Recommend an internal control procedure to prevent the problem in the future.

9-19. Cuts-n-Curves Athletic Club (Analyzing Internal Controls)
The Cuts-n-Curves Athletic Club is a state-wide chain of full-service fitness clubs that cater to the demographics of the state (about 60% of all adults are single). The clubs each have an indoor swimming pool, exercise equipment, a running track, tanning booths, and a smoothie caf´ for after-workout refreshments. The Club in Rosemont is open 7 days a e week, from 6:00 a.m. to 10:00 p.m. Just inside the front doors is a reception desk, where an employee greets patrons. Members must present their membership card to be scanned by the bar code reader, and visitors pay a $16 daily fee.
When the employee at the desk collects cash for daily fees, he or she also has the visitor complete a waiver form. The employee then deposits the cash in a locked box and files the forms. At the end of each day, the Club accountant collects the cash box, opens it, removes the cash, and counts it. The accountant then gives a receipt for the cash amount to the employee at the desk. The accountant takes the cash to the bank each evening. The

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next morning, the accountant makes an entry in the cash receipts journal for the amount indicated on the bank deposit slip.
Susan Richmond, the General Manager at the Rosemont Club, has some concerns about the internal controls over cash. However, she is concerned that the cost of additional controls may outweigh any benefits. She decides to ask the organization’s outside auditor to review the internal control procedures and to make suggestions for improvement.

Requirements
1. Assume that you are the outside (staff) auditor. Your manager asks you to identify any weaknesses in the existing internal control system over cash admission fees.
2. Recommend one improvement for each of the weaknesses you identified.

9-20. Emerson Department Store (Control Suggestions to Strengthen a
Payroll System)
As a recently hired internal auditor for the Emerson Department Store (which has approximately 500 employees on its payroll), you are currently reviewing the store’s procedures for preparing and distributing the weekly payroll. These procedures are as follows.
• Each Monday morning the managers of the various departments (e.g., the women’s clothing department, the toy department, and the home appliances department) turn in their employees’ time cards for the previous week to the accountant (Morris Smith).
• Morris then accumulates the total hours worked by each employee and submits this information to the store’s computer center to process the weekly payroll.
• The computer center prepares a transaction tape of employees’ hours worked and then processes this tape with the employees’ payroll master tape file (containing information such as each employee’s Social Security number, exemptions claimed, hourly wage rate, year-to-date gross wages, FICA taxes withheld, and union dues deducted).
• The computer prints out a payroll register indicating each employee’s gross wages, deductions, and net pay for the payroll period.
• The payroll register is then turned over to Morris, who, with help from the secretaries, places the correct amount of currency in each employee’s pay envelope.
• The pay envelopes are provided to the department managers for distribution to their employees on Monday afternoon.
To date, you have been unsuccessful in persuading the store’s management to use checks rather than currency for paying the employees. Most managers that you have talked with argue that the employees prefer to receive cash in their weekly pay envelopes so that they do not have to bother going to the bank to cash their checks.

Requirements
1. Assume that the store’s management refuses to change its current system of paying the employees with cash. Identify some control procedures that could strengthen the store’s current payroll preparation and distribution system.

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2. Now assume that the store’s management is willing to consider other options for paying employees. What alternatives would you suggest?

READINGS AND OTHER RESOURCES
Bollinger, M. 2011. Implementing internal controls. Strategic Finance 92(7): 25.
Klamm, B., and M. Watson. 2011. IT control weaknesses undermine the information value chain.
Strategic Finance 92(8): 39–45.
Nolan, M. 2008. Internal audit at the crossroads. Risk Management (November): 54–55.
Singh, G. 2008. What can SOX do for you? Risk Management (April): 78.
Tsay, B., and R. Turpen. 2011. The control environment in not-for-profit organizations. The CPA
Journal 81(1): 64–67.
Walker, K. 2008. SOX, ERP, and BPM., Strategic Finance (December): 47–53.

What Are the Benefits of Internal Control: http://www.ehow.com/video_5078690_benefits-internal-controls_.html Principles of Internal Control (fun and different!): http://www.youtube.com/watch?v=OWC6nbZBkVw Implementing Risk Assessment Framework: http://www.youtube.com/watch?v=T5aPT-TSxCE ANSWERS TO TEST YOURSELF
1. a

2. b

3. c

4. a

5. b

6. d

7. a

8. b

9. c

10. c

11. a

12. d

13. b

14. c

Chapter 10
Computer Controls for Organizations and Accounting Information Systems

INTRODUCTION
ENTERPRISE LEVEL CONTROLS
Risk Assessment and Security Policies
Integrated Security for the Organization

GENERAL CONTROLS FOR INFORMATION
TECHNOLOGY
Access to Data, Hardware, and Software
Protection of Systems and Data with Personnel Policies

The Big Corporation (Controls in Large, Integrated
Systems)
MailMed Inc. (Control Weaknesses and a Disaster
Recovery Plan)
Bad Bad Benny: A True Story (Identifying Controls for a System)

READINGS AND OTHER RESOURCES
ANSWERS TO TEST YOURSELF

Protection of Systems and Data with Technology and Facilities

APPLICATION CONTROLS FOR TRANSACTION
PROCESSING
Input Controls
Processing Controls
Output Controls

AIS AT WORK—BIOMETRICS USED
TO PREVENT FRAUD
SUMMARY
KEY TERMS YOU SHOULD KNOW
TEST YOURSELF
DISCUSSION QUESTIONS
PROBLEMS
CASE ANALYSES

After reading this chapter, you will:
1. Be familiar with control objectives related to
IT and understand how these objectives are achieved. 2. Be able to identify enterprise-level controls for an organization and understand why they are essential for corporate governance.
3. Understand general controls for IT and why these should be considered when designing and implementing accounting information systems.
4. Be familiar with IT general security and control issues for wireless technology, networked systems, and personal computers.
5. Know what input controls, processing controls, and output controls are and be familiar with specific examples of control procedures for each of these categories of controls.

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In an environment of IT security threats, data quality issues, corporate governance concerns, and privacy legislation, organizations need to ensure, more than ever, the integrity, confidentiality, and availability of information and the underlying systems.
Deloitte—Enterprise Risk Services1

INTRODUCTION
This chapter continues the discussion of internal controls from Chapter 9 by focusing on controls related to information technology. Control Objectives for Information and related
Technology (COBIT) is a governance framework designed to help organizations control
IT and maximize the value created by IT. COBIT provides a methodology for analyzing IT controls, but the process is lengthy and very complex—a detailed description of the many components of the COBIT framework is beyond the scope of a textbook chapter. In order to discuss IT controls in a more intuitive format, we organize this chapter according to three main classifications of IT-related controls, which are consistent with broad classifications in Auditing Standard No. 5 (AS5), COBIT, and COSO. Following AS5, we begin at the top level and work our way down to more specific controls at the application level. The three categories are: enterprise level controls, general controls, and application controls.
Enterprise level controls affect the entire organization, including other IT controls. The next level includes general controls for IT, which are controls that involve the entire AIS and other IT-based systems. Finally, at the third level, application controls are designed to protect transaction processing (i.e., to ensure complete and accurate processing of data).
These controls are typically programmed into specific modules and applications within the accounting information system.

ENTERPRISE LEVEL CONTROLS
Enterprise controls are those controls that affect the entire organization and influence the effectiveness of other controls. As we discussed in the previous chapter, management’s philosophy, operating style, integrity, policies, and procedures are all important characteristics that influence the tone of a company, and these characteristics represent the highest level of enterprise controls. The tone set by management helps to establish the level of security and control consciousness in the organization, which is the basis for the control environment. Enterprise level controls are particularly important because they often have a pervasive impact on many other controls, such as IT general controls and application-level controls. In 2007, the Public Company Accounting Oversight Board (PCAOB) released Auditing
Standard No. 5, ‘‘An Audit of Internal Control over Financial Reporting that Is Integrated with an Audit of Financial Statements.’’ This Standard introduces a framework describing entity-level controls at varying levels of precision (direct, monitoring, and indirect).2 The
1

http://www.deloitte.com/view/en_LU/lu/services/consulting/enterprise-risk-services/controlassurance/index.htm
2
http://pcaobus.org/Standards/Auditing/Pages/Auditing_Standard_5.aspx

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external auditor must evaluate these controls, and management must ensure that these controls are in place and functioning. We identified a number of these controls in Chapter 9: management’s ethical values, philosophy, assignment of authority and responsibility, and the effectiveness of the board of directors. Additional controls that are also very important include the following:
• Consistent policies and procedures, such as formal codes of conduct and fraud prevention policies. For example, a company may require all employees to periodically sign a formal code of conduct stipulating that computer resources are to be used only for appropriate business purposes and any acts of fraud or abuse will be prosecuted.
• Management’s risk assessment process.
• Centralized processing and controls.
• Controls to monitor results of operations.
• Controls to monitor other controls, including activities of the internal audit function, the audit committee, and self-assessment programs.
• The period-end financial reporting process.
• Board-approved policies that address significant business control and risk management practices. Risk Assessment and Security Policies
One level below the tone of the organization is the organization’s security policy—a comprehensive plan that helps protect an enterprise from both internal and external threats. The policy is based on assessment of the risks faced by the firm. Figure 10-1 presents issues that organizations should consider when developing this policy.

Key Issues for Developing Security Policies
• Evaluate information assets and identify threats to these assets
• Assess both external and internal threats
• Perform a risk assessment
• Determine whether information assets are underprotected, overprotected or adequately protected • Create a team for drafting the policy
• Obtain approval for the policy from the highest levels of the organization
• Create the specific security policies
• Implement the policies throughout the organization
• Develop policy compliance measures and enforce the policies
• Manage the policies

FIGURE 10-1 Issues that should be considered when developing a security policy.
Source: Creating and Enforcing an Effective Information Security Policy, ISACA Journal,
Journal On-line © 2005 ISACA®. All rights reserved. Used by permission.

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In developing its security policies, an organization should consider ISO/IEC 27002, the international information security standards that establish information security best practices. This Standard includes 12 primary sections: risk assessment, security policy, organization of security, asset management, human resources security, physical security, communications, access controls, acquisition and development, security incident management, business continuity management, and compliance. ISO certification is becoming an important consideration as more businesses maintain a Web presence. The first step to becoming certified under ISO/IEC 27002 is to comply with the Standard, and one way to measure and manage compliance is to use a risk analysis tool such as the COSO enterprise risk management (ERM) framework that we discussed in Chapter 9.

Integrated Security for the Organization
A current trend in security practice is to merge physical security and logical security across an organization. Physical security refers to any measures that an organization uses to protect its facilities, resources, or its proprietary data that are stored on physical media.
Logical security uses technology to limit access to only authorized individuals to the organization’s systems and information, such as password controls. Figure 10-2 identifies a number of examples of physical and logical security measures that firms commonly employ. The IT Governance Institute published a document that specifically addresses security, called Information Security Governance: Guidance for Boards of Directors and
Executive Management, 2nd edition (2006).
Many firms now use an integrated approach to security by combining a number of logical and physical security technologies, including firewalls, intrusion detection systems, content filtering, vulnerability management, virus protection, and virtual private networks.
An integrated security system, supported by a comprehensive security policy, can significantly reduce the risk of attack because it increases the costs and resources needed by an intruder. According to security experts, convergence (of physical and logical security) is the single most overlooked gap in enterprise-wide security—that is, the most insidious security risks are those that slip between physical and logical security systems. Figure 10-3 and the following example illustrate this.

Physical Security

Facility monitoring (surveillance systems, cameras, guards, exterior lighting)
Access controls to facilities/data center/computers (biometrics, access cards) Alarm systems (fire, burglar, water, humidity, power fluctuations)
Shred sensitive documents
Proper storage/disposal of hard drives and other electronic storage media
Secure storage of backup copies of data and master copies of critical software

Logical Security

e-IDs and passwords
System authentication
Biometrics
Logs of logon attempts
Application-level firewalls
Anti-virus and anti-spyware software Intrusion detection systems
Encryption for data in transit
Smart cards

FIGURE 10-2 Examples of physical security and logical security measures.

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11:00 a.m.

311

Logical Systems

Access
ERP

Check
Inventory

Order
Material
Scraping

Scraping
Order
Released

Separate systems make organizations vulnerable!

Greg

Access
Warehouse

8:00 p.m.

Check
Scrapped
Material

Load
Material for
Shipping

Ship
Scrapped
Material

Physical Systems

FIGURE 10-3 Diagram of the example in Case-in-Point 10.1.

Case-in-Point 10.1 Assume Greg Smith is authorized to scrap inventory. He also has an access badge for the warehouse where the scrapped inventory is located and can enter the warehouse after hours. Although independently these actions are not particularly interesting, when combined they create a wide variety of problems that could go unnoticed if the physical and logical security systems are not integrated—such as fraud, which could lead to misstated financial statements.

The U.S. government considers computer security a critical issue. The National Institute of Standards and Technology (NIST) issued guidelines on computer security controls for federal information systems. NIST believes that these security guidelines will play a key role in helping federal agencies effectively select and implement security controls and, by using a risk-based approach, do so in a cost-effective manner.3 This document, which is
3

http://csrc.nist.gov/groups/SMA/fisma/index.html

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mandatory for most federal systems, influences controls for systems at all governmental levels. Security controls (management, operational, and technical safeguards) are critical to protect the confidentiality, integrity, and availability of a computer system and its information. GENERAL CONTROLS FOR INFORMATION TECHNOLOGY
IT general controls protect the IT infrastructure, major components of the IT systems, and data. General controls primarily ensure that (1) access to programs and data is granted only to authorized users; (2) data and systems are protected from change, theft, or loss; and
(3) development of and changes to computer programs are authorized, tested, and approved before their use. IT general controls affect the integrity of the entire information system.
Accordingly, controls at this level are critical for reliance on the application controls that are programmed into specific components of the information system. For example, imagine that an AIS lacks control over access to financial statement records. If employees can access and change data in the financial statements at will, then the data in the financial statements will be unreliable. Even if there were thousands of application controls that ensured accurate processing of all financial data, the lack of adequate access controls to prevent unauthorized changes to the data make the financial data unreliable.

Access to Data, Hardware, and Software
Regulating who is permitted logical access to computers and files is a critical general control in terms of safeguarding sensitive organizational data and software. Remote terminals may be placed anywhere in the country and hooked up to a company’s servers through Internet connections. As a result, it is difficult to safeguard logical computer access with direct physical surveillance of terminals. Most computer systems therefore use passwords to restrict access. Such codes vary in length and type of password information required, but all have the same intent: to limit logical access to the computer only to those individuals authorized to have it.
Organizations should encourage employees to create strong passwords. Each character that is added to a password increases the protection that it provides. Passwords should be 8 or more characters in length; 14 characters or longer is ideal. For instance, a
15-character password composed only of random letters and numbers is about 33,000 times stronger than an 8-character password composed of characters from the entire keyboard.4
An ideal password combines both length and different types of characters. The greater the variety of characters (letters, numbers, and symbols) that are included in a password, the harder it is to hack.
Passwords can be a problem because they can be lost, given away, or stolen. Thus, security can be increased significantly by using biometrics and/or integrated security measures. Biometric identification devices identify distinctive user physical characteristics such as voice patterns, fingerprints, facial patterns and features, retina prints, body odor, signature dynamics, and keyboarding methods (i.e., the way a user types certain groups of characters). When an individual wants to access a company’s computer system, his or her biometric identifications are matched against those stored in the system. A match must occur for the individual to be given access to the computer system.
4

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Security for Wireless Technology. As we mentioned in Chapter 1, an important change in today’s business environment is the desire for instantly connecting with one another and rapidly exchanging ideas and data. Wireless fidelity (Wi-Fi) technology is based on radio wave transmissions, which makes the transmitted information vulnerable to interception. As a result, organizations that rely on wireless technology must understand the vulnerabilities that exist and explore the various methods of compensating for this risk.
Probably one of the largest users of wireless technology is the education sector.
Worldwide, colleges and universities are installing wireless local area networks (WLANs) for a variety of reasons, including: a technologically savvy and highly mobile audience
(students and faculty); older, often historic buildings (which cannot be wired); and innovative curricula that make use of wireless applications. Probably the most important control for wireless technology is installing a virtual private network (VPN), which is a security appliance that runs behind a university’s (or a company’s) firewall and allows remote users to access entity resources by using wireless, handheld devices.

Case-in-Point 10.2 Texas A&M University’s network infrastructure connects more than
340 buildings and 90,000 wired ports. The VPN network allows authorized users to access the University’s network with whatever type of mobile device they choose (e.g., PDAs, laptops, and digital mobile phones).5

The risk of unauthorized access to data through electronic eavesdropping is minimized by using data encryption. It can be used to prevent a company’s competitors from electronically monitoring confidential data transmissions. Encryption converts data into a scrambled format prior to their transmission and converts the data back into a meaningful form once transmission is complete. Figure 10-4 shows an example of using encryption keys to scramble accounting data and convert it back into readable form. The encrypted data can be read only by a person with a matching decryption key. Data encryption is relatively inexpensive, which makes it a very efficient control.

Net Income =
1,245,000

Decrypt

Encrypt

Encrypted
Message
Received

FIGURE 10-4 Data encryption.
5

http://nis.tamu.edu/index.php

#^*%&*^$

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Case-in-Point 10.3 Check Point, a firm specializing in IT security, analyzed the use of smartphones by businesses in 2010. The firm found that 70% of respondents indicated that their companies’ smartphones lacked any type of encryption. Further, nearly 90% of respondents indicated that they carried sensitive data on USB memory sticks that did not have encryption. The study indicates some serious shortfalls in current IT controls.6

Controls for Networks. Desktop computers are often placed throughout the organization and linked to a centralized computer to form a distributed data processing (DDP) system. The basic objective of each remote computer is to meet the specific processing needs of the remote location and communicate summary results to the centralized (host) computer. DDP systems are still viable in today’s business organizations. Large volumes of data are regularly transmitted over long-distance telecommunications technologies. As with wireless technology, the routine use of systems such as DDP and client/server computing increases the potential control problems for companies. These problems include unauthorized access to the computer system and its data through electronic eavesdropping (which allows computer users to observe transmissions intended for someone else), hardware or software malfunctions causing computer network system failures, and errors in data transmission.
Managers use data encryption to protect information. For example, many companies are encrypting all of their e-mail messages on local area networks (LANs) and wide area networks (WANs).
To reduce the risk of computer network system failures, companies design their network capacity to handle periods of peak transmission volume. Redundant components, such as servers, are used so that a system can switch to a backup unit in the event of hardware failure. A control procedure, such as a checkpoint, helps to recover from such a failure. Under a checkpoint control procedure, which is performed at periodic intervals during processing, a company’s computer network system temporarily does not accept new transactions. Instead, it completes updating procedures for all partially processed transactions and then generates an exact copy of all data values and other information needed to restart the system. The system records the checkpoint data on a separate disk file and repeatedly executes this process several times per hour. Should a hardware failure occur, the system is restarted by reading the last checkpoint and then reprocessing only those transactions that have occurred since the checkpoint.
Two control procedures that reduce the risk of errors in data transmission are routing verification procedures and message acknowledgment procedures. Routing verification procedures help to ensure that no transactions or messages are routed to the wrong computer network system address. They work in the following manner: any transaction or message transmitted over a network should have a header label that identifies its destination. Before sending the transaction or message, the system should verify that the transaction or message destination is valid and is authorized to receive data. Finally, when the transaction or message is received, the system should verify that the identity of the receiving destination is consistent with the transaction’s or message’s destination code.
Message acknowledgment procedures are useful for preventing the loss of part or all of a transaction or message on a computer network system. For example, if messages contain a trailer label, the receiving destination (or unit) can check to verify that the complete message was received. Furthermore, if large messages or sets of transactions are transmitted in a batch, each message or transaction segment can be numbered sequentially.
The receiving destination can then check whether all parts of the messages or transactions
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were received and were in the correct sequence. The receiving unit will signal the sending unit regarding the outcome of this evaluation. Should the receiving unit detect a data transmission error, the data will be retransmitted once the sending unit has been signaled about this error.

Controls for Personal Computers. Developing control procedures for an organization’s portable laptops and desktop PCs begins by taking an inventory of them throughout the organization. The various applications for which each PC is used should also be identified. This should be followed by classifying each PC according to the types of risks and exposures associated with its applications. To discourage outright theft of desktop PCs, many companies bolt them in place or attach monitors to desks with strong adhesives. A control procedure for laptops is to lock them in cabinets before employees leave at night.
Additional control procedures for laptops are identified in Figure 10-5.
PCs are relatively inexpensive. Therefore, it may not be cost-effective for a company to go to elaborate lengths to protect them. What companies should do is use inexpensive, yet effective, control procedures for PCs. It should be noted that because of the compact nature of laptop PCs, theft of these assets has become a big problem for both corporate entities and government agencies.

Case-in-Point 10.4 Recently, an insurance company handled $1 billion in claims for stolen laptops in a single year. In a survey of major corporations and large government agencies conducted a few years ago by the Computer Security Institute and the FBI computer crime squad, 69% of the respondents acknowledged incidents of laptop theft. One hundred fifty organizations cited a total of over $13 million in financial losses. The average annual price tag of losses per organization was $86,920.

Control Procedures for Laptops
Control Procedure
Identify your laptop

How to Use the Procedure
• Which model? What configuration? What is the serial number? Are there any other unique identifiers? Without these details, law enforcement agencies, airlines, hotels, and so on, have little chance of retrieving your company’s stolen laptop.
• Keep a copy of all relevant information about your laptop in a safe place. Leave it in your desk at the office or at your home. Never tape the relevant information to the laptop or store the information electronically on the laptop’s hard disk.

Use nonbreakable cables to attach laptops to stationary furniture

• For example, in a hotel room be sure to use a cable or other security device to attach the laptop to some stationary object such as a desk or some other piece of heavy furniture.

Load Antivirus software onto the hard disk

• Automatically perform an Antivirus scan whenever the laptop is turned on or whenever a diskette is inserted.
• Have Antivirus scanning software check all changed or new files.
• Keep Antivirus software current. Keep virus definitions current.

Back up laptop information • Never keep backups in the laptop case.
• While traveling, keep backup diskettes in a pocket or briefcase.
• If possible, back up to your company’s internal network via modem, when you are out of the office.
• Back up frequently and test regularly to ensure data integrity.

FIGURE 10-5 Additional control procedures for laptops.

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As laptops and tablet devices become more sophisticated, people are using them as primary PCs and are saving large amounts of critical data on portable drives. Three simple safeguards are (1) back up important laptop data often, (2) password protect them, and
(3) encrypt sensitive files. Organizations can also install antitheft systems in laptops and portable devices—for example, software that uses the integrated Web cam to take a picture of whoever uses it next or GPS systems can track the equipment itself.

Case-in-Point 10.5 ‘‘Laptops hardly ever get backed up,’’ laments Scott Gaidano, president of DriveSavers, ‘‘and because laptops are portable, they get into more adventures.’’
Among the many disasters he has seen regarding laptop computers include the following: one fell into the Amazon River, one melted in a car fire, one was run over by a bus, and four were dumped in bathtubs. In each case, although the machine was trashed, the data were salvaged.
And recently, the company has saved digital media that included everything from official photos of the President to images of athletes at the Sydney Olympics to cosmetic surgery photos.7

Protection of Systems and Data with Personnel Policies
An AIS depends heavily on people for creating the system, inputting data into the system, supervising data processing during computer operations, distributing processed data to authorized recipients, and using approved controls to ensure that these tasks are performed properly. General controls within IT environments that affect personnel include: separation of duties, use of computer accounts, and identifying suspicious behavior.

Separation of Duties. Within IT environments, separation of duties should be designed and implemented by requiring separate accounting and IT subsystems or departments and also by separate responsibilities within the IT environment.

Separate Accounting and Information Processing from Other Subsystems. An organization’s accounting and information processing subsystems are support functions for the other organizational subsystems and should be independent, or separate, from the subsystems that use data (accumulated by the accounting function and processed by the information processing subsystem) and perform the various operational activities. To achieve this separation, the functional design identified in Figure 10-6 should exist within organizations. Methods to Separate Accounting and Other Systems
1. User subsystems initiate and authorize all systems changes and transactions.
2. Asset custody resides with designated operational subsystems.
3. Corrections for errors detected in processing data are entered on an error log, referred back to the specific user subsystem for correction, and subsequently followed up on by the data control group (discussed shortly).
4. Changes to existing systems as well as all new systems require a formal written authorization from the user subsystem.

FIGURE 10-6 Functional design to separate accounting and information processing subsystems from other subsystems.
7

http://www.photoshopsupport.com/photoshop-blog/06/08/scott-gaidano-drivesavers.html

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Separate Responsibilities Within IT Environment. Highly integrated AISs often combine procedures that used to be performed by separate individuals. Consequently, an individual who has unlimited access to the computer, its programs, and live data also has the opportunity to execute and subsequently conceal a fraud. To reduce this risk, a company should design and implement effective separation of duties control procedures.
Figure 10-7 describes several functions within a company’s IT environment, where it is essential to divide the authority and responsibility for the functions.
The design and implementation of effective separation-of-duties control procedures make it difficult for any one employee to commit a successful fraudulent activity. However, detecting fraud is even more challenging when two or more individuals collude to override separation-of-duties control procedures. A recent survey by the Association of Certified

Function
Systems
analysis function Data control function Programming function Computer operations function

Explanation of Function/Division
• Analyze information, process needs, design/modify application programs.
• The person performing this function should not perform other related functions. For example, do not allow a programmer for a bank to use actual data to test her program for processing loan payments (she could conceivably erase her own car loan balance).
• Use a data control group; maintain registers of computer access codes; help acquire new accounting software (or upgrades); coordinate security controls with specific computer personnel (e.g., database administrator); reconcile input/output; distribute output to authorized users.
• Should be independent of computer operations. This function inhibits unauthorized access to computer facility and contributes to more efficient data processing operations.
• Require formal authorizations for program changes; submit written description of changes to a supervising manager for approval; test changes to programs prior to implementation.
• Rotate computer operators among jobs to avoid any single operator always overseeing the same application.
• Do not give computer operators access to program documentation or logic. • Two operators in the computer room during processing of data; maintain a processing log and periodically review for evidence of irregularities.

Transaction authorization function

AIS library function • Without these control procedures a computer operator could alter a program
(e.g., to increase his salary).
• For each batch of input data, user subsystems submit signed form to verify input data are authorized and proper batch control totals are compiled.
• Data control group personnel verify signatures and batch control totals before processing data.
• These procedures help prevent errors (e.g., a payroll clerk cannot submit unauthorized form to increase pay rate).
• Maintain custody of files, databases, and computer programs in separate storage area called the AIS library.
• Limit access to files, databases, and programs for usage purposes to authorized operators at scheduled times or with user authorization; maintain records of all usage.
• The librarian does not have computer access privileges.

FIGURE 10-7 Divide certain authority and responsibility functions within an IT environment.

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Fraud Examiners (ACFE) reports that over 36% of all fraud cases are committed by two or more individuals who work together to embezzle organizational assets. The median loss in these cases is $500,000, compared to a median loss of $115,000 in fraud cases that involve only one person.8

Case-in-Point 10.6 The former D.C. tax manager, Harriette Walters, was able to embezzle more than $48 million over two decades largely because the culture in the finance office in the District of Columbia was one of apathy and silence. Walters and 10 accomplices, who did not work for the city, pleaded guilty to creating and laundering bogus tax refund checks. The embezzlement scheme is the largest involving a city or state government.9

Use of Computer Accounts. Most computer networks maintain a system of separate computer accounts. Each user has an account, and each account has a unique password.
When the user logs onto the computer, the system checks the password against a master list of accounts. Only users with current passwords can access computer resources. Some organizations also use account numbers to allocate computer charges to departments. This control procedure is important to protect scarce computer resources from unauthorized use. While passwords have been the most used security method to grant users access, IT administrators have a variety of problems with them. Individuals paste their passwords on their monitors, share them with others, or choose simple passwords that are relatively easy for a hacker to guess. As a result, many firms now use biometric identification instead, as discussed earlier.

Identifying Suspicious Behavior. The 2008 ACFE survey notes that employees who are defrauding their organizations often display certain behaviors (red flags) that can alert coworkers and supervisors to trouble. Examples include lavish spending or becoming very irritable or secretive. In particular, the survey results indicate that in over 38% of the cases of fraud, the fraudsters were living beyond their means, 34% had financial difficulties, 20% had
‘‘wheeler-dealer’’ attitudes, 19% were unwilling to share duties (control issues), and 17% had family problems or were in the middle of a divorce. Sadly, the survey results indicate that the highest percentage of fraud involved employees in the accounting department
(29% of all cases reported by survey participants).
While it might be difficult for coworkers or supervisors to know intimate details of coworkers’ personal lives, some of these behaviors may be observed without directly confronting the suspicious coworker. The threats to an organization by its own employees should never be underestimated. To add emphasis to the need to be alert, PWC’s Global State of Information Security Study estimated that people inside organizations were the culprits in 69% of database breaches, and new technologies (e.g., ERPs, B2B processes, and mobile devices) make organizational data even more vulnerable to potential misappropriation.10
Accordingly, it is essential for organizations to safeguard computer files in an AIS from both intentional and unintentional errors. Figure 10-8 describes several reasons for these safeguards. 8

http://www.acfe.com/documents/2008-rttn.pdf
Nakamura, D., and H. Harris. 2008. Report on embezzlement blames ‘‘culture of apathy and silence.’’ Washington
Post (December 16): B04.
10 Roth, J., and D. Espersen. 2008. The insider threat. Internal Auditor (April): 71–73.
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Reasons for Safeguarding Files
1. The computer files are not human-readable. Controls must be installed to ensure that these files can be read when necessary.
2. The typical computer file contains a vast amount of data. In general, it is not possible to reconstruct such files from the memories of employees.
3. The data contained on computer files are in a very compact format. The destruction of as little as one inch of recording medium means the loss of thousands of characters of data.
4. The data stored on computer files are permanent only to the extent that tiny bits have been recorded on the recording tracks. Power disruptions, power surges, and even accidentally dropping a disk pack, for example, may cause damage.
5. The data stored on computer files may be confidential. Information such as advertising plans, competitive bidding plans, payroll figures, and innovative software programs must be protected from unwarranted use.
6. The reconstruction of file data is costly no matter how extensive a company’s recovery procedures. It is usually more cost-effective to protect against file abuse than to depend on backup procedures for file protection.
7. File information itself should be considered an asset of a company. As such, it deserves the same protection accorded other organizational assets.

FIGURE 10-8 Reasons for safeguarding computer files from both accidental and intentional errors. Protection of Systems and Data with Technology and Facilities
In addition to protecting systems and data by controlling personnel, organizations must adequately plan for the protection of hardware and software resources and design software to protect data assets.

File Security Controls. The purpose of file security controls is to protect computer files from either accidental or intentional abuse. For example, this requires control procedures to make sure that computer programs use the correct files for data processing.
Control procedures are also needed for the purpose of creating backup copies of critical files in the event that original copies of a file are lost, stolen, damaged, or vandalized.
Figure 10-9 provides examples of file security control procedures to verify that the correct file is being updated and to prevent accidental destruction of files.

Business Continuity Planning. Organizations develop and test business continuity plans to be reasonably certain that they will be able to operate in spite of any interruptions—such as power failures, IT system crashes, natural disasters, supply chain problems, and others. Although the distinction between business continuity plans and disaster recovery is not always obvious, they are different. Business continuity planning
(BCP) is a more comprehensive approach to making sure organizational activities continue normally, whereas disaster recovery involves the processes and procedures that organizations follow to resume business after a disruptive event such as an earthquake, a terrorist attack, or a serious computer virus. In this section, we discuss disaster recovery controls, controls to ensure fault-tolerant systems, and controls to back up data.

Disaster Recovery. Examples of natural disasters include such events as fires, floods, hurricanes, and earthquakes, as well as man-made catastrophes (such as terrorist attacks).
An organization’s disaster recovery plan describes the procedures to be followed in the

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File Security Control
External file labels
Internal file labels

Purpose of File Security Control
• Identify contents of a computer file and help prevent an individual from accidentally writing over a disk file.
• Record name of a file, date file created, and other identifying data on the file medium that will be read and verified by the computer.
• Internal file labels include header labels and trailer labels.
• Header label is a file description at the beginning of a file.
• Trailer label indicates end of a file and contains summary data on contents of file.

Lockout procedures
Read-only file designation

• Use to prevent two applications from updating the same record or data item at the same time.
• Use to earmark data on floppy disks so that data is available for reading only, data cannot be altered by users, nor can new data be stored on the file.

FIGURE 10-9 Examples of file security control procedures. event of an emergency, as well as the role of every member of the disaster recovery team (which is made up of specific company employees). The company’s management should appoint one person to be in charge of disaster recovery and one person to be second-in-command. An important part of any disaster recovery plan is the designation of specific backup sites to use for alternate computer processing. These backup sites may be other locations owned by the company, such as another branch of the same bank, or a site that is owned by other organizations, which it can use for short-term periods in the event of a disaster. It is a good idea for the various hardware locations for data processing to be some distance away from the original processing sites in case a disaster affects a regional location.

Case-in-Point 10.7 USAA, a large insurance company in San Antonio, TX, engaged outside consultants to help determine where the company should locate an alternate data processing center for operations in the event of an emergency. The consulting firm suggested the company build a second data center in the area as a backup. After weighing the costs and benefits of such a project, USAA initially concluded that it would be more efficient to rent space on the East Coast. Ironically, USAA was set to sign the lease contract the week of September
11, 2001. Instead, USAA built a center in Texas, only 200 miles away from its offices—close enough to drive between locations, but far enough away to pull power from a different grid and water from a different source.11
Disaster recovery sites may be either hot sites or cold sites. A hot site has a computer system with capabilities similar to the system it will replace. A hot site that also includes upto-date backup data is called a flying-start site because it can assume full data processing operations within a matter of seconds or minutes. A cold site is a location where power and environmentally controlled space are available to install processing equipment on short notice. If a disaster recovery plan designates a cold site, then arrangements are also necessary to obtain computer equipment matching the configuration of equipment lost in the disaster. In practice, the type of disaster recovery site used by a company should be determined by a cost-benefit analysis. Finally, simply preparing a disaster recovery plan
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does not provide assurance that the plan will work when needed. It is also important to periodically test the disaster recovery plan by simulating a disaster, thereby uncovering weaknesses in the plan as well as preparing employees for such emergencies.
Copies of a disaster recovery plan will not be of much use if they are located only in computer systems that are destroyed by a disaster. For this reason, members of a company’s disaster recovery team should each keep current copies of the plan at their homes. Finally, in addition to periodic testing, a disaster recovery plan should be reviewed on a continuous basis and revised when necessary. This process is an integral part of business continuity planning. Case-in-Point 10.8 A 2010 survey by CDW found that most companies report having a business continuity plan in place, but almost all of these same companies took a hit when there was a network disruption. Although 82% of the respondents felt confident that their
IT resources could sustain disruptions and support operations effectively, 97% admitted that network disruptions had detrimental effects on their businesses in the last year. Power loss ranked as the top cause of business disruptions over the past year. Hardware failures caused 29% of network outages, and 21% of the problems were a loss of telecom services to facilities.12 Fault-Tolerant Systems. Organizations use fault-tolerant systems to deal with computer errors and keep functioning so that data is accurate and complete. Fault-tolerant systems are often based on the concept of redundancy. Computer systems can be made fault-tolerant with duplicate communication paths or processors. Two major approaches are as follows: (1) Systems with consensus-based protocols contain an odd number of processors; if one processor disagrees with the others, it is thereafter ignored. (2) Some systems use a second watchdog processor. If something happens to the first processor, the watchdog processor then takes over the processing work.
Disks can be made fault tolerant through a process called disk mirroring (also known as disk shadowing). This process involves writing all data in parallel to multiple disks.
Should one disk fail, the application program can automatically continue using a good disk.
At the transaction level, a fault-tolerant system can use rollback processing, in which transactions are never written to disk until they are complete. Should there be a power failure or should another fault occur while a transaction is being written, the database program, at its first opportunity, automatically rolls itself back (reverts) to its prefault state.
Backup. Backup is similar to the redundancy concept in fault-tolerant systems. For example, if you write a research paper on a computer, you would be wise to backup your work on a flash drive. As we know, a variety of unfortunate events could occur, and you might lose all of your work! If you used a computer in a lab on campus, you are probably aware of the fact that the hard drives are automatically cleaned every night, so your paper would not be on the hard drive of that computer the next day. And of course, other events such as a power failure or human error might occur and—your paper is gone. However, if you copied your paper on a flash drive, you created redundancy so that a problem will not cause you to lose your work.
Because of the risk of losing data before, during, or after processing, organizations have an even greater need to establish backup procedures for their files. The backup and reconstruction procedure typically used under batch processing is called the grandfatherparent-child procedure. Very large organizations might store more than three such copies
12

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(i.e., great-grandfather, great-great-grandfather), and banks typically keep many more copies because of the nature of their business.
Three generations of reference data (i.e., previously processed data stored on master files) are retained with the transaction data used during the general ledger updating process.
If the most recent master file, the ‘‘child’’ copy, is destroyed, the data are reconstructed by rerunning the pertinent transaction data against the prior copy of the reference data
(the ‘‘parent’’ master file). Should a problem occur during this reconstruction run, there is still one more set of backup data (the ‘‘grandfather’’ master file) to reconstruct the parent.
The ‘‘parent’’ master file is then used to reconstruct the ‘‘child’’ master file. Figure 10-10 depicts this procedure.

Journal voucher batch of transaction data Key in journal voucher data

Unsorted journal vouchers

If we lost the "child" master file, we could process the transaction file against the "parent" master file.

Sort vouchers in chart of account order

Sorted journal vouchers
(Parent)
General ledger master

Edit input and update master file

Grandfather
"Old" general ledger master from preceding batch process run
(not shown on this day's run)
Old general ledger master

New general ledger master

Parent

Sorted journal vouchers

Error and exception report

Child

FIGURE 10-10 Grandfather-parent-child procedure under batch processing.

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With the sophisticated real-time systems widely used today, online backups are common. A hot backup is a backup performed while the database is online and available for read/write, whereas a cold backup is performed while the database is off-line and unavailable to its users. During processing, the reference data (master files) are periodically copied on a backup medium. A copy of all transaction data is stored as a transaction log as these data are entered into the system. The backup copies are stored at a remote site, which allows data to be recovered in the event a disaster occurs. Through a process called electronic vaulting, the data on backup media can be electronically transmitted to a remote site. Should the master file be destroyed or damaged, computer operations will roll back to the most recent backup copy of the master file. Recovery is then achieved by reprocessing the contents of the data transaction log against this master file backup copy.
A good disaster recovery plan also includes backups for hardware. With regard to electrical power backup, surge protectors provide protection in the case of short, intermittent power shortages or failures. However, large data processing centers may require additional generators for backup power. An uninterruptible power system
(UPS) is an auxiliary power supply that can smooth the flow of power to the computer, thereby preventing the loss of data due to momentary surges or dips in power. Should a complete power failure occur, the UPS provides a backup power supply to keep the computer system functioning.

Computer Facility Controls. Computer security experts point out that a blunt hammer trumps a strong password every time. What this means is that the physical assets of the data processing center (such as the Web servers, the peripheral devices, and the disk files of the computer library) must be protected. Below we describe some computer facility controls that prevent both unintentional and intentional physical harm to systems.

Locate Data Processing Centers in Safe Places. Usually, organizations locate data processing centers where the public does not have access. Locations away from public scrutiny and guarded by personnel are obviously preferred. The location of a data processing center should also take into consideration natural disasters. Although it is impossible to protect data processing centers completely from such hazards, advanced planning can minimize exposure to them. For example, companies can increase their protection from fires by locating computer facilities away from boiler rooms, heating furnaces, or fuel storage areas. Similarly, locating computer facilities on high ground or the upper stories of office buildings provides protection from floods. Finally, locating computer facilities in single-story buildings or in heavily reinforced ones can limit earthquake damage.

Limit Employee Access. Few people have reason to be inside a data processing center. Thus, another facility control is to limit access to company personnel who wear color-coded identification badges with full-face pictures. Security badges typically have embedded magnetic, electronic, or optical codes that can be read by badge-reading devices.
With advanced identification techniques, it is possible to have each employee’s entry into and exit from the data processing center automatically recorded in a computer log, which should be periodically reviewed by supervisory personnel.
Another facility control is to place a guard at the entrance to the data processing center.
A man trap is a small antechamber room between a public corridor and a controlled room.
The inner door to the center is self-locking and can be buzzed open only by the control person, who permits only authorized personnel to enter. Finally, issuing keys to authorized

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personnel or using dial-lock combinations limits access to the data processing center. With regard to this last control, it is also a good idea to change locks or lock combinations often and to use keys that cannot easily be duplicated.

Buy Insurance. Although insurance is usually thought to be an important method of protection for computer systems, it is actually the protection of last resort. Insurance does not protect the purchaser from loss, it merely compensates for losses if they occur.
Insurance policies for computer damages are usually limited in coverage, which means that not all instances of loss may be recoverable by the policyholder. Furthermore, compensation usually is restricted to the actual losses suffered by a company. As you might imagine, a fair estimate of the value of data losses is not an easy matter.

APPLICATION CONTROLS FOR TRANSACTION PROCESSING
Enterprise-level controls focus on firm-wide issues, while IT general controls apply to all information systems. The purpose of application controls is to prevent, detect, and correct errors and irregularities in processing transactions. IT general controls and application controls are becoming more integrated because IT general controls support application controls, and together, they ensure complete and accurate information processing.
Application controls are those controls that are embedded in business process applications. The three major stages of data processing are inputting data, processing the data, and reporting the processed data in some form of output (e.g., a performance report). We discuss various application control procedures for AISs based on these three stages. First, we examine application controls over data input (called input controls). Next, we identify application controls that are intended to protect the processing of data (called processing controls), and finally, we survey application controls related to data output (called output controls). Figure 10-11 emphasizes the important point that a company’s application controls consist of input, processing, and output controls. Since every company’s system is somewhat different, each company must consider the risk of errors and irregularities going undetected in processing its accounting data. The company must then design and implement its own cost-effective combination of input, processing, and output application controls.

Input Controls
Although many organizations are now using automated systems to collect data (e.g., bar code scanners), some applications still require employees to manually enter data in the information system. As a result, the risk of undetected errors and irregularities is typically

Application Controls

Input Controls

Processing Controls

Output Controls

FIGURE 10-11 The composition of a company’s application controls.

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higher in this stage compared to the processing and output stages. In an attempt to reduce this risk factor, the strongest application controls are commonly found in the input stage of data processing.
Input controls help ensure the validity, accuracy, and completeness of the data entered into an AIS. It is usually cost-effective to test input data for the attributes of validity, accuracy, and completeness as early as possible. There are at least four reasons for this:
1. Data that are rejected at the time they are input can be more easily corrected—for example, by reference to a source document.
2. It is not cost-effective to screen accounting data continuously throughout the processing cycles of an AIS. Past some point in the job stream, all data are considered valid and error-free. 3. It is vital that an AIS use accurate data in later data processing operations. This protects master files from inaccuracies and safeguards computer processing in subsequent stages of the data processing work.
4. An AIS cannot provide good outputs if it does not start with good inputs.
For discussion purposes, it is useful to divide the topic of input application controls into three categories: (1) observation, recording, and transcription of data; (2) edit tests; and (3) additional input controls.

Observation, Recording, and Transcription of Data. In general, data enter an AIS when business transactions are recorded. An organization often finds it useful to install one or more observation control procedures to assist in collecting data that will be recorded. One such control procedure is the introduction of a confirmation mechanism—for example, requiring a customer to sign, and therefore confirm, a sales order. The data observation process can also make use of dual observation. Under this control procedure, the accuracy of the data observation process is enhanced because more than one employee participates in the process. In some organizations, the dual observation control procedure is supervisory. Here, the supervisor of the employee (or employees) involved in collecting data is required to confirm the accuracy of the data gathered by the employee. Once accounting data have been collected, they must be recorded. Data collection and the subsequent recording of these data are areas in which a great deal of automation has taken place. For example, the use of point-of-sale (POS) devices (such as bar code readers that interpret the universal product code (UPC) commonly printed on store products and smart cash registers that are connected to off-site computers) to encode data have been found to substantially decrease error rates in the recording process as well as to eliminate the expense involved in rekeying data.
In some instances, automated data collection and recording are not feasible, and an initial source document must be prepared manually. To encourage accuracy in the data collection and recording processes in these situations, several control procedures are possible. One example is to use preprinted recording forms, such as the inventory receipts form illustrated in Figure 10-12. In general, these forms ensure that all the data required for processing have been collected and also enhance accuracy in the recording process.
For example, the exact number of spaces required for such field items as the inventory part number and the supplier account number is clear because a box has been provided for each numerical digit, thus guarding against the loss or addition of digits in these fields.
Organizations can use similar controls on Web pages.

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No. 11345736-A

Matt Camera Company
14 West Avon Road
Avon, CT 06001

Employee Name

Larry Burns

Employee Number

5362143

Inventory Receipts Form
Inventory Part Number

3 4 7 6 2 9 4
1

8 4 3 1

7

6 9 4 4

8

Date

4 0

15

16

0 7 2 4 1

2
27

1

1

9

20

Item Number
(If Applicable)

Cost per Unit

22

0 0

28

34

Unit
Code

Quant. Received

Supplier Account Number

1
21
1 = each
2 = dozen
3 = gross

L 2 4 1 4
35

40

Alphabetic Description of Item

C O O L P I
41

X

C A M E R A

Supervisor's Signature
55

FIGURE 10-12 A preprinted recording form for inventory receipts.

When using transcription, the data on source documents should be organized to facilitate the transcription process. Thus, well-designed, preprinted source-document forms are an important input control because they encourage adherence to the general principle of source-document and computer-input compatibility. Specially designed input forms are the most commonly used method to enter data in a database. Some advantages of database forms are that they can be designed to lock certain fields to prevent changes, to control certain fields so that a user cannot enter an unreasonable value, and to limit data values in certain fields.

Edit Tests. Programs or subroutines that check the validity and accuracy of input data after the data have been entered and recorded on a machine-readable file are called input validation routines (or edit programs). The specific types of validity and accuracy checks that input validation routines perform are called edit tests (or edit checks). Edit tests examine selected fields of input data and reject those transactions (or other types of data input) whose data fields do not meet the preestablished standards of data quality. Realtime processing systems perform edit tests during the data-entry process. Batch processing systems (illustrated in Figure 10-13) execute edit tests before regular data processing.
Edit tests can also be coordinated in what is called a redundant data check to ensure data accuracy. The idea is to encode repetitious data on a file or transaction record, thereby enabling a later processing test to compare the two data items for compatibility. For example, the reason you are always asked for the expiration date of your credit card is because that value is also encoded in the credit card number as well. Examples of edit tests are listed in Figure 10-14.
Additional Input Controls. It is possible for a data field to pass all of the edit tests previously described and still be invalid. To illustrate, a bank might use the incorrect

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Transactions

Transaction edit program

Error report Valid transactions Correction procedures To file maintenance Reentry

Rejected transactions Error correction program

Corrected transactions Merge with next batch of transactions FIGURE 10-13 Use of edit program to execute edit tests under batch processing. account number 537627 (instead of the proper account number 537621) when processing a customer’s transaction. When the incorrect account number is keyed into a remote terminal and submitted to edit tests, it will, for example, (1) pass a test of numeric field content ensuring that all digits were numeric, (2) pass a test of reasonableness ensuring that the account number itself fell within a valid range of values (e.g., account number greater than 100,000 and less than 800,000), (3) pass a test of sign (i.e., account number positive), and (4) pass a test of completeness (i.e., no blanks in fields).
Thus, additional control procedures are required for this error to be detected. One control procedure is to incorporate a validity test into the data processing routine used to update the master file of bank records. With this approach, any transaction for which there is no corresponding master file record would be recognized as invalid and rejected from the transaction sequence (it would be returned for correction). But what if a master file record did exist for account 537627—the incorrect account number? This would indeed be unfortunate because our ‘‘unfound-record’’ control procedure would not detect the error,

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Tests
Numeric field content
Alphabetic field content
Alphanumeric field content
Valid codes
Reasonableness
Sign
Completeness
Sequence

Consistency

Purpose
To make sure that data fields such as Social Security number, sales invoice number, and date contain only numbers
To make sure fields such as customer name contain only alphabetic letters
To make sure that fields such as inventory parts descriptions contain letters and/or numbers, but no special characters
For example, 1 = cash sale; 2 = credit sale
For example, total hours worked by an employee during a weekly pay period does not exceed 50
For example, paycheck amounts always positive
To check that there are no blanks in fields that require data
To make sure that successive input data are in some prescribed order (e.g., ascending, descending, chronological, and alphabetical)
For example, all transactions for the same sales office have the same office code number

FIGURE 10-14 Examples of edit tests. and, even worse, the legitimate master file record with account number 537627 would be updated with the transaction data generated by another customer.
Continuing with our bank example, an alternative to this unfound-record test is to expand the six-digit data field of customer bank account numbers to seven digits with a check-digit control procedure. Normally, the check digit is computed as a mathematical function of the other digits in a numeric field, and its sole purpose is to test the validity of the associated data. To illustrate, consider the original (correct) account number 537621.
The sum of these six digits is 5 + 3 + 7 + 6 + 2 + 1 = 24. One type of check digit would append the low-order digit of this sum ‘‘4’’ to the account number. The seven-digit value
5376214 would be used instead of the six-digit series 537621 to represent the account number. The computer program would duplicate this computational procedure at the time of data access and therefore validate the accuracy of the data before the transaction data were used to update a master file record.
A check digit does not guarantee data validity. For example, the check-digit procedure described here would be unable to distinguish between the correct account number
5376214 and the transposed number 5736214 because the transposition of digits does not affect the sum. There are, however, check-digit techniques that do include ‘‘ordering of digits’’ in the construction of check-digit values. However, these and other very detailed computer checks are beyond the scope of this textbook, so we’ll move on now to processing controls.

Processing Controls
Processing controls focus on the manipulation of accounting data after they are input to the computer system. An important objective of processing controls is to contribute to a good audit trail. A clear audit trail is essential, for example, to enable individual transactions to trace, to provide documentation for changes in general ledger account balances, to

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prepare financial reports, and to correct errors in transactions. To achieve a good audit trail, some systems require a printed transaction listing during each file update by batch processing systems and at the end of every day by online processing systems.
Furthermore, use of a unique and sequentially assigned transaction reference designator to identify each transaction in a listing promotes better audit trails. These transaction reference designators should be posted to the general ledger account records and recorded on the specific source documents pertaining to the transactions. Figure 10-15 illustrates an audit trail for a computer-based system, showing how source documents can be easily located by tracing back from an activity (or proof ) listing, which is discussed shortly under output controls.

Control Totals. Suppose you were the data processing manager at a bank that processed over 100,000 bank checks per day. How would you make sure that all these checks are correctly processed by the computer? One procedure is to batch the checks in separate bundles of, say 200 checks, and prepare a special batch control document to serve as a control on the contents of each bundle. The information on this document might include the bundle number, today’s date, and the total dollar amount for the checks themselves.
The total dollar amount represents the batch control total. When computer processing commences, the special information on the lead control record (i.e., the batch control document) is accessed first and the batch control total is stored in computer memory.
As the checks are accessed individually, their amounts are also accumulated in computer memory. Once all the checks in the batch are read, the accumulated total is compared with the batch control total. A match signals acceptable processing. A nonmatch signals an error, which may then be traced either to an error in the batch control total or to some difficulty in processing—for example, the inability of the MICR reader to understand the data on one or more checks.
In fact, MICR readers are themselves a form of control. An original check has a line of magnetic ink with specific information that is recognized by highly reliable MICR readers.
Even the best printers do not use this magnetic ink and copied checks can therefore be detected immediately.13
A control total that involves a dollar amount is called a financial control total. Other examples of financial control totals include the sum of cash receipts in an accounts receivable application, the sum of cash disbursements in an accounts payable application, and the sum of net pay in a payroll application.

BB
Source
document

CC

AMOUNT 1

Transaction listing BB AMOUNT 1
CC AMOUNT 2

Activity listing (here an account change report)
ACCT. NO XXX
CHANGES

BAL YYYY.YY
AMOUNTS

BB
CC

AMOUNT 1
AMOUNT 2

AMOUNT 2

BB, CC are transaction reference designators

FIGURE 10-15 An audit trail for a computer-based system.
13

http://www.pointofsale.com

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AISs also use nonfinancial control totals, which compute nondollar sums. For example, controls could compute the sum of the total number of hours worked by employees in a payroll application. A similar control is a record count. With this control procedure, the number of transaction items is counted twice: once when preparing transactions in a batch and again when actually performing the data processing. Yet a third example is the exact byte count of a legitimate computer program, which IT personnel can use to detect tampering. Control totals do not have to make sense to be useful. For example, when cash receipts from customers are processed, the manual sum of the customers’ account numbers in a batch of transactions might be computed to form a hash total. This sum is meaningless, but is useful as a check against an ‘‘internal’’ tally of this same hash total by the computer at the time of data access.

Data Manipulation Controls. Once data have been validated by earlier portions of data processing, they usually must be manipulated (i.e., processed) in some way by computer programs to produce decision-useful information, such as a report. One processing control procedure is to make sure that the computer programs are complete and thorough in their data manipulation. Ordinarily, this is accomplished by examining software documentation. System flowcharts, program flowcharts, data flow diagrams, and decision tables can also function as controls because they help systems analysts do a thorough job in planning data processing functions.
After computer programs have been coded, they are translated into machine language by an error-testing compiler. The compiler controls the possibility that a computer program contains programming language errors. A computer program can also be tested with specially designed test data that expose the program to the exception conditions likely to occur during its actual use.

Output Controls
Once data have been processed internally by a computer system, they are usually transferred to some form of output medium for storage, screen display, or, in the case of printed output, prepared as a report. The objective of output controls is to ensure the output’s validity, accuracy, and completeness. Two major types of output application controls within IT environments are (1) validating processing results and (2) regulating the distribution and use of printed output.

Validating Processing Results. The validity, accuracy, and completeness of computerized output in AISs can be established through the preparation of activity (or proof ) listings that document processing activity. These listings provide complete, detailed information about all changes to master files and thus contribute to a good audit trail.
Organizational employees use such activity listings to trace file changes back to the events or documents that triggered these changes and thereby verify current file information or printed information as valid, accurate, and complete output.

Regulating Distribution and Use of Printed Output. One of the more compelling aspects of output control deals with the subject of forms control. Perhaps the most interesting situations involve computerized check-writing applications in which MICR forms or perforated printer forms become the encoding media for preparing a company’s

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checks. Usually, these forms are preprinted with the company’s name, address, and bank account number. Control over the forms associated with check writing is vital.
The most common type of control used with computer-generated check-writing procedures is the coordination of a preprinted check number on the printer form with a computer-generated number that is printed on the same form at run time. The numbers on these prenumbered forms advance sequentially and are prepared by the forms’ supplier according to the specifications of an organization. The computer-generated numbers also run sequentially and are initialized by adding 1 to the check sequence number stored from the last processing run. The numbers on the prenumbered forms and the computergenerated numbers should match during normal processing. Discrepancies should be examined carefully, and the causes fully resolved. Other examples of forms that employ prenumbering methods include reports containing sensitive corporate information and computer-generated lottery and athletic event tickets.
Computer reports often contain sensitive information and it is important that such information be restricted. Thus, for example, a payroll register, indicating the earnings of each employee during a given pay period, is a type of report whose distribution should be restricted. The most common approach to distributional control is through an authorized distribution list. For each output report (hard copy or electronic), distribution is limited to authorized users only. Where data processing activities are centralized, it is sometimes the case that the user will physically visit the computer facility to pick up a copy of a sensitive report. In these instances, a notebook, or log, of pickups can be maintained and the pickup employee asked to sign the book. The employee’s identification number is recorded for security purposes at the time the report is taken.
In situations where it is not possible to have representatives from user groups pickup reports, bonded employees can be authorized to deliver the reports to users. Subsequently, random checks on the distribution of these reports can be made by the bonded employees’ supervisors to verify distribution. After sensitive reports are no longer needed, it is important to properly destroy them (i.e., use a document shredder). Shredding reports is a stronger control than throwing them away because discarded reports can be retrieved from trash bins.

AIS AT WORK
Biometrics Used to Prevent Fraud14
Many firms failed in 2009 and 2010 because of the economic crisis. In addition, investors lost billions of dollars as a result of fraud perpetrated by employees and executives. SAP is expanding the use of biometrics in its enterprise systems in order to better prevent and detect fraud. The idea is to combine biometric identification with passwords such that system users must first be identified with fingerprints and then must supply a password before the user can gain access to any system. In addition, biometric and password combinations are specific to applications and subsets of major systems, which prevents employees from accessing anything that they are not specifically authorized to access.
A recent fraud at Societe Generale Bank could have been prevented with biometric internal controls. One of the bank’s traders used his knowledge of the bank’s ERP system to engage in secret trading activity. The trader had been trained in using the bank’s ERP
14

http://en.sap.info/biometric-security-for-financial-meltdown-solutions/10874

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system prior to becoming a trader and he used his knowledge of the system to commit fraud. The trader was able to create e-mails in the system to establish fake authorizations, use his colleagues’ log-in passwords to conduct trades in other employees’ names, and delete records within the accounting system because he had access to more data within the AIS than he was authorized to have. Simple changes in IT general controls would have prevented the traders’ fraud. For example, biometric identification would have prevented him from logging in as other employees, and biometric identification in combination with password access to only the trading system would have prevented him from changing accounting records to cover his tracks. In brief, biometric identification systems would have stopped the trader from making secret trades and eliminated his ability to cover his tracks. New versions of SAP emphasize the combination of biometrics and passwords.
These systems also solve problems related to lost and stolen passwords. If a hacker is able to steal employees’ passwords, the passwords are useless without fingerprints or iris scans.

SUMMARY
Enterprise-level controls are so important because they often have a pervasive impact on many other controls, such as IT general controls and application-level controls.
At the organizational level, examples of important controls are management’s ethical values, philosophy, assignment of authority and responsibility, and the effectiveness of the board of directors. Firms are using an integrated approach to security by combining a number of technologies, including firewalls, intrusion detection systems, content filtering, vulnerability management, virus protection, and virtual private networks.
An integrated security system, supported by a comprehensive security policy, can significantly reduce the risk of attack because it increases the costs and resources needed by an intruder.
IT general controls are controls that are applied to all IT service activities. These controls are critical for reliance on application controls.
Senior management must have controls over human resources and data resources.
Business continuity planning is essential for surviving natural disasters and other business disruptions.
Organizations are increasingly relying on wireless networks and must recognize the need for a virtual private network (VPN) so that users may safely access entity data and other online resources. Due to increased mobility of employees, organizations must also develop controls for laptop computers to protect those assets as well as the data that resides on them.
Three major types of application controls are: (1) input controls, (2) processing controls, and
(3) output controls.

KEY TERMS YOU SHOULD KNOW application controls batch control total biometric identification business continuity planning (BCP)

checkpoint cold backup cold site consensus-based protocols

CHAPTER 10 / Computer Controls for Organizations and Accounting Information Systems

data encryption data manipulation controls disaster recovery disk mirroring disk shadowing edit programs edit tests electronic eavesdropping electronic vaulting fault-tolerant systems flying-start site hash total hot backup hot site input controls input validation routines integrated security

333

IT general controls logical security man trap message acknowledgment procedures output controls physical security processing controls red flags rollback processing routing verification procedures security policy strong passwords uninterruptible power system (UPS) validity test virtual private network (VPN) watchdog processor

TEST YOURSELF
Q10-1. A is a comprehensive plan that helps protect the enterprise from internal and external threats.
a. Firewall
c. Risk assessment
b. Security policy

d. VPN

Q10-2. According to PCAOB Standard No. 5, which of the following is an example of an entity-level control? a. Effectiveness of the board of directors
b. Personnel controls
c. Access to computer files
d. All of the above
Q10-3. Fault-tolerant systems are designed to tolerate computer errors and are built on the concept of:
a. Redundancy

c. COSO

b. COBIT

d. Integrated security

Q10-4. A site is a disaster recovery site that includes a computer system similar to the one the company regularly uses, software, and up-to-date data so the company can resume full data processing operations within seconds or minutes.
a. Hot

c. Flying start

b. Cold

d. Backup

Q10-5. Disaster recovery plans may not be of much use if:
a. They are not fully documented
b. The organization does not have a cold site for relocation purposes
c. The organization does not expect any natural disasters to occur
d. They are not tested periodically and revised when necessary

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Q10-6. Which of the following is not a computer facility control?
a. Place the data processing center where unauthorized individuals cannot gain entry
b. Limit access to the data processing center to all employees of the company
c. Buy insurance to protect against loss of equipment in a computer facility
d. Use advanced technology to identify individuals who are authorized access to the data processing center
Q10-7. In entering the billing address for a new client in Emil Company’s computerized database, a clerk erroneously entered a nonexistent zip code. As a result, the first month’s bill mailed to the new client was returned to Emil Company. Which one of the following would most likely have led to discovery of the error at the time of entry into Emil Company’s computerized database?15
a. Limit test

c. Parity test

b. Validity test

d. Record count test

Q10-8. A is a security appliance that runs behind a firewall and allows remote users to access entity resources by using wireless, handheld devices.
a. Data encryption

c. Checkpoint

b. WAN

d. VPN

controls to prevent, detect, and correct errors and irreguQ10-9. Organizations use larities in transactions that are processed.
a. Specific

c. Application

b. General

d. Input

Q10-10. A company’s management is concerned about computer data eavesdropping and wants to maintain the confidentiality of its information as it is transmitted. The company should utilize:16 a. Data encryption
b. Dial-back systems
c. Message acknowledgment procedures
d. Password codes
Q10-11. Which one of the following would most compromise the use of backups as protection against loss or damage of master files?17
a. Use of magnetic tape

c. Storing of all files in one location

b. Inadequate ventilation

d. Failure to encrypt data

DISCUSSION QUESTIONS
10-1. What is a security policy? What do we mean when we say organizations should have an integrated security plan?
10-2. What do we mean when we talk about convergence of physical and logical security? Why might this be important to an organization?
10-3. What guidance or framework would you use to establish IT governance if you were a senior executive in a firm? If you were a midlevel IT manager who was designing IT general controls?
A manager who was responsible for identifying the appropriate application controls?
15

Prior CMA exam question.
Prior CMA exam question.
17 Prior CMA exam question.
16

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335

10-4. What controls must be used to protect data that is transmitted across wireless networks?
10-5. Why is business continuity planning so important? Identify several reasons why testing the plan is a good idea.
10-6. What is backup and why is it important when operating an accounting system?
10-7. Discuss some of the unique control risks associated with the use of PCs and laptop computers compared to using mainframes. List what you consider to be three of the most important control procedures that should be implemented for PCs. For each control procedure, give your reason for including this procedure as an important control.
10-8. Jean & Joan Cosmetics has a complete line of beauty products for women and maintains a computerized inventory system. An eight-digit product number identifies inventory items, of which the first four digits classify the beauty product by major category (hair, face, skin, eyes, etc.) and the last four digits identify the product itself. Identify as many controls as you can that the company might use to ensure accuracy in this eight-digit number when updating its inventory-balance file.
10-9. Explain how each of the following can be used to control the input, processing, or output of accounting data: (a) edit tests, (b) check digits, (c) passwords, (d) activity listings, and
(e) control totals.
10-10. What is the difference between logical access to the computer and physical access to the computer? Why is the security of both important?
10-11. Discuss the following statement: ‘‘The separation of duties control is very difficult in computerized accounting information systems because computers often integrate functions when performing data processing tasks. Therefore, such a control is not advisable for those organizations using computers to perform their accounting functions.’’
10-12. Discuss the role of the hash total in accounting information systems.

PROBLEMS
10-13. E. Wilson & Sons, Inc. hired a consulting team from Chesapeake and Associates to discuss application controls for the company’s accounting data processing. In one of the workshops, the seminar leader stated, ‘‘We can classify all errors in processing accounting data as either accidental or intentional. Controls such as edit tests are primarily aimed at the former type of error, whereas personnel controls are primarily aimed at the latter type of error.’’ Comment on the leader’s statement.
10-14. Mark Goodwin, a computer programmer, had a grudge against his company. To get even, he coded a special routine in the mortgage loan program that erased a small, random number of accounts on the disk file every time the program was run. The company did not detect the routine until almost all of its records had been erased. Discuss what controls might have protected this company from its own programmer.
10-15. Jack Drucker, an accountant working for a medium-size company, set up several dummy companies and began directing the computer to write checks to them for fictitious merchandise.
He was apprehended only when several of the company executives began to wonder how he could afford a ski vacation in the Alps every year. What controls might have prevented this fraudulent activity?
10-16. Identify one or more control procedures (either general or application controls or both) that would guard against each of the following errors or problems.
a. Leslie Thomas, a secretary at the university, indicated that she had worked 40 hours on her regular time card. The university paid her for 400 hours worked that week.
b. The aging analysis indicated that the Grab and Run Electronics Company account was so far in arrears that the credit manager decided to cut off any further credit sales to the

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company until it cleared up its account. Yet, the following week, the manager noted that three new sales had been made to that company—all on credit.
c. The Small Company employed Mr. Fineus Eyeshade to perform all its accounts receivable data processing. Mr. Eyeshade’s 25 years with the company and his unassuming appearance helped him conceal the fact that he was embezzling cash collections from accounts receivable to cover his gambling losses at the racetrack.
d. The Blue Mountain Utility Company was having difficulty with its customer payments.
The payment amounts were entered directly onto a terminal, and the transaction file thus created was used to update the customer master file. Among the problems encountered with this system were the application of customer payments to the wrong accounts and the creation of multiple customer master file records for the same account.
e. The Landsford brothers had lived in Center County all their lives. Ben worked for the local mill in the accounts payable department and Tom owned the local hardware store. The sheriff couldn’t believe that the brothers had created several dummy companies that sold fictitious merchandise to the mill. Ben had the mill pay for this merchandise in its usual fashion, and he wrote off the missing goods as ‘‘damaged inventory.’’
10-17. Identify one or more control procedures (either general or application controls or both) that would guard against each of the following errors or problems.
a. A bank deposit transaction was accidentally coded with a withdrawal code.
b. The key-entry operator keyed in the purchase order number as a nine-digit number instead of an eight-digit number.
c. The date of a customer payment was keyed 2001 instead of 2010.
d. A company employee was issued a check in the amount of $−135.65 because he had not worked a certain week, but most of his payroll deductions were automatic each week.
e. A patient filled out her medical insurance number as 123465 instead of 123456.
f. An applicant for the company stock option plan filled out her employee number as
84-7634-21.The first two digits are a department code. There is no department 84.
g. A high school student was able to log onto the telephone company’s computer as soon as he learned what telephone number to call.
h. The accounts receivable department sent 87 checks to the computer center for processing.
No one realized that one check was dropped along the way and that the computer therefore processed only 86 checks.
10-18. To achieve effective separation of duties within a company’s IT environment, the company’s accounting and information processing subsystems should be separate from the departments that use data and perform operational activities. Discuss some of the ways this ‘‘separation of duties’’ is achieved.
10-19. Bristol Company has a high turnover rate among its employees. It maintains a very large computer system that supports approximately 225 networked PCs. The company maintains fairly extensive databases regarding its customers. These databases include customer profiles, past purchasing patterns, and prices charged. Recently, Bristol Company has been having major problems with competitors. It appears that one competitor seems to be very effective at taking away the company’s customers. This competitor has visited most of Bristol Company’s customers, and identical products have been offered to these customers at lower prices in every case.
a. What do you feel is the possible security problem at Bristol Company?
b. What can be done about this problem?
10-20. The Blatz Furniture Company uses an online data input system for processing its sales invoice data, salesperson data, inventory control, and purchase order data. Representative data for each of these applications are shown in Figure 10-16. Identify specific edit tests that might be used to ensure the accuracy and completeness of the information in each data set.

CHAPTER 10 / Computer Controls for Organizations and Accounting Information Systems

Application
Invoicing

Salesperson activity

Inventory control

Purchasing

337

Field Name

Field Length

Example

Customer number
Customer name
Salesperson number
Invoice number
Item catalog number
Quantity sold
Unit price
Total price
Salesperson number
Salesperson name
Store department number
Week’s sales volume
Regular hours worked
Overtime hours worked
Inventory item number
Item description
Unit cost
Number of units dispersed this week
Number of units added to inventory
Vendor catalog number
Item description
Vendor number
Number of units ordered
Price per unit
Total cost of purchase

6
23
3
6
10
8
7
12
3
20
8
12
5
4
10
15
7
4
4
12
18
10
7
7
14

123456
Al’s Department Store
477
123456
9578572355
13
10.50
136.50
477
Kathryn Wilson
10314201
1043.75
39.75
0.75
9578572355
Desk lamp
8.50
14
20
059689584996
Desk pad
8276110438
45
8.75
313.75

FIGURE 10-16 Data for the Blatz Furniture Company’s applications.

CASE ANALYSES
10-21. The Big Corporation (Controls in Large, Integrated Systems)
The Big Corporation has recently grown substantially and must upgrade its information systems. The company is developing a new, integrated, computer-based information system. In conjunction with the design of the new system, management is reviewing the data processing security to determine what new control features should be incorporated.
Two areas of concern are (1) confidentiality of company and customer records and
(2) protection of data, computer equipment, and facilities.
The new information system will process all company records, including sales, purchases, budgeting, customer, creditor, and personnel information. The stores and warehouses will be linked to the main computer at corporate headquarters by a system of remote terminals.
This will permit data to be communicated directly to corporate headquarters or to any other location from each location within the terminal network. Employees will also be able to access the system with laptops and handheld devices via a secured wireless network.
At the current time, certain reports have restricted distribution because not all levels of management need to receive them or because they contain confidential information. The introduction of remote terminals in the new system may provide access to these restricted

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data by unauthorized personnel. Management is concerned that confidential information may become accessible and be used improperly.
The company’s management is also concerned with potential physical threats to the system, such as sabotage, fire damage, water damage, or power failure. With the new system, a computer shutdown would severely limit company activities until the system is operational again.

Requirements
1. Identify and briefly explain the problems The Big Corporation could experience with respect to the confidentiality of information and records in the new system.
2. Recommend measures The Big Corporation could incorporate into the new system that would ensure the confidentiality of information and records in this new system.
3. What safeguards can The Big Corporation develop to provide physical security for its
(a) computer equipment, (b) data, and (c) data processing center facilities?

10-22. MailMed Inc. (Control Weaknesses and a Disaster Recovery Plan)
MailMed Inc. (MMI), a pharmaceutical firm, provides discounted prescription drugs through direct mail. MMI has a small systems staff that designs and writes MMI’s customized software.
Until recently, MMI’s transaction data were transmitted to an outside organization for processing on its hardware.
MMI has experienced significant sales growth as the cost of prescription drugs has increased, and medical insurance companies have been tightening reimbursements in order to restrain premium cost increases. As a result of these increased sales, MMI has purchased its own computer hardware. The data processing center is installed on the ground floor of its two-story headquarters building. It is behind large, plate-glass windows so that the state-of-the-art data processing center can be displayed as a measure of the company’s success and attract customer and investor attention. The computer area is equipped with halon gas fire suppression equipment and an uninterruptible power supply system. MMI has hired a small computer operations staff to operate its data processing center.
To handle MMI’s current level of business, the operations staff is on a two-shift schedule,
5 days per week. MMI’s systems and programming staff, now located in the same building, have access to the data processing center and can test new programs and program changes when the operations staff is not available. Because the systems and programming staff is small and the work demands have increased, systems and programming documentation is developed only when time is available. Periodically, but not on a scheduled basis, MMI backs up its programs and data files, storing them at an off-site location.
Unfortunately, due to several days of heavy rains, MMI’s building recently experienced serious flooding that reached several feet into the first-floor level and affected not only the computer hardware but also the data and program files that were onsite.

Requirements
1. Describe at least four computer control weaknesses that existed at MailMed Inc. prior to the flood occurrence.

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2. Describe at least five components that should be incorporated in a formal disaster recovery plan so that MailMed Inc. can become operational within 72 hours after a disaster affects its computer operations capability.
3. Identify at least three factors, other than the plan itself, that MailMed Inc.’s management should consider in formulating a formal disaster recovery plan.

10-23. Bad Bad Benny: A True Story (Identifying Controls for a System)18
In the early 20th century, there was an ambitious young man named Arthur who started working at a company in Chicago as a mailroom clerk. He was a hard worker and very smart, eventually ending up as the president of the company, the James H. Rhodes Company.
The firm produced steel wool and harvested sea sponges in Tarpon Springs, Florida for household and industrial use. The company was very successful, and Arthur decided that the best way to assure the continued success of the company was to hire trusted family members for key management positions—because you can always count on your family.
Arthur decided to hire his brother Benny to be his Chief Financial Officer (CFO) and placed other members of the family in key management positions. He also started his eldest son,
Arthur Junior (an accountant by training) in a management training program, hoping that he would eventually succeed him as president.
As the company moved into the 1920s, Benny was a model employee; he worked long hours, never took vacations, and made sure that he personally managed all aspects of the cash function. For example, he handled the entire purchasing process—from issuing purchase orders through the disbursement of cash to pay bills. He also handled the cash side of the revenue process by collecting cash payments, preparing the daily bank deposits, and reconciling the monthly bank statement.
The end of the 1920s saw the United States entering its worst Depression since the beginning of the Industrial Age. Because of this, Arthur and other managers did not get raises, and, in fact, took pay cuts to keep the company going and avoid layoffs. Arthur and other top management officials made ‘‘lifestyle’’ adjustments as well—for example, reducing the number of their household servants and keeping their old cars, rather than purchasing new ones. Benny, however, was able to build a new house on the shore of
Lake Michigan and purchased a new car. He dressed impeccably and seemed impervious to the economic downturn. His family continued to enjoy the theater, new cars, and nice clothes.
Arthur’s wife became suspicious of Benny’s good fortune in the face of others’ hardships, so she and Arthur hired an accountant to review the books. External audits were not yet required for publicly held companies, and the Securities and Exchange Commission (SEC) had not yet been formed (that would happen in 1933–1934). Jim the accountant was eventually able to determine that Benny had diverted company funds to himself by setting up false vendors and having checks mailed to himself. He also diverted some of the cash payments received from customers and was able to hide it by handling the bank deposits and the reconciliation of the company’s bank accounts. Eventually, Jim determined that
Benny had embezzled about $500,000 (in 1930 dollars).
If we assume annual compounding of 5% for 72 years, the value in today’s dollars would be about $17.61 million! Arthur was furious and sent Benny away. Arthur sold most of his personal stock holdings in the company to repay Benny’s embezzlement, which caused
18

Used with permission, Professor Constance Lehmann, Department of Accounting, University of Houston-Clear
Lake.

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him to lose his controlling interest in the company and eventually was voted out of office by the Board of Directors.
Jim, the accountant, wrote a paper about his experience with Benny (now referred to as
‘‘Bad Bad Benny’’ by the family). Jim’s paper contributed to the increasing call for required annual external audits for publicly held companies. Arthur eventually reestablished himself as a successful stockbroker and financial planner. Benny disappeared and was never heard from again.

Requirements
1. Identify the control weaknesses in the revenue and purchasing processes.
2. Identify any general controls Arthur should have implemented to help protect the company. 3. From Chapter 9, identify the internal control activities that Arthur should have considered (or implemented) that would have thwarted Benny’s bad behavior.

READINGS AND OTHER RESOURCES
Aldhizer, G. 2008. The insider threat. Internal Auditor (April): 71–73.
Cleary, B. 2008. How safe is your data? Strategic Finance (October): 33–37.
Masli, A., G. Peters, V. Richardson, and J. Sanchez. 2010. Examining the potential benefits of internal control monitoring technology. The Accounting Review 85(3): 1001– 1034.
Norman, C., M. Payne, and V. Vendrzyk. 2009. Assessing information technology general control risk:
An instructional case. Issues in Accounting Education 24(1): 63–76.

Biometric Security: http://www.youtube.com/watch?v=CL3Mjn7uAnA&feature=related Data Encryption: http://www.techrepublic.com/videos/news/the-future-of-data-encryption/388510 Introduction to Business Continuity Planning: http://www.availability.sungard.com/Pages/StepstoEffectiveBCP.aspx ANSWERS TO TEST YOURSELF
1. b

2. a

3. a

4. c

5. d

6. b

7. b

8. d

9. c

10. a

11. c

Chapter 11
Computer Crime, Fraud, Ethics, and Privacy

INTRODUCTION

SUMMARY

COMPUTER CRIME, ABUSE, AND FRAUD

KEY TERMS YOU SHOULD KNOW

Distinguishing Between Computer Crime, Computer
Abuse, and Fraud

TEST YOURSELF

Computer Crime Legislation

DISCUSSION QUESTIONS

Computer Crime Statistics

PROBLEMS

The Importance of Computer Crime and Abuse to AISs

CASE ANALYSES

THREE EXAMPLES OF COMPUTER CRIMES

The Magnificent Four Seasons Resort

Compromising Valuable Information

The Department of Taxation

Wire Fraud and Computer Hacking

The Ashley Company

Denial of Service

READINGS AND OTHER RESOURCES

PREVENTING COMPUTER CRIME AND FRAUD

ANSWERS TO TEST YOURSELF

Enlist Top-Management Support
Increase Employee Awareness and Education
Assess Security Policies and Protect Passwords
Implement Controls
Identify Computer Criminals
Don’t Forget Physical Security
Recognize the Symptoms of Employee Fraud
Employ Forensic Accountants

ETHICAL ISSUES, PRIVACY, AND IDENTITY
THEFT
Ethical Issues and Professional Associations
Meeting the Ethical Challenges
Privacy

After reading this chapter, you will:
1. Understand why it is difficult to define computer crime.
2. Know why there is an absence of good data on computer crime.
3. Be able to provide reasons why computer crime might be growing.
4. Be familiar with several computer crime cases and the proper controls for preventing them.
5. Be able to describe a profile of computer criminals.
6. Understand the importance of ethical behavior within the environment of computerized AISs.

Company Policies with Respect to Privacy
Identity Theft

AIS AT WORK—FIGHTING COMPUTER CRIME
AT THE BANK

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The actions of colleges and universities provide examples to their students of how to act with—or without—a high level of ethical standards.
Verschoor, C. 2010. Colleges and universities must be ethical.
Strategic Finance 92(4): 23–25.

INTRODUCTION
The connection between AISs and computer crime and fraud is both straightforward and important. Managers, accountants, and investors all use computerized information to control valuable resources, help sell products, authenticate accounting transactions, and make investment decisions. But the effectiveness of these activities can be lost if the underlying information is wrong, incomplete, or seriously compromised. This is why digital information is itself a valuable asset that must be protected. The more managers and accountants know about computer crime and fraud, the better they can assess risks and implement controls to protect organizational assets.
This chapter describes computer crime, fraud, and other irregularities that have occurred in the past and that may also occur in the future. In the first section, we take a closer look at computer crime, abuse, and fraud. In the second section, we examine three specific cases involving computer crime. The third section of this chapter identifies what organizations can do to protect themselves from computer crime and abuse—that is, what they can do to recognize potential problems and what they can do to control them.
Not all computer-related offenses are illegal—some are just unethical. Because of the importance of ethical behavior within the environment of computerized AISs, we also discuss the topic of computers and ethical behavior. Finally, the last section of our chapter addresses the importance of privacy and identity theft. The dramatic increase in the number of individuals, companies, and organizations using the Internet draws our attention to the question of personal privacy. What information is collected about us and how much of it is authorized? Also, how much of it is freely provided by individuals who do not realize that others will store and use the information for purposes other than what was intended?
Accordingly, we focus on the issue of collection and protection of information.

COMPUTER CRIME, ABUSE, AND FRAUD
Articles in Fortune, Business Week, the Wall Street Journal, Computerworld, Security
Focus, and WIRED all testify to the high level of public interest in computer crime, abuse, and fraud. Although data on computer crime and fraud are limited, at least three reputable organizations conduct surveys that help us understand the breadth and depth of these crimes. First, the Computer Security Institute (CSI) conducts an annual survey to help determine the scope of computer crime in the United States. The respondents to this survey are computer security practitioners in U.S. corporations, government agencies, financial institutions, medical institutions, and universities.
Second, KPMG, a global network of professional firms providing audit, tax, and advisory services, conducts surveys on fraud and business integrity. Survey participants are the business professionals who work for one of the top 2,000 companies listed in

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Dun and Bradstreet. Third, the Association of Certified Fraud Examiners (ACFE)—an international professional organization committed to detecting, deterring, and preventing fraud and white-collar crime—conducts a biannual survey and publishes the results in its
Report to the Nation on Occupational Fraud and Abuse. The participants in this survey are its members, each of whom provides detailed information on one occupational fraud case he or she had personally investigated within the past 2 years.

Distinguishing Between Computer Crime, Computer Abuse, and Fraud
While the terms ‘‘computer crime’’ and ‘‘computer abuse’’ seem to describe the same problem, there is a subtle difference between them. Computer crime means that someone manipulates a computer or computer data, by whatever method, to dishonestly obtain money, property, or some other advantage—or cause significant loss. In contrast, computer abuse means that someone, who does not have permission, uses or accesses someone else’s computer. So, a perpetrator commits a computer crime when he or she gains an illegal financial advantage or causes measurable loss to a person, company, or organization, while computer abusers are mischievous pests with such motives as a challenge or revenge.
Then, too, there are hackers who exploit the vulnerabilities of an organization’s computer systems just because they can.

Case-in-Point 11.1 At age 22, Adrian Lamo was well known for exposing gaping security holes at large corporations and then voluntarily helping the companies fix the vulnerabilities he exploited. At the New York Times site, Lamo obtained access to the names and Social Security numbers of employees. Although Lamo described this vulnerability to the New York Times, the publisher’s managers were not grateful and initiated an investigation. More recently,
Lamo reported to federal authorities that it was Bradley Manning who leaked sensitive U.S. government documents to WikiLeaks.1

The term computer crime is really a misnomer because computers do not commit crimes—people do. Figure 11-1 describes several cases that might qualify as computer crimes or abuses. In the first case, the primary objective was to disrupt a computer network—not personal gain. The second case is neither a computer crime nor an abuse.
Rather, ‘‘misrepresentation’’ would probably more accurately describe the problem. In the third case, a computer screen was damaged but the loss would probably not be a criminal charge. In the fourth case, the attempt to sell credit information would be a criminal offense. In the fifth case, no computer was used, so it is difficult to call this a ‘‘computer crime.’’ Finally, although the sixth case involved a computer and resulted in personal gain, it is perhaps more accurate to describe this crime as a ‘‘misappropriation of assets,’’ which is described below.
Another example of a computer offense, which could be either a crime or an abuse, is a logic bomb. This is a computer program that remains dormant until some specified circumstance or date triggers the program to action. Once ‘‘detonated,’’ a logic bomb program sabotages a system by destroying data and/or disrupting computer operations.
The following Case-in-Point describes the first person in America to be convicted of
‘‘harmful access to a computer’’ because of a logic bomb that he triggered on the day he was dismissed from USPA, a Fort Worth-based insurance company.2
1
2

http://www.wired.com/threatlevel/2010/05/lamo/and http://en.wikipedia.org/wiki/Adrian_Lamo http://www.cheycobb.com/logic_bombs.html 344

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1. A graduate student infected a computer network with a virus that eventually disrupted over 10,000 separate systems.
2. A company accused a computer-equipment vendor of fraudulently representing the capabilities of a computer system, charging that the full system was never delivered and that the software was inadequate. 3. In a fit of resentment, a keyboard operator shattered an LCD screen with her high-heeled shoe.
4. Some employees of a credit bureau sent notices to some of the individuals listed as bad risks in its files. For a fee, the employees would withhold the damaging information, thereby enhancing the credit worthiness of the applicants.
5. A computer dating service was sued because referrals for dates were few and inappropriate. The owner eventually admitted that no computer was used to match dates, even though the use of a computer was advertised.
6. A programmer changed a dividends-payment program to reduce the dividends of selected stock holders and to issue a check to himself for the sum of the reductions—$56,000.

FIGURE 11-1 Examples of computer crimes.

Case-in-Point 11.2 Donald Burleson was a disgruntled computer programmer who set off a logic bomb that erased 168,000 sales commission records. Consequently, company paychecks were held up for a month. He embedded the logic bomb in a legitimate program, which he designed to go off periodically to erase still more records. But a fellow programmer who was testing a new employee bonus system discovered the bomb before it could execute again. The company’s computers were shut down for 2 days while the bomb was located and diffused. The type of computer crime with which most professional accountants are familiar is financial fraud. Statement on Auditing Standards No. 99 identifies two types of such fraud: (1) fraudulent financial reporting and (2) misappropriation of assets.3 Fraudulent financial reporting (called cooking the books) happens when corporate officials such as senior-ranking executives intentionally falsify accounting records to mislead analysts, creditors, or investors. As a result, the annual financial statements do not fairly represent the true financial condition of the firm. The corporate scandals discussed in Chapter 1 are examples of this type of fraud.
Misappropriation of assets is usually committed by employees within an organization, although individuals can collude with outside conspirators to perform such acts as well.
The ACFE calls this type of crime occupational fraud and has developed a ‘‘fraud tree’’ to describe the many ways that employees can misappropriate assets from an organization.
Examples include skimming, larceny, payroll tampering, and check tampering. Figure 11-2 gives several examples of asset misappropriation. Most of these activities directly involve accounting information systems.

Computer Crime Legislation
A strict definition of computer crime must be found in the law. Such definitions are important because they determine what law enforcement officials can prosecute as well as how statistics on such crimes are accumulated. Both federal and state statutes govern computer usage.
3

AICPA. 2003. Statement on Auditing Standards No. 99, Consideration of Fraud in a Financial Statement Audit.

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345

Asset Class

Type of Fraud

Example

Cash

Larceny
Skimming

Direct theft or removal from bank deposit
Nonreporting or underreporting of sales
Write-offs of legitimate receivables as bad debts
Lapping schemes
Payments to ghost companies or employees
Payments for fictitious goods or services
Multiple payments for the same bill
Forged checks
Altered payee on legitimate check
False refunds
Use of corporate limousine or jet for personal travel

Fraudulent disbursements

Inventory and all other assets

Misuse
Larceny

Theft of raw materials or finished goods
Fictitious inventory adjustments
Nonreporting or underreporting of received goods

FIGURE 11-2 Examples of asset misappropriation.

Federal Legislation. Figure 11-3 lists some important federal legislation governing activities involving computers. Of these acts, the most important is probably the Computer
Fraud and Abuse Act of 1986 (CFAA), which was amended in 1994 and 1996. This act defines computer fraud as any illegal act for which knowledge of computer technology is essential for its perpetration, investigation, or prosecution. The following paragraphs identify the fraudulent acts found in the Computer Fraud and Abuse Act and give examples of each type of crime.
1. Unauthorized theft, use, access, modification, copying, or destruction of software or data. The PC manager at a King Soopers supermarket in Colorado was called repeatedly to correct computer errors that were thought to be responsible for a large number of sales voids and other accounting errors. Eventually, the company discovered that this manager was in fact the cause of these problems. Over the course of 5 years or more, officials estimate that he and two head clerks used a number of simple methods to steal more than $2 million from the company—for example, by voiding sales transactions and pocketing the customers’ cash payments.
2. Theft of money by altering computer records or the theft of computer time. To commit an inventory fraud, several employees at an east coast railroad entered data into their company’s computer system to show that more than 200 railroad cars were scrapped or destroyed. These employees then removed the cars from the railroad system, repainted them, and sold them.
3. Intent to illegally obtain information or tangible property through the use of computers. One case of industrial espionage involved Reuters Analytics, whose employees were accused of breaking into the computers of their competitor, Bloomberg, and stealing lines of programming code. These instructions were supposedly used in software that provides financial institutions with the capability to analyze historical data on the stock market. 4. Use, or the conspiracy to use, computer resources to commit a felony. Paul Sjiem-Fat used desktop publishing technology to perpetrate one of the first cases of computer forgery. Sjiem-Fat created bogus cashier’s checks and used these checks to buy computer

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Fair Credit Reporting Act of 1970. This act requires that an individual be informed why he or she is denied credit. The act also entitles the individual to challenge information maintained by the credit-rating company and to add information if desired. Seven years after this law was put into effect, the annual number of complaints filed under it exceeded 200,000.
Freedom of Information Act of 1970. This is a federal ‘‘sunshine law’’ guaranteeing individuals the right to see any information gathered about them by federal agencies.
Federal Privacy Act of 1974. This act goes further than the Freedom of Information Act of 1970 by requiring that individuals be able to correct federal information about themselves, by requiring that agency information not be used for alternate purposes without the individual’s consent, and by making the collecting agency responsible for the accuracy and use of the information. Under this act, an individual may ask a federal judge to order the correction of errors if the federal agency does not do so.
Small Business Computer Security and Education Act of 1984. This act created an educational council that meets annually to advise the Small Business Administration on a variety of computer crime and security issues affecting small businesses.
Computer Fraud and Abuse Act of 1986. This act makes it a federal crime to intentionally access a computer for purposes such as (1) obtaining top-secret military information or personal financial or credit information; (2) committing a fraud; or (3) altering or destroying federal information.
Computer Fraud and Abuse Act (1996 amendment). This act prohibits unauthorized access to a protected computer and illegal possession of stolen ‘‘access devices,’’ which includes passwords and credit card numbers. Computer Security Act of 1987. This act requires more than 550 federal agencies to develop computer security plans for each computer system that processes sensitive information. The plans are reviewed by the National Institute of Standards and Technology (NIST).
USA Patriot Act of 2001. This act gives federal authorities much wider latitude in monitoring Internet usage and expands the way such data is shared among different agencies. However, a judge must oversee the
FBI’s use of an e-mail wiretap, and the FBI must disclose what was collected, by whom, and who had access to the information that was collected.
Cyber Security Enhancement Act of 2002. This act permits the United States Sentencing Commission to review and, if appropriate, amend guidelines and policy statements applicable to persons convicted of a computer crime to reflect the serious nature of (1) the growing incidence of computer crimes, (2) the need for an effective deterrent, and (3) appropriate punishment to help prevent such offenses.
CAN-SPAM Act of 2003. This act requires unsolicited commercial e-mail messages to be labeled, to include opt-out instructions, and to include the sender’s physical address. It prohibits the use of deceptive subject lines and false headers in messages. This law took effect on January 1, 2004.

FIGURE 11-3 Federal legislation affecting the use of computers. equipment, which he subsequently sold in the Caribbean. He was caught while trying to steal $20,000 from the Bank of Boston. The bank called in the Secret Service, which raided his apartment and found nine bogus checks totaling almost $150,000. Sjiem-Fat was prosecuted and sent to prison.
5. Theft, vandalism, or destruction of computer hardware. A disgruntled tax payer became enraged over his tax bill. He was arrested for shooting at an IRS computer through an open window of the building.
6. Trafficking in passwords or other log-in information for accessing a computer. Two former software developers of Interactive Connection (now known as Screaming Media) were arrested for breaking into Interactive’s computer system one night. They allegedly stayed on the system for about 4 hours and copied proprietary files and software.
7. Extortion that uses a computer system as a target. A disgruntled employee of a
European company removed all of the company’s tape files from the computer room.
He then drove to an off-site storage location and demanded half a million dollars for

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their return. He was arrested while trying to exchange the data files for the ransom money. State Legislation. Every state now has at least one computer-crime law. Most of the laws have provisions that (1) define computer terms (many of which vary from state to state), (2) define some acts as misdemeanors (minor crimes), and (3) declare other acts as felonies (major crimes). These laws also require willful intent for convictions. Thus, words like maliciously, intentionally, or recklessly often appear in the wording of the computer-crime laws, and willful intent must be established for a successful prosecution.
The National Center for Computer Crime Data, a collector of computer-crime statistics, reports that 77% of computer cases brought to state courts end in guilty pleas and that another 8% of the defendants are found guilty at trials.

Computer Crime Statistics
No one really knows how much is lost each year as the result of computer crime and abuse. One reason for this is the fact that a large proportion of computer crime and abuse takes place in private companies, where it is handled as an internal matter. We have no laws that require organizations to report computer offenses. But the most important reason we know so little about computer offenses is because we believe that most of it is not discovered. Recently, for example, the FBI estimated that only 1% of all computer crime is detected. Other estimates of computer-crime detection are between 5% and 20%. We mostly catch computer criminals through luck, chance, or accident. This is why experts believe the computer crime that is detected is only the tip of the iceberg.
Despite our lack of complete statistics, there are several reasons why we believe computer crime is growing. One reason is the exponential growth in the use of computer resources—for example, microcomputers, computer networks, and the Internet. As more people become knowledgeable about how to use computers, more people are in a position to compromise computer systems.
Another reason why we believe computer crime is growing is because of continuing lax security. There are millions of computer users in the world, but many of them are not aware of, or conscientious about, computer security. Then, too, some users are dishonest and have a new tool with which to commit frauds. Lastly, many Web sites now give step-bystep instructions on how to perpetrate computer crimes. For example, an Internet search found more than 17,000 matches for ‘‘denial of service,’’ and there are now thousands of
Web sites that detail how to break into computer systems or disable Web servers.

Case-in-Point 11.3 Dan Farmer, who wrote SATAN (a network security testing tool), tested 2,200 high-profile Web sites at governmental institutions, banks, newspapers, and so forth. Only three of these Web sites detected his probes and contacted him to find out what he was trying to do. His conclusion: most Web sites have serious vulnerabilities, and most of the control procedures at these sites are ineffective.4

The FBI, in partnership with the National White Collar Crime Center, established the
Internet Fraud Complaint Center (IFCC) in May 2000 to provide cybercrime victims a point of contact for reporting computer crime and abuses. The IFCC changed its name in December 2003 to the Internet Crime Complaint Center (IC3) to reflect the broad
4

http://www.g4tv.com/techtvvault/features/3392/Interview_SATANs_Dan_Farmer.html

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nature of complaints that it handles, including international money laundering, online extortion, intellectual property theft, identity theft, online scams, and computer intrusions.
In 2010, there were 303,809 online fraud complaints reported, compared to only 75,000 in
2002. The majority of the complaints in 2010 were received from individuals in California
(38.1%), and the top crime type was nondelivery of merchandise and/or payment (21.1% of complaints), followed by identity theft (18.8% of complaints).5

The Importance of Computer Crime and Abuse to AISs
The absence of good computer-crime statistics does not detract from the importance of computer crime and abuse on accounting information systems. One reason for this is that AISs help control financial resources and thus are often the favored targets of computer abusers and criminals. Also, as noted previously, AISs are prized targets for disgruntled employees seeking to compromise computer systems for revenge. A third reason is that accountants are responsible for designing, selecting, or implementing the control procedures that protect AISs. Finally, computer crime is important because both the government and the investing public rely on internal and external auditors to vouchsafe the accuracy and completeness of the financial statements of the corporations and government agencies they audit.
Using a computer, fraud perpetrators are able to steal more, in much less time, with much less effort, and leave little or no evidence. Consequently, computer fraud is typically much more difficult to detect than other types of fraud. At any point in time, the FBI is investigating approximately 800 separate incidents of economic espionage, which is why this is such an important topic to accountants.
Computer crime and abuse are also significant because of the large proportion of firms that suffer million-dollar losses due to frauds, computer viruses, unauthorized access, and denial-of-service attacks. The 2008 ACFE Report to the Nation estimates that the annual total losses from occupational fraud are almost $1 trillion (not all of which is computer based).
The 2008 annual survey of the Computer Security Institute estimates that the average cost to target organizations from a computer-abuse incident is about $500,000—an amount whose financial impact can range from ‘‘substantial’’ to ‘‘catastrophic’’ to the victim firm.

THREE EXAMPLES OF COMPUTER CRIMES
Computer crime is perhaps best understood by studying selected cases. As one reads the fascinating accounts of different computer crimes, a pattern begins to emerge. One type of crime depends mostly on the falsification of input data, while others depend on unauthorized access to computerized files. This section of the chapter examines three specific cases of computer crime.

Compromising Valuable Information
A major class of computer crime involves illegal access to, or misuse of, the information stored in an AIS and is thus valuable-information computer crime. In the TRW Credit Data case, the valuable information involved was computerized credit data. TRW (now called
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