ńňđ. 11
(âńĺăî 25)



audited when preparing an audit report.

Required Identify each statement as true or false and explain your reasoning.

An essential requirement of any accounting system is that it provide accurate data. In-
correct data are not useful and can lead to poor decisions. Consequently, controls are
Describe the purpose of important in a company to help ensure that data are accurate. Incorrect data can re-
internal controls and sult from errors in recording data or from events that affect a company’s assets. For ex-
types of controls that ample, if Mom’s Cookie Company purchased inventory at a cost of $1,200, it would be
should be evident in incorrect to record the amount owed the supplier as $1,150. It is correct to record an
business organizations.
increase in Accounts Payable and Merchandise Inventory of $1,200. However, if the
merchandise is stolen from the company, the accounting data are in error because they
are not consistent with the amount of the asset actually available to the company. Ac-
cordingly, a company uses a system of internal controls both to protect assets and to
ensure accuracy of accounting information.

Management Philosophy
A strong system of internal controls begins with a management philosophy that en-
courages appropriate security and behavior in a company. If top management takes a
lax attitude about these matters, it is unlikely that it will develop and enforce an effec-
tive system. Accordingly, top management should develop policies and ensure that these
are communicated throughout the company. It should also ensure that procedures are
developed to monitor and enforce control policies. If Maria and Stan want their com-
pany’s employees to act with integrity, they must establish a tone of ethical conduct by
acting with integrity themselves and by creating and enforcing policies and procedures
that require ethical behavior in conducting business activities.
Part of management philosophy should involve developing rewards and incentives
that encourage employees to take appropriate actions. For example, a bonus system that
places too much emphasis on sales quotas could encourage employees to create false sales,
to predate sales orders, and to make credit sales to risky customers. A good system of re-
wards will encourage employees to focus on the value and ongoing success of a company.

Business Ethics
Management should create a code of ethics and other documents that establish com-
pany policy and inform employees of acceptable and expected behavior. These policies
CHAPTER F6: Full and Fair Reporting
240 Full and Fair Reporting

should consider the relationship between a company and its customers, employees, sup-
pliers, stockholders, and community. As an example, Exhibit 6 identifies the contents
of United Technologies Corporation’s Code of Ethics.
A major purpose of internal controls is to ensure compliance with laws and reg-
ulations. If a company fails to comply with laws, it can be subject to civil and criminal
penalties resulting in significant losses. Antitrust laws prohibit collaboration among
competitor companies that leads to unfair pricing or trade practices. Companies that
sell similar products in the same markets cannot collude to set prices or limit compe-
http://ingram. tition. The Foreign Corrupt Practices Act prohibits companies from offering or ac-
swlearning.com cepting bribes or other payments to obtain business or influence the behavior of
customers or government authorities.
Learn more about the
Ethical behavior involves treating individuals and companies fairly and providing
Foreign Corrupt Prac-
tices Act. full disclosure of information that might affect their decisions. Moral hazard is a po-
tential problem in dealing with customers, suppliers, employees, and others who in-
teract with a company. The company often has access to information that is not available
to external stakeholders. Full disclosure is often a remedy for moral hazard. In the long
run, fair treatment and disclosure will create a reputation for a company that will lead
to financial benefits.

Exhibit 6
Ethical Issues
between the
Associated with
Company and: Important Issues:
Corporate Conduct

Customers • Quality and safety of products
• Honesty in dealings
• Avoid conflicts of interest
• Protection of confidential information
• Comply with Foreign Corrupt Practices Act

Employees • Equal opportunity in hiring, compensation, and treatment
• Privacy of information about employees
• Treatment with dignity and respect
• Provide a safe and healthy work environment
• Provide opportunity for development

Suppliers • Fair competition

Stockholders • Provide superior returns
• Protect and improve investment value
• Protect assets
• Accurate accounting information and disclosure of
business activities

Competitors • Fairness
• Comply with antitrust laws

Communities • Responsible corporate citizenship
• Abide by laws
• Participate in civic affairs
• Support through corporate philanthropy
• Comply with laws concerning political donations
• Comply with export laws
• Protect environment

Source: www.utc.com/profile/ethics.
F240 SECTION F1: The Accounting Information System
Full and Fair Reporting

Computer System Controls
Many internal controls should be built into computer information systems. These con-
trols protect a company’s information resources from unauthorized access, improper
use, and destruction. System controls determine who can gain access to various parts
of a company’s database. Users should have appropriate identification and passwords
to log onto networks or to use network resources. Users typically are assigned to groups
based on the type of work they perform. For example, data entry personnel in the sales
division are permitted access to those files in the database that need to be updated when
customers submit orders. They should not have access to other data in the system that
they do not need in the course of their work.
System controls also manage databases to prevent several users from trying to up-
date particular records at the same time. While one user is accessing a record or file,
other users are locked out so that conflicting or incomplete changes cannot be made.
Other controls check data for errors to make sure that data entered in a system
are reasonable and appropriate. For example, a system may refuse to prepare a check
for an amount larger than $1,000. This control prevents a clerk from accidentally writ-
ing large checks by mistyping data or omitting a decimal. Automatic numbering should
be used to identify transactions and source documents such as sales orders, invoices,
and purchase orders. Each transaction or document is assigned a number that follows
a preset sequence. Consequently, each item can be tracked and missing items can be
identified. Using automatic numbering makes it more difficult for employees to create
fictitious transactions or falsify data by recording transactions and then deleting them
from the system. Missing numbers are easily identified, and those responsible for delet-
ing the numbered items can be held responsible.
Many other controls can be built into computer systems. Examples include the use
of software and hardware to make it difficult for unauthorized users to break into com-
puter networks and databases. The software and hardware also can monitor systems to
detect attempts to gain unauthorized access.
Duplicate copies of databases often are maintained so that if one database system
fails, the other is available for use. Backup systems and data are necessary to prevent
data from being lost if a database system fails and to permit a company to continue to
operate even if it has computer problems. Databases are backed up on a regular basis.
Data are copied to tape or other permanent storage devices so they can be retrieved in
case of a major problem with the active database. These backup data are stored in lo-
cations away from where the working database is maintained.
Complete computer systems must be protected. Many companies maintain cen-
tralized computer information system facilities. These facilities must be protected from
destruction by natural disasters (fire, flood, earthquake) and from those who might at-
tempt to destroy a company’s systems (terrorists, disgruntled employees, competitors).
An important control is a disaster recovery plan that a company can rely on to get its
computer systems back into working order in case of a major disaster. Such a plan usu-
ally requires access to facilities, hardware, and software at locations other than those
normally used.

Human Resources Controls
Many internal controls focus on a company’s human resources. Important controls in-
volve hiring qualified employees who have the appropriate skills for a particular job.
Background checks can identify employees who have a history of improper behavior.
A good training program can ensure that employees develop and maintain the skills
needed for their jobs.
An important control involves segregation of duties so that an employee does not
have access to resources and information that would make it easy for the employee to
misuse those resources. For example, an employee should not have access both to a re-
CHAPTER F6: Full and Fair Reporting
242 Full and Fair Reporting

source and to the accounting for that resource. If an employee has control over mer-
chandise, supplies, or cash, that employee should not have control over records show-
ing the amount of the resources received or transferred. Computer programmers and
systems developers should not have access to actual operations of computer systems.
Developers create the systems and can use them to create improper transactions that
can transfer cash or other resources to improper persons. Developers can also destroy
systems by creating programs to erase data or corrupt program logic. Disgruntled em-
ployees can be a major risk to an organization, especially if they understand and have
access to a company’s computer system.
Employees should understand their responsibilities and authority. They should
know what they are permitted to do in their jobs and what they are not permitted to
do. They should clearly understand lines of authority in a company. Employees should
be supervised and inappropriate behavior should be reported and addressed.

Physical Controls
Safeguarding assets often involves controlling physical access. Merchandise and mate-
rials can be secured in warehouses or display cases. Merchandise can be tagged elec-
tronically to make shoplifting or theft difficult. Surveillance equipment can monitor
important resources. Cash registers, vaults, and safety deposit boxes secure financial re-

A strong system of internal controls is essential for protecting any information sys-
tem. Though not all controls relate directly to how information is processed, the in-
tegrity of accounting information depends on controls that protect data and the
systems used to process those data. An internal control system is an important part
of an accounting information system. Without internal controls, users could not rely
on accounting information as an accurate description of a company’s economic ac-

Throughout this chapter we have considered various regulatory functions associated
with accounting. Accountants and the accounting profession have primary responsi-
bility for these functions. Accountants work to prepare financial information contained
in companies’ annual reports. They manage the information systems used to record
and report this information. They help other managers interpret information reported
by the accounting system and make sure the information is reliable and conforms with
GAAP and legal requirements.
Accountants serve on organizations like the FASB and SEC that establish and mon-
itor accounting standards. They research accounting issues, prepare standards, and re-
search company financial reporting practices. Independent CPAs audit business
financial reports to ensure that they fairly present the companies’ business activities.
The audit is an important tool in maintaining strong capital markets. If managers fail
in their responsibilities to report fairly to external users, independent audits are a ma-
jor line of defense to prevent misleading information from reaching investors. Conse-
quently, auditors are held to a high standard of professional responsibility and integrity.
Audit failure is a major source of concern for the SEC and society in general. CPAs and
the audit firms in which they work are required to maintain current professional knowl-
edge and are reviewed on a regular basis to make sure their practices are consistent with
current standards.
F242 SECTION F1: The Accounting Information System
Full and Fair Reporting

Case in Point
The Consequences of Audit Failure
Concerns about Enron Corporation’s accounting practices led to close scrutiny of the
company’s audit firm, Arthur Andersen. Congressional hearings raised concerns that
the auditor failed to protect the public interest and was involved in business activities
http://ingram. with Enron that reduced the audit firm’s independence. The Justice Department in-
swlearning.com dicted Andersen for obstruction of justice because its employees destroyed documents
that the Justice Department believed were important for its investigation of Enron’s
Learn more about the
and Andersen’s activities. In addition, Andersen was sued for billions of dollars by En-
largest public account-
ron stockholders and creditors. Because of these events, many of Andersen’s other
ing firms.
audit clients replaced the firm as their independent auditors. Andersen was forced to
lay off many of its employees, and many others resigned to take positions with other
audit firms or companies.
Prior to these events, Andersen was one of the “Big Five” accounting firms, along
with Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers. The
events associated with Enron removed Andersen from the ranks of the “Big Five” and
seriously jeopardized its ability to continue as an audit firm.

In addition to working as external auditors, accountants also work as internal au-
ditors. Internal auditors work for businesses and are responsible for developing and
monitoring internal control systems and for auditing a company’s divisions for com-
pliance with accounting rules, company policies, and legal requirements. They also may
evaluate the performance of a division or company to improve efficiency and effec-

3 SELF-STUDY PROBLEM Deborah Stinger works in the systems development department
of a major company. She helped develop the company’s com-
puterized accounting system. Occasionally, she fills in for one of the operators in the
accounts payable department. This operator is responsible for processing checks to sup-
pliers for purchases made by the company. While filling in, Deborah created an account
of a fictitious company, just to see if the system could be tricked into writing checks
for nonexistent purchases. She added data to the company’s file and entered some phony
purchases. The computer wrote the checks, and they were mailed to a post office box
Deborah opened. Over the last few years, Deborah has written over $80,000 in checks
to her fictitious company.

Required Identify some internal control deficiencies in the accounting system that
have allowed Deborah to embezzle money from her company.


1. Accounting regulations are important to protect the interests of external users of ac-
counting information who have limited access to business information. GAAP help en-
sure that reliable information is available to control moral hazard on the part of
corporate managers.

2. Several events and organizations are important for the development of accounting reg-
ulations in the United States.
a. The first regulations were established by the New York Stock Exchange.
b. The Securities Act of 1933 and the Securities and Exchange Act of 1934 are major
laws that affect accounting and financial reporting in the United States.
CHAPTER F6: Full and Fair Reporting
244 Full and Fair Reporting

3. Several organizations play a role in setting and enforcing accounting standards.
a. The SEC has the authority to establish and enforce accounting standards in the
United States.
b. The FASB is a private-sector organization that is largely responsible for setting ac-
counting standards in the United States.
c. The GASB is a private-sector organization that establishes accounting standards for
state and local governments in the United States.
d. The IASB is a private-sector organization that helps develop global accounting stan-

4. Accounting standards are set through a process of public discussion that permits those
affected by standards to have input into the standard-setting process.

5. The FASB’s conceptual framework provides guidance for the development of financial
accounting standards for business organizations.

6. Annual reports contain information supplemental to financial statements that is impor-
tant for understanding and interpreting those statements.
a. Supplemental financial disclosures provide information about business activities and
for periods other than those covered by the primary financial statements.
b. Notes to the financial statements provide additional information about business ac-
tivities and explain methods used in preparing financial statements.
c. The auditors’ report describes the audit and expresses an opinion as to whether the
financial statements are a fair presentation of a company’s business activities in con-
formity with GAAP.
d. The report of management’s responsibilities identifies responsibilities of managers for
financial statements and internal controls and describes a company’s audit committee.

7. Internal controls are designed to protect a company’s assets and ensure the reliability of
its accounting information.
a. Management is responsible for establishing an environment of integrity in which in-
ternal controls are important.
b. Management should establish a code of ethics and inform employees of expected
and appropriate behavior.
c. Computer controls are important for protecting a company’s data and computer
d. Human resource controls are designed to control the behavior of employees and
managers and to provide expectations about appropriate behavior.
e. Physical controls are designed to protect assets and to limit access to important re-

8. Accountants and the accounting profession are responsible for development and en-
forcement of accounting regulations.


attestation (F235) internal controls (F237)
audit (F235) International Accounting Standards Board
discussion memorandum (F230) (IASB) (F229)
exposure draft (F230) management’s discussion and analysis
FASB conceptual framework (F230) (MD&A) (F231)
Financial Accounting Standards Board Securities Act of 1933 (F226)
(FASB) (F229) Securities and Exchange Commission
General Accounting Office (GAO) (F229) (SEC) (F226)
generally accepted auditing standards Securities Exchange Act of 1934 (F226)
(GAAS) (F236) Statements of Financial Accounting Stan-
going concern (F236) dards (F230)
Governmental Accounting Standards Board
(GASB) (F229)
F244 SECTION F1: The Accounting Information System
Full and Fair Reporting

SSP6-1 GAAP are guidelines for the preparation of financial statements and other accounting infor-
mation. They are important because they provide standards for the content and format of fi-
nancial reports. How earnings and other accounting information are measured is important
for determining the reliability and usefulness of the information. If each company chose its
own accounting rules, it could select those rules that made the company appear successful.
Moral hazard results when a person, like Abe, has incentives to behave in ways that can
be harmful to others, such as creditors, who have a financial stake in the person’s activities.
To get a loan, Abe has an incentive to make his company appear financially strong. If he fails
to repay the loan, the bank will lose money. Reliable financial information is a means of con-
trolling moral hazard so that the bank can make a decision based on an accurate view of the
company’s business activities. GAAP help ensure that financial information is reliable.

A. False. An independent audit provides reasonable assurance about the reliability of au-
dited financial information. Auditors rely on information provided by management
and on evidence collected from a sample of a company’s transactions.
B. True. The cost of examining all of a company’s transactions is usually too high. Audi-
tors examine a representative sample of transactions.
C. True. GAAS are procedures that auditors must follow in performing an audit to help
ensure the audit has been performed properly.
D. False. The auditor is responsible for making sure a company notifies readers of its fi-
nancial reports of any events occurring between the end of the period covered by the
financial statements and the date of the audit report that would have a material affect
on interpretation of the financial statements.
Internal control deficiencies include access to the accounting system by an employee who
should not have access. Limitations on physical access, passwords, and employee identifica-
tion numbers should have prevented Deborah from gaining access to the system. Deborah
should not have authority to use the system. Another deficiency was the failure to separate
systems development from computer operations personnel. Deborah was able to embezzle
funds because she understood the computer programs that created accounting files. Computer
operators normally do not have sufficient knowledge of the system to manipulate it in this
manner. An additional deficiency was the failure of the system to verify transactions or com-
pare amounts from one part of the system to another. For example, use of sequentially num-
bered purchase orders should make it difficult for an employee to create fictitious data without
the system identifying a problem.

Thinking Beyond the Question
How do we ensure that reports to external users fairly present
business activities?

Full and fair reporting involves reliable financial statements that accurately re-
port a company’s business activities. Information to describe, interpret, and ex-
tend that information also is important. Audits and internal controls also help
ensure full and fair reporting. To what extent should full and fair reporting pro-
tect external users from poor management decisions? Does full and fair report-
ing guarantee that stakeholders will not suffer losses from their contractual
relations with a business? Why or why not?
CHAPTER F6: Full and Fair Reporting
246 Full and Fair Reporting

Other than business managers, who relies on financial reports to make decisions?
Obj. 1

Compliance with regulations is costly. Why are public companies required to comply with
Obj. 1

Why does the FASB issue a discussion memorandum prior to releasing an exposure draft of
a new pronouncement?
Obj. 2

The SEC is authorized by law to establish and enforce accounting standards in the United
States. Why are most accounting standards used by businesses issued by the FASB?
Obj. 2

What are the elements of financial statements, according to the FASB’s conceptual framework?
Where would an investor find these elements?
Obj. 3

One of the major components of the FASB conceptual framework is the objectives of finan-
cial reporting. What are the objectives of financial reporting?
Obj. 3

A friend has been reviewing the annual report of a firm in which he has invested. He says,
“I’m worried because the auditors gave an unqualified opinion on the financial statements.
Obj. 4
You’d think a big company like this would have auditors that were qualified.” Clear up your
friend’s misunderstanding.
What is the purpose of notes to financial statements? If a firm does a good job presenting its
financial statements, why are notes necessary?
Obj. 4

What is an audit and why is it important?
Obj. 4

Why is it necessary for managers and other decision makers to understand how accounting
information is developed and reported? Shouldn’t it just be management’s job to manage and
Obj. 5
the accountant’s job to account? Explain.
What are the two primary purposes of internal controls?
Obj. 5

Explain why internal controls are important to a computerized management information sys-
tem and identify several such controls that are commonly used.
Obj. 5

Why is management philosophy an important internal control issue?
Obj. 5

Q6-14 Identify some human resource controls that can be used in a company and explain why they
are important.
Obj. 5

Identify some physical controls that can be used in a company and explain why they are im-
Obj. 5

If your instructor is using Personal Trainer in this course, you may complete online the assign-
EXERCISES ments identified by .
Write a short definition for each of the terms listed in the Terms and Concepts Defined in this
Chapter section.
Objs. 1–5

Three major developments in the history of accounting involved the development of the New
York Stock Exchange, the 16th Amendment to the U.S. Constitution, and the events subse-
Obj. 1
quent to the stock market crash of 1929. Explain briefly the significance of each of these events
for contemporary accounting.
F246 SECTION F1: The Accounting Information System
Full and Fair Reporting

E6-3 Identify the major reporting requirements associated with each of the following:
Obj. 1
a. Securities Act of 1933
b. Securities and Exchange Act of 1934
c. 10-K report
d. 10-Q report
Identify each of the following:
Obj. 2
a. The private sector organization currently responsible for setting financial accounting
standards in the United States.
b. The private sector organization currently responsible for setting state and local govern-
mental accounting standards in the United States.
c. The organization that exists to influence the development of international accounting
d. The federal agency that oversees accounting at the federal government.
e. The organization responsible for the enforcement of financial accounting standards in
the United States.
How would you react to the following statement? “Accounting standards impose costs on cor-
porations and their managers to protect the interests of investors.”
Obj. 2

What is meant by the term “generally accepted accounting principles?” What is the signifi-
cance of the phrase “generally accepted?”
Obj. 2

What is the purpose of the qualitative characteristics of financial reports? What are the pri-
mary qualitative characteristics as defined by the FASB?
Obj. 3

What is the FASB’s conceptual framework?
Obj. 3

Identify each of the sections of an auditors’ report and explain its purpose.
Obj. 4

Corporate annual reports include a discussion and analysis of the company’s financial per-
formance. What is the purpose of this discussion?
Obj. 4

General Mills Corporation had sales of almost $8 billion in fiscal year 2002 from Betty Crocker,
Pillsbury, Wheaties, Cheerios, Pop Secret popcorn, and other products. The company reported
Obj. 4
total assets of more than $16.5 billion. Inspect the General Mills’ balance sheet found in Ap-
pendix B at the back of this book. (a) Does it seem strange to you that such a big company is
able to report all of its assets using only nine different accounts? How is this possible? (b) Why
is this done? (c) Would this level of detail meet the needs of the general manager of the Pills-
bury division, or the managers in other divisions of the company? Discuss.
Quick Transport Company owns a large fleet of trucks that move freight throughout the coun-
try. Some of these trucks cost hundreds of thousands of dollars and are operated for 15 years
Obj. 4
or more before being replaced. The company issues long-term debt to pay for most of its
equipment. The company’s fiscal year ends on June 30. For each fiscal year, the company pre-
pares financial reports that include estimates of its results of operations for the year. How do
the operations of Quick illustrate the periodic measurement and going concern principles of
Bill’s grandparents have been buying shares of stock for his college education fund since the
day he was born. Yesterday, Bill received the annual report of Thompson Consolidated Shoul-
Obj. 4
derpads, Inc., and is telling you about it. Bill says:

“I feel really good about the company because its financial statements were prepared
and audited by a well-known national accounting firm. Not only that, but the firm re-
ceived an unqualified audit report. This means that the auditor checked out all the com-
pany’s transactions and that the company is healthy. Since the auditors think the
company is doing well, I think I’ll invest some of my summer job savings in it.”

How would you respond to your friend? Do you believe he has a good understanding of what
information is conveyed by an auditors’ report? Discuss.
CHAPTER F6: Full and Fair Reporting
248 Full and Fair Reporting

E6-14 What is the role of an accountant who works for a business organization?
Obj. 5

Selma Fromm is a recent graduate in accounting. She has taken a position with Hand Writer
Company. The company has three divisions that manufacture three products: pencils, pens,
Obj. 5
and colored markers. Financial information for the most recent fiscal period for each division
includes the following:

Pencils Pens Markers
Division revenues $200,000 $ 300,000 $100,000
Division expenses 140,000 160,000 60,000
Division assets 600,000 1,000,000 200,000

One of Selma’s regular duties is to prepare an analysis of the performance of each division.
Prepare an analysis of division performance from the information provided. Which of the di-
visions appears to be most profitable? Is this responsibility typical of the tasks often performed
by accountants who work for business organizations? Explain.
What is the purpose of internal auditing? Why is it important to an organization?
Obj. 5

List and briefly describe the primary internal control procedures discussed in the chapter.
Obj. 5

What is the role of an independent CPA?
Obj. 5

Mag’s Pie Shop is a rapidly growing baker and distributor of specialty pies for festive occa-
sions. Mag’s CPA adviser keeps recommending that Mag install better internal controls over
Obj. 5
the business. Specifically, the CPA recommends that Mag separate the company’s record-
keeping function from the physical control of cash and other assets. The CPA also recom-
mends that Mag use only preprinted and prenumbered forms for all business transactions.
a. What is the purpose of internal controls? Be specific.
b. For each internal control suggested by the CPA, give one example of an unsatisfactory
situation or event that the control would prevent.
Ima Crook is a sales clerk for Free Cash Company. Ima runs a cash register. Each day she ob-
tains $200 from a supervisor and places the money in the cash register to make change. Cus-
Obj. 5
tomers bring goods to the sales counter, where Ima takes their money and writes out a sales
slip using a form provided for this purpose. If requested by the customer, she writes out a sep-
arate slip for the customer. Ima works from 9 A.M. to 5 P.M. except for breaks and lunch when
she is replaced by a coworker who runs the cash register for her. At 5 P.M. Ima takes all the
cash from her cash register and puts it in an envelope along with the sales receipts and hands
the envelope to a supervisor. Ima just bought a new $50,000 car and paid cash. What inter-
nal control problems exist in this situation? What can be done to solve the problems?

If your instructor is using Personal Trainer in the course you may complete online the assignments
PROBLEMS identified by .

The Importance of Financial Accounting Standards
Obj. 1 Accounting and financial reporting is highly regulated in the United States. Standards specify
the types of information to be reported and how accounting numbers are to be calculated.
Listed below are groups who benefit from these standards.
A. managers
B. stockholders
C. creditors
D. governmental authorities
E. employees

Required Explain why financial accounting standards are important to each of these groups.
F248 SECTION F1: The Accounting Information System
Full and Fair Reporting

P6-2 The Role of Accounting Regulation
Obj. 1
On Wednesday, July 10, 2002, the Wall Street Journal reported the following headlines:

Securities Threat1
Bush Crackdown on Business Fraud Signals New Era
Stream of Corporate Scandals Causes Bipartisan Outrage; Return of Big Government?
Fiery Rhetoric on Wall Street

President Bush’s tongue-lashing of big business marks a swing of the American political pen-
dulum away from a quarter-century of bipartisan deference to capitalists. “We will use the full
weight of the law to expose and root out corruption.”
“Book-cooking” has eroded “the trust and the confidence that is absolutely vital to the
function of our capital markets,” Rep. Patrick Toomey, a Republican from Pennsylvania,

Required Discuss the role of accounting regulation. Why is trust vital to the function of our
capital markets?

Setting Accounting Standards
Obj. 2 Accounting standards are set in the United States in the private sector. Public hearings and
written documents provide feedback during development of the standards. Opportunity is
provided to those affected by standards to contribute information to standard-setting organi-
zations such as the FASB.

Required List the major steps in the standard-setting process. Explain the purpose of each
of the primary documents that results from the process.

Obtaining the Most Recent Information about FASB Activities
Obj. 2 Visit the FASB’s website at http://www.fasb.org and prepare a report that summarizes the var-
ious types of information available on the site.

Obtaining the Most Recent Information about IASB Activities
Obj. 2 Visit the International Accounting Standards Board’s website at http://www.iasb.org.uk and
prepare a report that summarizes the various types of information available on the site. Are
Access the FASB and there similarities between the processes of developing standards used by the IASB and the
IASB sites through the FASB? Explain.
text’s Website.
The Purpose of the Conceptual Framework
Obj. 3 The Financial Accounting Standards Board developed a conceptual framework to provide
guidance in the development of financial accounting standards.

Required Identify the primary components of the conceptual framework for business or-
ganizations and explain the purpose of each component.

The Conceptual Framework—Qualitative Characteristics
Obj. 3 Draw a diagram that describes the relationships among the qualitative characteristics as de-
fined in the FASB conceptual framework. Explain your diagram.

Ethical Issues in Auditing
Objs. 3, 4 Larry Clint is the president of Hometown Bank. The bank has several thousand depositors
and makes loans to many local businesses and homeowners. Blanche Granite is a partner with
a CPA firm hired to audit Hometown Bank. The financial statements the bank proposes to
issue for the 2004 fiscal year include the following information.

The Wall Street Journal, Wednesday, July 10, 2002, Eastern Edition, p. A1.
CHAPTER F6: Full and Fair Reporting
250 Full and Fair Reporting

Loans receivable $4,000,000
Total assets 5,000,000
Net income 1,000,000

During the audit, Blanche discovers that many of the loans were made for real estate de-
velopment. Because of economic problems in the region, much of this real estate remains un-
sold or vacant. The current market value of the property is considerably less than its cost.
Several of the developers are experiencing financial problems, and it appears unlikely that the
bank will recover its loans if they default. Blanche described this problem to Larry and pro-
posed a write-down of the receivables to $2,800,000. The $1,200,000 write-down would be
written off against earnings for 2004.
Larry is extremely upset by the proposal. He notes the write-off would result in a reported
loss for the bank for 2004. Also, the bank would be in jeopardy of falling below the equity re-
quirements imposed by the bank regulatory board to which the bank is accountable. He fears
the board would impose major constraints on the bank’s operations. Also, he fears depositors
would lose confidence in the bank and withdraw their money, further compounding the bank’s
financial problems. He cites several economic forecasts indicating an impending improvement
in the region’s economy. Further, he notes the bank’s demise would be a major economic
blow to the local economy and could precipitate the bankruptcy of some of the bank’s major
Blanche acknowledges that Larry is correct in his perceptions of the possible outcomes of
the write-off. Larry proposes an alternative to Blanche. The bank will write down the receiv-
ables by $300,000 for 2004. The remaining losses will be recognized over the next three years,
assuming property values have not improved. Larry also tells Blanche that if she is unwilling
to accept his proposal, he will fire her firm and hire new auditors. The bank has been a long-
time client of Blanche’s firm and is one of its major revenue producers. Blanche also recog-
nizes Larry’s proposal is not consistent with accounting principles.

Required What are the ethical problems Blanche faces? What action would you recommend
she take?

Evaluating the Quality of Financial Reports
Obj. 4 The following statements describe the annual report issued by Short Sheet Company for the
fiscal year ended December 31, 2004.
A. The report was issued on October 1, 2005.
B. The balance sheet included management’s estimates of the increased value of certain
fixed assets during 2004.
C. Procedures used to calculate revenues and expenses were different for 2004 than for
2003 and earlier years.
D. Short’s financial statements were audited by an accounting firm owned by the presi-
dent’s brother.
E. Some of the company’s major liabilities were not included in the annual report.

Required For each statement, identify the qualitative characteristic that has been compro-

Understanding the Auditors’ Report
Obj. 4 A standard auditors’ report contains reference to each of the following:
A. Responsibility
B. Generally accepted auditing standards
C. Material misstatement and material respects
D. A test basis
E. Present fairly . . . in conformity with generally accepted accounting principles

Required Explain why each of these terms is important for understanding the auditors’ re-
port and the audit process.
F250 SECTION F1: The Accounting Information System
Full and Fair Reporting

P6-11 Distinguishing Among Types of Accounts
Obj. 4
Bonner Systems uses the following accounts when preparing its financial reports.

Type of Account Financial Statement
Income Balance
Asset Liability Equity Revenue Expense Statement Sheet
1. Wages Payable
2. Accounts Receivable
3. Retained Earnings
4. Buildings
5. Supplies Used
6. Inventory
7. Sales (for cash)
8. Accumulated
9. Loan from Bank
10. Land
11. Owners’ Investment
12. Supplies
13. Sales (on credit)
14. Bonds Payable
15. Unearned Revenue
16. Wages Earned by
17. Utilities Consumed

A. Place a mark in the appropriate column to indicate the type of account.
B. Place a mark in the appropriate column to indicate on which financial statement that
account is reported.

Interpreting Information Reported on Financial Statements
Obj. 4 The two most recent monthly balance sheets of Strauss Instrument Company are shown be-
low. Also shown is the most recent monthly income statement.

Balance Sheet May 31 June 30 May 31 June 30
Assets: Liabilities and Owners’ Equity:
Cash $ 3,200 $ 1,375 Accounts payable $ 2,300 $ 2,300
Accounts receivable 5,700 5,900 Wages payable 1,900 1,400
Equipment 26,300 26,300 Notes payable 48,600 40,100
Building 115,000 115,000 Owners’ investment 43,000 47,000
Accumulated depreciation (28,000) (28,500) Retained earnings 26,400 29,275
Total $122,200 $120,075 $122,200 $120,075

Income Statement for June
Service revenues $ 7,300
Rent expense (1,300)
Wages expense (1,900)
Supplies expense (400)
Depreciation expense (500)
Interest expense (325)
Net income $2,875

Required From the financial statements presented, identify and record the transactions that
occurred during June. Use the spreadsheet format shown on the next page to record the trans-
actions. One transaction is shown as an example.
CHAPTER F6: Full and Fair Reporting
252 Full and Fair Reporting

Other Contributed Retained
Accounts Cash Assets Capital Earnings
Beginning Amounts 3,200 119,000 52,800 43,000 26,400
1 Cash 7,100
Accounts Receivable 200
Service Revenues 7,300

Management Discussion and Analysis
Obj. 4 The letter to the shareholders from Douglas N. Daft, Chairman, Board of Directors, and Chief
Executive Officer of Coca-Cola is provided on the text’s Web site and on the student CD that
accompanies this text. This letter appeared in the company’s 2001 annual report.

Required Read Chairman Daft’s letter and comment on the following:
A. To whom is the letter addressed?
B. What is the overall tone of the letter?
C. What time periods are addressed in the letter? (past, present, future)
D. What are the accomplishments mentioned in the letter?

Management Discussion and Analysis
Obj. 4 The letter to the shareholders from Douglas N. Daft, Chairman, Board of Directors, and Chief
Executive Officer of Coca-Cola is provided on the text’s Web site and on the student CD that
accompanies this text. This letter appeared in the company’s 2001 annual report.

Required Read Chairman Daft’s letter and comment on the following:
A. Which segments of the market represent the largest growth for Coca-Cola?
B. Comment on the level of detail contained in the letter. For example, are the bulleted
points shown on the last page of the letter detailed, or general in nature?
C. The second paragraph of the chairman’s letter makes reference to the nature of the
competitive environment. What is the tone of the second paragraph? What is Chair-
man Daft telling the reader?

Earnings Restatement and Stock Prices
Objs. 4, 5 In April, 2001, the management of U.S. Aggregates, Inc., a producer of aggregates made of a
combination of crushed stone, sand, and gravel, announced that the company would be re-
stating its earnings for the first three quarters of 2000. After the announcement, the company’s
stock price per share dropped more than 75% from its high for the period affected by the
company’s restatement of earnings.
Financial irregularities of other companies have been announced in recent years. In
late May, 2001, trading of the stock of U.S. Wireless Corporation was halted on the Nas-
daq Stock Exchange when its share price dropped significantly. This sudden drop occurred
when the company announced irregularities had been uncovered and it had replaced its
chairman and chief executive. The price went from a high of $24.50 in March, 2000 to a
low of $2.91.

A. Did these companies practice full and fair disclosure? Why did the stock price of U.S.
Aggregates and U.S. Wireless Corporation fall when investors learned that the company
had produced financial information that was incorrect?
B. Do you believe “financial shenanigans” by management is an ethical issue? Explain.
F252 SECTION F1: The Accounting Information System
Full and Fair Reporting

P6-16 Evaluating Internal Control Procedures
Obj. 5
Consider each of the following situations.

A. Sales clerks in a retail store are assigned to a specific cash register. They are given a cash
drawer containing $100 in change at the beginning of their shifts. They are required to
record the amount of each purchase in the cash register. The cash register records an
identification and price for each item purchased. Cash payments are collected from
customers and placed in the cash drawer. A copy of the cash register sales slip is given
to the customer. At the end of each shift, the employee takes the cash drawer and cash
register tape to a supervisor who counts the cash, verifies the sales, and signs an ap-
proval form. The sales clerk also signs the form that identifies the amount of cash and
amount of sales for the day.
B. A ticket seller at a movie theater is issued a cash drawer with $100 in change and a roll
of prenumbered tickets when the theater opens each day. The seller collects cash from
customers and issues the tickets. Each customer hands a ticket to a ticket taker who
tears the ticket in half and gives half back to the customer. At the end of the day, the
ticket seller returns the cash drawer and tickets to a supervisor.

Required For each situation, discuss why the procedures are used and how they provide ef-
fective internal control.

Evaluating Internal Control
Obj. 5 The Spring Valley Church is a small congregation with about 50 members. The church is
financed by member donations. Most of these donations are collected during the Sunday
morning service. Many of the donations are in cash. Other donations are by checks made
payable to the church. Harvey Plump has served as treasurer for the church since be-
coming a member a few years ago. The church accepted Harvey’s offer to serve as trea-
surer as an indication of his interest in being active in the church. Harvey listed several
previous experiences with financial matters on his resume as qualifying him for the po-
Once donations are collected each week, Harvey takes the money to the church office
where he counts it. He makes out a deposit slip and deposits the money in the church’s ac-
count at a local bank. He records the deposit in the church’s check register. He writes checks
to pay the church’s expenses. In some cases, he writes small checks to himself as reimburse-
ment for incidental expenses he pays for the church. He opens bank statements received by
the church each month and reconciles them with the church’s check register. Harvey prepares
a monthly statement of cash received and disbursed that is distributed to members of the con-
The church always seems to be lacking sufficient financial resources. A recent meeting
was held to discuss expansion of the church’s building, but current finances seem to make ex-
pansion impossible. Some members don’t understand why the church’s financial condition
appears to be so bleak, since they believe they are making large donations.
The church has asked you to help them evaluate their financial situation.

Required Evaluate the internal control problems of the Spring Valley Church. What expla-
nation can be provided for the church’s financial problems?

Internal Controls for Cash Sales
Obj. 5 You and a friend have finished your Christmas shopping at the mall and have decided to re-
lax and have lunch in a small restaurant in the food court. After selecting your entrees, you
notice a sign on the cash register that reads “If you do not receive a receipt, your meal is free.”
Your friend is puzzled by the sign and asks you the purpose of giving away a free meal if a
cashier forgets to give you a receipt.

Required Is the policy of providing a free meal if a receipt is not given a form of internal
control? Why or why not?
CHAPTER F6: Full and Fair Reporting
254 Full and Fair Reporting

P6-19 Multiple-Choice Overview of the Chapter
1. To protect its assets and accounting information, a company should
a. give one person sole responsibility for the accounting system.
b. control access to its networks and databases.
c. permit access to accounting records only by top managers.
d. hire only employees with college degrees.
2. The purpose of an auditors’ report is to show that
a. a CPA has prepared the company’s financial statements.
b. all of the company’s transactions have been inspected for accuracy.
c. an independent party believes that the financial statements do not contain any sig-
nificant errors.
d. the company is healthy, profitable, and likely to remain that way into the foresee-
able future.
3. An organization’s plan and the procedures used to safeguard assets ensure accurate in-
formation, promote efficiency, and encourage adherence to policies is its
a. internal control system.
b. cost accounting system.
c. financial accounting system.
d. management information system.
4. An auditors’ report made by an independent accounting firm
a. is addressed to a company’s managers.
b. must contain only three paragraphs.
c. is dated at the balance sheet date of the audited financial statements.
d. identifies the responsibilities of the auditor.
5. The Securities and Exchange Act of 1934 established the
a. FTC.
b. SEC.
c. FASB.
d. GAO.
6. A 10-K report is
a. a quarterly financial report for the SEC.
b. a registration for a new stock issue with the SEC.
c. an annual financial report for the SEC.
d. a report of change in auditors for the SEC.
7. Financial accounting standards for businesses currently are established in the United
States primarily by the
a. Federal Accounting Standards Board.
b. Financial Accounting Standards Board.
c. Securities and Exchange Commission.
d. Accounting Principles Board.
8. All of the following are qualitative characteristics of financial reporting except
a. relevance.
b. reliability.
c. representational faithfulness.
d. conservatism.
9. The Governmental Accounting Standards Board (GASB) sets standards for
a. not-for-profit organizations.
b. state and local governments.
c. state and federal governments.
d. the federal government.
10. The FASB releases the following document(s) as part of creating new standards.
a. discussion memorandum
b. exposure draft
c. b only
d. a and b
F254 SECTION F1: The Accounting Information System
Full and Fair Reporting

Examining an Audit Report
Obj. 4 Examine the auditors’ report provided as part of the 2002 annual report of Nike, Inc., and
answer the following questions.

To the Board of Directors and Shareholders of Nike, Inc.
In our opinion, the consolidated financial statements listed in the index appearing under
Item 14(A)(1) on page 55 present fairly, in all material respects, the financial position of Nike,
Inc. and its subsidiaries at May 31, 2002 and 2001, and the results of their operations and their
cash flows for each of the three years in the period ended May 31, 2002 in conformity with
accounting principles generally accepted in the United States of America. In addition, in our
opinion, the financial statement schedule listed in the index appearing under Item 14(A)(2)
on page 55 presents fairly, in all material respects, the information set forth therein when read
in conjunction with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company’s management; our
responsibility is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America, which require that we
plan and perform the audit to obtain reasonable assurance about whether the financial state-
ments are free of material misstatement. An audit includes examining, on a test basis, evi-
dence supporting the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audits provide a reasonable ba-
sis for our opinion.
As discussed in Note 1 to the consolidated financial statements, effective June 1, 2001,
the Company changed its method of accounting for derivative instruments in accordance with
Statement of Financial Accounting Standards No. 133 Accounting for Derivative Instruments
and Hedging Activities and Statement of Financial Accounting Standards No. 138, Account-
ing for Certain Derivative Instruments and Certain Hedging Activities.
Portland, Oregon
June 27, 2002

A. Who was Nike’s external auditor? What date did the auditor complete its audit work?
B. What was the auditor’s responsibility with respect to the company’s financial state-
ments? What was the responsibility of management?
C. What kind of opinion did Nike’s auditors issue? Why is this opinion important to the
D. How does PricewaterhouseCoopers’ audit opinion differ from the Krispy Kreme’s opin-
ion shown in this chapter?

General Mills, Inc., Management Responsibilities and Audit Opinion
Objs. 4, 5 The General Mills 2002 Annual Report is reproduced in Appendix B at the end of the text.

Required Answer the following questions about the General Mills Report of Management
Responsibilities and the Report of the Independent Public Accountants.
A. Who is responsible for the accounting numbers in the annual report?
B. What safeguards are in place to ensure the accuracy of the reported numbers?
C. Does the independent accountant state that the reported amounts are correct? What
does the CPA assure?
D. Why does General Mills hire a CPA to audit the financial statements?
How do we implement a computerized accounting

A s Mom’s Cookie Company has grown and become more complex, a simple ac-
counting system kept with pencil and paper has become increasingly inadequate.
Large numbers of transactions, more customers and products, and more complex busi-
ness activities mean that the company is likely to benefit from a computerized accounting
system. Maria and Stan are now realizing that their manual system needs to be replaced by
a computerized one.

How does a computerized accounting system differ from a manual system? What issues must a company
consider with regard to a computerized system? Maria and Stan discuss these questions with Ellen, their

Recording transactions and preparing financial reports with our current accounting system is labor
intensive and a bit slow. It takes us several hours a week to record transactions and prepare reports.
Sometimes we are several days or even weeks behind in updating our accounts. Should we be looking at
a computerized accounting system?
Yes, there are a number of good systems on the market that are not expensive and that will meet your
How different are these systems from what we have been using? Will a computerized system be difficult
for us to learn?
No, computerized systems use similar concepts to the manual approach you have been using. The
computer will provide a means for you to record data. The main advantage of a computer system is that
the system can do much of the work for you. Once data are recorded, the system automatically updates
account balances and prepares financial statements.
That sounds easy. Are there problems with computer systems that we will need to avoid?
You need to make sure the system is secure and that you have good backup procedures to protect your
data in case the system fails. Let’s look at some key issues that are important for understanding these
F256 SECTION F1: The Accounting Information System
258 Computerized Accounting Systems


Once you have completed this chapter, you 3 Describe how data are processed in various
should be able to: modules of an accounting system.
1 Identify the primary components of a 4 Explain the use of relational databases to
computerized accounting system. perform accounting functions.
2 Describe the components of a 5 Describe how a database system can be
computerized accounting system used to used to create a simple accounting system.
process data and produce useful

Many of the mechanical functions of an accounting system—posting to ledger accounts,
updating account balances, and preparing schedules and reports from account bal-
Identify the primary ances—can be automated. Computers are capable of processing data through a series
components of a of steps to produce standard outputs such as reports. Consequently, certain account-
computerized accounting ing functions are automated in most companies.
system. Computerized accounting systems, even those for small companies like Mom’s
Cookie Company, are composed of modules. Each module provides a mechanism for
recording and reporting specific types of business activities. Common modules are those
associated with the most common business activities: sales and customer relations, pur-
chasing and inventory management, production (for manufacturing companies), hu-
man resources, asset management, and financial management. A separate module is
usually responsible for the general ledger and external financial reporting (GAAP-based
financial statements) functions. Exhibit 1 illustrates an accounting system as a set of
component modules.
All of the components in the system are linked so they share data with each other.
Some businesses use one software application that integrates all of these functions. Sys-
tems that integrate most of the business information functions as a basis for man-
agement decisions are referred to as enterprise resource planning (ERP) systems. Many
large companies have implemented these systems from ERP developers such as SAP®,
Peoplesoft®, and Oracle® Financials. Other companies may rely on software from dif-
ferent vendors for different components of their systems. Many smaller companies rely
on software that handles most of the company’s accounting functions. These systems
lack the capabilities of larger systems but provide for most of the common accounting
http://ingram. and financial reporting functions small businesses need. Thus, computerized account-
swlearning.com ing systems can be small basic systems such as QuickBooks®, MAS, Peachtree®, or Sim-
ply Accounting®; middle market systems such as Microsoft® Great Plains or ACCPAC®;
Learn more about these
ERP developers and or large-scale systems such as SAP and Oracle Financials. Regardless of size, each of
other computerized ac- these systems is made up of component modules.
counting systems. Each component in the information system has a particular role. This role depends
on the stakeholders who interact with the component.
• The sales module receives sales order data from customers and maintains accounts
receivable information.
• The purchases and inventory management module provides purchase order data
to vendors. Vendors are those who supply specific products to a company. This
module maintains accounts payable and inventory information.
• The human resources module maintains data about employees, including hours
worked and wage rates. It is used for preparing payroll and payroll tax informa-
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

Exhibit 1 Components of an Accounting Information System

Sales and
and Inventory



General Ledger
Asset Financial
Management Management

Creditors and

• The production module tracks the flow of costs through the manufacturing process.
• The asset management module identifies long-term asset costs, their expected use-
ful lives, and where these assets are located in a company.
• The financial management module keeps track of debt, repayment schedules, in-
terest rates, and shareholder information.
• The general ledger/financial reporting module provides information for use by
external stakeholders, including shareholders and government regulators.
The accounting process in a computerized system involves all modules. Each mod-
ule maintains data for specific entities and activities. The computerized system records
financial data about individual items of importance to a company in subsidiary ac-
counts. These accounts include transactions for individual customers, suppliers, or
products. Thus, when Mom’s Cookie Company sells goods to a customer on credit, it
uses the system to record customer and product identification data so that it can de-
termine what was sold and to whom it was sold. A separate subsidiary account is main-
tained for each customer to keep track of that customer’s sales and payments. Records
for all subsidiary accounts of a particular type are maintained in a subsidiary ledger.
A subsidiary accounts receivable ledger, for example, would consist of all the individ-
ual customer accounts, with data about purchases and payments for each customer. In
a computerized accounting system, a subsidiary ledger is a file that provides records for
a particular type of entity or activity. Thus, a customer file would contain data for the
amount owed by that customer and when payment was due.
Control accounts are summary accounts that maintain totals for all subsidiary
accounts of a particular type. For example, the balance of the accounts receivable con-
trol account is the sum of the balances of all accounts receivable subsidiary accounts
for the company’s customers. The same is true for inventory accounts for products a
company sells and for accounts payable accounts for amounts owed to vendors.
A company maintains subsidiary accounts for management purposes. For exam-
ple, Mom’s Cookie Company must be able to respond when a specific customer inquires
F258 SECTION F1: The Accounting Information System
260 Computerized Accounting Systems

about his current account balance or wishes to dispute a billing statement. A company
reports control account balances in financial statements to external users and in reports
for higher level management decisions. Accordingly, account balances for both sub-
sidiary and control accounts are updated on a regular basis. Control account balances
are maintained in a company’s general ledger. Records for each control account are
maintained in a company’s general ledger. The general ledger/financial reporting mod-
ule keeps track of each control account and the balances in each account. The general
ledger module uses these data to prepare general purpose financial statements for a
We examine modules in greater detail later in the chapter. First, we consider the
processing of data in computerized systems.

Each component of an information system receives data, stores the data, processes the
data to create useful information, and reports that information, as indicated in Exhibit 2.
Describe the components Input originates in business activities and can come from a variety of sources. It
of a computerized may originate as paper documents, such as sales orders prepared by or for customers
accounting system used to or sales receipts indicating the sale of goods to customers. Data must be entered into
process data and produce the computer system. Data entry may take place when clerical personnel transfer data
useful information.
by typing, or keying, information from paper documents to computer files. Increas-
ingly, data are entered directly into computer systems. For example, many retail stores
use scanners to read bar code data from products. The bar codes are linked to the com-
pany’s inventory data so that sales prices, costs, and inventory amounts are recorded
without data having to be keyed.
Many companies provide web-based input systems that permit customers to place
http://ingram. orders directly using the Internet. Companies like Amazon.com, Southwest Airlines,
and Banana Republic provide for online shopping, reservations, and sales. Data en-
tered by customers updates company order and inventory files. Customers also can re-
Visit the online shop-
ping sites of Amazon. trieve information about their orders from these systems.
com, Southwest Airlines,
and Banana Republic.
Exhibit 2 Data Processing in a Computerized Information System

Input Output

Application Software

Database Management

CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

Exhibit 3 provides a web page from Starbucks’ web site. It provides options for on-
line shopping such as selection of products and shipping information. Other web pages
provide for payment using a credit card. These pages are connected to Starbucks’ accounting
system so that sales, inventory, and customer information can be updated automatically.

Exhibit 3
Example of Web-Based

Reprinted with permission of Starbucks Coffee Company © 2002. All rights reserved

Using computer networks, such as the Internet, to make customer sales is re-
ferred to as E-business. Some E-business systems, like Starbucks’, provide a means for
a company to receive sales orders from customers. These systems are referred to as busi-
ness-to-customer, or b2c, systems. Other systems permit companies to order goods
from vendors and to track order information. These systems are referred to as busi-
ness-to-business, or b2b, systems. In either system, customers do most of their own
data entry. These data become the basis for recording sales, accounts receivable, cost of
goods sold, and related transactions. Thus, many routine transactions are recorded and
processed automatically without the seller having to take special steps.
Application software includes the computer programs that permit data to be
recorded and processed. If a customer enters an order using a web browser, application
software is needed to collect that data, to record it in the company’s files, and to process
the data to ensure that the appropriate actions occur. For example, a customer order must
be recorded, the shipping department must be notified of the order so the goods can be
shipped, a bill may need to be prepared and sent to the customer, and sales and accounts
receivable accounts need to be updated. Application software automates these functions.
Databases store data used by various components of a system. Data are transferred
by application software to databases. A database is a set of computerized files in which
company data are stored in a form that facilitates retrieval and updating of the data.
A database management system controls database functions to ensure data are
recorded properly and are accessed only by authorized users.
Computerized information systems have many internal controls. These controls
are important for protecting data and for helping to prevent errors. Controls, such as
F260 SECTION F1: The Accounting Information System
262 Computerized Accounting Systems

passwords, ensure that data are not accessed or modified by unauthorized personnel.
Controls built into database management systems prevent more than one user from
updating a particular record at the same time and make sure that all appropriate parts
of a database are updated when a transaction is recorded.
Other controls require management action. For example, databases must be backed
up on a regular basis so data will not be lost if a computer system fails or is destroyed.
A company also must have a plan in case its computer system is destroyed because of
natural disaster, sabotage, or terrorism. Failure to provide backup systems can result in
a company being unable to do business if its primary system is unusable.
Output from information systems often is in the form of reports. These reports
may contain prescribed information and may be prepared automatically by a system.
They may be print reports or electronic documents that are sent to users. Many out-
put reports can be modified and retrieved as needed by users. For example, managers
at Mom’s Cookie Company need to know which customer accounts are overdue by
more than 30 days. They need a report that gives them an up-to-date listing of grocery
stores that are late in paying their accounts. Other managers need to know how much
of each type of cookie the company sold in the last month. Database systems are use-
ful because they allow users to query the database to obtain current information.
Regardless of which of the modules in a company’s accounting system is involved,
data flow through the system from inputs to outputs. How the data are processed de-
pends on the module. Data flows are initiated by business activities, but they also stim-
ulate these activities. For example, a customer order creates data that are processed by
the system. Also, data about the order result in goods being shipped to the customer.
Thus, business activities create data that are processed to create additional business ac-
Computerized systems rely on networks for processing data. A computer network is
a set of hardware devices that are linked so they can exchange data among themselves
using software. Exhibit 4 illustrates a computer network. Input devices, such as scan-
ners, and client workstations allow data input as well as data access. A client is a com-
puter or other network device that uses software to request services from other software.

Exhibit 4
A Computer Network


Server Database


Web Server Firewall

Customers Internet
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

The services are provided by server software that resides on another computer, referred
to as a server. Networks involve the cables that connect the clients and servers and the
hardware and software needed to make the networks function properly. Most networks
are client-server networks because they provide for the exchange of data between clients
and servers.
Application software usually resides on one or more application servers on the
network. Application servers are connected to database servers, which store and man-
age data. Companies engaged in E-business or that permit their employees to connect
to their network from locations outside of the business, often use web servers to pro-
vide the software needed to interact across the Internet. The Internet provides a net-
work so that almost any computer can connect to a company to do business.
Networks pose security problems, especially when they are connected to the Inter-
net. A firewall usually is special software running on a computer that makes it difficult
for unauthorized users to gain access to a company’s internal network. Data must pass
through the firewall, where they are examined and filtered to determine whether they
should be passed to the internal network. Firewalls can be placed at many locations in
a network. Typically they are placed between devices that provide services to external
users and the internal network to prevent unauthorized access to data and devices in-
side the firewall.
The next section examines various modules in a company’s accounting system.

1 SELF-STUDY PROBLEM Lavender’s is a plant nursery that supplies specialty plants to other
nurseries around the country. It also sells plants to customers
from a retail store.

Required Describe the components of a computer network that Lavender’s might use
to run its business. Explain the purpose of each component.

The following section examines each of several primary modules in an accounting sys-
tem. Each module obtains, processes, and reports information for a particular type of
Describe how data are business activity.
processed in various
modules of an accounting
The Sales Module

Accounting systems are designed to meet information needs associated with business
activities. These needs vary from company to company. For example, a retail company
that sells goods directly to customers for cash relies primarily on point-of-sales systems
that provide for collecting data about the goods that are sold and the amount received
from customers. A company like McDonalds does not need to maintain data about its
customers, for example. However, a company that sells goods using an order system,
like Amazon.com, General Mills, or Southwest Airlines, must maintain customer data


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