Key Takeaways
- The primary purpose of accounting is to provide financial information about a business to various stakeholders. This information is produced by a company’s accounting information system through a systematic process of converting data into useful financial information.
- A computerized accounting information system has made the whole accounting process more efficient by simplifying the recording process and eliminating errors that are inherent in manual accounting systems.
- The users of financial information are stakeholders that can be classified as either internal or external. Internal stakeholders are those that belong to the business organization and have access to information that external stakeholders don’t usually have. Both types of stakeholders use financial information for decision-making.
Introduction to the Accounting Information System
If you’re a business owner or someone who makes important financial decisions for a company, you should ensure that you have access to reliable financial information about the business. You may not want to be placed in a situation where you have to blindly make a critical business decision because you don’t have the necessary information to support it.
The primary purpose of accounting is to provide financial information about a business that is useful to stakeholders in making important economic decisions. Information is the product of the accounting information system of a business. Therefore, it’s very important that this information is reliable and is capable of influencing a decision.
An Accounting Information System or AIS is a system that collects, stores and processes financial data into useful information that is communicated to interested parties for decision-making.
The processing of data into information involves a series of steps such as recording, classifying, storing, and summarizing data into useful information that is contained in the financial reports. These reports are then communicated to various stakeholders.
Below are the basic functions of a company’s accounting system:
- Efficient collection, analysis and recording of financial data.
- Classification and storage of financial data in the system.
- Processing of financial data and summarizing it into useful information that are contained in financial reports and communicating it to stakeholders for decision making.
- Placement of internal controls to ensure the accuracy and reliability of the information that is produced by the accounting system.
Components of an Accounting Information System
When establishing an accounting information system, you must have the important components or elements that it needs. A typical accounting information system is composed of the following:
- Data and Information
- Procedures and Statement of Accounting Policies and Standards
- Trained Personnel
- Software and Database
- Hardware
- Internal Controls
Data and Information
Data, in the context of accounting, includes all business source documents and records that are necessary for processing information. Information, on the other hand, is processed and organized data that is presented in financial reports. Financial information provides more context for the data collected and helps in decision making.
Examples of business source documents that go into the accounting system are sales invoices, official receipts, billing statements, bank statements, sales orders, purchase requisitions, payroll sheet, general ledger, and check registers.
Procedures and Statement of Accounting Policies and Standards
Procedures are formal instructions and methods that are used when processing data into useful financial information. They should be implemented and followed consistently by highly-trained personnel who are involved in the accounting information system.
The Statement of Accounting Policies and Standards serves as a guide and reference for personnel when preparing financial reports. This statement contains the accounting principles and policies that are being observed and implemented by the company.
Trained Personnel
Trained personnel include those who are directly involved in the accounting information system such as data encoders, accountants, managers, chief financial officers, auditors, and other users within the organization. These people should be properly trained and equipped to handle the specific tasks assigned to them.
The different departments within the company should be integrated in a centralized accounting system so that authorized personnel will be able to access only one system in real time. Hence, it is necessary for the accounting information system to be well-designed, efficient, user-friendly, and to meet the needs of its users.
Software and Database
Most businesses nowadays, regardless of size and industry, use accounting software for their accounting system. Gone are the days of tedious and inefficient work using paper spreadsheets and manual ledgers.
These accounting software are either developed in-house or outsourced to a third-party developer and then customized to the needs of the business. Some accounting software come as a subset of a larger Enterprise Resource Planning (ERP) system. A quality accounting software is reliable, secure and maintains a database that is readily accessible for various uses.
Businesses today have the option to use cloud accounting software instead of the traditional software that is locally installed in a computer. Below are some advantages of using cloud accounting:
- The data of the business can be accessed online and are hosted in secure remote servers. This makes it easier to collaborate with others.
- Eliminates regular, time-intensive manual updates and costly upgrades that are associated with traditional software. Cloud accounting software is instantly and continuously updated by the developers. Every update includes improvements and bug fixes.
- Financial information about the company is automatically synced backed up in the cloud, making it accessible everywhere, anytime and with any compatible device. Backup copies serve as security in case something goes wrong with the company’s data.
- The bank accounts of the business can be connected, eliminating the need for reconciliation. Transactions flow from the bank directly to the accounting software.
- Cloud accounting software can be more affordable to small and medium businesses because it eliminates the need to invest with costly IT hardware and staff. It also reduces paperworks that could occupy a large portion of an office. A business can choose from a selection of plans that are suitable for its needs.
Hardware
Complementing the accounting software should be a well-maintained hardware infrastructure that could help in the efficient running of the business’ accounting information system. A poorly-built hardware IT infrastructure could create unnecessary maintenance costs for the company and will result to an inefficient and slow accounting information system.
Hardware includes, but is not limited to, servers, computers, routers, storage drives, printers, scanners, and mobile devices. However, a business could take advantage of cloud accounting services to eliminate large capital investments on hardware infrastructures.
Internal Controls
The risks of a computer getting hacked or infected by a virus or malware are higher when it is connected to the internet or a local area network. This is the reason why threats and risks to network securities are inherent in a computerized accounting information system. Other risks include hardware damage due to natural or man-made disasters, and unauthorized computer and file access.
The accounting information system holds very sensitive information about the company and its employees, customers and suppliers. It is important to establish an effective internal control that contains security measures to prevent the risks that were mentioned earlier.
An example of internal control is providing access controls only to authorized persons on sections or files where they are only allowed to go or use. To avoid data loss, a back-up system that includes local storage disks and cloud storage services should be established to permit recovery of data at any given point in time. Data and operation security measures such as using strong passwords, hardware keys, biometric identification, firewalls, antivirus, anti-malware, and data encryption should also be strictly implemented.
Characteristics of a Reliable and Effective Accounting Information System
For the accounting information system in your company to be effective and reliable, it should be able to produce information that is relevant and can be relied upon by its users. It should have the following characteristics to be effective:
- Strong internal control
- Processing integrity and availability
- Competent personnel
- Cost-benefit relationship
- Audit trail
- Compatibility
Strong Internal Control
The established internal control of the system should be adequate and strong enough to detect and prevent any errors, inaccuracy and fraud. It should be able to provide security against possible breach on confidential and critical information stored in the system.
Processing Integrity and Availability
The system must be able to process data and provide accurate, timely, complete, and relevant reports. The availability of the system is important when meeting obligations and the demands of the business for timely information. The system should also be workable and flexible to permit any modifications that are needed to make it more efficient.
Competent Personnel
The personnel involved in the accounting system must be well-trained and knowledgeable in their respective areas. The limitations and access restrictions of the personnel should be strictly observed.
Cost-Benefit Relationship
The cost of maintaining the system should not exceed the benefits that are expected to be derived from it. This is important especially for businesses with limited available resources at their disposable.
Audit Trail
A well-designed system can provide adequate audit trail to help auditors conduct an audit efficiently and faster. An audit trail should be able to provide evidence concerning a business transaction and the processes that it went through in the accounting system. Any information in the financial statements should be properly traced back by auditors to its source.
Compatibility
The system should be compatible to the business organization’s accounting policies and procedures. When designing the system, it is important to consider the company’s size, resources, information needs, policies, and regulatory requirements.
The Accounting Information System Model
The figure below is a general model of the accounting information system.
The Accounting Process includes data input, data processing and the preparation of financial statements. It also includes the analysis and interpretation of the financial statements. Bookkeeping, which is a subset and procedural phase of accounting, only involves the data input and data processing steps.
Sources of Data
The accounting process starts with the identification and accumulation of data from internal and external sources. This data generally come from source documents that support and evidence the past financial transactions of the business.
Examples of business source documents are vouchers, invoices, checks, official receipts, bank statements, and employee time sheet.
Data Input
The data collected are analyzed and measured using the accounting standards that the company adheres to. Afterwards, all transactions are entered as journal entries in the appropriate accounting journals, i.e. general journal and special journals.
Data Processing
After journalizing the transactions, they are grouped and classified into single items of the same nature and characteristics. This step is done by posting all journal entries that were recorded from the journal into their respective accounts in the general ledger.
Posting means transferring and storing the entries from the journal to individual accounts in the ledger. Examples of ledger accounts are cash, accounts receivable, merchandise inventory, land, office buildings, vehicles, equipment, accounts payable, bonds payable, equity, retained earnings, sales, and cost of goods sold.
Output
The final step in the accounting process is to summarize the processed data into financial information that is reported in the company’s financial statements and reports.
Considering the voluminous and detailed business transactions that are processed in the accounting system, not summarizing and reducing them into a more meaningful and easier to understand form will only make the users unable to comprehend the information in the financial statements and reports.
Decision Making
Once the financial statements are prepared and distributed, the users can then analyze and interpret the information contained in those financial statements. With this information, various stakeholders can make important economic decisions concerning the company.
Computerized Accounting Information System
Most businesses today use accounting software for their accounting information system. The once tedious job of manually recording transactions and locating errors was virtually eliminated with the use of software and electronic spreadsheets.
Computerized systems are more accurate and efficient than manual systems. With an accounting software, recording of transactions and posting to ledgers are done simultaneously. Financial statements and managerial reports can also be readily generated as needed.
The basic functions of a computerized accounting information system is the same as the accounting information model illustrated above. However, computerized systems have simplified the recording process by providing electronic forms (e-forms) for authorized personnel to fill-up.
These e-forms automatically create the journal entries and post simultaneously to the ledgers. The processed data are then stored in the hardware and can be readily used when generating the needed reports. Information on current ledger account balances can also be provided by the computer software.
Though a computerized accounting information system can make the life of an accountant much easier and reduce tedious and repetitive tasks, current accounting software technology and machine learning is still remotely far from replacing humans on critical thinking required when interpreting financial statements and making economic decisions.
The costs of maintaining a computerized accounting system can also outweigh the benefits it provides especially in small and medium-size enterprises where resources are limited. Though manual systems are slow and prone to errors, they are still used by a lot of small businesses.
A packaged accounting software is designed and made available for use to small and medium-sized companies. Businesses can also opt to outsource the entire accounting system to companies that specialize in accounting services.
The Users of Accounting Information
A Stakeholder is a person or entity that has an interest or concern in the success and performance of a business.
If the purpose of accounting is to provide financial information about the business, then who are the people who need this information? Why do they need to know financial information about the company?
Stakeholders are the users of financial statements. They need the financial information contained in the financial statements primarily for decision-making. Stakeholders can either be internal or external users.
Internal Stakeholders
Internal Stakeholders are people within the business organization who use financial statements and management reports for decision making. They usually have access to information that stakeholders outside the company don’t have. Some examples of internal stakeholders are managers, employees, owners, and tax accountants.
Managers
Financial reports, which include management reports, are prepared to assist managers and officers in the company. Managers are responsible for planning and directing the activities and operations of the company. They use financial reports when planning for budgets and weighing between two or more capital investment options.
Employees
Employees, particularly those in the finance and accounting departments, need financial information about the business for their specific duties and tasks. They also need to be interested in their employer’s stability and ability to provide job security, compensation increases, retirement benefits, and career development trainings.
Tax accountants who are employed by the company need financial information as the basis for the preparation of tax returns. They also handle tax planning to minimize the income tax burden of the company.
Owners
Business owners, being the ones who risk their own capital to build a business, are naturally interested in financial information about the performance and condition of their company. This group doesn’t include investors of a corporation which we consider as external stakeholders.
External Stakeholders
External Stakeholders are the people outside the business organization who have no direct access to managerial reports and information that is only available to internal stakeholders. They rely primarily on general-purpose financial statements (audited in the case of public companies) to make decisions that are related to investment, credit and regulations.
Some examples of external stakeholders are lenders, investors, regulators, customers, suppliers, financial analysts, stockbrokers, and the public.
Creditors and Lenders
Creditors are individuals or entities to whom money is owed by the company. They rely on financial statements to determine the ability of the company to pay them back.
Lenders, on the other hand, are individuals or entities that lend money. They become creditors of a company once they have already extended a loan to that company.
Lenders want to know whether the business has enough assets to pay all of its short-term and long-term debts and whether it is profitable enough to sustain those payments. With the help of the company’s financial statements, they can determine if the applicant is qualified for a loan and how much credit can be extended to the company.
Investors
Shareholders are investors who purchase shares from a corporation, making them a part-owner of the business. Shareholders provide capital to the business in the hope of receiving a return on investment when their shares increase in value.
Bondholders, on the other hand, are those who purchase or invest in the bonds that are issued by a company. Essentially, they are creditors that lend money to the company. Bondholders can either hold the bonds until maturity and collected interest payments or sell them for an amount that is more than what they initially paid.
Investors use financial information to weight different investment options and to assess the risks involved in those investments. They do fundamental analysis of the financial statements to measure the profitability, liquidity and stability of the company, and to assess the ability of the enterprise to pay interests and dividends.
Comparative financial statements help investors study past performance and predict future performance of the company. They also use them to evaluate the stewardship function of the company’s management.
Government and Regulators
The government, with its tax collection agencies and industry regulators, use financial information about the business to determine the proper amount of taxes that the business should pay and whether the company complies with all the regulatory requirements they should adhere to. The government would also want to determine whether the company can be awarded contracts to build infrastructure and projects under a public-private partnership.
Customers
While this is uncommon, a customer can be interested in financial information about the company to determine if it can provide for their needs over a long period of time. They would also want to know if the company that they’re supporting invests in good customer service and corporate social responsibility (CSR) efforts.
Suppliers
Suppliers, particularly those who sell their goods on credit terms to the business, rely on financial statements to determine if the company could settle their trade payables on time. The ability of the company to pay its suppliers is very important especially if a substantial amount of income earned by the supplier comes from the company. Non-payment by the company may have an unfavorable effect on the operations of a supplier.
Financial Analysts and Investment Brokers
Financial information is used by financial analysts and investment brokers to help clients in making investment decisions. In pooled investments, fund managers have a huge responsibility towards their investors and should be very prudent when handling investment funds. Any misinformation about the financial condition of the companies where the funds are invested will negatively impact the performance of the fund.
Public
Every business, regardless of their size, has an impact in the lives of people living in communities that they serve. They have a moral duty to be transparent to the public and disclose any information that could potentially impact the environment and lives of the people.
Corporations whose shares are traded in a public exchange should adhere to regulations since they have a large impact to various stakeholders and even to the economy. This is the reason why they are required to disclose their financial information to the public.
Review Questions
- What are the six (6) components of an accounting information system?
- What is the difference between an internal and external stakeholder?
- What are the characteristics of an effective and reliable accounting information system?
- What are the advantages of using a computerized accounting information system?
- Why is it important for an accounting information system to provide adequate audit trail?
