The Revenue Cycle Processes

CHAPTER 7

Objectives
1. Understand
the
fundamental
tasks
performed in the revenue cycle, regardless
of the technology in place.
2. Be
able
to
identify
the
functional
departments involved in revenue cycle
activities and trace the flow of revenue
transactions through the organization.
3. Be able to specify the documents, journals,
and accounts that provide audit trails,
promote the maintenance of historical
records, support internal decision making,
and sustain financial reporting.
4. Understand the risks associated with the
revenue cycle and recognize the controls

INTRODUCTION
Economic enterprises, both for-profit
and not-for-profit, generate revenues
through business processes that
constitute their 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.

Revenue Cycle
More complex revenue cycles process
sales on credit.
This time lag splits the revenue
transaction into two phases:
a. The
physical
phase,
involving
the
transfer of assets or services from the
seller to the buyer;
b. The financial phase, involving the receipt
of cash by the seller in payment of the
account receivable.

Revenue Cycle
Hence, the revenue cycle actually
consists of two major subsystems:
a. The
sales
order
processing
subsystem
b. The cash receipts subsystem.
The
revenue
cycles
primary
objective is to provide the right
product in the right place at he right
time for the right price.

Revenue Cycle

Revenue Cycle
Business Activities
What are the four basic revenue
cycle business activities?
A. Sales order entry
B. Shipping
C. Billing and accounts receivable
D. Cash collections

Revenue Cycle Business

Activities:
Sales Order Entry

Sales order entry process entails 3

steps:
a. Taking the customers order and
respond to customer inquiries
b. Checking
and
approving
the
customers credit
c. Checking inventory availability

Revenue Cycle Business

Activities:
Shipping

The second basic activity in the

revenue
cycle : filling customer orders and
shipping the desired merchandise
entails
2 steps:
a. Picking and packing the order
b. Shipping the order

Revenue Cycle Business

Activities:
Billing and Accounts
Receivable
The third basic activity in the
revenue
cycle involves:
a. Billing customers
b. Updating accounts receivable

Revenue Cycle Business

Activities:
Cash Collections

The fourth step in the revenue

cycle is
cash collections. It involves:
a. Handling customer remittances
b. Depositing remittances in the
bank

Overview of Revenue Cycle

Activities
Using data flow diagrams (DFDs) as
a guide, the sequence of activities
can be traced through three
processes
that
constitute
the
revenue cycle for most retail,
wholesale,
and
manufacturing
organizations.
These are:
a. Sales order procedures,
b. Sales return procedures, and
c. Cash receipts procedures

Sales Order Procedures

Include the tasks involved in
a. Receiving
and
processing
a
customer order,
b. Filling the order and shipping
products to the customer,
c. Billing the customer at the proper
time, and
d. Correctly
accounting
for
the
transaction.

a. Receive Order
The sales process begins with
the receipt of a customer order
indicating the type and quantity
of merchandise desired.

a. Receive Order
The sales order captures vital
information such as the
a. Customers name, address, and
account number;
b. The name, number, and description
of the items sold; and
c. The quantities and unit prices of
each item sold

a. Receive Order
At
this
point,
information such as
a. Taxes,
b. Discounts, and
c. Freight charges

financial

Sales
Order

a. Receive Order
After creating the sales order, a
copy of it is placed in the
customer open order file for
future reference.

b. Check Credit
Before processing the order
further,
the
customers
creditworthiness needs to be
established.
The receive-order task sends the
sales order (credit copy) to the
check-credit task for approval.

b. Check Credit
A new customers may undergo a
full financial investigation to
establish a line of credit.
Credit checking on subsequent
sales may be limited to ensuring
that the customer has a history
of paying his or her bills and that
the current sale does not exceed
the pre-established limit.

c. Pick Goods
The
receive
order
activity
forwards
the
stock
release
document to the pick goods
function, in the warehouse.
This document identifies the
items of inventory that must be
located and picked from the
warehouse shelves.

c. Pick Goods
After picking the stock, the order
is verified for accuracy and the
goods and verified stock release
document are sent to the ship
goods task.

d. Ship Goods
Before the arrival of the goods
and the verified stock release
document,
the
shipping
department receives the packing
slip and shipping notice from the
receive order function.
The packing slip will ultimately
travel with the goods to the
customer
to
describe
the
contents of the order.

d. Ship Goods
The shipping notice will later be
forwarded to the billing function as
evidence that the customers order
was filled and shipped.
This document conveys pertinent new
facts such as
a. The date of shipment,
b. The items and quantities actually
shipped,
c. The name of the carrier, and
d. Freight charges.

d. Ship Goods
Upon receiving the goods from the
warehouse,
the
shipping
clerk
reconciles the physical items with
a. the stock release,
b. the packing slip, and
c. the shipping notice to verify that
the order is correct.
The ship goods function is the last
opportunity to detect errors before
shipment.

d. Ship Goods
The shipping clerk
a. packages the goods,
b. Attaches the packing slip,
c. completes the shipping notice, and
d. prepares a bill of lading.
The bill of lading is a formal contract
between the seller and the shipping
company (carrier) to transport the
goods to the customer.

Bill
of
Ladin
g

d. Ship Goods
Once the goods are transferred
to the carrier, the shipping clerk
a. records the shipment in the
shipping log,
b. forwards the shipping notice to the
bill customer function as proof of
shipment, and
c. updates the customers open order
file.

e. Bill Customer
The shipment of goods marks
the completion of the economic
event and the point at which the
customer should be billed.
Billing
before
shipment
encourages inaccurate record
keeping
and
inefficient
operations.

e. Bill Customer
Billing for goods not shipped
causes
confusion,
damages
relations with customers, and
requires additional work to make
adjustments to the accounting
records.
The completed sales invoice is
the
customers
bill,
which
formally depicts the charges to
the customer.

e. Bill Customer
In addition, the billing function
performs the following record
keepingrelated tasks:
1. Records the sale in the sales
journal.
2. Forwards the ledger copy of the
sales order to the update accounts
receivable task.
3. Sends the stock release document
to the update inventory records
task.

Journal Vouchers/Entries
How do we get them?
Inventory Control Department
prepares a journal voucher:
Cost of Goods Sold
Inventory

DR
CR

Billing Department prepares a

journal voucher:
Accounts Receivable
Sales

DR
CR

Journal Vouchers/Entries
How do we get them?
Cash
Receipts
Department
prepares a journal voucher:
Cash

DR
Accounts Receivable

CR

Revenue Cycle
Databases
Master files
customer master file
accounts receivable master file
merchandise inventory master file

Transaction and Open Document

Files
sales order transaction file
sales invoice transaction file
cash receipts transaction file

Revenue Cycle
Databases
Other Files
shipping and price data reference file
credit reference file (may not be
needed)
salesperson file (may be a master
file)
Sales history file
cash receipts history file
accounts receivable reports file

Update Inventory
Records
The
inventory
control
function
updates inventory subsidiary ledger
accounts from information contained
in the stock release document.
In a perpetual inventory system,
every inventory item has its own
record in the ledger containing.

Update Inventory
Records
Each stock release document reduces
the quantity on hand of one or more
inventory accounts.
The financial value of the total
reduction in inventory is summarized
in a journal voucher and sent to the
general ledger function for posting to
the following accounts.

Update Accounts Receivable

Customer records in the accounts
receivable (AR) subsidiary ledger
are updated from information the
sales order (ledger copy) provides.

Update Accounts Receivable

Every customer has an account
record in the AR subsidiary ledger
containing,
at
minimum,
the
following data:
a. customer name, customer address;
b. current balance, available credit;
c. transaction
dates,
invoice
numbers; and
d. credits for payments, returns, and
allowances.

Update Accounts Receivable

Periodically, the individual account
balances are summarized in a report
that is sent to the general ledger.

Post to General Ledger

The general ledger function has
received journal vouchers from the
billing and inventory control tasks
and an account summary from the AR
function.

Post to General Ledger

This information set serves two
purposes :
i. The general ledger uses the
journal vouchers to post to the
following control accounts

Post to General Ledger

This information set serves two
purposes :
ii. This
information
supports
an
important independent verification
control. The AR summary, which
the AR function independently
provides, is used to verify the
accuracy of the journal vouchers
from billing.

Summary :
Sales Order Processing
Begins with a customer placing an order
The sales department captures the
essential details on a sales order form.
The
transaction
is
authorized
by
obtaining credit approval by the credit
department.
Sales information is released to:
Billing
Warehouse (stock release or picking
ticket)
Shipping (packing slip and shipping
notice)

Summary :
Sales Order Processing
The merchandise is picked from the
Warehouse and sent to Shipping.
Stock records are adjusted
The merchandise, packing slip, and
bill of lading are prepared by
Shipping and sent to the customer.

Shipping
reconciles
the
merchandise received from the
Warehouse
with
the
sales
information on the packing slip

Summary :
Sales Order Processing
Shipping information is sent to
Billing.
Billing compiles and reconciles the
relevant facts and issues an invoice
to the customer and updates the
sales journal.
Information is transferred to:
Accounts Receivable (A/R)
Inventory Control

Summary :
Sales Order Processing
A/R records the information in the
customers account in the accounts
receivable subsidiary ledger.

Inventory
Control
adjusts
the
inventory subsidiary ledger.
Billing, A/R, and Inventory Control
submits summary information to the
General Ledger dept., which then
reconciles this data and posts to the
control accounts in the G/L.

Sales Return
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:
a. The company shipped the customer the
wrong merchandise.
b. The goods were defective.
c. The product was damaged in shipment.
d. The buyer refused delivery because the
seller shipped the goods too late or
they were delayed in transit.

Sales Return
When a return is necessary, the buyer
requests credit for the unwanted
products.
This involves reversing the previous
transaction
in
the
sales
order
procedure.

Sales Return Journal

Entry
G/L posts the following to control
accounts:
InventoryControl DR
Sales Returns and Allowances DR
Cost of Goods Sold CR
Accounts ReceivableControl CR

a. Prepare Return Slip

When
items
are
returned,
the
receiving
department
employee
counts, inspects, and prepares a
return slip describing the items.
The goods, along with a copy of the
return slip, go to the warehouse to be
restocked.
The employee then sends the second
copy of the return slip to the sales
function to prepare a credit memo.

b. Prepare Credit Memo

This document is the authorization for
the customer to receive credit for the
merchandise returned.

Credit
Memo

c. Approve Credit Memo

The credit manager evaluates the
circumstances of the return and
makes a judgment to grant (or
disapprove) credit.
The
manager
then
returns
the
approved credit memo to the sales
department.

d. Update Sales Journal

Upon receipt of the approved credit
memo, the transaction is recorded in
the sales journal as a contra entry.
The credit memo is then forwarded to
the inventory control function for
posting.
At the end of the period, total sales
returns are summarized in a journal
voucher and sent to the general
ledger department.

e. Update Inventory and AR

Records
The inventory control function
a. adjusts the inventory records and
forwards
the
credit
memo
to
accounts
receivable,
where
the
customers account is also adjusted.
b. sends a journal voucher summarizing
the total value of inventory returns
to the general ledger update task.
Accounts receivable submits an AR
account summary to the general ledger
function.

f. Update General Ledger

Upon receipt of the journal voucher
and account summary information,
the general ledger function reconciles
the figures and posts to the following
control accounts:

InventoryControl DR
Sales Returns and Allowances DR
Cost of Goods Sold CR
Accounts ReceivableControl CR

Cash Receipts
Procedures
Payment on the account receivable is
due at some future date, which the
terms of trade determine.
They involve
a. receiving and securing the cash;
b. depositing the cash in the bank;
c. matching
the
payment
with
the
customer and adjusting the correct
account; and
d. properly accounting for and reconciling
the financial details of the transaction.

a. Open Mail and Prepare

Remittance Advice
A
mail
room
employee
opens
envelopes
containing
customers
payments and remittance advices.
Remittance
advices
contain
information
needed
to
service
individual customers accounts.
This includes
a.
b.
c.
d.

payment date,
account number,
amount paid, and
customer check number.

a. Open Mail and Prepare

Remittance Advice
Its importance is most apparent in
firms that process large volumes of
cash receipts daily.
Errors are avoided and operational
efficiency is greatly improved when
using remittance advices.

Remittanc
e Advice

b. Record and Deposit Checks

A cash receipts employee verifies the
accuracy and completeness of the
checks against the prelist.
After reconciling the prelist to the
checks, the employee records the
check in the cash receipts journal.
All
cash
receipts
transactions,
including cash sales, miscellaneous
cash receipts, and cash received on
account, are recorded in the cash
receipts journal.

b. Record and Deposit Checks

The
cash
receipts
employee
summarizes the journal entries and
sends the following journal voucher
entry to the general ledger function.

c. Update Accounts Receivable

The remittance advices are used to
post to the customers accounts in
the AR subsidiary ledger.
Periodically, the changes in account
balances
are
summarized
and
forwarded to the general ledger
function.

d. Update General Ledger

Upon receipt of the journal voucher
and the account summary, the
general ledger function
a. reconciles the figures,
b. posts to the cash and AR control
accounts, and
c. files the journal voucher

e. Reconcile Cash Receipts and

Deposits
Periodically,
a
clerk
from
the
controllers office reconciles cash
receipts by comparing the following
documents:
a. a copy of the prelist,
b. deposit slips received from the bank,
and
c. related journal vouchers.

Summary :
Cash Receipts Processes
Customer checks and remittance
advices are received in the Mail
Room.
A mail room clerk prepares a cash
prelist and sends the prelist and
the checks to Cash Receipts.
The cash prelist is also sent to A/R
and the Controller.

Summary :
Cash Receipts Processes
Cash Receipts:
verifies
the
accuracy
and
completeness of the checks
updates the cash receipts journal
prepares a deposit slip
prepares a journal voucher to send
to G/L

Summary :
Cash Receipts Processes
A/R posts from the remittance
advices to the accounts receivable
subsidiary ledger.
Periodically, a summary
postings is sent to G/L.

of

the

G/L department:
reconciles the journal voucher from
Cash Receipts with the summaries
from A/R
updates the general ledger control
accounts

Summary :
Cash Receipts Processes
The Controller reconciles the bank
accounts.

Summary of Internal
Controls

A. Authorization Controls
Proper authorization of transactions
(documentation) should occur so that
only valid transactions get processed.
Within
the
revenue
cycle,
authorization should take place when:
a
sale
is
made
on
credit
(authorization)
a
cash
refund
is
requested
(authorization)
posting a cash payment received to
a customers account (cash pre-list)

a. Credit Check
Credit
checking
of
prospective
customers is a credit department
function.
This department ensures the proper
application of the firms credit
policies.

b. Return Policy
Most organizations have specific rules
for granting cash refunds and credits
to customers based on the materiality
of the transaction.
As
materiality
increases,
credit
approval becomes more formal.

c. Remittance List (Cash Prelist)

The prelist authorizes the posting of a
remittance advice to a customers
account.

B. Segregation of Functions
Three Rules
a. Transaction
authorization
should be
separate from
transaction processing.
b. Asset
custody
should
be
separate from asset recordkeeping.
c. The organization should be so
structured
that
the
perpetration of a fraud requires
collusion between two or more
individuals.

Segregation of Functions
Sales Order Processing
credit authorization separate from SO
processing
inventory
control
separate
from
warehouse
accounts receivable sub-ledger separate
from general ledger control account

Cash Receipts Processing

cash receipts separate from accounting
records
accounts receivable sub-ledger separate
from general ledger

C. Supervision
Often used when unable to enact
appropriate segregation of duties.
Supervision of employees serves as a
deterrent to dishonest acts and is
particularly
important
in
the
mailroom.

Example
The mail room is a point of risk in
most cash receipts systems. The
individual who opens the mail has
access both to cash (the asset) and
to the remittance advice (the record
of the transaction). A dishonest
employee may use this opportunity to
steal the check, cash it, and destroy
the remittance advice, thus leaving
no evidence of the transaction.

D. Accounting Records
With a properly maintained audit
trail, it is possible to track
transactions
through
the
systems and to find where and
when errors were made:
pre-numbered source documents
special journals
subsidiary ledgers
general ledger
files

E. Access Controls
Access to assets and information
(accounting
records)
should
be
limited.
Within the revenue cycle, the assets
to protect are cash and inventories
and access to records such as the
accounts receivable subsidiary ledger
and cash journal should be restricted.

E. Access Controls
Limiting access to these items
includes:
Warehouse security, such as fences,
alarms, and guards.
Depositing cash daily in the bank.
Using a safe or night deposit box
for cash.
Locking cash drawers and safes in
the cash receipts department.

Independent Verification
The
objective
of
independent
verification is to verify the accuracy
and completeness of tasks that other
functions in the process perform.
To
be
effective,
independent
verifications must occur at key points
in the process where errors can be
detected quickly and corrected.

Independent Verification
Independent verification controls in the
revenue cycle exist at the following
points:
shipping verifies the goods sent from the
warehouse are correct in type and
quantity
warehouse reconciles the stock release
document (picking slip) and packing slip
billing reconciles the shipping notice with
the sales invoice
general
ledger
reconciles
journal
vouchers from billing, inventory control,
cash receipts, and accounts receivable

Example
The general ledger function would detect a
sales transaction that had been entered in the
sales journal but not posted to the customers
account in the AR subsidiary ledger. The
journal voucher from billing, summarizing
total credit sales, would not equal the total
increases posted to the AR subsidiary ledger.
The specific customer account causing the
out-of-balance
condition
would
not
be
determinable at this point, but the error
would be noted. Finding it may require
examining all the transactions processed
during the period. Depending on the
technology in place, this could be a tedious