DEMBEL COLLEGE

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

CHAPTER ONE
ACCOUNTING INFORMATION SYSTEM: INTRODUCTION
1.1 DEFINITIONS OF TERMS
A system is a set of two or more interrelated components to achieve a goal. Systems are almost always
composed of smaller subsystems, each performing specific function important to and supportive of the
larger system for which it is a part.

An accounting information system is a collection of resources such as people and equipment designed to
transform financial data into information. The information is communicated to a wide variety of decision
makers. AISs perform the transformation whether they are manual or computerized.

Organizations depend on information system in order to stay competitive. Information is just as resource as
plant, equipment and any other assets. Productivity, which is crucial to stay competitive, can be increased
through better information systems. Accounting as an information system identifies, collects, processes and
communicates economic information about an entity to a wide variety of people.

The accounting profession has been criticized for focusing too narrowly on the role of accounting
information which is quantitative in its nature; now a day, many scholars suggest that accountancy should
go beyond debit, credit, double entry accounting and GAAP so as to provide useful information for decision
making and help organizations to identify and control business risks.

Modern managers need both financial and nonfinancial information in a format and at a level of aggregation
that traditionally GAAP based accounting systems fail to provide. To overcome this failure many
organizations come up with multiple information systems those are functionally disconnected. Often data
entered in one system need to be re-entered in the others. Therefore, AIS can support multiple users’ views
in a single information system which potentially can overcome the problem.

Data and information

Data refers to any and all of the facts that are collected, stored, and processed by an information system.
Three kinds of data need to be collected for an entity. These are facts about the events itself, the resource
affected by the event, and the agents participated in that event.

 Information is different from data, once data have been collected; the AIS will transform the facts in to
information through process so that they will be used to make decisions. Thus information is data that
have been organized and processed to provide meaning hence make them meaningful (helpful) for decision to be
made. Usually, more information and better information translates into better decisions. However, when
you get more information than you can effectively assimilate, you suffer from information overload.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

When you’ve reached the overload point, the quality of decisions declines while the costs of producing
the information increases.

 Data (raw facts; which are meaningless before process) →Process (series of activities)
→Information it is meaningful (useful for decision making).

 [Data → Process→ Information]

1.2 COMPONENTS OF AIS

AIS consists of five component:
1. The people who operate the system and perform various functions.
2. The procedures both manual and automated involved in collecting, processing, and storing data about
organization’s activities.
3. The data about organization’s transactions.
4. The software used to process the organization’s data.
5. The information technology infrastructure including computers, peripheral devices, and network
communication devices.
The five components together enable AIS to fulfill three important functions in any organization.
1. Collecting and storing data
2. Transferring data into information (processing)
3. Providing adequate controls to safeguard the organizations assets including its data and information, to
ensure that the assets (resources) are available when needed and are accurate and reliable.
1.3. INFORMATION SYSTEMS
The term information system suggests the use of computer technology in an organization to provide
information to users. A computer based information system is a collection of computer hardware and
software designed to transform data into useful information. There are several types of computer based
information systems which includes the following:
1. Data processing – electronic data processing (EDP):- is the use of computer technology to perform an
organization’s transaction oriented data processing. EDP is a fundamental accounting information
system application in every organization. As computer technology has become commonplace, the term
data processing has come to have the same meaning as EDP.
2. Management Information System (MIS): describes the use of computer technology to provide decision
oriented information to managers. MIS provides a wide variety of information beyond that which is
associated with data processing in organizations.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

It recognizes that managers within organizations use and require information in decision-making, and
that computer based information systems can assist in providing information to managers.
Functional MIS Systems: many organizations apply the MIS concept to specific functional areas
within the organization. This indicates the tailoring of MIS concept to the development of specific
information systems to support decision-making in a particular well-defined organization subunit:
a. Marketing Information System: is MIS that provide information to be used by the marketing
function. Much of the information is obtained from the organization’s accounting information
system. Example sales summaries and cost information. Other information must be gathered from
the organization’s environment. Examples of environmental information would include customers’
preference data, customers’ profiles, and information on competitor’s products.
b. Manufacturing Information System: is MIS that provide information to be used by the
manufacturing function. Much of the information is obtained from the organization’s accounting
information system. Example inventory summaries and cost information. Other information must
be gathered from the organization’s environment. . Examples of environmental information would
include raw material data, potential new vendor profiles, and information on new manufacturing
techniques.
c. Human Resources Information System: : is MIS that provide information to be used by the human
resource (personnel) function. Much of the information is obtained from the organization’s
accounting information system. Example wage and payroll tax summaries and benefit
information. Other information must be gathered from the organization’s environment. Examples of
environmental information would include government regulation data and general labor market
information.
d. Financial Information System: is MIS that provide information to be used by the finance function.
Much of the information is obtained from the organization’s accounting information system.
Example cash flow summaries and payment information. Other information must be gathered
from the organization’s environment. . Examples of environmental information would include
interest rate data, lender profiles and information on credit markets.
3. Decision Support System (DSS): provide data processed into a decision making format for the end user.
A DSS requires the use of decision models and specialized databases, and differs significantly from a
DP system. A DSS is designed for specific types of decisions for specific users. It is directed at serving
specific non-routine information requests by managers. A familiar example is the use of spreadsheet
software to perform what if analysis of operating or budgeted data such as sales forecasts by marketing
personnel.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

4. Expert System (ES): are knowledge based information systems that the knowledge about specific
application area to act as an expert consultant to end-users. Like DSS an ES is also requires the
development of a knowledge base-the special knowledge that an expert possesses in a decision area and
an inference engine- the process by which expert makes decision. An ES attempts to replicate the
decision that would be made by an expert, human decision maker in the same decision situation.
As ES differ from DSS in that the DSS assists the user in making a decision, whereas an ES makes the
decision.
5. Executive Information Systems (EISs): are systems tailored to the strategic information needs of top-
level management. Much of the information used by top-level management comes from sources other
than an organization’s information systems. Examples are meetings, memos, television, periodicals, and
social activities. But some information must be processed by the organizational information systems. An
EIS provides top-level management has identified as being critical to the organization’s success. Actual
versus projected market share for product groups and budget versus actual profit and loss data for
divisions might be key success factors for top-level executive.
6. Accounting Information systems: are computer-based systems designed to transform accounting data
into information. However, AIS is used broadly to include transaction processing cycles, the use of
information technology and the development of information systems.

1.4 WHY STUDY THE AIS?

Effective AIS is essential to the organization’s long run success.

 It enables monitoring the events that occurs and how well an organization works.
 It also tracks the effect of various events on the resources that the organization controls.
 Information about the agents who participate in the events is used to assign responsibility for actions
taken.
The AIS course fits into both the accounting and information system curricula. Study of AIS fundamental
to accounting because changes shall be incorporated in the accounting curricula. It is recommended that
accounting curricula should be designed to provide the following three essential concepts.
 The use of information in decision making
 The nature , design, use and implementation of AISs
 Financial information reporting
The other accounting courses, such as financial or tax accounting, focus on how to provide information. In
contrast, the AIS course focuses on understanding how the accounting system works i.e. how to collect
data about the organization’s activities and transactions; how to transform that data into information that
management can use to run the organization; and how to ensure the availability, reliability and accuracy of
that information, Hence, it complements the other accounting courses.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

There are many other systems courses that cover the design and implementation of information systems
and which help develop specialized skills in such area as databases, expert systems, and
telecommunications. The AIS course differs from these other information systems courses in its focus on
accountability and control.

These issues are important because in most large organizations, the managers are not owners. Instead, the
owners have entrusted the management with assets (including data and information) and hold them
accountable for their proper use. Hence, the AIS course complements the other systems course.

Three factors influence the design of AIS:

 Developments in information technology (IT)
 The organization’s strategy
 The organizational culture

Strategy
Organizational
culture

AIS

Information
technology

Factors which influence the design of AIS

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

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

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

The Role of the AIS in the Value Chain

The objective of most organization is to provide value to their customers. This requires performing a
number of different activities. These activities are conceptualized as forming a value chain. An
organization’s value chain consists of five primary activities that directly provide value to its customers.

These are:

1. Inbound logistics: consists of receiving, storing, and distributing the materials that are inputs used by
the organization to create the services and products that it sells.
2. Operations: activities that transform inputs into final products and\or services.
3. Outbound logistics: are the activities involved in distributing finished products and\or services to
customers.
4. Marketing and sales: refers to the activities involved in helping customers to buy the organization’s
products and\or services.
5. Services: activities that provide post sale support to customers. Examples are repairs and maintenance
services.
Organizations also perform a number of other support activities that enables the five primary activities to
be performed efficiently and effectively. Those support activities can be grouped into four categories:

1. Firm Infrastructure: refers to the accounting, finance, legal support, and general administrative
activities that are necessary for any organization to function. The AIS is part of the firm infrastructure.
2. Human resources: activities that include recruiting, hiring, training and providing employee benefits
and compensation.
3. Technology: activities that improve a product or service. Examples include research and development,
improvements in information technology, website development, and product design.
4. Purchasing: includes all the activities involving in procuring raw materials, supplies, machinery and
the buildings used to carry out the primary activities.
It shall be recalled that systems are often composed of subsystems. Thus, each step in an organization’s
value chain in itself a system consisting of a set of activities. For example, the sales and marketing step
includes such activities as market research, calling on customers, order processing, and credit approval.

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COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

In addition, an organization’s value chain is itself a part of a large system. Organizations interact with
suppliers, distributors, and customers.

How Can AIS Add Value to an Organization?

The value chain model shows that the AIS is a support activity. Thus, AIS can add value to the
organization by providing accurate and timely information so that the five primary value chain activities
can be performed more effectively and efficiently. A well-designed AIS can do this by:

1. Improving the quality and reducing the cost of products and services: an AIS for example can
monitor machinery so that operates are notified immediately when the process falls outside
acceptable quality limits. This helps not only maintain product quality but also reduces the amount
of wasted materials and the costs of having to rework anything.
2. Improving efficiency: a well designed AIS can help improve the efficiency of operations by
providing more timely information. For example, a just in time production approach requires
constant, accurate and up to date information about raw material inventories and their costs.
3. Improved decision making: An AIS can improve decision making by providing accurate
information in a timely manner.
4. Sharing of knowledge: A well designed AIS can make it easier to share knowledge and expertise,
perhaps thereby improving operations and even providing a competitive advantage.

Well designed AIS can also help an organization profit by improving efficiency and effectiveness of its
supply chain. For example, allowing customers directly to access the company’s inventory and sales order
entry systems can reduce the cost of sales and marketing activities. Moreover, if such access reduces
customer’s costs and time of ordering, both sales and customer retention rate may increase.
1.5 Data and information
Data refers to any and all of the facts that are collected. Stored, and processed by an information system.
Three kinds of data need to be collected for an entity. These are facts about the events itself, the resource
affected by the event, and the agents participated in that event. Consider selling process as an example.
Data need to be collected about the sales event itself (such as the date of sales, total amount etc), data about
the resource being sold (identity of the goods and services) and data about the agent who participated in the
sales event (the identity of the customer and salesperson). Once data have been collected, the AIS will
transform the facts so that they will be used to make decisions. Thus information is data that have been
organized and processed to provide meaning.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

There are different models of decision making and problem solving process. All those models depict that
decision making is a complex, multistep activity.
 First the problem has to be identified
 Then the decision maker must select a method for solving the problem
 Next the decision maker must collect the data needed to execute the decision the decision
model and, interpret the output of the model evaluating the merits of each alternative
 Finally, the decision maker chooses and executes the preferred solution.

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

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

1.6. Decision Structure and scope

Decision structure
Decision vary in terms of the degree they are structured. Decisions are classified in to three in this regard.

 Structured decision: are repetitive, routine, and understood well enough that they can be deleted to
lower level employees in the organization. For example, the decision about extending credit to
established customers require only knowledge about the customer’s credit limit and current balance.
Structured decisions can often be automated.
 Semi structured decisions: are characterized by incomplete rules for making the decisions and the
need for subjective assessments and judgments to supplement formal data analysis. Setting marketing
budget for new product is a typical example. Although such decision cannot be fully automated, they
are often supported by computer based decision aids.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

 Unstructured decisions: are nonrecurring and no routine decisions. For example, choosing the cover
of a magazine, hiring senior management and selecting basic research projects to be undertaken. No
framework or model exists to solve such problems. Instead, they require considerable judgment and
intuition. Nevertheless, unstructured decisions can be supported by computer based decision aids that
facilitate gathering information from diverse sources.

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

 Operational control: Concerns the effective and efficient performance of specific tasks. Decision
relating to inventory management and extending credit are examples of operational control activities.
 Management control: Concerns the effective and efficient resources for accomplishing organizational
objectives. Budgeting, developing human resource practices and deciding on research projects and
product improvements are examples of management control activities.
 Strategic planning: Concerns the establishing of organizational objectives and policies for
accomplishing those objectives. Setting financial and accounting policies, developing new product
lines, and acquiring new businesses are examples of strategic planning decisions.
There exists a correspondence between a manager’s level in an organization and his decision making
responsibilities.
 Top management: Unstructured and semi-structured decisions, involving strategic decisions
 Middle managers: Deals with semi-structured decisions, involving management control.
 Lower level supervisors and employees, faces semi-structured or structured decisions involving
operational control.

Value of information for decision making

The information produced by well-designed AIS can improve decision making in several ways:

 First, it identifies situation requiring management action. For example, a cost report with a large
variance might stimulate management to investigate and if necessary take corrective action.
 Second, by reducing uncertainty, accounting information provides a basis for choosing among
alternative actions.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

For example, accounting information is often used t set prices and determine credit policies.
 Third, information about the result of previous decisions provide valuable feedback that can be used to
improve future decisions.
Nevertheless, although more information is often better, this is only true to a point. There are limits to the
amount of information that the human mind can effectively absorb and process. Information overload
occurs when those limits are passed. Information overload is costly because decision making quality
declines while the cost of providing that information is increases. Thus, information overload reduce the
value of information. Consequently, information system designers must consider how advances in IT can
help decision makers more effectively filter and condense information thereby avoiding information
overload.

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

1.7 AIS and corporate strategy:

Strategy and strategy positions
There are two basic strategies that company can follow:
1. A product differentiation strategy entails adding some features or services to a product that are not
provided by competitors. Doing so allow a company to charge a premium price to its customers.
2. A low cost strategy entails striving to be the most efficient producer of a product or service.
Sometimes companies can succeed in both producing a better product than competitors and in doing at
costs below its industry average.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

Usually, however, companies must choose between the two basic strategies. If they concentrate on being
the lowest cost producers, they will have to forego some value added feature that might differentiate their
product.
If they focus on product differentiation, they most likely will not have the lowest cost in the industry. Thus
a business strategy involves making choices.
The choice of a business strategy involves the selection of a specific strategic position they shall adopt.

There are three strategic positions:

1. A variety based strategic position involves producing or providing a subset of the industry’s products
and/or services.
2. A needs based strategic position involves trying to serve most or all of the needs of a particular group
of customers. This entails first identifying a target market.
3. An access based strategic position involves serving a subset of customers who differ from other
customers in terms of factors such as geographic locations or size, which creates different
requirements for serving those customers.
The above strategic positions are not mutually exclusive and indeed often overlap. For example, a company
may adopt elements of all the three. Choosing a strategic position is important because it enables the
company to focus its efforts; otherwise, it risks trying to be everything to everybody.

Information technology and business strategy

We have seen that IT can affect strategy. In addition to directly affecting the way that organizations
carryout their value chain activities, IT such as Internet can also affect significantly both strategy and
strategic positioning. For example, it is dramatically cuts costs, thereby helping companies to implement a
low cost strategy.
1.8. The role of AIS
An organization’s AIS play an important role in helping it adopt and maintain a strategic position.
Achieving a close fit among activities requires that data to be collected about each activity. It is also
important that the information system collect and integrate both financial and nonfinancial data about the
organization’s activities.

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 DEMBEL COLLEGE
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE

Traditionally, the AIS was used as transaction processing system because it was concerned about financial
data. To handle nonfinancial data, other systems were used leading to redundancy and problem in updating
data.
Enterprise resource planning (ERP) systems: are designed to overcome these problems as they integrate all
aspects of a company’s operation with its traditional AIS. For example, when a sales order is entered by the
sales force, the effect of the transaction automatically flows to all affected parts of the company. Inventory
is updated, production schedules are adjusted, and purchase order of raw materials and supplies are
initiated. Moreover, important nonfinancial data such as the time of sales are collected and stored in the
same system.
A key feature of ERP systems is the integration of financial with other nonfinancial operating data. The
value of such integration is to suggest that there may be strategic benefits to more closely linking
traditionally separate functions of information systems and accounting, and many organizations are
beginning to combine these two functions.

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