Introduction to Transaction Processing:An Overview,TRANSACTION CYCLES,The Expenditure Cycle,The Conversion Cycle and The Revenue Cycle.

Introduction to Transaction Processing

Chapter 1 introduced the transaction processing system (TPS) as an activity consisting of three major subsystems called cycles: the revenue

cycle, the expenditure cycle, and the conversion cycle. Even though each cycle performs different specific tasks and supports different objectives, they share common characteristics. For example, all three TPS cycles capture financial records, and provide information about transactions to users in support of their day-to-day activities. In addition, transaction cycles produce much of the raw data from which management reports and financial statements are derived. Because of their financial impact on the firm, transaction cycles command much of the accountant’s professional attention.

The purpose of this chapter is to present some preliminary topics that are common to all three transaction processing cycles. In subsequent chapters, we will draw heavily from this material as we examine the individual subsystems of each cycle in detail. This chapter is organized into five major sections. The first is an overview of transaction proc- essing. This section defines the broad objective of the three transaction cycles and specifies the roles of their individual subsystems. The second section describes the relationship among accounting records in forming an audit trail in both manual and computer-based systems. The third section examines documentation techniques used to represent sys- tems. This section presents several documentation tech- niques for manual and computer-based systems. The fourth section addresses computer-based systems. It reviews the fundamental features of batch and real-time technologies and their implication for transaction processing. The final section examines data coding schemes and their role in transaction processing.

An Overview of Transaction Processing

TPS applications process financial transactions. A financial transaction was defined in Chapter 1 as 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.

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 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

Business activities begin with the acquisition of materials, property, and labor in exchange for cash—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 par- ties. The actual disbursement of cash takes place at some point after the receipt of the goods or services. Days or even weeks may pass between these two events. 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 here. Because of the extent of this body of material, two chapters are devoted to the expenditure cycle. Purchases/AP and cash disbursements systems are the topics of Chapter 5. Payroll and fixed asset systems are examined in Chapter 6.

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 pur- chases 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 of- ten represent the organization’s largest financial investment. Examples of fixed assets include land, buildings, furniture, machinery, and motor vehicles.

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. We examine the basic features of these systems in Chapter 7.

Manufacturing firms convert raw materials into finished products through formal conversion cycle operations. The conversion cycle is not usually formal and observable in service and retailing establish ments. Nevertheless, these firms still engage in conversion cycle activities that culminate in the development of a salable product or service. These activities include the readying of products and services for market and the allocation of resources such as depreciation, building amortization, and prepaid expenses to the proper accounting period. However, unlike manufacturing firms, merchandising companies do not process these activities through formal conversion cycle subsystems.

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, which are the topics of Chapter 4, are briefly outlined below.

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).