Accounting Information System CH 06.pptx

Chapter Six Accounting Information Systems Applications

Chapter Objective After the successful completion of this chapter, you will be able to:- Discuss basic business activities and related information processing operations in the :- Revenue Cycle Expenditure Cycle Production Cycle Human Resource Cycle Financial Cycle General Ledger and Reporting System Explain their general threats to those activities, and describe the controls that can mitigate those threats.

6 .1. Revenue Cycle It is a recurring set of business activities and related information processing associated with: Providing goods and services to customers Collecting their cash payments. The primary external exchange of information is with customers .

Cont’d… Information about revenue cycle activities flows to other accounting cycles, e.g.: The expenditure and production cycles The human resources/payroll cycle The general ledger and reporting function The primary objective of the revenue cycle: Provide the right product - place - time - price .

Cont’d… Decisions that must be made: Should we customize products? How much inventory should we carry and where ? How should we deliver our product? How should we price our product? Should we give customers credit ? If so, how much and on what terms? How can we process payments to maximize cash flow?

REVENUE CYCLE BUSINESS ACTIVITIES Four basic business activities that to be performed in revenue cycle are: Sales order entry Shipping Billing Cash collection

Sales Order Entry Sales order entry is performed by the sales order department. The sales order department typically reports to the VP of Marketing. Steps in the sales order entry process include: Take the customer’s order Check the customer’s credit Check inventory availability Respond to customer inquiries (may be done by customer service or sales order entry)

1.1 Take Order Customer Shipping 1.2 Approve Credit 1.3 Check Inv. Avail. Billing Ware- house Purchas- ing 1.4 Resp. to Cust . Inq. Customer Sales Order Customer Inventory Orders Rejected Orders Acknowledgment Orders Approved Orders Back Orders Picking List Sales Order Sales Order Inquiries Response Figure 6.1. DFD for Sales Order Entry

Sales Order … Take customer orders Order data are received on a sales order document which may be completed and received: In the store By mail By phone On a website By a salesperson in the field

Sales Order … The sales order (paper or electronic) indicates: Item numbers ordered Quantities Prices Salesperson To reduce human error, customers should enter data themselves as much as possible: On websites On Optical Character Recognition( OCR) forms Via phone menus

Sales Order … How IT can improve efficiency and effectiveness: Orders entered online can be routed directly to the warehouse for picking and shipping. Sales history can be used to customize solicitations. Choice boards can be used to customize orders.

Sales Order … Electronic data interchange (EDI) can be used to link a company directly with its customers . Email and instant messaging Laptops and handheld devices can equip sales staff with presentations, prices, marketing and technical data, etc.

Sales Order … One objective of AIS is to ensure the accuracy and reliability of the data collected. Hence, with respect to sales order data, the following assurance should be performed: Validity checks on the customer account and inventory item numbers. Completeness test to make sure all needed information was collected. Reasonableness tests comparing the quantity ordered to past history.

1.1 Take Order Customer Shipping 1.2 Approve Credit 1.3 Check Inv. Avail. Billing Ware- house Purchas- ing 1.4 Resp. to Cust . Inq. Customer Sales Order Customer Inventory Orders Rejected Orders Acknowledgment Orders Approved Orders Back Orders Picking List Sales Order Sales Order Inquiries Response

Sales Order … B. Check the customer’s credit Credit sales should be approved before the order is processed any further. There are two types of credit authorization: General authorization For existing customers below their credit limit who don’t have past-due balances. Credit limits vary by customer based on past history and ability to pay. General authorization involves checking the customer master file to verify the account and status.

Sales Order … Specific authorization For customers who are: New Have past-due balances Are placing orders that would exceed their credit limit Specific authorization is done by the credit manager, who reports to the treasurer.

Sales Order … How can IT improve the process? Automatic checking of credit limits and balances Emails or IMs to the credit manager for accounts needing specific authorization

1.1 Take Order Customer Shipping 1.2 Approve Credit 1.3 Check Inv. Avail. Billing Ware- house Purchas- ing 1.4 Resp. to Cust . Inq. Customer Sales Order Customer Inventory Orders Rejected Orders Acknowledgment Orders Approved Orders Back Orders Picking List Sales Order Sales Order Inquiries Response

Sales Order … C. Check inventory availability When the order has been received and the customer’s credit approved, the next step is to ensure there is sufficient inventory to fill the order and advise the customer of the delivery date. The sales order clerk can usually reference a screen displaying: Quantity on hand Quantity already committed to others Quantity on order

Sales Order … If there are enough units to fill the order: Complete the sales order Update the quantity available field Notify the following departments of the sale: Shipping Inventory Billing Send an acknowledgment to the customer

Sales Order … If there’s not enough to fill the order, initiate a back order. For manufacturing companies, notify the production department. For retail companies, notify purchasing department. Accurate inventory records are needed ,so customers can be accurately advised of their order status. Requires careful data entry in the sales and shipping processes. Can be problematic in retail establishments: Clerks running a similar item over the scanner several times instead of running each item Mishandling of sales returns such that returned merchandise isn’t re-entered in inventory records

1.1 Take Order Customer Shipping 1.2 Approve Credit 1.3 Check Inv. Avail. Billing Ware- house Purchas- ing 1.4 Resp. to Cust . Inq. Customer Sales Order Customer Inventory Orders Rejected Orders Acknowledgment Orders Approved Orders Back Orders Picking List Sales Order Sales Order Inquiries Response

Sales Order … D. Respond to customer inquiries (may be done by customer service or sales order entry) Another step in the sales order entry process is responding to customer inquiries: May occur before or after the order is placed The quality of this customer service can be critical to company success

Sales Order … Many companies use Customer Relationship Management/CRM / systems to support this process: Organizes customer data to facilitate efficient and personalized service Provides data about customer needs and business practices . The goal of CRM is to retain customers: Rule of thumb: It takes 5 times as much effort to attract a new customer as it does to retain an existing one. CRMs should be seen as tools to improve the level of customer service and encourage loyalty

Sales Order … Transaction processing technology can be used to improve customer relationships: POS systems can link to the customer master file to: Automatically update accounts receivable. Print customized coupons

Sales Order … IT should be used to automate responses to routine customer requests. Examples: Providing telephone menus or websites that lead customers to answers about Account balances Order status Frequently asked questions (FAQs) Online chat or instant messaging These methods free up customer service reps to deal with less routine issues.

2) SHIPPING Revenue cycle’s next task is filling customer orders and shipping the desired merchandise. The process consists of two steps Picking and packing the order Shipping the order The warehouse department typically picks the order The shipping departments packs and ships the order Both functions include custody of inventory and ultimately report to the VP of Manufacturing.

2.1 Pick & Pack Sales Order 2.2 Ship Goods Sales Order Entry Shipping Carrier Inventory Shipments Billing & Accts. Rec. Picking List Goods & Packing List Goods, Packing Slip, & Bill of Lading Bill of Lading & Packing Slip Sales Order

Shipping… a) Picking and packing the order A picking ticket is printed by sales order entry and triggers the pick-and-pack process The picking ticket identifies: Which products to pick What quantity Warehouse workers record the quantities picked on the picking ticket, which may be a paper or electronic document. The picked inventory is then transferred to the shipping department.

Shipping… Technology can speed the movement of inventory and improve the accuracy of perpetual inventory records: Bar code scanners Conveyer belts Wireless technology so workers can receive instructions without returning to dispatch Radio frequency identification (RFID) tags: Eliminate the need to align goods with scanner Allow inventory to be tracked as it moves through warehouse Can store up to 128 bytes of data

2.1 Pick & Pack Sales Order 2.2 Ship Goods Sales Order Entry Carrier Inventory Shipments Billing & Accts. Rec. Picking List Goods & Packing List Goods, Packing Slip, & Bill of Lading Bill of Lading & Packing Slip Sales Order

Shipping… b). Shipping the order The shipping department compares the following quantities: Physical count of inventory Quantities indicated on picking ticket Quantities on sales order Discrepancies can arise if: Items weren’t stored in the location indicated Perpetual inventory records were inaccurate If there are discrepancies, a back order is initiated.

Shipping… The clerk then records online: The sales order number The item numbers ordered The quantities shipped This process: Updates the quantity-on-hand field Produces a packing slip The packing slip lists the quantity and description of each item in the shipment.

Shipping… This produces Updates the quantity-on-hand field in the inventory master file Produces a packing slip Produces multiple copies of the bill of lading The bill of lading is a legal contract that defines responsibility for goods in transit It identifies: The carrier The source The destination Special shipping instructions Who pays for the shipping

Shipping… A major shipping decision is the choice of delivery methods: Some companies maintain a fleet of trucks Companies increasingly outsource to commercial carriers Reduces costs Allows company to focus on core business Selecting best carrier means collecting and monitoring carrier performance data for: On-time delivery Condition of merchandise delivered

Shipping… Another decision relates to the location of distribution centers Many customers want suppliers to deliver products only when needed Logistical software tools can help identify optimal locations to: Minimize amount of inventory carried Meet customers’ needs Also helps optimize the use of delivery vehicles on a day-to-day basis

Shipping… Globalization makes outbound logistics more complex: Distribution methods differ around the world in terms of efficiency and effectiveness. Country-specific taxes and regulations affect distribution choices. Logistical software can also help with these issues . Advanced communications systems can provide real-time info on shipping status and thus add value: If you know a shipment will be late and notify the customer, it helps the customer adapt.

3). BILLING It is the third revenue cycle activity This activity involves two tasks: Invoicing Updating accounts receivable

3.1 Billing Customer 3.2 Maintain Accts. Rec. Sales Order Entry Billing and Accounts Receivable Customer Sales General Ledger & Rept. Sys. Shipping Mailroom Sales Order Sales Packing Slip & Bill of Lading Invoice Monthly Statements Remittance List

Billing… Invoicing Accurate and timely billing is crucial. Billing is an information processing activity that repackages and summarizes information from the sales order entry and shipping activities Requires information from: Shipping Department on items and quantities shipped Sales on prices and other sales terms

Billing… The basic document created is the sales invoice. The invoice notifies the customer of: The amount to be paid Where to send payment Invoices may be sent/received: In paper form By EDI Common for larger companies Faster and cheaper than snail mail

Billing… When buyer and seller have accurate online systems: Invoicing process may be skipped Seller sends an email when goods are shipped Buyer sends acknowledgment when goods are received Buyer automatically remits payments within a specified number of days after receiving the goods Can produce substantial cost savings An integrated AIS may also merge the billing process with sales and marketing by using data about a customer’s past purchases.

3.1 Billing Customer 3.2 Maintain Accts. Rec. Sales Order Entry Customer Sales General Ledger & Rept. Sys. Shipping Mailroom Sales Order Sales Packing Slip & Bill of Lading Invoice Monthly Statements Remittance List

Billing… Updating accounts receivable The accounts receivable function reports to the controller This function performs two basic tasks Debits customer accounts for the amount the customer is invoiced Credits customer accounts for the amount of customer payments Two basic ways to maintain accounts receivable: Open-invoice method Balance forward method

Billing… Open-invoice Method: Customers pay according to each invoice Two copies of invoice are typically sent to the customer. Customer is asked to return one copy with payment This copy is a turnaround document called a remittance advice Advantages of open-invoice method Conducive to offering early-payment discounts Results in more uniform flow of cash collections Disadvantages of open-invoice method More complex to maintain

Billing… Balance Forward Method: Customers pay according to amount on their monthly statement, rather than by invoice. Monthly statement lists transactions since the last statement and lists the current balance. The tear-off portion includes pre-printed information with customer name, account number, and balance Customers are asked to return the stub, which serves as the remittance advice Remittances are applied against the total balance rather than against a specific invoice Advantages of balance-forward method : It’s more ;- Efficient & reduces costs because you don’t bill for each individual sale Convenient for the customer to make one monthly remittance

Billing… Cycle billing is commonly used with the balance-forward method Monthly statements are prepared for subsets of customers at different times. Example: Bill customers according to the following schedule: 1 st week of month—Last names beginning with A-F 2 nd week of month—Last names beginning with G-M 3 rd week of month—Last names beginning with N-S 4 th week of month—Last names beginning with T-Z

Billing… Advantages of cycle billing: Produces more even cash flow Produces more even workload Doesn’t tie up computer for several days to print statements

Billing… Image processing can improve the efficiency and effectiveness of managing customer accounts. Digital images of customer remittances and accounts are stored electronically Advantages: Fast, easy retrieval Copy of document can be instantly transmitted to customer or others Multiple people can view document at once Significantly reduces document storage space

Billing… Exception Procedures: Account Adjustments And Write-offs: Adjustments to customer accounts may need to be made for: Returns Allowances for damaged goods Write-offs as uncollectible These adjustments are handled by the credit manager( CMgr )

Billing… If there’s a return , the CMgr : Receives confirmation for actual return of inventory. Then, issues a credit memo for customer’s account. If goods are slightly damaged , there may be price reduction CMgr issues a credit memo to reflect that reduction.

Billing… Distribution of credit memos: One copy to A/R to adjust the customer account. One copy to the customer. If repeated attempts to collect A/R fail , the CMgr may issue a credit memo to write off an account: A copy will not be sent to the customer

Billing… Note : Since A/R handles the customer accounts, why does someone else have to issue the credit memos? Example; An A/R employee could allow a relative or friend /even himself to run up an account with the company and then simply write the account off or credit it for returns and allowances. Having the credit memos issued by the CMgr is good segregation of duties between: Authorizing a transaction (write-off) Recording the transaction

Cash Collections The final activity in the revenue cycle is collecting cash from customers The cashier, who reports to the treasurer, handles customer remittances and deposits them in the bank. Accounts receivable personnel should not have access to cash (including checks ).

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable The mailroom opens customer envelopes and forwards to accounts receivable either: Remittance advices Photocopies of remittance advices A remittance list prepared in the mailroom

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable Lockbox arrangements Customers remit payments to a bank P.O. box The bank sends the company: Remittance advices An electronic list of the remittances Copies of the checks Advantages: Prevents theft by company employees Improves cash flow management Lockboxes may be regional, which reduces time in the mail Checks are deposited immediately on receipt Foreign banks can be utilized for international customers

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable Lockbox arrangements Electronic lockboxes Upon receiving and scanning the checks, the bank immediately sends electronic notification to the company, including: Customer account number Amount remitted

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable Lockbox arrangements Electronic lockboxes Electronic funds transfer Customers remit payment electronically to the company’s bank Eliminates mailing delays Typically done through banking system’s Automated Clearing House (ACH) network PROBLEM: Some banks do not have both EDI and EFT capabilities, which complicates the task of crediting the customer’s account on a timely basis.

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable Lockbox arrangements Electronic lockboxes Electronic funds transfer Financial electronic data interchange (FEDI) Integrates EFT with EDI Remittance data and funds transfer instructions are sent simultaneously by the customer Requires that both buyer and seller use EDI-capable banks

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable Lockbox arrangements Electronic lockboxes Electronic funds transfer Financial electronic data interchange (FEDI) Accept credit cards or procurement cards from customers Speeds collection because credit card issuer usually transfers funds within two days Typically costs 2-4% of gross sales price.

Cash Coll… Possible approaches to collecting cash: Turnaround documents forwarded to accounts receivable Lockbox arrangements Electronic lockboxes Electronic funds transfer Financial electronic data interchange (FEDI) Accept credit cards or procurement cards from customers Electronic bill payment

Review Of Revenue Cycle Activities Review of the organization chart, including: Who does what in the revenue cycle? To whom they typically report

Partial Organization Chart For Units Involved In Revenue Cycle Takes customer orders Authorizes credit for existing customers in good standing Checks inventory availability

Partial Organization …. Responds to customer inquiries

Partial Organization … Picks the order

Partial Organization … Packs the order Ships the order

Partial Organization … Invoices the customer

Partial Organization … Maintains the customer’s account: Increases customer account when sales are made Decreases account when cash is collected

Partial Organization … Approves credit for new customers or existing customers with issues Authorizes credits to customer accounts for returns, allowances, and write-offs

Partial Organization … Deposits cash received from customers

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES In revenue cycle a well-designed AIS should provide adequate controls to ensure that the following objectives are met: All transactions are properly authorized All recorded transactions are valid. All valid and authorized transactions are recorded, All transactions are recorded accurately Assets are safeguarded from loss or theft Business activities are performed efficiently and effectively The company is in compliance with all applicable laws and regulations All disclosures are full and fair

CONTROL: OBJECTIVES, ... All transactions are properly authorized A related threat would be that a transaction would go through without proper authorization. Such a transaction might result from either a mistake or a fraud. Example: An employee might process an unauthorized write-off of his own account, so that he wouldn’t have to pay.

CONTROL: OBJECTIVES, ... All recorded transactions are valid The related threat is that a transaction would be recorded that isn’t valid, i.e., it didn’t actually occur. Example 1 : An employee records a return of merchandise on his own account when the goods were never really returned. Example 2 : Many financial statement frauds involve companies recording totally fictitious revenues in order to make the company’s financial position appear more favorable than it actually is.

CONTROL: OBJECTIVES, ... All valid and authorized transactions are recorded The related threat would be that a transaction that actually did occur didn’t get recorded. Example 1 : An employee fails to record a sale that the company made to him so he won’t have to pay the receivable. Example 2 : In financial statement fraud cases, the company often fails to record transactions that reduce income or net assets, e.g., don’t record returns from customers or discounts granted to them. This omission causes net sales to appear higher than they really are.

Control: Objectives, ... All transactions are recorded accurately The threat would be that a transaction is recorded inaccurately. Inaccurate recording typically means that a transaction is recorded either: In the wrong amount In the wrong account In the wrong time period It could also mean that the transaction was credited to the wrong agents or participants.

Control: Objectives, ... All transactions are recorded accurately Examples: A fraud might involve a company: Over-recording the amount of a sale (wrong amount) Recording an unearned revenue as an earned revenue (wrong account) Recording a sale earlier than it occurs (wrong time period) Crediting the wrong salesperson for the sale (wrong agent)

Control: Objectives, ... All transactions are recorded accurately Assets are safeguarded from loss or theft The reverse side of these activities might include: Under-recording a sales return (wrong amount). Debiting an asset account instead of sales returns (wrong account) Recording the return later than it actually occurred (wrong time period) Threats in this area usually involve theft, destruction, or misuse of assets, including data.

Control: Objectives, ... Business activities are performed efficiently and effectively The company is in compliance with all applicable laws and regulations The threat is that the activities would be performed inefficiently or ineffectively. The obvious threat is non-compliance with laws and regulations. An example in the revenue cycle could be a car dealer who: Sells a vehicle to which he doesn’t have clear title; or Refuses to allow a customer to return a car in violation of state lemon laws. Another example might be requesting a credit check on a customer in violation of the Fair Credit Reporting Act (FCRA).

Control: Objectives, ... All disclosures are full and fair The threat is incomplete and/or misleading disclosures. This threat is more important in other areas, particularly those areas that involve liabilities and contingencies. However, one threat in the revenue cycle could be misleading disclosures about customers’ rights to return product.

CONTROL: OBJECTIVES, … In the following sections, we’ll discuss the threats that may arise in the four major steps of the revenue cycle, as well as the controls that can prevent those threats.

THREATS IN SALES ORDER ENTRY The primary objectives of this process: Accurately and efficiently process customer orders. Ensure that all sales are legitimate and that the company gets paid for all sales Minimize revenue loss arising from poor inventory management

THREATS IN SALES … Threats in the sales order entry process include: THREAT 1: Incomplete or inaccurate customer orders THREAT 2: Sales to customers with poor credit THREAT 3: Orders that are not legitimate THREAT 4: Stockouts , carrying costs, and markdowns

THREATS IN SHIPPING The primary objectives of the shipping process are: Fill customer orders efficiently and accurately Safeguard inventory Threats in the shipping process include: THREAT 5: Shipping Errors THREAT 6: Theft of Inventory

THREATS IN BILLING The primary objectives of the billing process are to ensure: Customers are billed for all sales Invoices are accurate Customer accounts are accurately maintained Threats that relate to this process are: THREAT 7: Failure to bill customers THREAT 8: Billing errors THREAT 9: Errors in maintaining customer accounts

Threats In Cash Collection The primary objective of the cash collection process: Safeguard customer remittances The major threat to this process: THREAT 10: Theft of cash

General Control Issues Two general objectives pertain to activities in every cycle: Accurate data should be available when needed Activities should be performed efficiently and effectively The related general threats are: THREAT 11: Loss, Alteration, or Unauthorized Disclosure of Data THREAT 12: Poor performance

6 .2 The Expenditure Cycle: Purchasing & Cash Disbursements The primary external exchange of information is with suppliers (vendors). Information flows to the expenditure cycle from other cycles, e.g.: The revenue cycle, production cycle, inventory control, & various departments provide information about the need to purchase goods and materials. Information also flows from the expenditure cycle: When the goods and materials arrive. Information is provided to the general ledger and reporting function .

The Expenditure Cycle… The primary objective of the expenditure cycle is to minimize the total cost of acquiring and maintaining inventory, supplies, and services .

The Expenditure Cycle… The three basic activities performed in the expenditure cycle are: Ordering goods, supplies, and services Receiving and storing these items Paying for these items These activities mirror the activities in the revenue cycle.

A. ORDERING GOODS, SUPPLIES, AND SERVICES Key decisions in this process involve identifying what , when , and how much to purchase and from whom . Weaknesses in inventory control can create significant problems with this process: Inaccurate records cause shortages. One of the key factors affecting this process is the inventory control method to be used.

Ordering Goods… Alternate Inventory Control Methods We will consider three alternate approaches to inventory control: Economic Order Quantity (EOQ) Just in Time Inventory (JIT) Materials Requirements Planning (MRP)

Ordering Goods… Whatever the inventory control system, the order processing typically begins with a purchase request followed by the generation of a purchase order. A request to purchase goods or supplies is triggered by either: The inventory control function; or An employee noticing a shortage. Advanced inventory control systems automatically initiate purchase requests when quantity falls below the reorder point.

Ordering Goods… The need to purchase goods typically results in the creation of a purchase requisition . The purchase requisition is a paper document or electronic form that identifies: Who is requesting the goods Where they should be delivered When they’re needed Item numbers, descriptions, quantities, and prices Possibly a suggested supplier Department number and account number to be charged Most of the detail on the suppliers and the items purchased can be pulled from supplier and inventory master files.

Ordering Goods… The purchase requisition is received by a purchasing agent (aka, buyer ) in the purchasing department, who typically performs the purchasing activity. In manufacturing companies, this function usually reports to the VP of Manufacturing.

Ordering Goods… A crucial decision is the selection of supplier. Key considerations are: Price Quality Dependability Especially important in JIT systems because late or defective deliveries can bring the whole system to a halt. Consequently, certification that suppliers meet ISO 9000 quality standards is important. This certification recognizes that the supplier has adequate quality control processes.

Ordering Goods… Once a supplier has been selected for a product, their identity should become part of the product inventory master file so that the selection process does not have to be carried out for every purchase. A list of potential alternates should also be maintained. For products that are seldom ordered, the selection process may be repeated every time.

Ordering Goods… It’s important to track and periodically evaluate supplier performance, including data on: Purchase prices Rework and scrap costs Supplier delivery performance The purchasing function should be evaluated and rewarded based on how well it minimizes total costs, not just the costs of purchasing the goods.

Ordering Goods… A purchase order is a document or electronic form that formally requests a supplier to sell and deliver specified products at specified prices. The PO is both a contract and a promise to pay. It includes: Names of supplier and purchasing agent Order and requested delivery dates Delivery location Shipping method Details of the items ordered

Ordering Goods… Multiple purchase orders may be completed for one purchase requisition if multiple vendors will fill the request. The ordered quantity may also differ from the requested quantity to take advantage of quantity discounts. A blanket order is a commitment to buy specified items at specified prices from a particular supplier for a set time period. Reduces buyer’s uncertainty about reliable material sources Helps supplier plan capacity and operations

Ordering Goods… IT can help improve efficiency and effectiveness of purchasing function. The major cost driver is the number of purchase orders processed. Time and cost can be cut by: Using EDI to transmit purchase orders

Ordering Goods… IT can help improve efficiency and effectiveness of purchasing function. The major cost driver is the number of purchase orders processed. Time and cost can be cut by: Using EDI to transmit purchase orders Using vendor-managed inventory systems In a vendor-managed inventory (VMI) program: Inventory control and purchasing are outsourced to a supplier The supplier has access to POS and inventory data and automatically replenishes inventory This approach: Reduces amount of inventory carried Eliminates costs of generating purchase orders Requires good controls to ensure accuracy of inventory records

Ordering Goods… IT can help improve efficiency and effectiveness of purchasing function. The major cost driver is the number of purchase orders processed. Time and cost can be cut by: Using EDI to transmit purchase orders Using vendor-managed inventory systems Reverse auctions Suppliers compete with each other to meet demand at the lowest price Best suited to commodities, rather than critical components, where quality, vendor reliability, and delivery performance are not crucial

Ordering Goods… IT can help improve efficiency and effectiveness of purchasing function. The major cost driver is the number of purchase orders processed. Time and cost can be cut by: Using EDI to transmit purchase orders Using vendor-managed inventory systems Reverse auctions Pre-award audits Used for large purchases that involve formal bids Internal auditor visits each potential supplier in final cut to verify accuracy of their bid May identify mathematical errors in bid which can produce considerable savings

Ordering Goods… IT can help improve efficiency and effectiveness of purchasing function. The major cost driver is the number of purchase orders processed. Time and cost can be cut here by: Using EDI to transmit purchase orders Using vendor-managed inventory systems Reverse auctions Pre-award audits Procurement cards for small purchases A corporate credit card can be used with specific suppliers for specific types of purchases Spending limits can be set Account numbers on cards can be mapped to general ledger accounts

B. RECEIVING AND STORING GOODS The receiving department accepts deliveries from suppliers. Normally reports to warehouse manager, who reports to VP of Manufacturing. Inventory stores typically stores the goods. Also reports to warehouse manager. The receipt of goods must be communicated to the inventory control function to update inventory records.

Receiving … The two major responsibilities of the receiving department are: Deciding whether to accept delivery Verifying the quantity and quality of delivered goods The first decision is based on whether there is a valid purchase order. Accepting un-ordered goods wastes time, handling and storage.

Receiving … Verifying the quantity of delivered goods is important so: The company only pays for goods received Inventory records are updated accurately The receiving report is the primary document used in this process: It documents the date goods received, shipper, supplier, and PO number Shows item number, description, unit of measure, and quantity for each item Provides space for signature and comments by the person who received and inspected Receipt of services is typically documented by supervisory approval of the supplier’s invoice.

Receiving … When goods arrive, a receiving clerk compares the PO number on the packing slip with the open PO file to verify the goods were ordered. Then counts the goods Examines for damage before routing to warehouse or factory Three possible exceptions in this process: The quantity of goods is different from the amount ordered The goods are damaged The goods are of inferior quality

Receiving … If one of these exceptions occurs, the purchasing agent resolves the situation with the supplier. Supplier typically allows adjustment to the invoice for quantity discrepancies. If goods are damaged or inferior, a debit memo is prepared after the supplier agrees to accept a return or grant a discount. One copy goes to supplier, who returns a credit memo in acknowledgment. One copy to accounts payable to adjust the account payable. One copy to shipping to be returned to supplier with the actual goods.

Receiving … IT can help improve the efficiency and effectiveness of the receiving activity: Bar-coding Requiring suppliers to bar-code products speeds the counting process and improves accuracy.

Receiving … IT can help improve the efficiency and effectiveness of the receiving activity: Bar-coding RFID Passive radio frequency identification (RFID) tags eliminate the need to scan bar codes.

Receiving … IT can help improve the efficiency and effectiveness of the receiving activity: Bar-coding RFID EDI and satellite technology EDI and satellite technology make it possible to track the exact location of incoming shipments and have receiving staff on hand to unload trucks. Also enables drivers to be directed to specific loading docks where goods will be used.

Receiving … IT can help improve the efficiency and effectiveness of the receiving activity: Bar-coding RFID EDI and satellite technology Audits Audits can identify opportunities to cut freight costs and can ensure that suppliers are not billing for transportation costs they are supposed to assume.

C. Paying For Goods And Services There are two basic sub-processes involved in the payment process: Approval of vendor invoices Actual payment of the invoices

C. Paying… There are two basic sub-processes involved in the payment process: Approval of vendor invoices Actual payment of the invoices

C. Paying… Approval of vendor invoices is done by the accounts payable department, which reports to the controller. The legal obligation to pay arises when goods are received. But most companies pay only after receiving and approving the invoice. This timing difference may necessitate adjusting entries at the end of a fiscal period.

C. Paying… Objective of accounts payable: Authorize payment only for goods and services that were ordered and actually received. Requires information from: Purchasing—about existence of valid purchase order Receiving—for receiving report indicating goods were received

C. Paying… There are two basic approaches to processing vendor invoices: Non-voucher system Each invoice is stored in an open invoice file. When a check is written, the invoice is marked “paid” and then stored in a paid invoice file.

C. Paying… There are two basic approaches to processing vendor invoices: Non-voucher system Voucher system` A disbursement voucher is prepared which lists: Outstanding invoices for the supplier Net amount to be paid after discounts and allowances The disbursement voucher effectively shows which accounts will be debited and credited, along with the account numbers.

C. Paying… There are two basic approaches to processing vendor invoices: Non-voucher system Voucher system Advantages of a voucher system: Several invoices may be paid at once, which reduces number of checks written Vouchers can be pre-numbered which simplifies the audit trail for payables Invoice approval is separated from invoice payment, which makes it easier to schedule both to maximize efficiency

C. Paying… There are two basic sub-processes involved in the payment process: Approval of vendor invoices Actual payment of the invoices

C. Paying… Payment of the invoices is done by the cashier, who reports to the treasurer. The cashier receives a voucher package, which consists of the vendor invoice and supporting documentation, such as purchase order and receiving report. This voucher package authorizes issuance of a check or EFT to the supplier.

C. Paying… Processing efficiency can be improved by: Requiring suppliers to submit invoices by EDI Having the system automatically match invoices to POs and receiving reports Eliminating vendor invoices Referred to as Evaluated Receipt Settlement . Payments are issued based on what is ordered and received. Requires that: Suppliers quote accurate prices when orders are placed. Receiving personnel count accurately and inspect merchandise received. Typically incorporates very timely communications about shipments and receipts.

C. Paying… Processing efficiency can be improved by: Requiring suppliers to submit invoices by EDI Having the system automatically match invoices to POs and receiving reports Eliminating vendor invoices Using procurement cards for non-inventory purchases

C. Paying… Processing efficiency can be improved by: Requiring suppliers to submit invoices by EDI Having the system automatically match invoices to POs and receiving reports Eliminating vendor invoices Using procurement cards for non-inventory purchases Using company credit cards and electronic forms for travel expenses

C. Paying… Processing efficiency can be improved by: Requiring suppliers to submit invoices by EDI Having the system automatically match invoices to POs and receiving reports Eliminating vendor invoices Using procurement cards for non-inventory purchases Using company credit cards and electronic forms for travel expenses Preparing careful cash budgets to take advantage of early-payment discounts

C. Paying… Processing efficiency can be improved by: Requiring suppliers to submit invoices by EDI Having the system automatically match invoices to POs and receiving reports Eliminating vendor invoices Using procurement cards for non-inventory purchases Using company credit cards and electronic forms for travel expenses Preparing careful cash budgets to take advantage of early-payment discounts Using FEDI to pay suppliers

REVIEW OF EXPENDITURE CYCLE ACTIVITIES Before a brief review of the organization chart, including: Who does what in the expenditure cycle To whom they typically report

PARTIAL ORGANIZATION CHART FOR UNITS INVOLVED IN EXPENDITURE CYCLE Selects suitable suppliers Issues purchase orders

PARTIAL ORGANIZATION CHART FOR UNITS INVOLVED IN EXPENDITURE CYCLE Decides whether to accept deliveries Counts and inspects deliveries

PARTIAL ORGANIZATION CHART FOR UNITS INVOLVED IN EXPENDITURE CYCLE Stores goods that have been delivered and accepted

PARTIAL ORGANIZATION CHART FOR UNITS INVOLVED IN EXPENDITURE CYCLE Approves invoices for payment

PARTIAL ORGANIZATION CHART FOR UNITS INVOLVED IN EXPENDITURE CYCLE Issues payment to vendors

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES In the expenditure cycle (or any cycle), a well-designed AIS should provide adequate controls to ensure that the following objectives are met: All transactions are properly authorized All recorded transactions are valid All valid and authorized transactions are recorded All transactions are recorded accurately Assets are safeguarded from loss or theft Business activities are performed efficiently and effectively The company is in compliance with all applicable laws and regulations All disclosures are full and fair

Control… There are several actions a company can take with respect to any cycle to reduce threats of errors or irregularities. These include: Using simple, easy-to-complete documents with clear instructions (enhances accuracy and reliability). Using appropriate application controls, such as validity checks and field checks (enhances accuracy and reliability). Providing space on forms to record who completed and who reviewed the form (encourages proper authorizations and accountability).

Control… Pre-numbering documents (encourages recording of valid and only valid transactions). Restricting access to blank documents (reduces risk of unauthorized transaction).

THREATS IN ORDERING GOODS Threats in the process of ordering goods include: THREAT 1: Stockouts and/or Excess Inventory THREAT 2: Ordering Unnecessary Items THREAT 3: Purchasing Goods at Inflated Prices THREAT 4: Purchasing Goods of Inferior Quality THREAT 5: Purchasing from Unauthorized Suppliers THREAT 6: Kickbacks EDI-Related Threats Threats Related to Purchases of Services

THREATS IN RECEIVING AND STORING GOODS The primary objectives of this process are to: Verify the receipt of ordered inventory Safeguard the inventory against loss or theft Threats in the process of receiving and storing goods include: THREAT 7: Receiving unordered goods THREAT 8: Errors in counting received goods THREAT 9: Theft of inventory

THREATS IN APPROVING AND PAYING VENDOR INVOICES The primary objectives of this process are to: Pay only for goods and services that were ordered and received Safeguard cash Threats in the process of approving and paying vendor invoices include: THREAT 10: Failing to catch errors in vendor invoices THREAT 11: Paying for goods not received THREAT 12: Failing to take available purchase discounts THREAT 13: Paying the same invoice twice THREAT 14: Recording and posting errors to accounts payable THREAT 15: Misappropriating cash, checks, or EFTs

6.3. Production Cycle The production cycle is a recurring set of business activities and related data processing operations associated with the manufacture of products.

Information flows to the production cycle from other cycles, e.g.: The revenue cycle provides information on customer orders and sales forecasts for use in planning production and inventory levels. The expenditure cycle provides information about raw materials acquisitions and overhead costs. The human resources/payroll cycle provides information about labor costs and availability.

Information also flows from the expenditure cycle: The revenue cycle receives information from the production cycle about finished goods available for sale. The expenditure cycle receives information about raw materials needs. The human resources/payroll cycle receives information about labor needs. The general ledger and reporting system receives information about cost of goods manufactured.

Decisions that must be made in the production cycle include: What mix of products should be produced? How should products be priced? How should resources be allocated? How should costs be managed and performance evaluated? These decisions require cost data well beyond that required for external financial statements.

We’ll be looking at how the three basic AIS functions are carried out in the production cycle, i.e.: How do we capture and process data? How do we store and organize the data for decisions? How do we provide controls to safeguard resources, including data?

PRODUCTION CYCLE ACTIVITIES The four basic activities in the production cycle are: Product design Planning and scheduling Production operations Cost accounting Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.

PRODUCT DESIGN The objective of product design is to design a product that strikes the optimal balance of: Meeting customer requirements for quality, durability, and functionality; and Minimizing production costs. Simulation software can improve the efficiency and effectiveness of product design.

PRODUCT DESIGN Key documents and forms in product design: Bill of Materials: Lists the components that are required to build each product, including part numbers, descriptions,and quantity. Operations List : Lists the sequence of steps required to produce each product, including the equipment needed and the amount of time required.

PRODUCT DESIGN Role of the accountant in product design: Participate in the design, because 65-80% of product cost is determined at this stage. Add value by: Designing an AIS that measures and collects the needed data. Information about current component usage. Information about machine set-up and materials-handling costs. Data on repair and warranty costs to aid in future modification and design.

PRODUCT DESIGN Role of the accountant in product design: Participate in the design, because 65-80% of product cost is determined at this stage. Add value by: Designing an AIS that measures and collects the needed data Helping the design team use that data to improve profitability Compare current component usage with projected usage in alternate designs. Compare current set-up and handling costs to projected costs in alternate designs. Provide info on how design trade-offs affect total production cost and profitability.

PRODUCTION CYCLE ACTIVITIES The four basic activities in the production cycle are: Product design Planning and scheduling Production operations Cost accounting Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.

PLANNING AND SCHEDULING The objective of the planning and scheduling activity is to develop a production plan that is efficient enough to meet existing orders and anticipated shorter-term demand while minimizing inventories of both raw materials and finished goods.

PLANNING AND SCHEDULING There are two common approachs to production planning: Manufacturing Resource Planning (MRP-II) Lean Manufacturing

PLANNING AND SCHEDULING There are two common approaches to production planning: Manufacturing Resource Planning (MRP-II) Lean Manufacturing

PLANNING AND SCHEDULING MRP-II is an extension of MRP inventory control systems: Seeks to balance existing production capacity and raw materials needs to meet forecasted sales demands. Often referred to as push manufacturing.

PLANNING AND SCHEDULING There are two common approaches to production planning: Manufacturing Resource Planning (MRP-II) Lean Manufacturing

PLANNING AND SCHEDULING Lean manufacturing is an extension of the principles of just-in-time inventory systems: Seeks to minimize or eliminate inventories of raw materials, work in process, and finished goods. Theoretically produces only in response to customer orders, but in reality, there are short-run production plans. Often referred to as pull manufacturing.

PLANNING AND SCHEDULING Comparison of the two systems: Both plan production in advance. They differ in the length of the planning horizon. MRP-II develops plans for up to 12 months ahead. Lean manufacturing uses shorter planning horizons. Consequently: MRP-II is more appropriate for products with predictable demand and a long life cycle. Lean manufacturing more appropriate for products with unpredictable demand, short life cycles, and frequent markdowns of excess inventory.

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Specifies how much of each product is to be produced during the period and when. Uses information about customer orders, sales forecasts, and finished goods inventory levels to determine production levels. Although plans can be modified, production plans must be frozen a few weeks in advance to provide time to procure needed materials and labor. Scheduling becomes significantly more complex as the number of factories increases. Raw materials needs are determined by exploding the bill of materials to determine amount needed for current production. These amounts are compared to available levels to determine amounts to be purchased.

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Production order Authorizes production of a specified quantity of a product. It lists: Operations to be performed Quantity to be produced Location for delivery Also collects data about these activities

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Production order Materials requisition Authorizes movement of the needed materials from the storeroom to the factory floor. This document indicates: Production order number Date of issue Part numbers and quantities of raw materials needed (based on data in bill of materials)

PLANNING AND SCHEDULING Key documents and forms: Master production schedule Production order Materials requisition Move ticket Documents the transfer of parts and materials throughout the factory.

PLANNING AND SCHEDULING How can information technology help? Improve the efficiency of material-handling activities by using: Bar coding of materials to improve speed and accuracy RFID tags can eliminate human intervention in the scanning process Up to 40 times faster than using bar-code scanners. Not impeded by dirt. Not limited to reading only those items in line of sight. Much easier to locate needed products and broadcast their location to forklift operators or other warehouse workers.

PLANNING AND SCHEDULING Role of the accountant: Ensure the AIS collects and reports costs in a manner consistent with the company’s production planning techniques.

PRODUCTION CYCLE ACTIVITIES The four basic activities in the production cycle are: Product design Planning and scheduling Production operations Cost accounting Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.

PRODUCTION OPERATIONS Production operations vary greatly across companies, depending on the type of product and the degree of automation. The use of various forms of IT, such as robots and computer-controlled machinery is called computer-integrated manufacturing (CIM) . Can significantly reduce production costs. Accountants aren’t experts on CIM, but they must understand how it affects the AIS. One effect is a shift from mass production to custom-order manufacturing and the need to accumulate costs accordingly.

PRODUCTION OPERATIONS In a lean manufacturing environment, a customer order triggers several actions: System first checks inventory on hand for sufficiency. Calculates labor needs and determines whether overtime or temporary help will be needed. Based on bill of materials, determines what components need to be ordered. Necessary purchase orders are sent via EDI. The master production schedule is adjusted to include the new order.

PRODUCTION OPERATIONS Sharing information across cycles helps companies be more efficient by timing purchases to meet the actual demand. While the nature of production processes and the extent of CIM vary, all companies need data on: Raw materials used Labor hours expended Machine operations performed Other manufacturing overhead costs incurred

PRODUCTION CYCLE ACTIVITIES The four basic activities in the production cycle are: Product design Planning and scheduling Production operations Cost accounting Accountants are primarily involved in the fourth activity (cost accounting) but must understand the other processes well enough to design an AIS that provides needed information and supports these activities.

COST ACCOUNTING The objectives of cost accounting are: To provide information for planning, controlling, and evaluating the performance of production operations; To provide accurate cost data about products for use in pricing and product mix decisions; and To collect and process information used to calculate inventory and COGS values for the financial statements.

COST ACCOUNTING The objectives of cost accounting are: To provide information for planning, controlling, and evaluating the performance of production operations; To provide accurate cost data about products for use in pricing and product mix decisions; and To collect and process information used to calculate inventory and COGS values for the financial statements. To accomplish the first objective, the AIS must collect real-time data on the performance of production activities so management can make timely decisions. RFID technology can be especially helpful, e.g.: Broadcasting repair needs proactively Helping in the location of particular items

COST ACCOUNTING The objectives of cost accounting are: To provide information for planning, controlling, and evaluating the performance of production operations; To provide accurate cost data about products for use in pricing and product mix decisions; and To collect and process information used to calculate inventory and COGS values for the financial statements. To accomplish the 2 nd and 3 rd objectives, the AIS must collect costs by various categories and assign them to specific products and organizational units. Requires careful coding of cost data during collection because costs may be allocated in different ways for different reporting purposes.

COST ACCOUNTING Types of cost accounting systems: Job order costing Assigns costs to a specific production batch or job. Used when the product or service consists of discretely identifiable items. Example: Houses

COST ACCOUNTING Types of cost accounting systems: Job order costing Process costing Assigns costs to each process or work center in the production cycle Calculates the average cost for all units produced Used when similar goods or services are produced in mass quantities and discrete units can’t be easily identified Example: Paint

COST ACCOUNTING Accounting for Fixed Assets: The AIS must collect and process information about the property, plant, and equipment used in the production cycle. These assets represent a significant portion of total assets for many companies and need to be monitored as an investment.

COST ACCOUNTING The following information should be maintained about each fixed asset: ID number Serial number Location Cost Acquisition date Vendor info Expected life Expected salvage value Depreciation method Accumulated depreciation Improvements Maintenance performed

COST ACCOUNTING The purchase of fixed assets follows the same processes as other purchases in the expenditure cycle (order  receive  pay). But the amounts involved necessitate some modification to the process: Competitive bidding Machinery and equipment purchases almost always involve a formal request for competitive bids.

COST ACCOUNTING The purchase of fixed assets follows the same processes as other purchases in the expenditure cycle (order  receive  pay). But the amounts involved necessitate some modification to the process: Competitive bidding Number of people involved More people are likely to be involved in reviewing bids for fixed assets.

COST ACCOUNTING The purchase of fixed assets follows the same processes as other purchases in the expenditure cycle (order  receive  pay). But the amounts involved necessitate some modification to the process: Competitive bidding Number of people involved Payment Purchases of fixed assets are often paid for in installments, including interest.

COST ACCOUNTING The purchase of fixed assets follows the same processes as other purchases in the expenditure cycle (order  receive  pay). But the amounts involved necessitate some modification to the process: Competitive bidding Number of people involved Payment Controls The cost of fixed assets justifies more elaborate controls to safeguard them, including: Maintenance of detailed records of each item. RFID tags to: Monitor location Facilitate preventive maintenance

COST ACCOUNTING The purchase of fixed assets follows the same processes as other purchases in the expenditure cycle (order  receive  pay). But the amounts involved necessitate some modification to the process: Competitive bidding Number of people involved Payment Controls Disposal It’s critical to formally approve and accurately record the sale or disposal of fixed assets.

COST ACCOUNTING A typical AIS would look something like the following: Product design Engineering specifications result in new records for both the bill of materials and the operations list file. To create these lists, engineering accesses both files to view designs of similar products. They also access the general ledger and inventory files for info about alternate designs.

COST ACCOUNTING A typical AIS would look something like the following: Product design Production planning The sales department enters sales forecasts and customer special order information. Production planning uses that information and data on current inventory levels to develop a master production schedule. New records are added to the production order file to authorize the production of goods.

COST ACCOUNTING A typical AIS would look something like the following: Product design Production planning Cost accounting New records are added to the work-in-process file to accumulate cost data.

COST ACCOUNTING A typical AIS would look something like the following: Product design Production planning Cost accounting Production operations The list of operations to be performed is displayed at workstations. Instructions are also sent to the CIM interface to guide operation of machinery and robots. Materials requisitions are sent to inventory stores to authorize release of raw materials to production.

COST ACCOUNTING Such a system can be used for a job-order or process costing system. Both require that data be accumulated about: Raw materials Direct labor Machinery and equipment usage Manufacturing overhead The choice of method: Does not affect how data are collected Does affect how costs are assigned to products

COST ACCOUNTING Raw Material Usage Data: When production is initiated, the issuance of a materials requisition triggers a debit (increase) to work in process and a credit (decrease) to raw materials inventory. Work in process is credited and raw materials are debited for any amounts returned to inventory. Many raw materials are bar coded so that usage data is collected by scanning. RFID tags improve the efficiency of tracking material usage. Usage may be entered online for materials such as liquids that are not conducive to tagging.

COST ACCOUNTING Direct Labor Costs: Historically, job time tickets were used to record the time a worker spent on each job task. Currently, workers may: Enter the data on online terminals. Use coded ID badges which are run through a badge reader at the beginning and end of each job.

COST ACCOUNTING Machinery and Equipment Usage: Machinery costs make up an ever-increasing proportion of production costs. Data about machinery and equipment are collected at each production step, often with data about labor costs. Until recently, data was collected by wiring the factory so all equipment was linked to the computer system. Limits the ability to rearrange the shop floor. 3-D simulations can be used to assess the impact of altering floor layout.

COST ACCOUNTING Manufacturing Overhead Costs: Includes costs that can’t be easily traced to jobs or processes, such as utilities, depreciation, supervisory salaries. Most of these costs are collected in the expenditure cycle. An exception is supervisory salaries, which are collected in the HRM/payroll cycle.

COST ACCOUNTING Accountants help control overhead by assessing how product mix changes will affect overhead costs. They should also identify the factors that drive the changes in these costs. This information can be used to realign processes and layout. Accurate and complete information about production cycle activities are required to perform these analyses.

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES In the production cycle (or any cycle), a well-designed AIS should provide adequate controls to ensure that the following objectives are met: All transactions are properly authorized All recorded transactions are valid All valid and authorized transactions are recorded All transactions are recorded accurately Assets are safeguarded from loss or theft Business activities are performed efficiently and effectively The company is in compliance with all applicable laws and regulations All disclosures are full and fair

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES There are several actions a company can take with respect to any cycle to reduce threats of errors or irregularities. These include: Using simple, easy-to-complete documents with clear instructions (enhances accuracy and reliability). Using appropriate application controls, such as validity checks and field checks (enhances accuracy and reliability). Providing space on forms to record who completed and who reviewed the form (encourages proper authorizations and accountability).

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES Pre-numbering documents (encourages recording of valid and only valid transactions). Restricting access to blank documents (reduces risk of unauthorized transaction). Using RFID tags when feasible to improve data entry accuracy. In the following sections, we’ll discuss the threats that may arise in the four major steps of the production cycle, as well as general threats, EDI-related threats, and threats related to purchases of services.

THREATS IN PRODUCT DESIGN The major threats in the product design process is: THREAT 1: Poor Product Design You can click on the threat above to get more information on: The types of problems posed by each threat The controls that can mitigate the threat

THREATS IN PRODUCT DESIGN THREAT NO. 1—POOR PRODUCT DESIGN Why is this a problem? Higher materials purchasing and carrying costs Costs for inefficient production Higher repair and warranty costs Controls: Accurate data about the relationship between components and finished goods. Analysis of warranty and repair costs to identify primary causes of product failure to be used in re-designing product. Return to Threat Menu Go To Next Threat

THREATS IN PLANNING AND SCHEDULING Threats in the planning and scheduling process include: THREAT 2: Over- or Under-Production THREAT 3: Suboptimal Investment in Fixed Assets You can click on any of the threats above to get more information on: The types of problems posed by each threat The controls that can mitigate the threats.

THREATS IN PLANNING AND SCHEDULING THREAT NO. 2—OVER- OR UNDER-PRODUCTION Why is this a problem? Over-production may result in: Excess goods for short-run demand and potential cash flow problems Obsolete inventory Under-production may result in: Lost sales Customer dissatisfaction

THREATS IN PLANNING AND SCHEDULING Controls: More accurate production planning, including accurate and current: Sales forecasts Inventory data Investments in production planning Regular collection of data on production performance to adjust production schedule Proper authorization of production orders Restriction of access to production scheduling program Validity checks on production orders Return to Threat Menu Go To Next Threat

THREATS IN PLANNING AND SCHEDULING THREAT NO. 3—SUBOPTIMAL INVESTMENT IN FIXED ASSETS Why is this a problem? Over-investment causes excess costs Under-investment impairs productivity Controls: Proper authorization of fixed asset transactions: Larger purchases should be reviewed by a senior executive or executive committee. Smaller purchases (<$10,000) can be handled with departmental budgets, with managers being held responsible for department return.

THREATS IN PLANNING AND SCHEDULING Competitive bids should be sought via requests for proposals (RFPs) The capital investment committee should review and select the winning bid. Once a supplier is selected, acquisition may be handled through the expenditure cycle process. Return to Threat Menu Go To Next Threat

THREATS IN PRODUCTION OPERATIONS Threats in the production operations process include: THREAT 4: Theft of Inventories and Fixed Assets THREAT 5: Disruption of Operations You can click on any of the threats above to get more information on: The types of problems posed by each threat The controls that can mitigate the threats.

THREATS IN PRODUCTION OPERATIONS THREAT NO. 4—THEFT OF INVENTORIES AND FIXED ASSETS Why is this a problem? Loss of assets Mis-stated financial data Potential underproduction of inventory Controls: Physical access to inventory should be restricted. All internal movement of inventory should be documented.

THREATS IN PRODUCTION OPERATIONS Materials requisitions should be used to authorize release of raw materials. Should be signed by both inventory control clerk and production employee to establish accountability. Requests in excess of the bill of materials should be documented and have supervisory authorization. RFID tags and bar codes can be used to track inventory through production.

THREATS IN PRODUCTION OPERATIONS Proper segregation of duties should be enforced: Inventory stores has custody of raw materials and finished goods. Factory supervisors are responsible for work in process. Authorization of production orders, materials requisitions, and move tickets, should be done by production planners or the information system. Logical and physical access controls should be enforced for production records. An independent party should count inventory and investigate discrepancies. Fixed assets must be identified and recorded.

THREATS IN PRODUCTION OPERATIONS Managers should be held accountable for assets under their control. Fixed assets should be physically secured. Disposal of assets should be authorized and documented. Periodic reports of fixed asset transactions should be reviewed by the controller. Adequate insurance should be maintained. Return to Threat Menu Go To Next Threat

THREATS IN PRODUCTION OPERATIONS THREAT NO. 5—DISRUPTION OF OPERATIONS Why is this a problem? Disasters can disrupt functioning and destroy assets Controls: Backup power sources, such as generators and uninterruptible power supplies Investigate disaster preparedness of key suppliers and identify alternative sources for critical components Return to Threat Menu Go To Next Threat

THREATS IN COST ACCOUNTING Threats in the cost accounting process include: THREAT 6: Inaccurate Recording and Processing of Production Activity Data You can click on the threat above to get more information on: The types of problems posed by the threat The controls that can mitigate the threat

THREATS IN COST ACCOUNTING THREAT 6--INACCURATE RECORDING AND PROCESSING OF PRODUCTION ACTIVITY DATA Why is this a problem? Diminishes effectiveness of production scheduling Undermines management’s ability to monitor and control operations Controls: Automate data collection with RFID technology, bar code scanners, and badge readers to ensure accurate data entry.

THREATS IN COST ACCOUNTING Use online terminals for data entry. Restrict access with passwords, user IDs, and access control matrices to prevent unauthorized changes to data. Use check digits, closed-loop verification, and validity checks. Do periodic physical counts of inventory and compare to records. Do periodic inspections and counts of fixed assets . Return to Threat Menu Go To Next Threat

GENERAL THREATS Two general objectives pertain to activities in every cycle: Accurate data should be available when needed Activities should be performed efficiently and effectively Threats in the process of ordering goods include: THREAT 7: Loss, Alteration, or Unauthorized Disclosure of Data THREAT 8: Poor Performance You can click on any of the threats below to get more information on: The types of problems posed by each threat The controls that can mitigate the threats.

GENERAL THREATS THREAT NO. 7: LOSS, ALTERATION, OR UNAUTHORIZED DISCLOSURE OF DATA Why is this a problem? Loss or alteration of data could cause: Errors in external or internal reporting. Unauthorized disclosure of confidential information can cause: Unfair competition Loss of business

GENERAL THREATS Controls: All data files and key master files should be backed up regularly. At least one backup on site and one offsite. All disks and tapes should have external and internal file labels to reduce chance of accidentally erasing important data.

GENERAL THREATS Access controls should be utilized User IDs and passwords Compatibility matrices Controls for individual terminals (e.g., so the receiving dock can’t enter a sales order). Logs of all activities, particularly those requiring specific authorizations, should be maintained. Default settings on ERP systems usually allow users far too much access to data, so these systems must be modified to enforce proper segregation of duties.

GENERAL THREATS Sensitive data should be encrypted in storage and in transmission. Parity checks, acknowledgment messages, and control totals should be used to ensure transmission accuracy. Return to Threat Menu Go To Next Threat

GENERAL THREATS THREAT NO. 8--POOR PERFORMANCE Why is this a problem? Quality control problems increase expenses and reduce future sales Controls: Prepare and review performance reports Return to Threat Menu Go To Next Threat

PRODUCTION CYCLE INFORMATION NEEDS In a manufacturing environment, the focus must be on total quality management. Managers need info on: Defect rates Breakdown frequency Percent of finished goods needing rework Percent of defects discovered by customers

PRODUCTION CYCLE INFORMATION NEEDS In traditional systems, this type of data was not well linked with financial data, and cost accounting systems were separate from production operations information systems. However, both financial and operating information are needed to manage and evaluate these activities.

PRODUCTION CYCLE INFORMATION NEEDS Two major criticisms have been directed at traditional cost accounting systems: Overhead costs are inappropriately allocated to products Reports do not accurately reflect effects of factory automation

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Traditional cost accounting systems use volume-driven bases such as direct labor hours or machine hours to apply overhead. However, overhead does not vary with production volume. EXAMPLE: Purchasing costs vary with the number of purchase orders processed.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Allocating overhead based on output volume: Overstates the costs of products manufactured in large quantities Understates the costs of products manufactured in small batches Also, allocating overhead based on direct labor input can distort costs.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Example of Two Products: Product 1 uses: $5 of materials 1 hour of labor 5 minutes of machine time Product 2 uses: $5 of materials 1 hour of labor 42 hours of machine time on very expensive equipment

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Example of Two Products: Product 1 uses: $5 of materials 1 hour of labor 5 minutes of machine time Product 2 uses: $5 of materials 1 hour of labor 42 hours of machine time on very expensive equipment Under a traditional cost accounting system, both products will appear to have the same cost.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Solution to Criticism 1: Activity Based Costing (ABC) ABC can refine and improve cost allocations under either job-order or process costing systems. ABC traces costs to the activities that create them and allocates them accordingly. ABC aims to link costs to corporate strategy.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Corporate strategy results in decisions about what goods and services to produce. These activities incur costs. So corporate strategy determines costs. By measuring the costs of the basic activities, ABC provides information to management for evaluating the consequences of their decisions.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC vs. Traditional Cost Systems: There are three significant differences between ABC and traditional approaches. Tracing of overhead costs Number of cost pools Identification of cost drivers

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC vs. Traditional Cost Systems: There are three significant differences between ABC and traditional cost accounting approaches. Tracing of overhead costs Number of cost pools Identification of cost drivers

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC directly traces a larger proportion of overhead costs to products. This tracing is made possible by advances in IT.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC vs. Traditional Cost Systems: There are three significant differences between ABC and traditional cost accounting approaches. Tracing of overhead costs Number of cost pools Identification of cost drivers

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC uses a greater number of cost pools to accumulate indirect costs (manufacturing overhead). Most systems lump all overhead together, but ABC distinguishes three categories: Batch-related overhead EXAMPLES: Setup, inspection, and material handling costs. Accumulated for a batch and allocated to the products in that batch. Consequently, costs per product will be less when products are made in larger quantities.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC uses a greater number of cost pools to accumulate indirect costs (manufacturing overhead). Most systems lump all overhead together, but ABC distinguishes three categories: Batch-related overhead Product-related overhead Examples: R&D, environmental regulations, and purchasing costs. These costs are related to the diversity of the company’s product line. ABC attempts to link these costs to the products that generate them. For example, purchasing costs might be allocated to products based on the number of purchase orders generated for each product.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC uses a greater number of cost pools to accumulate indirect costs (manufacturing overhead). Most systems lump all overhead together, but ABC distinguishes three categories: Batch-related overhead Product-related overhead Company-wide overhead EXAMPLE: Rent or depreciation. These costs are applied to all products and allocated according to departmental or plant rates.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS ABC vs. Traditional Cost Systems: There are three significant differences between ABC and traditional cost accounting approaches. Tracing of overhead costs Number of cost pools Identification of cost drivers

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Benefits of ABC Systems ABC systems are more costly and complex. But proponents argue two important benefits: More accurate cost data result in better product mix and pricing decisions. More detailed cost data improve management’s ability to control and manage total costs.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Benefits of ABC Systems ABC systems are more costly and complex. But proponents argue two important benefits: More accurate cost data result in better product mix and pricing decisions More detailed cost data improve management’s ability to control and manage total costs.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Better Decisions ABC avoids problems of applying too much or too little overhead to products and consequently results in better price decisions. ABC uses the data collected to improve product design. ABC provides management with the information about the costs associated with specific activities, resulting in better analysis and decisions.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Benefits of ABC Systems ABC systems are more costly and complex. But proponents argue two important benefits: More accurate cost data result in better product mix and pricing decisions More detailed cost data improve management’s ability to control and manage total costs .

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Improved Cost Management ABC measures the results of managerial actions on overall profitability. ABC measures both the amount spent to acquire resources and the amount spent to consume them. ABC measures unused capacity: Cost of activity capability = Cost of activity used + Cost of unused capacity

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS EXAMPLE: A publishing company has five employees who operate printing presses. The employees each have annual salaries of $25,000 for a total salary cost of $125,000. Each employee should be able to print about 10,000 books per year. The total capacity, therefore is 50,000 books. The salary cost per book would be $125,000 / 50,000 books = $2.50 per book. During the most recent year, the presses produced 47,000 books.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS EXAMPLE: A publishing company has five employees who operate printing presses. The employees each have annual salaries of $25,000 for a total salary cost of $125,000. Each employee should be able to print about 10,000 books per year. The total capacity, therefore is 50,000 books. The salary cost per book would be $125,000 / 50,000 books = $2.50 per book . During the most recent year, the presses produced 47,000 books. The cost of the activity capability is the total book capacity for the year of 50,000 books times the salary cost per book of $2.50. 50,000 books x $2.50 = $125,000.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS EXAMPLE: A publishing company has five employees who operate printing presses. The employees each have annual salaries of $25,000 for a total salary cost of $125,000. Each employee should be able to print about 10,000 books per year. The total capacity, therefore is 50,000 books. The salary cost per book would be $125,000 / 50,000 books = $2.50 per book . During the most recent year, the presses produced 47,000 books. The cost of the activity used is the number of books actually produced times the salary cost per book of $2.50. 47,000 books x $2.50 = $117,500.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS EXAMPLE: A publishing company has five employees who operate printing presses. The employees each have annual salaries of $25,000 for a total salary cost of $125,000. Each employee should be able to print about 10,000 books per year. The total capacity, therefore is 50,000 books. The salary cost per book would be $125,000 / 50,000 books = $2.50 per book . During the most recent year, the presses produced 47,000 books. The unused capacity is the difference between the activity capability ($125,000) and the cost of the activity used ($117,500). $125,000 - $117,500 = $7,500 unused capacity. Alternately, unused capacity can be calculated as the cost per book of $2.50 times the difference between the books that could be produced and the books that were actually produced. $2.50 x (50,000 possible books – 47,000 actual books) = $7,500 unused capacity.

CRITICISM 1: INAPPROPRIATE ALLOCATION OF OVERHEAD COSTS Management may be able to improve profitability by: Applying the unused capacity to other revenue-generating activities; or Eliminating the unused capacity.

PRODUCTION CYCLE INFORMATION NEEDS Two major criticisms have been directed at traditional cost accounting systems: Overhead costs are inappropriately allocated to products Reports do not accurately reflect effects of factory automation

CRITICISM 2: REPORTS DO NOT ACCURATELY REFLECT EFFECTS OF AUTOMATION When an organization transitions from a traditional production system to a lean manufacturing system, inventory levels are depleted. Consequently, almost all production costs of the year are expensed that year. Although the effect is temporary, managers will be concerned if their performance evaluations are based on the company’s reported financial statements.

CRITICISM 2: REPORTS DO NOT ACCURATELY REFLECT EFFECTS OF AUTOMATION Solution to Criticism 2: Better Reports and Measures Produce reports based on lean accounting principles. Report for each product all costs incurred to design, produce, sell, deliver, process customer payments, and provide post-sale support for that product. Separate overhead costs from COGS. Identify changes in inventory levels as a separate expense item.

CRITICISM 2: REPORTS DO NOT ACCURATELY REFLECT EFFECTS OF AUTOMATION Solution to Criticism 2: Better Reports and Measures Produce reports based on lean accounting principles. Develop resources to focus on issues important to production cycle managers. Examples: Useable output produced per time period Monitoring of product quality

THROUGHPUT: A MEASURE OF PRODUCTION EFFECTIVENESS Throughput = Productive Capacity x Productive Processing Time x Yield Productive Capacity = Total Units Produced / Processing Time Can be improved by: Improving machine or labor efficiency. Improving factory layout. Simplifying product design specifications.

THROUGHPUT: A MEASURE OF PRODUCTION EFFECTIVENESS Throughput = Productive Capacity x Productive Processing Time x Yield Productive Capacity = Total Units Produced / Processing Time Productive Processing Time = Processing Time / Total Time The opposite of downtime. Can be improved by: Better maintenance to reduce machine downtime. Better scheduling of deliveries to reduce wait time.

THROUGHPUT: A MEASURE OF PRODUCTION EFFECTIVENESS Throughput = Productive Capacity x Productive Processing Time x Yield Productive Capacity = Total Units Produced / Processing Time Productive Processing Time = Processing Time / Total Time Yield = Good Units / Total Units Can be improved by: Using better raw materials Improving worker skills

QUALITY CONTROL Information About Quality Control Quality control costs can be divided into four categories : Prevention costs Costs incurred to reduce product defect rates.

QUALITY CONTROL Information About Quality Control Quality control costs can be divided into four categories : Prevention costs Inspection costs Costs incurred to ensure products meet quality standards.

QUALITY CONTROL Information About Quality Control Quality control costs can be divided into four categories : Prevention costs Inspection costs Internal failure costs Costs of rework and scrap when products are identified as defective prior to sale.

QUALITY CONTROL Information About Quality Control Quality control costs can be divided into four categories : Prevention costs Inspection costs Internal failure costs External failure costs Costs when defective products are sold to customers, e.g., warranty and repair costs, product liability costs, costs of customer dissatisfaction and damage to reputation.

QUALITY CONTROL Information About Quality Control Quality control costs can be divided into four categories : Prevention costs Inspection costs Internal failure costs External failure costs The objective of quality control is to minimize the sum of these four costs.

6.4.Human Resources / Payroll Cycle The HRM/Payroll cycle is a recurring set of business activities and related data processing operations associated with effectively managing the employee workforce.

The most important tasks performed in the HRM/payroll cycle are: Recruiting and hiring new employees Training Job assignment Compensation (payroll) Performance evaluation Discharge of employees (voluntarily or involuntarily) Payroll costs are also allocated to products and departments for use in product pricing and mix decisions.

The most important tasks performed in the HRM/payroll cycle are: Recruiting and hiring new employees Training Job assignment Compensation (payroll) Performance evaluation Discharge of employees (voluntarily or involuntarily) Payroll costs are also allocated to products and departments for use in product pricing and mix decisions. These two tasks are normally done only once for each employee.

INTRODUCTION The most important tasks performed in the HRM/payroll cycle are: Recruiting and hiring new employees Training Job assignment Compensation (payroll) Performance evaluation Discharge of employees (voluntarily or involuntarily) Payroll costs are also allocated to products and departments for use in product pricing and mix decisions. These tasks are done repeatedly as long as the employee works for the company.

INTRODUCTION The most important tasks performed in the HRM/payroll cycle are: Recruiting and hiring new employees Training Job assignment Compensation (payroll) Performance evaluation Discharge of employees (voluntarily or involuntarily) Payroll costs are also allocated to products and departments for use in product pricing and mix decisions. In most companies these six activities are split between a payroll system and an HRM system.

INTRODUCTION The most important tasks performed in the HRM/payroll cycle are: Recruiting and hiring new employees Training Job assignment Compensation (payroll) Performance evaluation Discharge of employees (voluntarily or involuntarily) Payroll costs are also allocated to products and departments for use in product pricing and mix decisions. The payroll system handles compensation and comes under the purview of the controller.

INTRODUCTION The most important tasks performed in the HRM/payroll cycle are: Recruiting and hiring new employees Training Job assignment Compensation (payroll) Performance evaluation Discharge of employees (voluntarily or involuntarily) Payroll costs are also allocated to products and departments for use in product pricing and mix decisions. The HRM system handles the other five tasks and comes under the purview of the director of human resources.

INTRODUCTION In this chapter, we’ll focus primarily on the payroll system: One of the largest and most important components of the AIS Must be designed to meet: Management’s needs Government regulations Incomplete or erroneous payroll records: Impair decision making Can results in fines and/or imprisonment

INTRODUCTION The design of the HRM system is also important because the knowledge and skills of employees are valuable assets, so HRM systems should: Help assign these assets to appropriate tasks; and Help monitor their continuous development.

INTRODUCTION There are five major sources of input to the payroll system: HRM department provides information about hirings, terminations, and pay-rate changes. Employees provide changes in discretionary deductions (e.g., optional life insurance). Various departments provide data about the actual hours worked by employees. Government agencies provide tax rates and regulatory instructions. Insurance companies and other organizations provide instructions for calculating and remitting various withholdings.

INTRODUCTION Principal outputs of the payroll system are checks: Employees receive individual paychecks . A payroll check is sent to the bank to transfer funds from the company’s regular account to its payroll account. Checks are issued to government agencies, insurance companies, etc., to remit employee and employer taxes, insurance premiums, union dues, etc. The payroll system also produces a variety of reports.

INTRODUCTION Employees are an organization’s most valuable assets: Their knowledge and skills affect quality and quantity of goods and services. Labor costs are a major expense in generating revenues and a key cost driver. The traditional AIS has not measured or reported on the status of a company’s human resources: Financial statements do not regard employees as assets. Under GAAP, the value of human services is not measured until they have been consumed.

INTRODUCTION However, some companies are now creating positions for a direction of intellectual assets. Some may even include HR info in their annual report, including reports on: Human capital: The knowledge employees possess, which can be enhanced. Intellectual capital: The knowledge that’s been captured and implemented in decision support systems, expert systems, or knowledge databases, so that it can be shared.

INTRODUCTION Because employees are so valuable, turnover is expensive: Average cost of replacement is 1.5 times the employee’s annual salary. Turnover rates need to be managed so they’re not excessive.

INTRODUCTION Employee morale is also important. Bad morale leads to high turnover. Employee attitudes affect customer interactions and are positively correlated with profitability. Employees need to: Believe they have the opportunity to do what they do best Believe their opinions count Believe their coworkers are committed to quality Understand the connection between their jobs and the company’s mission.

INTRODUCTION To effectively track intellectual capital and human resources, the AIS must do more than just record time and attendance and prepare paychecks. Payroll should be integrated with HRM so management can access data about employee-related costs and employee skills and knowledge.

PAYROLL CYCLE ACTIVITIES Let’s take a look at payroll cycle activities. The payroll application is processed in batch mode because: Paychecks are issued periodically. Most employees are paid at the same time.

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

UPDATE PAYROLL MASTER FILE The HRM department provides information on new hires, terminations, changes in pay rates, and changes in discretionary withholdings. Appropriate edit checks, such as validity checks on employee number and reasonableness tests are applied to all change transactions. Changes must be entered in a timely manner and reflected in the next pay period. Records of terminated employees should not be deleted immediately as some year-end reports (e.g., W-2s) require data on compensation for all employees during the year.

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

UPDATE TAX RATES AND DEDUCTIONS The payroll department receives notification of changes in tax rates and other payroll deductions from government agencies, insurers, unions, etc. These changes occur periodically.

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

VALIDATE TIME AND ATTENDANCE DATA Information on time and attendance comes in various forms depending on the employee’s pay scheme.

VALIDATE TIME AND ATTENDANCE DATA Some employees are paid on an hourly basis. Many companies use a time card to record their arrival and departure time. This document typically includes total hours worked during a pay period. Some use electronic time clocks , where employees swipe their badge through a reader when they come and go. Manufacturing companies may use job time tickets to record not only time present but also time dedicated to each job.

VALIDATE TIME AND ATTENDANCE DATA Some employees earn a fixed salary, e.g., managers and professional staff. Usually don’t record their time, but supervisors informally monitor their presence. Professionals in accounting, law, and consulting firms must track their time on various assignments to accurately bill clients.

VALIDATE TIME AND ATTENDANCE DATA Sales staff are often paid on a straight commission or base salary plus commission. Some may also receive bonuses for surpassing sales targets. Requires careful recording of their sales.

VALIDATE TIME AND ATTENDANCE DATA Increasingly, laborers may be paid partly on productivity. Some management and employees may receive stock to motivate them to cut costs and improve service.

VALIDATE TIME AND ATTENDANCE DATA The payroll system needs to link to the revenue cycle and other cycles to calculate these payments. It’s also important to design bonus schemes with realistic, attainable goals that: Can be measured Are congruent with corporate objectives Are monitored by management for continued appropriateness Are legal

VALIDATE TIME AND ATTENDANCE DATA Accountants and Compensation Policies Recent corporate scandals have led to scrutiny and criticism of executive compensation plans: FASB issued new rules requiring that stock options be expensed. Major U.S. stock exchanges now require companies to obtain shareholder approval of stock compensation.

VALIDATE TIME AND ATTENDANCE DATA Compensation boards are being created to design compensation plans, rather than having executives create their own. Accountants can help by: Advising on financial and tax effects of proposals. Identifying appropriate metrics to measure performance. Enabling compliance with legal and regulatory requirements. Suggesting appropriate public disclosures.

VALIDATE TIME AND ATTENDANCE DATA How can information technology help? Collecting time and attendance data electronically, e.g.: Badge readers Electronic time clocks Data entered on terminals Touch-tone telephone logs Using edit checks to verify accuracy and reasonableness when the data are entered.

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

PREPARE PAYROLL The employee’s department provides data about hours worked. A supervisor confirms the data. Pay rate information is obtained from the payroll master file.

PREPARE PAYROLL Procedures: The payroll transaction file is sorted by employee number (same sequence as master file). For each transaction, the payroll master file is read for pay rates, etc., and gross pay is calculated. Hourly Employees: Gross pay = (hours worked x wage rate) + Overtime + Bonuses Salaried Employees: Gross pay = annual salary x fraction of year worked

PREPARE PAYROLL Payroll deductions are summed and subtracted from gross pay to obtain net pay. There are two types of deductions: Payroll tax withholdings Voluntary deductions Year-to-date totals for gross pay, deductions, and net pay are calculated, and the master file is updated. Cumulative records are important because: Social Security and other deductions cease or decline at certain levels. The information will be needed for tax reports.

PREPARE PAYROLL The following are printed: Paychecks for employees--often accompanied by an earnings statement , which lists pay detail, current and year-to-date. A payroll register which lists each employee’s gross pay, deductions, and net pay in a multi-column format: Is used to authorize the transfer of funds to the company’s payroll bank account. May be accompanied by a deduction register , listing miscellaneous voluntary deductions for each employee .

PREPARE PAYROLL As payroll transactions are processed, labor costs are accumulated by general ledger accounts based on codes on the job time tickets. The totals for each account are used as the basis for a summary journal entry to be posted to the general ledger. Other payroll reports and government reports are produced.

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

DISBURSE PAYROLL Most employees are paid either by: Check Direct deposit In some industries, such as construction, cash payments may still be made, but does not provide good documentation

DISBURSE PAYROLL Procedures: When paychecks have been prepared, the payroll register is sent to accounts payable for review and approval. A disbursement voucher is prepared to authorize transfer of funds from checking to the payroll bank account. For control purposes, checks should not be drawn on the company’s regular bank account A separate account is created for this purpose Limits the company’s loss exposure Makes it easier to reconcile payroll and detect paycheck forgeries

DISBURSE PAYROLL The approved disbursement voucher and payroll register are sent to the cashier. The cashier: Reviews the documents. Prepares and signs the payroll check to transfer the funds. Reviews, signs, and distributes employee paychecks (which separates authorization and recording from distribution of checks). Re-deposits unclaimed checks in the company’s bank account. Sends a list of these paychecks to internal audit for investigation.

DISBURSE PAYROLL Returns the payroll register to payroll department, where it is filed with time cards and job time tickets. Sends the disbursement voucher to accounting clerk to update general ledger.

DISBURSE PAYROLL Efficiency Opportunity: Direct Deposit Direct deposit can improve efficiency and reduce costs of payroll processing Employee receives a copy of the check and an earnings statement Each bank receives a record of the payroll deposits for that bank via EDI. The record includes: Employee number Social Security number Bank account number Net pay amount

DISBURSE PAYROLL Savings occur because: While the cashier does authorize release of funds, he/she does not sign each check. Eliminates costs of buying, processing, and distributing paper checks. Eliminates postage. Additional costs: Elimination of float between when check is distributed and when it is deposited by employee. Savings typically outweigh costs

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

CALCULATE EMPLOYER-PAID BENEFITS AND TAXES The employer pays some payroll taxes and employee benefits directly The employer withholds federal and state taxes from employee paycheck, along with Medicare tax, and the employee’s share of Social Security. May also withhold voluntary deductions such as union dues, United Way contributions, credit union savings, retirement contributions, etc.

CALCULATE EMPLOYER-PAID BENEFITS AND TAXES In addition, the employer pays: A matching amount of Social Security Federal and state unemployment taxes The employer share of health, disability, and life insurance premiums, as well as pension contributions Some companies offer flexible benefit plans, sometimes called cafeteria-style benefit plans. These plans offer a menu of options.

CALCULATE EMPLOYER-PAID BENEFITS AND TAXES Benefit programs increase the demands on the HRM/payroll system for gathering employee data, disbursing payments and information, etc. Providing access to payroll/HRM information through a company intranet can help reduce costs.

PAYROLL CYCLE ACTIVITIES The seven basic activities in the payroll cycle are: Update payroll master file Update tax rates and deductions Validate time and attendance data Prepare payroll Disburse payroll Calculate employer-paid benefits and taxes Disburse payroll taxes and miscellaneous deductions

DISBURSE PAYROLL TAXES AND MISCELLANEOUS DEDUCTIONS The company must periodically prepare checks or EFT to pay tax and other liabilities.

OUTSOURCING OPTIONS Many entities outsource payroll and HRM to: Payroll service bureaus Maintain the payroll master file and perform payroll processing activities Professional employer organizations (PEOs) Perform the services of the payroll service bureau Also administer and design employee benefit plans Generally more expensive than payroll service bureaus

OUTSOURCING OPTIONS When organizations outsource payroll processing, they send the service bureau or PEO at the end of each period: Personnel changes Employee time and attendance data The service bureau or PEO then: Prepares paychecks, earnings statements, and a payroll register Periodically produces tax documents

OUTSOURCING OPTIONS Outsourcing is especially attractive to small and mid-size businesses because: It’s often cheaper for smaller companies The bureau or PEO may provide a wider range of benefits It frees up the company’s computer resources for other areas However, companies must carefully monitor service quality to ensure that these systems integrate HRM and payroll data in a manner that supports effective management of employees.

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES In the HRM/payroll cycle (or any cycle), a well-designed AIS should provide adequate controls to ensure that the following objectives are met: All transactions are properly authorized All recorded transactions are valid All valid and authorized transactions are recorded All transactions are recorded accurately Assets are safeguarded from loss or theft Business activities are performed efficiently and effectively The company is in compliance with all applicable laws and regulations All disclosures are full and fair

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES There are several actions a company can take with respect to any cycle to reduce threats of errors or irregularities. These include: Using simple, easy-to-complete documents with clear instructions (enhances accuracy and reliability). Using appropriate application controls, such as validity checks and field checks (enhances accuracy and reliability). Providing space on forms to record who completed and who reviewed the form (encourages proper authorizations and accountability).

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES Pre-numbering documents (encourages recording of valid and only valid transactions). Restricting access to blank documents (reduces risk of unauthorized transaction).

CONTROL: OBJECTIVES, THREATS, AND PROCEDURES Following is a discussion of threats to the HRM/payroll system, organized around three areas: Employment practices Payroll processing General control issues

THREATS IN EMPLOYMENT PRACTICES Objective: Effectively hire, retain, and dismiss employees. The major threats in the employment practices area are: THREAT 1: Hiring Unqualified or Larcenous Employees THREAT 2: Violation of Employment Law You can click on any of the threats below to get more information on: The types of problems posed by each threat The controls that can mitigate the threats.

THREATS IN EMPLOYMENT PRACTICES THREAT 1: HIRING UNQUALIFIED OR LARCENOUS EMPLOYEES Why is this a problem? Can increase production expenses Can result in theft of assets Can result in civil and criminal penalties for the company (e.g., if an employee attempts to make a bribe) Controls: State skill qualifications for each position explicitly in the position control report Ask candidates to sign a statement confirming the accuracy of the information on their application

THREATS IN EMPLOYMENT PRACTICES Recent honesty surveys indicate that 30% of Americans are dishonest, 30% are situationally honest, and 40% are honest. Therefore, ask candidates to consent to a thorough background check of their credentials, employment history, and credit: You cannot conduct these checks without a written consent Discard candidates who refuse to consent

THREATS IN EMPLOYMENT PRACTICES Conduct the background checks and verify skills and references, including college degrees earned: Data released in March 2004 indicate that 50% of resumes contain false or embellished information. Check at least three references, and regard it as a negative signal if at least one is not gratuitously positive. Return to Threat Menu Go To Next Threat

THREATS IN EMPLOYMENT PRACTICES THREAT 2: VIOLATION OF EMPLOYMENT LAW Why is this a problem? Can result in stiff government penalties as well as civil suits Controls: Carefully document all actions relating to advertising, recruiting, hiring new employees, and dismissal of employees, to demonstrate compliance Provide employees with continual training to keep them current with employment law Return to Threat Menu Go To Next Threat

THREATS IN PAYROLL PROCESSING Objective: Efficiently and effectively compensate employees for services provided . The major threats in the employment practices area are: THREAT 3: Unauthorized Changes to the Payroll Master File THREAT 4: Inaccurate Time Data THREAT 5: Inaccurate Processing of Payroll THREAT 6: Theft or Fraudulent Distribution of Paychecks You can click on any of the threats below to get more information on: The types of problems posed by each threat The controls that can mitigate the threats.

THREATS IN PAYROLL PROCESSING THREAT 3: UNAUTHORIZED CHANGES TO THE PAYROLL MASTER FILE Why is this a problem? Can increase expenses if wages, salaries, commissions, or base rates are falsified Can result in inaccurate reporting and erroneous decisions

THREATS IN PAYROLL PROCESSING Controls: Proper segregation of duties: Only HRM department should be able to update payroll master file. HRM employees should not directly participate in payroll processing or distribution. Prevents the creation of ghost employees and fraudulent checks. Changes to the payroll master file should be reviewed and approved by someone other than the person recommending the change. Department supervisors should receive copies of these documents for review.

THREATS IN PAYROLL PROCESSING Restrict logical and physical access to the payroll system: Utilize user IDs, passwords, and an access control matrix. Control terminals from which payroll data and programs can be accessed. Return to Threat Menu Go To Next Threat

THREATS IN PAYROLL PROCESSING THREAT 4: INACCURATE TIME DATA Why is this a problem? Can result in payments for services not rendered Inaccurate or missing checks can damage employee morale Can result in inaccurate labor reporting

THREATS IN PAYROLL PROCESSING Controls: Automation can reduce unintentional inaccuracies with: Badge readers Bar code scanners Online terminals Data entry programs should include edit checks: Field checks for employee number and hours worked Limit checks on hours worked Validity checks on employee numbers

THREATS IN PAYROLL PROCESSING Segregation of duties can reduce intentional inaccuracies: People who process payroll should not have access to payroll master file. Supervisors should approve all changes. Time clock data should be reconciled to job time tickets by an independent party. Supervisors should approve all time cards and job time tickets. Return to Threat Menu Go To Next Threat

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