Module 1

A Journey to the Transaction Process

Introduction

Transaction sounds familiar in the organizations. It is a common term

that every decision maker within and outside the organization can easily
understand. But, what is a transaction? Why is there such a thing?

Transactions are events or activities, which are usually financial in

nature that affect the economic resources controlled by the organization. These
events have an impact on the assets, liabilities and equity of the company.

Processing transactions may take the form of either manual or

automated or computerized. In a computerized and internet – based
environment, it could be batch, on – line or real – time processing. The process
usually involves the recognition, measurement, presentation and disclosure,
and the subsequent derecognition of the effects of the transaction to the
accounting equation.

With today’s technological change, transaction processing transcends

among business units and functional boundaries. If “Alice in Wonderland” were
alive today, and she makes an appointment with Mr. Manny Pangilinan of
PLDT regarding operational efficiency and effectiveness of its subsidiaries, what
could be the starting point of the conversation? Similarly, with the occurrence
of a particular business transaction, are you aware of what lies ahead of the
transaction processing; where it should begin and how it will start?

This module will cover different transaction cycles, various accounting

records effects of technologies under the batch and real – time processing on
traditional versus computer – based systems.

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Learning Outcomes
At the end of this module, you should be able to:

1. Summarize the fundamental objective of transaction cycles,

together with the various accounting documents and records.
2. Compare and contrast batch and real – time processing
technologies in terms of their implication in transaction processing
system.
3. List the documentation techniques used in Accounting Information
Systems.

I – Transactions and Transaction Cycles

Organizations, whether profit oriented or not, either private or public,
government and non – government alike conduct activities on a day to day
basis. These activities range from making a sales order, answering a phone
call, talking to a customer or attending a meeting. It can also be payment of
debts, purchase of equipment, collection of cash from customer, and
acquisition of goods for sale. These activities are called transactions.
Transactions are any event or activity that occurs within or even outside, which
affects the organization. It can be classified as financial or non – financial
transaction. Examples of non – financial transactions are making a phone call
to a manager, talking to a supervisor, celebrating the birthday of a friend and
even making a sales inquiry. On the other hand, financial transactions are
those that affect the resources, obligations and residual interests of the firm.
These involve economic resources that are of value to the organization and
measured in terms of money.

The activities of an organization usually involve exchanging of economic

resources (money, goods and services) between two (2) entities, in an arms -
length manner, wherein one will give up something and the other will receive

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something. This “give and receive” setup of activity, commonly referred to as
economic duality, is what we call financial transaction.

Business entities, regardless of the size and structure regularly engage in

financial transactions. These involve purchasing and acquiring raw materials
either for sale or use in the manufacturing process, transforming raw materials
into saleable goods (for manufacturing firms), selling goods to customers (in the
case of retail - merchandising), and services to customers for service companies
(such as financial institutions, BPOs). Since a bulk of the business
transactions are encountered every now and then, companies to be efficient in
transaction processing classify these into three (3) transactional cycles.

Figure 1-1: The Three Transactional Cycles

Expenditure Cycle Conversion Cycle Revenue Cycle

Among the three (3) transactional cycles, most firms usually begin with
expenditure cycle. Of course, every transactional cycle has two subsets;
namely, financial flow and physical flow. Physical flow pertains to the
movement of goods while financial flow refers to the accounting information
direction as it moves in the organization. Looking at Figure 1-1, usually the
start of transactions is the acquisition of goods for sale by a merchandising
company or the purchase of raw materials for use in the production process by
a manufacturing firm. Firms acquire or obtain goods from suppliers on credit

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terms. As such, there is time lag between acquisition of goods and payment of
goods. Remember that when companies acquire goods on credit, payment will
generally await the maturity of the obligation, unless cash discounts are
provided by the suppliers. In this scenario, the customer – company pays in
cash, thus, the effect on the cash flow of the supplier. The cash and accrual
basis in accounting must be taken into consideration in every Accounting
Information System (AIS). Normally, small business organizations are using the
cash basis of accounting, with simple AIS; while in contrast, large corporations
use the accrual method; making their AIS complex.

Noteworthily, firms also include in the expenditure cycle the payroll

flow and the acquisition of capital assets or long – term assets such as
property, plant and equipment items. So, in other words, the expenditure cycle
involves routine transactions that require cash disbursements, even if cash
payment is not concurrent with the occurrence of the transaction.

For most of the manufacturing firms, acquisition of raw materials is

just the first step. After obtaining the raw ingredients, the firm converts the
raw materials into finished products. This process of converting raw materials
into saleable goods is called production. In the production process, companies
apply labor, machinery and factory plants to produce outputs. In this
transaction cycle, cost flows are tracked, together with the physical movement
of the production process. Normally, information relating to raw materials
requisition and authorization of works in the production are part of production
planning, while information relating to costs accumulation, budgeting and
costs control are part of cost accounting.

After transforming the product into a marketable condition, the

company then sells it. Revenue cycle begins when a customer places an order
for the product. This cycle involves sales order processing and cash receipts

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subsystems. In the sales order processing, activities relating to granting of
credit, picking of goods from the warehouse and shipping them to the
customer, billing the customer and recording the transactions in the accounts,
are included. Cash collections, on the other hand, is under the subset of cash
receipts subsystem that usually begin when the company collects from the
customer when the credit granted has already become due and collectible.

Customer

Transaction
Processing System

Expenditure Conversion Revenue

Cycle Cycle Cycle

Figure 1-2 – Entity’s Transactional Cycle and Customer Relationship

The overall transaction processes are geared towards providing

customers satisfaction and added value. Essential in these cycles is the
recognition that customer is in both ends of the process and that companies
continuously seek process improvements to enhance value proposition among
customers.
Activity 1 – 1
There are a lot of transactions that a particular firm may encounter. In
this activity, you should:
1. List at least five (5) transactions and classify them as expenditure,
conversion or revenue. Also, indicate the subsets / subsystems to
which they relate. Follow the following format provided.
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2. Identify one (1) service oriented company, one (1) merchandising
company and one (1) manufacturing company. Give as many
transactions as you can under each of the three (3) transaction cycles.
II – Accounting Documents and Records

Let us recall that the first step of the accounting process is

documentation of transactions and gathering of source documents. This
processing phase is similar to both manual and computer – based accounting
systems. The difference lies on the actual processing of transactions.

In the manual system, when financial transactions (simply

transactions) occur, relevant and appropriate documents are gathered and
compiled before commencing the recording phase. Such documents can either
be a processing initiator, like the summary of an employee’s biometric time log
which is used for payroll computation, or it can also be a customer order for
the sales order processing. These documents, known as source documents
allow the particular process to begin.

The documents that are actually products of a process are called

product documents. Examples include payroll check for the payroll process
and sales order for the sales ordering process. If a document can both serve as
a process initiator and process output, it is called “hybrid document” or the
turnaround document. The statement of account that we usually receive from
utility companies (MERALCO, Maynilad, SMART, GLOBE, Sun Cellular and
credit card companies), is actually a two – fold document, the first half serves

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as the bill of customer’s account (product document) and the other half is the
remittance advice (source document).

Consequently, the documents are considered in processing the

transaction that occurs. Underlying business documents are then recorded
through the journalizing process. Figure 1 – 3 illustrates the process.

Figure 1 – 3 – Flow of Accounting Information Process

(taken from page 52 of Accounting Information System
(Philippine Edition) by James Hall, Cengage Learning.)

The journalizing phase starts when transactions are recorded in the

respective journals or books of original entry, either general or special. The
general journal is used for the company’s non – recurring, non – routine
transactions such as acquiring of fixed assets, providing of adjusting entries,
closing entries, reversing entries and correcting entries. When transactions are
voluminous and occur regularly, say for example on a daily basis, in order to
be efficient in the recording of the transactions, special journals are created.
Special journals can be provided for all sales transactions (sales journal), all
purchase transactions (purchases journal), cash collections (cash receipts

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journal), cash payments (cash disbursement journal), petty cash expenses
(petty cash journal), payroll registers, cash registers and check registers.

After the transactions are recorded as journal entries, they are then
posted to the ledgers, commonly known as book of final entry. Note that every
account formed from a transaction has its own general ledger, as set out in the
company’s chart of accounts. There are two (2) kinds of ledger, namely, general
ledger, which summarizes the effects of the transactions to a particular
account and the subsidiary ledger, which in turn, provides the details of the
summarized impact of the transactions to an account. An example of this is the
accounts receivable. Sales transactions are recorded in the sales journal, after
which, they are posted, and summarized amount goes to the general ledger
balance of the accounts receivable. The details of the outstanding balance can
be found in each customer subsidiary ledger or record. It can be observed that
the total of all customers’ subsidiary ledger balances is equal to the accounts
receivable general ledger balance. This is the thing. The presence of subsidiary
ledgers provides control is so far as the accuracy of the records is concerned,
because independent verification procedure may be performed anytime.

When the means of processing change from manual system to computer

– based processing, the accounting records are replaced with magnetic files. In
the modern world of digital technology, these data and transactions are
captured and stored in “digital” form such as CD – DVD, hard discs and the
like. Technically, there are four (4) types of magnetic file. These can be
transaction file, master file, reference file and archive file.

Figure 1- 4 – Illustration of Audit Trail

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 Source Documents Accounting Financial
Records Statements

Sales Order Sales Balance

Journal Sheet

Accounts
Receivable
Ledger

While the records may change depending on the manner by which

Ledger
accounting information is being processed, the links between the processes
remain the same. Although in computer – based processing, these links or
connections can be less observable, still they exist. Hence, the audit trail,
which establishes the flow of either the origination or the destination of the
information, is present in all accounting information processing. These are
nevertheless more observable in the manual processing because underlying
business documents readily exist in their original source and functions are
segregated in the information processing stage.

Activity 1 – 2

After obtaining an understanding of the accounting documents and

records, you are required to do the following:

1. Give at least five (5) common examples of underlying business

documents and expound on their purpose, their origination and
destination in an organization.

2. Give the transactional process involved in the following situations, then

identify the documents necessary for each situation:

a. Write – down of inventory to lower the cost or market value

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b. Write – off of bad debts expense.

c. Return to suppliers of goods purchased due to defects.

III – Accounting Information Systems Documentation Techniques

The system of processing accounting information should be clear and

easy to understand. As such, documentation techniques that will provide an
effective visual representation of the system are necessary. The following are
some of the useful techniques in laying out and conceptualizing the system:

1. Data Flow Diagram (DFD)

 According to Wikipedia, it is a “graphical representation of
the "flow" of data through an information system, modelling
its process aspects. Often this is the preliminary step used
to create an overview of the system which can later be
elaborated. Data Flow Diagram can also be used for the
visualization of data processing (structured design). A Data
Flow Diagram shows what kinds of information will be
input to and output from the system, where the data will
come from and go to, and where these will be stored. It
does not show information about the timing of processes or

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 any information about whether processes will operate in
sequence or in parallel”.

2. Entity Relationship (ER) Diagram

 As the name suggests, this diagram shows the relation
between entities of an organization. Entities are resources,
events and agents. Resources are those properties, items of
value or simply “assets” of the organization. Events on the
other hand, are activities that affect the resources, such as
buying goods, selling goods and ordering inventories.
Lastly, agents are those that participate in the event either
internal or external. In a give - and - receive transaction,
the one who gives is usually the internal agent while the
one that receives is the external agent. For example, in a
sales transaction, the seller is the internal agent and the
buyer is the external agent.
 The relationship among entities is expressed in terms of
their occurrences within the organization. The degree of
occurrence or degree of association is called cardinality.
Cardinality may be one – is – to - one occurrence (1:1), one
– to - many occurrence (1:M) or many - to - many
occurrence (M:M).

3. Flowcharts
 A visual representation of a system’s process which can
represent manual processing, computerized processing and
even the system programming process.

4. Process Map

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  Also known as process chart is used to identify the process,
the objectives, risks and controls of the process, to
understand the point of perspectives of persons in the
process and to those processes.

Activity 1 – 3
Read the book Accounting Information Systems by James Hall
(2012 Edition), Chapter 2 and obtain an understanding of the
documentation techniques cited. After reading, answer the following:
1. Differentiate data flow diagram and entity relationship diagram.
2. Differentiate document flowchart from systems flowchart and
program flowchart.
3. Draw a data flow diagram for a purchase process of the
expenditure cycle. In doing the DFD, what do you observe with the
symbols used? How do these symbols differ from that of entity
relationship diagram symbols?

IV – Timing of Accounting Information Processing

The time frame of processing transactions can be classified into two (2)
groups. The first is batch processing system wherein, transactions are grouped
or assembled into batches before they are processed. The actual processing will
await the completion of the batch size. An example of this is the payroll
processing system wherein employee data and summary of employee time
cards are grouped together before commencing the actual processing. The
second type is real – time processing system where there is no time lag between
the occurrence and the processing of the transaction because as it occurs, it is
also processed. Online transactions like purchasing a reservation of airline
tickets and making cash withdrawals with Automated Teller Machines (ATM’s)
belong to this type.
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 Relative to the resources allocation, since concurrency is applied in both
occurrence and processing in real – time processing system, more resources
will be required to be effective in making information currently available in this
system. This is especially true because this system needs storage capacities
that can support its smooth operations. The batch processing is effective even
in limited resources because it requires simpler procedures in processing the
transactions.

Activity 1 – 4
In this activity, you should be able to apply your understanding of the
processing systems relative to time frame. You should perform the following:
1. List at least five (5) companies for each processing system that would
most probably use the batch processing and real – time processing
system.
2. For each company listed above, identify the transactions that would
most likely be processed through batch processing system and real –
time processing system.
3. Give your idea on the implication of the relevant and appropriate
processing systems to the accounting information system and its
effects to the company’s efforts towards accuracy and efficiency.

Required Reading:

Hall, J. (2010). Introduction to Transaction Processing. Accounting

Information Systems (pp. 45 - 82). Philippine Edition. Cengage
Learning.

Hurt, R. (2010). Accounting Information Systems: Concepts and

Current Issues. 2nd Edition. McGraw –Hill / Irwin.

http://en.wikipedia.org/wiki/Process_map#cite_note-1. Retrieved on
August 18, 2013.

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