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Updating your accounting DP system: a case study.

Updating Your Accounting DP System

Companies spend billions of dollars each year for computer software and hardware. Managers justify these expenditures by predicting that the value of additional information will be greater than the cost of producing it. There is a general expectation that newer, more exotic systems will produce greater, more impressive benefits. A new accounting system is expected to generate more timely information and noticeable cost savings in both operations and information processing.

But for some companies, especially smaller firms, the cost of replacing an existing data processing system is prohibitive. Fortunately, this expense is often unnecessary. By performing a systematic review of existing capabilities, a company might find that it is possible to modify or update systems and procedures already in use to create a more efficient and effective data processing environment for significantly less than the cost of a new system. This article describes how one small company was able to analyze its needs and expand the capabilities of an old data processing system instead of investing the time and money (and headaches!) required to purchase and install a new system.

Reviewing the Existing

System

When a new computer system is installed, the cost of the new system generally exceeds the cost of maintaining or updating the old system. Periodically, however, changing business conditions require a critical management review of the firm's information system. Like many operating assets, an information system is subject to both physical deterioration and functional obsolescence. Computer hardware and software have long physical lives, but both the components and the system in which they are configured can quickly become outmoded. A management information system must be maintained and expanded as operations grow or the value of the asset will decline, not from physical decay, but from obsolescence. Managers cannot allow a firm's information system to remain static when the business environment is dynamic.

The effectiveness of the system must be a top priority regardless of the size of the business, the industry in which the business competes, or the complexity of the system. When an information system is reviewed, management must be sure the system is still providing the benefits generally associated with computerized system: 1. Clerical cost reduction, 2. Timely, sophisticated processing

and analysis of data, 3. Reduction of data-handling errors, 4. Automation of low-level decisions, 5. Automation of reporting systems, 6. Integration of separate management

activities.

Although each company might obtain a different benefit pattern, management must be certain the system is providing maximum benefit in the areas most important to the firm. Benefits that can be directly measured in dollars and cents are called "hard savings." The benefit of investing idle cash identified by computer analysis, for example, is the additional interest earned. The amount of additional interest can be determined directly and is entirely objective. Managers should quantify the hard savings of the system periodically and make any changes required to maintain or enhance these benefits. Benefits that may be objectively quantified include savings from: * Better cash flow management, * Better accounts receivable management, * Improved inventory management, * Better sales forecasting and performance

reporting, * Better control decisions in all

areas of operations.

Benefits that cannot be directly quantified are called "soft savings." These benefits are difficult to measure in dollars and cents. Managers might know, for example, that customers are pleased by the faster response time of the new computer system. The customers might tell them directly and with certainty. Still, managers might be unable to assign any objectively determined dollar value to the benefit. Soft savings can be measured only indirectly and subjectively. Soft savings are benefits that are largely qualitative and might only enhance the general corporate or operating environment. These benefits include: * An improved corporate image, * Better responses to customer,

vendor and suppliers' information

requests, * Higher employee morale due to

job enrichment and enhancement, * Improved supervision, leadership,

and planning, because management

is able to devote more

time to these activities.(1)

A cost/benefit analysis must compare the cost of a new or updated system with the total benefits provided, including both hard and soft savings. Management should not ignore corporate image or employee moral, for example. These are real benefits, even though their dollar value cannot be determined objectively. Management, however, should be cautious if the purchase of new system components is justified predominately by benefits with only soft, subjectively determined value.

To illustrate a system review that considered both hard and soft savings, the remainder of this article describes how one small company analyzed its needs and expanded the capabilities of an old data processing system instead of investing time and money to purchase and install a new system.

The Electric City Printing

Case

Electric City Printing Company of Anderson, South Carolina, is a closely held printing company with revenues in excess of $6.2 million. Over Electric City's 70 year history, the company grew from a simple letter press printer to a state-of-the-art operation. As an addition to its commercial printing, Electric City introduced a runners' number product in 1983 and provided runners' numbers for the 1984 Los Angeles Olympics, the 1987 Pan-American Games in Indianapolis and the 1989 Boston Marathon. Since 1983, over 25 million numbers have been sold. Four years ago, a new controller was hired. At that time the company was using a combination of in-house and purchased data processing services. As his first major task, the controller began a review of Electric City's financial and cost accounting computer programs. Proceeding systematically, he reviewed the accounting system, module by module, to determine its effectiveness.

The Problem

The general ledger system was maintained primarily outside the company. A local accounting firm produced monthly financial statements from the company's sales, accounts payable, accounts receivable and other subsidiary ledgers. It generally took 45 days after month-end for Electric City to receive the completed financial statements. The company paid $35,000 per year in accounting fees for this service. The Electric City payroll was also prepared by the accounting firm. Payroll time cards and records were delivered to the accountants. Weekly payroll checks and supporting journals were returned to the company a few days later.

The product costing system was based on estimated costs of materials, labor and overhead, applied to jobs based on attributes such as the type of printing, the number of items and the size of the items. The costs used in the estimates were intended to be all-inclusive cost standards in that they were used both to estimate the cost of jobs for bid purposes and to cost the jobs when they were completed. (On completion of a job, the cost calculated when the job was bid became the actual cost of the job.)

An accounting and cost estimation system has been purchased at a cost of $117,000, three years before. At the time of the purchase, the primary justification for the system was to provide the company's sales force quicker access to job bids through the system's cost estimation package. The system used historically-based cost estimates and individual job attributes to generate cost estimates and price quotes for each job. The system supposedly was capable of handling a general ledger and payroll module. But no one within Electric City recognized the full potential of the system.

After inspection, the controller realized that both the financial and management accounting systems were seriously flawed. He identified major problems in five areas: 1. The accounting system provided

neither timely operating information

nor the information required

to correct unfavorable

variances quickly. 2. The payroll system was unwieldy

and did not produce information

on the productivity of individual

employees. 3. Inventories of raw materials,

work in process, and finished

goods were difficult to value.

Variances in these accounts were

common, exceeded industry standards,

and were difficult to trace

to any specific job or activity. 4. The cost accounting system was

actually no more than a price

estimating system and the cost

estimates on which prices were

based were historic and infrequently

revised. It was difficult

to measure variances from the

estimated standards for material,

labor and overhead and, due

to the nature of the standards,

the variances calculated had little

meaning. 5. Because the system's inputs were

primarily estimates rather than

actual, real time data, it was not

possible to measure aggregate

attributes such as personnel productivity,

plant capacity utilization,

or cost variances for individual

product lines.

Reviewing Needs and

Alternatives

Faced with these problems, it was decided that Electric City needed a system that would fill both the financial and managerial accounting needs of the company. Ideally, the accounting system would interface with a production management system. Management was satisfied with how well the company was doing, but felt they had to grow in MIS capability. They needed a system that would provide enough information to manage by exception rather than by constantly monitoring each job produced. The printing industry sells only two products: raw materials and the time of people and machines to convert the materials into finished products. They needed systems that would produce timely information on the use of time and materials. And the information the system gathers should be presented such that line supervisors can recognize potential problems and act before they occur.

The first step was to review the existing system and potential replacements and to analyze the interaction of personnel with the information system. They started by reviewing the systems operations manual. The more they understood about the system capabilities, the more they were convinced that the MIS requirements could be supported internally. The system vendor had an outstanding reputation in the printing industry. However, it was determined that no one in Electric City was entirely familiar with the system documentation for the parts of the system in use or with the capabilities of the modules not in use.

To become familiar with the current system, the controller contacted the original system vendor and requested updated information on system version releases made after Electric City's purchase. In his review of the existing system, he found that some of the system he had envisioned could be developed using the software Electric City had purchased three years before. To his surprise, he saw that, using available updates and enhancements, the system already in place could support the information system the company needed - integrating general ledger, payroll, cost accounting and on-line production operation information. Finally, with full knowledge of what the system could do, management reviewed the job duties and responsibilities of personnel involved in the production of financial information. They needed to train employees to better understand system capabilities as they affected their jobs and to be able to define each job function in the new system as well.

Solving the Problem

After evaluating the system and the personnel used to run it, Electric City management prepared to design the new system. With his new knowledge of the system's full capabilities, and the priorities he had established, the controller prepared an outline of the revised system he envisioned. The system would fully integrate financial accounting, cost accounting and production reporting. The company information priorities should be satisfied using existing system modules that interfaced fully with the general ledger, wherever possible. A list of data processing functions that management felt should be performed in-house were evaluated on two criteria: 1. The opportunity cost of not having

information available for

management on a timely basis,

and 2. The costs that could be eliminated

by processing data internally.

The timetable for implementing system changes is shown below. Data was loaded from the July 1 start of their fiscal year to have the general ledger and fixed asset modules operative at calendar year end. Payroll processing began three months later and interactive programs were brought on line January 1.
 Module Date
 General Ledger December 31
 Fixed Assets December 31
 Payroll March 31
 Interactive Programs January 1


-Enhanced and Integrated Cost

Accounting System

-Producing Management System

-Inventories

The new general ledger and fixed asset modules were run parallel with existing manual system for three month-end closings. With these systems established and tested, the payroll module was installed. The company ran payroll in parallel for two pay periods. There was concern that confidence in the new system would be lost if employees saw any difference in the payroll procedure. Fortunately, they were able to use the checks produced by the system on our first try. However, manually produced checks were available just in case!

Close monitoring was also necessary when the interactive modules were installed. Management and accounting personnel had to be trained to think differently. Instead of producing historical, retrospective numbers, they were suddenly monitoring an on-line production management and cost accounting system. The amount of information produced by the enhanced system was staggering compared to that produced by the old reporting system. But the information was now timely and, most of all, a valuable tool for managing company resources and profitability.

In addition to the new reporting modules, Electric City management uncovered a hidden treasure in the old system. The original system contained a data-base report generator that allowed the user to define reports and get information from the data captured in the system. The updated system captured even more data and expanded the available data base. With this new data came the creation of reports that management could use to monitor operations and make critical decisions in the areas of finance, marketing and production management. Electric City's management team began to receive valuable information that had previously been either costly and time consuming to obtain or simply unavailable.

The Benefits of the Enhanced

System

A review of data processing can lead to changes that result in both hard and soft savings. As a result of their review of system priorities and capabilities, Electric City was able to implement system changes that achieved hard savings in two areas. 1. Reduced administrative costs:

Electric City was able to reduce,

through attrition and transfer,

the number of personnel involved

in the production of financial

data by one and a half full-time

positions for an annual savings of

$24,000. In addition, accounting

fees were reduced by $30,000

annually. 2. Better inventory management:

Through an enhanced inventory

module, Electric City was able

to track raw materials from the

receiving dock to the warehouse

and then to the production of

specific jobs. Because of this

tracking capability, inventory

variances were reduced from

2.5% to 0.6%, a percentage significantly

below industry standards.

This improvement resulted

in annual savings of

$22,000.

In addition to the clearly quantifiable hard savings above, soft savings were generated by improving the decision-making capability of Electric City management in the following areas:

Increased chargeable hours: New system hardware included input devices at each work station. Information on job description, raw material input and production personnel identification is input through these devices for each job in process and each work station. As a result of this improvement, chargeable hours (hours charged to specific printing jobs) increased by 5%. Measurement of capacity usage and employee productivity became an on-line function, reviewed by the plant manager in real time. This increase in chargeable hours did not directly result in additional revenue or reduced expense, but assisted management in determining the full cost of production and the prices that should be charged.

Job cost analysis: With job costs input into the accounting system on a real time, on-line basis, job costs can be analyzed and any variances reviewed and investigated quickly. The enhancement of the system capabilities and the improved response time of operating reports allowed the company to move from reactive to proactive decision making based on exceptions.

Productivity management: The new system can measure productivity in an on-line, real time basis. Productivity is expressed as the percentage of chargeable hours worked to total hours worked. The results are reported on line to the plant manager via CRT and are viewed by management every day from printed reports. More importantly, employees are able to see their productivity reports at the end of every shift. This instantaneous feedback is useful. Employees are genuinely interested in their productivity each day.

System integration: With our improved computer capability, the company now has integrated management information system. Integration is helpful in many ways. They are able to clearly see the total impact of production, inventory and capacity management on financial statements. Managers are immediately able to commend productivity or correct unproductive processes. They can see the whole picture, not just the pieces. The new system gives management the right tools to build profitability.

Quantifying Savings

Of course, these benefits were not achieved without incurring added costs. Electric City had to purchase updated software and additional hardware devices to facilitate data input from the production floor and from raw material and finished goods inventory storage areas. But the hard savings obtained with the enhanced system totaled $76,000 per year for a one time cost of only $40,475. With benefits and costs quantified, traditional capital budgeting techniques can be use to measure the value of the new system. In calculating the net present value of the project, a 12% discount rate and a five-year useful life was used. The net present value of the enhanced system shows an increase in the value of Electric City of $229,883, and the internal rate of return on the fund invested to update the system is 184.3%.

Conclusion

Obsolescence is the nemesis of an accounting information system. Because changing business conditions eventually make system objectives obsolete, the physical lives of the hardware and software components are much longer than their economic lives. But the economic life of an information system can be extended if management periodically reviews the goals and capabilities of the system. New releases by the system supplier, perhaps initially rejected and forgotten, may later provide the means to meet expanded objectives and extend system life. Before purchasing and installing a new system, the wise manager will heed the example of Electric City Printing Company and seek first to expand and enhance the information system already in place.

Footnotes

(1) Gordon E. Louvau, et. al, Evaluating Your Company's Computer Needs, 3rd Ed., American Management Associations, New York, 1984, pp. 7-16.

G. Tom Friedlob is a certified public accountant, certified management accountant and a certified commercial arbitrator. He is a fellow with the Institute of Internal Auditors Research Foundation faculty and a professor at the Clemson University School of Accountancy. Active in research and professional development, he has published in numerous professional publications including the CPA Journal, Internal Auditor, Management Accounting and The Journal of Tax Research. He is a coauthor of Keys to Reading an Annual Report, Keys to Improving Your ROI, and Business and Financial Statements.

Ronald M. Knorr is controller of Moorhead Oil Inc. of Anderson, South Carolina. He holds a bachelor's degree in financial management from Clemson University and an MBA from the University of North Florida. He is a certified management accountant and is a past president of the Anderson Area Chapter of the Institute of Management Accountants.
COPYRIGHT 1991 National Society of Public Accountants
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991 Gale, Cengage Learning. All rights reserved.

Article Details
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Title Annotation:data processing
Author:Friedlob, G. Tom; Knorr, Ronald M.
Publication:The National Public Accountant
Date:Oct 1, 1991
Words:3175
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