MGMT 549 Overview of Transaction Cycles and Information Flows

Last Revised: 9/1/2011 2:35 PM

Financial Transactions

A financial transaction is an economic event that:

Affects the assets and equities of the firm Is reflected in its accounts Is measured in monetary terms

Similar types of transactions are grouped together into process categories or transaction cycles:
Revenue cycle (sales and revenue collection) Expenditure cycle (purchases, payroll, fixed assets, and cash disbursements) Conversion cycle (production, resource management, and logistics) Administrative processes (capital, investment, and general ledger) not a transaction cycle in the same sense as the other categories, if only because they are performed less frequently

The word cycle implies a looping or repetition

For example, sales and collection processes are repeated many times per operating period The revenue, conversion, and expenditure categories form a larger loop (see next slide)

Relationship Among Transaction Cycles

Hall, Accounting Information Systems 6e (978-1-4390-7857-0), Figure 2-1, Copyright 2011 Cengage Learning

Supply Chain

Closely related to transaction cycles is the concept of a supply chain

Turner textbook definition: the entities, processes, and information flows that involve the movement of materials, funds, and related information through the full logistics process, from the acquisition of raw materials to the delivery of finished products to the end user. The supply chain includes all vendors, service providers, customers, and intermediaries

Sample Supply Chain McDonalds

Turner & Weickgenannt, Accounting Information Systems Controls and Processes (978-0-471-47951-2), Figure 1-2, Copyright 2009 Wiley

Supply Chain - Continued

Supply chain implications for AIS:

An organizations AIS and MIS are subsets of a larger AIS/MIS that extend across all organizations in the supply chain

In other words, your system is only a subsystem of a larger system

Transaction cycles extend out from your system to include reciprocal processes/cycles of partners

For example, your purchasing and cash disbursements processes combine with your vendors sales and cash receipts cycles to form a complete cycle

AIS auditing and security issues extend well beyond your own systems and organization

For example, if youre a power supply manufacturer who supplies parts to Dell, how do you validate/authenticate Dells incoming orders and payments and how do you ensure that the doorways Dell uses to send/receive transaction data arent entry points for hackers?

Exercise

Create a short list of capital and investment transactions/processes. How would you modify the transaction cycles figure (slide #3) to incorporate capital and investment processes? What would a combined transaction cycle diagram for Dell and its power supply vendor(s) look like?

Documents

Most financial events have one or more documents associated with them (e.g., invoices, bills of lading, and deposit receipts) Documents:
Contain much of the financial information reflected in accounting records and financial statements Are consumed and produced by accounting-related activities Play a significant role in internal control and auditing Exist even in paperless systems

Some document-related terminology:

Source document - used to capture and formalize transaction data needed for transaction processing (e.g., a purchase order sent by a customer Product document generated by transaction processing activities (e.g., processing a purchase order generates an invoice) Turnaround document - a product document of one system that becomes a source document for another system (e.g., data might be extracted from invoices for ordering and/or production scheduling)

Books of Record

Journal - a chronological record of transactions and other economic activity

Special journals record specific classes of transactions that occur frequently and have similar information content and structure (e.g., a sales journal) see next slide General journal records all transactions not recorded in special journals such transactions are typically nonrecurring, infrequent, and dissimilar

Ledger an account-by-account record of balances (beginning and ending) and transaction activity
General ledger (G/L) - shows activity for each account listed on the chart of accounts Subsidiary ledger - shows more detailed activity than the general ledger for a specific account (e.g., subaccounts for accounts receivable one subaccount per customer)

Ledgers and journals both record transactions but organize and/or summarize the financial data differently

Specialized Journal Examples

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 13, Copyright 2008 Armond Dalton Publishers

Chart of Accounts

The chart of accounts (COA) is a list of each general ledger account by number and name
Usually sorted numerically Usually grouped by income statement or balance sheet category

A COA is customized to the needs of a specific organization.

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 14, Copyright 2008 Armond Dalton Publishers

Account Numbering and Coding

Some of the ways in which charts of accounts are customized to a specific organization include:
Number of accounts in total and within specific categories Length, structure, and coding of account numbers

Most account numbers employ block coding, in which one or a few leading digits of the account number indicate a meaningful category
For example, in the COA on the preceding slide, the first digit encodes an income statement or balance sheet category

Account Numbering and Coding - Continued

Account numbers often employ group coding to represent embedded information such as organizational unit, division, or location For example:

A chain of retail stores might add three digits to the end of an account number to indicate a specific store number (e.g., xxx-yyy where xxx is the G/L account type and yyy is the store number) Accounts that arent store-specific (e.g., equity accounts) have only one instance (e.g., 501-000) There would be multiple store-specific accounts where needed/useful (e.g., 601-001, 601-002, ) Account 601-000 would be a summary or consolidated account totaling the balances of 601-001 through 601-999

Transaction Data Flow Into the General Ledger

Hall, Accounting Information Systems 6e (978-1-4390-7857-0), Figure 2-8, Copyright 2011 Cengage Learning

Data Flow Into the General Ledger - Continued

Customer order is the source document Sales order is a product document and includes all data needed to record related financial/accounting data in:
Sales journal (typically, debit cash or accounts receivable and credit sales) Accounts receivable subsidiary ledger (record debit to accounts receivable balance for specific customer

Posting Totals from special journals and all entries in the general journal are periodically posted to related accounts in the G/L Reconciliation Subsidiary ledgers are periodically reconciled to the general ledger
For example, the G/L accounts receivable balance should equal the total of all subaccount balances in the accounts receivable subsidiary ledger), reconciliation verifies this equality and resolves any discrepancies see Figure 2-10

Relationships Among Journals and Ledgers

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 17, Copyright 2008 Armond Dalton Publishers

Data Redundancy
The contents of various documents, journals, and ledgers are highly redundant (i.e., they contain overlapping information) Eliminating data redundancy is a key information system design principle Yet, redundancy is a fundamental basis for internal control and audit trails in both automated and manual systems (see next slide) Tension between the desire to simplify a system by minimizing redundancy and the need for internal controls and an audit trail is a fundamental conundrum in AISs

Audit Trail
Source Document
Financial Statements

Journal

General Ledger

Financial Statements

General Ledger

Journal

Source Document

Accountants should be able to trace in both directions. Sampling and confirmation are two common techniques.

Exercise

Consider a source document, for example:

Customer purchase order Deposit receipt Invoice for equipment purchase Promissory note Payroll time card Check (customer payment on account)

Identify one key financial information item on the document List all of the product documents, journals, and ledgers in which the financial information item should (eventually) appear

End of Period Processing

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 10, Copyright 2008 Armond Dalton Publishers

Trial Balance

A general ledger trial balance is a listing of general ledger account balances at a specific point in time usually end of month, quarter, or year:
Unadjusted trial balance before journal entries to correct errors and to record accruals and prepayments Adjusted trial balance after journal entries to correct errors and to record accruals and prepayments

A trial balance is prepared after all transactions for the period have been recorded

Sample Trial Balance

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 18, Copyright 2008 Armond Dalton Publishers

Adjusting Entries

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 20, Copyright 2008 Armond Dalton Publishers

Adjusting Entries - Continued

Adjusting entries are made in the general journal and posted to the general ledger Each adjusting entry affects both the balance sheet and income statement (e.g., a depreciation entry debits an expense account (I/S) and credits an asset or asset offset account (B/S) Adjusting entries are recorded in the general journal and posted individually to the general ledger to provide a maximal audit trail. Adjusting entries are added to the unadjusted trial balance to produce the adjusted trial balance

Sample Adjusting Entries

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 21, Copyright 2008 Armond Dalton Publishers

Prepare Financial Statements

The adjusted trial balance is the primary input to preparing financial statements. Rows of the adjusted trial balance are often combined into single lines of a financial statement (e.g., combining account balances for similar asset classes). Except for footnotes, the adjusted trial balance is a complete source document for the income statement and balance sheet Some information needed for the cash flow statement is not in the adjusted trial balance (e.g., loan payments and proceeds)

Closing Entries

Closing entries set income statement accounts to zero for the start of a new reporting period Closing entry categories:
Closing revenue accounts (to income summary) Closing expense accounts (to income summary) Transferring profit or loss to equity account(s)

Closing entries occur after period end and after the financial statements are prepared Closing entries are recorded in the general journal and posted to the general ledger

Sample Closing Entries

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 23, Copyright 2008 Armond Dalton Publishers

Summary of Information Flows and Accounting Procedures

Arens & Ward, Systems Understanding Aid 7e (978-0-912503-27-1), page 25, Copyright 2008 Armond Dalton Publishers

Exercise
Consult the previous slide and examine the example column on the right Prepare an additional example column using a different type of transaction, for example:

Purchase of inventory for sale Receipt of a payment from a customer for a previously invoiced purchase Payment of a previously invoiced purchase of equipment Payment of payroll for the last full period of the year

Be sure to identify specific specialized journals and subsidiary ledgers, if needed