CHAPTER TWO: OVERVIEW OF BUSINESS PROCESS

Chapter objectives
Dear students, at the end of this chapter, you are expected to;
 Understand the business process and events
 Identify the events in a business process
 Understand the transaction processing cycle
 Identify the types of files and data used in the transaction processing cycle both in manual
and computer based processing models.
 Explain the advantages and disadvantages of Enterprise Resource Planning (ERP) system.
2.1. Business Processes and Events
It is explained in the previous chapter that organizations must reorganize their business processes
into groups of related transactions. A transaction is an agreement between two entities to exchange
goods or services or any other event that can be measured in economic terms by an organization.
Examples include selling goods to customers, buying inventory from suppliers, and paying
employees. Many business activities are pairs of events involved in a give-get exchange. These
exchanges can be grouped into five major business processes or transaction cycles: The revenue
cycle, the expenditure cycle, the production or conversion cycle, the human resources/payroll cycle,
and the financing cycle,
2.2. Identifying events in business process
A financial transaction is an economic event that affects the assets and equities of the firm, is
reflected in its accounts, and is measured in monetary terms. The most common financial
transactions are economic exchanges with external parties. These include the sale of goods or
services, the purchase of inventory, the discharge of financial obligations, and the receipt of cash on
account from customers. Financial transactions also include certain internal events such as the
depreciation of fixed assets; the application of labor, raw materials, and overhead to the production
process; and the transfer of inventory from one department to another. These three 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 (grant) from outside sources
(revenue cycle).

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2.2.1. The Expenditure Cycle
Business activities begin with the acquisition of materials, property, and labor in exchange for cash
in the expenditure cycle. Figure 2.1 shows the flow of cash from the organization to the various
providers of these resources. 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. Thus, from a systems perspective, this transaction has two parts: a
physical component (the acquisition of the goods) and a financial component (the cash
disbursement to the supplier). A separate subsystem of the cycle processes each component. The
major subsystems of the expenditure cycle are outlined below.
 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.
 Fixed asset system: A firm’s fixed asset system processes transactions pertaining to the
acquisition, maintenance, and disposal of its fixed assets.

Labor Customers
Finished Goods

Materials
Cash

Cash

Physical Plant

Expenditure Cycle Conversion Cycle

Revenue Cycle
Subsystems Subsystems
Subsystems
· Purchasing/Accounts Payable · Production Planning and Control
· Sales Order Processing
· Cash Disbursements · Cost Accounting
· Cash Receipts
· Payroll
· Fixed Assets

Finished Goods
Cash

Figure 2.1. Relationship between Transaction Cycles

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2.2.2. 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. The
information this system produces is used for inventory valuation, budgeting, cost control,
performance reporting, and management decisions, such as make-or-buy decisions.
Manufacturing firms convert raw materials into finished products through formal conversion cycle
operations. However, the conversion cycle is not usually formal and observable in service and retail
enterprises.
2.2.3. 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. The primary
subsystems of the revenue cycle are:
 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).
2.3. Organizing data in AIS: The data (transaction) processing cycle
Accountants and other system users play a significant role in the data processing cycle. For
example, they interact with systems analysts to help answer questions such as these:
 What data should be entered and stored by the organization, and who should have access to
them?
 How should data be organized, updated, stored, accessed, and retrieved?
 How can scheduled and unanticipated information need be met?

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To answer these and related questions, the data processing concepts explained in this chapter must
be understood.
One important AIS function is to process company transactions efficiently and effectively. In
manual (non-computer-based) systems, data are entered into journals and ledgers maintained on
paper. In computer-based systems, data are entered into computers and stored in files and data
bases. The operations performed on data to generate meaningful and relevant information are
referred to collectively as the data processing cycle. In other words, the process that begins with
capturing transaction data and ends with informational output, such as the financial statements, is
called transaction processing. As shown in Figure 2.2., this process consists of four steps: data
input, data storage, data processing, and information output.
Figure 2.2. The data processing cycle

2.3.1. Data input

The first step in processing input is to capture transaction data and enter them into the system. The
data capture process is usually triggered (Caused) by a business activity. Data must be collected
about three facets of each business activity:
1) Each activity of interest
2) The resource(s) affected by each activity
3) The people who participate in each activity
Historically, most businesses used paper source documents to collect data about their business
activities. They later transferred that data into the computer. When the data is entered using
computer screens, they often retain the same name and basic format as the paper source document it
replaced.
Turns around documents are company output sent to an external party, who often adds data to the
document, and then are returned to the company as an input document. They are in machine-
readable form to facilitate their subsequent processing as input records. An example is a utility bill
that is sent to the customer, returned with the customer's payment, and read by a special scanning
device when it is returned. Source data automation devices capture transaction data in machine-

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readable form at the time and place of their origin. Examples include ATMs used by banks, point-
of-sale (POS) scanners used in retail stores, and bar code scanners used in warehouses.
The second step in processing input is to make sure captured data are accurate and complete. One
way to do this is to use source data automation or well-designed turnaround documents and data
entry screens. Well-designed documents and screens improve accuracy and completeness by
providing instructions or prompts about what data to collect, grouping logically related pieces of
information close together, using check off boxes or pull-down menus to present the available
options, and using appropriate shading and borders to clearly separate data items. Data input
screens usually list all the data the user needs to enter. Sometimes these screens resemble source
documents, and users fill out the screen the same way they would a paper source document.
Users can improve control either by purchasing pre-numbered source documents or by having the
system automatically assign a sequential number to each new transaction. Pre-numbering simplifies
verifying that all transactions have been recorded and that none of the documents has been
misplaced. (Imagine trying to balance a checkbook if the checks were not pre-numbered.)

The third step in processing input is to make sure company policies are followed, such as
approving or verifying a transaction. For example, Companies would not want to sell goods to a
customer who was not paying his bills or to sell an item for immediate delivery that was out of
stock. These problems are prevented by programming the system to check a customer's credit limit
and payment history, as well as inventory status, before confirming a customer sale.
2.3.2. Data storage
A company's data are one of its most important resources. However, the mere existence of relevant
data does not guarantee that they are useful. To function properly, an organization must have ready
and easy access to its data. Therefore, accountants need to understand how data are organized and
stored in an AIS and how they can be accessed. In essence, they need to know how to manage data
for maximum corporate use.
Imagine how difficult it would be to read a textbook if it were not organized into chapters, sections,
paragraphs, and sentences. Now imagine how hard it would be for a company to find an invoice if
all documents were randomly dumped into file cabinets. Fortunately, information in AIS is
organized for easy and efficient access.
Transaction data are often recorded in a journal before they are entered into a ledger. Cumulative
accounting information is stored in general and subsidiary ledgers.

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Coding techniques
Data in ledgers is organized logically using coding techniques. Coding is the systematic assignment
of numbers or letters to items to classify and organize them.
i. With sequence codes, items are numbered consecutively to account for all items. Any
missing items cause a gap in the numerical sequence. Examples include pre-numbered
checks, invoices, and purchase orders.
ii. With a block code, blocks of numbers are reserved for specific categories of data. For
example, business reserved the following numbers for major product categories:

Users can identify an item's type and model using the code numbers. Other examples include ledger
account numbers (blocked by account type), employee numbers (blocked by department), and
customer numbers (blocked by region).
iii. Group codes, which are two or more subgroups of digits used to code items, are often used
in conjunction with block codes. If organizations uses a seven-digit product code number,
the group coding technique might be applied as follows.

There are four sub codes in the product code, each with a different meaning. Users can sort,
summarize, and retrieve information using· one or more sub codes. This technique is often applied
to general ledger account numbers.
iv. With mnemonic codes, letters and numbers are interspersed to identify an item. The
mnemonic code is derived from the description of the item and is usually easy to memorize.
For example, Dry300W05 could represent a low end (300), white (W) dryer (Dry) made by
Whirlpool (05).

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Chart of accounts
A great example of coding is the chart of accounts, which is a list of the numbers assigned to each
general ledger account. These account numbers allow transaction data to be coded, classified, and
entered into the proper accounts. They also facilitate the preparation of financial statements and
reports, because data stored in individual accounts can easily be summed for presentation.
For example, in the chart of accounts in which each account number is three digits long. The first
digit represents the major account category and indicates where it appears on a company's financial
statements. Thus, all current assets are numbered in the 100s; noncurrent assets are numbered in the
200s, and so on.
The second digit represents the primary financial subaccounts within each category. Again, the
accounts are assigned numbers to match the order of their appearance in financial statements (in
order of decreasing liquidity). Thus, account 120 represents accounts receivable, and account150
represents inventory.
The third digit identifies the specific account to which the transaction data will be posted. For
example, account 501 represents cash sales, and account 502 represents credit sales. Similarly,
accounts 101 through 103 represent the various cash accounts used by the company. A chart of
accounts is tailored to the nature and purpose of an organization. For example, the chart of accounts
for a corporation includes equity accounts of common stock and retained earnings. In contrast, a
partnership would include separate capital and drawing accounts for each partner, instead of
common stock and retained earnings. Likewise, if a business is a retail organization, it has only one
type of general ledger inventory account. A manufacturing company, in contrast, would have
separate general ledger accounts for raw materials, work in process, and finished goods inventories.
Audit trail
An audit trail is a traceable path of a transaction through a data processing system from point of
origin to final output, or backwards from final output to point of origin. It is used to check the
accuracy and validity of ledger postings.
2.3.3. Data processing
Once business activity data have been entered into the system, they must be processed to keep the
databases current. The four different types of data processing activities, referred to as CRUD, are as
follows:
1. Creating new data records, such as adding a newly hired employee to the payroll database.
2. Reading, retrieving, or viewing existing data.

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 3. Updating, previously stored data. Figure 2.3. depicts the steps required to update an
accounts receivable record with a sales transaction. The two records are matched using the
account number. The sale amount ($360) is added to the account balance ($1,500) to get a
new current balance ($1,860).
4. Deleting data, such as purging the vendor master file of all vendors the company no longer
does business with.
Figure 2.3. The accounts receivable file update process

Batch vs. Real-Time Processing

There are two ways to process transactions: using batches and in real time. Updating done
periodically, such as daily, is referred to as batch processing. In a batch processing system,
transactions are accumulated over a period of time and processed as a single unit, or batch.
Although batch processing is cheaper and more efficient, the data are current and accurate only
immediately after processing. For that reason, batch processing is used only for applications, such
as payroll, that do not need frequent updating and those naturally occurs or are processed at fixed
time periods. Most companies’ update each transaction as it occurs referred to as real-time
processing because it ensures that stored information is always current, thereby increasing its
decision making usefulness. It is also more accurate because data input errors can be corrected in
real time or refused. It also provides significant competitive advantages.
In a real-time processing system, transactions are processed immediately as they occur without
any delay to accumulate transactions. Real-time processing is also referred to as online transaction
processing, or OLTP. In this case, the records in the system always reflect the current status. A
good example of a real-time processing system would be airline ticket reservations. When you book

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a ticket, and select a seat, that booking is made right away and nobody else can get that same seat
even a second later. Any changes you make to your reservation are also updated in real time.
Another example is the stock market. When you submit an order to buy a stock, that order is
processed immediately and not at the end of the day. While real-time processing is often more
efficient and in some cases, necessary, batch processing may be more effective. In the case of a
payroll system, there is really no need to keep track of how much an employee has earned every
minute of the day and doing every two weeks is likely sufficient.
2.3.4. Information output
The final step in the data processing cycle is information output. When displayed on a monitor,
output is referred to as soft copy. When printed on paper, it is referred to as hard copy. Information
is usually presented in one of three forms: a document, a report, or a query response.
Documents are records of transaction or other company data. Some, such as checks and invoices,
are transmitted to external parties. Others, such as receiving reports and purchase requisitions, are
used internally. Documents can be printed out, or they can be stored as electronic images in a
computer.
Reports are used by employees to control operational activities and by managers to make decisions
and to formulate business strategies. External users need reports to evaluate company profitability,
judge creditworthiness, or comply with regulatory requirements. Some reports, such as financial
statements and sales analyses, are produced on a regular basis. Others are produced on an exception
basis to call attention to unusual conditions. Reports can also be produced on demand.
A database query is used to provide the information needed to deal with problems and questions
that need rapid action or answers. A user enters a request for a specific piece of information; it is
retrieved, displayed, or analyzed as requested. Repetitive queries are often developed by
information systems specialists. One-time queries are often developed by users.
2.4. Types of Files and Data
This section presents the different types of files and data used in the data processing cycle described
in the above section both in the manual and computer systems. We begin with traditional records
used in manual systems (documents, journals, and ledgers) and then examine their magnetic
counterparts in computer-based systems.
2.4.1. The Manual Process Model
The manual process model is the oldest and most traditional form of accounting systems. Manual
systems constitute the physical events, resources, and personnel that characterize many business

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processes. This includes such tasks as order-taking, warehousing materials, manufacturing goods
for sale, shipping goods to customers, and placing orders with vendors. Traditionally, this model
also includes the physical task of record keeping. Often, manual record keeping is used to teach the
principles of accounting to business students. The following are the files and data used in the
manual process model.
A. 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. There are three types of
documents: source documents, product documents, and turnaround documents.
Source Documents: Economic events result in some documents being created at the beginning (the
source) of the transaction. These are called source documents. 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. For example, a payroll check to an employee is a product
document of the payroll system.
Turnaround Documents: Turnaround documents are product documents of one system that
become source documents for another system.
B. Journals
A journal is a record of a chronological entry. At some point in the transaction process, when all
relevant facts about the transaction are known, the event is recorded in a journal in chronological
order. Documents are the primary source of data for journals. The journal holds a complete record
of transactions and thus provides a means for posting to accounts. There are two primary types of
journals: special journals and general 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. Most organizations use several special journals, including the
cash receipts journal, cash disbursements journal, purchases journal, and the payroll journal.
 General Journals are used to record nonrecurring, infrequent, and dissimilar transactions. For
example, we usually record periodic depreciation and closing entries in the general journal.
Journal vouchers are used to record summaries of routine transactions, no routine transactions,
adjusting entries, and closing entries.

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C. Ledgers
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. There are two basic types of ledgers: (1)
general ledgers, which contain the firm’s account information in the form of highly summarized
control accounts, and (2) subsidiary ledgers, which contain the details of the individual accounts
that constitute a particular control account.
 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 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. Thus, in addition to providing financial statement information, the
general ledger is a mechanism for verifying the overall accuracy of accounting data that
separate accounting departments have processed. Any event incorrectly recorded in a journal or
subsidiary ledger will cause an out-of-balance condition that should be detected during the
general ledger update. By periodically reconciling summary balances from subsidiary accounts,
journals, and control accounts, the completeness and accuracy of transaction processing can be
formally assessed.
Generally, the accounting records described previously provide an audit trail for tracing transactions
from source documents to the financial statements. Of the many purposes of the audit trail, most
important to accountants is the year-end audit.

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2.4.2. Computer-Based Systems
Accounting records in computer-based systems are represented by four different types of magnetic
files: master files, transaction files, reference files, and archive files.
A. 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.
B. 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.
C. 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 employment tax. Other
reference files include price lists used for preparing customer invoices, lists of authorized suppliers
and customer credit files for approving credit sales.
D. 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.
2.5. Enterprise resource planning (ERP) systems
Traditionally, the AIS has been referred to as a transaction processing system because its only
concern was financial data and accounting transactions. For example, when a sale took place, the
AIS would record a journal entry showing only the date of the sale, a debit to either cash or
accounts receivable, and a credit to sales. Other potentially useful nonfinancial information about
the sale, such as the time of day that it occurred, would traditionally be collected and processed
outside the AIS. Consequently, many organizations developed additional information systems to
collect, process, store, and report information not contained in the AIS. Unfortunately, the existence
of multiple systems creates numerous problems and inefficiencies. Often the same data must be
captured and stored by more than one system, which not only results in redundancy across systems
but also can lead to discrepancies if data are changed in one system but not in others. In addition, it
is difficult to integrate data from the various systems.

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Enterprise resource planning (ERP) systems overcome these problems as they integrate all aspects
of a company's operations with traditional AIS. ERP is a set of integrated programs to manage
critical operations for an entire organization. At the center of the ERP system is a database that is
shared by all users. This makes it possible for all units in the organization to have access to current
data to support operations and planning. ERP has emerged as an important tool in controlling costs
and product flows through a complex enterprise. One of the defining characteristics of ERP is that it
integrates real-time information from across the entire enterprise.
Most large and many medium-sized organizations use ERP systems to coordinate and manage their
data, business processes, and resources. The ERP system collects, processes, and stores data and
provides the information managers and external parties need to assess the company.
A properly configured ERP system uses a centralized database to share information across business
processes and coordinate activities. This is important because an activity that is part of one business
process often triggers a complex series of activities throughout many different parts of the
organization. For example, a customer order may necessitate scheduling additional production to
meet the increased demand. This may trigger an order to purchase more raw materials. It may also
be necessary to schedule overtime or hire temporary help. Well-designed ERP systems provide
management with easy access to up-to-date information about all of these activities in order to plan,
control, and evaluate the organization's business processes more effectively.
ERP systems are modular, with each module using best business practices to automate a standard
business process. This modular design allows businesses to add or delete modules as needed.
ERP Systems

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ERP systems also have significant disadvantages:
 Cost: ERP hardware, software, and consulting costs.
 Amount of time required. It can take years to select and fully implement an ERP system,
depending on business size, number of modules to be implemented, degree of customization,
the scope of the change, and how well the customer takes ownership of the project.
 Changes to business processes: Unless a company wants to spend time and money
customizing modules, they must adapt to standardized business processes as opposed to
adapting the ERP package to existing company processes. The failure to map current business
processes to existing ERP software is a main cause of ERP project failures.
 Complexity: This comes from integrating many different business activities and systems, each
having different processes, business rules, data semantics, authorization hierarchies, and
decision centers.
 Resistance: Organizations that have multiple departments with separate resources, missions,
profit and loss, and chains of command may believe that a single system has few benefits. It
also takes considerable training and experience to use an ERP system effectively, and employee
resistance is a major reason why many ERP implementations do not succeed.

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