AIS CHAPTER FIVE: TRANSACTION CYCLES AND ACCOUNTING

APPLICATIONS

4.1. TRANSACTION CYCLES

 Repetitive flow of the activities of an ongoing enterprise described in terms of five major
transaction cycles as follows:
 The basic exchanges can be grouped into five major transaction cycles.
1. Revenue cycle—Interactions with customers.
2. Expenditure cycle—Interactions with suppliers.
3. Production cycle—Give labor and raw materials; get finished product.
4. Human resources/payroll cycle—Give cash; get labor.
5. Financing cycle—Give cash; get cash.
1. The Revenue Cycle
 The revenue cycle is the direct exchange of finished goods or services for cash in a single
transaction between a seller and a buyer.
 The revenue transaction divided into two phases: (1) the physical phase, involving the
transfer of assets or services from the seller to the buyer; and (2) the financial phase,
involving the receipt of cash by the seller in payment of the account receivable
 The revenue cycle actually consists of two major subsystems: (1) the sales order
processing subsystem and (2) the cash receipts subsystem.
 The sequence of activities through three processes that constitute the revenue cycle for
most retail, wholesale, and manufacturing organizations. These are: sales order
procedures, sales return procedures, and cash receipts procedures.
 Sales order procedures: Sales order procedures include the tasks involved in receiving
and processing a customer order, filling the order and shipping products to the customer,
billing the customer at the proper time, and correctly accounting for the transaction.
 Sales Return Procedures: An organization can expect that a certain percentage of its sales
will be returned. This occurs for a number of reasons, some of which may be:
 The company shipped the customer the wrong merchandise.
 Defective goods.  The product damaged in shipment.

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  The buyer refused delivery because the seller shipped the goods too late or they
were delayed in transit.
 Cash Receipts Procedures: The sales order procedure described a credit transaction that
resulted in the establishment of an account receivable.
 Revenue Cycle Controls: There are six classes of internal control activities that guide us in
designing and evaluating transaction processing controls. These are transaction
authorization, segregation of duties, supervision, accounting records, access control,
and independent verification.
 Transactions authorization: the objective is to ensure that only valid transactions are
processed
 Segregation of duties: ensures that no single individual or department processes a
transaction in its entirety.
 Supervision: closely supervising employees who perform potentially incompatible functions
 Accounting records: firm’s source documents, journals, and ledgers form an audit trail that
allows independent auditors to trace transactions through various stages of processing.
 Access controls: Access controls prevent and detect unauthorized and illegal access to the
firm’s assets.
 Independent verification: the objective is to verify the accuracy and completeness of tasks
that other functions in the process perform.
2. Expenditure cycle
 The expenditure cycle is the set of activities related to the acquisition of and payment for
goods and services.
 The expenditure cycle includes several stages, such as identifying a need for goods or
services, requesting quotes or proposals from vendors, selecting a vendor, negotiating
terms and conditions, placing an order, receiving the goods or services, and making
payments to the vendor.
 The objective of the expenditure cycle is to convert the organization‘s cash into the
physical materials and the human resources it needs to conduct business.
 Most business entities operate on a credit basis and do not pay for resources until after
acquiring them. The time lag between these events splits the procurement process into two
phases:

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 i. The physical phase, involving the acquisition of the resource and
ii. The financial phase, involving the disbursement of cash. As a practical matter,
these are treated as independent transactions that are processed through separate
subsystems.
 The principal features of the four major subsystems that constitute the expenditure cycle:
a. the purchases processing subsystem
b. the cash disbursements subsystem
c. the payroll processing subsystem and
d. the fixed assets subsystem.
a. Purchases Processing Procedures Purchases procedures include the tasks involved in
identifying inventory needs, placing the order, receiving the inventory, and recognizing the
liability.
b. The Cash Disbursements Systems: The cash disbursements system processes the payment of
obligations created in the purchases system. The principal objective of this system is to
ensure that only valid creditors receive payment and that amounts paid are timely and
correct.
c. The Payroll Processing System Payroll processing is actually a special-case purchases system
in which the organization purchases labor rather than raw materials or finished goods for
resale.
d. The Fixed Asset System Fixed assets are the property, plant, and equipment used in the
operation of a business. Examples of fixed assets include land, buildings, furniture,
machinery, and motor vehicles. A firm‘s fixed asset system processes transactions pertaining
to the acquisition, maintenance, and disposal of its fixed assets.
 Expenditure Cycle Controls
 Describes the primary internal controls in the expenditure cycle according to the control
procedures specified in Statement on Auditing Standards No. 78.
i. Transactions authorization: promotes efficient inventory management and ensures the
legitimacy of purchases transactions.
ii. Segregation of duties
iii. Supervision: reduces the chances of two types of exposure: (1) failure to properly
inspect the assets and (2) the theft of assets

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 iv. Accounting records: maintain an audit trail adequate for tracing a transaction from its
source document to the financial statements.
v. Access
vi. Independent verification
3. The production cycle
 The production cycle is comprised of all activities related to the conversion of raw
materials into finished goods.
 The production cycle is the sequence of production steps that a product or service goes
through from its planning to its delivery to the customer.
 It includes the steps of product design, production planning, raw material sourcing,
manufacturing, quality control, packaging, and distribution.
 The four basic activities in the production cycle are: (1) product design; (2) planning and
scheduling; (3) production operations; and (4) cost accounting.
4. Payroll cycle
 Payroll cycle is the list of tasks performed while processing payrolls when we pay
employees for a set period or on a given date. It can be the regular payment that is done
regularly for the current period salary or hourly Calculation along with Off Cycle payroll,
Retroactive Payroll and Final Payroll.
 Payroll activities mainly consist of record keeping, new employee reporting, check
processing, state and local tax compilation, and payments.
 The basic business activities and data processing operations that are performed in the
HRM/payroll cycle, including recruiting, hiring, training, assigning, compensating,
evaluating, and discharging employees.
5. Financing cycle
 Financing cycle is the counterpart to the Investment cycle and Business cycle. It covers the
period from raising financial resources to their repayment.
 Some Examples of Financing Activities are:
 Issuing bonds  Repayment of existing loans
 Sale of treasury stock  Cash from new stock issued
 Loan from a financial institution