Financial Information Systems

This article focuses on the financial accounting process and the benefits of automating the process. The financial accounting process is defined and each step of the financial accounting cycle is explained. The accounting department is a key player in an organization's ability to be successful. This department is responsible for providing information to internal and external entities so that they can make effective financial decisions that will benefit the organization. These decisions will have a profound effect on the organization so it is imperative that the data collected is accurate.

Keywords Accounting Information System; Audit Trail; Financial Accounting; Generally Accepted Accounting Principles (GAAP); Managerial Accounting; Matching Principle; Periodicity Principle; Source Document; Trial Balance

Finance > Financial Information Systems

Overview

The accounting department is a key player in an organization's ability to succeed. This department is responsible for providing information to internal and external entities so that they can make effective financial decisions that will benefit the organization. These decisions will have a profound effect on the organization so it is imperative that the data collected is accurate. One way to ensure that the data is accurate is to install an accounting information system (AIS).

An accounting information system (AIS) is a system that records an organization's financial data and transactions. This information consists of the organization's revenues and expenditures as well as other financial transactions. A business will implement an AIS in order to accumulate data so that those responsible for making decisions have a supply of information over a period of time.

Components of Accounting Information Systems

Most accounting information systems have two components — financial and managerial accounting. The objective of financial accounting is to provide information to external decision makers, whereas, the objective of managerial accounting is to provide information to internal decision makers. Although both areas need to use an organization's accounting records, there are differences between the two areas of accounting.

Choosing the Appropriate System

An organization's management team has the ability to create any type of internal accounting system. However, cost may be a key factor in deciding what type of system will be selected. The type and amount of information that needs to be stored is another factor in selecting the most appropriate information system.

The Foreign Corrupt Practices Act

Both financial and managerial accounting is bound by the Foreign Corrupt Practices Act. This act is a "U.S. law forbidding bribery and other corrupt practices, and requiring that accounting records be maintained in reasonable detail and accuracy, and that an appropriate system of internal accounting be maintained" (Horngreen, Stratton, & Sundem, 2002, p. 7). In summary, Drury (1996) stated that managerial accounting focuses on the provision of information to people within the organization so that they can make better decisions, whereas, financial accounting emphasizes the need of an organization having the ability to provide financial information to stakeholders outside of the organization.

One of the main objectives of financial accounting is to be able to process an organization's financial transactions in an effective manner in order to produce accurate financial statements, such as income statements and balance sheets (Moscove & Simkin, 1981). Managerial accounting has three main areas of operation: Cost accounting, budgeting and systems study.

Financial Accounting

Financial accounting focuses on preparing financial statements for external decision-makers such as banks and government agencies. The primary purpose of the field is to review and monitor an organization's financial performance and report the results of the evaluation to potential stakeholders. Financial accountants are expected to create financial statements based on Generally Accepted Accounting Principles (GAAP). Financial accounting exists in order to: Produce general purpose financial statements, provide information to decision makers in the accounting field, and meet regulatory requirements.

The Financial Accounting Audit Trail

The basic inputs of the financial accounting structure are transactions that measure money. Organizations should be able to conduct an audit trail of their accounting transactions. This audit trail will show the flow of data that moves through the accounting information system. The financial accounting audit trail consists of inputs, processing and outputs. Inputs consist of documents such as sales invoices and payroll time cards, whereas, the outputs are final documents such as financial statements and other external reports. Processing will go from the input phase to the output phase. Steps taken in between these two points include: Recording journal entries, posting the entries to a general ledger, and preparing a trial balance from the general ledger account balances. Processing these transactions is considered to be a part of an organization's accounting cycle, which has nine steps.

The Nine Steps of the Accounting Cycle

According to Moscove & Simkins (1985), the nine steps in the accounting cycle are:

  • Prepare transaction source documents. Any type of transaction that causes a change in assets, liability, or owners' equity must be accounted for through documentation. Business transactions are the result of source documents being created. For example, the sales invoice represents a transaction source document (also referred to as an original record). Source documents are visual representation that a transaction exists. Many corporations will have a policy indicating that a financial transaction cannot be entered into its accounting information system until the proper source documents are prepared and approved. Other common forms of source documents include purchase invoices, receiving reports, bills of lading, employee time cards, and voucher checks.
  • Sourcing documents allow an organization to collect its transaction data for subsequent entry into the accounting information system. In addition, transaction source documents act as the starting point in an organization's audit trail flow of data through its information system's accounting cycle.
  • Recording business transactions in a journal. Once the accounting data has been collected, it is recorded in the organization's journal. Many organizations will maintain a journal within an accounting information system in order to keep a chronological record of the activities that have occurred throughout its lifecycle. There are large amounts of transactions that need to be processed. Therefore, many organizations will switch from a manual system to a computerized financial information system. The computerized system can provide a more efficient approach to tracking the various categories that will occur when the company is performing business transactions. Some of the most common categories are: Assets, operating expenses, the sale of products and/or services, and the receipt and payment of cash.
  • Posting business transactions from the journal to the general ledger and determining individual account balances. The general ledger contains detailed information about the organization's assets, liabilities, owners' equity, revenue and expenses. A "T" account is created for each type of monetary item in the organization. In order for an organization's management team to have the appropriate information, the individual debits and credits from journal entries must be transferred from their proper accounts within the general ledger. This process is called posting. Once the posting process has been completed, managers can determine the balance of each general ledger.
  • Preparing a trial balance. Each organization determines when it wants to prepare financial statements. Common timeframes include annually, quarterly and monthly. Based on the established timeframe, all of the posting work must be completed by the designated time so that the value of each general ledger can be determined. Once the information is computed, the trial balance is prepared. The trial balance highlights all of the general ledger accounts together with their end of period balances. In addition, the trial balance determines whether the total debit and total credit account balances equal one another and prepares the financial statements for the organization.
  • Recording adjusting entries in a journal. Before one can prepare the organization's financial statements, adjustments (adjusting journal entries) may need to be made. The need to adjust is based on the periodicity principle and the matching principle. In addition, there are four major types of adjusting entries at the end of the organization's accounting period. The major types are unrecorded expenses, unrecorded revenues, deferred expenses or prepaid expenses and deferred revenues.
  • Posting adjusting journal entries to the general ledger, determining updated general ledger account balances and preparing an adjusted trial balance. An adjusted trial balance must be prepared before the organization can prepare its income statement and balance sheet. The purpose of preparing the second trial balance is to determine if the debit and credit account balances are still equal once the adjusting entry process has been completed.
  • Preparing financial statements from adjusted trial balance. The organization will use the adjusted trial balance to prepare its financial statements.
  • Recording closing entries in a journal, posting them to the general ledger and determining new balances of those accounts affected by closing entries.
  • An organization will record and post closing entries in order to eliminate its individual revenue and expense account balances and transfer the net income into the owner's equity account. Organizations should prepare financial statements immediately after the close of its accounting period so that the information is available to its decision makers.
  • Preparing a post-closing trial balance. Once the closing entries are journalized and posted, all of the revenue and expense accounts will have zero balances and the owners' equity capital accounts will have the current period's net income or loss. Once this information has been confirmed, a post-closing trial balance will be conducted in order to verify that the accounts with debit balances equal the accounts with credit balances. This is the final step.

Application

Financial Management Information Systems

Characteristics of Financial Management Information Systems

A financial management information system (FMIS) is a system that computerizes the public expenditure management process. According to Diamond and Khemani (2006), some of the characteristics of this type of system are:

  • It is a management tool. A FMIS should cater to the needs of the management team, and be a tool that supports change.
  • It should provide a wide range of nonfinancial and financial information. It should provide information that will assist the managers in making decisions. Also, the system should be imbedded in the government accounting system as well as be able to collect data on nonfinancial areas such as employee information, performance based budgets and types of goods and services produced.
  • It is a system. The system should be able to connect, collect, process and provide data to all essential personnel in the budget system on a regular basis. Thus, all key personnel should have access to the system so that they can perform their designated duties.

The core components of a FMIS are general ledger, budgetary accounting, accounts payable, and accounts receivable. The non-core components are payroll system, budget development, procurement, project ledger, and asset module.

Characteristics of a Well Designed Financial Management Information System

According to Diamond and Khemani (2006), a well designed FMIS should:

  • “Be modular, and capable of progressive upgrading to cater to future needs.”
  • “Offer a common platform and user interface to the stakeholders in different agencies responsible for financial management, for adding to and accessing the information database.”
  • “Maintain a historical database of budget and expenditure plans; transaction data at the highest level of detail; cash flows and bank account operations including checks issued, cancelled, and paid; cash balances, and; floats.”
  • “Have dedicated modules to handle monthly, rolling, short-term and long-term forward estimates of revenues, expenditures prepared by agencies, and corresponding estimates of the resulting cash flows.”
  • “Compile formal government accounts from the database of authorization and cash allocations, primary revenue and expenditure transactions of the agencies; and treasury operations, avoiding the need to duplicate data entry for accounting purposes.”
  • “Enable real-time reconciliation of parallel and related streams of transaction data.”
  • “Be flexible enough to provide user defined management information, aggregated at the desired level of detail from the database” (Diamond & Khemani, 2006).

Viewpoint

FMIS in Developing Countries

In most developing countries in the early 21st century, the budget and accounting process was either completed manually or with outdated software applications. As a result, their output was often unreliable and untimely. This created a concern when they needed to conduct budget planning, monitoring, expenditure control and reporting.

"Further, governments have found it difficult to provide an accurate, complete, and transparent account of their financial position to Parliament or to other interested parties, including donors and the general public. This lack of information has hindered transparency and the enforcement of accountability in government, and has only contributed to the perceived governance problems in many of these countries" (Diamond & Khemani, 2006, p. 98).

In order to overcome these problems, many developing countries have adopted financial management information systems in order to be more effective and efficient in the accounting reporting process. Additionally, as global markets became both more open and more competitve, by 2011 more than 120 countries moved to adopt the International Financial Reporting Standards (IFRS). High-quality financial reporting was seen as necessary to attract foreign investment and increase domestic surpluses and economic growth rates (Lasmin,2012).

The Four-Step FMIS Creation Process for Developing Countries

Diamond and Khemani (2006) devised a four step process for developing countries to introduce a FMIS.

• Step 1: Preparatory

  • “Preliminary concept design including an institutional and organizational assessment.
  • Analysis of the key problem areas and ongoing reform programs.
  • Feasibility study.
  • Design project and draft project proposal.
  • Formal approval of the project — securing government approval and donors' funding” (Diamond & Khemani, 2006).

• Step 2: Design

  • “Develop functional specification.
  • Outline information technology (IT) strategy, including hardware and organizational issues.
  • Prepare tender documents” (Diamond & Khemani, 2006).

• Step 3: Procurement

  • “Issue tenders for hardware and software and associated requirements.
  • Evaluation of bids and award contract” (Diamond & Khemani, 2006).

• Step 4: Implementation

  • “Configuration analysis and specification of any additional IT, infrastructure, and communication requirements.
  • Detailed business process and gap analysis mapping required functionality to package and identifying and specifying detailed parameterization, customization, procedural changes.
  • Agreed customization and configuration of the system.
  • Determine training needs and conduct training of personnel.
  • Pilot run — parallel run of the system; resolve initial problems and evaluate system performance for roll-out.
  • Roll out system to other ministries and agencies.
  • Phased implementation of additional modules.
  • Strengthening of internal system support and phasing out of consultant/contractor support” ((Diamond & Khemani, 2006, p 104).

Conclusion

The accounting department is a key player in an organization's ability to be successful. This department is responsible for providing information to internal and external entities so that they can make effective financial decisions that will benefit the organization. These decisions will have a profound effect on the organization so it is imperative that the data collected is accurate. One way to ensure that the data is accurate is to install an accounting information system (AIS).

Most accounting information systems have two components — financial and managerial accounting. The objective of financial accounting is to provide information to external decision makers, whereas, the objective of managerial accounting is to provide information to internal decision makers. Another objective of financial accounting is to process an organization's financial transactions in an effective manner in order to produce accurate financial statements, such as income statements and balance sheets (Moscove & Simkin, 1981).

A financial management information system (FMIS) is a system that computerizes the public expenditure management process. According to Khemani & Diamond (2006), the core components of a FMIS are general ledger, budgetary accounting, accounts payable, and accounts receivable. The non-core components are payroll system, budget development, procurement, project ledger, and asset module.

In most developing countries, the budget and accounting process is either completed manually or with outdated software applications. As a result, their output has been unreliable and not timely. Therefore, many have sought to implement a FMIS. This type of project should be viewed as a long term endeavor, and there should be a strong commitment to the project's successful completion.

Terms & Concepts

Accounting Information System: An organization's chronological list of debits and credits.

Audit Trail: A record of transactions in an information system that provides verification of the activity of the system.

Financial Accounting: Reporting of the financial position of an organization to external stakeholders.

Generally Accepted Accounting Principles (GAAP): Established by the Financial Accounting Standards Board, is a set of procedures and rules for compiling and recording financial information.

Managerial Accounting: Financial reporting that is aimed at helping managers to make decisions.

Matching Principle: Also known as the hedging principle or cash flow matching approach, refers to the process of balancing an organization’s assets with its liabilities; allows cash outflows to match cash inflows.

Periodicity Principle: Occurring at regular intervals.

Source Document: In finance, a document such as a purchase order, sales invoice or time card which provides original information on accounting transactions.

Trial Balance: Act of confirming that an organization’s total debits equal the total credits; done by totaling both figures.

Managerial Accounting Financial Accounting Primary User Internal decision makers External decision makers Time Focus Present and future Historical Organizational Focus Segmented Aggregate Time Span of Reports As needed Quarterly and annually Rules and Regulations Does not need to follow Mandatory to follow GAAP GAAP Record-keeping Formal or informal Formal

Bibliography

Al-Laith, A. (2012). Adaptation of the internal control systems with the use of information technology and its effects on the financial statements reliability: an applied study on commercial banks. International Management Review, 8, 12-20. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=75500334&site=ehost-live

Drury, C. (1996). Management and cost accounting (4th ed.). London: International Thompson Business Press.

Diamond, J., & Khemani, P. (2006). Introducing financial management information systems in developing countries. OECD Journal on Budgeting, 5, 98-132. Retrieved July 25, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=21777790&site=ehost-live

Eccles, R.G., & Armbrester, K. (2011). Integrated reporting in the cloud. IESE Insight, , 13-20. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=60227579&site=ehost-live

Horngreen, C. T., Stratton, W. O., & Sundem, G. L. (2002). Introduction to management accounting (12th ed.). New Jersey: Prentice Hall.

Lasmin. (2012). Culture and the globalization of the international financial reporting standards (IFRS) in developing countries. Journal of International Business Research, 1131-44. Retrieved October 31, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85227515&site=ehost-live

Moscove, S., & Simkin, M. (1981). Accounting information systems: Concepts and practice for effective decision making. New York: John Wiley & Sons.

Suggested Reading

Burrowes, A. (2005). Core concepts of accounting information systems. Issues in Accounting Education, 20, 216-217. Retrieved July 25, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=17022718&site=ehost-live

Bushman, R., Chen, Q., Engel, E., & Smith, A. (2004, June). Financial accounting information, organizational complexity and corporate governance systems. Journal of Accounting & Economics, 37, 167-201. Retrieved July 25, 2007, from Business Source Premier database. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=13576670&site=ehost-live

Gowland, D., & Aiken, M. (2005, September). Changes to financial management performance measures, accountability factors and accounting information systems of privatized companies in Australia. Australian Journal of Public Administration, 64, 88-99. Retrieved July 25, 2007, from Business Source Premier database. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=18102619&site=ehost-live

Essay by Marie Gould

Marie Gould is an Associate Professor and the Faculty Chair of the Business Administration Department at Peirce College in Philadelphia, Pennsylvania. She teaches in the areas of management, entrepreneurship, and international business. Although Ms. Gould has spent her career in both academia and corporate, she enjoys helping people learn new things — whether it's by teaching, developing or mentoring.