Financial Transactions and Cycles

Financial Transactions

• An economic event affects the assets and equities of a firm, is reflected in its accounts, and is measured in monetary terms.
• Similar types of transactions are grouped into three transaction cycles: the expenditure cycle, the conversion cycle, and the revenue cycle.

Relationship between Transaction Cycles

• The expenditure cycle relates to the acquisition of labor, materials, and physical plant in exchange for cash.
• The conversion cycle involves production planning and control, plus cost accounting, resulting in finished goods.
• The revenue cycle focuses on sales order processing and cash receipts, ultimately leading to cash.

Two Subsystems in Each Cycle

• Expenditure Cycle: Includes a physical component (acquisition of goods) and a financial component (cash disbursements to the supplier), with a time lag due to credit relations with suppliers.
• Conversion Cycle: Encompasses the production system (planning, scheduling, and control of the physical product) and the cost accounting system (monitoring the flow of cost information related to production).
• Revenue Cycle: Exhibits a physical component (sales order processing) and a financial component (cash receipts), with a time lag due to credit relations with customers.

Manual System Accounting Records

• Source Documents: Capture and formalize transaction data needed for processing.
• Product Documents: Result from transaction processing.
• Turnaround Documents: Product documents from one system that become source documents for another system.

Journals and Ledgers

• Journals: Chronological records of entries organized in special journals for high-frequency transactions and general journals for nonrecurring, infrequent, and dissimilar transactions.
• Ledger: A book of financial accounts, with a general ledger showing activity for each account on the chart of accounts, and a subsidiary ledger detailing activity for each account type.

Audit Trail

• Accountants should be able to trace in both directions within an audit trail.
• Sampling and confirmation are two common techniques.
• This facilitates verification of accounts receivable.
• This includes tracing from the Accounts Receivable Control Account-General Ledger down to individual customer balances.
• The AR Subsidiary Ledger is the sum of all customers' receivables.
• Tracing involves linking sales and cash receipts journals to source documents like sales orders, shipping notices, deposit slips, and remittance advices.

Computer-Based System Audit

• Compare the AR balance in the balance sheet with the AR control account balance in the master file
• Reconcile the AR control figure with the total AR subsidiary account
• Select a sample of update entries made to AR subsidiary ledger accounts
• Trace these transactions back the sales journal (archive file).
• Identify and verify source documents.
• If necessary, confirm with customers

Computer-Based Systems

• The audit trail is less observable in computer-based systems than in traditional manual systems.
• Data entry and computer programs constitute the physical trail.
• Data is stored in magnetic files.

Computer Files

• Master File: Generally contains account data like general ledger and subsidiary file information.
• Transaction File: Temporary file with transactions since the last update.
• Reference File: Contains constant information used in processing, like tax tables and customer addresses.
• Archive File: Contains past transactions for reference purposes.

Documentation Techniques

• Documentation in a computer-based environment is essential for various reasons.
• Five common documentation techniques: Entity Relationship Diagram, Data Flow Diagrams, Document Flowcharts, System Flowcharts, and Program Flowcharts

Entity Relationship Diagram (ERD)

• An ERD represents the relationship between entities in a system.
• The REA model version of ERD is widely used in AIS, involving resources, events, and agents.

Cardinalities

• Cardinalities represent the numerical mapping between entities, classified as one-to-one, one-to-many, or many-to-many.

Data Flow Diagrams (DFD)

• DFDs use symbols to represent processes, data sources, data flows, and entities in a system.
• DFDs depict the logical elements of a system.
• DFDs do not represent the physical system.

Data Flow Diagram Symbols

• Entity Name is external data input source or data output destination.
• Process Description is a process triggered or supported by data.
• Data Store Name is a store of a dataset as a master file, a transaction file, or a reference file.
• Data flow direction is an arrow.

Document Flowcharts

• Document flowcharts illustrate the relationship and flow of documents among processes.
• Contain more details than data flow diagrams.
• Clearly depict the separation of functions in a system.

System Flowcharts

• Represent the relationship between key elements of computer systems
• Input sources, programs, and output products.
• Depict the type of media used, such as paper, magnetic tape, magnetic disks, and terminals.
• Practice reveals not much difference between document and system flowcharts

Program Flowcharts

• Program flowcharts illustrate the logic used in programs.

Modern Systems vs. Legacy Systems

• Modern systems are client-server based, process transactions in real-time.
• Modern systems use relational database tables.
• Modern systems have a high degree of process integration and data sharing.
• Modern systems are sometimes mainframe based and use batch processing
• Legacy systems are mainframe-based applications.
• Legacy systems are batch oriented.
• Early legacy systems use flat files for data storage later, hierarchical, and network databases are used
• Legacy data storage systems encourage a single-user environment that discourages information integration.

Primary and Secondary Keys

• Master files contain primary keys (PK) and secondary keys (SK) for updating
• This include customer number and inventory number

Database Backup Procedures

• If destructive updates leave no backup, backup procedures must be implemented.
• The master file being updated is often copied as a backup.
• A recovery program uses this backup to create a pre-update version of the master file.

Computer-Based Accounting Systems

• Computer-based accounting systems are classified into two broad categories: batch systems and real-time systems.

Batch Processing

• Batch is a group of similar transactions accumulated over time then processed together.
• The transactions must be independent of one another during the accumulation period.
• A time lag exists between the event and its processing.

Steps in Batch Processing/Sequential File

• Keystroke: Source documents are transcribed by clerks to magnetic tape for later processing.
• Edit Run: Identifies clerical errors in the batch and moves them to an error file.
• Sort Run: Places the transaction file using a primary key, in the same order as the master file.
• Update Run: Modifies appropriate fields values in the master file to reflect the transaction.
• Backup Procedure: The original master file is maintained, and a new master file is created

Advantages of Batch Processing

• Efficiency is increased through grouping many transactions into batches.
• Batch processing allows more control over the transaction process via control figures.

Real-Time Systems

• Real-time systems process transactions individually as they occur.
• Have no time lag between economic event and processing.
• Typically require greater resources than batch systems.
• They require dedicated processing capacity but these cost differentials are falling.
• Systems development often takes longer.

Batch vs. Real-Time Processing

Batch Processing in AIS

• AIS processing often involves high-volume, independent transactions, like recording checks received in the mail.
• Processing high-volume checks can be done during off-peak computer time.
• Real-time data collection can also enable batch processing.

Explanation of financial transactions and their impact on a firm's assets and equities. The transactions are categorized into expenditure, conversion, and revenue cycles. Each cycle has physical and financial components.