CHAPTER 1: THE INFORMATION SYSTEM AN ACCOUNTANTS THE DATA HIEARCHY

PERSPECTIVE DATA ATTRIBUTE

- a logical and relevant characteristic of an entity about which the firm
INTERNAL AND EXTERNAL FLOWS OF INFORMATION captures data.
RECORD
- a complete set of attributes for a single occurrence within an entity class
FILES
- a complete set of records of an identical class.

DATABASE MANAGEMNT TASKS

- Storage, Retrieval, Deletion
DATA SOURCES
- are financial transactions that enter the information system from both
internal and external sources
- Internal Financial Transactions
- Exteranl Financial Transactions
SYSTEM
- the term system generates mental images of computers and DATABASE MANAGEMENT
programming DATA COLLECTION
- The first operatonal stage in information system
SUBSYSTEM
- called a subsystem when it is viewed in relation to the larger system DATA PROCESSING
of which it is a part. - Once the data is collected, data usually require processing to produce
information
SYSTEM DECOMPOSITION
- Decomposition is the process of dividing the system into smaller INFORMATION GENERATION
subsystem parts - the process of compiling, arranging, formatting and presenting
information to users
SYSTEM INTERDEPENDENCY
CHARACTERISTICS OF USEFUL INFORMATION
- A system’s ability to achieve its goal depends on the effective
- Relevance
functioning and harmonious interaction of its subsystems. - Accuracy
- Timeliness
GENERAL MODEL FOR AIS: The External Environment
- Completeness
- Summarization

FEEDBACK
- a form of output that is sent back to the system as a source of data.

INFORMATION SYSTEM OBJECTIVES

- To support the stewardship function of management.
- To support management decision making.
- To support the firm’s day-to-day operations.

AQUISISTION OF INFORMATION SYSTEM

(1) they develop customized systems from scratch through in-house
systems development activities and
(2) they purchase preprogrammed commercial systems from software
DATABASE MANAGEMENT vendors
- The organization’s database is its physical repository for financial 3 BASIC TYPES OF COMMERCIAL SOFTWARE
and nonfinancial data. It can be a filing cabinet or a computer disk. - Turnkey System
Regardless of the database’s physical form, we can represent its - Backbone System
contents in a logical hierarchy. - Vendor-supported System

ORGANIZATIONAL STRUCTURE
THE DATA HIEARCHY
- reflects the distribution of responsibility, authority, and accountability
throughout the organization.

BUSINESS SEGMENTS
- Firms organize into segments to promote internal efficiencies through
the specialization of labor and cost- effective resource allocations.
Managers within a segment can focus their attention on narrow areas of
responsibility to achieve higher levels of operating efficiency. Three of the
most common approaches include segmentation by:
GEOGRAPHIC LOCATION PERSONNEL
- A convenient way to manage such operations is to organize the - The objective of the personnel function is to effectively manage this
management of the firm around each geographic segment as a quasi- resource. A well-developed personnel function includes recruiting,
autonomous entity. training, continuing education, counseling, evaluating, labor relations,
PRODUCT LINE and compensation administration.
- allows the organization to devote specialized management, labor, and DISTRIBTUTION
resources to segments separately, almost as if they were separate firms. - the activity of getting the product to the customer after the sale. This
BUSINESS FUNCTION is a critical step. Much can go wrong before the customer takes
- Functional segmentation divides the organization into areas of possession of the product. Excessive lags between the taking and filling of
specialized responsibility based on tasks. The functional areas are orders, incorrect shipments, or damaged merchandise can result in
determined according to the flow of primary resources through the firm. customer dissatisfaction and lost sales.

FUNCTIONAL SEGMENTATION FINANCE

- most common way of organizing - manages the financial resources of the firm through banking and
treasury activities, portfolio management, credit evaluation, cash
disbursements, and cash receipts

THE ACCOUNTING INFORMATION

CAPTURING AND RECORDING
- These include events such as the movement of raw materials from the
warehouse into production, shipments of the finished products to
customers, cash flows into the firm and deposits in the bank, the
acquisition of inventory, and the discharge of financial obligations.

DISTRIBUTION OF TRANSACTION INFORMATION

- the accounting function distributes transaction information to
operations personnel to coordinate many of their key tasks. Accounting
activities that contribute directly to business operations include
inventory control, cost accounting, payroll, accounts payable, accounts
receivable, billing, fixed asset accounting, and the general ledger.

THE VALUE OF INFORMATION

- determined by its reliability
- information must possess certain attributes—relevance, accuracy,
completeness, summarization, and timeliness.
ACCOUNTING INDEPENDENCE
FUNCTIONAL AREAS OF A FIRM - Information reliability rests heavily on the concept of accounting
independence. Simply stated, accounting activities must be separate and
MATERIALS MANAGEMENT
independent of the functional areas that maintain custody of physical
- to plan and control the materials inventory of the company
resources.
Purchasing - responsible for ordering inventory from vendors when
inventory levels fall to their reorder points THE INFORMATION TECHNOLOGY FUNCTION
Receiving - the task of accepting the inventory previously ordered by CENTRALIZED DATA PROCESSING
purchasing. Receiving activities include counting and checking the - all data processing is performed by one or more large computers
physical condition of these items. housed at a central site that serve users throughout the organization.
Stores - takes physical custody of the inventory received and releases DISTRIBUTED DATA PROCESSING
these resources into the production process as needed. - reorganizing the computer services function into small information
processing units that are distributed to end users and placed under
PRODUCTION control.
- occur in the conversion cycle where raw materials, labor, and plant
ADVANTAGES OF DDP
assets are used to create finished products. - Cost reductions
- In general they fall into two broad classes: - Improved user satisfaction
(1) primary manufacturing activities and (2) production support - Improved cost control responsibility
activities.
Production Planning DISADVANTAGES OF DDP
- involves scheduling the flow of materials, labor, and machinery to - Mismanagement of organization-wide resources
efficiently meet production needs. - Consolidating Incompatible activities
- Hiring qualified professional
QUALITY CONTROL - monitor the manufacturing process at various
- hardware and software incompatibility
points to ensure that the finished products meet the firm’s quality
- redundant tasks
standards. - lack of standards
MAINTENANCE - keeps the firm’s machinery and other manufacturing
facilities in running order. THE EVOLUTION OF INFORMATION SYSTEM MODELS
THE MANUAL SYSTEM
MARKETING - oldest and most traditional form of accounting systems. Manual
- deals with the strategic problems of product promotion, advertising, systems constitute the physical events, resources, and personnel that
and market research. On an operational level, marketing performs such characterize many business processes
daily activities as sales order entry. - include such tasks as order-taking, warehousing materials,
manufacturing goods for sale, shipping goods to customers, and placing
orders with vendors.
- never used in practice.
- learning manual systems helps establish an important link between the ACCOUNTING RECORDS
AIS course and other accounting courses. 1. Manual System
- the logic of a business process is more easily understood when it is not - Documents
shrouded by technology. • Source Documents – Economic events result in the creation of some
documents at the beginning (the source) of the transaction. These are
THE FLAT-FILE MODEL called source documents and are used to capture and formalize
- most often associated with so-called legacy systems transaction data that the transaction cycle uses for processing.
- These are large mainframe systems that were implemented in the late
1960s through the 1980s.
- describes an environment in which individual data files are not related
to other files. End users in this environment own their data files rather
than share them with other users. Thus, stand-alone applications rather
than integrated systems per form data processing
- three significant problems in the flat-file environment: data storage,
data updating, and currency of information
- the user’s inability to obtain information as his or her needs change. This
called task-data dependancy
- single view model. Files are structured, formatted, and arranged to suit • Product Documents – are the result of transaction processing rather
the specific needs of the owner of primary user of the data than the triggering mechanism for the process.
THE DATABASE MODEL
- Through data sharing, the following traditional problems associated with
the flat-file approach may be overcome
- Elimination of data redundancy, Single update, Current values
- Flat-file and early database systems are called traditional systems
- True integration, however, would not be possible until the arrival of the
relational database model. This flexible database approach permits the
design of integrated systems applications capable of supporting the
information needs of multiple users from a common set of integrated • Turnaround Documents – are product documents of one system that
database tables. become source document for another system.

THE REA MODEL

- an accounting framework for modeling an organization’s critical
resources, events, and agents (REA) and the relationships between them.
Once specified, both accounting and nonaccounting data about these
phenomena can be identified, captured, and stored in a relational
database.
- proposed in 1982 as a theoretical model for accounting. Advances in
database technology have focused renewed attention on REA as a
practical alternative to the classical accounting framework
- Resources, Events, Agents
- structured around events rather than accounting artifacts such as
journals, ledgers, charts of accounts, and double entry accounting. - Journals
• Special Journals – are used to record specific classes of transactions
ENTERPRISE REOURCE PLANNING SYSTEM that occur in high volume. Such transactions can be grouped together in a
- an information system model that enables an organization to automate special journal and processed more efficiently than a general journal
and integrate its key business processes. ERP breaks down traditional permits.
functional barriers by facilitating data sharing, information flows, and the • General Journals – Firms use the general journal to record
introduction of common business practices among all organizational nonrecurring, infrequent, and dissimilar transactions permits. As a
users. practical matter, it is common practice to replace the traditional general
- Organizations that hope to successfully implement an ERP will need to journal with a collection of journal vouchers, which are written
modify their business processes to suit the ERP, modify the ERP to suit authorizations prepared for every transaction that meets the general
their business, or, more likely, modify both. journal requirements.
- . ERP packages are enormously expensive, but the savings in efficiencies - Ledgers
should be significant • General Ledger – Contain the firm's account information in the form of
highly summarized control accounts, The general ledger provides a single
Chapter 2: Introduction to Transaction Processing value for each control account, such as accounts payable, accounts
Expenditure Cycle receivable, and inventory.
- PURCHASING/ ACCOUNTSPAYABLE • Subsidiary Ledger – kept in various accounting departments of the
- CASH DISBURSEMENTS firm, including inventory, accounts payable, payroll, and accounts
- PAYROLL receivable. It is a mechanism for verifying the overall accuracy of
- FIXED ASSETS accounting data that separate accounting departments have processed.

Conversion Cycle
- PRODUCTION PLANNING AND
- CONTROLCOST ACCOUNTING
2. Digital Accounting Records - shows logical task being done but not how they are done, or who or
- Master File – contains account data. The general ledger and subsidiary what is performing them
ledgers are examples of master files. Data values in master files are - used to represent at different levels of detail from very general to highly
updated (changed) by transactions. detailed
- Transaction File – is a temporary file of transaction records used to
update data in a master file.
- Reference File – stores data that are used as standards for processing
trans-actions.
- Archive File – contains records of past transactions that are retained for
future reference and form an important part of the audit trail.

2. Entity Relationship Diagrams

- is a documentation technique used to represent the relationship
between business entities.
- The REA model of ERD is widely used in AIS. REA uses types of entities,
namely;
• resources - (cash, raw materials)
• events - ( release of raw materials to production process)
• agents - (inventory control clerk, vendor, production worker)
- CARDINALITY represents the numerical mapping of entities:
• one-to-one
• one-to-many
• many-to-many
File Structures
- the way data is organized and stored within a system to facilitate
efficient access and processing.

Types of File Structures

1. FLAT-FILE MODEL
- an old way of storing data where each user or department keeps their
own separate data files instead of sharing a common database. This was
common in older mainframe systems but is still used in some special
3. System Flowcharts
cases today.
- illustrates the physical relationship among processes and the
Major Issues Using Flat-file Model:
documents that flow between them.
- Data Capture and Storage: Storing the same data multiple times wastes
- contain more details than data flow diagrams.
space and increases costs.
- clearly depicts the separation of functions in a system.
- Data Updating: a customer’s details change, each separate file has to be
updated individually, which is time-consuming and costly.
2 Types of System Flowcharts
- Currency of Information: If one file is updated but others are not,
1. Document flowchart – is used to depict the elements of a manual
different departments may use old, incorrect information.
system, including accounting records, organizations involved in process,
- Task Data Dependency: users can only access the data they personally
and activities performed in departments
control. If they need new information, they must create a new file instead
of easily pulling the data from a shared source.
- flat-file system is designed for one primary user or department, which
means the data is stored in a way that works best for them but may not
be useful for others.

2. DATABASE MODEL
How It Works:
Centralized Data Storage – All company data is stored in one database
instead of scattered across multiple separate files.

Controlled Access with DBMS – A Database Management System (DBMS)

2. System Flowcharts - portray the computer aspects of a system
controls who can access which data, ensuring security and preventing
- are used to represent the relationship between the key elements --
unauthorized access.
input sources, programs, and output products -- of computer systems.
- depict the type of media being used ( paper, magnetic tape, magnetic
Granular Data Format – Data is stored in its most basic form, so it can be
disks and terminals ) in practice, not much difference between
used flexibly by different departments without being customized for just
documentation and system flowcharts.
one user.

DOCUMENTATION TECHNIQUES
1. Data Flow Diagram
- uses symbols to represent the entities, processes, data flows, and data
stores that pertain to a system.
 - This uncoded entry takes a great deal of recording space, is time-
consuming to record, and is obviously prone to many types of errors. The
negative effects of this approach may be seen in many parts of the
organization;
• Sales staff
• Warehouse personnel
• Accounting personnel

SYSTEM WITH CODES

- This is not to suggest that detailed information about the inventory and
the supplier is of no interest to the organization. These facts will be kept
in reference files and used for such purposes as the preparation of parts
lists, catalogs, bills of material, and mailing information. The inclusion of
such details, however, would clutter the task of transaction processing
and could prove dysfunctional, as this simple example illustrates.

Other Advantages of data coding in AIS

- Concisely representing large amounts of complex information that
would otherwise be unmanageable.
- Providing a means of accountability over the completeness of the
transactions processed.
4. Program Flowcharts - Identifying unique transactions and accounts within a file.
- is a more detailed diagram that shows how a specific program or - Supporting the audit function by providing an effective audit trail.
process works inside the system.
- illustrate the logic of how a computer processes information step by NUMERIC AND ALPHABETICAL CODES
step. 1. Sequential Codes
- supports the reconciliation of a batch of transactions, such as sales
5. Record Layout Diagram orders, at the end of processing. If the transaction processing system
- are used to reveal the internal structure of digital records in a flat-file or detects any gaps in the sequence of transaction numbers, it alerts
database table. The layout diagram usually shows the name, data type, management to the possibility of a missing or misplaced transaction.
and length of each attribute (or field) in the record. - carry no information content beyond their order in the sequence. For
instance, a sequential code assigned to a raw material inventory item tells
TRANSACTION PROCESSING MODELS us nothing about the attributes of the item (type, size, material,
1. BATCH SYSTEMS warehouse location, etc.). Also, sequential coding schemes are difficult to
- Because batch systems assemble transactions into groups for processing, change.
a time lag will always exist between the point at which an economic
event occurs and the point at which it is processed by the system and 2. Block Codes
reflected in the firm's accounts. - allows for the insertion of new codes within a block without having to
- demand fewer organization resources (such as programming costs, reorganize the entire coding structure.
computer time, and user training) than real-time systems - As with the sequential codes, the information content of the block code
- Batch processing of noncritical accounts, improves operational is not readily apparent.
efficiency by eliminating unnecessary activities at critical points in the
process. 3. Group Codes
- They facilitate the representation of large amounts of diverse data.
2. REAL-TIME SYSTEM - They allow complex data structures to be represented in a hierarchical
- process transactions individually at the moment the event occurs, form that is logical and more easily remembered by humans.
therefore, no time lags exist between occurrence and processing. - They permit detailed analysis and reporting both within an item class
- A large portion of total programming costs for real-time systems are and across different classes of items.
incurred in designing user interfaces. - Because group codes can effectively present diverse information, they
- Real-time processing of large volumes of transactions can create tend to be overused. Unrelated data may be linked simply because it can
operational inefficiencies. A single transaction may affect several be done. This can lead to unnecessarily complex group codes that cannot
different accounts be easily interpreted.

DATA CODING SCHEMES 4. Alphabetical Codes

SYSTEM WITHOUT CODES - The capacity to represent large numbers of items is increased
- Business organizations process large volumes of transactions that are dramatically through the use of pure alphabetic codes or alphabetic
similar in their basic attributes. For instance, a firm's AR file may contain characters embedded within numeric codes (alphanumeric codes)
accounts for several different customers with the same name and similar - The primary drawbacks with alphabetic coding are (1) as with numeric
addresses. To process transactions accurately against the correct codes, there is difficulty rationalizing the meaning of codes that have
accounts, the firm must be able to distinguish one John Smith from been sequentially assigned, and (2) users tend to have difficulty sorting
another. This task becomes particularly difficult as the number of similar records that are coded alphabetically.
attributes in an item class increases
5. Mnemonic Codes
- The mnemonic coding scheme does not require the user to memorize RECEIVE ORDER
meaning, the code itself conveys a high degree of information about the - The sales process begins with the receipt of a customer order indicating
item that is being represented. the type and quantity of merchandise desired. At this point, the customer
- Although mnemonic codes are useful for representing classes of items, order is not in a standard format and may or may not be a physical
they have limited ability to represent items within a class document. Orders may arrive by mail, by telephone, or from a field
representative who visited the customer.
CHAPTER 4: THE REVENUE CYCLE - When the customer is also a business entity, the order is often a copy of
Revenue Cycle - direct exchange of finished goods or services for cash in the customer’s purchase order.
a single transaction between a seller and a buyer.
Consists of two major subsystems: TYPES OF ORDER FORMS
(1) the sales order processing subsystem and; - Customer order forms
(2) the cash receipts subsystem. - Sales order forms
- Purchase order forms
This time lag splits the revenue transaction into two phases:
(1) the Physical Phase - involving the transfer of assets or services from CHECK CREDIT
the seller to the buyer; - Before processing the order further, the customer’s credit worthiness
(2) the Financial Phase - involving the receipt of cash by the seller in needs to be established. The circumstances of the sale will determine the
payment of the account receivable. nature and degree of the credit check.
Credit Approval Process
2 MAIN SECTIONS - an authorization control and should be performed as a function
1. CONCEPTUAL REVENUE CYCLE SYSTEM separate from the sales activity.
2. PHYSICAL SYSTEM - In our conceptual system, the receive-order task sends the sales order
(credit copy) to the check-credit task for approval. The returned
CONCEPTUAL REVENUE CYCLE SYSTEM approved sales order then triggers the continuation of the sales process
- It provides an overview of key activities and the logical tasks, sources by releasing sales order information simultaneously to various tasks.
and uses of information, and movement of accounting information - Stock release, packing slip, shipping notice, and sales invoice are simply
through the organization. The section concludes with a review of internal special-purpose copies of the sales order and are not illustrated
control issues. separately.

PHYSICAL SYSTEM PICK GOODS

- A manual system is first used to reinforce key concepts previously - The receive order activity forwards the stock release document (also
presented. It also explores large-scale computer-based systems. called the picking ticket) to the pick goods function, in the warehouse.
- The focus is on alternative technologies used to achieve various levels - This document identifies the items of inventory that must be located
of organizational change from simple automation to reengineering the and picked from the warehouse shelves. It also provides formal
work flow. authorization for warehouse personnel to release the specified items.
- After picking the stock, the order is verified for accuracy and the goods
THE CONCEPTUAL SYSTEM and verified stock release document are sent to the ship goods task. If
- In this section we examine the revenue cycle conceptually. Using Data inventory levels are insufficient to fill the order, a warehouse employee
Flow Diagrams (DFDs) as a guide, we will trace the sequence of activities adjusts the verified stock release to reflect the amount actually going to
through three processes that constitute the revenue cycle for most retail, the customer.
wholesale, and manufacturing organizations. -The employee then prepares a back-order record, which stays on file
These are: until the inventories arrive from the supplier. Back-ordered items are
Sales Order Procedures shipped before new sales are processed.
Sales Return Procedures
Cash Receipts Procedures SHIP GOODS
- Service companies such as hospitals, insurance companies, and banks - This document conveys pertinent new facts such as the date of
would use different industry-specific methods shipment, the items and quantities actually shipped, the name of the
carrier, and freight charges. In some systems, the shipping notice is a
SALES ORDER PROCEDURES separate document prepared within the shipping function.
- The shipping clerk packages the goods, attaches the packing slip,
completes the shipping notice, and prepares a bill of lading.
- The bill of lading is a formal contract between the seller and the
shipping company (carrier) to transport the goods to the customer. This
document establishes legal ownership and responsibility for assets in
transit.

BILL OF LADING
- is an important legal document used in the shipping industry. It acts as
the contract between the shipper (seller) and the carrier (transport
company) to transport goods

BILL CUSTOMERS
The shipment of goods marks the completion of the economic event and
the point at which the customer should be billed. Billing before shipment
encourages inaccurate record keeping and inefficient operations.
- When the customer order is originally prepared, some details such as
inventory availability, prices, and shipping charges may not be known with
- include the tasks involved in receiving and processing a customer order, certainty.
filling the order and shipping products to the customer, billing the -Billing for goods not shipped causes confusion, damages relations with
customer at the proper time, and correctly accounting for the customers, and requires additional work to make adjustments to the
transaction. accounting records
 The billing function performs the following record keeping–related UPDATE RECEIVABLE
tasks: - The remittance advices are used to post to the customers’ accounts in
- Records the sale in the sales journal. the AR subsidiary ledger. Periodically, the changes in account balances
- Forwards the ledger copy of the sales order to the update accounts are summarized and forwarded to the general ledger function
receivable task.
- Sends the stock release document to the update inventory records task UPDATE GENERAL LEDGER
- Upon receipt of the journal voucher and the account summary, the
UPDATE INVENTORY RECORDS general ledger function reconciles the figures, posts to the cash and AR
- The inventory control function updates inventory subsidiary ledger control accounts, and files the journal voucher
accounts from information contained in the stock release document. In a
perpetual inventory system, every inventory item has its own record in RECONCILE CASH RECEIPTS AND DEPOSITS
the ledger containing, at a minimum, the data depicted. Each stock - Periodically (weekly or monthly), a clerk from the controller’s office (or
release document reduces the quantity on hand of one or more inventory an employee not involved with the cash receipts procedures) reconciles
accounts. cash receipts by comparing the following documents: (1) a copy of the
prelist, (2) deposit slips received from the bank, and (3) related journal
UPDATE ACCOUNTS RECIEVABLE vouchers.
- Customer records in the accounts receivable (AR) subsidiary ledger are
updated from information the sales order (ledger copy) provides. Every
customer has an account record in the AR subsidiary ledger containing, at
minimum, the following data: customer name; customer address; current
balance; available credit; transaction dates; invoice numbers; and credits
for payments, returns, and allowances.

POST TO GENERAL LEDGER

- By the close of the transaction processing period, the general ledger
function has received journal vouchers from the billing and inventory
control tasks an account summary from the AR function.

CASH RECEIPTS PROCEDURES

- Payment on the account is due at some future date, which the terms of
trade determine. Cash Receipts procedures apply to this future event.
- They involve receiving and securing the cash; depositing the cash in the
bank; matching the payment with the customer and adjusting the correct
account; and properly accounting for and reconciling the financial details
of the transaction REVENUE CYCLE CONTROLS
Credit Check
- Credit checking of prospective customers is a credit department
function. This department ensures the proper application of the firm’s
credit policies. The principal concern is the creditworthiness of the
customer. In making this judgment, the credit department may employ
various techniques and tests. The complexity of credit procedures will
vary depending on the organization, its relationship with the customer,
and the materiality of the transaction

Return Policy
- Because credit approval is generally a credit department function, that
department authorizes the processing of sales returns as well. An
approval determination is based on the nature of the sale and the
circumstances of the return. The concepts of specific and general
OPEN MAIL AND PREPARE REMITTANCE ADVICE authority also influence this activity. Most organizations have specific
Remittance advices - is a form of a turnaround document. It contains rules for granting cash refunds and credits to customers based on the
information needed to service individual customers’ accounts. Includes materiality of the transaction. As materiality increases, credit approval
payment date, account number, amount paid, and customer check becomes more formal
number.
- In other cases, this could be the original customer invoice, which was Remittance List
described in the sales order procedures. - Provides a means for verifying that customer checks and remittance
advices match in amount. The presence of an extra remittance advice in
Remittance List (or cash prelist) - where all cash received is logged. the AR department or the absence of a customer’s check in the cash
receipts department would be detected when the batch is reconciled
RECORD AND DEPOSIT CHECKS with the prelist. Thus, the prelist authorizes the posting of a remittance
- A cash receipts employee verifies the accuracy and completeness of the advice to a customer’s account
checks against the prelist. Any checks possibly lost or misdirected
between the mail room and this function are thus identified.

Cash Receipts Journal - All cash receipts transactions, including cash sales,
miscellaneous cash receipts, and cash received on account, are recorded.
- Notice that each check received from a customer is listed as a separate
line item.
Bank Deposit Slip - showing the amount of the day’s receipts and
forwards this along with the checks to the bank
FILES
- The revenue cycle employs several temporary and permanent files that
contribute to the audit trail. The following are typical examples:
- Open sales order file shows the status of customer orders.
- Shipping log specifies orders shipped during the period.
- Credit records file provides customer credit data.
- Sales order pending file contains open orders not yet shipped or billed.
- Back-order file contains customer orders for out of-stock items.
- Journal voucher file is a compilation of all journal vouchers posted to the
general ledger

2. PHYSICAL SYSTEMS
Refers to the tangible components and processes involved in collecting,
processing, and storing financial data. This includes:
- Manual Systems: Paper-based records, physical documents (e.g.,
invoices, receipts), and human processing of transactions.
- Computer-Based Systems: Hardware (computers, servers), software
(accounting programs), and digital storage used to automate financial THE BILLING DEPARTMENT
processes. - The shipping notice is proof that the product has been shipped and is
- The physical system represents how data physically moves within an the trigger document that initiates the billing process. Upon receipt of
organization, whether through manual handling or digital processing the shipping notice, the billing clerk compiles the relevant facts about the
transaction (product prices, handling charges, freight, taxes, and discount
Inclusion of manual systems is controversial in the digital age but justified terms) and bills the customer. The billing clerk then enters the
for three reasons: transaction into the sales journal and distributes documents to the AR
- Visual Training Aid – Manual systems help illustrate key concepts and inventory control departments. Periodically, the clerk summarizes all
through document flowcharts, making information flow easier to transactions into a journal voucher and sends this to the general ledger
understand. department.
- Reinforces Segregation of Duties – Manual flowcharts clearly depict
departmental boundaries, unlike computer-based systems where controls ACCOUNTS RECIEVABLE, INVENTORY CONTROL, AND GENERAL LEDGER
are embedded in programming and passwords. - Upon receipt of sales order copies from the billing department, the AR
- Framework for Technological Innovation – Understanding manual and inventory control clerks update their respective subsidiary ledgers.
systems provides insights into technological evolution and helps Periodically they prepare journal vouchers and account summaries,
contextualize modern advancements which they send to the general ledger department for reconciliation and
posting to the control accounts
MANUAL SYSTEMS
- It is a traditional method of processing financial transactions without SALES RETURN PROCEDURES
the use of computers. It relies on physical records, such as paper ledgers, - An organization can expect that a certain percentage of its sales will be
journals, and vouchers, to document, process, and store financial data. returned. This occurs for a number of reasons, some of which may be:
- Transactions are recorded and calculated manually by accountants or - The company shipped the customer the wrong merchandise.
clerks. While less efficient than computerized systems, manual systems - The goods were defective.
are still used in small businesses or as a learning tool to understand - The product was damaged in shipment.
fundamental accounting concepts - The buyer refused delivery because the seller shipped the goods too
late or they were delayed in transit
Sales Order Processing Flow: - When a return is necessary, the buyer requests credit for the unwanted
1. Sales Department – Records customer order and files it pending credit products. This involves reversing the previous transaction in the sales
approval. order procedure.
2. Credit Department Approval – Independently reviews and approves
credit, then releases order copies to billing, warehouse, and shipping.
3. Warehouse Procedures – Retrieves inventory and sends it with stock
release to shipping; updates stock records.
4. Shipping Department – Verifies order accuracy, prepares bill of lading,
ships products, logs transaction, and sends notice to billing.
- This process ensures accuracy, accountability, and auditability in
manual systems

SALES RETURN PROCEDURE

RECEIVING DEPARTMENT - The sales return process begins in the
receiving department, where personnel receive, count, inspect for
damage, and send returned products to the warehouse. The receiving
clerk prepares a return slip, which is forwarded to the sales department
for processing

SALES DEPARTMENT - Upon receipt of the return slip, the clerk prepares
a credit memo. Depending on the materiality and circumstance of the
return, company policy will dictate whether credit department approval
(not shown) is required.
PROCESSING THE CREDIT MEMO - The objective of the sales return REENGINEERING
system is to reverse the effects of the original sales transaction. Billing - It involves radically rethinking the business process and the work flow.
records a contra entry into sales return, and allowance journal inventory The objective of reengineering is to improve operational performance
control debits the inventory records to reflect the return of goods. The AR and reduce costs by identifying and eliminating nonvalue-added tasks.
clerk credits the customer account. All departments periodically prepare This involves replacing traditional procedures and often very different
journal vouchers and account summaries, which are then sent to the from those that previously existed
general ledger for reconciliation and posting to the control account
AUTOMATING SALES ORDER PROCESSING WITH BATCH TECHNOLOGY
SALES ORDER NUMBER
- It is the primary key (PK) because it is the only field that uniquely
identifies each record in the file. This is the preprinted number on the
physical source document that is transcribed during the keystroke
operation. In systems that do not use physical source documents, the
system automatically assigns this unique number. The PK is critical in
preserving the audit trail. It provides the link between digital records
stored on a computer disk and the physical source documents.

ACCOUNT NUMBER AND INVENTORY

- They are both secondary keys (SK) as neither of these keys uniquely
identifies sales order records. For instance, there may be more than one
sales order for a particular customer. Similarly, the same inventory item
type may be sold to more than one customer. Hence, the values for
these keys are not unique. Their purpose is to locate the corresponding
records in the AR subsidiary and inventory master files
CASH RECIEPTS PROCEDURES
CASH RECIEPTS SYSTEM
Mail Room - Customer payments and remittance advices arrive at the
mail room, where the envelopes are opened. The checks are sent to the
cashier in the department, cash and receipts the remittance advices are
sent to the AR department
Cash Receipts - The cashier records the checks in the cash receipts journal
and promptly sends them to the bank, accompanied by two copies of the
deposit slip. Periodically, the employee prepares a journal voucher and
sends it to the general ledger department
ACCOUNTS RECEIVABLE - The AR department uses the remittance
advices to reduce the customers’ account balances consistent with the
SALES DEPARTMENT
amount paid. The AR clerk prepares a summary of changes in account
The sales process begins with a customer contacting the sales
balances, which is sent to the general ledger department
department and placing an order. The sales clerk records the essential
details and prepares multiple copies of a sales order, which are held
GENERAL LEDGER DEPARTMENT - Upon receipt of the journal voucher
pending credit approval.
and account summary from cash receipts and AR, respectively, the
general ledger clerk reconciles the information and posts to the control
CREDIT APPROVAL
accounts.
- When credit is approved, the sales department releases copies of the
sales order to the billing, warehouse, and shipping departments. The
CONTROLLER’S OFFICE - Because cash is a liquid asset and subject to
customer order and credit approval are then placed in the open order file
misappropriation, additional controls are necessary. In this case,
someone from the controller’s office periodically performs a bank
reconciliation by comparing deposit slips returned from the bank,
account summaries used to post to the accounts, and journal vouchers

COMPUTER BASED ACCOUNTING SYSTEM

AUTOMATION
- It involves using technology to improve the efficiency and effectiveness
of a task. Too often, however, the automated system simply replicates
the traditional (manual) process that it replaces.
WAREHOUSE PROCEDURES
- Next the warehouse clerk receives the stock release copy of the sales
order and uses this to pick the goods. The inventory and stock release are
then sent to the shipping department

THE SHIPPING DEPARTMENT

- The shipping clerk reconciles the products received from the warehouse
with the shipping notice. Assuming no discrepancies exist, a bill of lading
is prepared, and the products are packaged and shipped via common
carrier to the customer. The clerk then sends the ship ping notice to the
computer department

KEYSTROKE
- The automated element of the system begins with the arrival of
TRANSACTION PROCESSING PROCEDURE
batches of shipping notices from the shipping department. These
SALES PROEDURES
documents are verified copies of the sales orders that contain
- Under real-time processing, sales clerks receiving orders from customers
information about the customer and the items shipped. The keystroke
process each transaction separately as it is received. Using a computer
clerk converts the hard-copy shipping notices to digital form to produce
terminal connected to a sales order system, the clerk performs the
a transaction file of sales orders. This is a continuous process. Several
following tasks in real-time mode:
times throughout the day, the keystroke clerk transcribes batches of
shipping notices. The resulting transaction file will thus contain many
1. The system accesses the inventory subsidiary file and checks the
separate batches of records. For each batch stored on the file, batch
availability of the inventory. It then performs a credit check, by retrieving
control totals are automatically calculated.
the customer credit data in the customer’s (AR) file. This file contains
information such as the customer’s credit limit, current balance, date of
EDIT RUN
last payment, and current credit status. Based on programmed criteria,
- Periodically, the sales order system is executed. Depending on
the customer’s request for credit is approved or denied.
transaction volume and the need for current information, this could be a
single end-of-day task or performed several times per day. The system is
2. If credit is approved, the system updates the customer’s current
composed of a series of program runs. The edit program first validates
balance to reflect the sale and reduces inventory by the quantities of
all transaction records in the batch by performing clerical and logical
items sold to present an accurate and current picture of inventory on
tests on the data. Typical tests include field checks, limit tests, range
hand and available for sale.
tests, and price-times quantity extensions. The edit program recalculates
the batch control totals to reflect any changes due to the removal of
3. The system automatically transmits a digital stock release document
error records. The edited sales order file is then passed to the file update
to the warehouse, a digital shipping notice to the shipping department,
run
and records the sale in the open sales order file. The structure of this file
includes a CLOSED field that contains either the value N or Y to indicate
UPDATE PROCEDURES
the status of the order. Closed records (those containing the value Y)
- Starting at the top of the edited sales order file, the update program
have been shipped, so the customer can now be billed. This field is used
posts the first transaction to the corresponding inventory and AR
later to identify closed records to the batch procedure. The default value
subsidiary records using the secondary keys (INVENTORY NUMBER and
in this field when the record is created is N. It is changed to Y when the
ACCOUNT NUMBER) to locate the records directly. This trans action is
goods are shipped to the customer. The salesclerk can determine the
then recorded in the journal, and the program moves to the next
status of an order in response to customer inquiries by viewing the
transaction record and repeats the process. This continues until all
records.
records in the transaction file have been posted. The general ledger
accounts are typically updated after each batch. When the program
WAREHOUSE PROCEDURES
reaches the end of the transaction file, it terminates.
The warehouse clerk’s terminal immediately produces a hard copy
- This system generates a number of management reports, including
printout of the electronically transmitted stock release document. The
sales summaries, inventory status reports, transaction listings, journal
clerk then picks the goods and sends them, along with a copy of the
voucher listings, and budget and performance reports. Quality
stock release document, to the shipping department
management reports play a key role in helping management monitor
operations to ensure that controls are in place and functioning properly.
SHIPPING DEPARTMENT
A shipping clerk reconciles the goods, the stock release document, and
the hard copy packing slip produced on the terminal. The clerk then
selects a carrier and prepares the goods for shipment. From the terminal,
the clerk transmits a shipping notice containing shipping date and
freight charges. The system updates the open sales order record in real
time and places a Y value in the CLOSED field, thus closing the sales order

GENERAL LEDGER UPDATE

- the batch update program searches the open sales order file for records
marked closed and updates the following general ledger accounts:
Inventory—Control, Sales, AR—Control, and Cost of Goods Sold. The
inventory subsidiary and AR subsidiary records were updated previously
during the real-time procedures. Batch updating of general ledger
records is done to achieve operational efficiency in high-volume
transaction processing systems. An alternative approach is to update the
general ledger accounts in real time, if doing so poses no significant
operational delays. Finally, the batch program prepares and mails
customer bills and transfers the closed sales records to the closed sales
order file (sales journal)
 POINT-OF-SALES SYSTEMS
ADVANTAGES OF REAL TIME PROCESSING - only cash, checks, and bank credit card sales are valid. The organization
- Reengineering the sales order processes to include real-time technology maintains no customer accounts receivable. Inventory is kept on the
can significantly reduce operating costs while increasing revenues. store’s shelves, not in a separate warehouse. The customers personally
- greatly shortens the cash cycle of the firm. pick the items they wish to buy and carry them to the checkout location,
- Real-time processing can give the firm a competitive advantage in the where the transaction begins.
marketplace.
- Manual procedures tend to produce clerical errors, such as incorrect
account numbers, invalid inventory numbers, and price–quantity
extension miscalculations.
- Finally, real-time processing reduces the amount of paper documents in
a system. Hard-copy documents are expensive to produce and clutter the
system

AUTOMATED CASH RECIEPTS PROCEDURES

- Cash receipts procedures are natural batch systems. Unlike sales
transactions, which tend to occur continuously throughout the day, cash
receipts are discrete events. Checks and remittance advices arrive from
the postal service in batches
DAILY PROCEDURES
1. Mail Room - The mail room clerk separates the checks and remittance - First, the checkout clerk scans the universal product code (UPC) label on
advices and prepares a remittance list. These checks and a copy of the the items being purchased with a laser light scanner
remittance list are sent to the cash receipts department. The remittance - When all the UPCs are scanned, the system automatically calculates
advices and a copy of the remittance list are sent to the AR department taxes, discounts, and the total for the transaction.
2. Cash Receipt Department - The cash receipts clerk reconciles the - The clerk enters the transaction into the POS system via the register’s
checks and the remittance list and prepares the deposit slips. Via keypad, and a record of the sale is added to the sales journal in real time.
terminal, the clerk creates a journal voucher record of total cash - At the end of the clerk’s shift, a supervisor unlocks the register and
received. The clerk files the remittance list and one copy of the deposit retrieves the internal tape
slip. At the end of the day, the clerk deposits the cash in the bank
3. Accounts Receivable Department - The AR clerk receives and END-OF-DAY PROCEDURES
reconciles the remittance advices and remittance list. Via terminal, the - At the end of the day, the cash receipts clerk prepares a three-part
clerk creates the cash receipts transaction file based on the individual deposit slip for the total amount of the cash received
remittance advices. The clerk then files the remittance advices and the
remittance list REENGINEERING USING EDI
4. Data Processing Department - Data Processing Department. At the end - Many organizations have reengineered their sales order process through
of the day, the batch program reconciles the journal voucher with the electronic data interchange (EDI). EDI technology was devised to
transaction file of cash receipts and updates the AR subsidiary and the expedite routine transactions between manufacturers and wholesalers
general ledger control accounts (AR— Control and Cash). and between wholesalers and retailers.
- EDI is more than just a technology. It represents a business
arrangement between the buyer and seller in which they agree, in
advance, to the terms of their relation
- Thousands of organizations worldwide are establishing home pages on
the Internet to promote their products and solicit sales. By entering the
seller’s home page address into the Internet communication program
from a personal computer (PC), a potential customer can access the
seller’s product list, scan the product line, and place an order. Typically,
Internet sales are credit card transactions. The customer’s order and
credit card information is attached to the seller’s e-mail file.

CONTROL CONSIDERATION FOR COMPUTER-BASED SYSTEMS

> Authorization - Transaction authorization in real-time processing
systems is an automated task
> Segragation of Duties - Tasks that would need to be segregated in
manual systems are often consolidated within computer programs.
> Supervision - The individual who opens the mail has access both to
cash (the asset) and to the remittance advice (the record of the
transaction).
> Access Control - In computerized systems, digital accounting records
REENGINEERED CASH RECEIPTS PROCEDURES are vulnerable to unauthorized and undetected access. To preserve the
- The task of opening envelopes and comparing remittance advices integrity of accounting records, Sarbanes-Oxley legislation requires
against customer checks is labor-intensive, costly, and creates a control organization management to implement controls that restrict
risk. Some organizations have reengineered their mail room procedures unauthorized access
to effectively reduce the risk and the cost > Accounting Records - Digital Journals and Ledgers. Digital journals and
- The system uses special transaction validation software that employs master files are the basis for financial reporting and many internal
artificial intelligence capable of reading handwriting. The system scans decisions.
the remittance advices and the checks to verify that the dollar amounts File Backup. The physical loss, destruction, or corruption of digital
on each are equal and that the checks are signed accounting records is a serious concern.
- Organizations with sufficient transaction volume to justify the > Independent Verification - The consolidation of many accounting tasks
investment in hardware and software have the advantages of improved under one computer program removes some of the traditional
control and reduced operating costs. The system works best when a high independent verification control from the system
degree of consistency between remittance advices and customer checks
exists
PC-BASED ACCOUNTING SYSTEM Privacy
- The software market offers hundreds of PC based accounting systems. - People desire to be in full control of what and how much information
In contrast to mainframe and client-server systems that are frequently about themselves is available to others, and to whom it is available. This
custom-designed to meet the specific user requirements, PC applications is the issue of privacy. The creation and maintenance of huge, shared
tend to be general-purpose systems that serve a wide range of needs databases make it necessary to protect people from the potential misuse
of data. This raises the issue of ownership in the personal information
industry

Security (Accuracy and Confidentiality)

- Computer security is an attempt to avoid such undesirable events as a
loss of confidentiality or data integrity. Security systems attempt to
prevent fraud and other misuse of computer systems; they act to protect
and further the legitimate interests of the system’s constituencies

Ownership of Property
- Laws designed to preserve real property rights have been extended to
Segragation of Duties - PC systems tend to have inadequate segregation cover what is referred to as intellectual property, that is, software. The
of duties. question here becomes what an individual (or organization) can own.
Access Control PC - systems generally provide inadequate control over - ideas? Media? Source code? Object code? A related question is whether
access to data files. owners and users should be constrained in their use or access. Copyright
Accounting Records - Data losses that threaten accounting records and laws have been invoked in an attempt to protect those who develop
audit trails plague the PC environment. software from having it copied.

CHAPTER 3: ETHICS, FRAUD, AND INTERNAL CONTROL Equity in Access

BUSINESS ETHICS - Some barriers to access are intrinsic to the technology of information
- Ethics pertains to the principles of conduct that individuals use in systems, but some are avoidable through careful system design. Several
making choices and guiding their behavior in situations that involve the factors, some of which are not unique to information systems, can limit
concepts of right and wrong. More specifically, business ethics involves access to computing technology.
finding the answers to two questions: (1) How do managers decide what
is right in conducting their business? and (2) Once managers have Environmental Issues
recognized what is right, how do they achieve it? - Computers with high-speed printers allow for the production of printed
documents faster than ever before. It is probably easier just to print a
- Business organizations have conflicting responsibilities to their document than to consider whether it should be printed and how many
employees, shareholders, customers, and the public. Every major copies really need to be made. It may be more efficient or more
decision has consequences that potentially harm or benefit these comforting to have a hard copy in addition to the electronic version
constituents.
- The following ethical principles provide some guidance in the discharge ARTIFICIAL INTELLIGENCE
of this responsibility. - A new set of social and ethical issues has arisen out of the popularity of
- Proportionality. The benefit from a decision must outweigh the risks. expert systems. Because of the way these systems have been marketed,
Furthermore, there must be no alternative decision that provides the that is, as decision makers or replacements for experts, some people rely
same or greater benefit with less risk. on them significantly.
- Justice. The benefits of the decision should be distributed fairly to
those who share the risks. Those who do not benefit should not carry the UNEMPLOYMENT AND DISPLACEMENT
burden of risk - Many jobs have been and are being changed as a result of the
availability of computer technology. People unable or unprepared to
EQUITY change are displaced. Should employers be responsible for retraining
- Executive Salaries, Comparable Worth, Product Pricing workers who are displaced as a result of the computerization of their
functions
RIGHTS
- Corporate Due Process, Employee Health Screening, Employee Privacy, MISUSE OF COMPUTERS
Sexual Harassment, Diversity, Equal Employment Opportunity, - Computers can be misused in many ways. Copying proprietary software,
Whistleblowing using a company’s computer for personal benefit, and snooping through
other people’s files are just a few obvious examples. Although copying
HONESTY proprietary software (except to make a personal backup copy) is clearly
- Employee and Management, Conflicts of Interest, Security of illegal, it is commonly done
Organization Data and Records, Misleading Advertising , Questionable
Business Practices in Foreign Countries , Accurate Reporting of SARBANES-OXLEY ACT
Shareholder Interests - This wide-sweeping legislation, more commonly known as the Sarbanes-
Oxley Act (SOX), is the most significant securities law since the SEC Acts of
EXERCISE OF CORPORATE POWER 1933 and 1934. SOX has many provisions designed to deal with specific
- Political Action Committees, Workplace Safety, Product Safety, problems relating to capital markets, corporate governance, and the
Environmental Issues Divestment of Interests, Corporate Political auditing profession. Several of these are discussed later in the chapter. At
Contributions, Downsizing and Plant Closures this point, we are concerned primarily with Section 406 of the act, which
pertains to ethical issues
Computer ethics
- is “the analysis of the nature and social impact of computer technology SECTION 406-CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS
and the corresponding formulation and justification of policies for the - Section 406 of SOX requires public companies to disclose to the SEC
ethical use of such technology. This includes concerns about software as whether they have adopted a code of ethics that applies to the
well as hardware and concerns about networks connecting computers as organization’s CEO, CFO, controller, or per sons performing similar
well as computers themselves. functions.
 The financial loss differences associated with the previous
CONFLICTS OF INTEREST classifications are explained by the opportunity factor.
- The company’s code of ethics should outline procedures for - Gender, Position, Age, Education, Collusion.
dealing with actual or apparent conflicts of interest between
personal and professional relationships. Note that the issue here Fraudulent Statements
is in dealing with conflicts of interest, not prohibiting them. - are associated with management fraud. Whereas all fraud
involves some form of financial misstatement, to meet the
FULL AND FAIR DISCLOSURES definition under this class of fraud scheme the statement itself
- This provision states that the organization should provide full, must bring direct or indirect financial benefit to the perpetrator.
fair, accurate, timely, and understandable disclosures in the
documents, reports, and financial statements that it submits to The Underlying Problems
the SEC and to the public Lack of Auditor Independence, Questionable Executive
Compensation, Inappropriate Accounting Practices
LEGAL COMPLIANCE
- Codes of ethics should require employees to follow applicable Sarbanes-Oxley Act (SOX) of 2002
governmental laws, rules, and regulations. As stated previously, - Public Company Accounting Oversight Board, Stronger auditor
we must not confuse ethical issues with legal issues independence, Enhanced corporate governance, Greater financial
disclosures, Harsher penalties for fraud
INTERNAL REPORTING OF CODE VIOLATIONS
- The code of ethics must provide a mechanism to permit prompt CORRUPTION
internal reporting of ethics violations. This provision is similar in - involves an executive, manager, or employee of the organization
nature to Sections 301 and 806, which were designed to in collusion with an outsider. The ACFE study identifies four
encourage and protect whistleblowers principal types of corruption: bribery, illegal gratuities, conflicts
of interest, and economic extortion.
ACCOUNTABILITY
- An effective ethics program must take appropriate action when Bribery – Paying or receiving money or gifts to influence
code violations occur. This will include various disciplinary decisions.
measures, including dismissal Illegal Gratuities – Rewarding someone after they make a
favorable decision.
DEFINITIONS OF FRAUD Conflicts of Interest – Putting personal gain above the employer’s
- Fraud denotes a false representation of a material fact made by best interests.
one party to another party with the intent to deceive and induce Economic Extortion – Using threats to force someone into giving
the other party to justifiably rely on the fact to his or her money or benefits
detriment.
Asset Misappropriation
ACCORDING TO COMMON LAW, A FRAUDULENT ACT MUST - The most common form of fraud scheme. Certain assets are
MEET THE FOLLOWING FIVE CONDITIONS: more susceptible than others to misappropriation. Transactions
- False representation, Intent Material Fact, Justifiable reliance, involving cash, checking accounts, inventory, supplies, equipment,
Injury or loss and information are the most vulnerable to abuse.

IN ACCOUNTING LITERATURE, FRAUD IS ALSO COMMONLY Common methods include:

KNOWN AS Charges to Expense Accounts – Thieves conceal stolen assets by
- White-collar crime, Embezzlement, Defalcation, Irregularities falsely recording them as expenses.
Lapping – Employees cover up stolen cash by using new customer
EMPLOYEE FRAUD payments to balance accounts.
- Employee fraud, or fraud by nonmanagement employees, is Transaction Fraud – False transactions are recorded to divert
generally designed to directly convert cash or other assets to the money or assets (e.g., fake payroll for nonexistent employees).
employee’s personal benefit. Typically, the employee circumvents Computer Fraud – Misuse of computer systems to steal, alter
the company’s internal control system for personal gain records, or illegally access data

Management fraud DATA COLLECTION

- is more insidious than employee fraud because it often escapes Data Processing– Converts raw data into useful information
detection until the organization has suffered irreparable damage through various computational techniques
or loss. Usually management fraud does not involve the direct
theft of assets TYPES OF DATA PROCESSING FRAUD
1. Program fraud - Manipulating programs to alter, delete, or
Management fraud insert values (e.g., salami fraud).
- typically contains three special characteristics: 2. Operations Fraud - Misusing company computers for personal
- The fraud is perpetrated at levels of management above the one gain
to which internal control structures generally relate.
- The fraud frequently involves using the financial statements to Database Management Fraud:
create an illusion that an entity is healthier and more prosperous - Altering, deleting, or stealing company data, often through
than, in fact, it is. unauthorized access or destructive code (e.g., logic bombs).
- If the fraud involves misappropriation of assets, it frequently is
shrouded in a maze of complex business transactions, often Information Generation Fraud:
involving related third parties - Stealing or misusing computer output via scavenging (retrieving
discarded reports) or eavesdropping (intercepting
communications)
INTERNAL CONTROL SYSTEM Control Activities
- To safeguard assets of the firm. - Policies and procedures to address risks, categorized as IT
- To ensure the accuracy and reliability of accounting records and controls (system security and data integrity) and physical controls
information. (human oversight). Key measures include:
- To promote efficiency in the firm’s operations.
- To measure compliance with management’s prescribed policies Transaction Authorization – Ensures only valid transactions
and procedures occur.

Modifying Assumptions Segregation of Duties– Prevents fraud by separating

Management Responsibility– Management is responsible for authorization, custody, and record-keeping. firms.
establishing and maintaining internal controls.
Reasonable Assurance – Controls should be effective but cost Supervision – Compensates for control gaps, especially in small
efficient, recognizing that no system is perfect firms.
Methods of Data Processing – Controls must work regardless of
technology used, though techniques may vary. Accounting Records – Maintains an audit trail for transparency
Limitations – Controls have weaknesses, including errors, and verification.
circumvention (e.g., collusion), management override, and
changing conditions Access Control – Restricts unauthorized access to assets and
records
Exposures and Risk Exposures
- A weakness in internal control may expose the firm to one or
more of the following types of risks:
1. Destruction of assets (both physical assets and information).
2. Theft of assets.
3. Corruption of information or the information system.
4. Disruption of the information system

The Preventive–Detective–Corrective Internal Control Model

Preventive Controls– The first defense against errors and fraud,
designed to reduce their occurrence by enforcing compliance.

Detective Controls – The second line of defense, identifying and

exposing issues that preventive controls miss. They compare
actual events to standards and trigger alerts when discrepancies
occur

- Corrective controls fix errors detected by detective controls.

Unlike detective controls, which only identify issues, corrective
controls resolve them.

- The PDC model (Preventive, Detective, Corrective) is useful but

lacks detailed guidance. Frameworks like SAS No. 78, based on
COSO, provide specific control techniques

CONTROL ENVIRONMENT
- The foundation of internal control, setting the organization's
ethical tone and structure. Key elements include integrity,
governance, management style, performance assessment, and
regulatory influences. Auditors assess these aspects to ensure a
strong control culture

RISK ASSESSMENT
- Identifies and analyzes risks affecting financial reporting. Risks
arise from operational changes, new personnel, rapid growth,
technology shifts, and foreign market entry. Management must
prioritize and mitigate these risks

Information and Communication

- The accounting information system (AIS) ensures accurate
transaction processing and financial reporting. Auditors examine
how transactions are initiated, recorded, and processed for
reliable financial statements

MONITORING
- Ongoing or separate evaluations ensure internal controls
function effectively. Internal audits, management reports, and
embedded IT modules help identify weaknesses and improve
controls.