CHAPTER ONE

ACCOUNTING INFORMATION SYSTEMS: AN OVERVIEW

Learning objectives:
After studying this chapter, you should be able to:
Distinguish between data and information, discuss the characteristics of useful
information, and explain how to determine the value of information.
Explain what an accounting information system (AIS) is and describe the basic functions
it performs.
Discuss why a studying accounting information system is important.
Explain the role an AIS plays in a company`s value chain and discuss how the AIS can
add value to a business.
Discuss how an AIS can provide management with information for decision making.
Compare and contrast the basic strategies and strategic positions that a business can
adopt.

Systems, Data, and Information

What Is a System?
For many, the term system generates mental images of computers and programming. In fact, the
term has much broader applicability. Some systems are naturally occurring, whereas others are
artificial. Natural systems range from the atom—a system of electrons, protons, and neutrons—to
the universe—a system of galaxies, stars, and planets. All life forms, plant and animal, are
examples of natural systems. Artificial systems are manmade. These systems include everything
from clocks to submarines and social systems to information systems.
Regardless of their origin, all systems possess some common elements. To specify:
…A system is a group of two or more interrelated components or subsystems that serve a
common purpose.
Thus, a system is a set of two or more interrelated components that interact to achieve a goal.
Systems are almost always composed of smaller subsystems, each performing a specific function
important to and supportive of the larger system of which it is a part. For example, the college of
business is a system composed of various departments, each of which is a subsystem. Yet the
college itself is a subsystem of the university.
Each subsystem is designed to achieve one or more organizational goals. When the systems
concept is used in systems development, changes in subsystem cannot be made without
considering the effect on other subsystems and the system as a whole. In other words, every
organization has goals. The subsystems should be designed to maximize achievement of the
organization’s goals even to the detriment of the subsystem itself. For example, the production
department (a subsystem) of a company might have to forego its goal of staying within its
budget in order to meet the organization’s goal of delivering product on time.
Goal conflict occurs when a decision or action of a subsystem is inconsistent with the goals of
another subsystem or the system as a whole. Goal congruence is achieved when a subsystem
achieve its goals while contributing to the organization`s overall goal. In other words, goal
congruence occurs when the subsystem’s goals are in-line with the organization`s goals.

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Subsystems should maximize organizational goals, even if subsystem goals are not maximized.
The larger the organization and the more complicated the system, the more difficult it is to
achieve goal congruence.
The systems concept also encourages integration, which eliminates duplicate recording, storage,
reporting, and other processing activities in an organization. For example, companies that used to
have separate program to prepare customer statements, collect cash, and maintain accounts
receivable records now combine these functions into a single application.
Data are facts that are collected, recorded, stored, and processed by an information system. Data
usually represent observations or measurements of business activities that are of importance to
information system users. Data are facts stored in the system. A fact could be a number, a date,
name, and so on. For example, 22/2/2014, ABC Company, 123, 99, 3, 20, 60.
Several kinds of data need to be collected in businesses, such as:
▪ Facts about the activities that take place (i.e., events that occur)
▪ The resources that are affected by the activities
▪ The people (agents) who participate in the activity
For example, data need to be collected about a sales event (e.g., the date of sale, total amount),
the resources being sold (e.g., the identity of the goods or services, the quantity sold, unit price),
and the people who participated in the sale (e.g., the identity of the customer and the
salesperson).
Information is data that have been organized and processed to provide meaning to a user.
If we put those facts within a context of a sales invoice, for example, it is meaningful and
considered information.

Invoice Date: 22/2/2014 Invoice #: 123

Customer: ABC Company

Item # Quantity # Price Total Invoice Amount

99 3 $20 $60
Users typically need information to make decisions or to improve the decision making process.
As a general rule, users can make better decisions as the quantity and quality of information
increase.
However, there are limits to the amount of information the human mind can effectively absorb
and process. Information overload occurs when those limits are passed. For example, your final
exams week.
Information overload is costly, because decision-making quality declines while the costs of
providing that information increase. Consequently, information system designers must consider
how advances in information technology (IT) can help decision makers more effectively filter
and condense information, thereby avoiding information overload. For example, Wal-Mart has
over 500 terabytes (trillion of bytes) of data in its data warehouse. That is equivalent to 2000
miles of bookshelves or about 100 million digital photos. Wal-Mart has invested heavily in
technology so that it can effectively collect, store, and manage these data. Most important, it has

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spent a great deal of time and money figuring out how to turn all of these data into useful
information.
The value of information is the benefit produced by the information minus the cost of producing
it. The major benefits of information are:
✓ A reduction of uncertainty
✓ Improved decisions and
✓ A better ability to plan and schedule activities
The costs are the time and resources spent on:
✓ Collecting data
✓ Processing data
✓ Storing data
✓ Distributing information to decision makers
Unfortunately, determining the value of information is not easy. Information costs and benefits
can be difficult to quantify, and it is difficult to determine the value of information before it has
been produced and utilized. Nevertheless, the expected value of information should be calculated
as effectively as possible so information is not produced whose costs exceed its benefits.
Information can be provided to both internal and external users. The information supplied to
external users is either mandatory information required by a governmental entity (such as a
report to the Internal Revenue Service (IRS) on taxable income and withholdings) or essential
information required to conduct business with external parties (such as purchase orders and
customer billings).
In providing mandatory or essential information, the focus should be on:
Minimizing costs.
Meeting regulatory requirements.
Meeting minimum standards of reliability and usefulness.
Most internal information is discretionary information, since choices must be made regarding
what information should be made available, to whom, and how frequently. The primary
consideration in producing discretionary information is that its benefits exceed its costs i.e., the
information has positive value. Internal reporting is more difficult than external reporting
because most managerial decisions demand more detailed information than does external
reporting and there are more ways to report information to internal users than to external users.
Discussion Questions:
The value of information equals the difference between the benefits realized from using that
information and the costs of producing it. Would you, or any organization, ever produce
information if its expected costs exceeded its benefits? If so, provide some examples. If not, why
not?
Usually most organizations will only produce information if its value exceeds its cost. There are
two basic situations, however, in which information may be produced even if its costs exceed its
value. First, it is often difficult to accurately estimate the value of information and, sometimes,
the cost of producing it. Therefore, organizations may produce information that they expect will
produce benefits in excess of its costs, only to be disappointed after the fact. The second reason
is that production of the information may be mandated by either a government agency or a

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private organization. Examples include the tax reports required by the IRS and disclosure
requirements for financial reporting established by the Financial Accounting Standards Board.
Qualitative characteristics of useful financial information
If financial information is to be useful, it must be relevant and faithfully represent what it
purports to represent. The usefulness of financial information is enhanced if it is comparable,
verifiable, timely and understandable.
Fundamental qualitative characteristics
The fundamental qualitative characteristics are relevance and faithful representation.
Relevance
Relevant financial information is capable of making a difference in the decisions made by users.
Information may be capable of making a difference in a decision even if some users choose not
to take advantage of it or are already aware of it from other sources. Financial information is
capable of making a difference in decisions if it has predictive value, confirmatory value or both.
Financial information has predictive value if it can be used as an input to processes employed by
users to predict future outcomes. Financial information need not be a prediction or forecast to
have predictive value. Financial information with predictive value is employed by users in
making their own predictions. Financial information has confirmatory value if it provides
feedback about (confirms or changes) previous evaluations. The predictive value and
confirmatory value of financial information are interrelated. Information that has predictive value
often also has confirmatory value. For example, revenue information for the current year, which
can be used as the basis for predicting revenues in future years, can also be compared with
revenue predictions for the current year that were made in past years. The results of those
comparisons can help a user to correct and improve the processes that were used to make those
previous predictions.
Information is material if omitting it or misstating it could influence decisions that users make
on the basis of financial information about a specific reporting entity. In other words, materiality
is an entity-specific aspect of relevance based on the nature or magnitude, or both, of the items to
which the information relates in the context of an individual entity’s financial report.
Consequently, the Board cannot specify a uniform quantitative threshold for materiality or
predetermine what could be material in a particular situation.
Faithful representation
Financial reports represent economic phenomena in words and numbers. To be useful, financial
information must not only represent relevant phenomena, but it must also faithfully represent the
phenomena that it purports to represent. To be a perfectly faithful representation, a depiction
would have three characteristics.
It would be complete, neutral and free from error. Of course, perfection is seldom, if ever,
achievable. The Board’s objective is to maximize those qualities to the extent possible.
A complete depiction includes all information necessary for a user to understand the
phenomenon being depicted, including all necessary descriptions and explanations. For example,
a complete depiction of a group of assets would include, at a minimum, a description of the
nature of the assets in the group, a numerical depiction of all of the assets in the group, and a
description of what the numerical depiction represents (for example, original cost, adjusted cost

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or fair value). For some items, a complete depiction may also entail explanations of significant
facts about the quality and nature of the items, factors and circumstances that might affect their
quality and nature, and the process used to determine the numerical depiction.
A neutral depiction is without bias in the selection or presentation of financial information. A
neutral depiction is not slanted, weighted, emphasized, de-emphasized or otherwise manipulated
to increase the probability that financial information will be received favourably or unfavourably
by users. Neutral information does not mean information with no purpose or no influence on
behaviour. On the contrary, relevant financial information is, by definition, capable of making a
difference in users’ decisions. Faithful representation does not mean accurate in all respects. Free
from error means there are no errors or omissions in the description of the phenomenon, and the
process used to produce the reported information has been selected and applied with no errors in
the process. In this context, free from error does not mean perfectly accurate in all respects. For
example, an estimate of an unobservable price or value cannot be determined to be accurate or
inaccurate. However, a representation of that estimate can be faithful if the amount is described
clearly and accurately as being an estimate, the nature and limitations of the estimating process
are explained, and no errors have been made in selecting and applying an appropriate process for
developing the estimate.
A faithful representation, by itself, does not necessarily result in useful information. For
example, a reporting entity may receive property, plant and equipment through a government
grant. Obviously, reporting that an entity acquired an asset at no cost would faithfully represent
its cost, but that information would probably not be very useful. A slightly more subtle example
is an estimate of the amount by which an asset’s carrying amount should be adjusted to reflect an
impairment in the asset’s value. That estimate can be a faithful representation if the reporting
entity has properly applied an appropriate process, properly described the estimate and explained
any uncertainties that significantly affect the estimate. However, if the level of uncertainty in
such an estimate is sufficiently large, that estimate will not be particularly useful. In other words,
the relevance of the asset being faithfully represented is questionable. If there is no alternative
representation that is more faithful, that estimate may provide the best available information.
Applying the fundamental qualitative characteristics
Information must be both relevant and faithfully represented if it is to be useful. Neither a
faithful representation of an irrelevant phenomenon nor an unfaithful representation of a relevant
phenomenon helps users make good decisions. The most efficient and effective process for
applying the fundamental qualitative characteristics would usually be as follows (subject to the
effects of enhancing characteristics and the cost constraint, which are not considered in this
example). First, identify an economic phenomenon that has the potential to be useful to users of
the reporting entity’s financial information. Second, identify the type of information about that
phenomenon that would be most relevant if it is available and can be faithfully represented.
Third, determine whether that information is available and can be faithfully represented. If so,
the process of satisfying the fundamental qualitative characteristics ends at that point. If not, the
process is repeated with the next most relevant type of information.

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Enhancing qualitative characteristics
Comparability, verifiability, timeliness and understandability are qualitative characteristics that
enhance the usefulness of information that is relevant and faithfully represented. The enhancing
qualitative characteristics may also help determine which of two ways should be used to depict a
phenomenon if both are considered equally relevant and faithfully represented.
Comparability
Users’ decisions involve choosing between alternatives, for example, selling or holding an
investment, or investing in one reporting entity or another. Consequently, information about a
reporting entity is more useful if it can be compared with similar information about other entities
and with similar information about the same entity for another period or another date.
Comparability is the qualitative characteristic that enables users to identify and understand
similarities in, and differences among, items. Unlike the other qualitative characteristics,
comparability does not relate to a single item. A comparison requires at least two items.
Consistency, although related to comparability, is not the same. Consistency refers to the use of
the same methods for the same items, either from period to period within a reporting entity or in
a single period across entities. Comparability is the goal; consistency helps to achieve that goal.
Comparability is not uniformity. For information to be comparable, like things must look alike
and different things must look different. Comparability of financial information is not enhanced
by making unlike things look alike any more than it is enhanced by making like things look
different.
Some degree of comparability is likely to be attained by satisfying the fundamental qualitative
characteristics. A faithful representation of a relevant economic phenomenon should naturally
possess some degree of comparability with a faithful representation of a similar relevant
economic phenomenon by another reporting entity.
Although a single economic phenomenon can be faithfully represented in multiple ways,
permitting alternative accounting methods for the same economic phenomenon diminishes
comparability.
Verifiability
Verifiability helps assure users that information faithfully represents the economic phenomena it
purports to represent. Verifiability means that different knowledgeable and independent
observers could reach consensus, although not necessarily complete agreement, that a particular
depiction is a faithful representation. Quantified information need not be a single point estimate
to be verifiable. A range of possible amounts and the related probabilities can also be verified.
Verification can be direct or indirect. Direct verification means verifying an amount or other
representation through direct observation, for example, by counting cash. Indirect verification
means checking the inputs to a model, formula or other technique and recalculating the outputs
using the same methodology. An example is verifying the carrying amount of inventory by
checking the inputs (quantities and costs) and recalculating the ending inventory using the same
cost flow assumption (for example, using the first-in, first-out method).
It may not be possible to verify some explanations and forward-looking financial information
until a future period, if at all. To help users decide whether they want to use that information, it

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would normally be necessary to disclose the underlying assumptions, the methods of compiling
the information and other factors and circumstances that support the information.
Timeliness
Timeliness means having information available to decision-makers in time to be capable of
influencing their decisions. Generally, the older the information is the less useful it is. However,
some information may continue to be timely long after the end of a reporting period because, for
example, some users may need to identify and assess trends.
Understandability
Classifying, characterizing and presenting information clearly and concisely makes it
understandable. Some phenomena are inherently complex and cannot be made easy to
understand. Excluding information about those phenomena from financial reports might make
the information in those financial reports easier to understand. However, those reports would be
incomplete and therefore potentially misleading.
Financial reports are prepared for users who have a reasonable knowledge of business and
economic activities and who review and analyze the information diligently. At times, even well-
informed and diligent users may need to seek the aid of an adviser to understand information
about complex economic phenomena.
Applying the enhancing qualitative characteristics
Enhancing qualitative characteristics should be maximized to the extent possible. However, the
enhancing qualitative characteristics, either individually or as a group, cannot make information
useful if that information is irrelevant or not faithfully represented.
Applying the enhancing qualitative characteristics is an iterative process that does not follow a
prescribed order. Sometimes, one enhancing qualitative characteristic may have to be diminished
to maximize another qualitative characteristic. For example, a temporary reduction in
comparability as a result of prospectively applying a new financial reporting standard may be
worthwhile to improve relevance or faithful representation in the longer term. Appropriate
disclosures may partially compensate for non-comparability.
The cost constraint on useful financial reporting
Cost is a pervasive constraint on the information that can be provided by financial reporting.
Reporting financial information imposes costs, and it is important that those costs are justified by
the benefits of reporting that information. There are several types of costs and benefits to
consider. Providers of financial information expend most of the effort involved in collecting,
processing, verifying and disseminating financial information, but users ultimately bear those
costs in the form of reduced returns. Users of financial information also incur costs of analyzing
and interpreting the information provided. If needed information is not provided, users incur
additional costs to obtain that information elsewhere or to estimate it.
Reporting financial information that is relevant and faithfully represents what it purports to
represent helps users to make decisions with more confidence. This results in more efficient
functioning of capital markets and a lower cost of capital for the economy as a whole. An
individual investor, lender or other creditor also receives benefits by making more informed
decisions. However, it is not possible for general purpose financial reports to provide all the
information that every user finds relevant.

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In applying the cost constraint, the Board assesses whether the benefits of reporting particular
information are likely to justify the costs incurred to provide and use that information. When
applying the cost constraint in developing a proposed financial reporting standard, the Board
seeks information from providers of financial information, users, auditors, academics and others
about the expected nature and quantity of the benefits and costs of that standard. In most
situations, assessments are based on a combination of quantitative and qualitative information.
Because of the inherent subjectivity, different individuals’ assessments of the costs and benefits
of reporting particular items of financial information will vary. Therefore, the Board seeks to
consider costs and benefits in relation to financial reporting generally, and not just in relation to
individual reporting entities. That does not mean that assessments of costs and benefits always
justify the same reporting requirements for all entities. Differences may be appropriate because
of different sizes of entities, different ways of raising capital (publicly or privately), different
users’ needs or other factors.
WHAT IS AN AIS?
It has often been said that accounting is the language of business. If that is the case, then an
accounting information system (AIS) is the intelligence—the information-providing vehicle—
of that language. Accounting is a data identification, collection, and storage process as well as an
information development, measurement, and communication process. By definition, accounting
is an information system, since an AIS collects, records, stores, and processes accounting and
other data to produce information for decision makers.
An accounting information system (AIS) is a system that collects, records, stores, and processes
data to produce information for decision makers.
Figure 1.1: An AIS Processes Data to Produce Information for Decision Makers

An AIS can be a very simple paper-and-pencil-based manual system, a very complex system
using the very latest in computers or information technology, or something between these two
extremes. Regardless of the approach taken, the process is the same. The AIS and the people
who use it must still collect, enter, process, store, and report data and information. The paper and
pencil or the computer hardware and software are merely the tools used to produce the
information.
There are six components of an AIS:
1. The people who operate the system and perform various functions
2. The procedures and instructions, both manual and automated, involved in collecting,
processing, and storing data about the organization`s activities.
3. The data about the organization and its business processes.
4. The software used to process the organization`s data.

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 5. The information technology infrastructure, including computers, peripheral devices, and
network communications devices used to collect, store, process, and transmit data and
information.
6. The internal controls and security measures that safeguard the data in the AIS
Together, these six components enable an AIS to fulfill three important business functions:
1. Collect and store data about organizational activities, resources, and personnel.
Organizations have a number of business processes, such as making a sale or purchasing
raw materials, which are repeated frequently.
2. Transform that data into information that is useful for making decisions so
management can plan, execute, control, and evaluate activities, resources, and
personnel.
3. Provide adequate controls to safeguard the organization`s assets, including its data, to
ensure that the assets and data are available when needed and the data are accurate
and reliable. One function of the AIS is to provide adequate controls to ensure the
safety of organizational assets, including data. Many people, however, often view
control procedures as “red tape”. Discuss how controls can improve overall efficiency
and effectiveness. Well-designed controls should not be viewed as “red tape” because
they can actually improve both efficiency and effectiveness. Consider a control
procedure mandating weekly backup of critical files. Regular performance of this
control prevents the need to spend a huge amount of time and money recreating files
lost when the system crashes, if it is even possible to recreate the files at all. Similarly,
control procedures that require workers to design structured spreadsheets can help
ensure that the spreadsheet decision aids are auditable and are documented well
enough so that other workers can use them.

Why Study Accounting Information Systems?

This section explains several reasons why a student`s knowledge of accounting is not complete
without an understanding of accounting information systems.
Study of the AIS is Fundamental to Accounting
In Statement of Financial Accounting Concepts No. 2, the Financial Accounting Standards Board
defined accounting as being an information system. It also stated that the primary objective of
accounting is to provide information useful to decision makers. Therefore, it is not surprising the
Accounting Education Change Commission recommended that the accounting curriculum should
emphasize that accounting is an information identification, development, measurement, and
communication process. The commission suggested that the accounting curriculum should be
designed to provide students with a solid understanding of three essential concepts:
1. The use of information in decision making
2. The nature, design, use, and implementation of an AIS
3. Financial information reporting
In other words, accounting is an information-providing activity, so accountants need to
understand:
✓ How the system that provides that information is designed, implemented, and used.
✓ How financial information is reported.
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 ✓ How information is used to make decisions.
The other accounting courses you take (financial, managerial, tax, and auditing) focus on your
role as a user or provider of information (making journal entries, preparing or reading financial
statements or other reports, etc.). It is assumed that you have access to certain data and can
address questions about how to account for, report, or audit the information. For example, a
managerial accounting class may discuss how to use information to make decisions but never
discuss how information is collected, stored, or made available to the decision maker. The
question of where the information comes from is often not even asked in these classes. The
answer is that the AIS provides the information.
In contrast, the AIS course focuses on understanding how the accounting system works:
✓ How to collect data about an organization`s activities and transactions;
✓ How to transform that data into information that management can use to run the
organization;
✓ How to ensure the availability, reliability, and accuracy of that information.
Thus, the AIS course complements the other accounting system courses you take.
The AIS course focuses on the flow of accounting information in the organization from a systems
perspective. The AIS course traces the origin, processing, storing, and ultimate disposal of
information. An AIS course also focuses on business processes, organization structure,
information systems, and corporate planning and goals.
The accounting information systems class is unlike most other accounting classes. It is not a
number-crunching course─ the course is more concept driven than numbers driven. Some
students feel the AIS is more ambiguous than other accounting courses because there often are
no numbers to crunch to get the “one right answer.” Instead, there may be two or three or more
“right answers.” There are choices among alternative ways to develop an AIS or gather data and
process it to produce information. Each alternative will work, but each has pros and cons. The
developer must select the best mix of advantages and disadvantages to solve a problem or
achieve a desired result.
AIS Skills are Important to Your Career Success
You may intend to pursue a career in public accounting. Auditors need to evaluate the accuracy
and reliability of information produced by the AIS. To do so they must understand how a system
is developed, how it operates, and how it can be properly controlled. They must be able to
evaluate and understand the strengths and weaknesses of an AIS. This course provides you with
that knowledge; indeed, that is why many universities make the AIS course a prerequisite to the
auditing course.
If you specialize in tax, you need to understand enough about your client’s AIS adequately to be
confident that the information used for tax planning and compliance work is complete and
accurate.
Many students work in private industry or for not-for-profit organizations. Accounting
systems work is one of the most important activities performed by corporate accountants. Other
important activities include designing internal control systems, business process improvements,
and long-term strategic planning.

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A third career option is management consulting. One of the fastest-growing types of consulting
services entails the design, selection, and implementation of a new AIS. Indeed, the American
Institute of Certified Public Accountants (AICPA) has recently created a new credential, the
Certified Information Technology Professional (CITP), to provide CPAs with a means of
documenting their systems expertise. The AIS course provides an introduction to that body of
knowledge.
The AIS course complements other systems courses
Many other systems courses help you develop specialized skills in such areas as the design and
implementation of information systems, databases, expert systems (i.e., a computer program that
applies artificial-intelligence methods to problem-solving), and telecommunications. The AIS
differs from these information systems courses in its focus on accountability and control. These
issues are important because in most large businesses the managers are not the owners. Instead,
the owners have entrusted management with the assets and hold them accountable for their
proper use. Data and information are some of an organization`s most valuable assets. To see
why, consider what would happen if an organization lost all information about customers`
balances, or if a competitor obtained a list of its most profitable customers. Clearly, the AIS must
include controls to ensure the safety and availability of the organization`s data. Controls are also
needed to ensure that the information produced from that data is both reliable and accurate.
These topics usually receive little attention in other systems courses. Thus, the AIS course
complements other systems courses you may take and is an important part of the information
systems curriculum.
The Impact of the AIS on Corporate Strategy and Culture
Since most organizations have limited resources, it is important to identify the AIS
improvements likely to yield the greatest return. Making a wise decision requires an
understanding of the organization’s overall business strategy.
Three factors that influence the design of an AIS includes:
1. Developments in information technology (IT)
2. Business strategy and
3. Organizational (occupational) culture
Figure 1.1: Factors influencing design of the AIS

Organizational Business
Culture Strategy

AIS

Information
Technology
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The business press frequently report ways IT is changing the way accounting and other business
activities are performed. The AIS course, however, is more than a “computer course”.
Information technology affects the company’s choice of business strategy. For example, an
important IT developments include the widespread deployment of wireless networking and the
move to replace bar code technologies with radio frequency identification (RFID) tags because
such development`s affect business processes and often cause organizations to redesign their
accounting systems to take advantage of new capabilities. To perform cost-benefit analyses on
IT changes, you need to understand business strategy. This requires developing a basic
understanding of business strategies and how IT can be used to implement them, as well as how
new IT developments create an opportunity to modify those strategies. Developments in IT
affect both an organization`s strategy and the design of its AIS. How can a company
determine whether it is spending too much, too little, or just enough on IT? There is no easy
answer to this question. Although a company can try to identify the benefits of a new IT
initiative and compare those benefits to the associated costs, this is often easier said than done.
Usually, it is difficult to precisely measure the benefits of new uses of IT. Nevertheless,
companies should gather as much data as possible about changes in market share, sales trends,
cost reductions, and other results that can plausibly be associated with an IT initiative and
that were predicted in the planning process.
Although the organization`s culture should influence the design of its AIS, it is important to
recognize that the design of the AIS can also influence the organization`s culture by controlling
the flow of information within the organization. For example, an AIS that makes information
easily accessible and widely available is likely to increase pressures for more decentralization
and autonomy. Organizational culture and the design of an AIS influence one another. What
does this imply about the degree to which an innovative system developed by one company can
be transferred to another company? Since people are one of the basic components of any
system, it will always be difficult to successfully transfer a specific information systems design
intact to another organization. Considering in advance how aspects of the new organizational
culture are likely to affect acceptance of the system can increase the chances for successful
transfer. Doing so may enable the organization to take steps to mitigate likely causes of
resistance. The design of an AIS, however, itself can influence and change an organization`s
culture and philosophy. Therefore, with adequate top management support, implementation of
a new AIS can be used as a vehicle to change an organization. The reciprocal effects of
technology and organizational culture on one another, however, mean that it is unrealistic to
expect that the introduction of a new AIS will produce the same results observed in another
organization.
Discussion Questions
How does an organization`s line of business affect the design of its AIS? Give several examples
of how differences among organizations are reflected in their AISs.
An organization’s AIS must reflect its line of business. For example:

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 • Manufacturing companies will need a set of procedures and documents for the
production cycle; non-manufacturing companies do not.
• Government agencies need procedures to separately track all inflows and outflows
from various funds, to ensure that legal requirements about the use of specific funds
are followed.
• Financial institutions do not need extensive inventory control systems.
• Passenger service companies (e.g., airlines, bus, and trains) generally receive
payments in advance of providing services. Therefore, extensive billing and accounts
receivable procedures are not needed; instead, they must develop procedures to
account for prepaid revenue.
• Construction firms typically receive payments at regular intervals, based on the
percentage of work completed. Thus, their revenue cycles must be designed to
carefully track all work performed and the amount of work remaining to be done.
• Service companies (e.g., public accounting and law firms) do not sell physical goods
and, therefore, do not need inventory control systems. They must develop and
maintain detailed records of the work performed for each customer to provide backup
for the amounts billed.
Tracking individual employee time is especially important for these firms because labor is the
major cost component.
The Role of the AIS in the Value Chain
To provide value to their customers, most organizations perform a number of different activities.
While “adding value” is a commonly used buzzword, in its genuine sense, it means making the
value of the finished component greater than the sum of its parts. It may mean making it faster,
making it more reliable, providing better service or advice, providing something in limited
supply (like O-negative blood or rare gems), providing enhanced features, or customizing it.
Value is provided by performing a series of activities referred to as the value chain. A value
chain is a set of activities that a firm operating in a specific industry performs in order to deliver
a valuable product or service for the market. Value chain activities include primary and support
activities (sometimes referred to as “line” and “staff” activities respectively). The concept of a
value chain was introduced in 1985 by Michael Porter in his book entitled Competitive
Advantage. Romney and Steinbart also cite an article by Michael Porter and Victor A. Millar.
“How Information Gives You Competitive Advantage” Harvard Business Review, July-
August 1985.

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 Figure 1.2: The Value Chain
Support Activities

1. Firm infrastructure
2. Human resources
3. Technology
4. Purchasing

1. Inbound 2. Operations 3. Outbound 4. Marketing 5. Services

Logistics and Sales
Manufacturing Logistics
Repair
Receiving
Repackaging Distribution Advertising
and Maintenance
Storing Shipping Selling
Materials

Primary Activities
An organization`s value chain consists of five primary activities that directly provide value to its
customers:
1. Inbound logistics—consists of receiving, storing, and distributing the materials that are
inputs used by the organization to create the services and products that it sells. For
example, the activities of receiving, handling, and storing the steel, glass, and rubber
comprise the inbound logistics activities for an automobile manufacturer. For a
pharmaceutical company, for example, this activity might involve handling incoming
chemicals and elements that will be used to make their drugs.
2. Operations/productions activities—transform inputs into final products or services
(outputs). It is concerned with managing the process that converts inputs (in the forms of
raw materials, labor, and energy) into outputs (in the form of goods and/or services). For
example, the assembly line activities at an automobile manufacturer convert raw
materials into a finished car. For the pharmaceutical company, for example, this step
involves combining the raw chemicals and elements with the work of people and
equipment to produce the finished drug product that will be sold to customers.
3. Outbound logistics—are the activities involved in distributing goods or services to
customers. It is the process related to the storage and movement of the final product and
the related information flows from the end of the production line to the end user. For
example, shipping automobiles to car dealers is an outbound logistics activity. For the
pharmaceutical company, for example, this step involves packaging and shipping the
goods to drug stores, doctors, and hospitals.

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 4. Marketing and sales—refers to the activities involved in helping customers to buy the
organization`s products and services. It involves selling a product or service and
processes for creating, communicating, delivering, and exchanging offerings that have
value for customers, clients, partners, and society at large. Advertising is an example of a
marketing and sales activity. For the pharmaceutical company, for example, a
pharmacy representative may visit with drug stores, doctors, etc. to inform them about
their products and take orders.
5. Service activities—provide post-sale support to customers. It includes all the activities
required to keep the product/service working effectively for the buyer after it is sold and
delivered. Examples include repair and maintenance services. A pharmaceutical firm
will typically not be repairing its product (though the product may be periodically
reformulated). The pharmaceutical company is more likely to be providing advisory
services to pharmacists, etc.

Support activities allow the five primary activities to be performed efficiently and effectively.
They are grouped into four categories:
1. Firm infrastructure─ refers to the accounting, finance, legal, control, public relations,
quality assurance, general (strategic) management and general administration activities
that allow an organization to function. The AIS is part of the firm infrastructure.
2. Human resources activities─ include recruiting, hiring, training, and providing
employee benefits and compensation and if necessary, dismissing or laying off personnel.
3. Technology activities─ improve a product or service. Technological development
pertains to the equipment, hardware, software, procedures and technical knowledge
brought to bear in the firm's transformation of inputs into outputs. Examples include
research and development, investments in new information technology, web site
development, and product design. For the pharmaceutical company, for example, these
activities would include research and development to create new drugs and modify
existing ones.
4. Purchasing activities─ procure raw materials, supplies, machinery, and the buildings
used to carry out the primary activities. In the pharmaceutical company, the purchasing
folks are trying to get the best combination of cost and quality in buying chemicals,
supplies, and other assets the company needs to run its operations.

Primary and support activities systems have multiple activities. For example, the sales and
marketing system includes market research, calling on customers, order processing, and credit
approval activities.
Information technology can be used to redesign supply chain systems, yielding tremendous
benefits and large cost savings. In other words, information technology can facilitate synergistic
linkages that improve the performance of each company’s value chain.
The primary and support activity systems are subsystems of the value chain system. In addition,
an organization`s value chain is itself a part of a larger system called a supply chain, which is an
extended system that includes an organization`s value chain as well as its suppliers, distributors,
and customers.

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Figure 1-3: The Supply Chain

Raw Materials
Supplier

Manufacturer

Distributor

Retailer

Consumer

By paying attention to the interorganizational linkages in its supply chain, a company can
improve its performance by helping the other organizations in the supply chain to improve their
performance.
Forward integration: integration with a later production stage (i.e., integration between
manufacturer and consumer)
Backward integration: integration with an earlier stage of production (i.e., integration
between manufacturer and supplier)

How an AIS can Add Value to an Organization

As a support activity, the AIS adds value by providing accurate and timely information so the
five primary value chain activities can be performed more effectively and efficiently. A well-
designed AIS can do this by:
1. Improving the quality and reducing the costs of products or services. For example, an
AIS can monitor machinery so operators are notified immediately when performance
falls outside acceptable quality limits. This helps maintain product quality. It also reduces
the amount of wasted materials and the costs of having to rework anything.
2. Improve efficiency. A well-designed AIS can make operations more efficient by
providing more timely information. For example, a just-in-time manufacturing approach
requires constant, accurate, up-to-date information about raw materials inventories and
their locations.
3. Sharing knowledge. A well-designed AIS can make it easier to share knowledge and
expertise, perhaps thereby improving operations and even providing a competitive
advantage. For example, the largest public accounting firms all use their information
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 systems to share best practices and to support communication between people located at
different offices. Employees can search the corporate database to identify the relevant
experts to provide assistance for a particular client; thus, all of a public accounting firm`s
accumulated international expertise can be made available to service any local client.
4. Improving the efficiency and effectiveness of its supply chain. For example, allowing
customers to directly access the company`s inventory and sales order entry systems can
reduce the costs of sales and marketing activities. Moreover, if such access reduces
customers` costs and time of ordering, both sales and customer retention rates may
increase. Of course, creating such interorganizational information systems raises new
control concerns that must be addressed. It also requires increased reliability and
accuracy of the data in the accounting information system.
5. Improving the internal control structure. Security, control, and privacy are important
issues in today`s world. An AIS with the proper internal control structure can protect
systems from problems such as fraud, errors, equipment and software failures, and
natural and political disasters.
6. Improving decision making.
Providing Information for Decision Making
Decision making is a complex, multistep activity: identify the problem, collect and interpret
information, evaluate ways to solve the problem, select a solution methodology, and implement
the solution. An AIS can provide assistance in all phases of decision making. Reports can help to
identify potential problems. Decision models and analytical tools can be provided to users.
Query languages can gather relevant data to help make the decision. Various tools, such as
graphical interfaces, can help the decision maker interpret decision model results, evaluate them,
and choose among alternative courses of action. In addition, the AIS can provide feedback on the
results of actions.
Information can improve decision making in several ways:
▪ It identifies situations requiring management action. For example, a cost report with
a large variance might stimulate management to investigate and, if necessary, take
corrective action.
▪ It provides a basis for choosing among alternative actions by reducing uncertainty.
For example, information is used to set prices and determine credit policies.
▪ It can store information about the results of previous decisions, which provides
valuable feedback that can be used to improve future decisions. For example, if a
company tries a particular marketing strategy and the information gathered indicates
that it did not succeed, the company can use that information to select a different
marketing strategy.
▪ An AIS can improve decision making by providing accurate information in a timely
manner. For example, Wal-Mart has created an enormous database that contains
detailed information about sales transactions at each of its stores. It uses this
information to optimize the amount of each product carried at each store.
▪ It can analyze sales data to discover items that are purchased together, and it can
use such information to improve the layout of merchandise or to encourage

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 additional sales of related items. For example, Amazon uses its sales database to
suggest additional books for customers to purchase.
The degree to which an AIS can support decision making depends, however, on the type of
decision being made. Decisions can be categorized either in the terms of the degree of structure
that exists or by their scope.
Decision Structure
Decisions vary in terms of the degree to which they are structured.
a. Structured decisions—are repetitive, routine and understood well enough that they can be
delegated to lower-level employees in the organization. Structured decisions can often be
automated (i.e., done by prior arrangement). For example:
✓ The decision about extending credit to established customers only
requires knowledge about the customer`s credit limit and current
balance.
✓ Deciding whether to write an auto insurance policy for a customer with
a clean driving history.
b. Semi-structured decisions— are characterized by incomplete decision making rules and the
need for subjective assessments and judgments to supplement formal data analysis. Although
such decisions usually cannot be fully automated, they are often supported by computer-
based decision aids. Examples include:
✓ Setting a marketing budget for a new product
✓ Deciding whether to sell auto insurance to a customer with a tainted
driving history
c. Unstructured decisions— are non-recurring and non-routine. No framework or model exists
to solve such problems. Instead, they require considerable judgment and intuition (i.e., it
requires a great deal of subjective assessment). Nevertheless, unstructured decisions can be
supported by computer-based decision aids that facilitate gathering information from diverse
sources. Examples include:
✓ Choosing the cover for a magazine
✓ Hiring senior management
✓ Selecting basic research projects to undertake
✓ Deciding whether to begin selling a new type of insurance policy
Decision Scope
Decisions vary in terms of their scope.
a. Occupational (operational) control decisions—relates to the effective and efficient
performance of specific tasks. It often of a day-to-day nature. For example,
✓ Decisions relating to inventory management and extending credit
✓ Deciding whether to order inventory
b. Management control decisions—relates to the effective and efficient use of resources
for accomplishing organizational objectives. Examples include decisions relating to:
✓ Budgeting
✓ Developing human resource practices and
✓ Deciding on research projects and product improvements

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 c. Strategic planning decisions—relates to establishing organizational objectives and
policies for accomplishing those objectives. The “what do we want to be when we grow
up” types of questions relates to strategic planning. Examples include decisions
relating to:
✓ Setting financial and accounting policies
✓ Developing new product lines and
✓ Acquiring new businesses

A correspondence exists between a manager`s level in an organization and his or her decision-
making responsibilities.
✓ Top management faces unstructured and semi-structured decisions involving
strategic planning issues.
✓ Middle managers deal with semi-structured decisions involving management
control.
✓ Lower-level supervisors and employees face semi-structured or structured
decisions involving operational control.
The AIS and Corporate Strategy
There are many opportunities to invest in IT to improve decision making. Most organizations,
however, do not have unlimited resources to invest in improving their information systems.
Therefore, it is important to identify which potential AIS improvements are likely to yield the
greatest return. Making this decision wisely requires an understanding of the organization`s
overall business strategy.
Strategies and Strategic Positions
Michael Porter, world-renowned professor of business at Harvard, argues that there are two basic
business strategies that companies can follow:
1. A product-differentiation strategy entails adding some features or services to your
product that are not provided by competitors. Doing so allows a company to charge a
premium price to its customers. A product-differentiation strategy involves setting your
product apart from those of your competitors, i.e., building a “better” mousetrap by
offering one that’s faster, has enhanced features, etc.
2. A low-cost strategy entails striving to be the most efficient producer of a product or
service. A low-cost strategy involves offering a cheaper mousetrap than your
competitors. The low cost is made possible by operating more efficiently.
Sometimes a company can succeed in both producing a better product than its competitors and in
doing so at costs below its industry average. Usually, however, companies must choose between
the two basic strategies. If they concentrate on being the lowest cost producer, they will have to
forgo some value-added features that might differentiate their product. If they focus on product
differentiation, they most likely will not have the lowest costs in their industry. Thus, a business
strategy involves making choices.

Porter also argues that the fundamental choice companies must make involves selecting specific
position they wish to adopt. He describes three basic strategic positions:

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1. A variety-based strategic position (do what you do best) involves producing or
providing a subset of the industry`s products or services. For example, an insurance
company that only offers life insurance as opposed to life, health, property-casualty, etc
2. A needs-based strategic position (do everything, but only for a particular group of
customers) involves trying to serve most or all of the needs of a particular group of
customers. This entails first identifying a target market. For example, American
Association of Retired Persons (AARP) focuses on retirees. For example, the
original Farm Bureau-based insurance companies provided a portfolio of insurance
and financial services tailored to the specific needs of farmers.
3. An access-based strategic position (go where your customers are) involves serving a
subset of customers who differ from other customers in terms of factors such as
geographic location or size, which creates different requirements for serving those
customers. For example, Satellite Internet services are intended primarily for
customers in rural areas who cannot get digital subscriber line (DSL), which is a high-
speed telephone line supplying telephony, television, and Internet access or cable
services. Or the stock brokerage offices of Edward Jones are located primarily in
smaller towns and cities not served by the larger brokerage houses.
Porter explains that these three basic strategic positions are not mutually exclusive and,
indeed, often overlaps. For example, Southwest Airlines employs a variety-based strategic
position because it only offers a subset of the products produced by the airline industry (no first-
class seating, no meals, no international flights). Southwest also employs a need-based strategic
position in that it has identified a specific target market (price-sensitive leisure travelers) for
which it designs its services. Finally, Southwest employs an access-based strategic position
because it does not service all markets.
Choosing a strategic position is important because it helps/enables a company focus its efforts;
otherwise it risks trying to be everything to everybody. For example, a radio station that tries to
play all types of music will probably fail. Porter argues that the specific strategic position an
organization selects is not important. What is important is to design the organization’s activities
so they mutually reinforce one another in filling (or achieving) the selected strategic position and
implementing the business strategy. This results in synergy, wherein the entire system of
organizational activities is greater than the sum of each individual part. This makes it difficult for
competitors to successfully imitate, because they must do more than just mimic specific
procedures. Indeed, companies that have achieved a high degree of fit among their activities
often do not worry about keeping their process secret from competitors because they know that
they cannot be adopted piecemeal.
Information Technology and Business Strategy
IT developments can affect business strategy. The growth of the Internet is a classic illustration.
It has profoundly affected the way many value chain activities are performed. For example, the
Internet enables organizations to significantly streamline their inbound and outbound logistics
activities. The Internet also significantly affects both strategy and strategic positioning. For
example, the Internet dramatically cuts costs, thereby helping companies to implement a low-
cost strategy. If every company in a given industry, however, uses the Internet to adopt a low-

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cost strategy, then the effects may be problematic. Indeed, one possible outcome may be intense
price competition among firms, with the likely result that most of the cost savings provided by
the Internet get passed on to the industry`s customers, rather than being retained in the form of
higher profits. Moreover, because every company can use the Internet to steamline its value
chain activities, it is unlikely that any particular company will be able to use the Internet to gain
a sustainable long-term competitive advantage vis-à-vis its competitors. Therefore, once the
majority of companies in an industry being to fully integrate the Internet into their value chains,
the effect may be to encourage companies to shift from following primarily a low-cost strategy
toward adopting some form of product differentiation strategy.
The Internet may also affect the relative desirability of following the three strategic positions
described previously. For example, by drastically reducing or eliminating geographic barriers,
the Internet makes a company`s products available almost anywhere. Consequently, it may be
more difficult to establish and maintain an access-based strategic position.

The Internet Makes Strategy More Important Than Ever

The Internet has changed the way business processes are performed. It has also dramatically
affected the five characteristics that determine the profitability of an entire industry:
• The bargaining power of buyers,
• The bargaining power of suppliers,
• Barriers to entry,
• The threat of substitute products or services,
• The level of rivalry among existing competitors.
Unfortunately for companies in most industries, the development of the Internet has tended to
increase the relative power of one or more of these five factors, thereby decreasing the overall
profitability of the average firm in a given industry.
The Internet has reduced barriers to entry in many industries by reducing or eliminating the need
to invest in and develop specific assets, such as a dedicated sales force. It increases the power of
buyers by reducing switching costs and simplifying detailed comparisons across products and
services. The Internet creates new methods of performing basic business process, thereby
creating new substitute products and services. It enables suppliers to bypass (avoid)
intermediaries and sell directly to end consumers. Finally, because the Internet decreases the
level of variable costs relative to fixed costs, it increases pressures to compete more on price.
As a result of these factors, many companies find that although the Internet has made them more
efficient and effective, they are unable to retain much of those benefits in the form of increased
profits. In fact, if a company is not careful, it can find itself drawn into a vicious level of price
competition that benefits only consumers. The only way companies can avoid that trap is to
define a strategy and stake out a strategic position that effectively differentiates themselves from
their competitors. Thus, the most important effect of the development of the Internet is the
increased importance of strategy.
Many other technological advances affect company strategy and provide an opportunity to gain a
competitive advantage. An example is predictive analysis, which uses data warehouses and
complex algorithms to forecast future events, based on historical trends and calculated

21
probabilities. Predictive analysis provides an educated guess of what one may expect to see in
the near future, allowing companies to make better business decisions and improve their
processes.
An organization`s AIS plays an important role in helping it adopt and maintain a strategic
position. Achieving a close fit among activities requires that data be collected about each
activity. It is also important that the information system collect and integrate both financial and
nonfinancial data about the organization`s activities.
Discussion Questions:
One interest property of digital assets is that they can be reproduced and distributed via the
Internet at very little cost. What are some of the implications of having a product with a marginal
cost close to zero?
Initially, if a product has a marginal cost (i.e., additional cost of producing one more item for
sale) of production and distribution that is close to zero, there is the potential to significantly
increase profits. An important issue, however, is whether the asset in question is unique. If other
companies can provide the same product, or a close substitute, then intense price competition
may ensue. In a free market, the result is likely to reflect a basic economic principle that
marginal revenue = marginal cost. There are also accounting policy implications to digitized
assets: how to value the asset, how to account for its use (depreciation or amortization), and how
to safeguard that asset from misappropriation.
“END OF CHAPTER ONE”

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