Chapter 02 - Transaction Processing System

SOUTH EASTERN UNIVERSITY OF SRI LANKA
FACULTY OF MANAGEMENT AND COMMERCE
ACCOUNTING INFORMATION SYSTEMS
YEAR 03 – SEMESTER 01
CHAPTER 02
TRANSACTION PROCESSING SYSTEM
Ms. Viduni Udovita
Assistant Lecturer
Department of Accountancy and Finance

1. What is a Transaction?
An economic event that affects the assets and equities of the firm, is reflected
in its accounts, and is measured in monetary terms.
2. What are Transaction Cycles?
• Financial transactions are common events occur regularly.
• Thousands of transactions may occur daily. To deal with such big volume
daily efficiently, business firms group similar transactions together and
form transaction cycle.

• There are 3 transaction cycles.
• Every business;
1. Incur expenditures in exchange for resources – Expenditure cycle
2. Provide a value addition through its products and services – Conversion cycle
3. Receive revenue from outside sources – Revenue cycle

3. Relationship between Transaction Cycles?

a) Expenditure Cycle:
• Business activities begin with the acquisition of materials, property, and labor in
exchange for cash – i.e. the expenditure cycle.
• 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) a physical component (the acquisition of the goods)
b) and a financial component (the cash disbursement to the supplier).

Subsystems of Expenditure Cycle:
 Purchases/accounts payable system:
 This system recognizes the need to acquire physical inventory (such as raw materials).
 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.

b) Conversion cycle:
• The conversion cycle is composed of two major subsystems:
a. the production system and
b. 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.
c) 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.
• The revenue cycle is composed of two major subsystems:
a. Sales order processing system and
b. Cash receipts system.

 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).

4. Accounting Records Used in Transaction Cycles:
Accounting Records
Manual Computer - based
Manual System
Documents Journals Ledgers

4.1 Documents:
4.1.1 Source Documents:
• A document provides evidence of an economic event and may be used to
initiate transaction processing.
• Three types of documents as;
a) Source documents
b) Product documents
c) Turnaround documents
• A document created at the beginning of a transaction.
• Used to capture and formalize transaction data that the transaction cycle
needs for processing.
- Manual Recording -

4.1.2 Product Documents:
• A document created as a result of the transaction system.
• Eg: customers’ bill

4.1.3 Turnaround Documents:
• Turnaround documents are product documents of one system that
become source documents for another system.

4.2 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.

4.2.1 Special Journals:
• Records specific classes of transactions that occur in high frequency.
• Eg: Sales journal records only sales transactions
4.2.2 General Journals:
• Records non recurring infrequent and dissimilar transactions.

4.3 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.
• ledgers show activity by account type.
• A ledger indicates the increases, decreases, and current balance of each
account.
• There are 2 types of ledgers.

4.3.1 General Ledger:
• The general ledger (GL) summarizes the activity for each of the
organization’s accounts.
• 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.

4.3.2 Subsidiary Ledger:
• 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.
• The total of account balances in a subsidiary ledger should equal the
balance in the corresponding general ledger control account.

Flow of Economic Events into General Ledger:

Audit Trail:
• The accounting records described previously provide an audit trail for
tracing transactions from source documents to the financial statements.
• The auditor’s responsibility involves the review of selected accounts and
transactions to determine their validity, accuracy, and completeness
• Rather than examining every transaction that affected the AR account,
the auditor will use a sampling technique to examine a representative
subset of transactions.

Select no. of accounts from subsidiary ledger
Trace these back to journal
From the journal, identify specific source documents that
initiated the transaction
Pull them from files to verify their validity and accuracy

Contacting the customer to determine whether transactions
recorded actually took place.
Customers agree / disagree on record balance
• The auditor also could use confirmation technique.

- Computer Files Recording -
4.4 Master Files:
• Generally contains account data
• Eg: General ledger and subsidiary ledger
• Data values in master files are updated from transactions.
4.5 Transaction Files:
• A temporary file of transaction records used to change or update data in
a master file.
• Eg: Sales orders, inventory receipts, cash receipts

4.6 Reference Files:
• Stores data that are used as standards for processing transactions.
• Eg: Price lists, Tax tables, Supplier lists etc
4.7 Archive Files:
• Contains records of past transactions that are retained for future
reference.
• Very important for audit trail
• Eg: Journals, List of former employees, Prior period payroll information

5. Documentation Techniques:
5.1 Data Flow Diagrams (DFD):
• Five basic documentation techniques are introduced in this section:
- Data flow diagrams,
- Entity relationship diagrams,
- System flowcharts,
- Program flowcharts, and
- Record layout diagrams.
• The data flow diagram (DFD) uses symbols to represent the entities,
processes, data flows, and data stores that pertain to a system.
• Represents the logical elements of the system.

• Entities should be labeled as a
noun. Eg: Customer, Supplier
• Processes should be labled
with a descriptive verbs such as
ship goods, update records

5.2 Entity Relationship Diagrams:
• 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.
• The square symbol represents entities in the system.
• The labeled connecting line represents the nature of the relationship between two entities.
• The degree of the relationship, called cardinality, is the numeric mapping between entity instances.
• A relationship can be
• one-to-one (1:1),
• one-to-many (1:M), or
• many-to-many (M:M).

5.3 System Flowcharts:
• A graphical representation of the physical relationships among key elements of a system.
• I.e.: Input sources, Programs, output products
• System flowcharts also describe the type of computer media being employed in the system,
such as magnetic tape, magnetic disks, and terminals.

5.4 Programme Flowcharts:
• Shows the relationship between computer programmes, the files they use and the output
they produce.

5.4 Document Flowcharts:
• Illustrate the relationship among processes and the document that flow between them.
• Contains more details than DFD

How to draw a flowchart?
1. The flowchart should be labeled to clearly identify the system that it represents.
2. The correct symbols should be used to represent the various entities in the system.
3. All symbols on the flowchart should be labeled.
4. Lines should have arrowheads to clearly show the process flow and sequence of events.
5. If complex processes need additional explanation for clarity, a text description should be
included on the flowchart or in an attached document referenced by the flowchart.

Activity: Draw a manual process flowchart for the below case.
1. A clerk in the sales department receives a hard-copy customer order by mail and manually prepares four hard copies of a
sales order.
2. The clerk sends Copy 1 of the sales order to the credit department for approval. The other three copies and the original
customer order are filed temporarily, pending credit approval.
3. The credit department clerk validates the customer’s order against hard-copy credit records kept in the credit department.
The clerk signs Copy 1 to signify approval and returns it to the sales clerk.
4. When the sales clerk receives credit approval, he or she files Copy 1 and the customer order in the department. The clerk
sends Copy 2 to the warehouse and Copies 3 and 4 to the shipping department.
5. The warehouse clerk picks the products from the shelves, records the transfer in the hard-copy stock records, and sends
the products and Copy 2 to the shipping department.
6. The shipping department receives Copy 2 and the goods from the warehouse, attaches Copy 2 as a packing slip, and ships
the goods to the customer. Finally, the clerk files Copies 3 and 4 in the shipping department.

1. The first step in preparing the flowchart is to lay out these areas of activity / departments
and label each of them.

A clerk in the sales department receives a hard-copy customer order by mail and manually
prepares four hard copies of a sales order.

The clerk sends Copy 1 of the sales order to the credit department for approval. The other three
copies and the original customer order are filed temporarily, pending credit approval.

When the sales clerk receives credit approval, he or she files Copy 1 and the customer order in
the department. The clerk sends Copy 2 to the warehouse and Copies 3 and 4 to the shipping
department.

The warehouse clerk picks the products
from the shelves, records the transfer in the
hard-copy stock records, and sends the
products and Copy 2 to the shipping
department.
The shipping department receives Copy 2
and the goods from the warehouse, attaches
Copy 2 as a packing slip, and ships the
goods to the customer. Finally, the clerk files
Copies 3 and 4 in the shipping department.

6. Transaction Processing Models:
Transaction Processing
Batch Processing Real Time Processing
• Gathering transactions into
groups or batches and then
processing the entire batch
as a single event.
• A time lag exists between
the event and the processing.
• Can increase efficiency.
• Provide control over the
transaction process
• Process each and every
individual transaction at the
moment the event occurs.
• No time lag in-between
• Generally require more
resources.
• Cost is reduced.
• System development time is
longer.

6.1 Making the choice – Efficiency vs Effectiveness:
- In selecting a data processing mode, 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.

Updating a master file record involves changing the value of one or more of its variable fields
to reflect the effects of a transaction to get the new updated master file.
6.2 Updating Master Files From Transactions:

The update procedure in this example involves the following steps:
1. A sales order record is read by the system.
2. ACCOUNT NUMBER is used to search the AR master file and retrieve the corresponding AR record.
3. The AR update procedure calculates the new customer balance by adding the value stored in the
INVOICE AMOUNT field of the sales order record to the CURRENT BALANCE field value in the AR
master record.
4. Next, INVENTORY NUMBER is used to search for the corresponding record in the inventory master
file.
5. The inventory update program reduces inventory levels by deducting the QUANTITY SOLD value in a
transaction record from the QUANTITY ON HAND field value in the inventory record.
6. A new sales order record is read, and the process is repeated

6.3 Database Backup Procedures:
Master file update
Destructive update
Backup and recovery
approach

6.3.1 Destructive Approach:
• Original value will be
destroyed / erased and
replaced by the new value
and master file is updated.
• This approach does not
leave any backup data of
the original / current
values.
• Only the updated new
values are available to
users.

6.3.2 Backup & Recovery Approach:
• However, to preserve
adequate amount of
accounting records, Incase
the current master becomes
damaged a separate backup
procedure must be
implemented.
• Thus, before each batch is
updated to master file, the
original file in the master
file is copied to a backup
master to create a backup
database of the records.

Practice Questions
1. What three transaction cycles exist in all businesses?
2. Name the major subsystems of the expenditure cycle.
3. Identify and distinguish between the physical and financial components of the expenditure
cycle.
4. Distinguish between a general journal and journal vouchers.
5. Discuss the flow of cash through the transaction cycles. Include in your discussion the
relevant subsystems and any time lags that may occur.

Chapter 02 - Transaction Processing System

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