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. Sales order entry
2. Shipping
3. Billing
4. Cash collections
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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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 1015 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
the order is being entered, and when it is easiest to correct those
errors.
2. 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.
3. Inventory records are more accurate and timely, enabling sales
order entry staff to provide customers accurate information
about expected delivery dates
4. The warehouse and shipping departments can better plan
activities to minimize the time required to fill customer orders
5. 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
6. Cash receipts are processed more quickly, improving cash flow
7. 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
2. All recorded transactions are valid (actually occurred)
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3. All valid, authorized transactions are recorded

4. All transactions are recorded accurately
5. 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
limits. Customer credit approval must occur before releasing
the goods from the inventory.
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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;

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 Profitability analyses by product, customer, and sales

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.

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