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The Traditional Accounting Information System


Chapter 3 Objectives Pacioli: The Father of Traditional Accounting Pacioli was not really the inventor, but was the first accountant to combine his knowledge with ... – PowerPoint PPT presentation

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Title: The Traditional Accounting Information System

The Traditional Accounting Information System
  • Chapter 3

Describe the nature of the traditional accounting
cycle and its relationship to business events
Describe the impact of IT on the traditional
accounting system
Describe the limitations of the traditional
accounting system architecture
Describe how the traditional accounting system
architecture limits accountings ability to
enhance value
Pacioli The Father of Traditional Accounting
  • Pacioli was not really the inventor, but was the
    first accountant to combine his knowledge with
    the technology that enabled authors to print
    books using a movable type and a printing press
    to instruct the world on the subject in print.
  • Pacioli documented the double entry, chart of
    account classification scheme used to record and
    store accounting data.
  • To keep the accounts in balance, Pacioli proposed
    a rigorous process for recording, maintaining,
    and reporting accounting data. Pacioli suggested
    the use of three books
  • the memorandum book,
  • the journal and
  • the ledger.

The memorandum book should include notations of
every transaction, large and small, in whatever
currency was being used and in as much detail as
time and circumstance allowed.
The journal was the source for the ledger, where
the double entry bookkeeping was done.
It was in the ledger that the businessman could
learn before anyone else whether he was a success
or a failure
Rules for Accounting
  • Chart of Accounts See Exhibit 3-1
  • classify and summarize financial measurements
  • nominal accounts vs real accounts
  • One compendium of sample charts of accounts and
    accounting procedures for different industries is
    The Encyclopedia of Accounting Systems
  • Charles Sprague Any occurrence accounting
    transaction must be either an increase or a
    decrease of values, and there are three classes
    of values assets, liabilities, and equity ...
    in every transaction at least two of the
    occurrences must appear ... on opposite sides of
    the above list.
  • Assets Liabilities Owners Equity

Exhibit 2-1 Sample Chart of Accounts
Account Title
Account Title
  • Current Assets
  • Cash 110
  • Accounts Receivable 130
  • Allowance for Doubtful Accounts 140
  • Inventory 160
  • Prepaid Insurance 180
  • Notes Receivable 190
  • Property, Plant, and Equipment 200
  • Land 210
  • Building 220
  • Accumulate Depreciation Building 230
  • Equipment 240
  • Accumulated Deprec. Equipment 250
  • Current Liabilities
  • Accounts Payable 310
  • Long-Term Debt
  • Bonds Payable 410
  • Stockholders Equity
  • Common Stock 510
  • Capital in Excess 520
  • Retained Earnings 550
  • Revenue and Expense Summary 590
  • Revenue
  • Revenue 610
  • Interest Revenue 620
  • Rent Revenue 630
  • Expenses
  • Purchases 710
  • Freight on Purchases 720
  • Purchase Returns 730
  • Selling Expenses 740
  • General and Admin. Expenses 750
  • Interest Expense 760
  • Extraordinary Loss (pretax) 770

Exhibit 3-2 Steps in the Accounting Cycle and
Their Objectives
During the accounting period
Exhibit 3-2 Steps in the Accounting Cycle and
Their Objectives
Exhibit 3-2 Steps in the Accounting Cycle and
Their Objectives
At the beginning of the next accounting period
Ó The McGraw-Hill Companies, Inc., 2000
Step Identify Accounting Transactions to be
  • The purposes of this first step are to identify
    the business events that can be considered
    accounting transactions and to collect relevant
    economic data about those transactions.
    Accounting transactions are the business events
    that cause a change in the organizations assets,
    liabilities, or owners equity. These events
  • Exchanges of resources and obligations between
    the reporting firm and outside parties
    (reciprocal transfers or non-reciprocal
  • Internal Events within the firm that affect its
    resources or obligations but that do not involve
    outside parties
  • Economic and environmental events beyond the
    control of the company (changes in values)
  • Accounting transactions are typically accompanied
    by a source document prepared by someone other
    than the accountant

Step 2 - Journalize Accounting Transaction Data
  • Measure and record the economic impact of
  • Transactions are recorded in a journal - Debit,
    Credit, date, account number, amounts ,and
  • General journal and Special Journals
  • Historical Cost Principle
  • Posting References and page numbers

Step 3 Post Journal Data to Ledgers
  • The process of transferring transaction data from
    the journals to the ledger accounts is called
  • General Ledger and Subsidiary Ledgers
  • Totals of Special Journal Columns are posted
  • An audit trail should provide the capability to
    trace an individual transaction from its initial
    recording all the way through the accounting
    process to the final figures in the financial
  • Reconciliation is the process of summing the
    subsidiary ledgers and comparing the total with
    the balance in the general ledger control account

Step 4 Prepare Unadjusted Trial Balance
  • The unadjusted trial balance is a list of general
    ledger accounts and their account balances
  • Convenient method of determining that the sum of
    the Debit account balances equals the sum of the
    Credit account balances
  • If the trail balance does not balance the source
    of the error must beinvestigated

Exhibit 3-5 Unadjusted Trail Balance Illustrated
Click to Open
Step 5 Journalize and Post Adjusting Entries
  • Adjusting entries are required when their is no
    source document to trigger a transaction
  • Passage of time ( interest or depreciation)
  • Correct Errors
  • Record Changes in Estimates
  • Recording Deferrals
  • Recording Accruals
  • Reclassifying balances
  • Recognizing inventory losses

Source documents from earlier transactions are
the primary information sources for adjusting
Step 6 Prepare Adjusted Trial Balance
  • The adjusted trial balance lists all the account
    balances that will appear in the financial
    statements (with the exception of retained
    earnings, which does not yet reflect the current
    years net income and dividends).
  • The purpose of the adjusted trial balance is to
    confirm debit-credit equality, taking all
    Adjusting journal entries into consideration.
    Confirm Debit Credit Balance
  • Source for preparation of the Financial

Step 7 Prepare Financial Statements
  • The primary objective of financial accounting is
    to provide information that is useful to
    decision-makers. Financial statements can be
    produced for a period of any duration. However,
    monthly, quarterly, and annual statements are the
    most common.
  • The income statement, retained earnings
    statement, and balance sheet are prepared
    directly from the adjusted trial balance.
  • The temporary account balances are transferred
    to the income statement, and the permanent
    account balances are transferred to the balance

Step 8 Journalize and Post Closing Entries
  • Closing entries reduce the temporary accounts
    (e.g., revenues, expenses, and dividends) to a
    zero (closed) balance.
  • Closing entries are recorded in the general
    journal at the end of the accounting period and
    are posted to the appropriate ledger accounts.
  • Permanent accounts are not closed because they
    carry asset, liability, and owner's equity
    balances to the next accounting period.
  • The retained earnings account is the only
    permanent account involved in the closing

Step 9 Prepare Post-Closing Trial Balance
  • A post-closing trial balance lists only the
    balances of the permanent accounts after the
    closing process is finished. (The temporary
    accounts have zero balances.)
  • This step is taken to check for debit-credit
    equality after the closing entries are posted.
  • Firms with a large number of accounts find this a
    valuable procedure because the chance of error
    increases with the number of accounts and
  • The retained earnings account is now stated at
    the ending balance and is the only permanent
    account with a balance different from the one
    shown in the adjusted trial balance.

Step 10 Journalize and Post Reversing Entries
  • At the beginning of the next period, the
    accountant may prepare and post reversing entries
    to compensate for the difference in timing
    between the occurrence of an actual economic
    reality, and the recording of the economic event
    in the accounting system.
  • Reversing entries use the same accounts and
    amounts as adjusting entries but with the debits
    and credits reversed.
  • These entries reverse adjusting entries made at
    the end of one period and prepare the accounting
    records for normal processing of business events
    in the new period.

Applying Information Technology to the Accounting
  • Human information processing challenges
  • Human Error
  • Human inefficiency
  • Paper based communication is costly
  • Reasons why IT is not used
  • technology does not exist
  • technology is not cost effective
  • Using IT to replicate a manual system is not
  • The accounting architecture needs to be changed

Criticisms Of The Traditional Accounting System
  • One criticism of the traditional architectures is
    a lack of integration across functional areas of
    the organization.
  • Example an international computer manufacturer
    that maintains a separate chart of accounts and
    ledgers for its manufacturing and marketing
    divisions because they have different criteria
    for reporting financial information.
  • Manufacturing recognizes revenue when a product
    is shipped to a customer
  • Marketing recognizes revenue when the customer
    is billed for the product.
  • The entire accounting process is automated.
  • Example
  • Two business events
  • Shipping to customer 8 Journal entries
  • Billing customer 8 Journal Entries
  • Adjusting for Revenue Recognition 8 Journal

Criticisms of the Traditional Accounting System
  • Activities are performed to provide service to
    the customer
  • Many systems exist to record and report on
  • Different managers want different views of the
    data to make decisions in their area of influence
  • Too many systems

Multiple Views of the Same Business Event
Marketing people wants to know about the order to
evaluate pricing, plan advertising campaigns, and
target selling efforts.
Executive management wants to know about the
order to evaluate its impact on the organization
Investors and creditors want to know about all
orders to assess the profitability of their
investments and the likelihood of a return on
their investment
Personnel view
Production view
Personnel people want to know about the order to
pay sales commissions.
Production people want to know about the order to
plan production processes
Marketing view
Executive view
Investors and creditors view (GAAP)
The Proliferation of Accounting Subsystems
Business Event
System D Edit Audit Calculate Summarize Stored D
System C Edit Audit Calculate Summarize Stored D
System B Edit Audit Calculate Summarize Stored D
System A Edit Audit Calculate Summarize Stored D
Functional Views
Functional Views
Functional Views
Functional Views
Criticisms of Traditional Accounting Systems and
  • There is a proliferation of often conflicting,
    nonintegrated systems and subsystems within a
    single organization.
  • The architecture captures data about a subset of
    an organization's business events (the accounting
  • Data are not recorded and processed in real-time
  • The architecture stores and processes only a
    limited number of characteristics about
    accounting transactions.
  • The architecture captures and stores duplicate
    data in a highly summarized form
  • The architecture stores financial data to
    satisfy one primary view (perspective).

  • Based primarily on financial reporting
  • Income Statement Balance Sheet
  • Build new/alternative systems for alternative
    views of business data.
  • Confine recorded information to accounting
  • Store and summarize information in ledgers.

Architecture of Traditional Accounting
Accounting Data A Subset of Business Data
(Limited view limited data)
Data that describes Business Activities
Acct. Data
Business Activities
Accountants filter data
General Ledger
Limited Output Views / Formats
The Heart of the Problem with Traditional Systems
Process Classifies and summarizes transaction
Output Produces narrow functional views
Input Narrow set of transactions
Narrow functional views drive the selection of
transactions, classification, and summarization
Are These Criticisms Valid?
  • The criticisms we have presented simply highlight
    the difficulties of adapting the traditional
    accounting system architecture to a rapidly
    changing world.
  • Today's business world is fast paced, more
    information intensive, and involves complex
    business transactions beyond Pacioli's wildest
  • Todays information customers are very demanding.
    They desire a larger variety of faster,
    customized information products delivered in a
    variety of modes. For example, many people now
    want their information system to produce a much
    broader array of information products such as
    balanced scorecards.

Ways That Accounting Can Enhance Its Value to the
Helping Management Define Business Process Rules
- To help management define business process
rules presupposes involvement in an
organizations business processes. We should
develop an AIS architecture that enables
accountants to exercise influence over the
development and implementation of business
processes rules throughout the business process.
Providing More Useful Information - Traditional
accounting measures are expressed almost
exclusively in monetary terms a practice that
precludes information on productivity,
performance, reliability and other
multidimensional data that cannot be easily
expressed in monetary terms.
Helping to Embed Real-Time Information Processes
into Business Processes - Accountants should
provide meaningful, direct input into the design,
development, and implementation of real-time
information processes that execute business rules
and gather business data.
Role of the Office of the CFO (Chief Financial
  • Insightful contributions into the strategy and
    planning process
  • Measures that focus and motivate the organization
  • Information and analysis that provides insight
    into how value is being created and how progress
    is being matched to strategic initiatives.
  • Leadership of major financial initiatives.

We think objectives such as these provide
justification for changing the architecture of
any information system that limits the potential
of information providers in adding value to an
Event-Driven IT Application Overview
Enterprise-wide Information Customers
Business Events
Business Event Processor (business and information
processing rules)
Business Data Repository
Reporting Facility (Information processing rules)
Business Event Data
Useful Information
  • Based on business events (business activities)
    rather than information customer views.
  • Supports business process simplification and
  • Integrates all business data.
  • Integrates information processes and real-time

Characteristics of Future Architecture