Unit 4

Revenue and Collection Cycle

Introduction Unit Learning Outcomes

In this chapter, you will apply your knowledge from By the end of this unit you should be
previous units (transaction processing, system able to:
documentation, fraud and internal control) to a
comprehensive set of transaction cycles. This chapter is ✓ Describe the business activities
devoted to revenue and collection cycle. and related information
processing operations
Ready? Let’s get learning! performed in the revenue and
collection cycle.
Timing ✓ Identify the risks associated
with the revenue and collection
This unit is good for 1 week. You can devote three hours
cycle and recognize the controls
per day on the subject. Don’t worry, the content is
that reduce those risks.
abridged, which means it only includes the most salient
points you need to know relative to our module
learning outcomes (MLO).
For easier monitoring of your progress, you may use the study planner attached to this module. Be
sure to make use of your planner to have a more organized and orderly studying. Plus, the planner is
a PROCRASTINATION-beater!

Warm Up!

Before you proceed to the actual cognitive feat, try this exercise so you can get those neurons working!
Select one of the businesses below or you can create your own business:
✓ Bakery
✓ Meat shop
✓ Sari-sari Store
✓ Internet Cafe

On the space provided, draw:

What is needed to run the business?

How are sales processed?

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Getting Started!

4.1 REVENUE AND COLLECTION CYCLE ACTIVITIES

The basic purpose of this process is to provide goods and services to customers and to collect
the payment from them. In its simplest form, the revenue cycle is the direct exchange of finished goods
or services for cash in a single transaction between a seller and a buyer. More complex revenue cycles
process sales on credit. Many days or weeks may pass between the point of sale and the subsequent
receipt of cash. This time lag splits the revenue transaction into two phases:

(1) The physical phase, involving the transfer of assets or services from the seller to the buyer; and

(2) The financial phase, involving the receipt of cash by the seller in payment of the account
receivable.

Without an effective revenue/collection process, an organization will soon cease to exist.

Ineffective process may arise from lack of demand for a company’s product or service, inadequate
exposure to market place and/or poor credit policies.

Basic Activities

1. Sales Order Entry

The revenue cycle begins with the receipt of orders from customers. The sales order department
which reports to the vice president of marketing performs the sales order entry process. This process
entails three steps:

A. Taking the customer’s order – customer order data are recorded on a sales order document.
The document is usually an electronic form displayed on a computer monitor screen or a
manual document as shown in Figure 4-1.

The sales order contains information about item numbers, quantities, prices and other terms
of the sale. Customer orders can be received in many different ways: in store, by mail, by
phone, over a Web site, or by a salesperson/agent in the field.

B. Credit Approval – credit sales should be approved before they are processed. For existing
customers with well-established payment histories, a formal credit check for each sale is
usually unnecessary. Instead, order takers have general authorization to approve orders from
customers in good standing, meaning those without past due balances.

This is usually accomplished by establishing a credit limit (maximum allowable account

balance) for each customer based on the customer’s past credit history and ability to pay. In
such cases, approving customer credit involves checking the customer master file to verify
the account exists, identifying the customer’s credit limit and verifying that the amount of the
order plus any current account balance does not exceed this limit.

C. Checking Inventory Availability – determine if there is sufficient inventory available to fill

the order, so that customers can be informed of the expected delivery date. The information
typically available to the sales order entry clerk are quantity on hand, quantity already
committed to other customers and quantity available.

If sufficient inventory is available to fill the order, the sales order is completed and the
quantity-available in the inventory file for each item ordered is reduced by the amount
ordered. If there is not sufficient inventory on hand to fill the order, a back order for those
items must be created. In manufacturing companies, creating a back order involves notifying
the production department to initiate the production of the requested items. In retail
companies, the purchasing department would be notified about the need to order the
required items.

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Once inventory availability has been determined, the system then creates a picking ticket
that lists the items and quantities of each item that the customer ordered. The picking ticket
authorizes the inventory control function to release merchandise to the shipping department.
The accuracy of inventory records is important because customers may become justifiably
upset when unexpected delays occur in filling their orders.

Figure 4-1 Sales Order (Docformat.com)

2. Shipping
The second basic activity in the revenue cycle is shipping the ordered merchandise. The
warehouse and shipping departments perform these activities. This process consists of two steps:

A. Pick and Pack Order – the picking ticket printed by sales order entry triggers the pick and
pack process. Warehouse workers use the picking ticket to identify which products and the
quantity of each product, to remove from inventory. Warehouse workers record the
quantities of each item actually picked, either on the picking ticket itself if a paper document
is used or by entering the data into the system if electronic forms are used. The inventory is
then transferred to the shipping department.

B. 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.

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Discrepancies can arise either because the items were not stored in the location indicated on
the picking ticket or the perpetual inventory records were inaccurate. In such cases, the
shipping department needs to initiate the back ordering of the missing items and enter the
correct quantities shipped on the packing slip.

After the shipping clerk counts the goods delivered from the warehouse, the sales order
number, item number(s) and quantities are entered using online terminals. This process
updates the quantity on hand in the inventory master file. It also produces the packing slip
and multiple copies of the bill of lading. The packing slip (it may be a copy of the picking
ticket) lists the quantity and description of each item included in the shipment.

The bill of lading in Figure 4-2 is a legal contract that defines the responsibility for the goods
in transit. It identifies the carrier, source, destination and any special shipping instructions,
and it indicates who (customer or vendor) must pay the carrier. A copy of the bill of lading
and the packing slip accompany the shipment. If the customer is to pay the shipping charges,
this copy of the bill of lading may serve as a freight bill, to indicate the amount the customer
should pay to the carrier.

In other cases, the freight bill is a separate document. The shipping department keeps a
second copy of the bill of lading to track and confirm the transfer of goods to the carrier.
Another copy of the bill of lading and the packing slip are sent to the billing department to
indicate that the goods have been shipped and that an invoice should be prepared and mailed.
The carrier also retains a copy of the bill of lading for its records.

Figure 4-2 Bill of Lading

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3. Billing
The third basic activity in the revenue cycle involves billing customers. This involves two
separate, but closely related tasks: invoicing and updating accounts receivable, which are performed
by two separate units within the accounting department.

A. Invoicing – accurate and timely billing for shipped merchandise is crucial. The billing activity
is just an information processing activity that repackages and summarizes information from
the sales order entry and shipping activities. It requires information from the shipping
department identifying the items and quantities shipped and information about prices and
any special sales terms from the sales department.

The basic document created in the billing process is the sales invoice (See Figure 4.-3) which
notifies customers of the amount to be paid and where to send payment. The invoice
indicates the quantity of each item sold and the price charged for that item; but the price is
usually set at the time the order is placed, and the actual quantity sold is known at the time
the merchandise is shipped to the customer.

The details of sales invoices are entered in the journal individually. At the end of the
period, these entries are summarized into a sales journal voucher as shown in Figure 4-
4.

Figure 4.-3 Sales Invoice

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Figure 4-4 Journal Voucher

B. Maintain Accounts Receivable – the accounts receivable function, which reports to the
controller, performs two basic tasks: It uses the information on the sales invoice to debit
customer accounts and subsequently credits those accounts when payments are received.

The two basic ways to maintain accounts receivable are the open-invoice and the balance-
forward methods.

The two methods differ in terms of when customers remit payments, how those payments
are applied to update the accounts receivable master file, and the format of the monthly
statement sent to the customers.

➢ Open-invoice method – customers typically pay according to each invoice. Usually

two copies of the invoice are mailed to the customer, who is requested to return one
copy with the payment. This copy is a turn-around document called the remittance
advice as shown in Figure 4.5. Customer payments are then applied against specific
invoices.

One advantage of this method is that it is conducive to offering discounts for prompt
payment, as invoices are individually tracked and aged. It also results in a more
uniform flow of cash collections throughout the month.

A disadvantage of the open-invoice method is the added complexity required to

maintain information about the status of each individual invoice for each customer.

➢ Balance-forward method – customers typically pay according to the amount shown

on a monthly statement, rather than by individual invoices. A monthly statement lists
all transactions, including both sales and payments that occurred during the past
month and informs customers of their current account balances.

The monthly statement often has a tear-off portion containing pre-printed

information, including the customer’s name, account number and balance. Customers
are asked to return this stub, which serves as a remittance advice, with payment.
Remittances are applied against the total amount balance, rather than against specific
invoices.

This method is commonly used by utility companies (water, electricity, internet

service etc.) in billing their customers.

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Figure 4-5 Remittance Advice

Figure 4-6 Inventory Subsidiary Ledger

Figure 4-7 Accounts Receivable Subsidiary Ledger

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The inventory control function updates inventory subsidiary ledger accounts from
information contained in the stock release document. In a perpetual inventory system,
every inventory item has its own record in the ledger containing, at a minimum, the data
depicted in Figure 4-6.

Customer records in the accounts receivable (AR) subsidiary ledger are updated from
information the sales order (ledger copy) provides. Every customer has an account record
in the AR subsidiary ledger containing, at minimum, the following data: customer name;
customer address; current balance; available credit; transaction dates; invoice numbers;
and credits for payments, returns, and allowances. Figure 4-7 presents an example of an
AR subsidiary ledger record.

Exceptions: Account Adjustments and Write-offs

Adjustments to a customer’s account are sometimes necessary. For example, customer

accounts may be credited to reflect either return of items or allowances granted for
damaged goods.

To credit a customer’s account for returned goods, the credit manager must obtain
information from the receiving dock that the goods were actually returned and placed back
in inventory. Upon notification from the receiving department that the goods have been
returned, the credit manager issues a credit memo as shown in Figure 4-8, which
authorizes the crediting of the customer’s account.

If the damage to the goods is minimal, the customer may agree to keep them for a price
reduction. In such cases, the credit manager issues a credit memo to reflect the amount
that should be credited to the customer’s account. A copy of the credit memo is sent to
accounts receivable to authorize the adjustment to the customer’s account balance;
another copy is sent to the customer.

Figure 4-8 Credit Memo

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After repeated attempts to collect payment have failed, it may be necessary to write-off a
customer’s account. In such cases, the credit manager issues a memo to authorize the
write-off. An aged trial balance of accounts receivable should be prepared and reviewed
by the credit function also. The credit function is also responsible for preparing a report of
customer accounts that may require write-off as bad debts.

However, the final approval for writing off an account should come from an officer of the
company who is not responsible for credit or collections. If the authorization for bad debt
write-off is part of the credit function, it is possible for credit personnel who have access
to cash receipts to conceal misappropriation of cash by writing off customers’ balances.

In many organizations, the treasurer approves the write-off of customer accounts

because this individual is responsible for cash management activities and the treasurer’s
department is usually separate from the credit function.

4. Cash Collections
The final step in the revenue cycle is cash collections. The cashier, who reports to the treasurer,
handles customer remittances and deposits them in the bank. Because cash and customer checks can
be stolen easily, it is important to take appropriate measures to reduce the risk of theft. Accounts
receivable function, which is responsible for recording customer remittances, should not have
physical access to cash and checks. Yet, the accounts receivable function must be able to identify the
source of any remittances and the applicable invoices that should be credited.

One solution involves mailing the customer two copies of the invoice and requesting that one be
returned with the payment. An alternative solution is to have mailroom personnel prepare a
remittance list, which is a document identifying the names and amounts of all customer remittances,
and send it to accounts receivable.

In the mail room, the clerk endorses the checks “For Deposit Only” to secure them and reconcile
the check amount to the amount on the remittance advice. Each check is recorded on cash prelist,
which is copied three times (one for the mail room, one for the cashier, and one for the accounts
receivable department).

After reconciling the remittance list to the checks, the employee records the check in the cash
receipts journal. All cash receipts transactions, including cash sales, miscellaneous cash receipts, and
cash received on account, are recorded in the cash receipts journal.

Figure 4-9 illustrates this with an example of each type of transaction. Notice that each check
received from a customer is listed as a separate line item. A bank deposit is prepared and a general
ledger journal voucher is created for the total of the deposit

Figure 4-9 Cash Receipts Journal

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Another way to safeguard customer remittances and to speed-up the process, customers can pay
through the following:

1. Online Bank Transfer

2. Phone banking
3. Digital/Mobile Wallets
4. Credit Cards
5. Remittance Centers

4.2 REVENUE AND COLLECTION CYCLE RISKS AND CONTROLS

Process/Activity Risks/Threat Applicable Control Procedure

Sales Order Entry 1. Incomplete or inaccurate Data entry edit checks

customer orders

2. Credit sales to customers Credit approval by credit

with poor credit manager, not by sales function;
accurate records of customer
account balances

3. Legitimacy of orders Signatures on paper documents

4. Stockouts Inventory control systems; sales

forecasts; periodic physical
inventory counts

Shipping 5. Shipping errors: Reconciliation of sales order with

Wrong merchandise picking ticket and packaging slip;
Wrong quantities bar code scanners;
Wrong address

6. Theft of inventory Restrict physical access to

inventory; documentation of all
internal transfers of inventory;
periodic physical counts of
inventory and reconciliation of
counts with recorded amounts;
RFID (Radio-frequency
identification) and barcode
technology.

Billing 7. Failure to bill customers Separation of shipping and billing

functions; prenumbering of all
shipping documents and periodic
reconciliation with invoices;
reconciliation of picking tickets
and bills of lading with sales
orders

8. Billing errors Data entry edit controls; price

lists

9. Posting errors in Batch totals; reconciliation of

updating accounts subsidiary accounts receivable
receivable ledger with general ledger;
monthly statements to customers

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Cash Collections 10. Theft of cash Segregation of duties;
minimization of cash handling;
prompt endorsement and deposit
of all receipts; periodic
reconciliation of bank statement
with records by someone not
involved in cash receipts
processing

Computer-Based Accounting Systems

Technology is a tool for enabling organizational change, a spectrum ranging from automation of
human tasks (increasing efficiency and effectiveness of a particular task) to reengineering (rethinking
the flow of work into new and better tasks to reduce costs and eliminate non-value-added activities).

Noteworthy items:
• The Sales Department processes each transaction as it is received. The computer checks the
credit, and then checks the inventory availability. Quantities on hand are reduced, a stock release
message is sent to the warehouse and a shipping notice is sent to the shipping department. The
sale is recorded in the open sales order file.

• There is a field indicating whether the sales order is open or closed. A sales order is closed when
the goods are shipped to the customer.

• Warehouse computers automatically produce the stock release screen, the clerk there enters
what has been picked and a report is printed.

• Shipping department personnel still have to reconcile the goods, the stock release, and the
computer printed packing slip. The goods are packaged and shipped. The employee closes the
sales order.

• Periodically (as in each evening), the computer reviews the sales order file for closed sales orders.
These are removed from the file and used to update the accounts receivable and inventory
subsidiary ledgers, and the general ledger sales, accounts receivable, inventory, and cost of goods
sold accounts.

Point-of-Sale (POS) Systems

POS systems are used by merchandising companies that do not sell their goods on credit, but
rather make sales for cash or bank credit card charges (VISA, MasterCard, etc.) only. Laser light scanners
serve as the primary input devices for the system, and sales are recorded by scanning the Universal
Product Code (UPC) labels on each item.

This scanned code retrieves the price for each item and subtracts the item from inventory
records. In this manner, records of inventory levels are maintained in real time and ordering can take
place automatically when the appropriate inventory level for an item is reached.

A point of sale system also maintains the Sales Journal in real time by recording each sale
immediately upon it taking place on a tape internal to the machine (unavailable to the cashier). Debits
are made to Cash, Accounts Receivable and Cost of Goods Sold. Credits are made to Sales and Inventory.
At the end of each cashier’s shift, the cash and receipts in the register drawer are compared to the
internal tape for reconciliation. Differences are closed to the Cash Over and Short account.

Doing Business via EDI

Many organizations have reengineered their sales order process through electronic data
interchange (EDI). EDI technology was devised to expedite routine transactions between
manufacturers and wholesalers and between wholesalers and retailers. The customer’s computer is
connected directly to the seller’s computer via telephone lines.

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When the customer’s computer detects the need to order inventory, it automatically transmits
an order to the seller. The seller’s system receives the order and processes it automatically. This
system requires little or no human involvement.

EDI is more than just a technology. It represents a business arrangement between the buyer
and seller in which they agree, in advance, to the terms of their relationship. For example, they agree
to the selling price, the quantities to be sold, guaranteed delivery times, payment terms, and methods
of handling disputes. These terms are specified in a trading partner agreement and are legally binding.

Once the agreement is in place, no individual in either the buying or selling company actually
authorizes or approves a particular EDI transaction. In its purest form, the exchange is completely
automated.

Doing Business on the Internet

Thousands of organizations worldwide are establishing home pages on the Internet to
promote their products and solicit sales. By entering the seller’s home page address into the Internet
communication program from a PC, a potential customer can access the seller’s product list, scan the
product line, and place an order. Typically, Internet sales are credit card transactions. The customer’s
order and credit card information are attached to the seller’s e-mail file.

An employee reviews the order, verifies credit, and enters the transaction into the seller’s
system for processing in the normal way. Because of the need to review the e-mail file before
processing, the turnaround time for processing Internet sales is sometimes longer than for telephone
orders. Research is currently under way to develop intelligent agents (software programs) that
review and validate Internet orders automatically as they are received.

Unlike EDI, which is an exclusive business arrangement between trading partners, the Internet
connects an organization to the thousands of potential business partners with whom it has no formal
agreement. In addition to unprecedented business opportunities, risks for both the seller and the
buyer accompany this technology.

Connecting to the Internet exposes the organization to threats from computer hackers, viruses,
and transaction fraud.

Control Considerations for Computer-Based Systems

• Authorization: since this is automated, managers and auditors need to review and test the
programs that perform these functions.

• Segregation of Duties: Since segregation has been eliminated in the computer, managers and
auditors need to review the logic of and test the performance of the programs that perform these
functions.

• Supervision: Surveillance cameras and shop floor security personnel can do much to prevent
shoplifting.

• Access Controls: Magnetic media are vulnerable to unauthorized and undetected access.
Accounting records and accounting programs need to be restricted, and different cash drawers
need to be assigned to each cashier.

• Accounting Records: Journals are now outputs of computer processes rather than inputs. These
need to be reviewed and reconciled with close attention by managers. Ledgers need to be
protected and backed up.

• Independent Verification: Batch total controls reconciliations and reviews of managerial

reports are two successful methods of detecting erroneous data and processes.

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Self-Check
List in order the steps in the sales process of JMY Super
Store:
______ Bill the customer
______ Take customer’s order
______ Ship the product
______ Collect payment
______ Approve the customer’s credit
______ Fill the order based on approved credit

Unit Summary

• Notice that both financial and operating information are needed to manage and evaluate the
revenue cycle activities. For example, evaluating the efficiency and effectiveness of sales order
entry requires data not only about sales volumes but also about order processing time.
Evaluating the overall effectiveness of all revenue cycle activities also requires information
from external sources such as measures of customer satisfaction.

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