CHAPTER 2 : TRANSACTION PROCESSING

TRANSACTION CYCLES

Three transaction cycles process most of the firm’s economic activity: the
expenditure cycle, the conversion cycle, and the revenue cycle. These cycles
exist in all types of businesses— both profit-seeking and not-for-profit. For
instance, every business (1) incurs expenditures in exchange for resources
(expenditure cycle), (2) provides value added through its products or
services (conversion cycle), and (3) receives revenue from outside sources
(revenue cycle).

(1) THE EXPENDITURE CYCLE

Business activities begin with the acquisition of materials, property, and

labor in exchange for cash.

Most expenditure transactions are based on a credit relationship between

the trading parties. The actual disbursement of cash takes place at some
point after the receipt of the goods or services.

 PURCHASES/ACCOUNTS PAYABLE SYSTEM. This system

recognizes the need to acquire physical inventory (such as raw
materials) and places an order with the vendor. When the goods are
received, the purchases system records the event by increasing
inventory and establishing an account payable to be paid at a later
date.
 CASH DISBURSEMENTS SYSTEM. When the obligation created in
the purchases system is due, the cash disbursements system
authorizes the payment, disburses the funds to the vendor, and
records the transaction by reducing the cash and accounts payable
accounts.
 PAYROLL SYSTEM. The payroll system collects labor usage data for
each employee, computes the payroll, and disburses paychecks to
the employees. Conceptually, payroll is a special-case purchases
and cash disbursements system. Because of accounting
complexities associated with payroll, most firms have a separate
system for payroll processing.
 FIXED ASSET SYSTEM. A firm’s fixed asset system processes
transactions pertaining to the acquisition, maintenance, and
disposal of its fixed assets. These are relatively permanent items
that collectively often represent the organization’s largest financial
investment. Examples of fixed assets include land, buildings,
furniture, machinery, and motor vehicles.

(2) THE CONVERSION CYCLE

The conversion cycle is composed of two major subsystems: the production

system and the cost accounting system.

The PRODUCTION SYSTEM involves the planning, scheduling, and control

of the physical product through the manufacturing process. This includes
determining raw material requirements, authorizing the work to be
performed and the release of raw materials into production, and directing
the movement of the work-in-process through its various stages of
manufacturing.

The COST ACCOUNTING SYSTEM monitors the flow of cost information

related to production. Information this system produces is used for
inventory valuation, budgeting, cost control, performance reporting, and
management decisions, such as make-or-buy decisions.

(3) THE REVENUE CYCLE

Firms sell their finished goods to customers through the revenue cycle,
which involves processing cash sales, credit sales, and the receipt of cash
following a credit sale. Revenue cycle transactions also have a physical and
a financial component, which are processed separately.

 SALES ORDER PROCESSING. The majority of business sales are

made on credit and involve tasks such as preparing sales orders,
granting credit, shipping products (or rendering of a service) to the
customer, billing customers, and recording the transaction in the
accounts (accounts receivable, inventory, expenses, and sales).
 CASH RECEIPTS. For credit sales, some period of time (days or
weeks) passes between the point of sale and the receipt of cash.
Cash receipts processing includes collecting cash, depositing cash
in the bank, and recording these events in the accounts (accounts
receivable and cash).

ACCOUNTIING RECORDS

MANUAL SYSTEM

DOCUMENTS
A document provides evidence of an economic event and may be used to
initiate transaction processing. Some documents are a result of transaction
processing.

 SOURCE DOCUMENTS. Economic events result in some documents

being created at the beginning (the source) of the transaction.
Source documents are used to capture and formalize transaction
data that the transaction cycle needs for processing.
 PRODUCT DOCUMENTS. Product documents are the result of
transaction processing rather than the triggering mechanism for the
process.
 TURNAROUND DOCUMENTS. Turnaround documents are product
documents of one system that become source documents for
another system.

JOURNALS
A journal is a record of a chronological entry. Documents are the primary
source of data for journals.
 SPECIAL JOURNALS. Special journals are used to record specific
classes of transactions that occur in high volume. Such
transactions can be grouped together in a special journal and
processed more efficiently than a general journal permits.
  REGISTER. The term register is often used to denote certain types of
special journals. For example, the payroll journal is often called the
payroll register. We also use the term register, however, to denote a
log.
 GENERAL JOURNALS. Firms use the general journal to record
nonrecurring, infrequent, and dissimilar transactions.

LEDGER
A ledger is a book of accounts that reflects the financial effects of the firm’s
transactions after they are posted from the various journals. Whereas
journals show the chronological effect of business activity, ledgers show
activity by account type. A ledger indicates the increases, decreases, and
current balance of each account. Organizations use this information to
prepare financial statements, support daily operations, and prepare
internal reports.
 GENERAL LEDGERS. The general ledger summarizes the activity for
each of the organization’s accounts. The general ledger department
updates these records from journal vouchers prepared from special
journals and other sources located throughout the organization. The
general ledger provides a single value for each control account, such
as accounts payable, accounts receivable, and inventory. This
highly summarized information is sufficient for financial reporting,
but it is not useful for supporting daily business operations.
 SUBSIDIARY LEDGERS. Subsidiary ledgers are kept in various
accounting departments of the firm, including inventory, accounts
payable, payroll, and accounts receivable. This separation provides
better control and support of operations.

COMPUTER-BASED SYSTEM

TYPES OF FILES
 MASTER FILE. A master file generally contains account data. The
general ledger and subsidiary ledgers are examples of master files.
Data values in master files are updated from transactions.
 TRANSACTION FILE. A transaction file is a temporary file of
transaction records used to change or update data in a master file.
Sales orders, inventory receipts, and cash receipts are examples of
transaction files.
 REFERENCE FILE. A reference file stores data that are used as
standards for processing transactions. For example, the payroll
program may refer to a tax table to calculate the proper amount of
withholding taxes for payroll transactions.
 ARCHIVE FILE. An archive file contains records of past transactions
that are retained for future reference. These transactions form an
important part of the audit trail. Archive files include journals,
prior-period payroll information, lists of former employees, records
of accounts written off, and prior-period ledgers.
DOCUMENTATIONS TECHNIQUES
(1) DATAFLOW DIAGRAM
 The data flow diagram (DFD) uses symbols to represent the
entities, processes, data flows, and data stores that pertain
to a system.
 DFDs are used to represent systems at different levels of
detail from very general to highly detailed.
(2) ENTITY RELATIONSHIP DIAGRAMS
 An entity relationship (ER) diagram is a documentation
technique used to represent the relationship between
entities. Entities are physical resources (automobiles, cash,
or inventory), events (ordering inventory, receiving cash,
shipping goods), and agents (salesperson, customer, or
vendor) about which the organization wishes to capture data.
(3) DOCUMENTS FLOWCHART

(4) SYSTEM FLOWCHART

(5) PROGRAM FLOWCHART

(6) RECORD LAYOUTS DIAGRAMS

 Record layout diagrams are used to reveal the internal
structure of the records that constitute a file or database
table. The layout diagram usually shows the name, data
type, and length of each attribute (or field) in the record.
Detailed data structure information is needed for such tasks
as identifying certain types of system failures, analyzing
error reports, and designing tests of computer logic for
debugging and auditing purposes.
 This type of layout shows the content of a record.
COMPUTER-BASED ACCOUNTING SYSTEM

(1) BATCH SYSTEM

 Batch systems assemble transactions into groups for
processing. Under this approach, there is always a time lag
between the point at which an economic event occurs and
the point at which it is reflected in the firm’s accounts. The
amount of lag depends on the frequency of batch processing.
 Batch systems demand fewer organizational resources (such
as programming costs, computer time, and user training)
than real-time systems.
(2) REAL-TIME SYSTEM
 Real-time systems process transactions individually at the
moment the event occurs. As records are not grouped into
batches, there are no time lags between occurrence and
recording.
 Real-time processing is well suited to systems that process
lower transaction volumes and those that do not share
common records.
CHAPTER 3: ETHICS, FRAUD, AND INTERNAL CONTROL
CHAPTER 4: THE REVENUE CYCLE

THE CONCEPTUAL SYSTEM

(1) SALES ORDER PROCEDURE

 Sales order procedures include the tasks involved in receiving and
processing a customer order, filling the order and shipping products
to the customer, billing the customer at the proper time, and
correctly accounting for the transaction.
1. RECEIVE ORDER
- The sales process begins with the receipt of a customer order
indicating the type and quantity of merchandise desired. At
this point, the customer order is not in a standard format
and may or may not be a physical document. Sales Order
2. CHECK CREDIT
- Before processing the order further, the customer’s
creditworthiness needs to be established.
- [In our conceptual system, the receive-order task sends the
sales order (credit copy) to the check-credit task for
approval. The returned approved sales order then triggers
the continuation of the sales process by releasing sales order
information simultaneously to various tasks.]
3. PICK GOODS
- The receive order activity forwards the stock release
document (also called the picking ticket) to the pick goods
function, in the warehouse. This document identifies the
items of inventory that must be located and picked from the
warehouse shelves.
4. SHIP GOODS
- Before the arrival of the goods and the verified stock release
document, the shipping department receives the packing slip
and shipping notice from the receive order function. The
packing slip will ultimately travel with the goods to the
customer to describe the contents of the order. The shipping
notice will later be forwarded to the billing function as
evidence that the customer’s order was filled and shipped.
5. BILL CUSTOMER
- The shipment of goods marks the completion of the
economic event and the point at which the customer should
be billed. Billing before shipment encourages inaccurate
record keeping and inefficient operations.
- The bill customer function receives the sales order (invoice
copy) from the receive order task.
6. UPDATE INVENTORY RECORDS
- The inventory control function updates inventory subsidiary
ledger accounts from information contained in the stock
release document.
 7. UPDATE A/R
- Costumer records in the accounts receivable (AR) subsidiary
ledger are updated from information the sales order (ledger
copy) provides.
8. POST TO GL

(2) SALES RETURN PROCEDUERS

 When a return is necessary, the buyer requests credit for the
unwanted products. This involves reversing the previous
transaction in the sales order procedure.
1. PREPARE RETURN SLIP
- When items are returned, the receiving department
employee counts, inspects, and prepares a return slip
describing the items. The goods, along with a copy of the
return slip, go to the warehouse to be restocked.
2. PREPARE CREDIT MEMO
- Upon receipt of the return slip, the sales employee
prepares a credit memo. This document is the
authorization for the customer to receive credit for the
merchandise returned.
3. APPROVE CREDIT MEMO
- The credit manager evaluates the circumstances of the
return and makes a judgment to grant (or disapprove)
credit. The manager then returns the approved credit
memo to the sales department.
4. UPDATE SALES JOURNAL
- Upon receipt of the approved credit memo, the
transaction is recorded in the sales journal as a contra
entry.
5. UPDATE INVENTORY AND A/R
- The inventory control function adjusts the inventory
records and forwards the credit memo to accounts
receivable, where the customer’s account is also
adjusted.
 6. UPDATE GL
- Upon receipt of the journal voucher and account
summary information, the general ledger function
reconciles the figures and posts the control accounts.

(3) CASH RECEIPT PROCEDURE

 They involve receiving and securing the cash;
depositing the cash in the bank; matching the payment
with the customer and adjusting the correct account;
and properly accounting for and reconciling the
financial details of the transaction.
1. OPEN MAIL AND PREPARE REMITTANCE ADVICE
- A mail room employee opens envelopes containing
customers’ payments and remittance advices.
- Remittance advices contain information needed to
service individual customers’ accounts. This
includes payment date, account number, amount
paid, and customer check number.
2. RECORD AND DEPOSIT CHECKS
- A cash receipts employee verifies the accuracy and
completeness of the checks against the prelist. Any
checks possibly lost or misdirected between the
mail room and this function are thus identified.
After reconciling the prelist to the checks, the
employee records the check in the cash receipts
journal.
- Next, the clerk prepares a bank deposit slip
showing the amount of the day’s receipts and
forwards this along with the checks to the bank.
3. UPDATES A/R
4. UPDATE GENERAL LEDGER
5. RECONCILE CASH RECEIPTS AND DEPOSIT
REVENUE CYCLE CONTROLS

PHYSICAL SYSTEM

MANUAL SYSTEM