INTRODUCTION TO TRANSACTION PROCESSING

system records the event by increasing inventory

AN OVERVIEW OF TRANSACTION PROCESSING and establishing an account payable to be paid at a
• TPS applications process financial transactions. later date.
• The most common financial transactions are • Cash disbursements system. When the obligation
economic exchanges with external parties. These created in the purchases system is due, the cash
include the sale of goods or services, the purchase of disbursements system authorizes the payment,
inventory, the discharge of financial obligations, and disburses the funds to the vendor, and records the
the receipt of cash on account from customers. transaction by reducing the cash and accounts
• Financial transactions also include certain internal payable accounts.
events such as the depreciation of fixed assets; the • Payroll system. The payroll system collects labor
application of labor, raw materials, and overhead to usage data for each employee, computes the payroll,
the production process; and the transfer of inventory and disburses paychecks to the employees.
from one department to another. Conceptually, payroll is a special-case purchases and
• Financial transactions are common business events cash disbursements system. Because of accounting
that occur regularly. For instance, thousands of complexities associated with payroll, most firms
transactions of a particular type (sales to customers) have a separate system for payroll processing.
may occur daily. To deal efficiently with such volume, • Fixed asset system. A firm’s fixed asset system
business firms group similar types of transactions processes transactions pertaining to the acquisition,
into transaction cycles. maintenance, and disposal of its fixed assets. These
are relatively permanent items that collectively often
TRANSACTION CYCLES represent the organization’s largest financial
1. incurs expenditures in exchange for resources investment. Examples of fixed assets include land,
(expenditure cycle) buildings, furniture, machinery, and motor vehicles.
2. provides value added through its products or
services (conversion cycle) The Conversion Cycle
3. receives revenue from outside sources (revenue • The production system involves the planning,
cycle) scheduling, and control of the physical product
through the manufacturing process.
The Expenditure Cycle • The cost accounting system monitors the flow of
• Business activities begin with the acquisition of cost information related to production. Information
materials, property, and labor in exchange for cash. this system produces is used for inventory
• Most expenditure transactions are based on a credit valuation, budgeting, cost control, performance
relationship between the trading parties. reporting, and management decisions, such as
• The actual disbursement of cash takes place at make-or-buy decisions.
some point after the receipt of the goods or
services. The Revenue Cycle
• Thus, from a systems perspective, this transaction • Involves processing cash sales, credit sales, and the
has two parts: receipt of cash following a credit sale.
➢ a physical component (the acquisition of • Revenue cycle transactions also have physical and a
the goods) financial component, which are processed
➢ a financial component (the cash separately.
disbursement to the supplier) • Sales order processing. The majority of business
• A separate subsystem of the cycle processes each sales are made on credit and involve tasks such as
component. preparing sales orders, granting credit, shipping
• Purchases/accounts payable system products (or rendering of a service) to the
• Cash disbursements system customer, billing customers, and recording the
• Payroll system transaction in the accounts (accounts receivable,
• Fixed asset system inventory, expenses, and sales).
• Purchases/accounts payable system. This system • Cash receipts. For credit sales, some period of time
recognizes the need to acquire physical inventory (days or weeks) passes between the point of sale
(such as raw materials) and places an order with the and the receipt of cash. Cash receipts processing
vendor. When the goods are received, the purchases includes collecting cash, depositing cash in the
 bank, and recording these events in the accounts the process. For example, a payroll check to an
(accounts receivable and cash). employee is a product document of the payroll
system.
ACCOUNTING RECORDS • Customer’s bill is a product document of the sales
Manual System system.
• Documents
➢ Source Doc0uments Turnaround Documents
➢ Product Documents • Turnaround documents are product documents of
➢ Turnaround Documents one system that become source documents for
• Journals another system.
➢ Special Journals • The customer receives a perforated two-part bill or
➢ Register statement. The top portion is the actual bill, and the
➢ General Journals bottom portion is the remittance advice. Customers
• Ledgers remove the remittance advice and return it to the
➢ General Ledgers company along with their payment (typically a
➢ Subsidiary Ledgers check).
• A turnaround document contains important
Computer-Based Systems information about a customer’s account to help the
• Master File cash receipts system process the payment. One of
• Transaction File the problems designers of cash receipts systems
• Reference File face is matching customer payments to the correct
• Archive File customer accounts. Providing this needed
information as a product of the sales system
Documents ensures accuracy when the cash receipts system
• A document provides evidence of an economic processes it.
event and may be used to initiate transaction
processing. Journals
• Some documents are a result of transaction • A journal is a record of a chronological entry.
processing. • At some point in the transaction process, when all
• 3 types of documents: relevant facts about the transaction are known, the
1. source documents event is recorded in a journal in chronological order.
2. product documents • Documents are the primary source of data for
3. turnaround document journals.
• Each transaction requires a separate journal entry,
Source Documents reflecting the accounts affected and the amounts to
• Economic events result in some documents being be debited and credited.
created at the beginning (the source) of the • There is often a time lag between initiating a
transaction. These are called source documents. transaction and recording it in the accounts. The
• Source documents are used to capture and journal holds a complete record of transactions and
formalize transaction data that the transaction cycle thus provides a means for posting to accounts
needs for processing. • 2 primary types of journals
• The economic event (the sale) causes the sales clerk ➢ special journals
to prepare a multipart sales order, which is formal ➢ general journals.
evidence that a sale occurred. Copies of this source
document enter the sales system and are used to Special Journals
convey information to various functions, such as • Special journals are used to record specific classes
billing, shipping, and AR. The information in the of transactions that occur in high volume.
sales order triggers specific activities in each of • Such transactions can be grouped together in a
these departments. special journal and processed more efficiently than
a general journal permits.
Product Documents • As you can see, the sales journal provides a
• Product documents are the result of transaction specialized format for recording only sales
processing rather than the triggering mechanism for transactions.
• Most organizations use several other special of highly summarized control accounts,
journals, including the cash receipts journal, cash and
disbursements journal, purchases journal, and the ➢ subsidiary ledgers, which contain the
payroll journal. details of the individual accounts that
constitute a particular control account.
Register
• The term register is often used to denote certain General Ledgers
types of special journals. • The general ledger (GL) summarizes the activity for
• For example, the payroll journal is often called the each of the organization’s accounts.
payroll register. • The general ledger department updates these
• We also use the term register, however, to denote a records from journal vouchers prepared from
log. For example, a receiving register is a log of all special journals and other sources located
receipts of raw materials or merchandise ordered throughout the organization.
from vendors. Similarly, a shipping register is a log • The general ledger provides a single value for each
that records all shipments to customers. control account, such as accounts payable, accounts
receivable, and inventory. This highly summarized
General Journals information is sufficient for financial reporting, but
• Firms use the general journal to record it is not useful for supporting daily business
nonrecurring, infrequent, and dissimilar operations.
transactions.
• For example, we usually record periodic Subsidiary Ledgers
depreciation and closing entries in the general • Subsidiary ledgers are kept in various accounting
journal. departments of the firm, including inventory,
• Note that the columns are nonspecific, allowing any accounts payable, payroll, and accounts receivable.
type of transaction to be recorded. The entries are This separation provides better control and support
recorded chronologically. of operations.
• As a practical matter, most organizations have • The total of account balances in a subsidiary ledger
replaced their general journal with a journal should equal the balance in the corresponding
voucher system. general ledger control account. Thus, in addition to
• A journal voucher is actually a special source providing financial statement information, the
document t hat contains a single journal entry general ledger is a mechanism for verifying the
specifying the general ledger accounts that are overall accuracy of accounting data that separate
affected. Journal vouchers are used to record accounting departments have processed.
summaries of routine transactions, nonroutine • Any event incorrectly recorded in a journal or
transactions, adjusting entries, and closing entries. subsidiary ledger will cause an out-of-balance
The total of journal vouchers processed is condition that should be detected during the
equivalent to the general journal. general ledger update. By periodically reconciling
summary balances from subsidiary accounts,
Ledgers journals, and control accounts, the completeness
• A ledger is a book of accounts that reflects the and accuracy of transaction processing can be
financial effects of the firm’s transactions after they formally assessed.
are posted from the various journals.
• Whereas journals show the chronological effect of THE AUDIT TRAIL
business activity, ledgers show activity by account
type. A ledger indicates the increases, decreases,
• The accounting records described previously
provide an audit trail for tracing transactions from
and current balance of each account. source documents to the financial statements. Of
• Organizations use this information to prepare the many purposes of the audit trail, most
financial statements, support daily operations, and important to accountants is the year-end audit.
prepare internal reports.
• 2 basic types of ledgers: COMPUTER-BASED SYSTEMS
➢ general ledgers, which contain the • Audit trails in computer-based systems are less
firm’s account information in the form observable than in traditional manual systems, but
they still exist.
• Accounting records in computer-based systems are • Reconcile the AR control figure with the AR
represented by four different types of magnetic files subsidiary account total.
1. master files • Select a sample of update entries made to
2. transaction files accounts in the AR subsidiary ledger and trace
3. reference files these to transactions in the sales journal (archive
4. archive files file).
4 Different Types of Magnetic Files • From these journal entries, identify specific
• MASTER FILE source documents that can be pulled from their
➢ A master file generally contains account files and verified. If necessary, the auditor can
confirm the accuracy and propriety of these
data.
➢ The general ledger and subsidiary ledgers source documents by contacting the customers in
are examples of master files. question.
➢ Data values in master files are updated
from transactions. Documentation Techniques
• TRANSACTION FILE • data flow diagrams
➢ A transaction file is a temporary file of • entity relationship diagrams
transaction records used to change or • system flowcharts
update data in a master file. • program flowcharts
➢ Sales orders, inventory receipts, and cash • record layout diagrams
receipts are examples of transaction files.
• REFERENCE FILE • DATA FLOW DIAGRAMS
➢ A reference file stores data that are used as ➢ The data flow diagram (DFD) uses symbols to
represent the entities, processes, data flows, and
standards for processing transactions.
➢ For example, the payroll program may refer data stores that pertain to a system.
to a tax table to calculate the proper ➢ DFDs are used to represent systems at different
amount of withholding taxes for payroll levels of detail from very general to highly detailed.
transactions. ➢ Systems analysts use DFDs extensively to represent
➢ Other reference files include price lists used the logical elements of the system. This technique
does not, however, depict the physical system. In
for preparing customer invoices, lists of
authorized suppliers, employee rosters, and other words, DFDs show what logical tasks are
customer credit files for approving credit being done, but not how they are done or who (or
sales. what) is performing them. For example, the DFD
does not show whether the sales approval process
• ARCHIVE FILE
➢ An archive file contains records of past is separated physically from the billing process in
transactions that are retained for future compliance with internal control objectives.
reference. ➢ Entities in a DFD are external objects at the
➢ These transactions form an important part boundary of the system being modeled. They
of the audit trail. represent sources of and destinations for data.
Entities may be other interacting systems or
➢ Archive files include journals, prior period
functions, or they maybe external to the
payroll information, lists of former
organization. Entities should always be labeled as
employees, records of accounts written off,
and prior-period ledgers. nouns on a DFD, such as customer or supplier. Data
stores represent the accounting records used in
THE DIGITAL AUDIT TRAIL each process, and labeled arrows represent the
Like the paper trail, this digital audit trail allows data flows between processes, data stores, and
transaction tracing. An auditor attempting to evaluate entities.
the accuracy of the AR figure published in the balance ➢ Processes in the DFD should be labeled with a
sheet could do so via the following steps descriptive verb such as Ship Goods,Update
Records, or ReceiveCustomer Order. Process
• Compare the accounts receivable balance in the objects should not be represented as nouns like
balance sheet with the master file AR control Warehouse, AR Dept., or Sales Dept.
account balance. ➢ The labeled arrows connecting the process objects
represent flows of data such as Sales Order, Invoice,
 or Shipping Notice. Each data flow label should be ➢ If we think of entities in the ER diagram as files of
unique the same label should not be attached to records, cardinality is the maximum number of
two different flow lines in the same DFD. When records in one file that are related to a single record
data flow into a process and out again (to another in the other file and vice versa.
process), they have, in some way, been changed. ➢ Entity Relationship Diagrams
This is true even if the data have not been physically ➢ Cardinality reflects normal business rules as well as
altered. For example, consider the Approve Sales organizational policy. For instance, the 1:1
process in Figure 2-13, where Sales Order is cardinality in the first example suggests that each
examined for completeness before being processed salesperson in the organization is assigned one
further. It flows into the process as Sales Order and automobile. If instead the organization’s policy
out of it as Approved Sales Order. were to assign a single automobile to one or more
salespersons who share it, this policy would be
DATA FLOW DIAGRAM OF SALES ORDER reflected by a 1:M relationship. Similarly, the M:M
PROCESSING SYSTEM relationship between vendor and inventory implies
that the organization buys the same type of
products from one or more vendors. A company
policy to buy particular items from a single vendor
would be reflected by a 1:M cardinality.
➢ System designers identify entities and prepare a
model of them.. This data model is the blueprint for
what ultimately will become the physical database.
The data model presented in our example is not,
however, sufficiently refined to be the plan for a
workable database. Constructing a realistic data
model is an advanced topic that involves
understanding and applying techniques and rules
that are beyond the scope of this chapter.

• SYSTEM FLOWCHARTS
➢ A system flowchart is the graphical representation
of the physical relationships among key elements
of a system.
➢ These elements may include organizational
• ENTITY RELATIONSHIP DIAGRAMS departments, manual activities, computer
➢ An entity relationship (ER) diagram is a programs, hard-copy accounting records
documentation technique used to represent the (documents, journals, ledgers, and files), and digital
relationship between entities. Entities are physical records (reference files, transaction files, archive
resources (automobiles, cash, or inventory), events files, and master files).
(ordering inventory, receiving cash, shipping goods), ➢ System flowcharts also describe the type of
and agents (salesperson, customer, or vendor) computer media being employed in the system,
about which the organization wishes to capture such as magnetic tape, magnetic disks, and
data. terminals.
➢ Figure across shows the symbol set used in an ER ➢ The flowcharting examples in the following sections
diagram. The square symbol represents entities in illustrate techniques for representing both manual
the system. The labeled connecting line represents and computer-based accounting processes.
the nature of the relationship between two entities. ➢ SYMBOL SET FOR REPRESENTING MANUAL
➢ The degree of the relationship, called cardinality, is PROCEDURES
the numeric mapping between entity instances. A
relationship can be
1. one-to-one (1:1),
2. one-to-many (1:M), or
3. many-to-many (M:M).
 structure information is needed for such tasks as
identifying certain types of system failures,
analyzing error reports, and designing tests of
computer logic for debugging and auditing
purposes.
➢ A simpler form of record layout, shown below, suits
our purposes best. This type of layout shows the
content of a record. Each data attribute and key
field is shown in terms of its name and relative
location.

COMPUTER-BASED ACCOUNTING SYSTEMS

• BATCH SYSTEMS
➢ Batch systems assemble transactions into groups
➢ SYMBOL SET FOR REPRESENTING COMPUTER
for processing.
PROCESSES
➢ Generally, batch systems demand fewer
organizational resources (such as programming
costs, computer time, and user training) than real-
time systems.
➢ Batch processing of noncritical accounts improves
operational efficiency by eliminating unnecessary
activities at critical points in the process.

• REAL-TIME SYSTEMS
➢ Real-time systems process transactions individually
at the moment the event occurs.
• PROGRAM FLOWCHARTS ➢ Real-time systems use direct access files that
• PROGRAM FLOWCHART SYMBOLS require more expensive storage devices, such as
magnetic disks.
➢ Real-time processing in systems that handle large
volumes of transactions each day can create
operational inefficiencies. A single transaction may
affect several different accounts.
➢ Data Coding Schemes
• SYSTEM FLOWCHART
NUMERIC AND ALPHABETIC CODING SCHEMES
➢ Sequential Codes
➢ Block Codes
➢ Group Codes
➢ Alphabetic Codes
➢ Mnemonic Codes

• Sequential Codes
➢ As the name implies, sequential codes represent
items in some sequential order (ascending or
descending).
➢ A common application of numeric sequential codes
• RECORD LAYOUT DIAGRAMS is the prenumbering of source documents. At
➢ Record layout diagrams are used to reveal the printing, each hard-copy document is given a
internal structure of the records that constitute a unique sequential code number. This number
file or database table. The layout diagram usually becomes the transaction number that allows the
shows the name, data type, and length of each system to track each transaction processed and to
attribute (or field) in the record. Detailed data identify any lost or out-of-sequence documents.
➢ Digital documents are similarly assigned a example, each of the accounts consists of a three
sequential number by the computer when they are digit code. The first digit is the blocking digit and
created. represents the account classification; for example,
current assets, liabilities, or operating expense. The
ADVANTAGES other digit s in the code are sequentially assigned.
• Sequential coding supports the reconciliation of a
batch of transactions, such as sales orders, at the ADVANTAGES
end of processing. If the transaction processing • Block coding allows for the insertion of new codes
system detects any gaps in the sequence of within a block without having to reorganize the
transaction numbers, it alerts management to the entire coding structure.
possibility of a missing or misplaced transaction. • For example, if advertising expense is account
• By tracing the transaction number back through the number 626, the first digit indicates that this
stages in the process, management can eventually account is an operating expense. As new types of
determine the cause and effect of the error. expense items are incurred and have to be
Without sequentially numbered documents, specifically accounted for, they may be added
problems of this sort are difficult to detect and sequentially within the 600 account classification.
resolve. This three-digit code accommodates 100 individual
DISADVANTAGES items (X00 through X99) within each block.
• Sequential codes carry no information content • Obviously, the more digits in the code range, the
beyond their order in the sequence. more items that can be represented.
• For instance, inventory item tells us nothing about
the attributes of the item (type, size, material, DISADVANTAGES
warehouse location, and so on). • As with the sequential codes, the information
• Also, sequential coding schemes are difficult to content of the block code is not readily apparent.
change. Inserting a new item at some midpoint • For instance, account number 626 means nothing
requires renumbering the subsequent items in the until matched against the chart of accounts, which
class accordingly. identifies it as advertising expense.
• In applications where record types must be grouped • Group Codes
together logically and where additions and • Numeric group codes are used to represent
deletions occur regularly, this coding scheme is complex items or events involving two or more
inappropriate. pieces of related data. The code consists of zones or
fields that possess specific meaning.
• Block Codes • For example, a department store chain might code
➢ A numeric block code is a variation on sequential sales order transactions from its branch stores as
coding that partly remedies the disadvantages just follows:
described. This approach can be used to represent
whole classes of items by restricting each class to a • Group Codes
specific range within the coding scheme. A common ➢ Numeric group codes are used to represent
application of block coding is the construction of a complex items or events involving two or more
chart of accounts. pieces of related data. The code consists of zones or
➢ A well-designed and comprehensive chart of fields that possess specific meaning.
accounts is the basis for the general ledger and is ➢ For example, a department store chain might code
thus critical to a firm’s financial and management sales order transactions from its branch stores as
reporting systems. The more extensive the chart of follows:
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. Figure 2-33 presents an example of accounts ADVANTAGES
using block codes. • They facilitate the representation of large amounts
➢ Notice that each account type is represented by a of diverse data.
unique range of codes or blocks. Thus, balance • They allow complex data structures to be
sheet and income statement account classifications represented in a hierarchical form that is logical and
and subclassifications can be depicted. In this more easily remembered by humans.
• They permit detailed analysis and reporting both ➢ Mnemonic codes are alphabetic characters in the
within an item class and across different classes of form of acronyms and other combinations that
items. convey meaning.
➢ For example, a student enrolling in college courses
DISADVANTAGES may enter the following course codes on the
• The primary disadvantage of group coding results registration form:
from its success as a classification tool. Because
group codes can effectively present diverse
information, they tend to be overused. Unrelated
data may be linked simply because it can be done.
This can lead to unnecessarily complex group codes
that cannot be easily interpreted. Finally, overuse
can increase storage costs, promote clerical errors,
and increase processing time and effort.

• Alphabetic Codes ADVANTAGES

➢ Alphabetic codes are used for many of the same • The mnemonic coding scheme does not require the
purposes as numeric codes. user to memorize meaning; the code itself conveys
➢ Alphabetic characters may be assigned sequentially a high degree of information about the item that is
(in alphabetic order) or may be used in block and being represented.
group coding techniques.
DISADVANTAGES
ADVANTAGES • Although mnemonic codes are useful for
• The capacity to represent large numbers of items is representing classes of items, they have limited
increased dramatically through the use of pure ability to represent items within a class.
alphabetic codes or alphabetic characters • For example, the entire class of accounts receivable
embedded within numeric codes ( alphanumeric could be represented by the mnemonic code AR,
codes). but we would quickly exhaust meaningful
• The earlier example of a chart of accounts using a combinations of alphabetic characters if we
three-digit code with a single blocking digit limits attempted to represent the individual accounts that
data representation to only 10 blocks of account 0 make up this class. These accounts would be
through 9. Using alphabetic characters for blocking, represented better by sequential, block, or group
however, increases the number of possible blocks coding techniques.
to 26 A through Z.
• Furthermore, whereas the two-digit sequential
portion of that code has the capacity of only 100
items (10 2), a two-position alphabetic code can
represent 676 items (26 2). Thus, by using
alphabetic codes in the same three-digit coding
space, we see a geometric increase in the potential
for data representation

DISADVANTAGES
• The primary drawbacks with alphabetic coding are
(1) as with numeric codes, there is difficulty
rationalizing the meaning of codes that have been
sequentially assigned, and (2) users tend to have
difficulty sorting records that are coded
alphabetically.

• Mnemonic Codes