MODULE 2: OVERVIEW OF THE TRANSACTION CYCLES

I. Description

This module discusses the different transaction cycles and the key controls for each
transaction cycles.

II. Objectives

After completing the module, the students are expected to:

ü Describe the different categories of the transaction cycles.

ü Identify the forms and documentation used by the different departments

ü Identify and describe the functions of the departments in each transaction cycles

ü Identify the different possible controls in each transaction cycles.

III. Duration

Start: Week 2

End: Week 2

IV. Learning Contents

A. TRANSACTION CYCLES

Transaction cycles are the means through which an accounting system processed
transactions of related activities such as sale of goods to customers, acquisition of
merchandise and payment to vendors, production of finished products for sale, and
payment to employees for services they had rendered.

A Transaction is an agreement between two entities to exchange goods or services or

any other event that can be measured in economic terms by an organization.

Transaction Cycle Inclusion

Revenue and Receipt cycle · Sale of goods or services to customer

· Collection of cash
Expenditure and Disbursement cycle · Acquisition of goods and services

· Payment for the goods and services

acquired
Human Resources and Payroll · Acquisition of services from
employees

· Payment for the services acquired

Production or Conversion · Production of entity’s product for sale
Financing and Investing · Generation of capital funds from
outside investors

· Investment of capital funds to other

profitable activities

B. REVENUE AND RECEIPT CYCLE

Business Function:

ü Resources are distributed to customers in exchange for promises of future payments.

ü Customers pay cash for resources distributed to them.

Affected Accounts:

ü Sales

ü Sales Returns and Allowances

ü Sales Discount

ü Accounts Receivables

ü Allowance for Bad Debts

ü Bad Debts Expense

ü Cash

Departments Involved:

Department Activities Controls Within

Sales Department · Locates and encourages buyers · Exclusive function to
communicate with customer
· To manage and · Negotiates and deals with
improve the entity’s customers · Maintenance of master list
sales of customers and list of prices of
· Accepts Customer orders products and services
 · Prepares S.O. and distributes · Complete documentation
them for new customers

· File retention copy

· Monitor the status of the order

· Reviews and grants customer

request for returns.

· Sends out credit memo to the

concerned departments.
Credit Department · Receives S.O. from Sales · Must be independent from
Sales
· To minimize · Conduct Credit Investigation
exposure to high- · Maintain and update of list
risk customers · Approves Credit request of approved customers

· Notify Sales for the

approval/denial of credit request

· Forward S.O. to Warehouse

Warehouse · Review approved S.O. · Monitoring of inventory
levels to provide assurance of its
(Inventory Control) · Monitor the availability of availability when needed
inventories and update the Sales
· To control Dept. · Report to Sales dept
movement and regarding inventory count
monitor level and · Notifies Sales Dept of the
condition of shipment
inventories
· Release goods to the courier

· Forwards documents to Billing

dept.

· Receiving department receives

returned goods and prepares
receiving report.

· Compares received goods vs.

credit memo
Shipping · Compare S.O. and with approved · Pre-numbered shipping
inventories from Warehouse documents for proper
· To provide monitoring
reasonable · Completes shipping documents
assurance that all (DR) and prepares for shipment · Report for completed
shipments are shipped orders
authorized · Notify Sales dept that goods have
been shipped.

· Forwards S.O. and D.R. to Billing

Department
Billing Department ü Compares S.O., D.R. (Sales dept ü Pre-numbered Sales Invoice
and shipping dept)
ü To provide ü D.R. must be present to
reasonable ensure that billed S.O. has been
shipped.
assurance that all ü Prepares Sales Invoice and send
shipments are billed copies to customers and Accounting
Dep.

Accounting Dept.
Inventory · To provide costing information of
Accounting the goods sold.

· Updates inventory records

General Accounting · Record sale and forward S.I. to
A/R dept
Accounts · Updates SL related to customer
Receivable accounts

Collection/ Receipt Cycle

Mail Room · Receives the remittance advise and customer checks from
customer

· Prepares summary of receipts

· Endorses the checks and remittance advise to Treasury

Department

· Provides report to A/R dept.

Treasury Department · Updates cash records

· Prepared deposit slips for check received

· Prepares collection summary and send to AR and Gen.

Accounting

· Deposit collection to the bank

· The Treasurer authorize the write-off of AR

Accounting Departments:
Accounts Receivables · Compares remittance advice (mail room) and cash summary
from Treasury, updates Customer SL and prepare daily summary
to be forwarded to General Accounting

· Review individual customer accounts

· Performs aging of receivables

· Recommend write-off of delinquent accounts

General Accounting · Validates report from Treasury and Accounts Receivables
and updates General Ledger.

Forms/Documents:

Forms Description Initiated By: Given to:

SALES ORDER Details of goods or services Sales Department Customers
ordered
(Order slip/customer order) Billing Department

Shipping
DELIVERY RECEIPT Describes the goods to be Shipping Customer
shipped and serves as a Department
(Bill of lading/ shipping contract bet. courier and Carrier
document) seller
Billing Department
SALES INVOICE Details of the good/services Billing Department Customer
sold, amount due and terms of
(Billing statement) payment Carrier

Billing
PAYMENT ADVICE Document informing the seller Customer A/R Department
that the goods/service sold
(Remittance Advice) has been paid
DAILY SUMMARY Summary of daily Different dept’s General
transactions of all the involved in the cycle Accounting
departments
A/R Department

Treasury

CONTROLS:

ü Initiating department approves the form.

ü Initiating department is accountable for all the forms in their department, such as
access to the forms and unused forms.

ü If approved by the management through policies, forwarding of the form can be done
also electronically.

ü The initiating department must retain a copy of the forms for filing.

C. PURCHASE TO PAY (P2P)/ EXPENSE AND DISBURSEMENT CYCLE

Business Function

ü Resources are acquired from vendors in exchange for obligations to pay.

ü The entity pays cash to vendors.

Affected Accounts:
ü Purchases

ü Purchase Returns and Allowances

ü Accounts Payables

ü Cash

Departments:

Department Activities Controls Within

Requesting · Prepares requisition slip
Department
Purchasing/ · Receives approved requisition · Exclusive function to
Procurement slip communicate to the vendors

· To meet the · Locates and negotiates with · Maintains list of

specific needs of the vendors authorized/accredited vendors
requesting dept at
least possible cost · Prepares Purchase Orders and · Monitoring and comparing
sends out to vendors, user, receiving price
and AP

· Monitoring of the P.O.’s status

and updates the requesting party
Receiving · Files P.O. until goods are · Proper procedures to
Department received ensure that the receiving
department will count and check
· To provide · Upon receipt, counts and checks the goods received
reasonable the goods’ condition
assurance that
received goods are · Compares P.O. and shipping
based on approved document
P.O.
· Prepares receiving report to be
forwarded to Purchasing and AP
Accounts Payable · Check and review P.R., P.O., · AP Vouchers should be
receiving report and Vendor’s invoice supported by complete
· To provide attachments (P.R., P.O.,
reasonable · Prepares AP Voucher with Receiving docs)
assurance that the complete attachments
payments will be
made for shipments · Prepares daily summary to be
received forwarded to Treasury and General
Accounting
Treasury ü Reviews AP Vouchers ü Check voucher must be
Department stamped “paid”, “cancelled” and
ü Prepares Check Voucher and check check number must be stated
and submit for signing
ü Signatories should have
ü Forwards checks and remittance assigned limit and/or co-
advice to vendors signatories

ü Prepares Daily Summary to be ü No checks should be issued

forwarded to General Accounting with “Cash” payee
Forms/Documents

Forms Description Initiated By: Given to:

Requisition Slip (Purchase Contains the details of the Requesting Purchasing
Request) user department’s request department
Purchase Order Describes the goods to be Purchasing Vendor
acquired department
User

Receiving dept

Accounts Payable
Shipping document Describes the goods to be Vendor Receiving
shipped. department

Serves as contract between

seller and courier
Receiving report Described the goods to be Receiving Purchasing
received department
Accounts Payable
Vendor’s invoice Describes the goods Vendor Accounts Payable
purchased
Remittance Advice Informing the seller that their Treasury Vendor
invoice has been paid
Daily Summaries Summary of daily Accounts Payable General
transactions of all the Accounting
departments Treasury

D. HUMAN RESOURCES AND PAYROLL CYCLE

This cycle is part of the expenditure and disbursement cycle. This cycle covers the
entity’s acquisition of services from its employees and personnel.

Payroll includes different categories of employee benefits that could significantly affect
major elements of financial statements and for most entities, significant amounts of
resources is incurred.

Types of Employee Benefits:

ü Short-term

ü Post-employment

ü Other long-term benefits

ü Retirement benefits

Business Functions:

ü Services are received from employees in exchanged for obligations to pay.

ü Entity pays cash to employees

Affected Accounts:

ü Salaries and wages expense

ü Salaries and wages payable

ü Withholding taxes payable

ü Inventories (for inventoriable salaries and wages)

ü Cash

Departments Involved:

Department Activities Controls Within

User department · Monitors and approves daily time · Appropriate review
records activities to ensure the
· Ensures that time truthfulness of the DTR
records prepared by information
the employees
represent actual hours · Use of reliable computer
worked. system in place of manual
recording with exclusive access
to users and proper approvals
HR Department · Initiates, updates and maintains · Access on employees’ files
HR records shall be limited to HR
· To ensure that department only
employees included in · Forwards payroll related
the payroll are information to Payroll department · Limited employees’
rendering services to information shall be shared to
the entity · Determines terms of settlement appropriate department
in case of termination/resignation

· Monitors status of employment of

employees
Payroll Department · Receives and reviews · Appropriate level of
information from HR management not part of the
· To provide
reasonable assurance
that payroll calculation · Considers update on pay rates payroll department to conduct
is valid and deductions review for accuracy

· Prepares payroll register · Assure adequate of

segregation of duties internally
· Updates cumulative employee and inter-department
earnings per record
Treasury Department · Reviews payroll registered · Separate bank accounts for
received payroll distribution

· Prepares check and facilitates · Regular audit with different

signing intervals to be conducted to
check existence of employees
· Distributes payment to the
employees

· Prepares daily summary to be

forwarded to General Accounting
Inventory Accounting ü Records inventoriable costs to
appropriate jobs or customer
accounts and forwards daily summary
to General Accounting
General Accounting ü Reviews daily summary received
from different department and
records related expenses

Forms/Documents:

Forms Description Initiated By: Given to:

HR Records (201 file) Contains all information HR Department Payroll
related to the entity’s
employees.
Daily Time Record (DTR) Describes the number of User Department Payroll
hours worked by an employee
for a particular pay period
Payroll Register Shows all related payroll Payroll Treasury
information
General Accounting
Labor Cost Summary Shows all capitalizable payroll Payroll Inventory
information attributed to a Accounting
particular job or customer
order
Employee Earnings Record Cumulative YTD summary of Payroll Accounts Payable
earnings and deductions of
every employee
Daily Summary Summarizes transactions Payroll General Accounting
recorded during the day by
different departments Inventory

Treasury

E. PRODUCTION AND CONVERSION CYCLE

Production and conversion cycle covers the production of entity’s product for sale. This
is where materials, labor and overhead are converted into finished goods.
The primary objective is the proper valuation of inventories. This encompasses the
proper allocation of costs to each run made by the production department. This cycle
uses inputs from disbursement and expenditure cycle and provides information to
revenue and receipt cycle.

Function Departments Assigned Control Procedures

Custody Production Department – Physical count VS records
physical custody of the
materials and labor If held by other parties,
documents confirmation requests to
custodians for verification
Authorization Production Department – Validation of the auditors
authorized to make normal whether the production runs
production runs are authorized with
appropriate requests

Special runs must be

authorized by the BOD.
Recording Cost Accounting – records Competency of the staffs
daily summary and must be evaluated
forwarded to General
Accounting.

Reconciliation to GL

F. FINACE AND INVESTMENT CYCLE

This involves three (3) major categories:

ü Investments

ü Long-term Debts

ü Shareholders’ Equity

Processes involves the following:

ü Accounting for investments

ü Accounting for mergers

ü Accounting for long term liabilities

ü Accounting for equity transactions

FINANCE CYCLE

Functions Departments Assigned Controls

Custody Corporate Secretary – Frequent inquiries to the
unissued debt and equity custodian
certificates
Authorization Board of Directors Review of the auditors by
minutes of meetings
Recording General Accounting Competency of the staffs
must be evaluated

Reconciliation to GL

INVESTMENT CYCLE

Functions Departments Assigned Controls

Custody Negotiable Instruments – Auditor send out
Brokerage confirmation request to
external custodian. If
Titles to real estate accounts internally, auditor observes
– within the entity’s safe or accounting for certificates
bank deposit box held
Authorization Board of Directors Review of the auditors by
minutes of meetings
Recording General Accounting Competency of the staffs
must be evaluated

Reconciliation to GL

V. References

· Auditing and Assurance Concepts and Applications by Darrell Joe O. Asuncion,

Mark Alyson B. Ngina and Raymund Francis A. Escala

· Auditing and Assurance, Concepts and Applications by Ma. Elenita Balatbat

Cabrera and Gilbert Anthony B. Cabrera