Accounting Information System (AIS) and the Accounting Cycle

Accounting Information System (AIS): Core Concepts and Applications

What is an Accounting Information System (AIS)?

• An Accounting Information System is a set of interrelated activities, documents, and technologies.
• It is designed to collect data, process it, and report information.
• The reported information is provided to a diverse group of internal and external decision-makers within organizations.
• A well-designed AIS can significantly enhance decision-making by responding to many elements of the Financial Accounting Standards Board (FASB) Conceptual Framework.

FASB Conceptual Framework

• Purpose: The framework (established in $1988$) explains what accounting aims to achieve.
• Objective of Financial Reporting: To provide information for decisions.
• Qualitative Characteristics: Traits information should possess to be useful for decisions.
  • Primary Characteristics:
    • Relevance
    • Reliability
  • Secondary Characteristics:
    • Comparability
    • Consistency
• Elements of Financial Statements:
  • Assets
  • Liabilities
  • Equity
  • Revenue
  • Expense
  • Gains
  • Losses
  • Comprehensive Income
• Assumptions:
  • Economic entity
  • Going concern
  • Periodicity
  • Monetary unit
• Principles:
  • Historical cost
  • Realization
  • Matching
  • Full disclosure
• Constraints:
  • Cost-effectiveness
  • Materiality
  • Conservatism
  • Industry practices

How AIS Relates to the FASB Conceptual Framework

• Capturing Data: AIS documents changes in the elements of financial statements, regardless of their form or the information technologies used. This includes assets, liabilities, equity, revenues, expenses, gains, and losses.
• Transforming Data: Well-designed AIS can gather and transform these data, and also data beyond the financial statement elements, into relevant and reliable information.
• Cost-Benefit Constraint: AIS recognizes and adapts to this constraint. It involves making choices and trade-offs regarding:
  • What data to capture.
  • What information technologies to use for processing.
  • What information to report.

AIS Structure

The fundamental components of an AIS are:

• Inputs
• Processes
• Outputs
• Storage
• Internal Controls

Accounting vs. Bookkeeping

• Accounting: The broader process of identifying, measuring, and communicating economic information to allow informed judgments and decisions by information users.
• Bookkeeping: A specific part of accounting devoted to identifying and measuring economic information. It is the record-keeping aspect.

The Accounting Cycle

The accounting cycle comprises $10$ steps:

1. Obtain information about external transactions from source documents.
2. Analyze transactions.
3. Record the transactions in a journal.
4. Post from the journal to the general ledger accounts.
5. Prepare an unadjusted trial balance.
6. Record adjusting entries and post to the general ledger accounts.
7. Prepare an adjusted trial balance.
8. Prepare financial statements.
9. Close the temporary accounts to retained earnings (at year-end only).
10. Prepare a post-closing trial balance (at year-end only).

Transaction Types

• External Transactions: Involve exchanges of goods and services with other individuals and business entities (e.g., suppliers, shareholders, government agencies, employees).
  • Accountants typically become aware of these through source documents (paper or electronic).
• Internal Transactions: Include adjusting entries, closing entries, and reversing entries.

Common Internal Controls for Source Documents

• Sequential numbering
• Physical security
• Transaction limits

Transaction Analysis

This involves five steps:

1. Identify the accounts affected by the transaction.
2. Identify the effect of the transaction on each account (i.e., increase or decrease).
3. Determine the element of financial statements represented by each account.
4. Based on the principles of debit and credit, determine which kind of entry is required for each account.
5. Verify that, for each transaction, the total debits equal the total credits.

Example Trial Balance (DMN Corporation, September $30$, $2004$)

A trial balance ensures total debits equal total credits for all accounts. For instance:

• Cash: Debit $15,800$
• Accounts receivable: Debit $5,200$
• Inventory: Debit $4,800$
• Equipment: Debit $5,000$
• Accumulated depreciation: Credit $1,400$
• Accounts payable: Credit $2,000$
• Notes payable: Credit $800$
• Bonds payable: Credit $6,000$
• Capital stock: Credit $12,000$
• Additional paid-in capital: Credit $7,400$
• Retained earnings: Credit $2,500$
• Sales: Credit $13,800$
• Cost of goods sold: Debit $6,300$
• Advertising expense: Debit $5,000$
• Depreciation expense: Debit $2,800$
• Supplies expense: Debit $1,000$
• Totals: Debits $45,900$, Credits $45,900$

Adjusting Entries

Adjusting entries are internal transactions made at the end of an accounting period.

Financial Statements

The final step (before closing entries and post-closing trial balance) is the preparation of general-purpose financial statements. These are four in number:

1. Income Statement
2. Balance Sheet
3. Statement of Cash Flows
4. Statement of Changes in Shareholders' Equity

Example Post-closing Trial Balance (DMN Corporation, September $30$, $2004$)

After closing temporary accounts, only permanent accounts remain:

• Cash: Debit $15,800$
• Accounts receivable: Debit $5,200$
• Inventory: Debit $4,800$
• Equipment: Debit $5,000$
• Accumulated depreciation: Credit $1,400$
• Accounts payable: Credit $2,000$
• Notes payable: Credit $800$
• Bonds payable: Credit $6,000$
• Capital stock: Credit $12,000$
• Additional paid-in capital: Credit $7,400$
• Retained earnings: Credit $1,200$
• Totals: Debits $30,800$, Credits $30,800$

Coding Systems

Coding systems help organize and identify accounting data.

• Sequential Coding:
  • Description: Items are numbered in a sequential order.
  • Example: Purchase order numbers ($101, 102, 103$).
• Block Coding:
  • Description: Blocks of numbers are reserved for specific categories.
  • Example: Uniform system of accounts for restaurants.
    • Current assets: $101, 105, 109$
    • Plant assets: $202, 206, 208$
    • Current liabilities: $301, 303, 305$
  • Benefit: Can improve clarity compared to a poorly designed chart of accounts where codes are seemingly random (e.g., Cash $252$ vs. Accounts Receivable $256$ in a poor design, compared to Cash $101$ vs. Accounts Receivable $103$ in a block-coded system).
• Hierarchical Codes:
  • Description: Codes contain segments that represent a hierarchy of information.
  • Example: State university system ($101-11-08-81$).
    • $101$: Big City campus
    • $11$: Academic affairs division
    • $08$: College of business
    • $81$: Accounting department
• Mnemonic Codes:
  • Description: Codes that use letters or abbreviations to represent items, making them easier to remember.
  • Example: Inventory items.
    • DVR: digital video recorder
    • FSTV: flat-screen television

Human Judgment & Information Technology in AIS

• Human Judgment: Essential in AIS for:
  • Designing source documents.
  • Recognizing recordable transactions.
  • Estimating amounts and interpreting accounting rules.
• Information Technology (IT): Has significantly reduced the tediousness associated with many steps in the accounting cycle, automating repetitive tasks and improving data processing efficiency.