CHAPTER 4

THE REVENUE CYCLE

LEARNING OBJECTIVES
Tasks performed in the revenue cycle, regardless the
technology used
Functional departments in the revenue cycle and the flow of
revenue transactions through the organization
Documents, journals, and accounts needed for audit trails,
records, decision making, and financial reporting
Risks associated with the revenue cycle and the controls that
reduce these risks
 The operational and control implications of technology used
to automate and reengineer the revenue cycle
REVENUE CYCLE

Economic enterprises, both for-profit and not-for-

profit, generate revenues through business
processes that constitute their revenue cycle.
Is the direct exchange of finished goods or
services for cash in a single transaction between
a seller and a buyer.
THE CONCEPTUAL SYSTEM

■Overview of Revenue
In this section Cycle
we examine the revenue cycle
Activities
conceptually. Using data flow diagrams (DFDs) as a
guide, we will trace 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. Service
companies such as hospitals, insurance companies, and
banks would use different industry-specific methods.
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
◇Receive
Order
■The sales process begins with the receipt of a customer order
indicating the type and quantity of merchandise desired. At this point,
the customer order is not in a standard format and may or may not be a
physical document.
■Because the customer order is not in the standard format that the
seller’s order pro-cessing system needs, the first task is to transcribe it
into a formal sales order.
■After creating the sales order, a copy of it is placed in the customer
open order file for future reference. The task of filling an order and
SALES ORDER PROCEDURES

◇Check
Credit
■Before processing the order further, the customer’s creditworthiness
needs to be established. The circumstances of the sale will determine
the nature and degree of the credit check.

■The credit approval process is an authorization control and should

be performed as a function separate from the sales activity. In our
conceptual system, the receive-order task sends the sales order
(credit copy) to the check-credit task for approval.

■The returned approved sales order then triggers the continuation of

the sales process by releasing sales order information simultaneously
to various tasks.
SALES ORDER PROCEDURES

◇Pick Goods
■The receive order activity forwards the stock
release document (also called the picking ticket) 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.
 SALES ORDER PROCEDURES

◇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.
-The shipping notice will later be forwarded to the billing
function as evidence that the customer’s order was filled and
shipped.
 SALES ORDER PROCEDURES

◇Ship
Goods
■The shipping clerk packages
the goods, attaches the
packing slip, completes the
shipping notice, and 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.
SALES ORDER PROCEDURES

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.
 SALES ORDER PROCEDURES

Update Inventory
Records
The inventory control function updates inventory subsidiaryledger
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, at a minimum, the data depicted in
Figure 4-5.
SALES ORDER PROCEDURES

Update Accounts
Receivable.
Customer records in the accounts receivable (AR) subsidiary ledger
are updated from information the sales order (ledger copy) provides.
 SALES ORDER PROCEDURES

Post to General Ledger

By the close of the transaction processing period, the general ledger
function has received journal vouchers from the billing and inventory
control tasks and an account summary from the AR function.
SALES RETURN PROCEDURE

■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.
The goods were defective.
The product was damaged in shipment.
1. The buyer refused delivery because the seller shipped the goods
too late or they were delayed in transit.

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 PROCEDURE

PREPARE RETURN SLIP. When items are returned, the receiving

department employee counts, inspects, and prepares a return slip
describing the items.

PREPARE CREDIT MEMO. Upon receipt of the return slip, the sales
employee prepares a credit memo. This document is the authorization
for the customer to receive credit for the merchandise returned.

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.
SALES RETURN PROCEDURE

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.

UPDATE INVENTORY AND AR RECORDS. The inventory control

function adjusts the inventory records and forwards the credit memo
to accounts receivable, where the customer’s account is also
adjusted.

UPDATE GENERAL LEDGER. Upon receipt of the journal voucher and

 CASH RECEIPTS PROCEDURES

OPEN MAIL AND PREPARE REMITTANCE

ADVICE
■Mail room employee opens envelopes containing
customers’ payments and remittance advices.
■Remittance advices contain information needed to service
individual customer accounts which include payment date,
account number, amount paid, and customer check number.
■Mail room personnel route the checks and remittance
advices to an administrative clerk who endorses the checks
"For Deposits Only" and reconciles the amount on each
remittance advice with the corresponding check
 CASH RECEIPTS PROCEDURES

OPEN MAIL AND PREPARE REMITTANCE

ADVICE
■The clerk records each check on a form called a
remittance list or cash prelist.
■The clerk prepares three copies of remittance list
and sends the original copy together with the check
to the record and deposit function, the second copy
together with the remittance advices to the update
AR function, and the third copy to the reconciliation
task.
 CASH RECEIPTS PROCEDURES

RECORD AND DEPOSIT CHECK

■Cash receipts employee verifies the accuracy and

completeness of the checks against the prelist

■After reconciling the prelist to the checks, the

employee records check in the cash receipts journal

■Cash receipts journal is where all cash receipts

transactions are recorded such as cash sales,
miscellaneous cash receipts, and cash receives on
account.
 CASH RECEIPTS PROCEDURES

RECORD AND DEPOSIT CHECK

■The clerk prepares a bank deposit slip showing

the amount of the day's receipts and forward this
along with the checks to the bank. The bank teller
validates the deposit slip and returns it to the
company for reconciliation.

■Cash receipts employee summarizes the journal

entries and sends the journal voucher entry to the
general ledger function
 CASH RECEIPTS PROCEDURES

UPDATE ACCOUNTS RECEIVABLE

■The remittance advices are used to post to the

customers' accounts in the AR subsidiary ledger.

■The changes in the accounts balances are

forwarded to the general ledger function
periodically
 CASH RECEIPTS PROCEDURES

UPDATE GENERAL LEDGER

■Upon receipt of the journal voucher and the

accounts summary, the general ledger function
reconciles the figures, posts to the cash and AR
control, and files the journal voucher
 CASH RECEIPTS PROCEDURES

RECONCILE CASH RECEIPTS AND

DEPOSITS
Periodically, a clerk from the controller's office or an
employee not involved with the cash receipts
procedures reconciles cash receipts by comparing

1) Copy of the prelist;

2) Deposit slips received from the bank
3) Related journal vouchers
 REVENUE CYCLE CONTROL

TRANSACTION AUTHORIZATION
- Its objective is to ensure that only valid
transactions are processed.

■CREDIT CHECK- the credit department ensures

that proper application of the firm's credit policy
■RETURN POLICY- the credit department
determines the approval of return based on nature
of the sale and circumstances of the return.
 REVENUE CYCLE CONTROL

TRANSACTION AUTHORIZATION
- REMITTANCE LIST (CASH PRELIST)- provides a
means for verifying that customer checks and
remittance advices match in amount.
 REVENUE CYCLE CONTROL

SEGREGATION OF DUTIES
- ensures that no single individual or department
processes a transaction in its entity.
3 RULES
1. Transaction authorization should be separate from
transaction processing
2. Asset custody should be separate from the task of
record keeping
3. The organization should be structured so that the
preparation of a fraud requires collusion between two
or more individuals
 REVENUE CYCLE CONTROL

SUPERVISION
- - a form of compensating control and also provides
control in systems that are properly segregated
 REVENUE CYCLE CONTROL

ACCOUNTING RECORDS

PRENUMBERED DOCUMENTS- permits the isolation and

tracking of a single event (among may thousands)
through the accounting system.
SPECIAL JOURNALS- by grouping similar transactions
together into special journals, the system provides a
concise record of an entire class of events. Revenue
cycle systems use the sales journal and cash receipt
journal.
 REVENUE CYCLE CONTROL

ACCOUNTING RECORDS

SUBSIDIARY LEDGERS- two subsidiary ledgers are used

for capturing transaction event details in revenue cycle:
the inventory and accounts receivable ledgers
 REVENUE CYCLE CONTROL

ACCOUNTING RECORDS

■GENERAL LEDGERS- basis for financial statement

preparation. Revenue cycle transactions affect the
following general ledger accounts: Sales, Inventory, Cost
of Goods Sold, Accounts Receivable and Cash.

■FILES
-OPEN SALES ORDER FILE - Shows the status of
customer orders
-SHIPPING LOG - special orders shipped during the
period
 REVENUE CYCLE CONTROL

ACCOUNTING RECORDS

■FILES
-CREDIT RECORDS FILE – provides customers credit data
-SALES ORDER PENDING FILE – contains open order not
yet shipped or billed
-BACK ORDER FILE – contains customer order for out of
stock items
-JOURNAL VOUCHER FILE – a compilation of all journal
vouchers posted to the general ledger
 REVENUE CYCLE CONTROL

ACCESS CONTROLS
- prevent and detect unauthorized and illegalaccess to
the firms assets

➤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 sales in the cash receipts
department
 REVENUE CYCLE CONTROL

INDEPENDENT VERIFICATION
- the objective is to verify the accuracy and
completeness of tasks that other functions in the
process perform

Independent verification controls in the revenue cycle

exits at the following point:
1) Shipping function
2) Billing function
3) Prior to posting to control accounts
PHYSICAL SYSTEMS: MANUAL SYSTEM
SALE ORDER PROCESSING

■Sales Department
■Credit Department Approval
■ Warehouse Procedures
■ Shipping Department
■Billing Department
■ Accounts Receivable, Inventory Control,
and General Ledger Department
MANUAL SALES ORDER PROCESSING
SYSTEM (CONT'N)

■Upon receipt of sales documents from

the billing department, AR and Inventory
Control clerks update their subsidiary
ledger.

■ Prepare journal vouchers and account

summaries periodically and send to the
General Ledger Department for
reconciliation and posting to control
accounts.
 SALES RETURN PROCEDURES

➤In the receiving department, personnel receive, count

inspect for damage, and send returned products to the
warehouse.
➤ The receiving clerk prepares return slip.
➤ The return slip is forwarded to the sales department for
processing.
➤ Upon receipt of return slip, clerk prepares credit memo.
➤ Billing records contra entry into sales, return and allowance
journal inventory control to reflect the return of goods.
➤ All departments periodically prepares journal vouchers and
account summaries, then send those to the general ledger
CASH RECEIPTS PROCEDURES

➤ Customer payments and remittance advices arrives at

Mail Room, where envelopes are opened.
➤ The checks are send to the cash receipts department.
➤ Remittance advices are send to AR department
➤ The cashier records the check in the cash receipts
journal and sends them to the bank, together with the
two copies of deposit slips.
➤ Periodically, prepares journal voucher and send it to
general ledger department.
CASH RECEIPTS PROCEDURES

➤AR department uses the remittance advices to reduce

customer account's balances consistent with the amount
paid.
➤ Prepares summary of change in account balances, and
send it to the general ledger department.
➤Upon receipt of journal vouchers and account
summaries, general ledger clerk reconciles the
information and posts to the control accounts.
➤Controller's officer periodically performs bank
reconciliation
➤Comparing deposit slips returned from the bank,
CONCLUDING REMARKS OF USING
MANUAL SYSTEM

-It generates a great deal of hard-copy

documents
-Physical documents need to be purchases,
prepared, transported and stored.
-Many functions of physically separate
departments that are labor-intensive and error-
prone activities.
-Hence, higher cost of system operation.
- The use of computer-based systems design is
advisable.
COMPUTER-BASED ACCOUNTING SYSTEM

Automation
➤ involves using technology to improve the efficiency
and effectiveness of a task
➤ replicates the traditional process that it replaces

Reengineering
➤ involves radically rethinking the business process and
the work flow ➤to improve operational performance and
reduce cost by identifying and eliminating non-value
added tasks
AUTOMATED SALES ORDER SYSTEM

Sales Department
➤Customer contacts the sales department and
place an order
➤ The sales clerk records the essential details and
create a multiple copies of sales order, which are
held pending credit approval
Credit Department Approval
➤ When credit is approved, sales department
releases copies of sales order to the billing,
warehouse and shipping department.
 AUTOMATED SALES ORDER SYSTEM

Warehouse
➤Receives the stock release copy of the sales order
and uses this to pick the goods
➤Inventory and stock release are send to shipping
department Shipping Department
➤Reconcile the products received from the
warehouse with the shipping notice.
➤Bill of lading is prepared, products are packaged
and shipped via common carrier to customer.
➤Send the shipping notice to the computer
 AUTOMATED SALES ORDER SYSTEM

Keystroke
➤Shipping notice received are verified copies of the
sales order that contains information of customer
and items shipped
➤Keystroke clerk converts the hard-copy shipping
notices to digital form to produce a transaction file
of sales orders.
➤The transaction file contains many separate
batches of records
➤For each batch stored on the file, batch control
 AUTOMATED SALES ORDER SYSTEM

EDIT RUN
➤ Edit program validates all transaction records in
the batch by performing clerical and logical test on
data
➤ Field checks, limit test, range test, and price-
times-quantity extensions
➤ Recalculates the batch control totals to reflect any
changes due to he removal of error accounts
➤ Edited sales order file is passed to the file update
run
 TRANSACTION PROCESSING PROCEDURE

Sales Procedure
- The sales clerk performs the following in real-time
mode:
●System access inventory subsidiary file and checks
the availability of the inventory.
● Perform credit check by retrieving customer credit
data in the customer's (AR) file.
●Customer's credit limit, current balance, date of last
payment, current credit status
●If credit is approved, system updates customer current
balance to present an accurate and current inventory on
 TRANSACTION PROCESSING PROCEDURE

Sales Procedure
➤System automatically transmits a digital stock
release to the warehouse, digital shipping notice
to shipping department, records the sales in the
sales order file
➤ Set value to indicate the status of the order
➤Default value is N when record is created, Y if
the goods are shipped.
 TRANSACTION PROCESSING PROCEDURE

Warehouse Procedures
➤ Automatically produce hard-copy printout of
electronically transmitted stock release
documents.

➤Picks the goods and send to shipping

department, along with the copy of stock release
documents
 TRANSACTION PROCESSING PROCEDURE

Shipping Department
➤ Reconciles the goods, stock release documents,
hard-copy packing slip
➤ Select a carrier and prepares the goods for
shipment
➤ The clerk transmits a shipping notice containing
shipping date and freight charges.
➤ The system updates the open sales order record
in real time and places Y value in the closed field.
GENERAL LEDGER UPDATE PROCEDURES
At the end of the day, the batch update program searches
the open sales order file for records marked closed and
updates the following general ledger accounts: Inventory-
Control, Sales, AR-Control, and Cost of Good Sold. The
inventory subsidiary and AR subsidiary records were
updated previously during the real-time procedures. In
the previous chapter, the batch of general ledger records
is done to achieve operational efficiency in high-volume
transaction processing systems. An alternative approach
is to update the general ledger accounts in real time, if
doing so poses no significant operational delays. Finally,
ADVANTAGES OF REAL-TIME PROCESSING

1. Real-time processing greatly shortens the cash

cycle of the firm.
2. Real-time processing can give the firm a
competitive advantage in the workplace.
3. Real-time editing permits the identification of
many kinds of errors as they occur and greatly
improves the efficiency and the effectiveness of
operations.
4. Finally, real-time processing reduces the
amount of paper documents in a system.
AUTOMATED CASH RECEIPTS PROCEDURES

Mail Room. The mail room clerk separates the checks and
remittance advices and pre-pares a remittance list
Cash Receipts Department. The cash receipts clerk
reconciles the checks and the remittance list and prepares
the deposit slips.
Accounts Receivable Department. The AR clerk receives
and reconciles the remittance advices and remittance list.
Data Processing Department. At the end of the day, the
batch program reconciles the journal voucher with the
transaction file of cash receipts and updates the AR
subsidiary and the general ledger control accounts (AR-
REENGINEERED CASH RECEIPTS PROCEDURES

1. The mail room is frequent target for

reengineering
2. Companies send their customers preprinted
envelopes and remittance advices
3. Upon receipt, these envelopes are scanned to
provide a control procedure against theft.
4. Machines open the envelopes, scan remittance
advices and checks, and separate the checks.
5. Artificial intelligence may be used to read
handwriting, such as remittance amounts and
POINT-OF-SALE (POS) SYSTEMS

-Point of sale systems are used extensively in

retail establishments.
Customers pick the inventory from the shelves
and take them to a cashier.
-The clerk scans the Universal Product Code
(UPC). The POS system is concerned to an
inventory file, where the price and description are
retrieved.
The inventory levels are updated and reorder
needs can immediately be detected
POINT-OF-SALE (POS) SYSTEMS

-The system computes the amount due. Payment

is either cash, check, ATM or credit card in most
cases.
No accounts receivables
-If checks, ATM or credit cards are used, an on-line
link to receive approval is necessary.
-At the end of the day or a cashier's shift, the
money and receipts in the drawer are reconciled
to the internal cash register tape or a printout
from the computer's database.
REENGINEERING USING EDI(ELECTRONIC
DATA INTERCHANGE)

-EDI helps to expedite transactions.

-The customer's computer:
Determines that inventory is needed
Selects a supplier with whom the business has a
formal business agreement
Dials the supplier's computer and places the
order
The exchange is completely automated.
No human intervention or management
REENGINEERING USING THE INTERNET

-Typically, no formal business agreements exist as

they doing EDI.
-Most orders are made with credit cards.
-Mainly done with e-mail systems, and thus a
turnaround time is necessary
Intelligent agents are needed to eliminate this
time lag.
-Security and control over data is a concern with
internet transactions
 CONTROL CONSIDERATIONS FOR
CUSTOMER-BASED SYSTEMS

Authorization- in real-time systems, authorizations

are automated
Programmed decision rules must be closely
monitored.
Segregation of Duties- consolidation of tasks by the
computer is common
Protect the computer programs
Coding, processing, and maintenance should be
separated.
Supervision- in POS systems, the cash register's
 CONTROL CONSIDERATIONS FOR
CUSTOMER-BASED SYSTEMS

Access Control- magnetic records are vulnerable to both

authorized and unauthorized exposure and should be
protected
Must have limited file accessibility
Must safeguard and monitor computer programs
Accounting Records- rests on reliability and security of
stored digitalized data.
Digital Journal and Ledgers. Digital journal and master
files are the basis for financial reporting and many internal
decisions. Accountants should be skeptical about the
accuracy of hard-copy printouts.
 CONTROL CONSIDERATIONS FOR
CUSTOMER-BASED SYSTEMS

Independents Verification- consolidating accounting tasks

under one computer program can remove traditional
independent verification controls. To counter this problem:
Perform batch control balancing after each run
Produce management reports and summaries for end users
to review
 PC-BASED ACCOUNTING SYSTEMS

●Used by small firms and some large decentralized firms

●Allow one or few individuals to perform entire accounting
function
●Most systems are divided into modules controlled by a
menu-driven program: -General ledger
-Inventory Control
-Payroll
-Cash disbursements
-Purchases and accounts payable
-Cash receipts
-Sales order
 PC CONTROL ISSUES

Segregation of Duties- tend to be inadequate and should be

compensated for with increased supervision, detailed
management reports, and frequent independent verification
Access Control- access controls to the data stored on the
computer tends to be weak; methods such as encryption and
disk locking devices should be used
Accounting Records- computer disk failures cause data
losses; external backup methods need to be implemented to
allow data recovery
THANK YOU!