AC330 Instructor Outline CHAPTER 10 THE REVENUE CYCLES: SALES TO CASH COLLECTIONS As a result of your study of this chapter,

you should be able to:

1. 2. 3. 4.

Describe the basic business activities and related information processing operations performed in the revenue cycle. Discuss the key decisions that need to be made in the revenue cycle, and identify the information needed to make those decisions. Document your understanding of the revenue cycle. Identify major threats in the revenue cycle, and evaluate the adequacy of various control procedures for dealing with those threats.

Revenue Cycle 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. Refer to Figure 10-2 on Page 371 for the context diagram of the revenue cycle The revenue cycles primary objective is to provide the right product in the right place at the right time for the right price. To accomplish that objective, management must make the following key decisions: To what extent can and should products be customized to individual customers needs and desires? How much inventory should be carried, and where should that inventory be located? How should merchandise be delivered to customers? Should the company perform the shipping function itself or outsource it to a third party that specializes in logistics? What are the optimal prices for each product or service? Should credit be extended to customers? How much credit should be given to individual customers? What credit terms should be offered? How can customer payments be processed to maximize
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cash flow? Revenue Cycle Business Activities Figure 10-3 on page 372 shows the four basic business activities performed in the revenue cycle. 1. 2. 3. 4. Sales Order Entry The revenue cycle begins with the receipt of orders from customers. Figure 10-4 on Page 373 shows that the sales order entry process entails three steps: 1) taking the customers order, 2) checking and approving customer credit, and 3) checking inventory availability Taking Customer Orders Sales orders are recorded on a sales order document as shown in Figure 10-5 on Page 374. Normally, this order document is electronically displayed on a computer monitor screen. Orders can be received in the store, by mail, by phone, over a Web site, or by a salesperson in the field. Web sites provide another way to automate sales order entry. Online order information can be automatically routed to the warehouse to generate picking and shipping instructions. Of course, once you order from a company over the Internet, you will most likely start receiving subsequent commercials via email. If you have ever ordered from Amazon.com; when you bring up their Web site, it should have your personal page that shows what you have previously ordered and new related items, such as new movies. Another technique involves the use of interactive sales order entry systems, called choiceboards, to allow customers to customize products to meet their exact needs.
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Sales order entry Shipping Billing Cash collections

Yet another way to improve the sales order entry process involves using Electronic Data Interchange (EDI) to link directly with customers. Some manufacturers and distributors even use EDI to assume responsibility for managing a retail customers inventory, referred to as vendor-managed inventory (VMI). With VMI, the customer provides the supplier with access to data from the customers point-of-sale (POS) system. The POS system tracks what inventory is sold. The supplier uses that data to monitor inventory levels and automatically initiates replenishment when inventory falls to specified levels. Focus 10-1 on Page 375 describes how sophisticated software can be used to optimize selling prices. Price optimization software uses detailed sales data (e.g., sales volume by customer, by region, competitor prices, etc.) and sophisticated marketing models to identify fast moving products for which customers might be willing to pay more. The software also identifies which sets of optional features appeal to specific subsets of customers. Figure 10-6 on Page 376 provides a typical sales order entry screen Credit Approval Most business-to-business sales are made on credit. Credit sales should be approved before they are processed. Each customer will have a credit limit. Credit limit is the maximum allowable account balance for each customer based on the customers past credit history and ability to pay. Figure 10-7 on Page 376 shows the information typically available for this purpose: the customers credit limit, current balance and age of any outstanding unpaid invoices. Checking Inventory Availability The next step is to determine if there is sufficient inventory available to fill the order. The accuracy of inventory records is important because customer may become justifiably upset when unexpected delays occur in filling their orders. Figure 10-8 on Page 377 shows an example of the information that is usually available to the sales order entry clerk. When there are not sufficient items on hand to fill the customers order, a back order is created.
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Once the item(s) become available, a picking ticket is created. The picking ticket authorizes the inventory control function to release merchandise to the shipping department. Responding To Customer Inquiries Step 1.4 in Figure 10-4 back on Page 373 shows that the sales order entry process includes responding to customer inquiries. Customer services is so important that many companies use special software packages, called Customer Relationship Management (CRM) systems, to support this vital process. The goal of customer relationship management is to retain customers. This is important because a general marketing rule of thumb is that it costs at least five times as much to attract and make a sale to a new customer as it does to make a repeat sale to an existing customer. Transaction processing technology can also be used to improve customer relationships. For example, many commercial POS systems can link not only with the inventory file but also with the customer master file. This not only automatically updates accounts receivable balances but provides an opportunity to print customized coupons and personal messages on each sales receipt, such as Thank you. Information technology can be used to automate responses to many customer routine inquiries. Web sites provide a cost-effective alternative to traditional toll-free telephone customer support, automating that process with a list of frequently asked questions (FAQs). Discussion boards can also be provided so that customers can share information and useful tips with one another. Web sites also enable customers to use personal identification numbers (PINs) to directly access their account information and to check on the status of orders.

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Shipping The second basic activity in the revenue cycle is filling customer orders and shipping the desired merchandise. Refer to circle 2 in Figure 10-3 back on Page 372 and Figure 10-9 on Page 379 provides a data flow diagram for shipping. Shipping consists of the following two steps: (1) picking and packing the order and (2) shipping the order Pick and Pack the Order The picking ticket printed by sales order entry triggers the pick and pack process. Some of the investments companies have in automated warehouse systems include, computers, bar-code scanners, conveyer belts and communications technology. J.C. Penney equips its forklift with Radio-Frequency Data Communication (RFDC) terminals to provide drivers with information about which items to pick next and where they are located. At Corporate Express, warehouse workers wear headsets and listen to computer-synthesized voice instructions. Radio-Frequency Identification (RFID) replaces the bar codes. The RFID tag eliminates the need to align items with scanners; instead, the tags can be read as the inventory moves throughout the warehouse. Focus 10-2 on Page 365 discusses how RFID can help companies improve revenues. Ship The Order The shipping department compares the physical count of inventory with the quantities indicated on the picking ticket and with the quantities indicated on the copy of the sales order that was sent directly to shipping from sales order entry. The packing slip lists the quantity and description of each item included in the shipment. The bill of lading is a legal contract that defines responsibility for the goods in transit. Figure 10-10 on Page 381 provides a sample of a bill of lading.

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If the customer is to pay the shipping charges, the copy of the bill of lading may serve as a freight bill, to indicate the amount the customer should pay to the carrier. One major decision that needs to be made when filling and shipping customer orders concerns the choice of delivery method. Another important decision concerns the location of distribution centers. RFID systems can provide real-time information on shipping status and thus provide additional value to customers. Billing The third basic activity in the revenue cycle, shown in circle 3.0 in Figure 10-3 on page 372, involves billing customers and Figure 10-11 on Page 382 provides a data flow diagram of invoicing and accounts receivable. Invoicing The document created in the billing process is the sales invoice, which notifies customers of the amount to be paid and where to send payment. Figure 10-12 on Page 383 provides an example of an invoice. The Grocery Manufacturers of America and the National Association of Convenience Stores found that switching from paper to electronic invoices cut the time it took a convenience store manager to process each invoice from 5 minutes to 30 seconds. Over the course of a year, this could save over $100,000 in labor costs. Maintain Accounts Receivable The accounts receivable function uses the information on the invoice to debit the customers accounts for credit purchases and credit the customers accounts when payment is received. Under the open-invoice method, customers normally pay according to each invoice. The customer is asked to return a

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copy of the invoice when mailing in their payment. This return copy is referred to as the remittance advice. Under the balance-forward method, customers typically pay according to the amount shown on a monthly statement. A monthly statement lists all transactions, including both sales and payments. Figure 10-13 on Page 385 provides an example of a monthly statement. One advantage of the open-invoice method is that it is conducive to offering discounts for prompt payment, as invoices are individually tracked and aged. A disadvantage of the open-invoice method is the added complexity required to maintain information about the status of each individual invoice for each customers. Under cycle billing, monthly statements are prepared for subsets of customers at different times. For example, the customer master file might be divided into four parts, and each week monthly statements would be prepared for one-fourth of the customers. Exceptions: Account Adjustments and Write-offs This involves either the return of merchandise by customers for credit or the write of customers who do not pay their bill. Figure 10-14 on Page 386 provides an example of a credit memo. After repeated attempts (at least three attempts in a three month period) to collect payment have failed, it may be necessary to write off a customers account. In such cases, the credit manager issues a credit memo to authorize the write-off. Cash Collections The final step in the revenue cycle is cash collections. Refer to circle 4.0 in Figure 10-3 back on Page 372. The cashier handles customer remittances and deposits them in the bank. Notice that the cashier reports to the treasurer in the Figure 101 organization chart on Page 370.

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A remittance list provides the names and amounts of all customer remittances, and sends it to accounts receivable. Focus 10-3 on page 387 describes how imaging technology can be used to improve the efficiency of processing customer payments. A lockbox is a postal address to which customers send their remittances. The participating bank picks up the checks from the post office box and deposits them to the companys account. Under an electronic lockbox arrangement, the bank electronically sends the company information about the customer account number and the amount remitted as soon as it receives and scans those checks. With electronic funds transfer (EFT), customers send their remittances electronically to the companys bank and thus eliminate the delay associated with the time the remittance is in the mail system. EFT is usually accomplished through the banking systems Automated Clearing House (ACH) network. EFT only involves the transfer of funds. Although every bank can do EFT through the ACH system, not every bank possesses the EDI capabilities necessary to process the related remittance data. As shown in the top panel of Figure 10-15 on page 388, many companies have to separate the EFT and EDI components of processing customer payments. Electronic date interchange (EDI) is the use of computerized communication to exchange business data electronically in order to process transactions. Financial electronic data interchange (FEDI) integrated the exchange of electronic funds transfer (EFT) with the exchange of the remittance data, electronic data interchange (EDI). Figure 10-15 on Page 388 provides a picture of the difference between EDI and EFT and FEDI. When dealing with customers who are not FEDI capable, or with individual consumers, companies can also speed the

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collection process by accepting credit cards or procurement cards (a special type of credit card discussed in chapter eleven). Information Processing Procedures In response to the Y2K crisis, many organizations replaced their accounting information systems with an integrated Enterprise Resource Planning (ERP) system. Figure 10-16(a & b) on Pages 389 & 390 depicts the portion of AOE's new ERP system that supports its revenue cycle activities. Key improvements are as follows:
1. Real-time order entry detects errors, such as missing data, as

2.

3.

4. 5.

6. 7.

the order is being entered, and when it is easiest to correct those errors. Credit approval decisions can be made at the time the customer places the order. If special approval is required, the credit manager is notified by e-mail or IM and can immediately make that decision. Inventory records are more accurate and timely, enabling sales order entry staff to provide customers accurate information about expected delivery dates The warehouse and shipping departments can better plan activities to minimize the time required to fill customer orders The system compares data that the shipping department entered with the sales order file, thereby detecting and facilitating correction of any errors prior to shipment Cash receipts are processed more quickly, improving cash flow Reports and performance measures are timelier, enhancing managements ability to monitor and improve efficiency and effectiveness.

Control Objectives, Threats and Procedures In the revenue cycle, a well-designed accounting information system should provide adequate controls to ensure that the following objectives are met: 1. All transaction are properly authorized
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2. 3. 4. 5.

All recorded transactions are valid (actually occurred) All valid, authorized transactions are recorded All transactions are recorded accurately Assets, (cash, inventory and data) are safeguarded from loss or theft. 6. Business activities are performed efficiently and effectively. Table 10-1 on Page 392 lists the major threats in the revenue cycle and the appropriate control procedures that should be in place to mitigate them. Sales Order Entry The primary objectives of the sales order entry process are to accurately and efficiently process customer orders, ensure that the company gets paid for all credit sales and that all sales are legitimate, and to minimize the loss of revenue arising from poor inventory management. The following are Threats 1 through 4 listed for sales order entry in Table 10-1. Threat 1: Incomplete or Inaccurate customers Orders Incomplete or inaccurate information about the customer and his/her order could prove embarrassing because most likely you will need to call that customer to get the correct information. Threat 2: Credit Sales to Customers with Poor Credit A second threat in sales order entry is the possibility of making sales that later turn out to be uncollectible. Requiring proper authorization for each credit sale diminishes this threat. Segregation of duties: Credit manager sets credit policies and approves extension of credit to new customers and increases the credit limit for existing customers. Sales staff can have general authorization to approve additional credit sales to existing customers as long as it doesnt exceed the customers approved credit limit. Sales order entry checks should be granted read-only access to information about customer credit

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limits. Customer credit approval must occur before releasing the goods from the inventory. Threat 3: Legitimacy of Orders Purchase orders signed by the customer, digital signatures, and digital certificates provide establishment of the legitimacy of orders. Threat 4: Stockouts, Carrying Costs and Markdowns Sales could be lost due to stock outs. Excess inventory means additional carrying costs and potential markdowns. Companies need accurate inventory control and sales forecasting systems. Shipping The primary objective of the shipping function is to fill customer orders efficiently and accurately, and to safeguard inventory. Threat 5: Shipping Errors Shipping the wrong items or quantities of merchandise and shipping to the wrong locations are serious errors because they can significantly reduce customer satisfaction and thus future sales. Online systems can reduce the risk of shipping errors if shipping personnel are required to enter the quantities of items being sent before the goods are shipped. A comparison of the shipping data to the sales order can reduce this risk. Threat 6: Theft of Inventory This is the threat that an employee or customer could steal the merchandise. Also, inventory can be stolen in transit. Several control procedures can reduce the risk of inventory theft:
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 Inventory should be kept in a secure location and access should be limited to responsible personnel only. All inventory transfers should be documented Inventory should be released to shipping employees based on approved sales orders Both warehouse and shipping employees should sign the transfer document when goods are transferred from the warehouse to shipping Billing and Accounts Receivable The primary objectives of the billing and accounts receivable functions are to ensure that customers are billed for all sales that invoices are accurate and that customer accounts are accurately maintained. Threat 7: Failure to Bill Customers Failure to bill customers for items shipped results in the loss of assets and erroneous data about sales, inventory and accounts receivable. Segregating the shipping and billing functions can reduce this threat. Threat 8: Billing Errors Billing errors, such as pricing mistakes and billing customers for items not shipped or on back order, represent another potential threat. Pricing mistakes can be avoided by retrieving the data from the master file. Shipping the wrong quantities can be avoided by reconciling the quantities listed ion the packing slips to that on the sales order.

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Threat 9: Error in Maintaining Customer Accounts The following edit checks should be used to ensure accuracy in updating customer accounts:
1. Validity checks on the customer and invoice numbers, 2. Closed-loop verification to ensure that the proper

account is being credited, and 3. A field check to ensure that only numeric values are entered for payment amounts Cash Collections The primary objective of the cash collections function is to safeguard customer remittances. Threat 10: Theft of Cash The following segregation of duties should be used to reduce this risk:
1. Handling cash or checks and posting remittances to

customer accounts 2. Handling cash or checks and authorizing credit memos 3. Issuing credit memos and maintaining customer accounts In general, the handling of money and checks within the organization should be minimized. The optimal methods are a bank lockbox arrangement or the use of EFT or FEDI for customer payments. One main purpose of segregation is to ensure that the individual that handle the cash does not record its collection (remittance). Also, dont let the cash or checks lay around the organization too long. Get it to the bank as soon as possible.

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Segregating the recording and custody functions as follows provides additional control: Only the remittance data should be sent to the accounts receivable department, with customer payments being sent to the cashier. Retail stores and organizations that receive cash directly from customers should use cash registers that automatically produce a written record of all cash received. Finally, the employee who reconciles the bank statement should be independent of all other activities involved in handling or recording the receipt of cash. General Control Issues Two general objectives pertaining to all revenue cycle activities are that accurate data be available when needed and that all activities be performed efficiently and effectively. Threat 11: Loss, Alteration or Unauthorized Disclosure of Data Loss of all accounts receivable data could threaten a companys continued existence. Unauthorized disclosure of confidential business data, such as marketing plans, can jeopardize the companys competitiveness. The master accounts receivable, sales and cash receipts files must be backed up regularly. Access controls are also important. Unauthorized access increases the risk of damage to important data files and of disclosure of sensitive information.

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Threat 12: Poor Performance In addition to ensuring accuracy and safeguarding assets, another objective of internal control is to encourage efficient and effective performance of duties. Revenue Cycle Information Needs Effective management of revenue cycle activities requires timely access to accurate information. Operational data are needed to monitor performance and to perform the following recurring tasks: Respond to customer inquiries about account balances and order status, Decide whether to extend credit to a particular customer, Determine inventory availability, Select methods for delivering merchandise In addition, current and historical information is needed to enable management to make the following strategic decisions: Setting prices for products and services, Establishing policies regarding sales returns and warranties, Deciding what types of credit terms to offer, Determining the need for short-term borrowing, Planning new marketing campaigns The accounting information system must also supply the information needed to evaluate performance of the following critical processes: Response time to customer inquiries; Time required to fill and deliver orders; Percentage of sales that required back orders; Customer satisfaction rates and trends; Analyses of market share and sales trends; Profitability analyses by product, customer, and sales
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region; Sales volume in both dollars and number of customers; Effectiveness of advertising and promotions; Sales staff performance; Bad-debt expenses and credit policies; Days receivables outstanding; Remittances processed daily

Figure 10-17 on Page 398 provides a sample of a sales analysis report. Figure 10-18 on Page 399 provides a sample of a profitability analysis by product. Figure 10-19 on Page 399 provides a sample of a cash budget. Figure 1020 on Page 400 provides a sample of an accounts receivable aging report. Also, Focus 10-4 on Page 400 discusses one example of a new type of metric designed specifically to provide a leading indicator of revenue cycle performance. Revenue Margin equals gross margin minus all selling costs: Payroll Commissions Salesforce travel expense reimbursements Customer service and support costs Warranty expenses Marketing and advertising expenses Distribution and delivery expenses

Net sales minus cost of goods sold = gross margin Support costs includes such departments/activities as accounting and human resources. The value of revenue margin as a metric/measurement is that it integrates the effects of changes in sales, pricing and the costs associated with generating sales on overall company operating profits. Growth in revenue margins indicates that customers are satisfied; productivity is increasing, or both. Back to Homepage
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