Information technology auditing 4th edition hall solutions manual

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CHAPTER 6 TRANSACTION PROCESSING AND FINANCIAL REPORTING SYSTEMS OVERVIEW REVIEW QUESTIONS 1.

What three transaction cycles exist in all businesses?

Response: The expenditure cycle, conversion cycle, and revenue cycle.

2.

Name the major subsystems of the expenditure cycle.

Response: Purchases/accounts payable, cash disbursements, payroll, and fixed asset systems

3.

Identify and distinguish between the physical and financial components of the expenditure cycle.

Response: The physical component includes the acquisition of goods, while the financial component includes the recognition of a liability owed to the supplier and the transfer of the payment to the supplier.

4.

Name the major subsystems of the conversion cycle.

Response: production system and cost accounting system

5.

Name the major subsystems of the revenue cycle.

Response: sales order processing system and cash receipts system

6.

Name the three types of documents.

Response: source documents, product documents, and turnaround documents

7.

Name the two types of journals.

Response: special journals and the general journal

8.

Distinguish between a general journal and journal vouchers.

Response: A general journal is used to record nonrecurring and infrequent transactions.

Often, general journals are replaced with a journal voucher system. The journal voucher is used to record a single nonrecurring and infrequent transaction, and it is used as a special source document for the transaction. The total of journal vouchers processed is equivalent to the general journal.

9.

Name the two types of ledgers.

Response: general ledger and subsidiary ledger

10.

What is an audit trail?

Response: A trail that allows the auditor to begin with a summary total found on the financial statements and track it back to the individual transactions that make up this total. Conversely, an auditor should be able to track transactions from their source documents to their final impact on the financial statements.

11.

What is the confirmation process?

Response: The confirmation process entails selecting customers and contacting them to determine whether the transactions recorded in the financial statements actually took place and are valid.

12.

Computer-based systems employ four types of files. Name them.

Response: Master file, transaction file, reference file, and archive file

13.

Give an example of a record that might comprise each of the four file types found in a computer-based system.

Response: Master files correspond to general ledger accounts and subsidiary ledgers.

Examples include accounts receivable and customer subsidiary accounts, accounts payable and vendor subsidiary accounts, inventory, etc. Transaction files correspond to general and special journals. Examples include the general journal, sales journals, cash receipts journals, payroll journals, etc. Reference files include lists of vendors, delinquent customers, tax tables, sales tax rates, discount rates, lists of customers granted specific discounts, etc. Archive files are typically composed of records that have been processed but are retained for their history. Examples include payroll transactions, sales transactions, etc.

14.

What is the purpose of a digital audit trail?

Response: The digital audit trail, like the paper trail, allows us to trace transactions from the financial statement balance back to the actual transaction so we may: compare balances, perform reconciliations, select and trace samples of entries, and identify, pull, and verify specific transactions.

15.

Give an example of how cardinality relates to business policy.

Response: Cardinality reflects normal business rules as well as organizational policy. For instance, the 1:1 cardinality in the first example in Figure 6-14 suggests that each salesperson in the organization is assigned one automobile. If instead the organization’s policy were to assign a single automobile to one or more salespeople that share it, this policy would be reflected by a 1: M relationship.

16.

Distinguish between entity relationship diagrams, data flow diagrams, and system flowcharts.

Response: Entity relationship diagrams represent the relationship between entities (resources, events, and agents) in a system, i.e. it models the data used in or affected by the system. Dataflow diagrams represent the logical elements (i.e. what is being done) of a system by illustrating processes, data sources, data flows, and entities, i.e. it models the business processes. System flowcharts graphically represent the physical elements being used (i.e., how the tasks are being conducted) by illustrating the relationship between input sources, program, and output products. System flowcharts can also represent both the logical and physical elements of manual systems and also illustrate the preparation and handling of documents.

17.

What is meant by cardinality in entity relationship diagrams?

Response: Cardinality refers to the numerical mapping between entity instances, and it is a matter of organizational policy. The relationship can be one-to-one, one-to-many, or many-to-many.

18.

For what purpose are entity relationship diagrams used?

Response: An entity relationship (ER) diagram is a documentation technique used to represent the relationship between entities. One common use for ER diagrams is to model an organization’s database, which we examine in detail in Chapter 8.

19.

What is an entity?

Response: Entities are physical resources (automobiles, cash, or inventory), events (ordering inventory, receiving cash, shipping goods), and agents (salesperson, customer, or vendor) about which the organization wishes to capture data.

20.

Distinguish between batch and real-time processing.

Response: Batch processing occurs when similar transactions are accumulated over time and processed together. Real-time processing captures each event or transaction and processes it before engaging in another transaction. If transactions are independent of one another, such as the processing of daily cash receipts, then batch processing is appropriate. If transactions are dependent on one another, such as credit sales, ticket sales, etc., then real-time processing is more appropriate.

21.

Distinguish between the sequential file and database approaches to data backup.

Response: During the file update process, sequential master files are completely reproduced in the form of a physically new file, thus creating a backup copy automatically. Databases use destructive update procedures and require separate backup procedures.

22.

Is a data flow diagram an effective documentation technique for identifying who or what performs a particular task? Explain.

Response: No. A DFD shows the tasks being performed, but not who performs them. It depicts the logical system only.

23.

Is a flowchart an effective documentation technique for identifying who or what performs a particular task? Explain.

Response: Yes. A flowchart depicts the physical system and illustrates the type of task performed, the location of the performed task, and the person performing the task.

24.

How may batch processing be used to improve operational efficiency?

Response: A single transaction may affect several different accounts. Some of these accounts, however, may not need to be updated in real time. In fact, the task of doing so takes time which, when multiplied by hundreds or thousands of transactions, can cause significant processing delays. Batch processing of non-critical accounts, however, improves operational efficiency by eliminating unnecessary activities at critical points in the process.

25.

Why might an auditor use a program flowchart?

Response: When testing an application program, the auditor needs details about its internal logic to design the audit tests. This information can be provided by the program flowchart.

26.

How are system flowcharts and program flowcharts related?

Response: The system flowchart shows the relationship between two computer programs, the files that they use, and the outputs that they produce. However, this level of documentation does not provide the operational details that are sometimes needed. An auditor wishing to assess the correctness of a program’s logic cannot do so from the system flowchart. A program flowchart provides this detail. Every program represented in a system flowchart should have a supporting program flowchart that describes its logic.

27.

What are the distinguishing features of a legacy system?

Response: Legacy systems tend to have the following distinguishing features: they are mainframe-based applications, they tend to be batch-oriented, and early legacy systems use flat files for data storage. However, hierarchical and network databases are often associated with later-era legacy systems. These highly structured and inflexible storage systems promote a single-user environment that discourages information integration within business organizations.

28.

What are the two data processing approaches used in modern systems?

Response: batch processing and real-time processing

29.

How is backup of database files accomplished?

Response: Prior to each batch update or periodically (every few minutes), the master file being updated is copied to create a backup version of the original file. Should the current master be destroyed after the update process, reconstruction is possible in two stages.

First, a special recovery program uses the backup file to create a pre-update version of the master file. Second, the file update process is repeated using the previous batch of transactions to restore the master to its current condition.

30.

What information is provided by a record layout diagram?

Response: Record layout diagrams are used to reveal the internal structure of the records that constitute a file or database table. The layout diagram usually shows the name, data type, and length of each attribute (or field) in the record.

31.

In one sentence, what does updating a master file record involve?

Response: Updating a master file record involves changing the value of one or more of its variable fields to reflect the effects of a transaction.

32.

Comment on the following statement: “Legacy systems always use flat-file structures.”

Response: A flat-file structure is a single-view model that characterizes legacy systems in which data files are structured, formatted, and arranged to suit the specific needs of the owner or primary user of the system. Such structuring, however, may omit or corrupt data attributes that are essential to other users, thus preventing successful integration of systems across the organization. Legacy systems do not always use this flat-file structure. Some later-era legacy systems use hierarchical and network databases.

33.

Explain the technique known as destructive update.

Response: Destructive update involves replacing an old data value with a new value and thus destroying the original.

34.

What factor influences the decision to employ real-time data collection with batch updating rather that purely real-time processing? Explain.

Response: Transaction volume is the key factor. Large-scale systems that process high volumes of transactions often use real-time data collection and batch updating. Master file records that are unique to a transaction such as customer accounts and individual inventory records can be updated in real time without causing operational delays.

Common accounts should be updated in batch mode. Real-time processing is better suited to systems that process lower transaction volumes and those that do not share common records.

35.

What are the advantages of real-time data processing?

Response: In a real-time processing environment, the master files are updated as soon as the transaction is submitted and accepted into the system. Thus, reports are more accurate in the sense that the information is as current as possible. Faster operational response time to customer requests such as the shipping of an order is another very important benefit. Finally, the reduction of paper and storage space of physical source documents is another benefit.

36.

What are the advantages of real-time data collection?

Response: By collecting data in real-time, certain transaction errors can be prevented, or detected and corrected at their source.

37.

What are some of the more common uses of data codes in accounting information systems?

Response: Some of the more common uses are data codes in accounting information systems are: a. block codes for the general ledger accounts, b. sequential codes for documents, and c. group codes for coding transactions.

38.

Compare and contrast the relative advantages and disadvantages of sequential, block, group, alphabetic, and mnemonic codes.

Response: a. Sequential codes are appropriate for items in either an ascending or descending sequence, such as the numbering of checks or source documents. An advantage of sequential coding is that any gap detected in the sequence signals that a transaction may be missing. A disadvantage is that the codes carry little, if any, information other than the sequence order. Another disadvantage is that sequential codes are difficult to manage when items need to be added; the sequence needs either to be reordered or the items must be added to the end of the list. b. Block codes provide some remedies to sequential codes by restricting each class to a pre-specified range. The first digit typically represents a class, whereas the following digits are sequential items which may be spaced in intervals in case of future additions.

An example of block coding is a chart of accounts. A disadvantage of block coding is that the information content does not provide much meaning, i.e. an account number only means something if the chart of accounts is known. c. Group codes may be used to represent complex items or events involving two or more pieces of related data. The code is comprised of fields, which possess specific meaning.

The advantages of group codes over sequential and block codes are: 1. facilitating the representation of large amounts of diverse data, 2. allowing complex data structures to be represented in a hierarchical form that is logical (and therefore easier to remember), and 3. permitting detailed analysis and reporting within an item class and across different classes of items.

A disadvantage of group codes is that the codes may be overused to link classes, which do not need to be linked, and thus create an unnecessarily complex coding system. d. Alphabetic codes may be used sequentially, in block codes, or in group codes. An advantage of alphabetic codes is that a system using alphabetic codes can represent far more situations than a system with numeric codes (where each code has a specified field size). A disadvantage of alphabetic codes includes the fact that sequentially assigned

codes have little meaning. Also, people typically find alphabetic data more difficult to sort than numeric data. e. Mnemonic codes are alphabetic characters in the form of acronyms, abbreviations or other combinations that convey meaning. The advantage of mnemonic codes is inherent in the meaning of the code. A disadvantage of mnemonic codes is that they are limited in their ability to represents items within a class (i.e. names of all of American Express’s customers).

39.

What information is contained in a journal voucher?

Response: A journal voucher is used to make entries into the general ledger accounts.

The information may be a summary of many transactions or a single, unique transaction.

A journal voucher identifies the financial amounts and affected general ledger accounts.

40.

How are journal vouchers used as a control mechanism?

Response: Journal vouchers must be approved by an authorized person, and thus provide an effective control against errors and unauthorized general ledger entries.

41.

What information is contained in the general ledger master file?

Response: The general ledger master file is ordered by the chart of accounts. The account number, the account description, the asset class, the normal balance, beginning balance, total debits and total credits for the period, and the current balance are the typical pieces of information found in each record of a general ledger master file.

42.

What is the purpose of the general ledger history file?

Response: The purpose is to present comparative financial reports on a historic basis.

43.

What is the purpose of a responsibility center file?

Response: The responsibility center file is used to collect data regarding the revenues, expenditures and relevant resources of each responsibility center. Managers of responsibility centers are held accountable for the operations of their centers and the information found in these files helps to assess performance.

List the primary users of the FRS and discuss their information needs.

Response: The primary users of financial statement information are external users such as stockholders, creditors, and government agencies such as the IRS and the SEC. These users need information that allows them to assess performance over time and to compare performance with other organizations. The IRS needs financial information to determine whether the corporation is paying the appropriate amount of taxes, while the SEC requires the information of publicly traded organizations to ensure that the market place is fair to the average investor.

44.

45.

Name in order the eleven steps of the financial reporting process?

Response: i. capture the transaction ii. record in special journal iii. post to subsidiary ledger iv. post to the general ledger v. prepare the unadjusted trial balance vi. make adjusting entries vii. journalize and post adjusting entries viii. prepare the adjusted trial balance ix. prepare the financial statements

x. journalize and post the closing entries xi. prepare the post-closing trial balance 46.

What assumption is made regarding the external users of financial statements?

Response: The financial statements are prepared based upon the assumption that the users of financial reports understand the conventions and accounting principles that are applied, and that the financial statements have information content that is useful.

47.

When are adjusting entries made to the worksheet and what is their purpose? When are the corresponding voucher entries made?

Response: Adjusting entries are made after the regular accounting entries have been made and posted to the general ledger and any corresponding subsidiary ledgers. After an unadjusted trial balance of the general ledger has been prepared, the adjusting entries are made to correct any errors and to record any unrecorded transactions (i.e. accruals) during the period. The vouchers are prepared after the adjusting entries have been identified and made to the worksheet.

48.

What tasks should the general ledger clerk not be allowed to do?

Response: The general ledger clerks should not: a. have record keeping responsibility for special journals or subsidiary ledgers, nor b. prepare journal vouchers, or have custody of physical assets.

49.

What does XML stand for?

Response: XML stands for: eXtensible Markup Language; it is a meta-language for describing markup languages. The term extensible means that any markup language can be created using XML. This includes the creation of markup languages capable of storing data in relational form, where tags (formatting commands) are mapped to data values.

50.

What does XBRL stand for?

Response: XBRL stands for: eXtensible Business Reporting Language; it is an XMLbased language that was designed to provide the financial community with a standardized method for preparing, publishing, and automatically exchanging financial information, including financial statements of publicly held companies.

51.

What is an XBRL taxonomy?

Response: Taxonomies are classification schemes that are compliant with XBRL specifications to accomplish a specific information exchange or reporting objective such as filing with the SEC. Taxonomies specify the data to be included in an exchange or report.

52.

What is an XBRL instance document?

Response: An XBRL instance document is created by a computer by interpreting the embedded tags in the database. The XBRL instance document is the actual financial report.

53.

What is an XBRL tag?

Response: An XBRL tag is a formatting command that is mapped to data values to facilitate the generation of reports using XBRL.

DISCUSSION QUESTIONS 1.

Discuss the flow of cash through the transaction cycles. Include in your discussion the relevant subsystems and any time lags that may occur.

Response: Cash flows into the firm from sales made to customers. The sales order processing subsystem of the revenue cycle captures the intent of customers to exchange cash for services or goods manufactured. Typically sales are made on credit. The cash receipts subsystem of the revenue cycle captures the actual receipt of cash. Depending on the credit terms and promptness of payment by the customer, the lag between the sales order processing subsystem and the cash receipts subsystem may be days, weeks, or months.

The cash inflow allows the organization to purchase raw materials, pay workers, and buy capital assets necessary to manufacture the product (or to provide services). The raw `materials requirements are determined by the production planning subsystem of the conversion cycle. These requirements trigger orders being placed through the purchases/accounts payable subsystem of the expenditure cycle. For credit sales, the cash is ultimately released once the goods are received (or services are performed) and an invoice has been received. The lag between receiving goods and disbursement of cash may be days or weeks. Cash is also disbursed to employees, typically after services are rendered by the employees. The lag is usually no more than one-half a month for salaried employees and as short as one-half a week for hourly wage earners. The payroll subsystem of the expenditure system captures these disbursements to employees.

2.

Explain whether the cost accounting system primarily supports internal or external reporting.

Response: Initially, the cost accounting system was used for the valuation of inventory and cost of goods sold reported to external users; however, the valuable use of cost accounting data for budgeting, cost control, performance reporting, and management decision making have proved to be crucial internal support.

3.

Discuss the role of the conversion cycle for service and retailing entities.

Response: The conversion cycle activities for service and retailing entities include: planning the items to purchase or the services to produce, planning the workforce to accomplish the necessary tasks (extremely crucial in service entities), and directing the workforce in performing the service or selling the good.

4.

Can a turnaround document contain information that is subsequently used as a source document? Why or why not?

Response: Yes. For example, the remittance advice of a bill that is returned with the payment serves as a source document for the cash receipts transaction processing system.

Thus, the product document becomes a source document.

5.

Would the writing down of obsolete inventory be recorded in a special journal or the general journal? Why? Response: This type of transaction is recorded in the general journal since it is nonrecurring, infrequent, and not similar to other types of transactions.

6.

Are both registers and special journals necessary?

Response: Sometimes the terms are used interchangeably, for example, the sales journal is sometimes called the sales register. The term journal is appropriate when the

information needs to be ultimately posted to the general ledger. Registers may be used to keep logs of information that may support, but do not specifically get posted to the general ledger, such as a raw materials receipts register or a shipping log.

7.

Discuss the relationship between the balance in the accounts payable general ledger control account and what is found in the accounts payable subsidiary ledger.

Response: The balance in the general ledger is considered a control account. This amount is an aggregated number representing the total amount owed to creditors listed in the accounts payable journal. The accounts payable subsidiary ledger details the exact amount owed to each creditor. The sum of the amounts owed to each creditor listed in the accounts payable journal should equal the corresponding total in the general ledger control account. Thus, the accounts payable subsidiary ledger is a detailed breakdown of the summary of accounts payable in the general ledger control account.

8.

What role does the audit trail play in the task of confirmation?

Response: Confirmation is most typically used for confirming the accounts receivable account as reported on the balance sheet. The audit trail is used to trace from the general ledger accounts receivable control account to the subsidiary account, and then to specific customer accounts. A sample of the customer accounts is then selected for confirmation.

9.

Explain how the digital audit trail functions.

Response: In theory, the digital audit trail functions the same as a manual audit trail. In practice, the steps are slightly different. The archive file that consists solely of valid transactions is the file to which the accounts receivable subsidiary account balances and transactions are traced. The customers still need to be contacted for confirmation.

10.

Are large batch sizes preferable to small batch sizes? Explain.

Response: Small batches have the advantage of fewer transactions to sort through for error detection, but they are not processed as efficiently. Further, computing facilities and constraints might dictate whether multiple small batches may be processed throughout the day or whether a single large batch is processed at night when the computing facilities have excess capacity. (Multiple small batches may still be processed in the evening.)

11.

Discuss why an understanding of legacy system technologies is of some importance to auditors.

Response: Not all modern organizations use entirely modern information systems. Some firms employ legacy systems for certain aspects of their data processing. When legacy systems are used to process financially significant transactions, auditors need to know how to evaluate and test them.

12.

If an organization processes large numbers of transactions that use common data records, what type of system would work best (all else being equal)?

Response: Large-scale systems that process high volumes of transactions often use realtime data collection and batch updating. Master file records that are unique to a transaction, such as customer accounts and individual inventory records, can be updated in real time without causing operational delays. Common accounts should be updated in batch mode. Real-time processing is better suited to systems that process lower transaction volumes and those that do not share common records.

13.

If an organization processes transactions that have independent (unique) data needs, what type of system would work best (all else being equal)?

Response: Real-time processing is better suited to systems that process lower transaction volumes and those that do not share common records.

14.

Should an auditor wishing to assess the adequacy of separation of functions examine a data flow diagram or a system flowchart? Why? Response: The auditor should examine the system flowchart since it clearly depicts the separation of functions and illustrates who is responsible for performing specific processing steps. The dataflow diagram illustrates the logical system and is too general because many different physical designs may be applicable.

15.

Discuss some of the problems associated with general ledger systems that do not have data coding schemes.

Response: Un-coded data takes a great deal of recording space, is time-consuming to record and is prone to many types of errors. Consider a firm that manufactures bicycles and carries reflector lights in its inventory. The lights come in six sizes, two colors, and four different grades of material. Thus, 48 different varieties of reflector lights are held (6x2x4). Every time lights are purchased, the description would need to be included rather than a code. For example if 100 units of one type of reflector light were purchased, and 200 units of another were purchased from Collins Manufacturer in Roanoke, Virginia, the journal entry would be: Inventory-2”, yellow, metal reflector light 75 Inventory-3”, orange, plastic reflector light 120 A/P-Collins Mnf-Roanoke, VA 195 Some problems this approach may produce are: i. the sales staff will have a more tedious job in writing up orders, and more errors may occur (i.e. what if they forget to write the color or material type?), ii. the warehouse personnel will have a more difficult time locating and picking the goods for shipment, and again more errors may occur, and iii. the accounting personnel will also have a more tedious job posting to the subsidiary ledgers, which may prompt additional errors.

16.

For each of the following items, indicate whether a sequential, block, group, alphabetic, or mnemonic code would be most appropriate (you may list multiple methods; give an example and explain why each method is appropriate): Response: a. state codes—alphabetic code, i.e. PA, this method is appropriate because it corresponds with the postal services abbreviation and is meaningful to humans. b. check number—numeric, sequential. This method allows the checks to be examined to determine if any are missing. c. chart of accounts—block coding since this method allows a whole class of items to be restricted to a specific range. i.e. assets 100-199, liabilities 200-299, equity accounts, 300-399. d. inventory item number—alpha-numeric. The numeric portion allows the items to be easily sorted and found. The alphabetic portion allows more combinations to be made with fewer digits or characters. i.e. 2000A, 2000B, 2000C could represent virtually the same inventory item but in three different sizes. e. bin number (inventory warehouse location)—group codes since certain digits may be used to represent which warehouse, certain digits may be used to represent floor, certain

digits may be used to represent rows, certain digits may be used to represent bins. i.e.

211225 could represent warehouse 2, floor 1, row 12, and bin #25. f. sales order number—numeric, sequential. This method allows the sales orders to be examined to determine if any are missing. g. vendor code—alpha-numeric. The alphabetic portion allows more meaningful codes to be used and found. The numeric portion allows different firms with similar names to be distinguished. i.e. ALPH01, ALPH02 where ALPH01 is the vendor code for Alphahydraulics and ALPH02 is the vendor code for Alpha Trucking Services. Once the name of the company is known, finding the vendor code is much easier than if only numbers are used. h.invoice number—numeric, sequential. This method allows the invoices to be examined sequentially. Gaps in the sequence may signify missing invoices. i. customer number—same as for vendor code.

17.

Discuss any separation of duties necessary to control against unauthorized entries to the general ledger. What other control procedures regarding the general ledger should be employed?

Response: Since general ledger clerks have access to the general ledger, they should not have access to the journal vouchers in the source departments. If these journal vouchers were acquired by the general ledger clerks, or anyone else with authorization to enter the general ledger, these vouchers may be used to make unauthorized entries. Pre-numbering and logging these documents at their source provides a means of accountability.

18.

Discuss the various sources of data for the financial reporting system output and how these data are processed into information (output) for the different external users.

Response: The data comes from the various transaction processing departments.

Specifically, the cash receipts journal, sales journal, purchases journal, and any another miscellaneous transactions are the various sources of data which are input into the system. Once this data is input into the system, the general ledger, as well as subsidiary ledgers, are updated. After inspection of a trial balance of the general ledger accounts, any necessary adjustments and error corrections are made. Finally, the financial statements are prepared and distributed to the appropriate user groups.

19.

Explain how erroneous journal vouchers may lead to litigation and significant financial losses for a firm.

Response: If journal vouchers are missing, fabricated, or erroneous, and information is misrepresented in the financial statements, then any decisions made by investors and governmental agencies are based upon bad data. If an investor provides capital to a firm based upon its financial statements and these financial statements are incorrect, if the investor loses money once the corrections are made, the external user which suffered a loss may claim the firm was either fraudulent or negligent and sue for the lost amount.

Governmental agencies, such as the IRS, may impose severe penalties for inaccurate reporting of data.

20.

Ultimately, is the purpose of an audit trail to follow a transaction from its input through its processing and finally to the financial statements or vice versa? Explain your answer.

Response: Ultimately, the purpose is to be able to take any account on the financial statement and trace back to the source documents which comprise the number. However, the audit trail must also be examined from the other direction to ensure that all

transactions end up being reflected in the financial statements. In other words, if the financial statement balance for an account is traced back to the originating documents, then accuracy and verifiability is present, but completeness is not necessarily present.

Tracing a sample of source documents through to their effect on the financial statements allows the property of completeness to be verified.

21.

Discuss the benefits that may be realized in switching from a computerized batch processing system to a direct access storage system. Also, discuss any additional control implications.

Response: This system does not recreate the general ledger database each time it is updated. Thus processing efficiency results. Updates may be performed more frequently, which results in a general ledger with more current information which internal users should find beneficial. Also, errors may be noticed and corrected in a more timely fashion. A control issue which needs to be considered when switching from a computerized batch processing system to a direct access storage system is proper segregation of functions. The fundamental separation between authorizations and transaction processing no longer exists. Detailed report listings are provided for added control over transactions, which are processed. Another control issue is the accessibility of accounting records when they are stored on magnetic disks, which may be accessed by many different user groups. Access controls over the accounting files must be implemented.

22.

Controls are only as good as the predetermined standard on which they are based.

Discuss the preceding comment and give an example.

Response: If the standards are unrealistic or outdated, then variances will be reported constantly and probably ignored. For example, if 5 ounces of a raw material is set as the standard based upon past data, but the most realistic amount to be used for each unit is actually 5.25 ounces (the unit specifications have changed slightly), then the exception reports will constantly show a variance since the standard is not realistic given the design change. The manager will get used to seeing an unfavorable variance. If a machine begins to have problems and starts to require 5.5 ounces, then the unfavorable variance will increase, but the manager may not see the difference as readily since he/she is used to seeing an unfavorable variance in every report.

23.

Discuss three audit implications of XBRL. Response: Audit implications include the following: i. Taxonomy Creation. Taxonomy may be generated incorrectly, resulting in an incorrect mapping between data and taxonomy elements that could result in material misrepresentation of financial data. Controls must be designed and in place to ensure the correct generation of XBRL taxonomies. ii. Validation of Instance Documents. As noted, once the mapping is complete and tags have been stored in the internal database, XBRL instance documents (reports) can be generated. Independent verification procedures need to be established to validate the instance documents to ensure that appropriate taxonomy and tags have been applied before posting to Web server. iii. Audit Scope and Timeframe. Currently, auditors are responsible for printed financial statements and other materials associated with the statements. What will be the impact on the scope of auditor responsibility as a consequence of real-time distribution of financial statements across the Internet? Should auditors also be responsible for the accuracy of other related data that accompany XBRL financial statements, such as textual reports?

24.

Although HTML and XML documents look very similar, and both use tags, explain how they differ significantly as a financial reporting medium.

Response: Although both use tags (words that are bracketed by the symbols < and >) and attributes such as Doe, John, the way in which these tags and attributes are used differs.

In HTML the tags have predefined meaning that describes how the attributes will be presented in a document. In the case of the XML the tags are customized to the user, and the user’s application can read and interpret the tagged data.

MULTIPLE CHOICE QUESTIONS: 1.

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c a e b a d d c a c b b c b d c d c a c a

PROBLEMS: 1. TRANSACTION CYCLE IDENTIFICATION Required: Categorize each of the following activities into the expenditure, conversion, or revenue cycles and identify the applicable subsystem.

Response: a. Expenditure cycle-payroll subsystem. b. Conversion cycle-production planning and control subsystem. c. Revenue cycle-cash receipts subsystem. d. Revenue cycle-sales order processing subsystem. e. Expenditure cycle-purchases subsystem. f. Conversion cycle-production planning and control subsystem.

2. TYPES OF FILES Required: For each of the following records, indicate the appropriate related file structure: master file, transaction file, reference file, or archive file.

Response: a. master file b. transaction file c. reference file d. archive file e. master file f. transaction file g. reference file h. archive file

3. SYSTEM FLOWCHART Required: Develop a similar flowchart for the process of paying hourly employees.

Response:

Employee Employee Time Sheets

Cost Center Managers

Data Validation

Data Collection

Cost Center Reports

Discrepancy / Acceptance Reports

Employee Time Sheets

Payroll System

4. ENTITY RELATIONSHIP DIAGRAM Required: Describe the business rules represented by the cardinalities in the diagram.

Response: The receiving department is a department that prepares many purchase requisitions, which are sent to the purchasing department. The purchasing department prepares many purchase orders, which are sent to suppliers. The many different suppliers each may ship many different inventory items to the receiving department of the customer, although each purchase order will be for only one inventory item. The receiving clerk receives the many different inventory items and prepares a receiving report for each shipment that will relate to one purchase order.

5. ENTITY RELATIONSHIP DIAGRAM Required: Modify the diagram in problem 4 to deal with payments of merchandise purchased. Explain the business rules represented by the cardinalities in the diagram.

Response: The drawing for Problem 4 would be modified to add the supplier’s invoice. Each purchase order would correspond to an individual supplier’s invoice, and there could be many invoices from each supplier. One payment disbursement would be associated with each of the many possible invoices.

6. ENTITY RELATIONSHIP DIAGRAM Required: Prepare an entity relationship diagram, in good form, for the expenditure cycle, which consists of both purchasing and cash disbursements. Describe the business rules represented by the cardinalities in the diagrams.

Response: Business Rules:

An inventory item may be ordered many times from many suppliers. A purchase order may list many items and a supplier may supply many items.

A purchase order may be sent to only one vendor. A vendor may receive more than one purchase order.

An invoice comes from only one vendor, but a vendor may send more than one invoice.

7. SYSTEM FLOWCHART Required: Use the diagram for Problem 7 to answer the following questions: a. Symbol 1 is a terminal showing the source or destination of a document or report; symbol 2 is a course document or report. b. Symbols 3 and 4 depict the entry of data in real time into a system from a computer terminal. c. Symbols 4 and 5 depict the storage/ retrieval of data to/ from a computer disk. d. Symbols 6, 7, 8, and 9 depict the manual processing of source documents and its placement into a file.

8. SYSTEM FLOWCHART Required: Analyze the system flowchart on for Problem and describe in detail the processes that are occurring.

Response: Time sheets are collected in a batch, and the information is manually keyed into the system. This data is now stored on a magnetic disk. An editing program is run, which verifies whether the employee number is valid by checking it against an employee master file.

The validity of the cost center assigned is also verified against a master file. Logical and clerical errors should also be tested, such as an employee working an unreasonable number of hours in a day/week. Records that are found to be in error are sent to an error file. These errors need to be investigated and corrected. The good records are stored in a data file. The next program takes the edited transaction records, one at a time, and updates any corresponding fields in the master files. Finally, a report program generates paychecks and management reports.

9. SYSEM FLOWCHARTS AND PROGRAM FLOWCHART Required: From the diagram in Problem 8, identify three types of errors that may cause a payroll record to be placed in the error file. Use a program flowchart to illustrate the edit program.

Response: Any of the following types of errors may cause a payroll record to be placed in the error file: a. invalid employee number b. invalid cost center c. incorrect batch/ control total that does not equal the totals computed by the program A program flowchart is presented below:

10. DATA FLOW DIAGRAM Required: What are the four symbols used in a DFD, and what does each symbol represent?

Response: A rectangle is used to represent an entity. An entity might be the source of a document or activity, or the destination of a document.

A rectangle with rounded corners represents and a process.

A rectangle without the right most line represents a data store, i.e. a transaction file, a master file, or a reference file.

Arrows represent the flow and direction of information within the diagram.

11. TRANSACTION CYCLE RELATIONSHIP Required: Modify Figure 6-1 to reflect the transaction cycles you might find at a dentist’s office.

Response:

12. SYSTEM DOCUMENTATION—EXPENDITURE CYCLE (MANUAL PROCEDURES) Required: Prepare a data flow diagram and a system flowchart of the expenditure cycle procedures previously described.

Response:

13. RECORD STRUCTURES FOR RECEIPT OF ITEMS ORDERED Required: Prepare a diagram (similar to Figure 6-28) that presents the record structure for the receipt (receiving report) of inventory items ordered.

Receiving Report File (PK) (SK)

(SK)

(SK)

Receiving

Purchase

Inventory

Vendor

Quantity

Report

Order

Number

Number

Received

Number

Number

Purchase Order File Purchase

Condition

Inventory

Vendor

Quantity

Number

Number

Ordered

Order Number

Vendor Master File Vendor

Name

Address

Balance

Terms

Number

Inventory Master File Inventory Description

Quantity

Reorder

Number

On Hand

Point

EOQ

Unit Cost

14. SYSTEM DOCUMENTATION—PAYROLL Required: Prepare a data flow diagram and a system flowchart of the payroll procedures previously described.

Response:

15. SYSTEM DOCUMENTATION—PAYROLL Required: Assuming the payroll system described in Problem 14 uses database files and computer processing procedures, prepare a data flow diagram, an entity relationship diagram, and a systems flowchart.

Response:

is the

\ 16. SYSTEM DOCUMENTATION—REVENUE CYCLE MANUAL AND COMPUTER PROCESSES Required: Prepare a data flow diagram and a system flowchart of the revenue cycle procedures previously described.

Sales Department

Customer

Shipping Department

Billing Department

SO

A

SO

SO Customer Order

Prepare Sales Order

SO

SOSO SO

Pick Goods and Ship

T

Add Prices and Taxes

SO SO SO

SO SO

SO SOSO

SO

Record Sale

SO SO

Sales Journal

SO SOSO SO

Customer A

Problem 6-16 Flowchart Page 1

B

C

Inventory Control

Accounts receivable

SO

SO

Post to Accoun ts

SO

Receive and Distribute

Receiv e and Distri bute

Cash rec Journal

Check

Invent ory

Ac ct

Check

RA Check

Post to Accoun ts

Cash receipts

Custome r

C

D

B

Mail Room

RA

Dep Slip

Check

SO

Dep Slip

D

RA

Bank

Problem 6-16, Flowchart Page 2

SO1

Problem 6-16, DFD

Customer Order Customer SO1, SO2,

Prepare SO

SO4, SO5,

SO6

SO4

File

S O Bill Customer

Sale s

Update AR

SO5

SO6

Update Inventory

RA Check

File

Dep

Slip

Temp File

SO6

RA

Receive Mail

SO6

File

SO5

AR

SO4, SO5,

SO4, SO5, SO6

File

Check, RA

SO3

Ship Goods

SO3

Prep Dep Slip

CR Jour

Inventory

Dep Slip, Check

Bank

17. SYSTEM DOCUMENTATION—EXPENDITURE CYCLE (MANUAL AND COMPUTER PROCEDURES) Required: Prepare a data flow diagram and a system flowchart of the expenditure cycle procedures previously described.

Purchasing Department

Data Processing Center

Receiving Department

A

PO

Inspect Good and Review PO

PO Inventory Purchasing System

Rec Rept

Review and Sign PO

PO File Rec Rept PO Rec Rept

PO

Stores

SO SO Check

Purchases Journal

Check AP Sub

Supplier B

CD Journal

Problem 6-17 Flowchart Page 1

Accounts Payable

Cash Disbursements Dept B

Supplier Check Invoice

Check

A

Review and Sign Checks

Review and Reconcile

Check

Supplier

Problem 6-17 Flowchart Page 2

Check Copy

PO 1 Review Inventory and prepare PO

PO 1, 2

Review and sigh PO

File PO2 Supplier

Stores Inventory Check Rec Rept PO File

Post to AP and record in Purch Journal

Receive and inspect Goods Update Inventory

Rec Rept Record

File

Rec Rept

CD Journal

File

Review AP for Item Due and prepare Check

Check 1,2

Review, Sign, Distribute Check

AP Ledger Purch Journal

Invoice

Supplier

Problem 6-17 DFD

18. CODING SCHEME Required: Devise a coding scheme using block and sequential codes for the chart of accounts for Jensen Camera Distributors.

Response: 101.0 102.0 103.0 104.0 105.0 121.0 131.0 131.5 132.0 132.5 133.0

Cash Accounts Receivable Office Supplies Inventory Prepaid Insurance Inventory Investments in Marketable Securities Delivery Truck Accumulated Depreciation – Delivery Truck Equipment Accumulated Depreciation – Equipment Furniture and Fixtures

133.5 134.0 134.5 135.0 201.0 202.0 203.0 221.0 222.0 301.0 302.0 311.0 390.0 401.0 401.5 420.0 501.0 501.0 521.0 522.0 531.0 541.0 551.0 561.0 571.0

Accumulated Depreciation – Furniture and Fixtures Building Accumulated Depreciation – Building Land Accounts Payable Wages Payable Taxes Payable Notes Payable (Long-term) Bonds Payable Common Stock Paid in Capital in Excess of Par Treasury Stock Retained Earnings Sales Sales Returns and Allowances Dividend Income Cost of Goods Sold Wages Expense Utility Expense Office Supplies Expense Insurance Expense Depreciation Expense Advertising Expense Fuel Expense Interest Expense

19. CODING SCHEME Required: Devise a coding scheme for the warehouse layout shown in Problem 19.

Response: The following scheme uses group codes with alphabetic and numeric data since they can be used to categorize information in a hierarchical form.

Warehouse 1

Aisle C

Left or right Side of Aisle L

Shelf 5

Bin 08

Thus, code 1CL08 represents the above. 2AR415 represents inventory in warehouse #2, aisle A, right side of aisle, shelf 4, bin #15.

20. BACKUP AND RECOVERY PROCEDURES FOR DATABASE FILES Required: a. Which, if any, files contain noncorrupted data (transaction file, accounts receivable master file, sales master file, or backup master files)? b. Will a clerk have to reenter any data? If so, what data will have to be reentered?

c.

What steps will the company have to take to obtain noncorrupted master files that contain the previous day’s sales data?

Responses: a. Only the backup files can be presumed to be uncorrupted. b. The clerk will have to reenter the data for the previous day’s sales. c. The company will first have to restore the backed-up data to the computer. Once the clerk has reentered the sales data, this new transaction file will have to go through the edit process.

Finally, an updated master file(s) may be generated and then a new backup file created.

21. GENERAL LEDGER SYSTEM OVERVIEW Required: Draw a diagram depicting the relationship between the general ledger master file, control accounts, subsidiary files, and financial statements.

Response:

22. FINANCIAL REPORTING PROCESS Required: Place steps in the proper order and indicate whether each step is a function of the TPS, GLS, or FRS. Response 2 Record transaction in special journal TPS 6 Make adjusting entries FRS 1 Capture the transaction TPS 11 Prepare the post-closing trial balance FRS 8 Prepare the adjusted trial balance FRS 9 Prepare the financial statements FRS 7 Journal and post adjusting entries GLS 3 Post to the subsidiary ledger TPS 4 Post to the general ledger GLS 10 Journalize and post the closing entries GLS 5 Prepare the unadjusted trial balance FRS 23. XBRL Required: a. Research the current state of XBRL and determine if this technology is appropriate for internal reporting projects such as this. b. Identify the enhancements to current information and reporting that the company could realize by using XBRL. c. Discuss any data integrity, internal control, and reporting concerns associated with XBRL. Responses: a. Yes it is appropriate. XBRL is typically used for reporting aggregated financial data but can also be applied to communicating information pertaining to individual transactions and internal business units. To make the data useful to others they need to be organized, labeled, and reported in a manner that is generally accepted. This involves mapping the organization’s internal data to XBRL taxonomy elements to produce an XBRL instance document. Companies that use native-XBRL database technology internally as their primary information storage platform can speed the process of reporting. Users can import XBRL documents into internal databases and analysis tools to greatly facilitate decision making. b. i. Can provide the financial community with a standardized method for preparing, publishing, and automatically exchanging financial information, including financial statements of publicly held companies. ii. XBRL documents can be placed on an intranet server for internal use. iii. They can be placed on an extranet for dissemination to customers or trading partners. c. Controls must be designed and in place to ensure the correct generation of XBRL taxonomies. Independent verification procedures need to be established to validate the instance documents to ensure that appropriate taxonomy and tags have been applied before posting to Web server. Additionally, audit scope and responsibility needs to be assessed and implemented with respect to these documents.

24. INTERNAL CONTROL Required: Discuss any potential control weaknesses and problems in this scenario.

Responses: If Leslie is preparing the journal vouchers and/or posting to the subsidiary ledgers, she should not be entering the information into the general ledger. Performing these two functions is not in conformance with segregation of functions. A separate general ledger clerk should post the entries to the general ledger and reconcile the control accounts in the general ledger to the corresponding subsidiary ledger.

Having source documents, such as journal vouchers, without pre-assigned numbers is very risky. If a separate general ledger clerk did exist as mentioned above, this person could visit Leslie’s office and inconspicuously take a couple of journal vouchers without anyone knowing (since the forms are not numbered). The general ledger clerk could then enter unauthorized entries into the general ledger. Further, the possibility that Leslie makes an error in recording journal voucher numbers incorrectly is highly possible.

25. DATABASE GL SYSTEM Required: Redraw figure to reflect this change in the financial reporting process.

Response: See drawing on the following page. The only change made is that the daily sales transactions are used to immediately update the sales file. The daily applications create cumulative totals of each day’s transactions on disk. The totals are merged with the other applications’ totals prior to updating the general ledger and other database files.

26. DATABASE GL SYSTEM Required: Adjust figure to accommodate this request by top management, assuming that the nightly updates to the general ledger are sufficient.

Response:

27. INTERNAL CONTROL Required: Expand figure to incorporate the journal voucher listing and general ledger change report as control mechanisms. Also discuss the specific controls they impose on the system.

Response: The journal voucher listing and general ledger change reports allow the transactions to be analyzed for accuracy and completeness. Any errors noted can be changed and input into the system prior to preparing the financial statements. For Figure 8-10, the update general ledger procedure would include a listing of the journal voucher listing and general ledger change report. Again, any noted errors can be corrected prior to the generation of financial statements.