Chapter 2 Introduction to Transaction Processing

Learning Objectives

After studying this chapter, you should:

■ Understand the broad objectives of transaction cycles.

■ Recognize the types of transactions processed by each of the three transaction cycles.

■ Know the basic accounting records used in transaction processing systems.

■ Understand the relationship between traditional accounting records and their magnetic equivalents in
computer-based systems.

■ Be familiar with the documentation techniques used for representing manual and computer-based
systems.

■ Understand the differences between batch and real-time processing and the impact of these
technologies on transaction processing.

■ Be familiar with data coding schemes used in accounting information systems.

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 types.
- 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).
Figure 2-1 shows the relationship of these cycles and the resource flows between them.
The Expenditure Cycle
- The expenditure cycle is the set of activities related to the acquisition of and payment
for goods and services. These activities include the determination of what needs to be
purchased, purchasing activities, the receipt of goods, and payments to suppliers.
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 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.
ACCOUNTING RECORDS
 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. In this
 section, we discuss 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. We will study many other examples of product
documents in later chapters
 TURNAROUND DOCUMENTS
- Turnaround documents are product documents of one system that become source
documents for another system. A turnaround document contains important
information about a customer’s account to help the cash receipts system process the
payment. One of the problems designers of cash receipts systems face is matching
customer payments to the correct customer accounts. Providing this needed
information as a product of the sales system ensures accuracy when the cash receipts
system processes it.
 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.
 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. Figure 2-6 shows a special journal for
recording sales transactions.
 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. For example, a receiving register is a log of all receipts of raw
materials or merchandise ordered from vendors. Similarly, a shipping register is a log
that records all shipments to customers.
 GENERAL JOURNALS
- Firms use the general journal to record nonrecurring, infrequent, and dissimilar
transactions. For example, we usually record periodic depreciation and closing entries in
the general journal.
- As a practical matter, most organizations have replaced their general journal with a
journal voucher system. A journal voucher is actually a special source document that
contains a single journal entry specifying the general ledger accounts that are affected.
Journal vouchers are used to record summaries of routine transactions, nonroutine
transactions, adjusting entries, and closing entries. The total of journal vouchers
processed is equivalent to the general journal. Subsequent chapters discuss the use of
this technique in transaction processing.
 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.
 GENERAL LEDGERS
- The general ledger (GL) 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.
 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. 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.
 THE AUDIT TRAIL
- 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.
 Although the study of financial auditing falls outside the scope of this text, the following
thumbnail sketch of the audit process will demonstrate the importance of the audit trail.
- Audit trails in computer-based systems are less observable than in traditional manual
systems, but they still exist. Accounting records in computer-based systems are
represented by four different types of magnetic files: master files, transaction files,
reference files, and archive files.

COMPUTER-BASED SYSTEMS
 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. Other reference files include price lists used
for preparing customer invoices, lists of authorized suppliers, employee rosters, and
customer credit files for approving credit sales
 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, priorperiod payroll information, lists of former employees, records of
accounts written off, and prior-period ledgers

SYSTEM FLOWCHARTS
- A system flowchart is the graphical representation of the physical relationships among
key elements of a system. These elements may include organizational departments,
manual activities, computer programs, hard-copy accounting records (documents,
journals, ledgers, and files), and digital records (reference files, transaction files, archive
files, and master files).3 System flowcharts also describe the type of computer media
being employed in the system, such as magnetic tape, magnetic disks, and terminals.
NUMERIC AND ALPHABETIC CODING SCHEMES
 Sequential Codes
- As the name implies, sequential codes represent items in some sequential order
(ascending or descending). A common application of numeric sequential codes is the
prenumbering of source documents. At printing, each hard-copy document is given a
unique sequential code number. This number becomes the transaction number that
allows the system to track each transaction processed and to identify any lost or out-of-
sequence documents. Digital documents are similarly assigned a sequential number by
the computer when they are created.
 Block Codes
- A numeric block code is a variation on sequential coding that partly remedies the
disadvantages just described. This approach can be used to represent whole classes of
items by restricting each class to a specific range within the coding scheme. A common
application of block coding is the construction of a chart of accounts.
- A well-designed and comprehensive chart of accounts is the basis for the general ledger
and is thus critical to a firm’s financial and management reporting systems. The more
extensive the chart of accounts, the more precisely a firm can classify its transactions
and the greater the range of information it can provide to internal and external users.
 Group Codes
- Numeric group codes are used to represent complex items or events involving two or
more pieces of related data. The code consists of zones or fields that possess specific
meaning. For example, a department store chain might code sales order transactions
from its branch stores as follows:

 Alphabetic Codes
- Alphabetic codes are used for many of the same purposes as numeric codes.
Alphabetic characters may be assigned sequentially (in alphabetic order) or may be
used in block and group coding techniques.
 Mnemonic Codes
- Mnemonic codes are alphabetic characters in the form of acronyms and other
combinations that convey meaning. For example, a student enrolling in college courses
may enter the following course codes on the registration form: