1. Concepts in Enterprise Resource Planning 2 nd Edition Chapter 5 Accounting in ERP Systems

2. Concepts in Enterprise Resource Planning, Second Edition2 Introduction Accounting is a functional area that is tightly integrated with other functional areas like: Marketing and Sales Supply Chain Management Accounting activities are necessary for decision making

3. Concepts in Enterprise Resource Planning, Second Edition3 Types of Accounting Firms require three types of accounting activities Financial Accounting Documents all transactions that have an impact on the firm Uses this transaction data to make external reports for various agencies (FASB, SEC, IRS) Managerial Accounting Determine costs and profitability of a company’s activities Managerial Information is used for planning and to control a company’s day-to-day activities Tax Accounting is a specialized field that used Financial Accounting information

4. Concepts in Enterprise Resource Planning, Second Edition4 Financial Accounting Common Financial Accounting statements include: Balance Sheet Shows account balances at a particular point in time Gives a good picture of the overall financial health of a company Income Statement Shows sales, cost of sales and overall profit for a period of time (quarter, year)

5. Concepts in Enterprise Resource Planning, Second Edition5 Figure 5.1 Fitter Snacker sample balance sheet

6. Concepts in Enterprise Resource Planning, Second Edition6 Figure 5.2 Fitter Snacker sample income statement

7. Concepts in Enterprise Resource Planning, Second Edition7 ERP for Accounting Information Early information systems gathered data primarily for their own functional area (sales, production, payroll, etc.) Data sharing with accounting did not occur in “real time” Accountants and functional area clerks frequently had to do significant research to gather the data needed for reports ERP systems, with centralized databases, avoid these problems Materials Management module sees a goods receipt as an increase in inventory Accounting module sees goods receipt as an increase in the value of inventory A single data entry transaction provides the data for both

8. Concepts in Enterprise Resource Planning, Second Edition8 General Ledger A company’s accounts are kept in the general ledger In SAP R/3, input to the general ledger occurs simultaneously with the business transaction in the functional module Sales and Distribution (SD) Sales to customers create accounts receivable entries Materials Management (MM) Purchase orders create accounts payable entries Human Resources (HR) Payroll processing creates expense entries

9. Concepts in Enterprise Resource Planning, Second Edition9 General Ledger Other modules also create general ledger entries Financial Accounting (FI) Manages the accounts receivable and accounts payable items created in SD and MM Module where general ledger accounts are closed at the end of a fiscal period Controlling (CO) Tracks the costs associated with producing products Asset Management (AM) Manage fixed-asset purchases (plant, machinery, etc.) and associated depreciation

10. Concepts in Enterprise Resource Planning, Second Edition10 Operational Decision Making Problem: Credit Management A company with an un-integrated information system can have accounting data that is out-of-date or inaccurate Out-of-date or inaccurate data can lead to bad operational decisions Fitter Snacker has this problem with credit management Companies routinely sell to customers on credit Sound credit management gives customers enough credit to promote sales while minimizing the risk from default Making the correct credit management decision requires accurate and timely sales and payment data

11. Concepts in Enterprise Resource Planning, Second Edition11 Operational Decision Making Problem: Credit Management At Fitter Snacker: The sales clerk uses a weekly printout of all customer balances and credit limit to see if credit should be granted for a new order Sales data are transmitted to accounting 3 times per week Both sales and accounting work off data that is not real-time and may be more than a week old Customer orders that would bring them over the credit limit may be accepted Customers may be denied credit because recent payments are not available to the sales clerk

12. Concepts in Enterprise Resource Planning, Second Edition12 Product Profitability Analysis Accounting data is used to determine the profitability of a company and its products Inaccurate and/or incomplete data can lead to a flawed analysis The three main causes of data problems are: Inconsistent record keeping Inaccurate inventory costing Problems consolidating data from subsidiaries

13. Concepts in Enterprise Resource Planning, Second Edition13 Inconsistent Record Keeping At Fitter Snacker: Sales data is not maintained so that sales reports are easily generated Analyzing sales data by region or division usually must be done by hand Production data is maintained with paper records Data must be typed into a spreadsheet from paper records before it can be analyzed Manual entry leads to errors Without an integrated information system, much of the effort in generating reports is devoted to working around the limitations of the systems

14. Concepts in Enterprise Resource Planning, Second Edition14 Inaccurate Inventory-Costing Systems Correctly calculating inventory costs is an important and challenging task in any manufacturing company A manufactured item’s cost has three elements: 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

15. Concepts in Enterprise Resource Planning, Second Edition15 Direct and Indirect Costs Materials and labor are called direct costs Direct costs are relatively easy to tie to the production of specific products Overhead is an indirect cost Indirect costs are difficulty to associate with a specific product e.g. the relationship between the cost of heating and lighting and a specific batch of NRG-A bars To determine the cost of a manufactured product, indirect costs must be allocated to products

16. Concepts in Enterprise Resource Planning, Second Edition16 Direct and Indirect Costs Allocating indirect costs One method is to use total machine hours Total overhead cost divided by the total machine production time (hours) available for a period to get an overhead rate per machine hour Example: Overhead costs per month: $152,500 Production line capacity: 50 cases/hour 160 hours/month

17. Concepts in Enterprise Resource Planning, Second Edition17 Direct and Indirect Costs Allocating indirect costs Another method is to use direct labor hours The assumption with this method is that overhead costs are incurred so workers can do their jobs For Fitter Snacker, the snack bar bake line is the fundamental production process as well as capacity constraint, so allocating indirect costs using machine hours (snack bar bake line hours) would make sense

18. Concepts in Enterprise Resource Planning, Second Edition18 Standard Costs Costs are typically recorded using standard costs, which are based on historical cost data At the end of an accounting period, adjustments to accounts must be made as actual costs will differ from estimates made using standard costs Balance sheet: cost of inventory held will need to be adjusted Income statement: cost of goods sold will have to be adjusted Difference between actual costs and standard costs are called cost variances Cost variances arise with both direct and indirect costs

19. Concepts in Enterprise Resource Planning, Second Edition19 Activity-Based Costing (ABC) In ABC, records are kept on overhead costs and the activities associated with overhead cost generation The goal is to more precisely associate costs with the causes (drivers) and avoid rough allocation procedures Profitability of particular products is more accurately determined ABC is often used when: Competition is stiff Overhead costs are high Products are diverse Not all overhead costs can be linked to activities

20. Concepts in Enterprise Resource Planning, Second Edition20 Activity-Based Costing (ABC) ABC requires more bookkeeping than traditional cost- accounting approaches ABC is often used for strategic purposes in parallel with standard cost accounting A recent study noted that: ERP companies had nearly twice as many cost- allocation bases to use in management decision- making ERP companies’ managers rated their cost- accounting system much higher

21. Concepts in Enterprise Resource Planning, Second Edition21 Companies with Subsidiaries Companies with subsidiaries must prepare financial statements for each subsidiary, plus be able to provide a consolidated statement for the entire company Different currencies and transactions between subsidiary companies can make the consolidation task challenging Currency translation is challenging because exchange rates fluctuate daily Intercompany transactions must be handled properly 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

22. Concepts in Enterprise Resource Planning, Second Edition22 Management Reporting with ERP Systems Reporting accounting information is often challenging Without an ERP system, obtaining the information needed for a report is frequently a monumental task With ERP, the information is in a single system, however: The system configuration must be set to gather the correct “raw data” The appropriate reports are needed, which may require custom coding (e.g. ABAP)

23. Concepts in Enterprise Resource Planning, Second Edition23 Document Flow for Customer Service In SAP R/3, Document Flow is a tool that finds, organizes and displays a summary of all documents related to a sales order Sales orders can be very complicated, with: multiple products multiple shipments multiple invoices multiple payments Being able to find all related documents easily is important in providing efficient customer service

24. Concepts in Enterprise Resource Planning, Second Edition24 Figure 5.6 Document flow of a transaction in SAP R/3 Details of any document can be viewed from the document flow screen—a process known as “drilling down”

25. Concepts in Enterprise Resource Planning, Second Edition25 Management-Reporting and Analysis Tools Because ERP systems use a database, the database can be queried to provide a wide range of reports and analyses Because reports access the same database where transactions are recorded, reporting and analysis requests can slow down the processing of regular business transactions

26. Concepts in Enterprise Resource Planning, Second Edition26 Enron Collapse Enron was a trailblazing energy company that was revolutionizing the oil and gas business and making millionaires of its investors On Oct. 16, 2001, Enron’s creative financial arrangements began to unravel On Dec. 2, 2001, Enron made the largest bankruptcy filing in history A primary cause of the collapse was Enron’s partnerships that shifted billions of debt off Enron’s books so that Enron could borrow money more cheaply Arthur Andersen, a highly regarded accounting firm, had annually issued annual reports attesting to the validity of Enron’s financial statements

27. Concepts in Enterprise Resource Planning, Second Edition27 Enron Collapse Arthur Andersen was indicted for, among other things, the destruction of Enron documents in the face of an SEC investigation As a result of the 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, once a firm with 28,000 employees, has been all but dismantled 31 individuals either have been tried or will be tried on criminal charges The Sarbanes-Oxley Act was passed

28. Concepts in Enterprise Resource Planning, Second Edition28 Sarbanes-Oxley The Sarbanes-Oxley Act is designed to encourage top management accountability Top managers in recent scandals (Enron, WorldCom, Global Crossing) have claimed ignorance of accounting abuses Title IX of Sarbanes-Oxley requires a company’s CEO and CFO to sign a statement that financial statements comply with SEC rules Penalties can be up to $5 million and 20 years in prison Title II restricts the non-audit services that an auditor can provide

29. Concepts in Enterprise Resource Planning, Second Edition29 Sarbanes-Oxley and ERP Title IV of the act specifies more stringent requirements for financial reporting Section 404 requires a public company’s annual report contain management’s internal control report The control report outlines management’s responsibility for: Establishing and maintaining adequate internal control over financial reporting Assess the effectiveness of its internal control over financial reporting To meet the internal control report requirements, a company must document the controls that are in place and verify that they are not subject to error or manipulation

30. Concepts in Enterprise Resource Planning, Second Edition30 Sarbanes-Oxley and ERP An integrated information system provides the tools to implement internal controls Controls cannot necessarily prevent a pervasive effort to circumvent standard processes by a company’s leadership (e.g. Enron) Companies with ERP systems in place will have an easier time complying with Sarbanes-Oxley than those without

31. Concepts in Enterprise Resource Planning, Second Edition31 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

32. Concepts in Enterprise Resource Planning, Second Edition32 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

33. Concepts in Enterprise Resource Planning, Second Edition33 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

34. Concepts in Enterprise Resource Planning, Second Edition34 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