Types of transaction cycles in accounting

February 02, 2018

A transaction cycle is an interlocking set of business transactions. Most business transactions can be
aggregated into a relatively small number of transaction cycles related to the sale of goods, payments to
suppliers, payments to employees, and payments to lenders. We explore the nature of these transaction
cycles in the following bullet points:

Sales cycle. A company receives an order from a customer, examines the order for creditworthiness,
ships goods or provides services to the customer, issues an invoice, and collects payment. This set of
sequential, interrelated activities is known as the sales cycle, or revenue cycle.

Purchasing cycle. A company issues a purchase order to a supplier for goods, receives the goods, records
an account payable, and pays the supplier. There are several ancillary activities, such as the use of petty
cash or procurement cards for smaller purchases. This set of sequential, interrelated activities is known
as the purchasing cycle, or expenditure cycle.

Payroll cycle. A company records the time of its employees, verifies hours and overtime worked,
calculates gross pay, deducts taxes and other withholdings, and issues paychecks to employees. Other
related activities include the payment of withheld income taxes to the government, as well as the
issuance of annual W-2 forms to employees. This cluster of activities is known as the payroll cycle.

Financing cycle. A company issues debt instruments to lenders, followed by a series of interest payments
and repayments of the debt. Also, a company issues stock to investors, in exchange for periodic dividend
payments and other payouts if the entity is dissolved. These clusters of transactions are more diverse
than the preceding transaction cycles, but may involve substantially more money.

A key role of the accountant is to design an appropriate set of procedures, forms, and integrated
controls for each of these transaction cycles, to mitigate the opportunities for fraud and ensure that
transactions are processed in as reliable and consistent a manner as possible.

Types of Transaction Cycles in Accounting

by Osmond Vitez - Updated September 26, 2017

Every business activity can be traced to specific accounting cycles, which are critical when analyzing
businesses individually and as part of a larger industry. Identifying these cycles and the specific activities
within them are essential to determining the effectiveness and profitability of a business. Businesses
engage in multiple financial transactions during normal operations, and accurate reporting of each
accounting transaction cycle helps determine the profitability of a process or product.
Financial Cycle

Knowing how to determine the starting point and interaction of one cycle to the next is a critical step in
understanding the workflow operations. Once each step is identified, management can assess the
effectiveness of each cycle. The starting point for each business is the financial cycle, which consists of
how the business obtains the initial capital for funding operations. The capital may come from the
owner, venture capitalists or through a bank loan. The amount of start-up capital is usually based on
financial projections relating to needs of the business, such as buildings, equipment, licenses and
inventory.

Expenditure Cycle

Based on the projections from the financial cycle, businesses begin spending their budget on materials
needed for inventory. Goods may be raw materials for manufacturing, food products for a restaurant,
tools for repair personnel or vehicles for a delivery service.

Payroll Cycle

The payroll cycle is the process of hiring personnel to conduct the daily operations of the business. Most
businesses have several layers of personnel, from frontline service workers, shift management,
secretarial staff, accountants and executive management. Each class of workers may have different pay
scales and bonus levels, creating unique accounting needs for the payroll cycle.

Conversion Cycle
The conversion cycle is the crux of each business; daily transactions from normal operations include
pieces from the expenditure and payroll cycle to make up the conversion process. The goods purchased
for the business are used by the personnel from payroll to earn the business cash. A large portion of
accounting transactions will occur in this phase because of the repetitious conversion activities of
business operations.

Revenue Cycle

A large amount of accounting transactions also will occur in the revenue cycle. This cycle includes the
transactions relating to the sales of goods and services to customers and any expenses related to those
revenues. Revenues can only be generated once the conversion cycle is complete; unfinished goods or
services are not reported in the revenue cycle until the completion of the previous cycle.

Accounting Transaction Cycle

Inside each previous transaction cycle are more detailed and specific information: the accounting
transactions. These transactions consist of the daily paperwork generated by the individual activities of
each previous cycle. Purchase orders, payroll checks, job tickets and sales invoices are found in each step
of the accounting cycles. Paperwork generated from each cycle must be analyzed for validity before
being entered in the accounting information system. After the numbers are verified and entered in the
system, trial balance reports and financial statements are generated to determine the company’s
profitability.

References

Accounting Tools: Types of Transaction Cycles in Accounting

QuickMBA: Individual Accounting Transactions

Free CPA Exam Lesson: Specific Transaction Cycles

In this month’s free video lecture from Wiley CPAexcel, Prof. Don Tidrick, PhD, CPA, CMA, CIA, of
Northern Illinois University provides an excellent overview of Specific Transaction Cycles.
These concepts will be heavily tested in the Auditing (AUD) section of the CPA Exam.

Take it away Prof. Tidrick …

Transaction Cycles Overview

Transaction cycles are a group of homogeneous transactions, or similar functions.

Common transaction cycles include:

Receipts/Revenue

Purchasing/Expenditures

Payroll

Production/manufacturing inventory

Fixed Assets (PP&E)

Financing/investing activities

Auditors are required to obtain an understanding of internal controls and document that understanding.

As Prof. Tidrick points out, the AICPA literature states that internal controls consist of five interrelated
components:

Control Environment

Risk Assessment

Information and Communications Systems

Control Activities – the above video goes into great detail on these.

Monitoring