CHAPTER 12: The Production Cycle

PRODUCTION CYCLE ACTIVITIES

1. PRODUCT DESIGN
The objective of product design is to design a product that
strikes the optimal balance of:
Meeting customer requirements for quality,
durability, and functionality; and
Minimizing production costs.
Simulation software can improve the efficiency and
effectiveness of product design.
Key documents and forms in product design:
Bill of Materials: Lists the components that are
required to build each product, including part
numbers, descriptions ,and quantity.
OperationsList: Lists the sequence of steps
required to produce each product, including the
equipment needed and the amount of time required.
Role of the accountant in product design:
Participate in the design, because 65-80% of
product cost is determined at this stage.
Add value by:
Designing an AIS that measures and collects the
needed data.
Information about current component
usage.
Information about machine set-up and
materials-handling costs.
Data on repair and warranty costs to aid
in future modification and design.
Helping the design team use that data to improve
profitability
Compare current component usage with
projected usage in alternate designs.
Compare current set-up and handling
costs to projected costs in alternate
designs.
Provide info on how design trade-offs
affect total production cost and
profitability.
2. PLANNING AND SCHEDULING
a production plan that is efficient enough to meet existing
orders and anticipated shorter-term demand while
minimizing inventories of both raw materials and finished
goods.
There are two common approaches to production planning:
Manufacturing Resource Planning (MRP-II)-
extension of MRP
Seeks to balance existing production capacity
and raw materials needs to meet forecasted sales
demands.
pushmanufacturing.
Lean Manufacturing- extension of JIT
Seeks to minimize or eliminate inventories of
raw materials, work in process, and finished
goods.
Theoretically produces only in response to
customer orders, but in reality, there are short-
run production plans.
pull manufacturing.
Comparison of the two systems:
Both plan production in advance.
They differ in the length of the planning horizon.
MRP-II develops plans for up to 12 months
ahead.
Lean manufacturing uses shorter planning
horizons.
Consequently:
MRP-II is more appropriate for products with
predictable demand and a long life cycle.
Lean manufacturing more appropriate for
products with unpredictable demand,
Key documents and forms:
Master production schedule
Specifies how much of each product is to be
produced during the period and when.
Uses information about customer orders, sales
forecasts, and finished goods inventory levels to
determine production levels.
Although plans can be modified, production
plans must be frozen a few weeks in advance to
provide time to procure needed materials and
labor.
Scheduling becomes significantly more complex
as the number of factories increases.
Raw materials needs are determined by
exploding the bill of materials to determine
amount needed for current production. These
amounts are compared to available levels to
determine amounts to be purchased.
Production order
Authorizes production of a specified quantity of
a product. It lists:
Operations to be performed
Quantity to be produced
Location for delivery
Also collects data about these activities
Materials requisition
Authorizes movement of the needed materials
from the storeroom to the factory floor.
This document indicates:
Production order number
Date of issue
Part numbers and quantities of raw materials
needed (based on data in bill of materials)
Move ticket
Documents the transfer of parts and materials
throughout the factory.
How can information technology help?
Improve the efficiency of material-handling
activities by using:
Bar coding of materials to improve speed and
accuracy
RFID tags can eliminate human intervention in
the scanning process
Role of the accountant:
Ensure the AIS collects and reports costs in a
manner consistent with the companys production
planning techniques.
3. PRODUCTION OPERATIONS
Production operations vary greatly across companies,
depending on the type of product and the degree of
automation.
The use of various forms of IT, such as robots and
computer-controlled machinery is called computer-
integratedmanufacturing(CIM).
Can significantly reduce production costs.
Accountants arent experts on CIM, but they must
understand how it affects the AIS.
One effect is a shift from mass production to
custom-order manufacturing and the need to
accumulate costs accordingly.
In a lean manufacturing environment, a customer order
triggers several actions:
System first checks inventory on hand for
sufficiency.
Calculates labor needs and determines whether
overtime or temporary help will be needed.
Based on bill of materials, determines what
components need to be ordered.
Necessary purchase orders are sent via EDI.
The master production schedule is adjusted to
include the new order.
Sharing information across cycles helps companies be
more efficient by timing purchases to meet the actual
demand.
While the nature of production processes and the extent of
CIM vary, all companies need data on:
Raw materials used
Labor hours expended
Machine operations performed
Other manufacturing overhead costs incurred
4. COST ACCOUNTING
The objectives of cost accounting are:
To provide information for planning, controlling,
and evaluating the performance of production
operations;
To accomplish the first objective, the AIS must
collect real-time data on the performance of
production activities so management can make
timely decisions.
RFID technology can be especially helpful, e.g.:
Broadcasting repair needs proactively
Helping in the location of particular items
To provide accurate cost data about products for
use in pricing and product mix decisions; and
To collect and process information used to calculate
inventory and COGS values for the financial
statements.
To accomplish the 2
nd
and 3
rd
objectives, the AIS
must collect costs by various categories and
assign them to specific products and
organizational units.
Requires careful coding of cost data during
collection because costs may be allocated in
different ways for different reporting purposes.
Types of cost accounting systems:
Job order costing
Assigns costs to a specific production batch or
job.
Used when the product or service consists of
discretely identifiable items.
Process costing
Assigns costs to each process or work center in
the production cycle
Calculates the average cost for all units produced
Used when similar goods or services are
produced in mass quantities and discrete units
cant be easily identified
Accounting for Fixed Assets:
The AIS must collect and process information
about the property, plant, and equipment used in the
production cycle.
These assets represent a significant portion of total
assets for many companies and need to be
monitored as an investment.
The following information should be maintained about
each fixed asset:
ID number
Serial number
Location
Cost
Acquisition date
Vendor info
Expected life
Expected salvage value
Depreciation method
Accumulated depreciation
Improvements
Maintenance performed
The purchase of fixed assets follows the same processes as
other purchases in the expenditure cycle (order receive
pay).
But the amounts involved necessitate some modification to
the process:
Competitive bidding
Machinery and equipment purchases almost
always involve a formal request for competitive
bids
Number of people involved
More people are likely to be involved in
reviewing bids for fixed assets
Payment
Purchases of fixed assets are often paid for in
installments, including interest.
Controls
The cost of fixed assets justifies more elaborate
controls to safeguard them, including:
Maintenance of detailed records of each item.
RFID tags to:
Monitor location
Facilitate preventive maintenance
Disposal
Its critical to formally approve and accurately
record the sale or disposal of fixed assets.
A typical AIS would look something like the following:
Product design
Engineering specifications result in new records
for both the bill of materials and the operations
list file.
To create these lists, engineering accesses both
files to view designs of similar products.
They also access the general ledger and
inventory files for info about alternate designs.
Production planning
The sales department enters sales forecasts and
customer special order information.
Production planning uses that information and
data on current inventory levels to develop a
master production schedule.
New records are added to the production order
file to authorize the production of goods.
Cost accounting
New records are added to the work-in-process
file to accumulate cost data.
Production operations
The list of operations to be performed is
displayed at workstations.
Instructions are also sent to the CIM interface to
guide operation of machinery and robots.
Materials requisitions are sent to inventory stores
to authorize release of raw materials to
production.
Such a system can be used for a job-order or process
costing system.
Both require that data be accumulated about:
Raw materials
Direct labor
Machinery and equipment usage
Manufacturing overhead
The choice of method:
Does not affect how data are collected
Does affect how costs are assigned to products
Raw Material Usage Data:
When production is initiated, the issuance of a
materials requisition triggers a debit (increase) to
work in process and a credit (decrease) to raw
materials inventory.
Work in process is credited and raw materials are
debited for any amounts returned to inventory.
Many raw materials are bar coded so that usage
data is collected by scanning.
RFID tags improve the efficiency of tracking
material usage.
Usage may be entered online for materials such as
liquids that are not conducive to tagging.
Direct Labor Costs:
Historically, job time tickets were used to record
the time a worker spent on each job task.
Currently, workers may:
Enter the data on online terminals.
Use coded ID badges which are run through a
badge reader at the beginning and end of each
job.
Machinery and Equipment Usage:
Machinery costs make up an ever-increasing
proportion of production costs.
Data about machinery and equipment are collected
at each production step, often with data about labor
costs.
Until recently, data was collected by wiring the
factory so all equipment was linked to the computer
system.
Limits the ability to rearrange the shop floor.
3-D simulations can be used to assess the impact of
altering floor layout.
Manufacturing Overhead Costs:
Includes costs that cant be easily traced to jobs or
processes, such as utilities, depreciation,
supervisory salaries.
Most of these costs are collected in the expenditure
cycle.
An exception is supervisory salaries, which are
collected in the HRM/payroll cycle.
Accountants help control overhead by assessing
how product mix changes will affect overhead
costs.
They should also identify the factors that drive the
changes in these costs.
This information can be used to realign
processes and layout.
Accurate and complete information about
production cycle activities are required to perform
these analyses.
CONTROL: OBJECTIVES, THREATS, AND
PROCEDURES
In the production cycle (or any cycle), a well-designed
AIS should provide adequate controls to ensure that the
following objectives are met:
All transactions are properly authorized
All recorded transactions are valid
All valid and authorized transactions are recorded
All transactions are recorded accurately
Assets are safeguarded from loss or theft
Business activities are performed efficiently and
effectively
The company is in compliance with all applicable
laws and regulations
All disclosures are full and fair
There are several actions a company can take with respect
to any cycle to reduce threats of errors or irregularities.
These include:
Using simple, easy-to-complete documents with
clear instructions (enhances accuracy and
reliability).
Using appropriate application controls, such as
validity checks and field checks (enhances accuracy
and reliability).
Providing space on forms to record who completed
and who reviewed the form (encourages proper
authorizations and accountability).
Pre-numbering documents (encourages recording of
valid and only valid transactions).
Restricting access to blank documents (reduces risk
of unauthorized transaction).
Using RFID tags when feasible to improve data
entry accuracy.
In the following sections, well discuss the threats that
may arise in the four major steps of the production cycle,
as well as general threats, EDI-related threats, and threats
related to purchases of services.
THREATS IN PRODUCT DESIGN
THREAT NO. 1POOR PRODUCT DESIGN
Why is this a problem?
Higher materials purchasing and carrying costs
Costs for inefficient production
Higher repair and warranty costs
Controls:
Accurate data about the relationship between
components and finished goods.
Analysis of warranty and repair costs to identify
primary causes of product failure to be used in
re-designing product.
THREATS IN PLANNING AND SCHEDULING
THREAT NO. 2OVER- OR UNDER-PRODUCTION
Why is this a problem?
Over-production may result in:
Excess goods for short-run demand and
potential cash flow problems
Obsolete inventory
Under-production may result in:
Lost sales
Customer dissatisfaction
Controls:
More accurate production planning, including
accurate and current:
Sales forecasts
Inventory data
Investments in production planning
Regular collection of data on production
performance to adjust production schedule
Proper authorization of production orders
Restriction of access to production scheduling
program
Validity checks on production orders
THREAT NO. 3SUBOPTIMAL INVESTMENT IN
FIXED ASSETS
Why is this a problem?
Over-investment causes excess costs
Under-investment impairs productivity
Controls:
Proper authorization of fixed asset transactions:
Larger purchases should be reviewed by a
senior executive or executive committee.
Smaller purchases (<$10,000) can be
handled with departmental budgets, with
managers being held responsible for
department return.
Competitive bids should be sought via
requests for proposals (RFPs)
The capital investment committee
should review and select the winning
bid.
Once a supplier is selected, acquisition
may be handled through the expenditure
cycle process.
THREATS IN PRODUCTION OPERATIONS
THREAT NO. 4THEFT OF INVENTORIES AND
FIXED ASSETS
Why is this a problem?
Loss of assets
Mis-stated financial data
Potential underproduction of inventory
Controls:
Physical access to inventory should be restricted.
All internal movement of inventory should be
documented.
Materials requisitions should be used to
authorize release of raw materials.
Should be signed by both inventory control
clerk and production employee to establish
accountability.
Requests in excess of the bill of materials should
be documented and have supervisory
authorization.
RFID tags and bar codes can be used to track
inventory through production.
Proper segregation of duties should be enforced:
Inventory stores has custody of raw
materials and finished goods.
Factory supervisors are responsible for
work in process.
Authorization of production orders,
materials requisitions, and move tickets,
should be done by production planners or
the information system.
Logical and physical access controls should be
enforced for production records.
An independent party should count inventory
and investigate discrepancies.
Fixed assets must be identified and recorded.
Managers should be held accountable for assets
under their control.
Fixed assets should be physically secured.
Disposal of assets should be authorized and
documented.
Periodic reports of fixed asset transactions
should be reviewed by the controller.
Adequate insurance should be maintained.
THREAT NO. 5DISRUPTION OF OPERATIONS
Why is this a problem?
Disasters can disrupt functioning and destroy
assets
Controls:
Backup power sources, such as generators and
uninterruptible power supplies
Investigate disaster preparedness of key
suppliers and identify alternative sources for
critical components
THREATS IN COST ACCOUNTING
THREAT 6--INACCURATE RECORDING AND
PROCESSING OF PRODUCTION ACTIVITY DATA
Why is this a problem?
Diminishes effectiveness of production
scheduling
Undermines managements ability to monitor
and control operations
Controls:
Automate data collection with RFID technology,
bar code scanners, and badge readers to ensure
accurate data entry.
Use online terminals for data entry.
Restrict access with passwords, user IDs, and
access control matrices to prevent unauthorized
changes to data.
Use check digits, closed-loop verification, and
validity checks.
Do periodic physical counts of inventory and
compare to records.
Do periodic inspections and counts of fixed
assets.
GENERAL THREATS
Two general objectives pertain to activities in every
cycle:
Accurate data should be available when needed
Activities should be performed efficiently and
effectively
THREAT NO. 7: LOSS, ALTERATION, OR
UNAUTHORIZED DISCLOSURE OF DATA
Why is this a problem?
Loss or alteration of data could cause:
Errors in external or internal reporting.
Unauthorized disclosure of confidential
information can cause:
Unfair competition
Loss of business
Controls:
All data files and key master files should be backed
up regularly.
At least one backup on site and one offsite.
All disks and tapes should have external and
internal file labels to reduce chance of accidentally
erasing important data.
Access controls should be utilized
User IDs and passwords
Compatibility matrices
Controls for individual terminals (e.g., so the
receiving dock cant enter a sales order).
Logs of all activities, particularly those requiring
specific authorizations, should be maintained.
Default settings on ERP systems usually allow
users far too much access to data, so these systems
must be modified to enforce proper segregation of
duties.
Sensitive data should be encrypted in storage and in
transmission.
Parity checks, acknowledgment messages, and
control totals should be used to ensure transmission
accuracy.
THREAT NO. 8--POOR PERFORMANCE
Why is this a problem?
Quality control problems increase expenses and
reduce future sales
Controls:
Prepare and review performance reports
PRODUCTION CYCLE INFORMATION NEEDS
In a manufacturing environment, the focus must be on
total quality management. Managers need info on:
Defect rates
Breakdown frequency
Percent of finished goods needing rework
Percent of defects discovered by customers
In traditional systems, this type of data was not well linked
with financial data, and cost accounting systems were
separate from production operations information systems.
However, both financial and operating information are
needed to manage and evaluate these activities.
Two major criticisms have been directed at traditional cost
accounting systems:
Overhead costs are inappropriately allocated to
products
Reports do not accurately reflect effects of factory
automation
CRITICISM 1: INAPPROPRIATE ALLOCATION OF
OVERHEAD COSTS
Traditional cost accounting systems use volume-driven
bases such as direct labor hours or machine hours to apply
overhead.
However, overhead does not vary with production volume.
EXAMPLE: Purchasing costs vary with the number of
purchase orders processed.
Allocating overhead based on output volume:
Overstates the costs of products manufactured in
large quantities
Understates the costs of products manufactured in
small batches
Also, allocating overhead based on direct labor input can
distort costs.
Solution to Criticism 1: Activity Based Costing (ABC)
ABC can refine and improve cost allocations under
either job-order or process costing systems.
ABC traces costs to the activities that create
them and allocates them accordingly.
ABC aims to link costs to corporate strategy.
Corporate strategy results in decisions about what
goods and services to produce.
These activities incur costs.
So corporate strategy determines costs.
By measuring the costs of the basic activities, ABC
provides information to management for evaluating
the consequences of their decisions.
ABC vs. Traditional Cost Systems:
There are three significant differences between
ABC and traditional cost accounting approaches.
Tracing of overhead costs
ABC directly traces a larger proportion of
overhead costs to products.
This tracing is made possible by advances
in IT.
Number of cost pools
ABC uses a greater number of cost pools to
accumulate indirect costs (manufacturing
overhead).
Most systems lump all overhead together,
but ABC distinguishes three categories:
Batch-related overhead
Product-related overhead
Company-wide overhead
Identification of cost drivers
Benefits of ABC Systems
ABC systems are more costly and
complex.
But proponents argue two important
benefits:
More accurate cost data result
in better product mix and
pricing decisions.
More detailed cost data
improve managements ability
to control and manage total
costs.
Management may be able to improve profitability by:
Applying the unused capacity to other revenue-
generating activities; or
Eliminating the unused capacity.
PRODUCTION CYCLE INFORMATION NEEDS
Two major criticisms have been directed at traditional cost
accounting systems:
Overhead costs are inappropriately allocated to
products
Reports do not accurately reflect effects of
factory automation
When an organization transitions from a
traditional production system to a lean
manufacturing system, inventory levels are
depleted. Consequently, almost all production
costs of the year are expensed that year.
Although the effect is temporary, managers will
be concerned if their performance evaluations
are based on the companys reported financial
statements.
CRITICISM 2: REPORTS DO NOT ACCURATELY
REFLECT EFFECTS OF AUTOMATION
Solution to Criticism 2: Better Reports and Measures
Produce reports based on lean accounting
principles.
Report for each product all costs incurred to
design, produce, sell, deliver, process customer
payments, and provide post-sale support for that
product.
Separate overhead costs from COGS.
Identify changes in inventory levels as a separate
expense item.
Develop resources to focus on issues important
to production cycle managers.
Examples:
Useable output produced per time
period
Monitoring of product quality
THROUGHPUT: A MEASURE OF PRODUCTION
EFFECTIVENESS
Throughput = Productive Capacity x Productive
Processing Time x Yield
Productive Capacity = Total Units Produced /
Processing Time
Can be improved by:
Improving machine or labor efficiency.
Improving factory layout.
Simplifying product design specifications
Productive Processing Time = Processing Time /
Total Time
The opposite of downtime.
Can be improved by:
Better maintenance to reduce machine
downtime.
Better scheduling of deliveries to reduce wait
time.
Yield = Good Units / Total Units
Can be improved by:
Using better raw materials
Improving worker skills
Throughput = Productive Capacity x Productive
Processing Time x Yield
Productive Capacity = Total Units Produced /
Processing Time
Productive Processing Time = Processing Time /
Total Time
Yield = Good Units / Total Units
QUALITY CONTROL
Information About Quality Control
Quality control costs can be divided into four
categories:
Prevention costs
Inspection costs
Internal failure costs
External failure costs
The objective of quality control is to minimize
the sum of these four costs.
CHAPTER 13: The Human Resources Management / Payroll
Cycle
INTRODUCTION
The HRM/Payroll cycle is a recurring set of business
activities and related data processing operations associated
with effectively managing the employee workforce.
The most important tasks performed in the HRM/payroll
cycle are:
Recruiting and hiring new employees
Training
Job assignment
Compensation (payroll)
Performance evaluation
Discharge of employees (voluntarily or
involuntarily)
Payroll costs are also allocated to products and
departments for use in product pricing and mix decisions.
In this chapter, well focus primarily on the payroll
system:
One of the largest and most important components
of the AIS
Must be designed to meet:
Managements needs
Government regulations
Incomplete or erroneous payroll records:
Impair decision making
Can results in fines and/or imprisonment
The design of the HRM system is also important because
the knowledge and skills of employees are valuable assets,
so HRM systems should:
Help assign these assets to appropriate tasks; and
Help monitor their continuous development.
There are five major sources of input to the payroll
system:
HRM department provides information about
hirings, terminations, and pay-rate changes.
Employees provide changes in discretionary
deductions (e.g., optional life insurance).
Various departments provide data about the actual
hours worked by employees.
Government agencies provide tax rates and
regulatory instructions.
Insurance companies and other organizations
provide instructions for calculating and remitting
various withholdings.
Principal outputs of the payroll system are checks:
Employees receive individual paychecks.
A payroll check is sent to the bank to transfer
funds from the companys regular account to its
payroll account.
Checks are issued to government agencies,
insurance companies, etc., to remit employee and
employer taxes, insurance premiums, union dues,
etc.
The payroll system also produces a variety of reports.
Employees are an organizations most valuable assets:
Their knowledge and skills affect quality and
quantity of goods and services.
Labor costs are a major expense in generating
revenues and a key cost driver.
The traditional AIS has not measured or reported on the
status of a companys human resources:
Financial statements do not regard employees as
assets.
Under GAAP, the value of human services is not
measured until they have been consumed.
However, some companies are now creating positions for a
direction of intellectual assets.
Some may even include HR info in their annual report,
including reports on:
Human capital: The knowledge employees
possess, which can be enhanced.
Intellectual capital: The knowledge thats been
captured and implemented in decision support
systems, expert systems, or knowledge databases,
so that it can be shared.
Because employees are so valuable, turnover is expensive:
Average cost of replacement is 1.5 times the
employees annual salary.
Turnover rates need to be managed so theyre not
excessive.
Employee morale is also important.
Bad morale leads to high turnover.
Employee attitudes affect customer interactions and
are positively correlated with profitability.
Employees need to:
Believe they have the opportunity to do what
they do best
Believe their opinions count
Believe their coworkers are committed to quality
Understand the connection between their jobs
and the companys mission.
To effectively track intellectual capital and human
resources, the AIS must do more than just record time and
attendance and prepare paychecks.
Payroll should be integrated with HRM so management
can access data about employee-related costs and
employee skills and knowledge.
PAYROLL CYCLE ACTIVITIES
Lets take a look at payroll cycle activities.
The payroll application is processed in batch mode
because:
Paychecks are issued periodically.
Most employees are paid at the same time.
UPDATE PAYROLL MASTER FILE
The HRM department provides information on new hires,
terminations, changes in pay rates, and changes in
discretionary withholdings.
Appropriate edit checks, such as validity checks on
employee number and reasonableness tests are applied to
all change transactions.
Changes must be entered in a timely manner and reflected
in the next pay period.
Records of terminated employees should not be deleted
immediately as some year-end reports (e.g., W-2s) require
data on compensation for all employees during the year.
UPDATE TAX RATES AND DEDUCTIONS
The payroll department receives notification of changes in
tax rates and other payroll deductions from government
agencies, insurers, unions, etc.
These changes occur periodically.
VALIDATE TIME AND ATTENDANCE DATA
Information on time and attendance comes in various
forms depending on the employees pay scheme.
Some employees are paid on an hourly basis.
Many companies use a timecardto record their
arrival and departure time.
This document typically includes total hours
worked during a pay period.
Some use electronic timeclocks, where employees
swipe their badge through a reader when they come
and go.
Manufacturing companies may use job time tickets
to record not only time present but also time
dedicated to each job.
Some employees earn a fixed salary, e.g., managers and
professional staff.
Usually dont record their time, but supervisors
informally monitor their presence.
Professionals in accounting, law, and consulting
firms must track their time on various assignments
to accurately bill clients.
Sales staff are often paid on a straight commission or base
salary plus commission.
Some may also receive bonuses for surpassing sales
targets.
Requires careful recording of their sales.
Increasingly, laborers may be paid partly on productivity.
Some management and employees may receive stock to
motivate them to cut costs and improve service.
The payroll system needs to link to the revenue cycle and
other cycles to calculate these payments.
Its also important to design bonus schemes with realistic,
attainable goals that:
Can be measured
Are congruent with corporate objectives
Are monitored by management for continued
appropriateness
Are legal
Accountants and Compensation Policies
Recent corporate scandals have led to scrutiny and
criticism of executive compensation plans:
FASB issued new rules requiring that stock
options be expensed.
Major U.S. stock exchanges now require
companies to obtain shareholder approval of
stock compensation.
Compensation boards are being created to design
compensation plans, rather than having executives
create their own.
Accountants can help by:
Advising on financial and tax effects of
proposals.
Identifying appropriate metrics to measure
performance.
Enabling compliance with legal and regulatory
requirements.
Suggesting appropriate public disclosures.
How can information technology help?
Collecting time and attendance data electronically,
Using edit checks to verify accuracy and
reasonableness when the data are entered.
PREPARE PAYROLL
The employees department provides data about hours
worked.
A supervisor confirms the data.
Pay rate information is obtained from the payroll master
file.
Procedures:
The payroll transaction file is sorted by employee
number (same sequence as master file).
For each transaction, the payroll master file is read
for pay rates, etc., and gross pay is calculated.
Hourly Employees: Gross pay = (hours worked
x wage rate) + Overtime + Bonuses
Salaried Employees: Gross pay = annual salary
x fraction of year worked
Payroll deductions are summed and subtracted from
gross pay to obtain net pay. There are two types of
deductions:
Payroll tax withholdings
Voluntary deductions
Year-to-date totals for gross pay, deductions, and
net pay are calculated, and the master file is
updated. Cumulative records are important
because:
Social Security and other deductions cease or
decline at certain levels.
The information will be needed for tax reports.
The following are printed:
Paychecks for employees--often accompanied by
an earningsstatement, which lists pay detail,
current and year-to-date.
A payroll register which lists each employees
gross pay, deductions, and net pay in a multi-
column format:
Is used to authorize the transfer of funds to
the companys payroll bank account.
May be accompanied by a deduction
register, listing miscellaneous voluntary
deductions for each employee.
As payroll transactions are processed, labor costs
are accumulated by general ledger accounts based
on codes on the job time tickets.
The totals for each account are used as the basis
for a summary journal entry to be posted to the
general ledger.
Other payroll reports and government reports are
produced.
DISBURSE PAYROLL
Most employees are paid either by:
Check
Direct deposit
In some industries, such as construction, cash
payments may still be made, but does not provide
good documentation
Procedures:
When paychecks have been prepared, the payroll
register is sent to accounts payable for review and
approval.
A disbursement voucher is prepared to authorize
transfer of funds from checking to the payroll bank
account.
For control purposes, checks should not be
drawn on the companys regular bank account
A separate account is created for this purpose
Limits the companys loss exposure
Makes it easier to reconcile payroll and
detect paycheck forgeries
The approved disbursement voucher and payroll
register are sent to the cashier. The cashier:
Reviews the documents.
Prepares and signs the payroll check to
transfer the funds.
Reviews, signs, and distributes employee
paychecks (which separates authorization
and recording from distribution of checks).
Re-deposits unclaimed checks in the
companys bank account.
Sends a list of these paychecks to internal
audit for investigation.
Returns the payroll register to payroll
department, where it is filed with time
cards and job time tickets.
Sends the disbursement voucher to
accounting clerk to update general ledger.
Efficiency Opportunity: Direct Deposit
Direct deposit can improve efficiency and reduce
costs of payroll processing
Employee receives a copy of the check and an
earnings statement
Each bank receives a record of the payroll
deposits for that bank via EDI. The record
includes:
Employee number
Social Security number
Bank account number
Net pay amount
Savings occur because:
While the cashier does authorize release of
funds, he/she does not sign each check.
Eliminates costs of buying, processing, and
distributing paper checks.
Eliminates postage.
Additional costs:
Elimination of float between when check is
distributed and when it is deposited by
employee.
Savings typically outweigh costs
CALCULATE EMPLOYER-PAID BENEFITS AND TAXES
The employer pays some payroll taxes and employee
benefits directly
The employer withholds federal and state taxes
from employee paycheck, along with Medicare tax,
and the employees share of Social Security.
May also withhold voluntary deductions such as
union dues, United Way contributions, credit union
savings, retirement contributions, etc.
In addition, the employer pays:
A matching amount of Social Security
Federal and state unemployment taxes
The employer share of health, disability, and life
insurance premiums, as well as pension
contributions
Some companies offer flexible benefit plans, sometimes
called cafeteria-style benefit plans.
These plans offer a menu of options.
Benefit programs increase the demands on the
HRM/payroll system for gathering employee data,
disbursing payments and information, etc.
Providing access to payroll/HRM information through a
company intranet can help reduce costs.
DISBURSE PAYROLL TAXES AND MISCELLANEOUS
DEDUCTIONS
The company must periodically prepare checks or EFT to
pay tax and other liabilities.
OUTSOURCING OPTIONS
Many entities outsource payroll and HRM to:
Payroll service bureaus
Maintain the payroll master file and perform
payroll processing activities
Professional employer organizations (PEOs)
Perform the services of the payroll service
bureau
Also administer and design employee benefit
plans
Generally more expensive than payroll service
bureaus
When organizations outsource payroll processing, they
send the service bureau or PEO at the end of each period:
Personnel changes
Employee time and attendance data
The service bureau or PEO then:
Prepares paychecks, earnings statements, and a
payroll register
Periodically produces tax documents
Outsourcing is especially attractive to small and mid-size
businesses because:
Its often cheaper for smaller companies
The bureau or PEO may provide a wider range of
benefits
It frees up the companys computer resources for
other areas
However, companies must carefully monitor service
quality to ensure that these systems integrate HRM and
payroll data in a manner that supports effective
management of employees.
CONTROL: OBJECTIVES, THREATS, AND
PROCEDURES
In the HRM/payroll cycle (or any cycle), a well-designed
AIS should provide adequate controls to ensure that the
following objectives are met:
All transactions are properly authorized
All recorded transactions are valid
All valid and authorized transactions are recorded
All transactions are recorded accurately
Assets are safeguarded from loss or theft
Business activities are performed efficiently and
effectively
The company is in compliance with all applicable
laws and regulations
All disclosures are full and fair
There are several actions a company can take with respect
to any cycle to reduce threats of errors or irregularities.
These include:
Using simple, easy-to-complete documents with
clear instructions (enhances accuracy and
reliability).
Using appropriate application controls, such as
validity checks and field checks (enhances accuracy
and reliability).
Providing space on forms to record who completed
and who reviewed the form (encourages proper
authorizations and accountability).
CONTROL: OBJECTIVES, THREATS, AND
PROCEDURES
Pre-numbering documents (encourages recording of
valid and only valid transactions).
Restricting access to blank documents (reduces risk
of unauthorized transaction).
CONTROL: OBJECTIVES, THREATS, AND
PROCEDURES
Following is a discussion of threats to the HRM/payroll
system, organized around three areas:
Employment practices
Payroll processing
General control issues
THREATS IN EMPLOYMENT PRACTICES
THREAT 1: HIRING UNQUALIFIED OR LARCENOUS
EMPLOYEES
Why is this a problem?
Can increase production expenses
Can result in theft of assets
Can result in civil and criminal penalties for the
company (e.g., if an employee attempts to make
a bribe)
Controls:
State skill qualifications for each position
explicitly in the position control report
Ask candidates to sign a statement confirming
the accuracy of the information on their
application
Recent honesty surveys indicate that 30% of
Americans are dishonest, 30% are situationally
honest, and 40% are honest. Therefore, ask
candidates to consent to a thorough background
check of their credentials, employment history,
and credit:
You cannot conduct these checks without a
written consent
Discard candidates who refuse to consent
Conduct the background checks and verify
skills and references, including college
degrees earned:
Data released in March 2004 indicate
that 50% of resumes contain false or
embellished information.
Check at least three references, and
regard it as a negative signal if at
least one is not gratuitously positive.
THREAT 2: VIOLATION OF EMPLOYMENT LAW
Why is this a problem?
Can result in stiff government penalties as well
as civil suits
Controls:
Carefully document all actions relating to
advertising, recruiting, hiring new employees,
and dismissal of employees, to demonstrate
compliance
Provide employees with continual training to
keep them current with employment law
THREATS IN PAYROLL PROCESSING
Objective:
Efficiently and effectively compensate employees
for services provided.
THREAT 3: UNAUTHORIZED CHANGES TO THE
PAYROLL MASTER FILE
Why is this a problem?
Can increase expenses if wages, salaries,
commissions, or base rates are falsified
Can result in inaccurate reporting and erroneous
decisions
Controls:
Proper segregation of duties:
Only HRM department should be able to
update payroll master file.
HRM employees should not directly
participate in payroll processing or
distribution.
Prevents the creation of ghost
employees and fraudulent checks.
Changes to the payroll master file should
be reviewed and approved by someone
other than the person recommending the
change.
Department supervisors should
receive copies of these documents for
review.
Restrict logical and physical access to the payroll
system:
Utilize user IDs, passwords, and an access
control matrix.
Control terminals from which payroll data
and programs can be accessed.
THREAT 4: INACCURATE TIME DATA
Why is this a problem?
Can result in payments for services not rendered
Inaccurate or missing checks can damage
employee morale
Can result in inaccurate labor reporting
Controls:
Automation can reduce unintentional
inaccuracies with:
Badge readers
Bar code scanners
Online terminals
Data entry programs should include edit checks:
Field checks for employee number and
hours worked
Limit checks on hours worked
Validity checks on employee numbers
Segregation of duties can reduce intentional
inaccuracies:
People who process payroll should not
have access to payroll master file.
Supervisors should approve all changes.
Time clock data should be reconciled to job time
tickets by an independent party.
Supervisors should approve all time cards and
job time tickets.
THREAT 5: INACCURATE PROCESSING OF
PAYROLL
Why is this a problem?
Errors damage employee morale, especially if
they cause late paychecks.
Penalties can accrue if:
Proper payroll taxes are not remitted to the
government
Court-ordered paycheck garnishments are
not made appropriately
Controls:
Batch totals:
Run and reconcile batch totals before and
after processing and at the end of each
stage, including hash totals of employee
numbers
Cross-footing of payroll register
Make sure that sum of rows equals sum of
columns, i.e., total of net pay column
should equal total of gross pay minus
deduction totals.
Payroll clearing account
A general ledger account used in a two-step
process
First step:
Payroll control account is debited for
amount of gross pay
Cash is credited for net pay
Various liabilities are credited for
withholdings
Second step
Cost accounting process distributes
labor costs to various expense
categories and credits payroll control
account for sum of the allocations.
Result should be a zero balance in the control
account.
Review decisions to hire temporary or outside help
to make sure workers are properly classified as
employees or independent contractors.
Improper classification can result in significant
back taxes, interest, and penalties.
THREAT 6: THEFT OR FRAUDULENT
DISTRIBUTION OF PAYCHECKS
Why is this a problem?
Payments may be made to fictitious (ghost) or
terminated employees, resulting in:
Increased expenses
Loss of cash
Controls:
Restrict access to blank payroll checks and check
signing machine.
All checks should be sequentially pre-numbered
and accounted for periodically.
Cashier should sign all checks, but only
when supported by proper documentation.
An imprest payroll bank account should be
used.
Someone independent of the payroll
process should reconcile the payroll bank
account.
Segregate duties between those who
authorize and record payroll and those who
distribute checks and transfer funds.
Have internal audit observe payroll
distribution on a surprise basis.
Unclaimed checks should be returned to
the treasurers office for prompt re-deposit
and should be investigated.
GENERAL THREATS
Two general objectives pertain to activities in every cycle:
Accurate data should be available when needed
Activities should be performed efficiently and
effectively
THREAT 7: LOSS, ALTERATION, OR
UNAUTHORIZED DISCLOSURE OF DATA
Why is this a problem?
Loss or alteration of payroll data can result in
delayed and/or inaccurate paychecks and reports.
Unauthorized disclosure of confidential
employee data can violate state and federal laws
and damage employee morale.
Controls:
Payroll files should be backed up regularly.
At least one backup on site and one offsite.
All disks and tapes should have external and
internal file labels to reduce chance of
accidentally erasing important data.
Access controls should be utilized
User IDs and passwords
Compatibility matrices
Controls for individual terminals (e.g., so
the receiving dock cant enter a sales
order).
Logs of all activities, particularly those
requiring specific authorizations, should be
maintained.
Default settings on ERP systems usually allow
users far too much access to data, so these
systems must be modified to enforce proper
segregation of duties.
Sensitive data should be encrypted in storage and
in transmission.
Websites should use SSL for secure employee
communications.
Payroll service bureaus and PEOs can help
provide security for data.
VPNs should be used to exchange data with
service bureaus or PEOs.
Parity checks, acknowledgment messages, and
control totals should be used to ensure
transmission accuracy.
THREAT 8: POOR PERFORMANCE
Why is this a problem?
May damage employee relations.
Reduces profitability
Controls:
Prepare and review performance reports
KEY DECISIONS AND INFORMATION NEEDS
The payroll system should be integrated with cost data and
HR information so management can make decisions with
respect to the following types of issues:
Future work force staffing needs
Employee performance
Employee morale
Payroll processing efficiency and effectiveness
Benefits of an integrated HRM/payroll model:
Access to current, accurate information about
employee skills and knowledge.
HRM activities can be performed more efficiently
and costs reduced.
CHAPTER 14: General Ledger and Reporting System
INTRODUCTION
The general ledger and reporting system (GLARS)
includes the processes in place to update general ledger
accounts and prepare reports that summarize results of the
organizations activities.
One of the primary functions of GLARS is to collect and
organize data from:
Each of the accounting cycle subsystems,
which provide summary entries related to the
routine activities in those cycles.
The treasurer, who provides entries with
respect to non-routine activities such as
transactions with creditors and investors.
The budget department, which provides budget
numbers.
The controller, who provides adjusting entries.
The information must be organized to meet the
needs of internal and external users.
The system must be designed to produce
regular periodic reports and to support real-
time inquiries.
GENERAL LEDGER AND REPORTING SYSTEM
UPDATE THE GENERAL LEDGER
Updating the general ledger consists of posting journal
entries from two sources:
Summary journal entries of routine transactions
from the accounting subsystems
Individual journal entries for non-routine
transactions from the treasurer. Examples:
Issuances of or payment of debt and the associated
interest.
Issuances of or repurchases of company stock and
paying dividends on that stock.
Journal entries are often documented on a form called a
journal voucher.
After updating the general ledger (GL), journal entries are
stored in a journal voucher file.
POST ADJUSTING ENTRIES
Adjusting entries originate in the controllers office at the
end of each accounting period (month, quarter, year, etc.)
and after the initial trial balance has been prepared.
The trial balancelists the balances for all of the GL
accounts.
If properly recorded, the total of all debit balances equal
the total of all credit balances.
There are five types of adjusting entries:
Accruals- no cash flow
Deferrals- with cash, not earned/incurred
Estimates
Re-evaluations
Error corrections
Journal vouchers for adjusting entries should be stored in
the journal voucher file.
Once adjusting entries have been recorded, an adjusted
trial balance is prepared from the new balances in the
general ledger.
The adjusted trial balance serves as the input for the next
steppreparation of the financial statements.
PREPARE FINANCIAL STATEMENTS
Activities in the preparation of financial statements are as
follows:
Prepare an incomestatement
Prepare closingentries
Prepare a statement of stockholders equity
Prepare a balancesheet
Prepare a statement of cash flows
PRODUCE MANAGERIAL REPORTS
The final step is prepare of reports for internal purposes,
including:
Reports to verify the accuracy of the posting
process.
Budgets for planning and evaluating
performance
Operating budget
Depicts planned revenues and
expenses for each unit
Capital expenditure budget
Shows planned cash inflows and
outflows for each project.
Cash flow budget
Shows anticipated cash inflows
and outflows for use in determining
borrowing needs.
DIFFERENCE B/N OPERATING BUDGET AND THE
CASH FLOW BUDGET
Budgets and performance reports should be developed on
the basis of responsibilityaccounting, i.e., reporting
results on the basis of the manager responsible:
Breaks down financial results by subunit.
Shows actual costs and variances for current
month and year-to-date for items the subunit
controls.
The cost of a sub-unit is displayed as a single
line item on the report for the next level up.
Contents of the budgetary performance reports should be
tailored to the nature of the unit being evaluated.
Cost centers
Revenue centers
Profit centers
Investment centers
The method used to calculate the budget standard is
crucial:
Can use a fixed target and compare actual
results to the fixed budget.
Problem: Does not adjust for unforeseen
changes in operating environment and may
penalize manager for factors beyond his
control.
Solution:
Develop a flexible budget.
Break each item into fixed and
variable components.
Adjust the variable components for
variations in sales or production.
XBRL: REVOLUTIONIZING THE REPORTING
PROCESS
While financial statements appear electronically in a
variety of formats, until recently disseminating this
information was cumbersome and inefficient.
Recipients (SEC, IRS, etc.) required the
information in a variety of formats which was
time-consuming.
Also conducive to errors, since re-entry of the
information was often necessary.
Underlying problem: lack of standards for identifying the
content of data.
Solution: Extensible Business Reporting Language
(XBRL)
A variant of XML designed specifically to
communicate the contents of financial data.
Creates tags for each data item much like
HTML tags.
Tag names specify line items in financial statements.
Other fields in the tag provide information such as
the year, units of measure, etc.
Major software vendors are developing tools to
automatically generate XBRL codes so accountants wont
need to write code.
XBRL provides two major benefits:
Organizations can publish their financial
statements on time in a format that anyone can
use.
Recipients will no longer need to manually
reenter data they acquired electronically so that
decision support tools can analyze them.
Means search for data on the Internet will be more
efficient and accurate.
Benefits of XBRL apply to exchanging financial
information both externally and internally.
XBRL provides a great example of how accountants can
actively participate in IT development, since the
accounting profession spearheaded its development.
CONTROL: OBJECTIVES, THREATS, AND PROCEDURES
In the general ledger and reporting system (or any cycle), a
well-designed AIS should provide adequate controls to
ensure that the following objectives are met:
All transactions are properly authorized
All recorded transactions are valid
All valid and authorized transactions are
recorded
All transactions are recorded accurately
Assets are safeguarded from loss or theft
Business activities are performed efficiently
and effectively
The company is in compliance with all
applicable laws and regulations
All disclosures are full and fair
There are several actions a company can take with respect
to any cycle to reduce threats of errors or irregularities.
These include:
Using simple, easy-to-complete documents
with clear instructions (enhances accuracy and
reliability).
Using appropriate application controls, such as
validity checks and field checks (enhances
accuracy and reliability).
Providing space on forms to record who
completed and who reviewed the form
(encourages proper authorizations and
accountability).
Pre-numbering documents (encourages
recording of valid and only valid transactions).
Restricting access to blank documents (reduces
risk of unauthorized transaction).
In the following sections, well discuss the threats that
may arise in the general ledger and reporting system, as
well as the controls that can prevent those threats.
THREATS IN THE GENERAL LEDGER AND REPORTING
SYSTEM
THREAT 1: ERRORS IN UPDATING THE GENERAL
LEDGER AND GENERATING REPORTS
Why is this a problem?
Can lead to poor decisions based on incorrect
information
Controls:
Input edit and processing controls
Checking that the summary journal entries
from the accounting cycles represent activity
for the most recent time period.
For non-routine entries from the treasurer and
controller:
Validity checks on the general ledger
account numbers.
Field checks for numeric data in the
amount fields.
Zero balance checks (debits = credits).
Completeness tests to ensure all data is
entered.
Closed-loop verification matching
account numbers with account
descriptions.
Standard adjusting entry file for recurring
adjusting entries.
Sign checks on the ledger account
balance.
Run-to-run totals to verify the accuracy of
journal voucher batch processing, i.e.,
account balance before entries, adjusted
for total debits and credits entered, should
equal balance after adjustments.
Reconciliations and control report
Trial balances.
Checking that clearing and suspense accounts
have zero balances.
Checking balances in control accounts against
totals of subsidiary accounts.
Examining transactions near year end for
proper timing.
Listings of:
Journal vouchers by account number to
identify cause of errors in a particular
account.
Journal voucher by sequence to look for
missing entries.
General journal to check that total debits
to the ledger = total credits.
Audit trail
Depicts the path of a transaction through the
accounting system. Facilitates:
Tracing transaction from origin to any
reports or documents produced.
Tracing any item in a report back to its
origin.
Tracing all account changes from
beginning balance to ending balance.
The journal voucher file provides information
about the source of all entries to the general
ledger.
Various master files can also help verify
accuracy of general ledger.
Usefulness of the audit trail depends on its
integrity, so you need to:
Make periodic backups.
Control access.
THREAT 2: LOSS, ALTERATION, OR
UNAUTHORIZED DISCLOSURE OF DATA
Why is this a problem?
Can result in leaks of confidential data.
Can conceal a theft of assets.
Controls:
Back up and recovery procedures:
At least one backup of general ledger on site
and one offsite.
Disaster recovery plan should be developed and
practiced.
All disks and tapes should have external and internal
file labels to reduce chance of accidentally erasing
important data.
Access controls should be utilized
User IDs and passwords.
Compatibility matrices.
Controls for individual terminals (e.g., so the
receiving dock cant enter a sales order).
Logs of all activities, particularly those
requiring specific authorizations, should be
maintained.
Default settings on ERP systems usually allow users
far too much access to data, so these systems must be
modified to enforce proper segregation of duties.
Sensitive data should be encrypted in storage and in
transmission.
Parity checks, acknowledgment messages, and
control totals should be used to ensure transmission
accuracy.
THREAT 3: POOR PERFORMANCE
Why is this a problem?
The company might provide tainted or late
information to government agencies, regulatory
bodies, investors, creditors, etc..
May not get internal reports on a timely basis.
Reduces profitability.
Controls:
Prepare and review performance reports.
Implement XBRL.
Redesign business processes.
SUPPORTING MANAGEMENTS INFORMATION NEEDS
Three tools or abilities can be particularly useful to
management in decision making:
THE BALANCED SCORECARD
A balancedscorecardis a report that provides a multi-
dimensional perspective on organizational performance.
Contains measures relating to four perspectives of the
organization:
Financial
Customer
Internal operations
Innovation and learning
The balanced scorecard shows:
The organizations goals for each of the four
dimensions
Specific measures of performance in attaining
those goals.
It provides a more comprehensive overview of
organizational performance than financial measures alone.
Properly designed, it measures key aspects of the
organizations strategy and reflects important causal links.
With respect to the goals:
Many organizations mistakenly use industry
benchmarks in designing their balanced
scorecards.
This approach limits the companys
performance to that of its competitors and fails
to consider the organizations unique strengths
and weaknesses.
EXAMPLE: Dumbledore Insurance Companys top
management agreed on three key financial goals:
Increased revenue streams through the sale of
new products.
Increased profitability as reflected in return on
equity.
Maintaining adequate cash flows to meet
obligations.
They then created the following hypotheses (or causal
links) as to how these goals could be achieved:
If we increase employee training (innovation
and learning dimension), that should improve
our service quality (internal operations
dimension).
If we increase our service quality (internal
operations dimension), that should improve
our customer satisfaction (customer
dimension) and cause us to pick up a greater
market share.
Improved customer satisfaction and market
share (customer dimension) should therefore
result in improved profitability (financial
dimension).
Given these hypotheses, Dumbledore designs and
implements the scorecard shown on the following slide.
Analyzing trends in the actual measures allows
Dumbledores management to test the validity of their
hypotheses:
If improvements in one perspective dont
generate expected improvements in other areas,
top management should reevaluate and revise
their hypotheses.
The ability to test and refine their strategy is
one of the major benefits of the balanced
scorecard.
In developing a balanced scorecard:
Top management should specify the goals to be
pursued in each dimension
Accountants and IS professionals:
Help them choose appropriate measures for tracking
attainment of these goals.
Provide input on the feasibility of collecting data to
implement the various measures.
USING DATA WAREHOUSES FOR BUSINESS
INTELLIGENCE
Management must constantly monitor and reevaluate the
organizations financial and operating performance in light
of strategic goals and must be able to alter plans quickly
when the environment changes.
They may adopt ERP systems and integrated AIS systems
to facilitate these activities.
However, these systems are designed primarily to support
transaction processing needs, and typically contain data
only for the current fiscal year and maybe an extra month.
But strategic decision making requires access to large
amounts of historical data.
To fill this need, organizations are building
separate databases called data warehouses.
These are typically huge databases that contain
both detailed and summarized data for a
number of years.
They are separate from the AIS.
Organizations may also build separate, smaller
warehouses, called data marts, for individual
functions such as finance or human resources.
Data warehouses and data marts are updated
periodically to reflect the results of transactions
that have occurred since the last update.
They are structured differently than transaction
processing databases:
Transaction processing databases are designed to
minimize redundancy and maximize efficiency of
updates.
Data warehouses are purposely designed to be
redundant in order to maximize query efficiency.
They are usually dimensional in nature.
Most use a star schema
Business intelligence is the process of accessing data in a
warehouse and using it for strategic decision making. Two
basic techniques:
Online analytical processing (OLAP)
The user employs queries to investigate
hypothesized relationships in the data.
Can drill down to deeper levels with each
query.
Data mining
Uses sophisticated statistical analysis and
artificial intelligence techniques such as
neural networks to discover
unhypothesized relationships in the data.
Lets just dig and see what we find!
Proper controls are needed for data warehouses:
Data validation controls are essential to
ensuring data accuracy.
The process of verifying the accuracy of the data, aka
scrubbing, is often one of the most time-consuming
and expensive steps.
Information should be protected from
competitors or from destruction by using:
Access controls
Encryption
Backup provisions
PRINCIPLES OF GRAPH DESIGN
Accountants and IS professionals can help management
deal with information overload by preparing graphs that
highlight and summarize important facts.
Well-designed graphs make it easy to identify and
understand trends and relationships.
Poorly-designed graphs can impair decision making.
Principles that make bar charts easy to read:
Use titles that summarize the basic message.
Include data values with each element
instead of labeling the vertical axis. This
practice facilitates mental calculations and
analyses
Use 2-dimensional, instead of 3-dimensional,
bars. This practice makes it easier to
accurately assess magnitude of changes and
trends.
Use different shades of gray or colors instead
of patterns, dots, or stripes. They are easier
Begin vertical axis at zero
For graphs that depict time-series data,
order the x-axis chronologically from left to
right.
Many annual reports contain graphs that violate these
principles:
Some done automatically by software.
Some done intentionally.
There are no authoritative guidelines in GAAP or auditing
standards that prohibit these behaviors, even though the
results can be deceptive.b