. 12
( 25)


that identifies customers, addresses, billing information, and, perhaps, shipping infor-
Exhibit 5 illustrates a sales and customer relations module for a company that re-
ceives orders from customers and sells goods on credit. To illustrate, Mom™s Cookie
Company permits its commercial customers, such as grocery stores, to submit orders by
phone or by mail. When Fair-Price Foods submits a sales order, that order is received
by the sales division at Mom™s Cookie Company. The sales division checks to make sure
the product is available. Also, the sales division checks with the credit department to
make sure Fair-Price Foods has not exceeded its credit limit and that its payments are
not overdue. If the sale is approved, the sales division notifies the shipping division at
F262 SECTION F1: The Accounting Information System
264 Computerized Accounting Systems

Exhibit 5
A Sales Processing sales order
Sales Customer files

Sales files

Ledger files

Shipping Inventory files

Mom™s Cookie Company, which ships the cookies to the customer. The sales division
also notifies the accounting department of the order. Accounting updates the customer
file for the amount the customer owes. The transaction is recorded to sales revenue and
accounts receivable. The general ledger accounts are posted either at the time the trans-
action is recorded or on a periodic basis. Inventory files are updated for the goods shipped
to the customer. Accounting sends an invoice to the customer for the amount of the
sale. The invoice notifies Fair-Price Foods of the amount owed and requests payment.
When Fair-Price Foods pays for the order, the accounting department updates the cus-
tomer™s account and accounts receivable in the general ledger. The cash is transferred to
a bank.
Good internal control requires that the personnel who account for the cash should
not also have physical access to the cash. Therefore, these functions should be separated
within the accounting department.
How much human intervention is needed in the processing of these data depends
on the company and the sophistication of its computer systems. In many companies,
the computer system handles most of these activities.
Sales, accounting, and shipping functions all are sources of data in the sales mod-
ule. In addition, these functions also receive information from the system. An impor-
tant part of this system is its ability to provide information to decision makers. The
database files provide up-to-date data about sales activities. The sales department re-
trieve data about particular customers, such as what they purchased and how much
they have purchased. These data guide decisions about advertising and promotion cam-
paigns and about sales bonuses and commissions. Purchasing and production use this
information to determine which products to purchase or produce and the amounts
needed. The profitability of products and profits earned from sales to certain customers
may help a company determine its strategy for which products or types of customers
to emphasize. Customers who do not pay their accounts on a timely basis may be flagged
to prevent future sales. A company can also use these data to evaluate performance. For
example, a company may monitor how long it takes to process orders and ship goods.
Unnecessary delays may help explain decreased sales or dissatisfied customers.
Accounting for transactions is an important part of each systems module. The sales
department notifies accounting of a customer order. Shipping notifies accounting of
goods shipped to customers. Accounting compares data from sales and shipping and
bills the customer. Accounts receivable and sales revenue transactions are recorded
at the time goods are shipped to customers. Cash and accounts receivable transac-
tions are recorded when cash is received. These transactions update the general ledger
account balances in the General Ledger files. However, they are a relatively small part
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

of the overall data processing that occurs in the sales module. A considerable amount
of data are collected and processed to keep track of customers, sales, shipments, in-
ventory, receivables, and cash flow.

The Purchasing and Inventory Management Module
The purchasing and inventory management functions are responsible for the acquisi-
tion of merchandise and supplies. In a manufacturing company, these functions indi-
cate when to acquire materials that are used in the products the company manufactures.
Inventory management involves keeping track of the amounts and locations of inven-
tories and making sure these inventories are available when needed.
Exhibit 6 illustrates the purchasing and inventory management module. Purchas-
ing is responsible for placing orders with vendors when additional merchandise or ma-
terials are needed. Vendor files identify approved vendors for each type of merchandise
or material. Mom™s Cookie Company purchases cookies from several bakeries. As ad-
ditional cookies are needed to sell to grocery stores, orders are placed with the bakeries.
Vendor files identify the names, locations, and contacts for each vendor. Also, they keep
track of amounts owed to each vendor and when payments are due. Inventory files
identify each type of cookie and the number of cases Mom™s Cookie Company has avail-
able for sale. When inventory levels fall below a predetermined minimum, the pur-
chasing department contacts a vendor and orders additional cookies. The receiving
department receives cookies from the bakeries. The vendor sends a bill to the accounting
department. Accounting compares the bill with information from the receiving de-
partment to verify that the goods were received. Once the billing information is veri-
fied, the vendor records are updated. Accounting also uses information from the
receiving department to update inventory records to show the number of cases of each
type of cookie available for sale.

Exhibit 6 purchase
A Purchases and order
Purchasing Vendor files
Inventory Management

cash Accounting
Ledger files

Receiving Inventory files

When accounts payable become due to vendors, cash is transferred to the vendors
in the form of checks or electronic transfers to the vendor bank accounts. Accounts
payable and cash accounts are updated for these transfers.
The system permits appropriate personnel to determine the amount of each in-
ventory item available, the cost of these items, and amounts owed to each vendor. In
addition, the efficiency of vendors in responding to orders can be determined. Thus,
the purchasing department may be interested in which vendors respond promptly and
provide the best service in response to a company™s orders.
Many vendors now permit their customers to place orders online. The purchaser
can identify the items to be purchased and the cost of these items and submit an order
directly to the vendor™s computer system. The customer may also be able to connect to
F264 SECTION F1: The Accounting Information System
266 Computerized Accounting Systems

the vendor™s system to determine product availability and when goods are expected to
be shipped.
The interaction of a company and its suppliers is known as supply-chain man-
agement. Companies reduce purchasing and inventory costs by developing relation-
ships with vendors to supply needed products promptly and efficiently. Many
companies rely on close relationships with suppliers to make sure materials and mer-
chandise are available when they are needed. If suppliers are reliable, the purchasing
company can place orders and receive goods as they are needed rather than having
to maintain large amounts of inventory. In addition, companies depend on their sup-
pliers to provide inventory of the type and quality they need. Companies also work
with suppliers to make sure they are getting the best deal possible on the goods they
If Mom™s Cookie Company cannot get the cookies it needs from bakeries, if the
quality of the cookies is not satisfactory, or if the costs are too high, it will not meet the
needs of its customers.

The Human Resources Module
The human resources function in a business is responsible for hiring and training em-
ployees. The data needed to account for employee activities involve employees™ hours
and their wages or salaries. How these data are obtained and processed depends on the
type of company and the type of work employees perform.
Exhibit 7 illustrates the processing of employee wages for a manufacturing com-
pany, such as Parma™s Bakery, one of Mom™s Cookie Company™s suppliers. Employees™
hours are collected from time sheets or are entered automatically as employees log into
computer systems to obtain data and perform tasks. The wage rate data are maintained
by the personnel department. Accounting receives time data from the production di-
vision and wage rate information from personnel to determine how much each em-
ployee has earned each pay period.

Exhibit 7 Time
A Human Resources worked Production

Ledger files
Cash and
payroll tax

Governments Employee

Wage data are important for several activities. Amounts earned by and owed to
each employee are in employee files. These data are used to process payroll informa-
tion and to prepare paychecks or to transfer cash to employee bank accounts. Payroll
taxes, such as income taxes, and benefits, such as retirement and health insurance, also
usually are tied to amounts earned by employees. A company must keep track of taxes
and other amounts associated with wages and provide information about these amounts
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

to governments and other organizations. Payments also must be made to these orga-
nizations for payroll taxes and benefits.
Wage information also is important for determining production costs. Labor costs
become part of the cost of manufacturing, as examined in the discussion of the pro-
duction module in the next section. Amounts paid to employees and governments af-
fect wages and taxes payable accounts and cash in a company™s general ledger accounts.

The Production Module
Manufacturing companies carry out many complex activities and transactions. These
companies may produce many different products, and each product may require nu-
merous types of materials and processing activities. Many costs have to be recorded and
many events have to be tracked by a manufacturing company™s information system.
Exhibit 8 illustrates basic components of a production module. The manufactur-
ing process usually responds to the actual or expected demand for a company™s prod-
ucts. Sales orders or forecasts are inputs for the production planning and scheduling
process. Planning and scheduling functions determine which products, how much of
each, and when various products will be produced.

Exhibit 8 Orders/
A Production Module forecast
Manufacturing Inventory files

Employee files
Ledger files

Asset files

A special accounting function, known as cost accounting, keeps track of the costs
of resources used in the manufacturing process. Materials, labor, and the costs of other
resources used in producing goods must be identified and tracked throughout the man-
ufacturing process. Materials and supplies are obtained from stores (or the manufac-
turers™ storage facilities) and placed into production. The costs of these materials must
be identified in association with particular jobs or goods that are being produced. The
wages earned by employees who work on these jobs or goods also must be identified.
Other costs are associated with plant assets used in the production process, including
utilities, insurance, and other resources used during a production period. Once goods
are completed, they are shipped to customers or transferred to warehouses for storage
until they are shipped.
Cost accounting identifies and records these costs. They are used to determine the
costs of goods produced during a period or the cost of completing a particular order.
These data become cost of goods sold once goods are completed and sold to customers.
For example, Parma™s Bakery keeps track of all the ingredients used in preparing an or-
der for Mom™s Cookie Company. Also, it keeps track of the labor costs associated with
producing the cookies. These costs, along with other production costs, are used to
F266 SECTION F1: The Accounting Information System
268 Computerized Accounting Systems

identify Parma™s cost for the goods prepared for Mom™s Cookie Company. These costs
are important for Parma to make sure it has earned a profit from the order.
Each module in an accounting system is responsible for data associated with cer-
tain business activities. As noted earlier, each module collects, records, and processes
data and provides information to decision makers. The next section considers how a
database system functions to provide these information services.

2 SELF-STUDY PROBLEM Suppose you were in charge of production at Parma™s Bakery.

Required What actions would you perform that would require you to interact with
the company™s computer system?

Most computerized accounting systems are constructed as relational databases. A rela-
tional database is a set of related files that are linked so that files can be updated and
information can be retrieved from the files efficiently.
Explain the use of
relational databases to A relational database stores data in tables. A table is a file that contains data rep-
perform accounting resented as rows and columns. Each column identifies a particular attribute of the en-
functions. tity or process described in the table. Each attribute in the table is referred to as a field.
A customer table would include customer name and address attributes, for example.
Each row in the table contains a record of data for a particular entity. Rows in a cus-
tomer table would contain data for each customer, for example. Separate tables are used
for specific types of entities (customers and products) and processes (sales orders and
shipping). Each table contains one or more primary keys that uniquely identifies the
entities or processes recorded in the rows of the table. These primary keys are used to
connect the tables into relationships. The primary key in one table connects to the pri-
mary key or a foreign key in another table. A foreign key is a field that is a primary key
in a different table.
Exhibit 9 illustrates the tables and relationships in a database. The boxes represent
tables, identified by their captions at the top. Fields stored in each table are listed in the
boxes. Fields in bold are primary keys. Lines connect the primary and foreign keys that
form the relationships in the database.

Exhibit 9 Tables in a Relational Database

Sale Order
Customer Table Inventory Table
Sales Order Table
Inventory Table
Sales Order Number
Customer ID Inventory ID
Sales Order Number
Inventory ID
Customer Name Description
Sales Order Date
Quantity Ordered
Customer Street Unit Price
Customer ID
Customer City Unit Cost
Customer State Quantity Available
Customer Zip
Customer Phone
Customer E-mail

The relationships permit a change to a field to affect each table containing that
field. For example, when a sales order number is entered into the system, the Sales Or-
der Number field is updated in the Sales Order and Sales Order Inventory tables. The
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

relationships also permit a user to obtain data from more than one table. For instance,
by using a particular sales order number, a user can obtain data from the Sales Order
and Sales Order Inventory tables because these tables are linked by the sales order num-
ber. The sales order number can then be used to identify the customer and the items
the customer has ordered.
Thus, a relational database is a network of information objects that permits effi-
cient storage and retrieval of data. Knowing the relationships in the database, a user
can retrieve any combination of fields to serve a particular decision need.
Individual tables in the database store data about a particular entity or activity. Ex-
hibit 10 provides an example of a simple table. The top row identifies the attributes
stored in the table. The remaining rows are records. The first column of each record
identifies the sales order number that identifies that record. Records are listed sequen-
tially by sales order number, which is the primary key for the table. Other fields iden-
tify other attributes associated with each sales order, such as the date and an identifier
for the customer who placed the order.

Exhibit 10 Sales Order Number Sales Order Date Customer ID
A Table in a Database 04/12/04
SO12473 CU3452
SO12474 CU2490
SO12745 CU2873

Data are entered into a database using forms. Forms are computer screens that
provide templates for entering data. Exhibit 11 provides an illustration of a simple form.
The form provides input areas where data are keyed into the system. Form fields are
linked to attributes in tables in the database. Thus, when a new sales order number is
entered in the form in Exhibit 11, data are added to the sales order table in the com-
pany™s database.

Exhibit 11
Sales Order Number SN001
A Form for Data Entry
Sales Order Date 9/2/04

Customer ID CID001

Name Moore Clothing Co.

Product ID Type Style Quantity On Hand Quantity Ordered
PID01010 Blanket Blue 44 10

Record: of 1

As noted earlier, most data needed by a computerized system may be entered au-
tomatically through scanning devices. Customers enter data in forms when they place
orders using web-based systems. However, most data needed in database systems are
entered by company employees who are responsible for various data entry functions.
Each module of a computerized accounting system consists of tables and forms that
collect and store data for the activities associated with that module. Individual tables
F268 SECTION F1: The Accounting Information System
270 Computerized Accounting Systems

often are part of more than one module. For example, an inventory table may be ac-
cessed by the sales module to determine product availability and price. It may be ac-
cessed by the purchasing module to update it for goods received from vendors.
The following section illustrates a database accounting system that is typical of real
accounting systems, though it uses simple examples with limited transactions and ex-
amines only a small part of a total accounting system. The illustration is designed to
help you see how accounting data are processed in a real system from data entry to
storage and financial reporting.

This section illustrates various components of a computerized accounting system. The
illustration examines the sales module of Mom™s Cookie Company™s accounting sys-
Describe how a database tem. Example transactions are provided for September 2004 to illustrate sales activi-
system can be used to ties: receiving sales orders, shipping goods to customers, updating inventory files,
create a simple invoicing customers, receiving cash, updating accounting records, and producing
accounting system. summary reports.
The electronic file used in this module is a Microsoft® Access database, which can
be found in the CD that accompanies this text or which can be downloaded from
http://ingram.swlearning.com. Directions for use of the software are provided as part
of the description that follows. To use the database, you must have a computer with a
Microsoft® Windows®) operating system and Access 2000 or a more recent version.
Access is application software built around a database system. It is inadequate for
large-scale accounting applications but is useful for illustrating database systems. Un-
like most business systems, all of the software runs on a workstation. Though it can be
configured to run on a network with separate client and server components, it is eas-
ier to use and easier to understand when it is operated from a single computer.

Copying and Opening the Database
It is highly recommended that the database be copied to a hard disk before it is used.
To copy the database, open Windows® Explorer and select the drive where the data-
base is located. Click on MomsCookies.mdb and drag it to a folder. Release the mouse
button, and the database will be copied. It is a good idea to make several copies of the
database under different names (MomsCookies1.mdb, MomsCookies2.mdb, and so
on). If the database is modified or accidentally corrupted, you still have an unmodified
version for use.
Use one of the following options to open the database.
Option 1. Open Access by clicking Start, Programs, Microsoft Access. Once Access
has opened, click File, Open Database. Double-click MomsCookies.mdb in the
folder to which it was copied.
Option 2. Open Windows Explorer. Select the folder in which the database was
copied. Double-click on MomsCookies.mdb.
Database files can become large when they are modified through use. It is a good
idea to compact the database periodically. To compact the database, open it in Access,
click Tools, Database Utilities, Compact Database. The database will be compacted au-
tomatically. Compacting removes unused space in the database. Running a database
from a floppy disk requires frequent compacting.

Database Contents
A database consists of objects. Once you open MomsCookies.mdb database, these ob-
jects appear in various categories: tables, queries, forms, reports, macros, and modules.
Examine these categories. Tables contain the data stored in the system. Queries are short
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

programs that permit a user to obtain data from one or more tables. Forms provide a
means for entering or reading data stored in the database. Reports provide summary in-
formation intended primarily to be printed. Macros are sequences of steps a user per-
forms to complete a particular task. A macro runs a task without the user having to enter
each keystroke separately. Pages provide a means of creating web documents for ac-
cessing a database. Modules are computer programs (written in Visual Basic) to provide
higher level functions in the database. The Mom™s Cookie Company database contains
no macros or modules. Also, pages are not included in this illustration.

Tables are the key to understanding a database. Tables contain the data in the database.
Other objects manipulate these data by adding new data, modifying existing data, delet-
ing data, or retrieving data.
Begin by examining the tblProduct table. Click on the Tables tab in the Database
window. Double-click on tblProduct or click on tblProduct and then click the Open
button. Columns in the table identify categories (also known as fields or attributes) of
data. The Product ID is a code that uniquely identifies each product. Name and Size
describe the products. Unit Price and Unit Cost indicate the selling price and cost per
unit. Quantity on Hand indicates the number of units available for sale. Units for Mom™s
Cookie Company are cases. Each case contains 20 bags of cookies that the grocery store
sells individually. The stores must purchase the cookies in cases rather than as individ-
ual bags of cookies, however. Additional products could be added to the table by en-
tering data in the bottom row. Existing data can be modified by entering the data in
the appropriate cell. For example, if the unit price for PID0201 increased to $35.00, the
new price could be entered in the Unit Price column for this product. Close the table
by clicking the X box in the upper right corner of the table window. Do not click the
X box in the Access window (top right of screen) or you will close the Access program.
If you close Access by mistake, reopen it and the MomsCookies.mdb database.
Next examine the tblCustomer table. This table identifies Mom™s Cookie Company™s
existing customers. Each customer is identified by a Customer ID. The table includes
name and address data to identify where to ship goods and mail invoices. Close the table.
The tblProduct and tblCustomer tables are examples of master files. Master files
contain data that are relatively stable and that may be updated periodically.
You can examine the relationships among all the tables in the database by clicking
on the relationships button in the top row (toolbar) of buttons in the Database win-
dow. (This looks similar to Exhibit 9.) The relationship diagram that appears contains
the tables and identifies the fields in each table. Lines in the diagram link the primary
and foreign keys. Close the relationship window by clicking on the bottom X in the up-
per right corner of the screen.

Entering Transactions
You will have a chance to examine other database objects as you work through the
process of entering transactions and producing information.

Sales Orders
Begin with a sales order. Open the tblSalesOrder table. Each order is identified by a
Sales Order Number. The Order Date and Customer ID also are listed for each order.
(This is similar to Exhibit 10.) The Customer ID connects each sales order to a specific
customer. Close this table and open the tblSOProduct table. This table identifies the
Sales Order Number, Product ID, and Quantity Ordered. This table connects to both
the tblSalesOrder and tblProduct tables. Scroll down the table to the final row. Note
the data for the last sales order. Once a new sales order is entered, new rows will ap-
pear in the tblSalesOrder and tblSOProduct tables. Close the table.
F270 SECTION F1: The Accounting Information System
272 Computerized Accounting Systems

Personnel in the sales department would normally enter sales orders. To enter a
transaction, click on the Forms tab of the Database window. Then open the frmSales-
Order form. Notice that the form identifies the Sales Order Number, Date, and Cus-
tomer ID. (This is similar to Exhibit 11.) It also identifies customer name and address
information and information about the products ordered. You can click on the Record
selector arrow at the bottom of the form window to view existing orders. To enter
a new order, click on the New Record selector arrow at the bottom of the form
window. Two sets of arrows appear near the bottom of the form. Use the bottom set of
arrows to move among the sales orders. Enter a new Sales Order Number, SN010, at the
top of the form. You may wish to press the Caps Lock key when entering transaction
data. Press the Tab key to go to the Sales Order Date box. Type 09/30/04 in the box.
Click on the Customer ID selector arrow to see a list of customers. Click on CID003.
The name of the customer appears on the form as confirmation of the customer™s iden-
tity. Click on the Product ID selector arrow, and click on PID0201. The product Type,
Style, and Quantity on Hand appear on the form. Tab to the Quantity Ordered box and
enter 12. Click on the second Product ID selector arrow, click on PID0202, tab to the
Quantity Ordered box, and enter 9. To save the order, you can click the new record se-
lector arrow at the bottom of the form or close the form window.
To view the data entered for the order, open the tblSalesOrder and tblSOProduct ta-
bles, scroll to the last row, and observe the new data. Close each table after you view it.
You can view a summary of sales orders, including the one just entered, by select-
ing the Reports tab on the Database window and double-clicking on rptSalesOrders. A
report appears listing the orders for September. To see the entire report you may need
to enlarge the window and set the zoom control on the menu bar to 75% 75% .
Sales orders are listed in the report by date. The order you just entered is listed at the
bottom of the report. If you wish, print a copy of the report. Only transactions occur-
ring in September 2004 are included in reports in this tutorial. Close the report when
you have finished examining it.
Reports in the Mom™s Cookie Company database are derived from queries. Queries
obtain data from tables, manipulate these data in some cases to produce new data items,
and store them temporarily. Click on the Queries tab to view the queries. Double-click
on qrySalesOrders and view the data that appear in the rptSalesOrders report. Queries
can be used to present data in table form when a formal report is not needed. Each of
the reports described in this tutorial is associated with a query. Close the query.

Shipping Information
Once an order is received, personnel in the shipping department can review the order
information. Review can take place on screen or from a printed copy of the sales order
report. The shipping department then selects the goods and prepares them for ship-
ment. Also, they update shipping records and prepare a shipping report.
To view shipping data, click on the Tables tab in the Database window and dou-
ble-click on the tblShipping table. The table contains the Sales Order Number, Prod-
uct ID, Date Shipped, and Quantity Shipped for each order shipped. The table also
contains an Inventory Updated field. When a shipment is entered in this table, the Up-
dated field is set to No, indicating that inventory records have not been updated. Ob-
serve that all the fields contain Yes in the tblShipping table, indicating that inventory
records have been updated for all shipments. Close the table.
To enter a shipment, click on the Forms tab in the database window and double-
click on the frmShipping form. This form indicates the Sales Order Number, customer
information, and product information for each shipment. You can review previous en-
tries by clicking on the selection arrow at the very bottom of the Form window .
To enter data for the sales order you just completed, click on the Last Record arrow at
the bottom of the form window . The form will display the Sales Order Number of
the order you just entered, SN010. The customer information also is displayed for this
order. Click on the Product ID selection arrow and click on the product being shipped,
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

PID0201. Press the Tab key and enter 09/30/04 for the shipping date. Press the Tab key
again and enter 12 for quantity shipped. Click on the second Product ID selection ar-
row and repeat the process for the second item ordered (PID0202, 09/30/04, 9). Close
the form to save the data.
You can view a report of shipments by clicking on the Reports tab of the Database
window and double-clicking on rptShipping. You may need to expand the Report win-
dow and set the zoom to 75% to see the entire report. Use the Record selection arrows
at the bottom of the Report window to view each page of the report. To see the most
recent shipment, click on the Last Record selection arrow . A copy of the shipping
report can be printed and enclosed with the goods shipped to the customer. A copy
also may be sent to the billing department, or the shipping data may be viewed elec-
tronically by that department. Close the report.
Open the tblShipping table and scroll to the bottom of the table to view the data.
Observe that the Inventory Updated field contains No for the items just shipped. It is
important for the shipping personnel to update the inventory records so that the quan-
tity of each product available is correct. Quantity available data are contained in the
tblProducts table. Close the tblShipping table and open the tblProducts table. Note the
Quantity on Hand for the products associated with the sales order you entered, PID0201
(29 units) and PID0202 (47 units). Close the table.
To update the inventory records, click on the Queries tab of the Database window
and double-click on the qryUpdateShipments query. If you are asked if you want to
run an update query, click the YES button. A dialog box appears asking for the sales
order number associated with the records to be updated. Enter the number for the ship-
ment, SN010, and click the OK and Yes buttons. The inventory records have now been
updated. Verify the update by opening the tblProducts table and viewing the Quantity
on Hand for PID0201 (29 12 17 units) and PID0202 (47 9 38 units). Also,
if you examine the tblShipping table, you will find that the Inventory Updated field has
been changed to Yes for the last shipment. The change to this field is an important con-
trol. Once inventory quantity has been updated for a particular Sales Order Number,
it cannot be updated again. Close any tables you have open.

Receiving Goods
As goods are shipped, the quantity of goods available for sale decreases. The supply of
goods must be increased periodically. In the case of Mom™s Cookie Company, the in-
crease occurs when goods are received at the warehouse from the supplier™s manufac-
turing division. When goods are received, the receiving department places the goods
in the appropriate location to be retrieved by shipping personnel. In addition, they
update inventory records by completing the frmProductReceipt form. Click on the
Forms tab of the Database window and double-click on frmProductReceipt to open
this form. Review the form contents, then click on the New Record arrow at the
bottom of the form window. Enter the following data in the form: Product Receipt
Number, 10906; Product ID, PID0201; Receipt Date, 9/30/04; and Quantity Received,
25. Close the form.
The data entered in the form update the tblProductReceipt table. Open this table
to see the items received. The Inventory Updated field is set to No for the most recent
acquisition to indicate that the inventory records have not been updated for this re-
ceipt. Close the table.
To update the inventory records, click on the Queries tab of the Database window
and double-click on the qryUpdateReceipts query. If you are asked if you want to run
an update query, click the YES button. Enter the Product Receipt Number for the in-
ventory item you entered in frmProductReceipt, 10906. Click the OK and Yes buttons
and the inventory records are updated. To verify the update, open the tblProduct table
and examine the Quantity On Hand value for PID0201 (17 25 42 units). Close
the table. Open the tblProductReceipt table and confirm that the Inventory Updated
field has changed to Yes. Close the table.
F272 SECTION F1: The Accounting Information System
274 Computerized Accounting Systems

A report of available inventory is provided by rptInventory. Click on the Reports
tab and double-click rptInventory. Each product is listed with quantity and cost data.
The balance of the inventory account is the total cost for all products. Close the report.

Billing Customers
Once a shipment is made, the accounting department prepares a sales invoice to mail
to the customer. The accounting department also creates the accounting transactions
associated with the sale of goods to the customer. These transactions involve recording
Sales and Accounts Receivable for the sales price of the goods shipped. In addition, Cost
of Goods Sold and Inventory are adjusted for the cost of the goods shipped.
To view sales invoice data, click on the Tables tab of the Database window and
double-click on the tblSalesInvoice table. This table contains Sales Invoice Number,
Date, Sales Order Number, and Amount Billed associated with each invoice. Close the
Before preparing an invoice, the accounting department needs to determine the
amount a customer owes. This information is found on the sales order and shipping
reports. The Mom™s Cookie Company database allows users to calculate the amount
associated with each sales order. Click on the Queries tab and double-click on qrySales-
Amount. Each sales order is listed with the amount owed. Close the query.
To prepare a sales invoice, click on the Forms tab of the Database window and
double-click on frmSalesInvoice. You can review previously entered invoice data by
clicking on the selection arrow at the bottom of the form. To enter a new sales invoice,
click on the New Record arrow at the bottom of the form. Enter 10910 for the
sales invoice number, 9/30/04 for the sales invoice date, and SN010 for the sales order
number. Click the Tab key. Customer information appears on the form. Enter Amount
Billed, 765. Do not enter the dollar sign. Close the form to save the data. You can ver-
ify that the data have been saved by clicking on the Tables tab of the Database window
and double-clicking on the tblSalesInvoice table. Scroll down to view the last record in
the table. Close the table.
View or print sales invoices from the rptSalesInvoice report on the Reports tab.
Double-click on the report and scroll through the records to view each sales invoice.
The last entry is the sales invoice you just prepared. Close the report.

Reporting Sales and Income
Once goods are shipped to customers, the accounting system updates Sales and Cost of
Goods Sold. Obtain a list of sales from the rptSalesbyCustomer report. Double-click on
the report. All sales for September are listed for each customer, including the most re-
cent sale to customer CID003. Close the report.
A simple income statement is provided by rptIncomeStatement. The only income
statement accounts included in this tutorial are Sales and Cost of Goods Sold. The sim-
plified income statement lists these accounts, which have been updated for all transac-
tions in September. Close the report.

Cash Receipts and Accounts Receivable
The last step in the revenue cycle is recording cash received from customers. The
rptAccountsReceivable report lists the amounts sold to each customer, the cash received
from these sales, and the amount the customer owes. Double-click on the report to view
this information. Note the amount owed by customer CID001, $3,180. Close the report.
To record a cash receipt, open the frmCashReceipts form in the Forms tab. Use the
Record selection arrow at the bottom of the form to scroll through the cash receipts.
Go to record number 4. Observe that the sales order number and customer informa-
tion appear on the form. Sales invoice number and cash receipts data do not appear
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

because the cash has not been received. When a customer pays an invoice, a check is
mailed to Mom™s Cookie Company along with a copy of the sales invoice (the copy is
known as a remittance advice). The accounting department receives the remittance ad-
vice and records the sales invoice number and amount of cash received. The check is
deposited in a bank account.
To record a cash receipt for SN004, enter the sales invoice number associated with
this sales order, 10904. Enter the cash receipt date, 9/30/04, and enter the cash receipt
amount, 2280. Do not enter a dollar sign or comma. Close the form to update the
The tblCashReceipts table contains data on the amounts paid for each invoice. The
rptAccountsReceivable report has been updated for the amount paid by customer
CID001. Review the table and report to confirm that the cash receipt has been recorded.
Close the table and report. Close the Access program.

Most companies use computerized accounting systems. These systems contain modules
to handle the business activities that are accounted for in the system. Network compo-
nents and database systems in accounting modules capture, store, and process data.

3 SELF-STUDY PROBLEM The accounting system described in the last section of this chap-
ter did not provide separate accounts for sales revenue and ac-
counts receivable. Suppose you wanted to determine the accounts receivable for Mom™s
Cookie Company at the end of September.

Required Describe the steps you would go through to obtain the data necessary to
determine accounts receivable for the company as reported in an accounts receivable


1. Accounting systems contain modules. Each module handles data collection, processing,
and reporting for a particular type of business activity, such as sales or purchasing.

2. Computer systems receives input from data entry sources, use application software to
process the data, and store the data in databases. Database management systems con-
trol database operations as well as access to the database. Application software obtains
data from the database and provides information as output to decision makers.

3. Accounting systems are implemented on computer networks. Client workstations and
input devices, such as scanners, provide input to the system. Application servers, web
servers, and database servers respond to client requests by processing and storing data,
and by making information available to users.

4. The sales module receives customer orders, processes shipments, bills customers, and
maintains data about customer purchases and receivables.

5. The purchasing and inventory management module is responsible for the acquisition of
merchandise, materials, and supplies. It tracks available inventories, processes orders,
and identifies goods received and on hand. It also determines amounts owed to ven-

6. The human resources module maintains employee information, processes payroll, and
monitors amounts owed to employees and to government agencies for payroll taxes.
F274 SECTION F1: The Accounting Information System
276 Computerized Accounting Systems

7. The production module tracks the flow of costs from materials, labor, and other
sources into the production process. It tracks these costs until goods are completed and
shipped to customers. It may also assist managers with scheduling production jobs and
monitoring the availability of materials for use in the production process.

8. Accounting systems usually are implemented as relational database systems. These sys-
tems contain tables that are linked through primary and foreign keys to facilitate the
processing of data. Data are input in electronic forms. Queries allow users to access
data and produce reports for decision makers.


application software (F259) enterprise resource planning (ERP) systems
computer network (F260) (F256)
control accounts (F257) general ledger (F258)
database (F259) relational database (F266)
database management system subsidiary accounts (F257)
(F259) supply-chain management (F264)
E-business (F259) table (F266)

SSP7-1 A client workstation and scanning device might be used to input data from local customers.
A web server would be needed to provide access for web orders. An application server would
provide the software needed to collect and process the data and convert data into reports. A
database server would store data for customer orders, plant inventories, and shipments. A net-
work would connect the servers and the client workstation and scanning device. An Internet
connection would be needed to connect the web server to the Internet.
SSP7-2 To produce a product, such as cookies, you would need data about the materials needed to
produce the product, availability of these materials, and production processes. You would need
to schedule the production to make sure materials, labor, and equipment, such as mixers and
ovens, are available. You would need information about sales orders so you know how much
of each product to produce. Also, you would need to transfer goods from process to process
as they are manufactured, and eventually you would need to transfer completed goods to ship-
ping or to retail outlets. As you engage in these activities, you would need to update the com-
pany™s information system so that the cost of goods produced could be determined.
SSP7-3 To determine accounts receivable, you would need to compare the amount shipped to each
customer with the amount paid by the customer at a particular date. This comparison would
require a query that retrieved data from several tables. The fields involved in this query are
underlined in the following diagram.
The Customer ID would be needed to identify each customer. All sales orders for each
customer would need to be examined, using the Sales Order Number. Each sales order would
be used to identify the product ordered, based on the Product ID, the cost per unit of each
product (Unit Cost), and the Quantity Shipped. The total of unit cost times quantity shipped
would determine the amount of each order for each customer. The Date Shipped field or the
Sales Invoice Date would be used to establish the date of each receivable. The Cash Receipt
Date and Cash Receipt Amount would determine when the customer made a payment. Com-
paring the total of the sales to each customer minus the total of cash received at a particular
date would determine how much the customer owes at that date. A total of amounts owed
for all customers would determine total accounts receivable.
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

tblCustomer tblProduct
1 11
11 Sales Order Number
Customer ID Product ID
Sales Order Number
Product ID
Name Type
Sales Order Date
Quantity Ordered
Address Style
Customer ID
CityState Unit Price
Unit Cost
Quantity On Hand

tblCashReceipts tblProductReceipt
1 1
Sales Order Number
Sales Invoice Number ProductReceiptNumber
Sales Invoice Numbe
Product ID
Cash Receipt Date ProductID
Sales Invoice Date
Date Shipped
Cash Receipt Amount ProductReceiptDate
Sales Order Number
Quantity Shipped QuantityReceived
Inventory Updated Inventory Updated

Thinking Beyond the Question
How do we implement a computerized accounting system?

Computerized accounting systems reduce the labor needed to record account-
ing information and prepare accounting reports. How can computerized sys-
tems also help managers, investors, and other stakeholders with their analysis
and decision making tasks?

Why are integrated business systems more efficient than using individual systems for differ-
ent functions in a business?
Obj. 1

Suppose a company sells to customers on-line. Customers are required to pay for their orders
with credit cards at the time of the order. What primary activities would be required of the
Obj. 3
sales module to process and account for these orders?
Q7-3 The human resources module described in Exhibit 7 is for a manufacturing company. How
would the module differ for a retail or service company?
Obj. 3

Q7-4 What is a computer network? Why are they used by businesses to maintain accounting sys-
Obj. 2

What is the purpose of a database management system?
Obj. 2

Irmo Company™s asset management module lists each piece of equipment the company has
purchased, when it was purchased, its cost, its expected life, and its location in the company.
Obj. 3
Why would the company want this information?
Kreel Company™s financial management module lists each loan the company has outstanding,
when the money was borrowed, the amount borrowed, the interest rate, the dates payments
Obj. 3
were made, and the amounts of these payments. Why is this information important to the
F276 SECTION F1: The Accounting Information System
278 Computerized Accounting Systems

Q7-8 What purposes does a retail company™s purchasing module serve? What accounts and types
of transactions are associated with this module?
Obj. 3

What purposes does a service company™s human resources module serve? What accounts and
types of transactions are associated with this module?
Obj. 3

Q7-10 Street Inc.™s financial management module lists each stockholder™s name, address, the num-
ber of shares owned, and when the stock was purchased. How might the company use this in-
Obj. 3
Q7-11 Why would the sales module of Burger King differ from the sales module of the mail order
clothing company, Lands™ End? What transactions would Lands™ End record as part of its sales
Obj. 3
process that would differ from those of Burger King?
Q7-12 Why is it important for the accounting department of a company to receive data from sales
and shipping? What internal control function is served by this process?
Obj. 3

Q7-13 Why is it important for the accounting department of a company to receive data from pur-
chasing and receiving? What internal control function is served by this process?
Obj. 3

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.
E7-2 Complete each sentence with the appropriate term.
Objs. 1, 2, 3, 4, 5
1. Systems that integrate most of the business information functions are referred to as
2. Financial data about individual items of importance to a company are recorded in
3. Summary accounts that maintain totals for all subsidiary accounts of a particular type
are called _____________.
4. A _____________ is an accounting record of each (control) account and the balance of
each such account.
5. The use of computer networks, such as the Internet, to provide for customer sales is re-
ferred to as _____________.
6. A computer program that permits data to be recorded and processed is one kind of
7. A _____________ is a set of computerized files in which company data are stored in a
form that facilitates retrieval and updating of the data.
8. A _____________ controls database functions to ensure data are recorded properly
and can be accessed only by those authorized to record, update, or retrieve the data.
9. The interaction of a company and its suppliers is known as_____________.
10. A _____________ is a set of related files that are linked so the files can be updated and
information can be retrieved from the files efficiently.
Match each term with the appropriate definition.
Objs. 1, 2, 3, 4, 5
a. application software g. general ledger
b. control accounts h. relational database
c. database management system i. subsidiary accounts
d. database j. supply-chain management
e. E-business
f. enterprise resource planning (ERP) sys-
___ 1. A set of computerized files in which company data are stored in a form that facili-
tates retrieval and updating of the data
___ 2. A set of related files that are linked so the files can be updated and information
can be retrieved from the files efficiently
___ 3. An accounting record of each (control) account and the balance of each such account
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

___ 4. Controls database functions to ensure data are recorded properly and can be ac-
cessed only by those authorized to record, update, or retrieve the data
___ 5. Includes the computer programs that permit data to be recorded and processed
___ 6. Type of account in which financial data about individual items of importance to a
company are recorded
___ 7. Summary accounts that maintain totals for all subsidiary accounts of a particular type
___ 8. Systems that integrate most of the business information functions
___ 9. The interaction of a company and its suppliers
___ 10. Term that refers to the use of computer networks, such as the Internet, to provide
for customer sales
A friend is confused about entries to computerized accounting systems. She says, “I under-
stand that there are both subsidiary accounts and control accounts, but why are the effects of
Obj. 1
individual transactions entered only into the subsidiary accounts? Doesn™t this cause the sub-
sidiary accounts and the control to report different information?” Explain the difference be-
tween a general ledger and a subsidiary ledger and the difference in how the information
contained in each is used.
Lands™ End, Inc., is a large, well-known mail-order retailer. Assume you logged onto its web
site, ordered three pairs of shorts, and paid for them by credit card. Describe the business ac-
Obj. 2
tivities that would occur at Lands™ End, including linkages to the accounting system, in han-
dling your order.
Great Plains Manufacturing recently ordered 100 tons of raw materials including steel, alu-
minum, glass, and various plastics. Today, the goods were received via rail at the company™s
Objs. 2, 3
warehouse. Identify the documents that will be handled today (either by hand or electroni-
cally) and identify the specific and/or control accounts affected by this event.
Modern accounting information systems often are maintained as relational databases. What
is a relational database and what are the advantages of these database systems? Identify parts
Obj. 4
of a relational database and explain the purpose of each part.
Computerized accounting systems create special control problems for an organization. Com-
mon control procedures used by organizations include the following:
Obj. 2
a. Use of passwords to access terminals and programs
b. Limits placed on amounts that the computer will accept for various transactions
c. Backing up of data and programs regularly
d. Separation of design from operation of systems
Explain the purpose of each control procedure.
Howard Company sells woolen goods and maintains its accounting system using a relational
database. To prepare information about sales transactions, the company uses the following ta-
Obj. 4
bles in its database. The fields that appear in each table are in brackets following the table.
• customers [customer ID, name, shipping address, phone number]
• sales orders [sales order number, customer ID, order date, product ID, order quantity]
• inventory [product ID, product name, quantity on hand, unit price]
• customer shipments [sales order number, shipping date]
• sales invoice [sales invoice number, sales order number, invoice date]
• cash receipts [sales invoice number, cash receipt amount, receipt date]
For each of the following events, identify the tables that would be needed to record the event.
1. Received an order from Jones & Sons for 12 blankets on November 3.
2. Shipped the blankets to Jones & Sons and billed the customer on November 6.
3. Received cash from Jones & Sons for the purchase on December 5.
Refer to information provided in E7-9 as you answer the following questions.
Obj. 4
1. If a manager for Howard Company wanted to query the company™s database to obtain
information about customer sales during November, which tables should she use to
obtain the information? Explain why.
2. If the same manager wanted to query the database to obtain information about
amounts owed by customers at the end of November, which tables should she use to
obtain the information? Explain why.
F278 SECTION F1: The Accounting Information System
280 Computerized Accounting Systems

E7-11 Computer networks in many organizations include client software, business management pro-
grams and databases on servers, and connections among the computers running these pro-
Obj. 2
grams. For each of the following activities, identify the portions of the computer system that
would be affected. Explain how the portions are affected.
1. Access to company data is requested
2. Records are updated
3. Data are transferred between a client and a server
4. New data for processing are entered
5. Data being used by another user are required
6. Data to print a report are obtained
One Star Co. recently lost all of its customer and accounts receivable records. An irate cus-
tomer walked into the company™s sales office and took a sledge hammer to the company™s
Obj. 2
computer. The company now has no basis for determining which customers owe it money or
how much they owe. Identify control problems that permitted the loss to occur and controls
that should have been in place to prevent the loss. Why is this an accounting problem?

If your instructor is using Personal Trainer in this course, you may complete online the assign-
PROBLEMS ments identified by .

Purpose of Relational Databases
Obj. 4 Barbury Company sells machine parts to manufacturing companies. Parts usually are pur-
chased to replace worn or broken parts. Most of Barbury™s customers order goods by phone
or through Internet connections from regional sales offices throughout North America. Sales
are made on credit and are shipped immediately to avoid manufacturing delays at customer
plants. Barbury uses a relational database for its accounting system.

Required Explain the purpose of a relational database and why it is useful to a company.
Describe the parts of a relational database and identify specific examples of how these parts
would be used by Barbury to obtain and fill customer orders.

Tables and Forms in Relational Databases
Obj. 4 Exhibit 9 in this chapter provides examples of tables that might appear in a company™s rela-
tional database. Exhibit 11 provides an example of a sales order form.

Required Using these exhibits as examples, explain the purpose of tables and forms in a re-
lational database. Be specific about what the rows and columns in a table represent and how
individual entities are identified in tables. Explain how forms are related to tables.

Computer Networks
Obj. 2 You have just been hired as an account representative for a large financial institution. Your
supervisor shows you to your desk that contains a workstation. She explains that the work-
station is part of a wide-area network connecting all of the bank™s offices through a client-
server system. All of the bank™s data are maintained in databases on servers and are accessed
through a database management system. To obtain account information, you must log on to
the network and use the bank™s account service program on your workstation to retrieve data
from the database.

Required What is the supervisor talking about? Explain the function of each part of the
bank™s computer network. Why do most companies use computer networks for their ac-
counting systems?

Controlling Networks
Obj. 2 Dora Company uses a client-server network for its accounting system. The company™s data-
base servers are kept at a central computer center. Users of the system access the company™s
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

database through workstations on their desks. Data are updated continuously throughout the
day based on sales, production, billing, and other transactions recorded by users. Dora is a
large company and its network connects offices in several states.

Required Identify four threats to the accounting system and accounting data that exist in
Dora™s network system that should be managed through internal controls. Identify an inter-
nal control that would be useful for dealing with each threat.

Web Interfaces to Relational Databases
Obj. 4 Connect to http://www.amazon.com on a web browser.

Required Identify the data items that are collected and processed by Amazon™s web inter-
face as part of selecting and placing an order for a book. How might these items be stored in
a relational database? Identify potential tables and fields in the tables associated with these

Tables in Relational Databases
Obj. 3 You have been assigned the responsibility of developing a purchasing module for a retail com-

Required Identify the tables that you think would be necessary as part of a relational data-
base that will store data for the module. Identify the fields that will be important in each table
and the primary and foreign keys that will link the tables together.

Application Software
Obj. 2 An Excel spreadsheet provides an example of an application program that can be used as a
simple database.

Required Describe the applications that a spreadsheet can provide and how a spreadsheet
could be used as a database. How do the application functions in the software differ from the
database functions?

Database Management Systems
Obj. 2 Open an Access database like the Mom™s Cookie Company database described in this chap-
ter. Examine the Tools menu in the database window.

Required What database management functions are provided by the Tools menu options?
Based on your examination, what are some of the primary purposes of a database manage-
ment system?

Network Components
Obj. 2 Trainor Company has decided to market its pet supplies on the Internet. It has developed a
web site so that customers can identify products and order them online.

Required Describe a network configuration that Trainor might use to support its E-busi-
ness activities.

Fields in a Relational Database
Obj. 4 Linden Company sells more than 100 different types of nuts, bolts, and screws. Each product
has an identification number and is described by its type, size, and material composition. Each
product is purchased from one vendor.

Required Linden Company is developing a database system for its inventory. What fields
would be important to include in the database for the inventory items? Why would these fields
be important?
F280 SECTION F1: The Accounting Information System
282 Computerized Accounting Systems

P7-11 Relational Database Design
Obj. 4
Niven Company manufactures and sells ornamental flamingoes. The flamingoes come in one
color, pink, but come in three sizes, small, medium, and large. Customers order the products
through the web by specifying the quantity of each product, and by providing a shipping ad-
dress and credit card number. The credit card is verified and the customer™s account is charged
when the order is placed. Orders are rejected if the card cannot be charged.

Required Design a relational database system that Niven might use for its products and or-
ders. Identify the tables, fields, and primary and foreign keys that would be part of the database.

Diagramming a Relational Database
Obj. 4 Plaxa Company developed a design for its order system that consisted of three tables. Tables
and associated fields are listed below. The primary keys for each table are underlined.

Product Table [Product ID, Size, Price, Quantity Available]
Customer Table [Customer ID, Name, Address, City, State, Zip, email]
Order Table [Customer ID, Product ID, Order Date, Quantity Ordered]

Required Provide a relational diagram for the order system like that illustrated in Exhibit 9.

Determining Revenue in a Relational Database System
Obj. 4 Refer to P7-12. Plaxa ships its products on the same day orders are received.

Required Describe the process that Plaxa would use to determine the amount of sales it
made during a particular period.

Multiple-Choice Overview of the Chapter
1. Which of the following statements does NOT describe an advantage of a computerized
accounting system?
a. Many accounting cycle steps are performed by the computer.
b. It is easier to control than a manual system.
c. It is faster than a manual system.
d. Fewer opportunities for error exist than in a manual system.
2. Which of the following is NOT part of a computer network?
a. transmitters
b. clients
c. servers
d. databases
3. Data needed by a computerized accounting system may be entered
a. automatically through scanning devices.
b. by customers who enter data in forms when they place orders using web-based sys-
c. by a company™s employees.
d. by all of the above.
4. An information system that integrates most of the business information functions of a
company is known as an
a. enterprise resource planning system.
b. enterprise manufacturing relations system.
c. enterprise resource module system.
d. enterprise business planning system.
5. The part of a computer system that controls access to data and ensures reliability of
processing in the system is the
a. relational database.
b. application software.
c. database management system.
d. control module.
CHAPTER F7: Computerized Accounting Systems
Computerized Accounting Systems

6. The part of a client-server system that requests services from the system is the
a. database server.
b. application server.
c. web server.
d. client.
7. The Internet is an example of a
a. client.
b. network.
c. server.
d. database.
8. The module in an accounting system that is most concerned with vendors is the
a. sales module.
b. purchases module.
c. human resources module.
d. financial management module.
9. The field in a table that uniquely identifies records in the table is the
a. primary key.
b. foreign key.
c. relation key.
d. access key.
10. The part of a relational database system that permits users to define the information
provided as output from the system is a
a. form.
b. table.
c. query.
d. report.

Working with a Relational Database System
Obj. 5 Mom™s Cookie Company received an order from Fair-Price Foods on September 30, 2004 for
seven boxes of Terrific Cookies, 24 oz. size.

Required Use the Mom™s Cookie Company database to record the sale. Begin with the Sales
Order form. Use 09/30/04 for all dates. Follow the example in the chapter for processing the
order. Once the order has been recorded, complete the Shipping form, and then the Sales In-
voice form. Print the Sales Invoice for this sale.
F8 8 F8
How much will it cost to borrow money?

M aria and Stan have been successful in starting Mom™s Cookie Company. The com-
pany has been profitable and is growing as more customers demand its products.
Maria and Stan are now concerned about meeting the additional demand. They need to
expand their operations, and they are considering producing their own products rather
than purchasing them from other bakeries. Before they can expand, however, they must
obtain additional financing for their company. The time value of money is an important
concept that business owners need to understand before they borrow money.

If you were going to borrow money, how much would you have to pay back over the life of the loan? How
much would you have to pay each period? How much interest expense would you incur? Borrowing
money always involves an investment by one entity, a bank for example, in another entity, such as Mom™s
Cookie Company. The amount repaid by the borrower includes interest in addition to the amount
borrowed. Maria and Stan are considering borrowing from a local bank but have decided to discuss the
loan with their accountant, Ellen, to determine how much the loan will cost.

Ellen, Maria and I are considering expanding our business. To finance the expansion, we will need a loan.
We are concerned about how much the debt will cost us and how much cash we will need to repay the
principal and interest.
Ellen: You should be concerned about these issues. You should never borrow money without a clear idea of how
much you will have to repay.
Maria: We know we™ll have to repay the principal of the loan plus interest. We™re not sure, however, how much
the bank will require us to repay each period.
Ellen: To understand loan payments, you need to understand time value of money concepts. Interest
computations can be complex, depending on when payments are made and whether you repay the loan in
a single payment or in a series of payments. Let™s review these concepts.
CHAPTER F8: The Time Value of Money
286 The Time Value of Money


Once you have completed this chapter, you 4 Determine the present value of a single
should be able to: amount to be received in the future.
1 Define future and present value. 5 Determine the present value of an annuity.
2 Determine the future value of a single 6 Determine investment values and interest
amount invested at the present time. expense or revenue for various periods.
3 Determine the future value of an annuity.

Suppose a wealthy relative gives you $1,000 on January 1, 2004. You may use it as you
like. What could you do with this money? One option is to spend it. You probably
Define future and present would have no difficulty identifying things you would like to buy. The total amount of
value. goods you could purchase in January 2004 would be $1,000, the amount of money you
Suppose, however, that instead of spending the money immediately, you decide to
invest it in a savings account at a local bank. The bank agrees to pay 5% interest on
your savings account. Consequently, if you invest
LEARNING NOTE your money with the bank for a year, you will earn
$50 interest ($1,000 principal invested 5% inter-
Interest rates are stated as annual rates unless you are told oth-
est rate).
erwise. The amount of interest financial institutions pay on sav-
The value of your investment in the future, at
ings and for other investments usually is stated as an annual
December 31, 2004, for example, is the future value
percentage rate.
of the investment. The future value of an amount is
the value of that amount at a particular time in the
future. The future value of $1,000 invested on January 1, 2004, at 5% interest is $1,050
on December 31, 2004. The amount invested is the present value of the investment.
The present value of an amount is the value of that amount on a particular date prior
to the time the amount is paid or received. The present value of $1,050 received on
December 31, 2004, is $1,000 on January 1, 2004, assuming 5% interest is earned.
The future value of an investment is expected to be larger than its present value.
The difference between future and present value of a single investment is the amount
of interest earned by the investor. If you choose to invest in savings for a year, you are
forgoing the option to buy goods you might like to have. The interest you earn on your
savings is compensation for delaying your purchases to some time in the future.
In many situations, the relationship between future and present value is easily de-
termined. The future value (FV) is the present value (PV) plus the interest earned (or
expected) for the period of the investment. The interest earned is determined by the
interest rate (R) paid on the investment. Therefore, we can express the relationship be-
tween future and present value as follows:

FV PV(1 R)

For example:

$1,050 $1,000(1.05)

where 0.05 (5%) is the interest rate on the investment.
F286 SECTION F2: Analysis and Interpretation of Financial Accounting Information
The Time Value of Money

Compound Interest
Suppose you decide to leave your money in the savings account for a second year, un-
Determine the future
til December 31, 2005. How much would your investment be worth at that time? As-
value of a single amount
suming that you do not withdraw the interest earned for the first year ($50) and the
invested at the present
bank continues to pay 5% interest, the value of your investment at the end of the sec-
ond year would be as follows:

$1,102.50 $1,050(1.05)

This amount is the future value on December 31, 2005, of the amount invested at the
beginning of 2004. The earnings for the second year are higher than those for the first
year because in the second year you earn interest both on the amount originally in-
vested ($1,000) and on the amount earned in the first year ($50). Earning interest in
one period on interest earned in an earlier period is known as compound interest. An
investor earns compound interest any time an investment extends beyond one period
and interest earned in prior periods is not withdrawn.
When compound interest is earned, computing the future value of an investment
is more complicated. The simple equation previously described cannot be used. For ex-
ample, the future value on December 31, 2005, of a $1,000 investment made on Janu-
ary 1, 2004, would be as follows:

$1,102.50 $1,000(1.05)(1.05)



We express the equation for computing the future value of an investment when inter-
est is compounded like this:


where t is an exponent representing the number of periods of investment.
To illustrate, assume that you invest $500 for three years at 8% interest. How much
would your investment be worth at the end of three years? This is another way of say-
ing, What would be the future value of your investment at the end of three years? Com-
pute the answer as follows:

$629.86 $500(1.08)(1.08)(1.08)

Future value calculations of this type are relatively simple with a calculator that has
an exponential function.

For Future Value of a
Spreadsheet programs also are commonly used for future value calculations. The fu-
Single Amount
ture value of $500 that earns interest at 8% compounded for three years can be cal-
culated by entering the following formula in a cell: 500*(1.08^3). The caret symbol
(^) is used in Excel for exponents. The amount appearing in the cell is the future value
($629.86 in this example).


Tables also are available to assist with these calculations. Table 1 at the back of this
text can be used for this purpose. This table contains the interest factors for computing
CHAPTER F8: The Time Value of Money
288 The Time Value of Money

future values for various interest rates and time periods. Remember, the interest factor
is represented by (1 R)t in the future value equation.

Excerpt from Table 1 Future Value of a Single Amount

Interest Rate

Period 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09

1 1.01000 1.02000 1.03000 1.04000 1.05000 1.06000 1.07000 1.08000 1.09000

2 1.02010 1.04040 1.06090 1.08160 1.10250 1.12360 1.14490 1.16640 1.18810

3 1.03030 1.06121 1.09273 1.12486 1.15763 1.19102 1.22504 1.25971 1.29503

For example, the interest factor for 8% and three years in Table 1 is 1.25971. This
number is equivalent to (1.08)3 (1.08)(1.08)(1.08) 1.25971. The table provides the
interest factor to simplify future value calculations. Thus, if you want to calculate the fu-
ture value of $500 invested for three years at 8%, use the interest factor from Table 1:

$629.86 $500 1.25971

Using Table 1, compute the future value of a single amount as follows:


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