CHAPTER: 5: Transaction
cycles
The Revenue Cycle: Sales and Cash
Collections
Introduction
The revenue cycle is a recurring set of
business activities and related information
processing operations associated with
providing goods and services to customers and
collecting cash in payment for those sales.
The primary external exchange of information
is with customers.
Information about revenue cycle activities
flows to other accounting cycles, e.g.:
◦ The expenditure and production cycles
◦ Receive information about sales transactions
so they’ll know when to initiate the purchase or
production of more inventory.
◦ The human resources/payroll cycle
◦ Uses information about sales to
calculate commissions and bonuses.
The general ledger and reporting
function
◦ Uses information produced by the
revenue cycle in preparing financial
statements and performance reports.
The primary objective of the revenue
cycle:
◦ Provide the right product in the right
place at the right time for the right price.
Revenue Cycle Business Activities
Four basic business activities are performed
in the revenue cycle:
◦ Sales order entry
◦ Shipping
◦ Billing
◦ Cash collection
1. Sales order entry
Sales order entry is performed by the sales
order department.
Steps in the sales order entry process include:
Take the customer’s order
Check the customer’s credit
Check inventory availability
Respond to customer inquiries
Take customer orders
◦ Order data are received on a sales order
document which may be completed and
received:
In the store, By mail, By phone, On a
website, By a salesperson in the field
The sales order (paper or electronic) indicates:
◦ Item numbers ordered, Quantities,
Prices, Salesperson
◦ Electronic data interchange (EDI) can
be used to link a company directly
with its customers to receive orders
or even manage the customer’s
inventory.
◦ Email and instant messaging are
used to notify sales staff of price
changes and promotions.
Check the customer’s credit
Credit sales should be approved before
the order is processed any further.
SALES ORDER ENTRY
There are two types of credit authorization:
◦ General authorization
• For existing customers below their credit
limit who don’t have past-due balances.
• Credit limits vary by customer based on
past history and ability to pay.
• General authorization involves checking
the customer master file to verify the
account and status.
• Credit sales should be approved before the
order is processed any further.
◦ Specific authorization
• For customers who are:
– New
– Have past-due balances
– Are placing orders that would
exceed their credit limit
• Specific authorization is done by the
credit manager, who reports to the
treasurer.
Check inventory availability
When the order has been received and
the customer’s credit approved, the next
step is to ensure there is sufficient
inventory to fill the order and advise the
customer of the delivery date.
The sales order clerk can usually
reference a screen displaying:
◦ Quantity on hand
◦ Quantity already committed to others
◦ Quantity on order
If there are enough units to fill the order:
◦ Complete the sales order
◦ Update the quantity available field in
the inventory file
◦ Notify the following departments of the
sale:
Shipping
Inventory
Billing
◦ Send an acknowledgment to the
customer
If there’s not enough to fill the order,
initiate a back order.
◦ For manufacturing companies, notify
the production department that more
should be manufactured.
◦ For retail companies, notify purchasing
that more should be purchased.
Respond to customer inquiries (may be
done by customer service or sales order
entry)
Another step in the sales order entry process
is responding to customer inquiries:
◦ May occur before or after the order is placed
◦ The quality of this customer service can be
critical to company success
Many companies use Customer
Relationship Management (CRM) systems
to support this process:
◦ Organizes customer data to facilitate
efficient and personalized service
◦ Provides data about customer needs and
business practices so they can be contacted
proactively about the need to reorder
SALES ORDER ENTRY
The goal of CRM is to retain
customers:
◦ Rule of thumb: It takes 5 times as
much effort to attract a new customer as
it does to retain an existing one.
Generally, Sales order entry
involved the steps of:
◦ Taking the customer’s order
◦ Checking the customer’s credit
◦ Checking inventory availability
◦ Responding to customer inquiries
We have now completed sales
order entry and are ready to move
to the next step.
2. Shipping
The second basic activity in the revenue
cycle is filling customer orders and
shipping the desired merchandise.
The process consists of two steps
◦ Picking and packing the order
◦ Shipping the order
The warehouse department typically
picks the order
The shipping departments packs and
ships the order
A picking ticket is printed by sales order
entry and triggers (activate) the pick-
and-pack process
The picking ticket identifies:
◦ Which products to pick
◦ What quantity
Warehouse workers record the
quantities picked on the picking ticket,
which may be a paper or electronic
document.
The picked inventory is then transferred
to the shipping department.
The clerk then records online:
◦ The sales order number
◦ The item numbers ordered
◦ The quantities shipped
This process:
◦ Updates the quantity-on-hand field in
the inventory master file
3. Billing
The third revenue cycle activity is
billing customers.
This activity involves two tasks:
◦ Invoicing
◦ Updating accounts receivable
Accurate and timely billing is crucial.
Billing is an information processing
activity that repackages and
summarizes information from the sales
order entry and shipping activities
Requires information from:
◦ Shipping Department on items and
quantities shipped
◦ Sales on prices and other sales
terms
The basic document created is the
sales invoice. The invoice notifies the
customer of:
◦ The amount to be paid
◦ Where to send payment
Invoices may be sent/received:
◦ In paper form
◦ By EDI
Common for larger companies
When buyer and seller have accurate
online systems:
◦ Invoicing process may be skipped
Seller sends an email when goods
are shipped
Buyer sends acknowledgment when
goods are received
Buyer automatically remits
payments within a specified number
of days after receiving the goods
◦ Can produce substantial cost savings
4. Cash Collections
The final activity in the revenue cycle is
collecting cash from customers
The cashier, who reports to the treasurer,
handles customer remittances and
deposits them in the bank.
Possible approaches to collecting
cash:
◦ Turnaround documents
forwarded to accounts
receivable
• The mailroom opens customer
envelopes and forwards to accounts
receivable either:
– Remittance advices
– Photocopies of remittance advices
– A remittance list prepared in the
mailroom
◦ Lockbox arrangements
• Customers remit payments to a bank P.O.
box
• The bank sends the company:
– Remittance advices
– An electronic list of the remittances
– Copies of the checks
• Advantages:
– Prevents theft by company employees
– Improves cash flow management
• Lockboxes may be regional, which
reduces time in the mail
• Checks are deposited immediately
◦ Electronic lockboxes
• Upon receiving and scanning the checks,
the bank immediately sends electronic
notification to the company, including:
– Customer account number
– Amount remitted
Electronic funds transfer
• Customers remit payment electronically to the
company’s bank
• Eliminates mailing delays
• Typically done through banking system’s
Automated Clearing House (ACH) network
◦ Financial electronic data interchange
(FEDI)
• Integrates EFT with EDI
• Remittance data and funds transfer
instructions are sent simultaneously by
the customer
• Requires that both buyer and seller use
EDI-capable banks
Review Of Revenue Cycle Activities
let’sdo a brief review of the
organization chart, including:
◦ Who does what in the revenue cycle
◦ To whom they typically report
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
• Takes customer orders Billing Accounts Credit Cashier
• Authorizes credit for
existing customers in good
Dept. Receivable Manager
standing
• Checks inventory
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
• Responds to Billing Accounts Credit Cashier
customer inquiries
Dept. Receivable Manager
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
• Picks the Billing Accounts Credit Cashier
order
Dept. Receivable Manager
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
• Packs the Billing Accounts Credit Cashier
order
• Ships the
Dept. Receivable Manager
order
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
Billing Accounts Credit Cashier
• Invoices the Dept. Receivable Manager
customer
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
• Maintains the customer’s
account:
– Increases customer
Billing Accounts Credit Cashier
account when sales are Dept. Receivable Manager
made
– Decreases account
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
• Approves credit for new
customers or existing
customers with issues Billing Accounts Credit Cashier
• Authorizes credits to customer Dept. Receivable Manager
accounts for returns,
allowances, and write-offs
PARTIAL ORGANIZATION CHART FOR
UNITS INVOLVED IN REVENUE CYCLE
CEO
VP of Marketing VP of Manufacturing CFO
Sales Customer Warehouse Shipping Controller Treasurer
Order Service
Billing Accounts Credit Cashier
• Deposits cash Dept. Receivable Manager
received from
customers
In the revenue cycle (or any cycle), a well-
designed AIS should provide adequate controls to
ensure that the following objectives are met:
◦ All transactions are properly authorized
• A related threat would be that a transaction
would go through without proper authorization.
• Such a transaction might result from either a
mistake or a fraud.
All recorded transactions are valid
• The related threat is that a transaction would be
recorded that isn’t valid, i.e., it didn’t actually
occur.
• EXAMPLE 1: An employee records a return of
merchandise on his own account when the goods
were never really returned.
All valid and authorized transactions are
recorded
• The related threat would be that a transaction
that actually did occur didn’t get recorded.
• EXAMPLE: An employee fails to record a sale
that the company made to him so he won’t
have to pay the receivable.
• All transactions are recorded accurately
• The threat would be that a transaction is recorded
inaccurately. Inaccurate recording typically
means that a transaction is recorded either:
– In the wrong amount
– In the wrong account
– In the wrong time period
• EXAMPLES: A fraud might involve a
company:
– Over-recording the amount of a sale
(wrong amount)
– Recording an unearned revenue as an
earned revenue (wrong account)
– Recording a sale earlier than it occurs
(wrong time period)
Assets are safeguarded from loss or
theft
Threats in this area usually involve theft,
destruction, or misuse of assets, including
data.
◦ Business activities are performed
efficiently and effectively
◦ The threat is that the activities would be
performed inefficiently or ineffectively
◦ The company is in compliance with all
applicable laws and regulations
• The obvious threat is non-compliance with
laws and regulations.
• An example in the revenue cycle could be a
car dealer who:
– Sells a vehicle to which he doesn’t have
clear title;
◦ All disclosures are full and fair
◦ The threat is incomplete and/or misleading
disclosures.
◦ one threat in the revenue cycle could be
misleading disclosures about customers’
Control: Objectives, Threats
&Procedures
In the following sections, we’ll discuss
the threats that may arise in the four
major steps of the revenue cycle, as
well as the controls that can prevent
those threats.
Threats In Sales Order Entry
◦ Threats in the sales order entry process include:
◦ 1) Incomplete Or Inaccurate Customer Order
Causes customer dissatisfaction and may impact
future sales.
◦ Controls
Data entry controls, such as completeness checks
Automatic lookup of reference data like customer
address
Reasonableness tests comparing quantity ordered
to past history
2) sales To Customers With Poor Credit
- Sales may be uncollectible, resulting in lost assets
or revenues.
◦ Controls
Credit approval by credit manager, not by sales function.
Threats In Shipping
The primary objectives of the shipping process are:
◦ Fill customer orders efficiently and accurately
◦ Safeguard inventory
Threats in the shipping process include:
1) Shipping Errors
Customer dissatisfaction and lost sales may
occur if customers are shipped the wrong items
or there are delays because of a wrong
address.
Shipping to the wrong address may also result
in loss of the assets.
◦ Controls:
Using Online shipping systems can require
shipping clerks to enter the quantities being
shipped before the goods are actually shipped.
Errors can thus be detected and corrected
before shipment.
Threats In Billing
The primary objectives of the billing process
are to ensure:
◦ Customers are billed for all sales
◦ Invoices are accurate
◦ Customer accounts are accurately
maintained
Threats that relate to this process are:
1) Failure to Bill Customers
Loss of assets and revenues
Inaccurate data on sales, inventory, and
accounts receivable
◦ Controls
Segregate shipping and billing functions. (An
employee who does both could ship
merchandise to friends without billing them.)
Threats In Cash Collection
The primary objective of the cash collection
process:
◦ Safeguard customer remittances
The major threat to this process:
Theft of cash
Loss of cash
◦ Controls:
Segregation of duties between:
Handling cash and posting to customer
accounts. (A person who can do both can lap
accounts.)
Handling cash and authorizing credit memos.
(A person who does both could steal a
customer remittance and authorize a credit to
the customer’s account, so the customer won’t
be notified he’s past due.)
Revenue Cycle Information
Needs
Information is needed for the
following operational tasks in the
revenue cycle:
◦ Responding to customer inquiries
◦ Deciding on extending credit to a
customer
◦ Determining inventory availability
◦ Selecting merchandise delivery
methods
Information
is needed for the following
strategic decisions:
◦ Setting prices for products/services
◦ Establishing policies on returns and
warranties
◦ Deciding on credit terms
◦ Determining short-term borrowing needs
◦ Planning new marketing campaigns
The AIS needs to provide information to
evaluate performance of the following:
◦ Response time to customer inquiries
◦ Time to fill and deliver orders
◦ Customer satisfaction rates and trends
◦ Analyses of market share and sales trends
◦ Profitability by product, customer, and
region
◦ Sales volume in dollars and market share
◦ Effectiveness of advertising and
promotions
◦ Sales staff performance
◦ Bad debt expense and credit policies
The Expenditure Cycle:
Purchasing and Cash Disbursements
Introduction
The primary external exchange of
information is with suppliers (vendors).
Information flows to the expenditure cycle
from other cycles, e.g.:
◦ The revenue cycle, production cycle, inventory
control, and various departments provide
information about the need to purchase goods
and materials.
Information
also flows from the
expenditure cycle:
◦ When the goods and materials arrive, the
expenditure cycle provides information about
their receipt to the parties that have requested
them.
The primary objective of the
expenditure cycle is to minimize the
total cost of acquiring and
maintaining inventory, supplies, and
services.
Expenditure Cycle Business
Activities
The three basic activities performed
in the expenditure cycle are:
◦ Ordering goods, supplies, and
services
◦ Receiving and storing these items
◦ Paying for these items
These activities mirror the activities
in the revenue cycle.
1. Ordering Goods, Supplies, And
Services
Key decisions in this process involve
identifying what, when, and how much
to purchase and from whom.
Weaknesses in inventory control can
create significant problems with this
process:
◦ Inaccurate records cause shortages.
One of the key factors affecting this
process is the inventory control method
to be used.
Alternate Inventory Control
Methods
◦ We will consider three alternate
approaches to inventory control:
Economic Order Quantity (EOQ)
Just in Time Inventory (JIT)
Materials Requirements Planning (MRP)
a)EOQ: is the traditional approach to
managing inventory.
◦ Goal: Maintain enough stock so that
production doesn’t get interrupted.
◦ Under this approach, an optimal order
size is calculated by minimizing the
sum of several costs:
Ordering costs
Carrying costs
Stock-out costs
◦ The EOQ formula is also used to
calculate reorder point, i.e., the
inventory level at which a new order
should be placed.
b) Materials Requirements Planning
(MRP):
seeks to reduce inventory levels by
improving the accuracy of forecasting
techniques and carefully scheduling
production and purchasing around that
forecast.
C) Just in Time Inventory (JIT): systems
attempt to minimize or eliminate inventory by
purchasing or producing only in response to actual
(as opposed to forecasted) sales.
These systems have frequent, small deliveries of
materials, parts, and supplies directly to the
location where production will occur.
A factory with a JIT system will have multiple
receiving docks for their various work centers.
Whatever the inventory control system,
the order processing typically begins
with a purchase request followed by the
generation of a purchase order.
Advanced inventory control systems
automatically initiate purchase requests
when quantity falls below the reorder
point.
The need to purchase goods typically
results in the creation of a purchase
requisition. The purchase requisition
is a paper document or electronic form that
identifies:
◦ Who is requesting the goods
◦ Where they should be delivered
◦ When they’re needed
◦ Item numbers, descriptions, quantities,
and prices
◦ Possibly a suggested supplier
◦ Department number and account number
to be charged
Most of the detail on the suppliers and the
items purchased can be pulled from the
supplier and inventory master files.
The purchase requisition is received by
a purchasing agent in the purchasing
department, who typically performs the
purchasing activity.
◦ In manufacturing companies, this
function usually reports to the VP of
Manufacturing.
A crucial decision is the selection of
supplier.
Key considerations are:
◦ Price
◦ Quality
◦ Dependability
Especially important in JIT systems because
late or defective deliveries can bring the
whole system to a halt.
A purchase order is a document or electronic
form that formally requests a supplier to sell
and deliver specified products at specified
prices.
The PO is both a contract and a promise to pay.
It includes:
◦ Names of supplier and purchasing agent
◦ Order and requested delivery dates
◦ Delivery location
◦ Shipping method
◦ Details of the items ordered
A blanket order is a commitment to buy specified
items at specified prices from a particular supplier
for a set time period.
◦ Reduces buyer’s uncertainty about reliable material
sources
◦ Helps supplier plan capacity and operations
IT can help improve efficiency
and effectiveness of purchasing
function.
◦ The major cost driver is the number
of purchase orders processed. Time
and cost can be cut by:
Using EDI to transmit purchase
orders
Using vendor-managed inventory
systems
• In a vendor-managed inventory (VMI) program:
– Inventory control and purchasing are
outsourced to a supplier
– This approach:
Reverse auctions
• Suppliers compete with each other to
meet demand at the lowest price
• Best suited to commodities, rather than
critical components, where quality,
vendor reliability, and delivery
performance are not crucial
[Link] and Storing Goods
The receiving department accepts
deliveries from suppliers.
◦ Normally reports to warehouse manager,
who reports to VP of Manufacturing.
The receipt of goods must be
communicated to the inventory control
function to update inventory records.
The two major responsibilities of the receiving
department are:
◦ Deciding whether to accept delivery
◦ Verifying the quantity and quality of delivered goods
Verifying the quantity of delivered goods is important
so:
◦ The company only pays for goods received
◦ Inventory records are updated accurately
The receiving report is the primary document used
in this process:
◦ It documents the date goods received, shipper,
supplier, and PO number
◦ Shows item number, description, unit of measure,
and quantity for each item
◦ Provides space for signature and comments by the
person who received and inspected
When goods arrive, a receiving clerk
compares the PO number on the packing
slip with the open PO file to verify the goods
were ordered.
◦ Then counts the goods
◦ Examines for damage before routing to warehouse
or factory
Three possible exceptions in this process:
◦ The quantity of goods is different from the amount
ordered
◦ The goods are damaged
◦ The goods are of inferior quality
Paying For Goods And Services
There are two basic sub-processes
involved in the payment process:
◦ Approval of vendor invoices
◦ Actual payment of the invoices
a. Approval of vendor invoices
Approval of vendor invoices is done by
the accounts payable department, which
reports to the controller.
The legal obligation to pay arises when
goods are received.
◦ But most companies pay only after
receiving and approving the invoice.
◦ This timing difference may necessitate
adjusting entries at the end of a fiscal
period.
b. Actual payment of the invoices
Payment of the invoices is done by
the cashier, who reports to the
treasurer.
The cashier receives a voucher
package, which consists of the vendor
invoice and supporting
documentation, such as purchase
order and receiving report.
Review Of Expenditure Cycle
Activities
Before we move on to discuss
internal controls in the
expenditure cycle, let’s do a brief
review of the organization chart,
including:
◦Who does what in the expenditure
cycle
◦To whom they typically report
PARTIAL ORGANIZATION CHART FOR UNITS
INVOLVED IN EXPENDITURE CYCLE
CEO
VP of M anufacturing CFO
Purchasing Receiving Inventory Controller Treasurer
Stores
• Selects suitable suppliers Accounts Cashier
• Issues purchase orders
Payable
PARTIAL ORGANIZATION CHART FOR UNITS
INVOLVED IN EXPENDITURE CYCLE
CEO
VP of M anufacturing CFO
Purchasing Receiving Inventory Controller Treasurer
Stores
• Decides whether to accept Accounts Cashier
deliveries
• Counts and inspects
Payable
deliveries
PARTIAL ORGANIZATION CHART FOR UNITS
INVOLVED IN EXPENDITURE CYCLE
CEO
VP of M anufacturing CFO
Purchasing Receiving Inventory Controller Treasurer
Stores
• Stores goods that Accounts Cashier
have been
delivered and Payable
accepted
PARTIAL ORGANIZATION CHART FOR UNITS
INVOLVED IN EXPENDITURE CYCLE
CEO
VP of M anufacturing CFO
Purchasing Receiving Inventory Controller Treasurer
Stores
• Approves invoices Accounts Cashier
for payment
Payable
PARTIAL ORGANIZATION CHART FOR UNITS
INVOLVED IN EXPENDITURE CYCLE
CEO
VP of M anufacturing CFO
Purchasing Receiving Inventory Controller Treasurer
Stores
Accounts Cashier
Payable
• Issues payment to
vendors
Threats In Ordering Goods
Threats in the process of ordering
goods include:
◦ THREAT 1: Stockouts
and/or Excess Inventory
◦ THREAT 2: Ordering Unnecessary Items
◦ THREAT 3: Purchasing Goods at Inflated
Prices
◦ THREAT 4: Purchasing Goods of Inferior
Quality
◦ THREAT 5: Purchasing from Unauthorize
d Suppliers
Threats In Receiving And Storing
Goods
The primary objectives of this process
are to:
◦ Verify the receipt of ordered inventory
◦ Safeguard the inventory against loss or theft
Threats in the process of receiving and
storing goods include:
◦ THREAT 1: Receiving unordered goods
◦ THREAT 2: Errors in counting received
goods
◦ THREAT 3: Theft of inventory
Threats In Approving And
Paying Vendor Invoices
The primary objectives of this process are to:
◦ Pay only for goods and services that were ordered and
received
◦ Safeguard cash
Threats in the process of approving and paying
vendor invoices include:
◦ THREAT 1: Failing to catch errors in vendor invoices
◦ THREAT 2: Paying for goods not received
◦ THREAT 3
: Failing to take available purchase discounts
◦ THREAT 4: Paying the same invoice twice
◦ THREAT 5
: Recording and posting errors to accounts payable
◦ THREAT 6: Misappropriating cash, checks
Expenditure Cycle Information
Needs
Information is needed for the following
operational tasks in the expenditure
cycle, including:
◦ Deciding when and how much inventory to
order
◦ Deciding on appropriate suppliers
◦ Determining if vendor invoices are accurate
◦ Deciding whether to take purchase discounts
◦ Determining whether adequate cash is
available to meet current obligations
Information is also needed for the
following strategic decisions:
◦ Setting prices for products/services
◦ Establishing policies on returns and
warranties
◦ Deciding on credit terms
◦ Determining short-term borrowing needs
◦ Planning new marketing campaigns
The AIS needs to provide information to
evaluate the following:
◦ Purchasing efficiency and effectiveness
◦ Supplier performance
◦ Time taken to move goods from receiving to
production
Both financial and operating information
are needed to manage and evaluate these
activities
Both external and internal information are
needed
When the AIS integrates information
from the various cycles, sources, and
types, the reports that can be
generated are unlimited. They include
reports on:
◦ Supplier performance
◦ Outstanding invoices
◦ Performance of expenditure cycle
employees
◦ Number of POs processed by purchasing
agent
◦ Number of invoices processed by A/P clerk
◦ Number of deliveries handled by receiving
clerk
THANK YOU FOR YOUR
ATTENTION!