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CHAPT E R 2 Introduction to Transaction Processing 43

The Expenditure Cycle
Business activities begin with the acquisition of materials, property, and labor in exchange for cash—the
expenditure cycle. Figure 2-1 shows the flow of cash from the organization to the various providers of
these resources. Most expenditure transactions are based on a credit relationship between the trading par-
ties. The actual disbursement of cash takes place at some point after the receipt of the goods or services.
Days or even weeks may pass between these two events. Thus, from a systems perspective, this transac-
tion has two parts: a physical component (the acquisition of the goods) and a financial component (the
cash disbursement to the supplier). A separate subsystem of the cycle processes each component. The
major subsystems of the expenditure cycle are outlined here. Because of the extent of this body of mate-
rial, two chapters are devoted to the expenditure cycle. Purchases/AP and cash disbursements systems are
the topics of Chapter 5. Payroll and fixed asset systems are examined in Chapter 6.

Purchases/accounts payable system. This system recognizes the need to acquire physical inventory
(such as raw materials) and places an order with the vendor. When the goods are received, the pur-
chases system records the event by increasing inventory and establishing an account payable to be paid
at a later date.

Cash disbursements system. When the obligation created in the purchases system is due, the cash
disbursements system authorizes the payment, disburses the funds to the vendor, and records the
transaction by reducing the cash and accounts payable accounts.
Payroll system. The payroll system collects labor usage data for each employee, computes the payroll,
and disburses paychecks to the employees. Conceptually, payroll is a special-case purchases and cash
disbursements system. Because of accounting complexities associated with payroll, most firms have a
separate system for payroll processing.

Fixed asset system. A firm’s fixed asset system processes transactions pertaining to the acquisition,
maintenance, and disposal of its fixed assets. These are relatively permanent items that collectively of-
ten represent the organization’s largest financial investment. Examples of fixed assets include land,
buildings, furniture, machinery, and motor vehicles.

The Conversion Cycle
The conversion cycle is composed of two major subsystems: the production system and the cost account-
ing system. The production system involves the planning, scheduling, and control of the physical product
through the manufacturing process. This 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. The cost accounting system monitors
the flow of cost information related to production. Information this system produces is used for inventory
valuation, budgeting, cost control, performance reporting, and management decisions, such as make-
or-buy decisions. We examine the basic features of these systems in Chapter 7.
Manufacturing firms convert raw materials into finished products through formal conversion cycle
operations. The conversion cycle is not usually formal and observable in service and retailing establish-
ments. Nevertheless, these firms still engage in conversion cycle activities that culminate in the develop-
ment of a salable product or service. These activities include the readying of products and services for
market and the allocation of resources such as depreciation, building amortization, and prepaid expenses
to the proper accounting period. However, unlike manufacturing firms, merchandising companies do not
process these activities through formal conversion cycle subsystems.

The Revenue Cycle

Firms sell their finished goods to customers through the revenue cycle, which involves processing cash
sales, credit sales, and the receipt of cash following a credit sale. Revenue cycle transactions also have a