1 Week 10: Accounting process MIS2101: Management Information Systems Based on material developed by C.J. Marselis

2 Agenda  Introduction to Accounting  Problems due to lack of Information  Enron Case  ERP and Sarbanes Oxely

3 Introduction  Accounting tightly integrated with other functional areas Purchasing Marketing and Sales Supply Chain Management  Accounting activities are necessary for decision making

4 Types of Accounting  Financial Accounting Documents all transactions that impact the firm Uses this transaction data to make external reports for various agencies (FASB, SEC, IRS)  Managerial Accounting Determine profitability of a company’s activities Managerial information is used for planning and to control a company’s day-to-day activities  Tax Accounting Specialized field that uses Financial Accounting information

5 Financial Accounting Statements Income Statement Shows sales, cost of sales and overall profit for a period of time (quarter, year) Balance Sheet Shows account balances Picture of the overall financial health of a company

6 Accounting Information  Before integrated systems Data gathered by each functional area Accounting department didn’t have real-time access Accountants and clerks had to “research” their own company to get information  With ERP Materials management records a goods receipts as an increase in inventory Accounting records a goods receipts as an increase in the value of inventory The same transaction provides information for both

7 The General Ledger (GL) in an Integrated System  All accounts are kept in the general ledger  Input to the GL occurs simultaneously with business transaction in functional module SAP ModuleFeeds to GL Sales and Distribution (SD) - Sales to Customer Accounts Receivable (AR) Entries Materials Management (MM) - Purchase Orders made in Accounts Payable (AP) Entries Payroll Processing (HR)Expense Entries Financial Accounting (FI) - Manages the AR and AP items created in SD and MM GL accounts closed in FI at end of a fiscal period

8 Accounting Data and Profitability Analysis  Inaccurate or incomplete data leads to flawed analysis  3 main causes of data problems Inconsistent record keeping  Much of work done manually including analyses  Manual entry leads to errors Inaccurate inventory costing Problems consolidating data from subsidiaries

9 Inaccurate Inventory Costing Systems  Inventory is expensive Cost of raw materials used in the item Labor used specifically to produce the product (direct labor) Overhead (all other costs)  Factory utilities  General factory labor (custodial services, security)  Manager’s salaries  Storage  Insurance

10 Case Study – Cisco and One-Day Close  Closing books zeroing out temporary accounts  Takes days/weeks/months to get all the financial figures in balance before company can close the financial period  “Virtual closings” during the month can show how well the company is doing  Cisco’s closing went from 2 weeks to 1 day by switching from “un-integrated” systems to Oracle ERP

11 Even More Complicated for Companies with Subsidiaries  Must prepare Financial statements for each subsidiary Consolidated statement for entire company  Different currencies and transactions Must consider changes in exchange rates Sales from one subsidiary to another within a company do not result in a profit or loss, because no money has entered or left the consolidated company

12 Case Study: Microsoft  Microsoft consolidates financial information from 130 subsidiaries  Pre-SAP: each subsidiary had separate accounting Each used different systems, with different field sizes, types of characters, account structures Transmitted the files to another system where manipulation of the data was required Consolidation took over a week  With SAP: Microsoft can look directly at financial activity at any subsidiary around the world

13 Enron Collapse  Energy company revolutionizing the oil and gas business  On Oct. 16, 2001, Enron’s creative financial arrangements began to unravel  On Dec. 2, 2001, Enron made the largest bankruptcy filing in history  Key cause: Enron’s partnerships shifted billions of debt off Enron’s books so Enron could borrow money more cheaply  Arthur Andersen: Respected accounting firm with firm with 28,000 employees - issued annual reports attesting to the validity of Enron’s financial statements Arthur Andersen indicted for, among other things, destruction of Enron documents

14 Results of Enron Collapse  Enron’s 20,000 creditors will receive approximately 20% of the $63 billion they are owed  Shareholders will receive nothing Many employees invested large sums of money in Enron stock via 401K savings plans  Arthur Andersen dismantled  31 individuals either have been tried or will be tried on criminal charges  Similar Fraud at WorldCom exposed  The Sarbanes-Oxley Act was passed

15 Sarbanes-Oxley Act of 2002  Requires public company’s annual report contain management’s internal control report  Must include documentation of controls  An integrated information system provides tools to implement internal controls But controls cannot necessarily prevent effort to circumvent standard processes  But companies with ERP systems will have an easier time complying with Sarbanes-Oxley

16 Archiving  In SAP R/3, there are limited situations where data can just be deleted  If data could just be deleted, an unscrupulous employee could: Create a fictitious vendor Post an invoice from the vendor Make payment to a Swiss bank account Delete all records of the transactions so the fraud won’t be detected  In SAP R/3, most data must be archived before it can be removed from the system, so auditors can reconstruct the company’s financial position at any point in time

17 Figure 5.7 Transaction options for material master data Data on a company’s materials cannot be deleted directly, but must be archived for deletion

18 Integrated System (like an ERP) and Fraud Detection  Changes to data are tracked SAP R/3 maintains detailed records on all changes made to material master data

19 User Authorizations  A fundamental tool to avoid fraud is separation of duties and user authorizations To complete critical business processes, more than one employee must participate so that a single employee cannot commit a fraud User authorizations ensure that employees can only perform those transactions required for their job SAP R/3’s Profile Generator provides a simple method for creating user authorizations based on the functions (transactions) a user should be allowed to perform Pre-defined roles make developing authorizations easier

20 Figure 5.9 Role for material management master data Menu paths/transactions that a person assigned the role of maintaining management master data can perform

21 Tolerance Groups  Another way to ensure that employees do not exceed their authority (and to minimize the risk from fraud and abuse) is to set limits on the size of a transaction that an employee can process  Tolerance groups are predefined limits on an employee’s ability to post a transaction  Tolerance limits can be set on items like: Line items in a document Total document amount Payment difference Discounts

22 Figure 5.10 Default tolerance group No group specified, so this is the default tolerance The default only allows posting of documents for $1,000 or less Payments can differ by $10 or 1%

23 Financial Transparency  An advantage of an ERP system is the ability to “drill down” from a report to the source documents (transactions) that created it  “Drill down” capability makes it easier for auditors to verify the integrity of reports and financial statements  By double-clicking on an item in a report in SAP R/3, the user will be taken to the document(s) that created the created the item

24 Figure 5.11 G/L (general ledger) account balance for raw material consumption Double-clicking on the 8, debit will provide details on the transactions that make up the item

25 Line items linked… Figure 5.12 Documents that make up G/L Account Balance for Raw Material Consumption Selecting the item and clicking on the details icon will provide more information on the item

26 …to the documents that created them Figure 5.13 Details on $10.00 line item in G/L account for raw material consumption

27 Summary  Companies use accounting systems to record transactions and generate financial statements  Should have ability to summarize data to assist managers in their daily and strategic work  With “un-integrated” systems, accounting data might not be current  Integrated IS with common database to record accounting data facilitates inventory benefits  Compliance with Sarbanes-Oxley Act facilitated with integrated systems

28 Key Learnings  Introduction to Accounting Function  Problems due to Lack of Information Integration  Case Studies: Cisco, Microsoft  Role of Accounting in Enron Collapse  Sarbanes Oxley Act  How ERP Systems help ensure compliance with Sarbanes Oxley Act