Chapter 5: Accounting in ERP Systems

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

Concepts in Enterprise Resource Planning, Second Edition 2
Chapter Objectives
• Describe the differences between financial and
managerial accounting .
• Identify and describe problems associated with
accounting and financial reporting in un-integrated
information systems.
• Describe how ERP systems can help solve accounting
and financial reporting problems in an un-integrated
system.
• Describe how the Enron scandal and the Sarbanes-
Oxley Act will affect accounting information systems
• Explain accounting and management-reporting benefits
that accrue from having an ERP system.

Introduction
• Accounting is a functional area that is tightly integrated
with other functional areas like:
• Marketing and Sales
• Supply Chain Management
• Accounting activities are necessary for decision making

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

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

Figure 5.1 Fitter Snacker sample balance sheet

Figure 5.2 Fitter Snacker sample income statement

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

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

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

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

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

Credit Management in SAP R/3
• SAP R/3 allows for a number of configuration options to
determine how the system responds to an order that
would cause a customer to exceed its credit limit
• The system may block the sales order
• The system may prevent the sales order from being
saved
• The system may issue warning messages to the
sales order clerk
• Credit is a sensitive issue, so the system response must
be configured to match a company’s procedures
• Typically, sales orders are blocked, with no warning
given to the sales order clerk
• A credit specialist would regularly review blocked
orders and take corrective action

Figure 5.3 Credit management configuration
Dynamic
credit
check Only orders for
the next two
months are
considered
Reaction C: warning
message is issued
when order is saved

Figure 5.4 Credit management for Health Express
Credit limit for Health Express
Outstanding
obligations

Figure 5.5 Blocked sales order
Options to release, reject or
forward blocked sales orders

Product Profitability Analysis
• Accounting data is used to determine the profitability of a
company and its products
• Inaccurate and/or incomplete data can lead to a
flawed analysis
• The three main causes of data problems are:
• Inconsistent record keeping
• Inaccurate inventory costing
• Problems consolidating data from subsidiaries

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

Inaccurate Inventory-Costing Systems
• Correctly calculating inventory costs is an important and
challenging task in any manufacturing company
• A manufactured item’s cost has three elements:
• Cost of raw materials used in the item
• Labor used specifically to produce the product (direct
labor)
• Overhead: all other costs
• Factory utilities
• General factory labor (custodial services, security)
• Manager’s salaries
• Storage
• Insurance

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

• Allocating indirect costs
• One method is to use total machine hours
• Total overhead cost divided by the total
machine production time (hours) available for a
period to get an overhead rate per machine
hour
• Example:
• Overhead costs per month: $152,500
• Production line capacity: 50 cases/hour
160 hours/month
hour/950$
hour/mo.160
.mo/000,152$
= case/19$
case/hour50
hour/950$
=

• Allocating indirect costs
• Another method is to use direct labor hours
• The assumption with this method is that
overhead costs are incurred so workers can do
their jobs
• For Fitter Snacker, the snack bar bake line is the
fundamental production process as well as
capacity constraint, so allocating indirect costs
using machine hours (snack bar bake line hours)
would make sense

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

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

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

Companies with Subsidiaries
• Companies with subsidiaries must prepare financial
statements for each subsidiary, plus be able to provide a
consolidated statement for the entire company
• Different currencies and transactions between subsidiary
companies can make the consolidation task challenging
• Currency translation is challenging because exchange
rates fluctuate daily
• Intercompany transactions must be handled properly
• Sales from one subsidiary to another within a
company do not result in a profit or loss, because no
money has entered or left the consolidated company

Example: Microsoft
• Microsoft must consolidate financial information from 130
subsidiaries
• Prior to installing SAP R/3, each subsidiary did
accounting in its own system, then transmitted the files
to another system, where manipulation of the data was
required
• Subsidiaries used different systems, with different
field sizes, types of characters, account structures,
etc.
• Consolidation took over a week
• With SAP R/3, Microsoft can look directly at financial
activity at any subsidiary around the world

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

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

Figure 5.6 Document flow of a transaction in SAP R/3
Details of any
document can be
viewed from the
document flow
screen—a
process known
as “drilling down”

Management-Reporting and Analysis Tools
• Because ERP systems use a database, the database
can be queried to provide a wide range of reports and
analyses
• Because reports access the same database where
transactions are recorded, reporting and analysis
requests can slow down the processing of regular
business transactions
• SAP R/3 has built-in information systems (SIS, LIS,
etc.) with their own data tables for analysis
• Business Warehouse (BW) is a completely separate
system that extracts data from the SAP R/3 system
• BW provides greater reporting flexibility and can
combine data from other information systems

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

Enron Collapse
• Arthur Andersen was indicted for, among other things, the
destruction of Enron documents in the face of an SEC
investigation
• As a result of the Enron collapse:
• Enron’s 20,000 creditors will receive approximately 20% of
the $63 billion they are owed
• Shareholders will receive nothing
• Many employees invested large sums of money in
Enron stock via 401K savings plans
• Arthur Andersen, once a firm with 28,000 employees, has
been all but dismantled
• 31 individuals either have been tried or will be tried on
criminal charges
• The Sarbanes-Oxley Act was passed

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

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

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

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

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

Figure 5.8 Change record for material master
SAP R/3 maintains
detailed records on all
changes made to
material master data

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

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

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

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

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

Figure 5.11 G/L (general ledger) account balance for raw material consumption
Double-clicking on the 8,810.00 debit
will provide details on the transactions
that make up the item

Figure 5.12 Documents that make up G/L Account Balance for
Raw Material Consumption
Selecting the 10.00 item
and clicking on the details
icon will provide more
information on the item

Figure 5.13 Details on $10.00 line item in G/L account for
raw material consumption

Another Look—The One-Day Close
• Some companies strive to “close the books” in one day
• Other companies take days, weeks and even months
to get all the financial figures correct and in balance
• Some companies perform virtual closings, simulating the
closing process at various times during the month to see
how well the company is doing
• Cisco’s closing went from 2 weeks to 1 day by switching
from un-integrated systems to Oracle ERP
• With ERP, companies can streamline their financial
supply chains, holding less cash in the same way supply
chains hold less inventory

Summary
• Companies need accounting systems to record
transactions and generate financial statements. The
accounting system should let the user summarize data
in meaningful ways. The data can then be used to
assist managers in their day-to-day work and in long-
range planning.
• With un-integrated information systems, accounting
data might not be current, and this can cause problems
when trying to make operational decisions, such as
granting credit. Data can also be inaccurate because of
weaknesses in un-integrated systems, and this problem
can have an effect on decision-making and therefore on
profitability.

Summary
• Closing the books at the end of an accounting period
can be difficult with an un-integrated IS, but it is
relatively easy with an integrated IS. Closing the books
means zeroing out the temporary accounts.
• Using an integrated IS and a common database to
record accounting data has important inventory cost-
accounting benefits. More precise record keeping is
possible, and this can lead to more accurate product
cost calculations. These, in turn, can help managers
decide which products are profitable and which are not.

Summary
• The use of an integrated system and a common
database to record accounting data has important
management-reporting benefits. The user has built-in
drill-down and query tools available as a result.
• The introduction of the Sarbanes-Oxley Act, a 2002
U.S. federal regulation written and passed in the wake
of the Enron collapse, promotes top management
accountability by requiring extra financial approval and
reporting. Because ERP systems can help companies
meet the requirements of this legislation, the act has
increased the need for integrated data reporting.

Chapter 5: Accounting in ERP Systems

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Chapter 5: Accounting in ERP Systems

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