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CHAPTER 2: INTRODUCTION TO TRANSACTION PROCESSING

AN OVERVIEW OF TRANSACTION PROCESSING

Financial Transaction – an economic event that affects the assets and equities of the firm, is reflected in its accounts, and is
measured in monetary terms.

- Most common financial transactions are exchanges with external parties. Example, sale of goods or services, purchase of
inventory, discharge of financial obligation, etc.

- Financial Transaction also include internal events such as depreciation of fixed asset, application of labor, raw materials, and
overhead to production process, etc.

- Financial transactions are common business events that occur regularly.

- To deal efficiently with volumes of transactions, business firms group similar types of transactions into transaction cycles.

Transaction Cycles

1. Expenditure Cycle – Acquisition of materials, property, and labor in exchange for cash.
- Has two parts:
1. Physical Component – Acquisition of the goods or services
2. Financial Component – The cash disbursement to the supplier

Purchases/Accounts Payable (AP) System – Recognizes the need to acquire physical inventory (such as raw materials)
and places an order with the vendor.
- When goods are received, the AP system recognizes this by increasing inventory and establishing an account payable
to be paid at a later date.

Cash Disbursement System – When the obligation created in the AP System becomes due, the CD system authorizes
the payment, disburses the funds to the vendor, and records the transaction by reducing the cash and accounts payable
accounts.

Payroll System – Collects labor usage data for each employee, computes the payroll, and disburses paychecks to the
employees.
- It is a special-case purchases and cash disbursement system

Fixed Asset System – processes transactions pertaining to the acquisition, maintenance, and disposal of its fixed assets.
- These are relatively permanent assets that collectively represent the organization’s largest financial investment.

2. The Conversion Cycle

Composed of two major subsystems:
1. Production System – Involves the planning, scheduling, and control of the physical product through the
manufacturing process.
- Includes determining raw material requirements, authorizing the work to be performed and the release of raw
materials into production, and directing the movement of the work-in-process through its various stages of
manufacturing.

2. Cost accounting system – monitors the flow of cost information including labor, overhead, and raw materials
related to production.
- Information produced from this system is used for inventory valuation, budgeting, cost control, performance
reporting, and management decisions, etc.

3. The Revenue Cycle – involves processing cash sales, credit sales, and the receipt of cash following a credit sale.
- Time lag between the two dues to credit relations with customers
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Sales Order Processing (Physical Component) – Majority of business sales are made on credit and involve tasks
such as preparing sales orders, granting credit, shipping products to the customer, billing customers, and recording
the transaction in the accounts.

Cash Receipts (Financial Component) – includes collecting cash, depositing cash in the bank, and recording these
events in the accounts.

ACCOUNTING RECORDS – are documents, journal, ledger used in the system or transaction cycles.

Manual Systems

1. DOCUMENTS – these may initiate transaction processing or be an output of a process. They provide auditors with
evidence of economic events.

 Source Documents – documents that capture and formalize transactions data needed for processing by their
respective transaction cycles.
 Product Documents – documents that result from transaction processing rather than triggering mechanism for the
process.
 Turnaround Documents – product documents of one system that become source documents for another system.

2. JOURNALS – a chronological record of financial transactions.

- The primary sources of data entry into journals are documents.
- Journals fall into two classes:
1. Special Journals – used to record specific classes of transactions that occur in high volume.
 Register – often used to denote certain types of special journals
2. General Journals – Used to record nonrecurring, infrequent, and dissimilar transactions.
- Example: Depreciation and closing entries
- For practicality, it is a common practice to replace the traditional general journal with a collection of Journal
Vouchers.

 Journal Vouchers – Written authorizations prepared for every transaction that meets the general journal
requirements.
 Each Journal Voucher contains:
1. Unique Voucher Number
2. Transaction Date
3. Transaction Amount
4. Ledger Accounts to be updated
5. Signatures of individuals authorized to create or approve the journal voucher

3. LEDGERS – A book of accounts that reflects the financial effects of the firm’s transactions after they are posted
from the various journals and journal vouchers.
- Ledgers show activity by account type
- Ledgers indicate the increases, decreases, and current balance of each account
- Organizations use this information to prepare financial statements, support daily operations, and prepare internal
reports.

Ledgers fall into two categories:

1. General Ledgers – contain the firm’s account information in the form of highly summarized control amounts
- Summarizes the activity for each of the organization’s financial accounts.
- The GL function updates these records from journal vouchers submitted from various accounting
departments located throughout the organization.
- Provides a single value for each control account, such as accounts payable, accounts receivable, and
inventory.
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- This highly summarized information is sufficient for financial reporting, but it is not useful for supporting daily
business operations.
- The general ledger is a mechanism for verifying the overall accuracy of accounting data that separate
accounting departments have processed.

2. Subsidiary Ledgers – contain the details that support a particular control account
- Kept in various accounting departments of the firm, including inventory, accounts payable, payroll, and
accounts receivable.
- This separation provides better control and support of operations.
- The total of account balances in a subsidiary ledger should equal the balance in the corresponding general
ledger control account.

THE AUDIT TRAIL – Used to trace account balances contained in financial statements back to source documents and the
economic events that created them.
- An audit trail is of utmost importance in the conduct of a financial audit
- Not exclusively for auditors

 SOURCE DOCUMENT  JOURNAL  GENERAL LEDGER  FINANCIAL STATEMENTS

 FINANCIAL STATEMENTS  GENERAL LEDGER  JOURNAL  SOURCE DOCUMENT
- Accountants should be able to trace in both directions.
- Sampling and Confirmation are two common techniques

Confirmation – A procedure which involves contacting selected customers to determine if the transactions recorded in the
accounts actually took place and if customers agree with the recorded balance.
- Information contained in source documents and subsidiary accounts enables the auditor to identify and locate customers
choses for confirmation.

DIGITAL ACCOUNTING RECORDS

Computer-Based Systems
- The audit trail is less observable in computer-based systems than traditional manual systems
- The data entry and computer programs are the physical trail
- The data are stored in magnetic files

Computer Files
 Master File – generally contains account data (e.g., general ledger and subsidiary file)
- Data values are updated by transactions
 Transaction File – a temporary file of transaction records used to update data in a master file
- (e.g., Sales orders, inventory receipts, and cash receipts)
 Reference File – stores data that are used as standards for processing transactions
- (e.g., tax tables, customer addresses, price lists used for customer invoices, list of authorized suppliers, customer credit
history)
 Archive File – contains records of past transactions that are retained for future references and form an important part
of the audit trail
- (e.g., journals, prior period payroll information, lists of former employees, records of accounts written off)

THE DIGITAL AUDIT TRAIL

Steps:
1. Capture of Economic Event. Sales are recorded manually on source documents.
2. Convert the Source Documents to Digital Form. This is done in the Entry Data Stage.
3. Update the various master file subsidiary and GL control accounts affected by the transaction
- Editing of transactions takes place to detect errors
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- Records with errors are rejected and transferred to the error file, which are later reviewed off-line, corrected, and
resubmitted for processing.
- Records that pass successfully through editing are used to updated the master files.
- Only these valid transactions are added to the archive file, which serves as the sales journal.
- By copying the valid transactions to the journal, the original transaction file is not needed for audit trail purposes and
can now be erased in preparation for the next batch of sales order.

FILE STRUCTURES
- Digital file structures and storage techniques vary widely among transaction processing systems.
- No single structure works well for all data processing tasks
- Some structures are effective at processing all records in larger master files
- Some file structures are better for directly locating and processing a single record in a large file, without having to search
through thousands of other records on the file.
- Selecting a data management file structure often involves compromise

The Flat-File Model

- Flat-file approach is often associated with so-called Legacy Systems
 Legacy Systems – are large mainframe systems that were commonplace in the 1960s and 1970s but still exists today
- Serves as an environment where end users own their file data files rather than share them with other users
- Thus, stand alone applications rather than integrated systems perform data processing
- Results to DATA REDUNDANCY because multiple users need the same or similar data for different purposes that are structured
to their specific needs

Three Significant Problems in the Flat File Model:

1. Data Storage
- Efficient information system captures and stores data only once and makes this single source available to all users
who need it
- In flat-file model, organizations must incur the costs of both multiple collection and multiple storage procedures.

2. Data Updating
- Organizations have stored data that require periodic updating to reflect changes
- When users keep separate files, all changes must be made separately for each user.
- Adds significantly to the task and the cost of data management

3. Currency of Information
- In relation to data updating, if update information is not properly disseminated, changes will not be reflected in some
user’s data, resulting in actions and decisions based on outdated information.

Task-Data Dependency
- User’s inability to obtain additional information as his or her needs change
- The user’s information set is constrained by the data that he or she possesses and controls
- Establishing a mechanism for the formal sharing of data is difficult because users act independently rather than as members
of a community

Flat Files Limit Data Integration

- The flat-file approach is a single user view model
- Files are structured, formatted, and arranged to suit the specific needs of the owner or primary user of the data.
- Such structuring, may exclude data needed by other users, thus preventing successful integration of data across the
organization.

The Database Model

- Organizations have overcome some of the problems associated with the flat files by implementing the database
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- With the organization’s data in a central location, all users have access to the data they need to achieve their respective
objectives.
- Data are stored in the most granular format rather than being shaped and configured to the needs of a single user
- Access to the data resource is controlled by a database management system (DBMS)
 Database Management System (DBMS) – a software system that permits users to access authorized data only
- The most striking difference between the database model and the flat file model is the pooling of data into a common
database that all organizational users share

DOCUMENTATION TECHNIQUES
Five common documentation techniques:
1. Entity Relationship Diagram
2. Data Flow Diagrams
3. Document Flowchart
4. System Flowchart
5. Program Flowchart

Data Flow Diagrams (DFD) – use symbols to represent the entities, processes, data sources, data flows, and entities in a system
- Used to represent systems at different levels of detail from very general to highly detailed
- Entities in a DFD represent objects that lie outside the system being modeled
- Entities are being labeled as singular nouns on a DFD (e.g., customer and supplier)
- Data stores represent the accounting files and records used in each process
- Labeled arrows represent data flows between processes, data stores, and entities
- Processes in the DFD should be labeled with a descriptive verb (e.g., Review Inventory Levels, Prepare Purchase Orders, etc.)
- Processes should not be represented as nouns like Inventory Warehouse, Purchases Dept., etc.
- Arrows connecting the DFD objects should be labeled to represent specific flows of data
- Each data flow label should be uniquely named; the same label should not be attached to two different flow lies in the same
DFD
- When data flow into a process and out again, that data have been changed
- System analysts use DFDs extensively to represent the logical elements of a system
- This technique does not represent the physical system
- DFDs show what logical tasks are being performed but not how they are performed or who is performing them

Data Flow Diagram Symbol Set

Entity Input source or output destination of data

Name

N
A process that is triggered or supported by data
Process
Description

Data Store A store of data such as a transaction file, a master file, or a reference file
Name

Direction or Data Flow

Entity Relationship Diagram (ERD) – A documentation technique to represent the relationship between entities in a business
- The term entity applies to anything about which the organization captures data
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- Entity may be a physical resource (e.g. automobile, cash, or inventory), an event (e.g., customer order, purchase inventory,
etc.) or and agent (e.g., salesperson, customer, or vendor)
- One common use for ER diagrams is to model an organization’s database
- The square symbol represents entities in the system
- The labeled connecting line represents the nature of the relationship between two entities
 Cardinality – Degree of relationship
- Numeric mapping between entities such as:
o One to one (1:1)
o One to many (1:M)
o Many to many (M:M)

Relationship between ER Diagrams and DFDs

- DFDs ad ER diagrams are different aspects of systems but related
- DFDs model system processes while ER diagrams model the data used in the systems
- Each data store in a DFD is represented as an entity in a corresponding ER diagram

System Flowchart – is the graphical representation of the physical relationship among key elements of a system.
- Key elements may include: organizational departments, manual activities, computer programs, etc.
- Describes the physical computer media being employed in the system, such as a magnetic tape, magnetic disks, and terminals.
- Contain more details than DFDs
- Clearly depict the separation of functions in a system
- In practice, not much difference between document and system flowcharts

Certain rules and conventions needed to be observed:

1. Flowchart should be labeled
2. Correct symbols should be used to represent various entities
3. All symbols on the flowchart should be labeled
4. Lines should have arrowheads to clearly show the process flow direction and sequence of events
5. Text description should be included if complex processes need additional explanation for clarity

“N” – Numeric
“C” – Chronological
“A” – Alphabetical Order

SYMBOL SET FOR REPRESENTING MANUAL PROCEDURES

Terminal showing source or File for storing source

destination of documents Source document or report Manual Operation documents and reports
and reports

Accounting records Calculated batch total On-page connector Off-page connector

(journals, registers, ledgers)

Description of process or Document flowline

comments
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SYMBOL SET FOR REPRESENTING COMPUTER PROCEDURES

Hard copy (source Computer process Direct access storage device Magnetic Tape (sequential
documents and output) (program run) (disk pack) storage device)

Terminal input/output Process Flow Real-time (online) Video display device

device connection

Program Flowcharts
- Every program represented in a system flowchart should have a supporting program flowchart that describes its logic
- A separate symbol represents each step of the program’s logic, and each symbol represents one or more lines of computer
program code
- The connector lines between the symbols establish the logical order of execution

Program Flowchart Symbols

Logical Process Decisions Terminal Start or End Input/Output Flow of logical process
Operation Operation
(read and write
records)

Logical Steps of Program Flowchart:

1. The program retrieves a single record from the unedited transaction file and stores it in memory
2. The first logical test is to see if the program has reached the end-of-file (EOF) condition for the transaction file.
- Most file structures use a special record or marker to indicate an EOF
- When EOF is reached, the edit program will terminate and the next program in the system will be executed.
- As long as there is a record in the unedited transaction file, the result of the EOF test will be “no,” and the
process control is passed to the next logical step in the edit program
3. Processing involves a series of tests to identify certain clerical and logical errors.
- Each test, represented by a decision symbol, evaluates the presence or absence of a condition
- E.g., an edit test could be to detect the presence of alphabetic data in a field that contain only numeric data
4. Error-free records are sent to the edited transaction file
5. Records containing errors are sent to the error file
6. The program loops back to Step 1 and the process is repeated until the EOF condition is reached

RECORD LAYOUT DIAGRAMS – used to reveal the internal structure of digital records in a flat-file or database table
- Layout diagrams usually show the name, data type, and length of each attribute in the record
- Detailed data structure is needed for such tasks such as identifying certain types of system failures, analyzing error reports,
and designing tests of computer logic for debugging and auditing purposes.

TRANSACTION PROCESSING MODELS

Two Types:
1. Batch Processing – involves gathering transactions into groups or batches and then processing the entire batch as a
single event
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- The transactions must be independent of one another during the time period over which the transactions are
accumulated in order for batch processing to be appropriate
2. Real-time Processing – process individual transactions continuously as they occur

CHARACTERISTIC DIFFERENCES BETWEEN BATCH AND REAL-TIME PROCESSING

Batch Processing Real-Time Processing
Information Time Frame  Assemble transactions into groups for  Process transactions individually at the
processing time the event occurs
 Time lag will always exist between time  There is no time lag.
when the economic event occurs and  E.g., Airline Reservation System
when it is recorded
 E.g., Payroll Processing
Resources  Demand fewer organizational resources  More resources are required
 Programming logic of batch systems are  Large portion of total programming costs
generally simpler than Real-time are incurred
Processing  Require dedicated processing capacity
 Shorter development periods because they must deal with transactions
as they occur
Operational Efficiency  Certain records are processed after the  Operational delays are not an issue
event to avoid operational delays  All records pertaining to the event are
processed immediately

UPDATING MASTER FILES FROM TRANSACTIONS

- Whether batch or real time processing is being used, updating a master file record involves changing the value of one or
more of its variable fields to reflect the effects of a transaction.

Inventory Number – These secondary keys are used for locating the corresponding records in the master files.

Example procedure:
1. The computer update program reads a sales order record
2. ACCOUNT NUMBER is used to search the AR master file and retrieve the corresponding AR record.
3. The update program calculates the new customer balance by adding the value stored in the INVOICE AMOUNT field
of the sales order record to the CURRENT BALANCE field value in the AR master record
4. Next, INVENTORY NUMBER is used to search for the corresponding record in the inventory master file
5. The update program reduces inventory levels by deducting the QUANTITY SOLD value in a transaction record from
the QUANTITY ON HAND field value in the inventory record
6. A new sales order record is read, and the process is repeated

Master File Backup Procedures

- is a standard procedure in transaction processing systems to maintain master file integrity in the event that any of the following
events may occur:
1. An update program error corrupts the master files being updated
2. Undetected errors in the transaction data result in corrupted master file balances
3. A disaster such as a fire or flood physically destroys current master files

- Back up procedures will vary depending on whether batch or real time processing is being used

Batch Processing Using Real-time Data Collection

- A popular data processing approach, particularly for large operations, is to digitally capture and process aspects of the
transaction at the source as they occur, and process other aspects of the transaction in batch mode.

Key steps in the process:

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 The sales department clerk captures customer sales data pertaining to the item(s) being purchased and the customer’s
account
 The system then checks the customer’s credit limit from data in the customer record (AR subsidiary file) and updates his or
her account balance to reflect the amount of sale
 Next, the system updates the quantity-on-hand field in the inventory record (inventory subsidiary file) to reflect the
reduction in inventory. This provides up-to-date information to other clerks as to inventory availability.
 A record of the sale is then added to the sales order file (transaction file), which is processed in batch mode at the end of
the business day. This batch process records each transaction in the sales journal and updates the affected general ledger
accounts
Each customer sales transaction will affect:
1. Customer account receivable (Subsidiary unique to the customer)
2. Inventory items (Subsidiary almost unique)
3. Inventory Control (GL common to all customers)
4. Account Receivable control (GL Common)
5. Sales (GL Common)
6. COGS (GL Common)

- To maintain integrity of accounting data, once a particular record is accessed for updating, it is locked by the system and
made unavailable to other processes until the current process is complete
- When processing a customer AR subsidiary record, the rule has no implications for other users of the system. Each user
accessed his or her unique record.
- Master file records that are unique to a transaction such as customer accounts and individual inventory records may be
updated in real time without causing delays.
- In high volume data processing systems, updating general ledger records in real time may cause data access delays.

Deadlock – happens when one process places a lock on one or more of the records it needs for processing, but has not locked
all of them. At the same time, a second process places a lock on the remaining record(s) needed by the first. Neither transaction
can be completed because they are in deadlock as both processes wait for the locks to be removed by the other.
- This situation creates a standoff that can bring processing to a halt because a deadlock will never resolve itself without outside
intervention.
- Typically, after a period of time when the deadlock is detected, the system will terminate the transactions that are furthest
form completion to make them restart.
- To avoid these problems and to achieve internal control benefits associated with batch processing, general ledger accounts
are often updated periodically in batch mode.
- Batch processing may be performed as end-of-day procedures or more frequently throughout the day.

Real-Time Processing
- Real-time systems process the entire transaction as it occurs.
- Such a system has many potential benefits, including improved productivity, reduced inventory, increased inventory turnover,
decreased lags in customer billing, and enhanced customer satisfactions.
- Because transaction information is transmitted electronically, physical source documents can be eliminated or greatly reduced.
- Real-time processing is well suited to systems that process lower transaction volumes and those that do not share common
records.
- Makes extensive use of local area network and wide area network technology.

Why Do So Many AIS Use Batch Processing?

- AIS processing is characterized by high-volume, independent transactions, such are recording cash receipts checks received
in the mail
- The processing of such high-volume checks can be done during an off-peak computer time
- This is one reason why batch processing maybe done using real time data collection
DATA CODING SCHEMES
- Involves creating simple numeric or alphabetic codes to represent complex economic phenomena that facilitate efficient data
processing.
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- Secondary and primary keys are instances of data coding.

A System Without Codes

- An uncoded entry takes up a recording space
- It is time consuming to record
- Prone to many errors

Negative effects can be seen in many parts of the organization:

1. Sales Staff – Properly identifying the items sold requires transcriptions of large amounts of detail onto source
documents.
- Tends to promote clerical errors and incorrect shipments
2. Warehouse Personnel – Locating and picking goods for shipment are impeded and shipping errors will likely result
3. Accounting Personnel – Posting to the ledgers will require searching through the subsidiary files using lengthy
descriptions as the key. This will be painfully slow, and posting to the wrong accounts will be common.

Advantages of Data Coding in AIS:

1. Concisely representing large amounts of complex information that would otherwise be unmanageable
2. Providing a means of accountability over the completeness of the transactions processed
3. Identifying unique transactions and accounts within a file
4. Supporting the audit function by providing an effective audit trail

NUMERIC AND ALPHABETIC CODING SCHEMES

Sequential Codes
- Represent items in some sequential order (ascending or descending)
- Used to prenumber source documents
- Used to track each transaction processed
- Identify out-of-sequence documents

 Disadvantages:
- Sequential Codes carry no information content beyond their order in the sequence
- Sequential Coding schemes are hard to change and make insertions

Block Codes
- A variation on sequential coding that partly remedies the disadvantages just described
- Represent whole classes by assigning each class a specific range within the coding scheme
- Used for making Chart of Accounts
Chart of Accounts – basis of the general ledger

 Advantages:
- Allows for the easy insertion of new codes within a block without having to reorganize the entire coding structure
 Disadvantages:
- The information content of the block code is not readily apparent

Group Codes
- Used to represent complex items or events involving two or more places of related data. The code consists of zones or fields
that possess specific meaning.
- For example, a coding scheme for tracking sales might be 04-009-476214-99, meaning:

Store Number Department Number Item Number Salesperson

04 09 476214 99
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 Advantages:
- They facilitate the representation of large amounts of diverse data
- They allow complex data structures to be represented in a hierarchical form that is logical and more easily remembered
by humans
- They permit detailed analysis and reporting both within an item class and across different classes of items

 Disadvantages:
- Group codes can effectively present diverse information, they tend to be overused
- Unrelated data may be linked simply because it can be done which can lead to unnecessarily complex group codes that
cannot be easily interpreted.
- Overuse can lead to storage costs, promote clerical errors, and increase processing time and effort

Alphabetic Codes
- Used for many of the same purposes as numeric codes
- Can be assigned sequentially or used in block and group coding techniques
- May be used to represent large numbers of items
 Advantages:
- Can represent up to 26 variations per field

 Disadvantages:
- There is difficulty rationalizing the meaning of codes that have been sequentially assigned
- Users tend to have difficulty sorting records that are coded alphabetically

Mnemonic Codes
- Alphabetic characters in the form of acronyms and other combinations that convent meaning
- Mnemonics do not require users to memorize the meaning since the code itself is informative – and not arbitrary
 E.g., NY = New York, ACCTG = Accounting
- They have limited ability to represent items within a class