Chapter 2

Introduction to Transaction
Processing
 Introduction to Transaction Processing

• An economic event that affects the assets and equities of the firm.
• Financial transactions are common business events that occur
regularly. For instance, thousands of transactions of a particular type
(sales to customers) may occur daily. To deal efficiently with such
volume, business firms group similar types of transactions into
transaction cycles.

• 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).
 i) The Expenditure Cycle
• Expenditure Cycle: is time lag between the two due to credit
relations with suppliers:
– physical component (acquisition of goods)
– financial component (cash disbursements to the supplier)

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
 ii) The Conversion Cycle

• Conversion Cycle :
– the production system (planning, scheduling, and control of the
physical product through the manufacturing process)
– the cost accounting system (monitors the flow of cost information
related to production)

– 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.
– Information this system produces is used for inventory valuation,
budgeting, cost control, performance reporting, and management
decisions, such as make or-buy decisions.
 iii) The Revenue Cycle

 Firms sell their finished goods to customers through the revenue cycle
which includes Cash sales, credit sales, and the receipt of cash following a
credit sale

• Revenue Cycle: time lag between the two due to credit relations with
customers :
– physical component (sales order processing)
– financial component (cash receipts)
• Sales order processing: 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)
 Accounting Records
Manual System:
This section describes the purpose of each type of accounting
record used in transaction cycles.

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 - used to capture and formalize
transaction data needed for transaction processing
• Product Documents - the result of transaction processing
• Turnaround Documents - a product document of one system
that becomes a source document for another system
Creation a source Document
A Product Document
A Turnaround Document
 Manual System Accounting Records
Journals - a record of chronological entry.
 special journals - specific classes of transactions that occur in
high frequency
 Such transactions can be grouped together in a special journal
and processed more efficiently than a general journal permits.
 At the end of the processing period (month, week, or day), a clerk
posts the amounts in the columns to the ledger accounts
indicated
 general journal - nonrecurring, infrequent, and dissimilar
transactions.
 periodic depreciation and closing entries are recorded in the
general journal
 Journal vouchers are used to record summaries of routine
transactions, non-routine transactions, adjusting entries, and
closing entries
Manual System Accounting Records
• Ledger – a book of financial accounts that reflects the
financial effects of the firm’s transactions after they are
posted from the various journals .

– general ledger - shows activity for each account listed on the

chart of accounts
– subsidiary ledger - shows activity by detail for each account
type
Flow of Economic Events Into the General Ledger
 Audit Trail
• tracing transactions from source documents to the financial
statements.
• auditor wishes to verify the accuracy of a client’s AR as published in
its annual financial statements.
• The auditor can trace the AR figure on the balance sheet to the
general ledger AR control account. This balance can then be
reconciled with the total for the accounts receivable subsidiary ledger.
• the auditor can select a number of accounts from the AR subsidiary
ledger and trace these back to the sales journal.
• From the sales journal, the auditor can identify the specific source
documents that initiated the transactions and pull them from the files
to verify their validity and accuracy
 Computer-Based Systems

Types of Files
• Master File - generally contains account data (e.g., general
ledger and subsidiary file)
• Transaction File - a temporary file containing transactions
since the last update (sales orders, cash receipt, and inventory
receipt).
• Reference File - contains relatively constant information (price
list, lists of authorized supplier)
• Archive File: An archive file contains records of past
transactions that are retained for future reference (lists of
former employees).
 The Digital Audit Trail

• Let’s look how computer files provide an audit trail. Start with the
capture of the economic event. In this example, sales are
recorded manually on source documents, just as in the manual
system. The next step in this process is to convert the source
documents to digital form. This is done in the data input stage,
where the transactions are edited and a transaction file of sales
orders is produced. Some computer systems do not use physical
source documents. Instead, trans-actions are captured directly on
digital media.

• The next step is to update the various master file subsidiaries and
control accounts that the transaction affects. During the update
procedure, additional editing of transactions takes place.
Like the paper trail, this digital audit trail allows transaction tracing. Again,
an auditor attempting to evaluate the accuracy of the accounts
receivable figure published in the balance sheet could do so via the
following steps:

• Compare the accounts receivable balance in the balance sheet with

the master file AR control account balance.
• Reconcile the AR control figure with the AR subsidiary account total.
• Select a sample of update entries made to accounts in the AR
subsidiary ledger and trace these to transactions in the sales journal
(archive file).
• From these journal entries, identify specific source documents that can
be pulled from their files and verified. If necessary, the auditor can
confirm the accuracy and propriety of these source documents by
contacting the customers in question.
 Documentation Techniques

• It is important for accountants to understand the

documentation that describes how processing takes place.

• Documentation includes the flowcharts, narratives, and other

written communications that describe the inputs, processing,
and outputs of an AIS.
 Documentation Techniques
• Six common documentation techniques:
1. Entity Relationship Diagram
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 (sales-person,
customer, or vendor) about which the organization wishes to capture
data.
2. Data Flow Diagrams
The data flow diagram (DFD) uses symbols to represent the entities,
processes, data flows, and data stores that pertain to a system.
3. Document Flowcharts
A document flowchart is used to depict the elements of a manual
system, including accounting records (documents, journals, ledgers,
and files), organizational departments involved in the process, and
activities (both clerical and physical) that are performed in the
departments.
4. System Flowcharts
System flowcharts portray the computer aspects of a system.
They depict the relation-ships between input (source) data,
transaction files, computer programs, master files, and output
reports produced by the system. System flowcharts also
describe the type of media being used in the system, such as
magnetic tape, magnetic disks, and terminals.

5. Program Flowcharts
The system flowchart shows the relationship between two
computer programs, the files they use, and the outputs they
produce. However, this level of documentation does not provide
the operational details that are sometimes needed. For
example, an auditor wishing to assess the correctness of the
edit program’s logic cannot do so from the system flowchart.
This requires a program flowchart.
6. Record Layout 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.
 Computer-Based Accounting Systems

• Computer-based accounting systems fall into two broad

classes: batch systems and real-time systems:
1. batch systems
2. real-time systems
 1. Batch Systems

• A batch is a group of similar transactions that are

accumulated over time and then processed together.

• 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.
• A time lag exists between the event and the processing.
• Payroll processing is an example of a typical batch system.
• At the end of the period, the paychecks for all employees are
prepared together as a batch
 2. Real-Time Systems

• Process transactions individually at the moment the

economic event occurs.
• Have no time lag between the economic event and the
processing.
• An example of real-time processing is an airline reservations
system, which processes requests for services from one
traveler at a time while he or she waits
 Efficiency Versus Effectiveness

• The designer must consider the trade-off between

efficiency and effectiveness. For example, users of an airline
reservations system cannot wait until 100 passengers (an
efficient batch size) assemble in the travel agent’s office
before their transactions are processed. When immediate
access to current information is critical to the user’s needs,
real-time processing is the logical choice. When time lags in
information have no detrimental effects on the user’s
performance and operational efficiencies can be achieved
by processing data in batches, batch processing is probably
the superior choice.