ACCOUNTING INFORMATION SYSTEM Accounting Process Classified in Two Parts

(MIDTERM NOTES) 1. Recording Phase

➢ Include analyzing the transaction,
Accounting
journalizing and posting.
➢ a service activity
➢ Its function is to provide quantitative Recordable transactions supported by source
information, primarily financial in nature, documents:
about economic entities, that is intended to - Official receipts
be useful in making economic decision.
- Sales invoice
(Accounting Standards Council)
- Vouchers (Check vouchers or petty cash
➢ Accounting is the art of recording,
vouchers)
classifying and summarizing in a significant
manner and in terms of money, transactions, - Delivery or Collection Receipt
and events which are in part at least of a - Bank Statement
financial character and interpreting the - Bank Credit or bank Debit
results thereof. (The Committee on 2. Summarizing Phase
Accounting Terminology of the American ➢ Includes unadjusted trial balance,
Institute of Certified Public Accountants) adjusting entries, financial
➢ Accounting is the process of identifying, statements, closing entries, post-
measuring and communicating economic closing trial balance and reversing
information to permit informed judgement entries.
and decision by users of the information.
(The American Accounting Association). Journal or General Journal

Steps in Accounting Process ➢ Chronological record of transactions

➢ Consists of transaction date, the
1. Analyzing accounts and amounts to be debited or
2. Journalizing credited, and a brief explanation of
3. Posting the transaction.
4. Unadjusted Trial Balance
5. Adjusting Entries Simple Journal Entry
6. Financial Statements
➢ Consist of one debit and one credit
7. Closing Entries
8. Post-closing Trial Balance Compound Journal Entry
9. Reversing Entries
➢ Consist of two or more debits and two or
more credits.
Ledger or General Ledger
➢ A group of accounts
Account
➢ Is the accounting device used in summarizing
the effects of transaction on each asset,
liability, equity, revenue and expense.
➢ Are usually expressed in the form of chart of
accounts.
 Chart of Accounts Adjusting Entries
➢ A listing of all the entity general ledger
➢ Are made at the end of every accounting
accounts in a systematic form.
period in order to split mixed accounts or to
Trial Balance bring the accounts up to date.
➢ Allocate revenue and expenses between
➢ A list of general ledger accounts with respect
current and future periods
to debit and credit balance
➢ Affects both a real account and nominal
➢ Often called the unadjusted trial balance
account.
because account balances do not reflect
➢ Necessary for a fair and accurate
adjustments.
measurement of performance of financial
➢ Prepared at the end of every accounting
position on the accrual basis.
period after all the transactions for the period
have been recorded and posted to the ledger. Cash Basis Accounting
➢ A control device that helps eliminate
➢ Revenue is recorded only when cash is
accounting errors. When total debits do not
received and expenses are recorded when
equal total credits, the trial balance it out of
paid in cash.
balance. This condition alerts the accountant
that errors have been made. Accrual Basis of Accounting
Purpose of trial balance ➢ Required recognition of revenue when earned
and recognition of expense when incurred.
1. Provides evidence that the total debits in the
general ledger equal the total credits *Generally accepted accounting principle required
2. Provides information that helps accountants the use of accrual accounting.
to formulate adjustments
Items Normally Require Adjusting Entries
Types of Error
1. Ending Inventory
1. Transposition – The figures are ➢ Inventory end
interchanged. E.g. 1234 written as 4123. Income summary or cost of sales
2. Transplacement – Error in placing decimal 2. Doubtful Accounts
point. E.g. 4.65 written as 46.5 ➢ Doubtful accounts/ doubtful accounts exp
3. Error of omission – A transaction is not Allowance for doubtful accounts
recorded. 3. Depreciation
➢ Depreciation Expense
Two Methods of Recording Expense
Accumulated Depreciation
1. Expense Method
➢ The account to be debited is expense. Worksheet
2. Asset Method ➢ Is a multicolumn sheet of paper that an
➢ The account to be debited is asset. accountant uses in compiling an summarizing
the information necessary for the preparation
Two Methods of Recording Income
of financial statements.
1. Income Method ➢ Not a formal statement, only a tool of an
➢ The account to be credited is income accountant in preparation of financial
2. Liability Method statements.
➢ The account to credited is liability ➢ Prepared at the stage of the accounting cycle
when it is time to make adjustments and
prepare financial statements.
➢ Facilitates the preparation of financial
statements by:
 a. Providing a place where adjusting entries An Information System: An Accountant
can be made informally before they are Perspective
journalized and posted.
The Information Environment
b. Providing an orderly means whereby each
account can be classified according to the Business Information
financial statement that will appear.
c. Providing a balancing mechanism that 1. Financial Information – Accounting
helps uncover accounting errors. Information System (referring to Financial
Reports and Financial Transaction)
*If the total debits exceed the total of credits in the 2. Non-Financial Information – Managerial
income statement columns, there is a net loss. Information System
* If the total of credits exceeds the total of debits in
Financial Transaction – An economic event that
the statement of financial position columns there is
affects the assets and equities of the organization, is
also a net loss.
reflected in its accounts, and is measured in monetary
*If the total credits exceeds the total of the debits in terms.
the income statement columns there is net income.
Non-Financial Transaction – If it has no effect on
*If the statement of financial position columns if the the accounting equation.
total of the debits exceeds the total of the credits there
is also a net income.
Closing Entries President and Vice Stake holders
president and Board of
➢ Made at end of an accounting period after Directors - Responsible
adjusting entries and financial statements for expansion of
have been prepared for the purpose of closing operation and long
al nominal or temporary accounts. term decision TOP
• All credit balance accounts must be MANAGEMENT
debited.
• All debit balance accounts must be
credited.
Post-closing Trial Balance MIDDLE
MANAGEMENT
➢ Simply a listing of general ledger accounts
after the closing entries have been made.
• Only real accounts will be left
Reversing Entries OPERATIONS
MANAGEMENT Suppliers
➢ Made at the beginning of the new accounting
period in order to transfer all accrued and
prepaid items established by adjusting entries OPERATIONS PERSONNEL
to the nominal accounts that are to be used in
recording transactions during the new period.
DAY-TO-DAY OPERATIONS INFORMATION

customers
System An Information System Framework

➢ A group of two or more interrelated Information System

components or subsystems that serve two or
more purpose. ➢ The set of formal procedures by which data
are collected, processed into information, and
Characteristics of a System distributed to users.
Multiple Components Transaction
➢ A system must contain mor than one part. ➢ An event that affects or is of interest of the
organization and is processed by its
Relatedness
information system as a unit processing of
➢ A common purpose relates the multiple parts financial transactions. of work.
of the system.
Accounting Information System (AIS
➢ If a particular component does not
Subsystems) – Process financial and non-financial
contribute to the common goal then it is not
transactions that directly affect the
part of the system.
Transactions Processed by the Information
Purpose
System
➢ A system must serve at least one purpose,
but it may serve several. FINANCIAL
INFORMATION
➢ When a system ceases to serve a purpose, it TRANSACTION
must be replaced INFORMATION USER
SYSTEM
System versus Subsystem DECISIONS
NON-
➢ Distinction depends on the matter of FINANCIAL
perspective TRANSACTION

System – Is called a subsystem when it is viewed in

relation to the larger system which it is part. THREE MAJOR SUBSYTEMS OF AIS

Subsystem – Is called a system when it is the focus 1. Transaction Processing System

of the attention. ➢ Supports daily business operations with
numerous reports, documents, and messages
System Decomposition for users throughout the organization.

➢ A process of dividing the system into Three Transaction Cycles of TPS

smaller subsystem parts.
➢ A convenient way of representing, viewing a. Revenue Cycle
and understanding the relationships among b. Expenditure Cycle
subsystems. c. Conversion Cycle

System Interdependency 2. General Ledger / Financial Reporting

System
➢ A system’s ability to achieve its goals ➢ Produces the traditional financial statements
depends on the effective functioning and 3. Management Reporting System
harmonious interaction of its subsystems.
 ➢ Provides internal management with special- Source Data
purposes financial reports and information
needed for decision making such as ➢ Are financial Transactions that enter the
budgets, variance reports, and responsibility information system from both internal and
reports. external sources.
1. External Source
Non-Discretionary Reporting ➢ Are economic exchanges with other
entities and individual outside firm.
➢ The organization has a few or no choices in ➢ Example: Purchase invoice, sale of
the information it provides goods and services, purchases inventory,
➢ General Purpose (Internal and External receipt of cash, disbursement of cash.
users) 2. Internal Source
➢ Based on Generally Accepted Accounting ➢ Involve the exchange or movement of
Principles and PFRS resources within the organization.
➢ Example: Sales invoice, movement of
Discretionary Reporting raw materials in WIP, transfer of WIP to
finished goods inventory and
➢ The organization can choose what
depreciation.
information to report and how to present it.
➢ Specific Purpose (Internal Users generally Data VS. Information
management use)
➢ Used for management decisions Data

Management Reporting System ➢ Are facts which may or may not be processed
and have no direct effect on user.
➢ Provides the internal financial information
needed to manage a business. Information

Two General Groups of End Users ➢ Causes the user to take an action that he or
she could not or would not have taken.
1. External ➢ Defined simply as processed data.
➢ Includes creditors, stockholders, potential ➢ Determined by the effect it has on users not
investors, regulatory agencies, tax by its physical form.
authorities, suppliers, customers.
2. Internal Data Collection
➢ Includes managements, operations
personnel. ➢ First operational stage in the information
system
➢ Objective : To ensure that event data
entering the system are valid, complete and
free from material errors.
➢ Most important stage in the system.

Two Rules that Govern Date Collection

1. Relevance – The information system should

capture only relevant data.
2. Efficiency
Data Management 1. Storage – Assign keys to new record and
store them in their proper location in the
➢ The organization’s database is its physical data base.
repository for financial and non-financial 2. Retrieval – The task of locating and
data. extracting an existing record from the
➢ Can represent its contents in a logical database for processing. After processing is
hierarchy – attribute, record, and file. complete the storage task restores the
updated record to its place in the database.
Data Attribute 3. Deletion – The task of permanently
removing obsolete or redundant records
➢ The most elemental piece of potentially
from the database.
useful data in the database.
➢ A logical and relevant characteristic of an Information Generation
entity about which the firm captures data.
➢ The absence of any single relevant attribute ➢ The process of compiling, arranging,
diminishes and destroys the information formatting and presenting information to
content of the set. users.
➢ The addition of relevant or illogical data
would not enhance the information content Characteristics of Useful Information
of the set.
1. Relevance
Record - The contents of the report must serve a
purpose
➢ A complete set of attributes for single 2. Timeliness
occurrence within entity class. - The age of information is critical factor
➢ To find a particular record within the data in determining its usefulness.
base it must be uniquely identifiable - Information must be no older than the
therefor, every record in the data base must time of the action it supports.
be unique in at least one attribute. 3. Accuracy
- Information must be free from material
errors.
4. Completeness
- No piece of information essential to a
decision or task should be missing.
5. Summarization
- Information should aggregated in
accordance with users’ need.

INTRODUCTION TO TRANSACTION
PROCESSING

Transaction Cycles
Files ➢ Three transaction cycles process most
➢ A complete set of record of an identical of the firm's economic activity:
class. (1) incurs expenditures in
exchange for resources
Data Base Management Tasks (expenditure cycle),
 (2) provides value added through authorizes the payment, disburses the funds
its products or services to the vendor, and records the transaction by
(conversion cycle), and reducing the cash and accounts payable
(3) receives revenue from outside accounts.
sources (revenue cycle).
Payroll system

Relationship Between Transaction Cycles ➢ collects labor usage data for each employee,
computes the payroll, and disburses
paychecks to the employees.
➢ Conceptually, payroll is a special case
purchases and cash disbursements system
➢ Because of accounting complexities
associated with payroll, most firms have a
separate system for payroll processing

Fixed asset system

➢ processes transactions pertaining to the

acquisition, maintenance, and disposal of its
fixed assets. These are relatively permanent
The Expenditure Cycle items that collectively of ten represent the
organization's largest financial investment.
➢ Business activities begin with the ➢ Examples of fixed assets include land,
acquisition of materials, property, and buildings, furniture, machinery, and motor
labor in exchange for cash vehicles
➢ Most expenditure transactions are
based on a credit relationship between The Conversion Cycle
the trading par ties.
➢ two major subsystems
➢ Has two parts:
1. The production system
1. a physical component (the
- involves the planning, scheduling, and
acquisition of the goods)
control of the physical product through
2. a financial component (the cash
the manufacturing process.
disbursement to the supplier).
- This includes determining raw material
Purchases/accounts payable system requirements, authorizing the work to be
performed and the release of raw
➢ This system recognizes the need to acquire materials into production, and directing
physical inventory (such as raw materials) the movement of the work-in-process
and places an order with the vendor. When through its various stages of
the goods are received, the purchases system manufacturing.
records the event by increasing inventory and 2. The cost accounting system
establishing an account payable to be paid at - monitors the flow of cost information
a later date. related to production. Information this
system produces is used for inventory
Cash disbursements system valuation, budgeting, cost control,
performance reporting, and management
➢ When the obligation created in the purchases decisions, such as make or-buy decisions.
system is due, the cash disbursements system
 ➢ Manufacturing firms convert raw materials ➢ this section describes the purpose of each
into finished products through formal type of accounting record used in transaction
conversion cycle operations. cycles.
➢ the conversion cycle is not usually formal and ➢ traditional records used in manual systems
observable in service and retailing 1. Documents
establishments. Nevertheless, these firms - provides evidence of an economic event
still engage in conversion cycle activities that and may be used to initiate transaction
culminate in the development of a salable processing
product or service. Ex. Readying of products - Some documents are a result of
and services for market and the allocation of transaction processing.
resources such as depreciation, building
amortization, and prepaid expenses to the Three Types of Documents
proper accounting period.
SOURCE DOCUMENTS,
The Revenue Cycle
➢ Economic events result in some documents
➢ Firms sell their finished goods to customers being created at the beginning the source) of
through the revenue cycle, which involves the transaction called source documents.
processing cash sales, credit sales, and the ➢ are used to capture and formaline transaction
receipt of cash following a credit sale. data that the transaction cycle needs for
➢ physical and a financial component, which processing
are processed separately.
Creation of source document
The primary subsystems of the revenue cycle

Sales order processing

➢ The majority of business sales are made on

credit and involve tasks such as preparing
sales orders, granting credit, shipping
products (or rendering of a service) to the
customer, hilling tomers, and rending the
transaction in the accounts (accounts ➢ The economic event the sale) causes the
receivable, imventory, expenses, and sales) salesclerk to prepare a multipart sales order,
which is formal evidence that sale occurred.
Cash receipts
Copies of this source document enter the
➢ For credit sales, some period of time (days or sales system and are used to convey
weeks) passes between the point of sale and information to various functions, such as
the receipt of cash billing, shipping, and AR. The information in
➢ Cash receipts processing includes collecting the sales order triggers specific activities in
cash, depositing cash in the bank, and each of these departments
recording these events in the accounts
PRODUCT DOCUMENTS
(accounts recible and cash)
➢ are the result of transaction processing rather
Accounting Records
than the triggering mechanism for the
MANUAL SYSTEMS process.
➢ For example, a payroll check to an employee
is a product document of the payroll system.
 Such transactions can be grouped
together in a special journal and
processed more efficiently than a general
journal permits.
- Most organizations use several special
journals, including the sales journal, cash
receipts journal, cash disbursements
journal, purchases journal, and the
payroll journal

REGISTER

➢ often used to denote certain types of special

TURNAROUND DOCUMENTS journals. For example, the payroll journal is
often called the payroll register.
➢ are product documents of one system that
➢ We also use the term register, however, to
become source documents for another
denote a log. For example, a receiving
system.
register is a log of all receipts of raw
➢ contains important information about a
materials or merchandise ordered from
customer's account to help the cash receipts
vendors. Similarly, a shipping register is a log
system process the payment.
that records all shipments to customers.
2. GENERAL JOURNALS
- to record nonrecurring, infrequent, and
dissimilar transactions. For example, we
usually record periodic depreciation and
closing entries in the general journal.
- Note that the columns are nonspecific,
allowing any type of transaction to be
recorded. The entries are recorded
chronologically.

Journal Voucher System

➢ is actually a special source document that

2. JOURNALS contains a single journal entry specifying the
general ledger accounts that are affected.
➢ is a record of a chronological entry. ➢ are used to record summaries of routine
➢ Documents are the primary source of data for transactions, nonroutine transactions,
journals. adjusting entries, and closing entries.
➢ Each transaction requires a separate journal ➢ The total of journal vouchers processed is
entry, reflecting the accounts affected and the equivalent to the general journal.
amounts to be debited and credited.
➢ The journal holds a complete record of Ledgers
transactions and thus provides a means for
➢ is a book of accounts that reflects the
posting to accounts.
financial effects of the firm's transactions
➢ two primary types of journals
after they are posted from the various
1. SPECIAL JOURNALS
journals.
- are used to record specific classes of
transactions that occur in high volume.
 ➢ Whereas journals show the chronological
effect of business activity, ledgers show
activity by account type.
➢ indicates the increases, decreases, and current
balance of each account. Organizations use
this information to prepare financial
statements, support daily operations, and
prepare internal reports.
➢ There are two basic types of ledgers:
(1) general ledgers which contain the firm's
account information in the form of highly
summarized control accounts, and
(2) subsidiary ledgers, which contain the
details of the individual accounts that
constitute a particular control account.

SUBSIDIARY LEDGERS

➢ are kept in various accounting departments of

the firm, including inventory, accounts payable,
payroll, and accounts receivable.

GENERAL LEDGERS ➢ This separation provides better control and

support of operations.
➢ summarizes the activity for each of the
organization's accounts. Note: in addition to providing financial statement
information, the general ledger is a mechanism for
➢ The general ledger department updates these verifying the overall accuracy of accounting data that
records from journal vouchers prepared from separate accounting departments have processed.
special journals and other sources located Any event incorrectly recorded in a journal or
throughout the organization. subsidiary ledger will cause an out-of-balance
condition that should be detected during the general
➢ Provides a single value for each control account ledger update.

AUDIT TRAIL

➢ Of the many purposes of the audit trail, most

important to accountants is the year-end audit.

➢ The auditor's responsibility involves, in part, the

review of selected accounts and transactions to
 determine their validity, accuracy, and Types of Files
completeness.
1. MASTER FILE.
➢ The audit of AR often includes a procedure
called confirmation. This involves contacting ➢ generally contains account data.
selected customers to determine if the
transactions recorded in the accounts actually ➢ The general ledger and subsidiary ledgers are
took place and that customers agree with the examples of master files.
recorded balance.
➢ Data values in master files are updated from
transactions.

2. TRANSACTION FILE

➢ is a temporary file of transaction records used to

change or update data in a master file.

➢ Sales orders, inventory receipts, and cash

receipts are examples of transaction files.

3. REFERENCE FILE.

➢ stores data that are used as standards for

processing transactions. For example, the
payroll program may refer to a tax table to
calculate the proper amount of withholding taxes
for payroll transactions.
COMPUTER-BASED SYSTEMS
➢ Other reference files include price lists used for
Audit trails in computer-based systems are less preparing customer in voices, lists of authorized
observable than in traditional manual systems, but suppliers, employee rosters, and customer credit
they still exist. files for approving credit sales.

4. ARCHIVE FILE

➢ contains records of past transactions that are

retained for future refer ence. These transactions
form an important part of the audit trail.

➢ Archive files include journals, prior period

payroll information, lists of former
employees, records of accounts written off,
and prior-period ledgers

Digital Audit Trail

➢ Let's walk through the system represented in

Figure 2-11 to illustrate how computer files
provide an audit trail.
➢ We begin with the capture of the economic 1. Compare the accounts
event. In this example, sales are recorded receivable balance in the balance sheet with the
manually on source documents, just as in the master file AR control account balance.
manual system.
2. Reconcile the AR control figure
➢ The next step in this process is to convert the with the AR subsidiary account total.
source documents to digital form. This is
done in the data-input stage, when the 3. Select a sample of update
transactions are edited and a transaction file entries made to accounts in the AR subsidiary ledger
of sales orders is produced. and trace these to transactions in the sales journal
(archive file).
➢ Some computer systems do not use physical
source docu ments. Instead, transactions are 4. From these journal entries,
captured directly on digital media. identify specific source documents that can be pulled
from their files and verified. If necessary, the auditor
➢ The next step is to update the various master can confirm the accuracy and propriety of these
file subsidiary and control accounts that the source documents by contacting the customers in
transaction affects. During the update question..
procedure, additional editing of transactions
takes place. Documentation Techniques

➢ Some transactions may prove to be in error ➢ The old saying that a picture is worth a
or invalid for such reasons as incorrect thousand words is very applicable when it
account numbers, insufficient quantities on comes to documenting systems.
hand, or customer credit problems. In this
example, the system determines the available ➢ A written description of a system can be
credit for each customer from the credit file wordy and difficult to follow. Experience has
before processing the sale. shown that a visual image can convey vital
system information more effectively and
➢ Any records that are rejected for credit efficiently than words.
problems are transferred to the error file. The
remaining good records are used to update ➢ Accountants use system documentation
the master files. routinely, as both systems designers and
auditors, The ability to document systems in
➢ Only these transactions are added to the graphic form is thus an important skill for
archive file that serves as the sales journal. accountants to master.
By copying the valid transactions to the
journal, the original transaction file is not ➢ Five basic docu mentation techniques are
needed for audit trail purposes. introduced in this section: data flow
diagrams, entity relationship diagrams, sys
➢ This file can now be erased (scratched) in tem flowcharts, program flowcharts, and
preparation for the next batch of sales orders. record layout diagrams.

➢ Like the paper trail, this digital audit trail

allows transaction tracing. Again, an auditor
attempting to evaluate the accuracy of the AR DATA FLOW DIAGRAMS AND ENTITY
figure published in the balance sheet could do RELATIONSHIP DIAGRAMS
so via the following steps, which are
➢ Two commonly used systems design and
identified in Figure 2-11.
documentation techniques are the entity
 relationship diagram and the data flow ➢ The labeled arrows connecting the process
diagram. objects represent flows of data such as Sales
Order, Invoice, or Shipping Notice.
➢ This section introduces the principal features
of these techniques, illustrates their use, and ➢ Each data flow label should be unique the
shows how they are related. same label should not be attached to two
different flow lines in the same DFD.

➢ When data flow into a process and out again

Data Flow Diagrams (to another process), they have, in some way,
been changed.
➢ The data flow diagram (DFD) uses symbols
to represent the entities, processes, data ➢ This is true even if the data have not been
flows, and data stores that pertain to a system. physically altered.

➢ Figure 2-12 presents the symbol set most ➢ Systems analysts use DFDs extensively to
commonly used. DFDs are used to represent represent the logical elements of the system.
systems at different levels of detail from very
general to highly detailed. ➢ This technique does not, however, depict the
physical system. In other words, DFDs show
➢ In Chapter 14, we will study the construction what logical tasks are being done, but not
of multilevel DFDs. At this point, a single- how they are done or who (or what) is
level DFD is sufficient to demonstrate its use performing them.
as a documentation tool. We see an example
of this in Figure 2-13. Entity Relationship Diagrams

➢ Entities in a DFD are external objects at the ➢ An entity relationship (ER) diagram is a
boundary of the system being modeled. They documentation technique used to represent
represent sources of and destinations for data. the relationship between entities.
Entities may be other interacting systems or
functions, or they may be external to the ➢ Entities are physical resources (automobiles,
organization. cash, or inventory), events (ordering
inventory, receiving cash, shipping goods),
➢ Entities should always be labeled as nouns on and agents (salesperson, customer, or vendor)
a DFD, such as customer or supplier. Data about which the organization wishes to
stores represent the accounting records used capture data.
in each process, and labeled arrows represent
the data flows between processes, data stores, ➢ One common use for ER diagrams is to
and entities. model an organization's database,

➢ Processes in the DFD should be labeled with

a descriptive verb such as Ship Goods,
Update Records, or Receive Customer Order.

➢ Process objects should not be represented as

nouns like Warehouse, AR Dept., or Sales
Dept.
 ➢ This data model is the blueprint for what
ultimately will become the physical database.

which we examine in detail in Chapter 9.

Relationship between ER Diagrams and Data
➢ Figure 2-14 shows the symbol set used in an Flow Diagrams
ER diagram. The square symbol represents
entities in the system. The labeled connecting ➢ DFDs a Ds and ER diagrams depict different
line represents the nature of the relationship aspects of the same system, but they are
between two entities. related and can be reconciled.

➢ The degree of the relationship, called ➢ A DFD is a model of system processes, and
cardinality, is the numeric mapping between the ER diagram models the data used in or
entity instances. affected by.

➢ A rela tionship can be one-to-one (1:1), one-

to-many (1M), or many-to-many (MM). If
we think of entities in the ER diagram as files
of records, cardinality is the maximum
number of records in one file that are related
to a single record in the other file and vice
versa

➢ Cardinality reflects normal business rules as

well as organizational policy.

➢ If instead the organization's policy were to SYSTEM FLOWCHARTS

assign a single automobile to one or more
salespersons who share it, this policy would ➢ A system flowchart is the graphical
be reflected by a 1M relationship. Similarly, representation of the physical relationships
the MM relationship between vendor and among key elements of a system.
inventory in Figure 2-14 implies that the
organization buys the same type of products ➢ These elements may include organizational
from one or more vendors. departments, manual activities, computer
programs, hard-copy accounting records
➢ A company policy to buy particular items (documents, journals, ledgers, and files), and
from a single vendor would be reflected by a digital records (reference files, transaction
1:M cardinality. System designers identify files, archive files, and master files).
entities and prepare a model of them, similar
to the one presented in Figure 2-15. ➢ System flowcharts also describe the type of
com puter media being employed in the
 system, such as magnetic tape, magnetic records, and sends the products and Copy 2 to the
disks, and terminals. shipping department.

➢ The flowcharting examples in the following 6. The shipping department receives Copy 2 and the
sections illustrate techniques for representing goods from the warehouse, attaches Copy 2 as a
both manual and computer-based accounting packing slip, and ships the goods to the customer.
processes. Finally, the clerk files Copies 3 and 4 in the shipping
department.
➢ We begin by documenting manual
procedures. We will add computer elements ➢ Based on these facts, the auditor can create a
to the system later. flowchart of this partial system.

Flowcharting Manual Activities ➢ It is important to note that flowcharting is as

much an art form as it is a technical skill,
➢ To demonstrate the flowcharting of manual giving the flowchart author a great deal of
activities, let's assume that an auditor needs license.
to flowchart a sales order system to evaluate
its internal controls and procedures. ➢ Nevertheless, the primary objective should
be to provide an unambiguous description of
➢ The auditor will begin by interviewing the system.
individuals involved in the sales order
process to determine what they do. ➢ With this in mind, certain rules and
conventions need to be observed:
➢ This information will be cap tured in a set of
written facts similar to those below. Keep in 1. The flowchart should be labeled to clearly identify
mind that the purpose here is to demonstrate the system that it represents.
flowcharting. Thus, for clarity, the system
facts are intentionally simplistic. 2. The correct symbols should be used to represent
the various entities in the system.
1. A clerk in the sales department receives a hard-
copy customer order by mail and manually prepares 3. All symbols on the flowchart should be labeled.
four hard copies of a sales order.
4. Lines should have arrowheads to clearly show the
2. The clerk sends Copy 1 of the sales order to the process flow and sequence of events.
credit department for approval. The other three cop
ies and the original customer order are filed 5. If complex processes need additional explanation
temporarily, pending credit approval. for clarity, a text description should be included on
the flowchart or in an attached document referenced
3. The credit department clerk validates the by the flowchart.
customer's order against hard-copy credit records
kept in the credit department. The clerk signs Copy I LAY OUT THE PHYSICAL AREAS OF
to signify approval and returns it to the sales clerk. ACTIVITY.

4. When the sales clerk receives credit approval, he ➢ Remember that a flowchart reflects the
or she files Copy I and the customer order in the physical system, which is represented as
department. The clerk sends Copy 2 to the warehouse vertical columns of events and actions
and Copies 3 and 4 to the shipping department. separated by lines of demarcation.

5. The warehouse clerk picks the products from the ➢ Generally, each of these areas of activity is a
shelves, records the transfer in the hard-copy stock separate column with a heading.
 ➢ From the written system facts, we see that 2. The clerk sends Copy I of the sales order to the
there are four distinct areas of activity: sales credit department for approval. The other three
department, credit department, warehouse, copies and the original customer order are filed
and shipping department. temporarily, pending credit approval

➢ The first step in preparing the flowchart is to 3. The credit department clerk validates the
lay out these areas of activity and label each customer's order against hard-copy credit records
of them. This step is illustrated in Figure 2- kept in the credit department. The clerk signs Copy I
16. to signify approval and returns it to the sales clerk

TRANSCRIBE THE WRITTEN FACTS INTO ➢ Two new symbols are introduced in this
VISUAL FORMAT. figure. First, the upside-down triangle
symbol represents the temporary file
➢ At this point we are ready to start visually mentioned in Fact 2.
representing the system facts.
➢ This is a physical file of paper documents
➢ The symbols used for this purpose will be such as a drawer in a filing cabinet or desk.
selected from the set presented in Figure 2-
17, We begin with the first stated fact: ➢ Such files are typically arranged according to
a specified order. To signify the filing sys tem
1. A clerk in the sales department receives a hard- used, the file symbol will usually contain an
copy customer order by mail and manually prepares "N" for numeric (invoice number), "C" for
four hard copies of a sales order. chronologi cal (date), or "A" for alphabetic
order (customer name). Secondly, the
Figure 2-18 illustrates how this fact could be parallelogram shape represents the credit
represented. The customer is the source of the order, records mentioned in Fact 3.
but is not part of the system. The oval object is
typically used to convey a data source or destination ➢ This symbol is used to depict many types of
that is separate from the system being flowcharted. hand-copy accounting records, such as
The document symbol entering the sales department journals, subsidiary ledgers, general ledgers,
signifies the hard-copy customer order and is labeled and shipping logs.
accordingly.
➢ Having laid these foundations, let's now
➢ The bucket-shaped symbol represents a complete the flowchart by depicting the
manual process. In this case, the clerk in the remaining facts.
sales department prepares four copies of the
sales order. Notice that the clerk's task, not 4. When the sales clerk receives credit approval, he
the clerk, is depicted. or she files Copy I and the customer order in the
department. The clerk sends Copy 2 to the warehouse
➢ The arrows between the objects show the and Copies 3 and 4 to the shipping department.
direction of flow and the sequence of events.
5. The warehouse clerk picks the products from the
➢ By transcribing each fact in this way, we shelves, records the transfer in the hard-copy stock
systematically construct a flowchart. See records, and sends the products and Copy 2 to the
how the second and third facts restated below shipping department.
add to the flowchart in Figure 2-19.
6. The shipping department receives Copy 2 and the
goods from the warehouse, attaches Copy 2 as a
packing slip, and ships the goods to the customer.
Finally, the clerk files Copies 3 and 4 in the ship ping ➢ Typically, a system flowchart shows only the
department. The completed flowchart is presented in flow of documents, not physical assets.
Figure 2-20. Notice the circular symbol labeled "A."
This is an on-page connector used to replace flow ➢ Finally, for visual clarity, system flowcharts
lines that otherwise would cause excessive clutter on show the processing of a single transaction
the page. only.

In this instance, the connector replaces the lines that ➢ You should keep in mind, however, that
signify the movement of Copies 3 and 4 from the transactions usually pass through manual
sales department to the shipping department. procedures in batches (groups).

Lines should be used whenever possible to promote ➢ Before exploring documentation techniques
clarity. Restricted use of connectors, however, can further, we need to examine some important
improve the readability of the flowchart. issues related to batch processing.

Batch Processing

➢ Batch processing permits the efficient

management of a large volume of
transactions.

➢ A batch is a group of similar transactions

(such as sales orders) that are accumulated
over time and then processed together.

➢ Batch processing offers two general

advantages.

➢ First, organizations improve operational

efficiency by grouping together large
numbers of transactions into batches and

processing them as a unit of work rather than

processing each event separately.

➢ Second, batch processing provides

control over the transaction process. The
accuracy of the process is established by
periodically reconciling the batch against
the control figure.

➢ Both of these advantages have

implications for designing batch systems.

➢ Notice also that the physical products or ➢ The first is that economies are derived by
goods mentioned in Facts 4 and 5 are not making transaction batches large as
shown on the flow chart. possible. The average transaction cost is
thus reduced when the processing fixed
➢ The document (Copy 2) that accompanies cost associated with the batch is allocated
and controls the goods, however, is shown. across a large number of transactions.
 ➢ The second implication is that finding an 2. A computer program edits the transactions, checks
error in a very large batch may prove the customers' credit by referencing a credit history
difficult. When a batch is small, error file, and produces a transaction file of sales orders.
identification is much easier.
3. The sales order transaction file is then processed
➢ In designing a batch system, the by an update program that posts the transactions to
accountant should seek a bal ance corresponding records in AR and inventory files.
between the economic advantage of large
batches and the troubleshooting 4. Finally, the update program produces three hard
advantage of small batches. copies of the sales order. Copy I is sent to the
warehouse, and Coples 2 and 3 are sent to the
➢ There is no magic number for the size of shipping department.
a batch. This decision is based on a
number of opera tional, business, and 5. On receipt of Copy 1, the warehouse clerk picks
economic factors. the products from the shelves. Using Copy I and the
warehouse personal computer (PC), the clerk records
➢ Among these are the volume of the inventory transfer in the digital stock records that
transactions, the competitiveness of the are kept on the PC. Next, the clerk sends the physical
industry, the normal frequency of errors, inventory and Copy I to the shipping department.
the financial implications of an
undetected error, and the costs of 6. The shipping department receives Copy I and the
processing. goods from the warehouse. The clerk reconciles the
goods with Copies 1, 2, and 3 and attaches Copy I as
➢ Depending on these factors, a system a packing slip. Next, the clerk ships the goods (with
might be designed to process many small Copy I attached) to the customer. Finally, the clerk
batches throughout the day or an entire records the shipment in the hard copy shipping log
day's activity as a single batch. and files Copies 2 and 3 in the shipping department.

Flowcharting Computer Processes

We now examine flowcharting techniques to

represent a system that employs both manual and
computer processes. The symbol set used to
construct this system flowchart will come from both
Figure 2-17 and Figure 2-21. Again, our example is
based on a sales order system with the following
facts:
LAY OUT THE PHYSICAL AREAS OF
1. A clerk in the sales department receives a customer
ACTIVITY.
order by mail and enters the information into a
computer terminal that is networked to a centralized ➢ The flowcharting process begins by creating
computer program in the computer operations a template that depicts the areas of activity
department. The original customer order is filed in similar to the one shown in Figure 2-16.
the sales department. Facts 2, 3, and 4 relate to
activities that occur in the computer operations ➢ The only differences in this case are that this
department. system has a computer operations department
but does not have a credit department.
TRANSCRIBE THE WRITTEN FACTS INTO ➢ If the terminal was also used to receive output
VISUAL FORMAT. (the facts do not specify such an operation),
arrowheads would be on both ends of the line.
➢ As with the manual system example, the next
step is to systematically transcribe the written ➢ Recall that the emphasis in flowcharting is
facts into visual objects. Figure 2-22 on the physical system.
illustrates how Facts 1, 2, and 3 translate
visually. ➢ For example, the terminal used by the sales
clerk to enter customer orders is physically
➢ The customer, customer order, and file located in the sales department, but the
symbols in this flowchart are the same as in programs that process the transactions and
the previous exam ple. the files that it uses and updates are stored in
a separate computer operations department.
➢ The sales clerk's activity, however, is now
automated, and the manual process symbol ➢ Notice how the flow line points from the
has been replaced with a computer terminal credit history file to the edit program. This
symbol. indicates that the file is read (referenced) but
not changed (updated) by the program. In
➢ Also, because this is a data-input operation, contrast, the interactions between the update
the arrowhead on the flowchart line points in program and the AR and inventory files are
the direction of the edit and credit check in the opposite direction.
program. If the terminal was also used to
receive output (the facts do not specify such ➢ The relevant records in these files have been
an operation), arrowheads would be on both changed to reflect the transactions. The logic
ends of the line. of a file update is explained later in the
chapter.
TRANSCRIBE THE WRITTEN FACTS INTO
VISUAL FORMAT. ➢ Let's now translate the remaining facts into
visual symbols. Fact 4 states that the update
➢ As with the manual system example, the next program pro duces three hard-copy
step is to systematically transcribe the written documents in the computer operations
facts into visual objects. department, which are then distributed to the
warehouse and shipping departments.
➢ Figure 2-22 illustrates how Facts 1, 2, and 3
translate visually. The customer, customer ➢ The translation of this fact is illustrated in
order, and file symbols in this flowchart are Figure 2-23. Fact 5 states that the warehouse
the same as in the previous exam ple. clerk updates the stock records on the
department PC and then sends the physical
➢ The sales clerk's activity, however, is now inventory and Copy I to the shipping
automated, and the manual process symbol department.
has been replaced with a computer terminal
symbol. ➢ Notice on Figure 2-23 how this computer
activity is represented. The warehouse PC is
➢ Also, because this is a data-input operation, a stand-alone computer system that is not
the arrowhead on the flowchart line points in networked into the computer operations
the direction of the edit and credit check department like the terminal in the sales
program. department.
 ➢ The PC, the stock record update program, and ➢ The connector lines between the symbols
the stock records themselves are all establish the logical order of execution.
physically located in the warehouse. As with
manual procedures, when documenting
computer operations the flowchart author
must accurately represent the physical
arrangement of the system components.

➢ As we will see in later chapters, the physical

arrange ment of system components (both
manual and computer) often plays an
important role in the auditor's assessment of
internal control.

➢ Finally, Fact 6 describes how the shipping

department clerk reconciles the goods with
the supporting documents, sends the goods
and the packing slip to the customer, updates
the shipping log, and files two copies of the
sales order. This is entirely a manual
operation, as evidenced by the symbols in
➢ Tracing the flowchart downward from the
Figure 2-23. Note that the shipping log uses
start symbol, we see that the program
the same symbol that is used for representing
performs the following logical steps in the
journals and ledgers.
order listed:
PROGRAM FLOWCHARTS
1. The program retrieves a single record
The system flowchart in Figure 2-23 shows the from the unedited transaction file and
relationship between computer programs, the files stores it in memory.
they use,
2. The first logical test is to see if the
PROGRAM FLOWCHARTS program has reached the end-of-file
(EOF) condition for the transaction file.
➢ The system flowchart in Figure 2-23 shows Most file structures use a special record
the relationship between computer or marker to indicate an EOF condition.
programs, the files they use, and the outputs When EOF is reached, the edit program
they produce. will terminate and the next program in
the system (in this case, the update
➢ This high level of documentation does not program) will be executed. As long as
provide the operational details that are there is a record in the unedited
sometimes needed. transaction file, the result of the EOF test
will be "no" and process control is passed
to the next logical step in the edit
program.
➢ A separate symbol represents each step of
the program's logic, and each symbol 3. Processing involves a series of tests to
represents one or more lines of computer identify certain clerical and logical errors.
program code. Each test, represented by a decision
symbol, evaluates the presence or
 absence of a condition. For example, an program is actually doing what the
edit test could be to detect the presence of documentation describes.
alphabetic data in a field that should
contain only numeric data. ➢ Program flowcharts provide essential details
for conducting information technology
4. Error-free records are sent to the edited audits.
transaction file.

5. Records containing errors are sent to the

error file. RECORD LAYOUT DIAGRAMS

6. The program loops back to Step 1, and the ➢ are used to reveal the internal structure of the
process is repeated until the EOF records that constitute a file or database table.
condition is reached.
➢ usually shows the name, data type, and length
of each attribute (or field) in the record.

➢ Detailed data structure information is needed

for such tasks as identifying certain types of
system failures, analyzing error reports, and
designing tests of computer logic for
debugging and auditing purposes.

COMPUTER-BASED ACCOUNTING
SYSTEMS

➢ two broad classes: batch systems and real-

time systems.

➢ A number of alternative configurations exist

within each of these classes.

➢ Systems designers base their configuration

choices on a variety of considerations.

➢ Accountants sometimes use program DIFFERENCES BETWEEN BATCH AND

flowcharts to verify the correctness of REAL-TIME SYSTEMS
program logic.
Information Time Frame
➢ They compare flowcharts to the actual
program code to determine whether the ➢ Batch systems assemble transactions into
groups for processing.
 ➢ Under this approach, there is always a time ➢ As batch systems are generally simpler than
lag between the point at which an economic their real-time counterparts, they tend to have
event occurs and the point at which it is shorter development periods and are easier
reflected in the firm's accounts. for programmers to maintain.

➢ The amount of lag depends on the frequency ➢ On the other hand, as much as 50 percent of
of batch processing. the total programming costs for real-time
systems are incurred in designing the user
➢ Time lags can range from minutes to weeks. interfaces.
➢ Payroll processing is an example of a typical ➢ Finally, real-time systems require dedicated
batch system. The economic events the processing capacity.
application of employee labor-occur
continuously throughout the pay period. At ➢ Real-time systems must deal with
the end of the period, the paychecks for all transactions as they occur.
employees are prepared together as a batch.
➢ Some types of systems must be available 24
hours a day whether they are being used or
not.
➢ Real-time systems process transactions
individually at the moment the event occurs. ➢ The computer capacity dedicated to such
systems cannot be used for other purposes.
➢ Because records are not grouped into batches,
there are no time lags between occurrence ➢ Thus, implementing a real-time system may
and recording. require either the purchase of a dedicated
computer or an investment in additional
➢ An example of real-time processing is an computer capacity.
airline reservations system, which processes
requests for services from one traveler at a ➢ In contrast, batch systems use computer
time while he or she waits. capacity only when the program is being run.
When the batch job completes processing, the
Resources freed capacity can be reallocated to other
applications.
➢ Generally, batch systems demand fewer
organizational resources (such as
programming costs, computer time, and user
training) than real-time systems.

➢ For example, batch systems can use

sequential files stored on magnetic tape.

➢ Real-time systems use direct access files that Operational Efficiency

require more expensive storage devices, such
as magnetic disks. ➢ Real-time processing in systems that handle
large volumes of transactions each day can
➢ The most significant resource differentials create operational inefficiencies.
are in the areas of systems development
(programming) and computer operations. ➢ A single transaction may affect several
different accounts. Some of these accounts,
 however, may not need to be updated in real o they are mainframe-based
time. applications; they tend to be batch
oriented;
➢ In fact, the task of doing so takes time that,
when multi plied by hundreds or thousands of o early legacy systems use flat files for
transactions, can cause significant processing data storage, but hierarchical and
delays. network databases are often
associated with later-era legacy
➢ Batch processing of noncritical accounts, systems.
however, improves operational efficiency by
eliminating unnecessary activities at critical ➢ These highly structured and inflexible
points in the process. storage systems promote a single-user
environment that discourages information
Efficiency Versus Effectiveness integration within business organizations.

➢ In selecting a data processing mode, the ➢ Modem systems tend to be client-server

designer must consider the trade-off between (network)-based and process transactions in
efficiency and effectiveness. real time.

➢ When immediate access to current ➢ A major advantage of database storage is the

information is critical to the user's needs, degree of process integration and data
real-time processing is the logical choice. sharing that can be achieved.
➢ When time lags in information have no ➢ Although legacy system configurations no
detrimental effects on the user's performance longer constitute the defining features of
and operational efficiencies can be achieved accounting information systems (AIS), they
by processing data in batches, batch are still of marginal importance to
processing is probably the superior choice. accountants.

Updating Master Files from Transactions

ALTERNATIVE DATA PROCESSING ➢ Whether batch or real-time processing is

APPROACHES being used, updating a master file record
involves changing the value of one or more
Legacy Systems Versus Modern Systems of its variable fields to reflect the effects of a
transaction.
➢ Not all modern organizations use entirely
modern information systems. Some firms
employ legacy systems for certain aspects of
their data processing.

➢ When legacy systems are used to process

financially significant transactions, auditors
need to know how to evaluate and test them.

➢ Legacy systems tend to have the following

distinguishing features:
 ➢ The primary key (PK) the unique identifier ➢ Because only a single valid location exists for
for the inventory file is INVENTORY each record, updating the record must occur
NUMBER. in place.

➢ The primary key for AR is ACCOUNT ➢ Figure 2-29 shows this technique.
NUMBER.

➢ Notice that the record structure for the sales

order file contains a primary key (SALES
ORDER NUMBER) and two secondary key
(SK) fields, ACCOUNT NUMBER and
INVENTORY NUMBER.

➢ These secondary keys are used for locating

the corresponding records in the master files.
➢ The destructive update approach leaves no
The update procedure in this example involves the
backup copy of the original master file.
following steps:
➢ Only the current value is available to the user.
1. A sales order record is read by the system.
➢ To preserve adequate accounting records in
2. ACCOUNT NUMBER is used to search the
case the current master becomes damaged or
AR master file and retrieve the corresponding
corrupted, separate backup procedures, such
AR record. 3. The AR update procedure
as those shown in Figure 2-30, must be
calculates the new customer balance by
implemented.
adding the value stored in the INVOICE
AMOUNT field of the sales order record to
the CURRENT BALANCE field value in the
AR master record.

3. Next, INVENTORY NUMBER is used to

search for the corresponding record in the
inventory master file.
➢ Prior to each batch update or periodically (for
4. The inventory update program reduces example, every 15 minutes), the master file
inventory levels by deducting the being updated is copied to create a backup
QUANTITY SOLD value in a transaction version of the original file.
record from the QUANTITY ON HAND
field value in the inventory record. ➢ Should the current master be destroyed after
the update process, reconstruction is possible
5. A new sales order record is read, and the in two stages.
process is repeated.
➢ First, a special recovery program uses the
Database Backup Procedures backup file to create a pre-update version of
the master file.
➢ Each record in a database file is assigned a
unique disk location or address that is ➢ Second, the file update process is repeated
determined by its primary key value. using the previous batch of transactions to
restore the master to its current condition.
 ➢ Because of the potential risk to accounting
records, accountants are naturally concerned
about the adequacy of all backup procedures.

BATCH PROCESSING USING REAL-TIME

DATA COLLECTION

➢ A popular data processing approach,

particularly for large operations, is to
electronically capture transaction data at the
source as they occur.

➢ By distributing data input capability to users,

certain transaction errors can be prevented or
detected and corrected at their source.
➢ Why the sales journal and general ledger
➢ The result is a transaction file that is free from accounts are being processed in batch mode.
most of the errors that plague older legacy Why not update them in real time along with
systems. the subsidiary accounts?

➢ The transaction file is later processed in batch ➢ The answer is to achieve operational
mode to achieve operational efficiency. efficiency.

Key steps in the process are: Each customer sale affects the following six
accounting records:
• The sales department clerk captures customer
sales data pertaining to the item(s) being • Customer account receivable (Subsidiary-
purchased and the customer's account. unique)

• The system then checks the customer's credit • Inventory item (Subsidiary-almost unique)
limit from data in the customer record
(account receivable subsidiary file) and • Inventory control (GL-common)
updates his or her account balance to reflect
the amount of the sale. • Account receivable control (GL-common)

• Next the system updates the quantity-on- • Sales (GL-common)

hand field in the inventory record (inventory
subsidiary file) to reflect the reduction in • Cost of good sold (GL-common)
inventory. This provides up-to-date
information to other clerks as to inventory
availability. ➢ To maintain the integrity of accounting data,
once a record has been accessed for
• A record of the sale is then added to the sales
processing, it is locked by the system and
order file (transaction file), which is
made unavailable to other users until its
processed in batch mode at the end of the
processing is complete.
business day. This batch process records each
transaction in the sales journal and updates
the affected general ledger accounts.
 ➢ When processing a customer account
receivable subsidiary record, the rule has no
implications for other users of the system. REAL-TIME PROCESSING

➢ Each user accesses only his or her unique ➢ Real-time systems process the entire
record. transaction as it occurs.

➢ General rule, therefore, master file records ➢ Is well suited to systems that process lower
that are unique to a transaction such as transaction volumes and those that do not
customer accounts and individual inventory share common records.
records can be updated in real time without
causing operational delays. ➢ For example, a sales order processed by the
system in Figure 2-32 can be captured, filled,
➢ Updating the records in the general ledger is and shipped the same day. Such a system has
a different matter. many poten tial benefits, including improved
productivity, reduced inventory, increased
➢ All general ledger accounts previously listed inventory turnover, decreased lags in
need to be updated by every sales transaction. customer billing, and enhanced customer
satisfaction. Because transaction information
is transmit ted electronically, physical source
documents can be eliminated or greatly
REAL-TIME PROCESSING reduced.
➢ Real-time systems process the entire Data Coding Schemes
transaction as it occurs.
➢ Within the context of transaction processing,
➢ A system has many potential benefits, data coding involves creating simple numeric
including improved productivity, reduced or alpha betic codes to represent complex
inventory, increased inventory turnover, economic phenomena that facilitate efficient
decreased lags in customer billing, and data processing.
enhanced customer satisfaction.
➢ To emphasize the importance of data codes,
➢ Because transaction information is we first consider a hypothetical system that
transmitted electronically, physical source does not use them.
documents can be eliminated or greatly
reduced. A SYSTEM WITHOUT CODES

➢ Real-time processing is well suited to ➢ Firms process large volumes of transactions

systems that process lower transaction that are similar in their basic attributes. For
volumes and those that do not share common instance, a firm’s AR file may contain
records. accounts for several different customers with
the same name and similar addresses.
➢ These systems make extensive use of local
area network and wide area network ➢ Consider the most elemental item that a
technology. machine shop wholesaler firm might carry in
its inventory-a machine nut.
➢ Terminals at distributed sites throughout the
organization are used for receiving, ➢ As a result, this entire class of inventory must
processing, and sending information about be distinguished on the basis of these three
current transactions. features, as follows:
 1. The size attribute ranges from ¼ inch to
1% inches in diameter in increments of %
of an inch, giving 96 nut sizes. This uncoded entry takes a great deal of
recording space, is time-consuming to record,
2. For each size subclass, four materials are and is obviously prone to many types of errors.
available: brass, copper, mild steel, and The negative effects of this approach may be
case-hardened steel. seen in many parts of the organization:

3. Each of these size and material subclasses 1. Sales staff. Properly identifying the items
come in three different threads: fine, sold requires the transcription of large
standard, and coarse. amounts of detail onto source documents.
Apart from the time and effort involved, this
tends to promote clerical errors and incorrect
shipments.

2. Warehouse personnel. Locating and picking

goods for shipment are impeded and shipping
errors will likely result.

3. Accounting personnel. Postings to ledger

accounts will require searching through the
subsidiary files using lengthy descriptions as
the key. This will be painfully slow, and
postings to the wrong accounts will be
Under these assumptions, this class of inventory common.
could contain 1,152 separate items (96 x 4 x 3).
The identification of a single item in this class A SYSTEM WITH CODES
thus requires a description featuring these
distinguishing attributes. To illustrate, consider ➢ These problems are solved, or at least greatly
the following journal entry to record the receipt reduced, by using codes to represent each
of $1,000 worth of half-inch, case hardened steel item in the inventory and supplier accounts.
nuts with standard threads supplied by Industrial
➢ Other uses of data coding in AIS are to:
Parts Manufacturer of Cleveland, Ohio.
1. Concisely represent large amounts of
Debit Credit complex information that would
otherwise be unmanageable.
Inventory nut, 1000 2. Provide a means of accountability
% inch, case- over the completeness of the
hardened steel, transactions processed.
standard thread
3. Identify unique transactions and
AP- 1000 accounts within a file.
Industrial Parts
4. Support the audit function by
Manufacturer,
providing an effective audit trail.
Cleveland,
Ohio The following discussion examines some of the
more commonly used coding techniques and
explores their respective advantages and ➢ ADVANTAGES. Block coding
disadvantages allows for the insertion of new codes
within a block without having to
NUMERIC AND ALPHABETIC CODING reorganize the entire coding structure.
SCHEMES For example, if advertising expense is
account number 626, the first digit
• Sequential Codes indicates that this account is an
operating expense.
➢ As the name implies, sequential codes
represent items in some sequential ➢ DISADVANTAGES. As with the
order (ascending or descending). A sequential codes, the information
common application of numeric content of the block code is not
sequential codes is the prenumbering readily apparent. For instance,
of source documents. account number 626 means nothing
until matched against the chart of
➢ ADVANTAGES. Sequential coding
accounts, which identifies it as
supports the reconciliation of a batch
advertising expense.
of transactions, such as sales orders,
at the end of processing. If the • Group Codes
transaction processing system detects
any gips in the sequence of ➢ Numeric group codes are used to
transaction numbers, it alerts represent complex items or events
management to the possibility of a involving two or more pieces of
missing or misplaced transaction. related data. The code consists of
zones or fields that possess specific
➢ DISADVANTAGES. Sequential meaning. For example, a depart ment
codes carry no information content store chain might code sales order
beyond their order in the sequence. transactions from its branch stores as
For instance, a sequential code follows:
assigned to a raw material inventory
item tells us nothing about the
attributes of the item (type, size, Store Dept. Item Salesper
material, warehouse location, and so Num Num Num son
on). ber ber ber

• Block Codes 04 09 47621 99

4
➢ A numeric block code is a variation
on sequential coding that partly
remedies the disadvantages just ➢ ADVANTAGES. Group codes have
described. This approach can be used a number of advantages over
to represent whole classes of items by sequential and block codes.
restricting each class to a specific
range within the coding scheme. A 1. They facilitate the representation of large
common application of block coding amounts of diverse data.
is the construction of a chart of
2. They allow complex data structures to be
accounts.
represented in a hierarchical form that is logical
and more easily remembered by humans.
3. They permit detailed analysis and reporting (26 blocks x 676 items each)=17,576 items
both within an item class and across different
classes of items. ➢ DISADVANTAGES. The primary
drawbacks with alphabetic coding are
➢ DISADVANTAGES, Ironically, the (1) as with numeric codes. There is
primary disadvantage of group difficulty rationalizing the meaning
coding results from its success us a of codes that have been sequentially
classification tool. Because group assigned, and (2) users tend to have
codes can effectively present diverse difficulty sorting records that are
information, they tend to be over coded alphabetically.
used.
• Mnemonic Codes
• Alphabetic Codes
➢ Mnemonic codes are alphabetic
➢ Alphabetic codes are used for many characters in the form of acronyms
of the same purposes as numeric and other combinations that convey
codes. Alphabetic characters may be meaning. For example, a student
assigned sequentially (in alphabetic enrolling in college courses may enter
order) or may be used in block and the following course codes on the
group coding techniques. registration form:

➢ ADVANTAGES. The capacity to

Course Type Course Number
represent large numbers of items is
increased dramatically through the
use of pure alphabetic codes or Acctng 101
alphabetic characters embedded
within numeric codes (alphanumeric Psyc 110
codes). The earlier example of a chart
of accounts using a three-digit code
with a single blocking digit limits Mgt 270
data representation to only 10 blocks
of accounts-0 through 9. Using Mkgt 300
alphabetic characters for blocking,
however, increases the number of
➢ Another example of the use of
possible blocks to 26-A through Z.
mnemonic codes is assigning state
Furthermore, whereas the two-digit
codes in mailing addresses:
sequential portion of that code has the
capacity of only 100 items (10), a NY(New York); CA( California)
two-position alphabetic code can
represent 676 items (26). Thus, by ➢ ADVANTAGES. The mnemonic
using alphabetic codes in the same coding scheme does not require the
three-digit coding space, we see a user to memorize meaning, the code
geometric increase in the potential for itself conveys a high degree of
data representation. information about the item that is
being represented.
(10 blocks x 100 items each) = 1,000 items
➢ DISADVANTAGES. Although
to mnemonic codes are useful for
representing classes of items, they
have limited ability to represent items
within a class.