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4.0 Introduction
4.1. Objectives
4.2 Revenue-Cycle Applications
4.3. Transaction Flows in Account Receivable Systems
4.4 Summary
4.5 Answers to Check Your Progress


Most enterprises, both for profit and not for profit, general revenue through activities that
constitute their revenue cycle. The revenue cycle is the simplest form if the direct exchange of
finished goods or services is made on cash in a single transaction between a seller and a buyer
and is more complex when sales is processed on credit basis. Many days or weeks may pass
between sales processing and the subsequent receipt of cash. This time lag splits the revenue
transactions into two phases:
1. the physical phase, involving the transfer of assets or services from seller to the buyer
2. the financial phase, involving the receipt of cash by the seller in payment of the
account receivable
Hence, the revenue cycle actually consists of two major subsystems (assuming sales on credit
1. the sales order processing system and
2. the account receivable system


After careful reading of this unit the reader must be able to:
describe the major features and operations in a sale order application system.
describe the major features and operations in an accounts receivable application


4.2.0 Overview
An organizations revenue cycle includes the functions required to exchange its products or
services with customers. Common functions include credit granting, order taking and
processing, shipment of goods, billing, and accounts receivable. This section discusses two
revenue-cycle application systems: sale order processing and accounts receivable.
4.2.1 Objectives
After careful reading of this section, the reader must be able to:
describe the major features and operations in a sale order application system
draw a flow diagram (DFD) for sales order application system.

4.2.2 Sales order processing

A sales order application system comprises the procedures involved in accepting and shipping
customer orders and in preparing invoices that describe products services, and assessment.
The sales order is the interface between the various function necessary to process a customer
order. These functions are sales order, credit, finished goods, shipping, billing, accounts
receivable, and general Ledger. The Sales Department

The sales process begins in the sales department with the receipt of a customer order
indicating the type and quantity of merchandise being requested. At this point, the customer
order is not in a standard format and may not be a physical document. Orders may arrive by
mail, by telephone, or from a field representative who visited the customers place of
business. When the customer is also a business entity, the order is usually a copy of the
customers purchase order. If the customer order is not in the standard format needed by the
sellers order processing system, it must be transcribed into a formal sales order.

The principal source document in the sales order system is the sales order.
The sales order captures such vital information as the name and address of the customer
making the purchase; the customers account number; the name, number, and description of
the items sold; the quantities and unit prices of each item sold, and other financial information

such as taxes, discounts, and freight charges. Multiple copies of sales orders are produced to
serve different purposes.

The sales order copies distributed for credit authorizations, packing slips, stock release
documents, shipping notices, sales invoices, and ledger posting. In an actual system, the
various sales order copies would be numbered or color-coded to signify their purpose and
distribution. Copies that are used for more than one purpose, and that go to several locations,
sometime shave routing information printed on them.
After preparing the sales order, the sales clerk files one copy of it in the customer open order
file for future reference. Customers frequently contact their suppliers by telephone to check
the status of their orders. To facilitate customer inquiries, the open order file is often
organized alphabetically by customer name. Although customer name is not an efficient
primary key for accessing data, it is used as a secondary key to cross-reference customers
orders. Customers do not always know their account numbers and may not have a copy of
their invoice handy. In these situations, the customer file enables the clerk to find the sales
order and respond to the customers questions. Credit department

A customers credit standing should be verified prior to the shipment of goods. For regular
customers, the credit check involves determining that the total amount of credit granted does
not exceed managements general or specific authorization. For new customers, a credit check
is necessary to establish the terms of sale to the customer. The sales order function should be
subject to the control of an independent credit function to maintain the separation of duties.

Once credit has been approved, the sales order function distributes the sales order set. One
copy of each sales order is forwarded to billing. These are filed as open orders, allowing the
billing function to anticipate the receipt of matching shipping advices from the shipping
advices from the shipping function. One copy-usually called the packing slip copy-is
forwarded to shipping. This copy authorizes shipping to receive goods from finished goods
for shipping. Another copy-usually called the stock copy-is
copy-is forwarded to finished goods. This
copy authorizes finished goods to release goods from its custody for shipment to customers.

In some cases, a customers order may require that a production order be issued to produce
the goods, because the goods are not in stock. Such situations arise when the order is for a
special nonstick item. They also may arise as standard company practice due to either the
customized nature of the product or a short production cycle that alleviates the need for an
inventory of finished goods. Such situations also occur when items are out-of-stock and must
be back ordered. If the time between receiving an order an actual shipment of the order is
significant, an acknowledgment copy of the sales order may be sent to the customer to inform
the customer that the order has been received and is being processed. Finished Goods Department

The sales department sends the stock release (also called the picking ticket) copy of the sales
order to the warehouse. This document identifies which items of inventory must be located
and picked from the warehouse shelves. It also provides formal authorization for the
warehouse clerk to release custody of the specified assets. After picking the stock, the clerk
initials the stock release copy to indicate that the order is complete and accurate. Any out-of-
stock items are noted on the stock release copy. One copy of the stock release travels with the
goods to the shipping department, and the other is filed in the warehouse to provide a record
of the transaction. shipping should sign the stock copy to acknowledge receipt of the
quantities noted thereon from finished goods. The clerk then adjusts the stock records to
reflect the reduction in inventory. The stock records are not the formal accounting records for
these assets. Charging the warehouse clerk with responsibility for asset custody and record-
keeping would be a weakness in internal control. The inventory accounting records are kept in
the inventory control department. Shipping department

Before the arrival of the goods and the stock release copy, the shipping department receives
the packing slip and shipping notice copies from the sales department. The packing slip
travels with the goods to the customer to describe the contents of the order. Packing slips may
be placed either inside the shipping container or attached to the outside in a special plastic
pouch. The shipping notice informs the billing department that the customers order has been
filled and shipped. This document contains such pertinent facts as the date of shipment, items
and quantities shipped the carrier, and freight charges.

Upon receiving the goods from the warehouse, the shipping clerk reconciles the physical
items with the stock release documents, the packing slip, and the shipping notice to verify the
correctness of the order. This is an important step and the last opportunity to detect errors
before shipment. This shipping clerk packages the goods, attaches the packing slip to the
container, 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) that transports the
goods to the customer. This document establishes legal ownership and responsibility for assets
in transit.
The shipping clerk transfers custody of the goods, the packing slip, and two copies of the bill
of lading to the carrier, then performs the following tasks:
1. Records the shipment in the shipping log
2. Sends the stock release document and the shipping notice to the billing department as
proof of shipment.
3. Files one copy each of the bill of lading and the shipping document. Billing Department

Shipping forwards documentation of the shipment to the billing function. This documentation
is termed the shipping advice and is usually the stock copy of the sales order and a copy of the
bill of lading. Billing pulls the related open order documentation, verifies the order, then
prepares the invoice by extending the charges for actual quantities shipped, freight charges (if
any) , and taxes (if any). Invoices are mailed to customers. Invoices are recorded in the sales
journal and posting copies are sent to accounts receivable. Sends the shipping document to the
sales department to close the open customer file. Periodically, a journal voucher is prepared
and forwarded to the general ledger function for posting to the general ledger.

The sales journal is a special journal for recording sales transactions. Each sales invoice is
entered in the journal as a separate item. At the end of the period the clerk summarizes these
entries and prepares a journal voucher that is sent to the general ledger for posting.

Each journal voucher represents a general journal entry and identifies the general ledger
accounts affected. Current transactions, adjusting entries, and closing entries are all entered
into the general ledger.

157 Accounts Receivable department.
The accounts receivable department posts from the ledger copy of the sales order to the
customer accounts in the accounts receivable subsidiary ledger.
Each ledger copy of the sales order increases a customers account for the full amount of the
sale. After posting, the AR clerk files the ledger copy. Periodically, the clerk summarizes the
individual account balance into a single figure and sends this to the general ledger. General ledger department

By the close of the processing period, the general ledger has received journal vouchers from
the billing and an account summary from the accounts receivable department.
The account summary independently provided by the accounts receivable department is used
to verify the internal accuracy of the overall process. By reconciling journal vouchers and
account summaries received from operating departments, the general ledger can detect many
types of errors.

The above-discussed functions in an organization's sales order application are clearly shown
on the following flow diagram.

A data flow diagram for sales order application system.

Credit Finished 7 Shippin

Goods g

2 3 4 5
1 Sales
order 6

Billing 11 A/R

10 13 Details
12 Customer
Data flow key
1. Order
2. Sales order
3. Approved sales order
4. Shipping order
5. Packing slip
6. Billing memo
7. shipping advice
8. shipment
9. shipping advice
10. invoice
11. posting memo
12. journal voucher
13. Control total.

Learning activity 1
1. What is the difference between billing and accounts receivable function?


4.3.0 Overview
Accounts receivable represents that money owed by customers for merchandise sold or
services rendered. Because approximately 90% of U.S. business is done on credit, accounts
receivable often represents the majority of an organization's working capital. Accounts
receivable also maintains customer credit and payment history information, which is useful in
the overall administration of company credit policies.

4.3.1 Objectives
After careful reading of this section, the reader must be able to:
describe the transaction flows in account receivable application system.
draw a flow diagram for accounts receivable application system.

4.3.2. Cash receipts department

The mail room under cash receipt department receives customers check along with a source
document called the remittance advice. The remittance advice is a portion of the original
invoice used to bill the customer. When payment is made, the customer tears off the
remittance advice portion and return it to the seller with the cash payment. The importance of
this document is most apparent in firms that have a large number of customer accounts and
process large volume of cash receipts daily. Because of the possibility of the transcription
errors and omission, sellers are generally reluctant to ask customers to provide this
information directly on their checks. A more efficient method of dealing with this problem is
for the seller to provide remittance information to the buyer through the original billing
process. Later, when this documentation is returned with customers payment, the seller can
rely upon its accuracy.

The cashier verifies the accuracy and completeness of the checks against the remittance
advice. After reconciling, the cashier records the cash receipts in the cash receipts journal.
Next, the clerk progress a bank deposit slip in triplicate showing the total amount of the days
receipts and forwards the checks and two copies of the deposit slip to the bank. Upon the
deposit of the funds, the bank teller validates the deposit slip and returns a copy to the

Customer remittance sips are then forwarded to account receivable for posting from cash
receipts department. Accounts receivable does not have access to the cash or checks that
accompany customer remittance.

4.3.3. Billing
Invoices, credit memos, and other invoice adjustments are routed to accounts receivable for
posting to the customer accounts. This maintains a separation of functions. Billing does not
have direct access to the accounts receivable records.

4.3.4 Accounts Receivable

Accounts receivable is responsible for maintaining the subsidiary accounts receivable ledger.
A control account is maintained in the general ledger department. Debits and credits are
posted to the customer accounts from the posting media-remittance
media-remittance advices, invoices, and so
on-received from billing and cash receipts. This maintains separation of functions.
Periodically, customer statements are mailed directly to customers by the accounts receivable
department. Periodic processing also includes the preparation of an aged trial balance of the
accounts receivable subsidiary ledger for review by the credit department. Other types of
customer credit reports may be prepared based on the needs of the company. Such reports are
often prepared as a by-product of the processing required to send customers their statements.

4.3.5. Credit
Credit department functions in an accounts receivable application system include the approval
of sales returns and allowances and other adjustments to customer accounts, the review and
approval of the aged trial balance to ascertain customers creditworthiness, and the initiation
of write-off memos to charge accounts to bad-debt expense.

4.3.6 General ledger
General ledger maintains the accounts receivable control account. Debits and credits are
posted to the accounts receivable control account from the journal vouchers/control totals
received from billing and cash receipts. These amounts are reconciled to the control totals sent
to the general ledger directly from accounts receivable, this reconciliation is an important
control in the accounts receivable application system.

4.3.7. Sales Returns and Allowances

Sales returns and allowance typically require careful control. Allowances occur when, because
of damaged merchandise, shortages, clerical errors, or the like, the customer and the seller
agree to reduce the amount owed by the customer. Generally, the merchandise is retained or
destroyed by the customer. The amount of an allowance is negotiated between the customer
and the sales order department (or salesperson). The allowance should be reviewed and
approved by an independent part (usually the credit department); when authorized, billing
issues a credit memorandum to document the reduction to the customers account.(i.e. , for
goods actually returned, usually for full credit) are typically initiated by the receiving
department. Once goods are received and returned to inventory for proper control (this would
be evidenced by documentation), the credit manager authorizes billing to issue a credit
memorandum. Note that for both returns and allowance, two independent parties are required
to approve the transaction, and a third party maintains the records.

4.3.8. Write-off of accounts receivable

The central feature in a write-off procedure is an analysis of past due accounts, usually done
with an aged trial balance. Numerous techniques are available to collect past due accounts
(e.g., follow-up letters, collection agencies), but some accounts are ultimately worthless. In
this case the credit manager initiates a write-off, which is approved by the treasure. On
approval, accounts receivable is authorized to write off the account. A copy of the
authorization is also sent to an independent third party (internal audit) for purposes of record
keeping. This is necessary because after the write-off, accounts receivable no longer has an
active record of the account. Note that internal audit confirms write-offs directly with the
customer to ensure that no collections have been made on written-off accounts. An employee

might intercept a customers payment on account and then arrange for the account to be
written off, so that the customer does not continue to be billed for the amount.
The above functions will be shown with a flow diagram below.

Cash receipts G/L

Customer Customers
Details 13 14
8 9 Internal
7 5
manager 4 Billing


Data flow key

1. remittance advices
2. control total
3. sales return memo
4. sales return advice

5. credit memo
6. write off memo
7. write off advice
8. aged trial balance
9. journal voucher
10. control total
11. worthless account list
12. statements
13. total write offs
14. write off confirmation
15. write off memo

Learning activity 2
1. What is the role of credit department in the accounts receivable application system?
2. What is ageing analysis?

Answers to learning activities

Learning activity 1
1. What is the distinction between billing and accounts receivable?
The distinction between billing and accounts receivable is important to maintain
separation of functions. Billing is responsible for invoicing individual sales transactions,
and accounts receivable maintains customer- accounts information and sends periodic
statements of account to customers. Billing does not have access to the financial records
(the receivable ledger), and the financial records are independent of the invoicing

Learning activity 2
1. What is the role of credit department in the accounts receivable application system?
Credit department functions in an accounts receivable application system include the approval
of sales returns and allowances and other adjustments to customer accounts, the review and
approval of the aged trial balance to ascertain customers creditworthiness, and the initiation
of write-off memos to charge accounts to bad-debt expense.

2. What is ageing analysis?

Ageing analysis involves the review of individual subsidiary account receivable, thereby
determining the number of day an account is past due from the due date. It usually involves
determining the age of the account and assigning the related probability of uncollectibleity.
Check Your Progress

1. Which of the following departments should mach shipping documents with open sales
orders and prepares daily sales summaries?
A. Billing
B. Sales order
C. Accounts receivable
D. Shipping

2. Which of the following departments should normally be responsible for the preparation and
journalizing of credit memos upon the receipt of approved sales return memos to authorize
a reduction in customers balances because of returned goods?
A. Receiving
B. Accounts receivable
C. Credit
D. Billing
3. Which document often accompanies merchandise shipped to a customer?
A. Picking list
B. Packing slip

C. Credit memo
D. Sales order
4. Which activity is part of the sakes order entry process?
A. Setting customer credit limits
B. Preparing a bill of lading
C. Checking customer credit
D. Approving sales returns
5. For good internal control credit memos should be approved by the
A. Credit manager
B. Sales manager
C. Billing manager
D. Treasurer


1. The sales process begins with a customer contacting the sales department. This initial
contact may be by telephone, mail, or in person. The sales department captures the
essential details of this event on a sales order. This information triggers a number of
2. The first step in the sales process is to authorize the transaction by obtaining credit
approval for the customer.
3. When credit is approved, the sales information is released to the billing, warehouse,
and shipping processes.
4. The next step is to ship the merchandise, which should be done as soon after credit
approval as possible. If required to wait too long, the customer may cancel the order
and go elsewhere. The shipping process reconciles the products received from the
warehouse with the sales information that it received earlier. This reconciliation
ensures that the firm sends the correct goods to the customer. If an error has occurred,
such as the warehouse releasing the wrong products or quantities, the problem should
be detected at this point. Assuming all is well with the order; the goods will be packed
and shipped via common carrier to the customer. The shipping information is then sent
to the billing process.

5. The billing process compiles the relevant facts about the transaction (product prices,
handling charges, freight, taxes and discount terms) and bills the customer. The billing
department then transmits this information to the accounts receivable and inventory
control processes.
6. Accounts receivable receives the billing information and records this in the customers
7. Likewise, inventory control uses information from billing to adjust the inventory
records to reflect a decrease in inventory.
8. Periodically (after each batch, daily, weekly, monthly, or so forth) the billing, accounts
receivable, and inventory control transmit summarized information to the general
ledger process. This includes: (1) the total of all sales from billing; (2) the total
increases to accounts receivable. From this information, the general ledger posts to the
control accounts affected by sales transactions during this period. In addition, the
general ledger process reconciles these independently compiled summaries to identify
record-keeping errors. For example, if billing had failed to bill a customer or accounts
receivable had recorded an incorrect amount, a discrepancy between their summarized
figures would be detected in the general ledger process.


1. A
2. D
3. B
4. E
5. A