Lecture 5 TRANSACTION CYCLES AND ACCOUNTING APPLICATIONS

Chapter Overview

Focuses on transaction cycles and accounting applications. Organized into four sections: revenue cycle, physical system, expenditure cycle, general ledger and reporting.

Chapter Objectives

• Understand the revenue cycle and its activities and controls.

• Differentiate manual and computer-based transaction models.

• Explore expenditure cycle activities and controls.

• Learn payroll processing system activities and controls.

• Review the fixed asset system and its controlling techniques.

• Distinguish between financial reporting and management reporting.

Revenue Cycle

Definition: The revenue cycle involves the exchange of goods/services for cash, which includes credit transactions. It is vital for maintaining cash flow and managing customer relationships.

Phases:

1. Physical Phase: Focuses on the transfer of physical assets or services to the customers, ensuring they receive what they paid for.

2. Financial Phase: Entails the receipt of cash or cash equivalents from customers after goods/services have been exchanged.

Subsystems:

• Sales Order Processing: Manages customer orders from receipt to fulfillment, ensuring accuracy and efficiency.

• Cash Receipts: Involves the collection of cash and management of accounts receivables to maintain liquidity.

Revenue Cycle Activities

• Sales Order Procedures: Receive and Process Customer Order, Check Customer Credit, Pick Goods from Inventory, Ship Goods with Proper Documentation, Bill Customer Post-Shipment, Update Inventory and Accounts Receivable, Post to General Ledger.

• Sales Return Procedures: Prepare Return Slip for Returned Goods, Generate and Approve Credit Memo, Update Sales Journal and Accounts Receivable, Adjust Inventory Records, Update General Ledger.

• Cash Receipts Procedures: Open Mail and Prepare Remittance Advice, Record and Deposit Checks Received, Update Accounts Receivable Records, Reconcile Cash Receipts and Deposits, Post Entries to General Ledger.

Physical Systems

Describes the manual and computer-based systems used in transaction processes.

• Manual Systems: Involve significant paper documentation and can be prone to human error, requiring rigorous checks and balances.

• Computer-Based Systems: Enhance efficiency, reduce errors, and allow for real-time data processing and reporting. They often integrate with various accounting software systems to streamline operations.

Expenditure Cycle

Objective: Convert cash into physical and human resources, ensuring the operational needs of the organization are met efficiently.

Phases:

1. Physical phase: Involves the acquisition of necessary resources, ensuring that quality and cost-effectiveness are prioritized.

2. Financial phase: Focuses on the structured disbursement of cash while managing liabilities effectively.

Subsystems:

• Purchases Processing: Systematically manage inventory levels and vendor relations.

• Cash Disbursements: Control cash flow through scheduled payment processes.

• Payroll Processing: Ensure timely and accurate compensation of employees.

• Fixed Assets Management: Oversee capital expenditures and the utilization of physical resources.

Major Activities

• Purchases Processing: Monitor Inventory, Prepare Purchase Requisitions, Send Purchase Orders to Vendors, Receive and Inspect Goods, Update Inventory and Accounts Payable.

• Cash Disbursements: Identify Liabilities Due, Prepare Cash Disbursement Checks, Update Accounts Payable and General Ledger.

• Payroll Processing: Process Employee Time Records, Prepare Payroll, Issue Employee Paychecks, Update Accounts Payable for Payroll Liabilities.

General Ledger System (GLS)

Inputs: Transactions processed by journals and subsidiary ledgers.

Components:

• Journal Voucher: Authorizes entries to the GL, forming a basis for transaction integrity.

• GLS Database: Houses master data and historical files necessary for audits and reporting.

Procedures:

Include journalizing, posting, adjusting, and closing entries to maintain the accuracy and integrity of financial records.

Financial Reporting System (FRS)

Provides mandatory financial statements to external users. The process involves capturing financial transactions, posting them to the general ledger, preparing trial balances, and generating formal financial statements (like balance sheets, income statements, and cash flow statements) as per regulatory requirements. The FRS must ensure that financial reports are accurate, timely, and comply with legal standards, thus fostering trust among stakeholders and maintaining organizational transparency.

Management Reporting System (MRS)

Definition: Discretionary reporting for internal decision-making and control. The MRS focuses on producing customized reports that are tailored to specific management needs. These reports may include operational performance metrics, financial forecasts, and variance analysis.

Influenced by:

• Management principles

• Functions of management

• Problem structures

• Behavioral considerations

Purpose:

Supports planning and control by providing timely information that meets managerial needs, facilitating improved decision-making. The MRS can influence strategies, improve operational efficiency, and guide resource allocation decisions through its focus on internal metrics rather than external regulations.

Key Controls

Internal Control Activities: Ensure accountability and accuracy in systems through:

• Authorization: Ensure transactions are legitimate before processing.

• Segregation of Duties: Prevent fraud by dividing responsibilities.

• Supervision: Oversee processes to ensure compliance with policies.

• Access Controls: Limit access to systems based on roles to prevent unauthorized transactions.

• Independent Verification: Conduct audits and reconciliations to ensure accuracy and catch errors.