Revenue and Receipt Cycle

Economic enterprises, both for-profit and not-for-profit, generate revenues

through business processes that constitute their revenue cycle. 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. As a matter of processing convenience, most firms treat each
phase as a separate transaction. Hence, the revenue cycle actually consists of two
major subsystems: (1) the sales order processing subsystem and (2) the cash receipts
subsystem.
In this part, the flow of the transactions will be described and every document
used will be determine in each flow of the transaction.
Examine the revenue cycle conceptually. Using data flow diagrams (DFDs) as a
guide, trace the sequence of activities through three processes that constitute the
revenue cycle for most retail, wholesale, and manufacturing organizations. These are:
sales order procedures, sales return procedures, and cash receipts procedures.
The tasks described may be performed manually or by computer. At various
stages in the processes we will examine specific documents, journals, and ledgers as
they are encountered. Again, this review is technology-neutral. These documents and
files may be physical (hard copy) or digital (computer generated).
Sales Order Procedures
Sales order procedures include the tasks involved in receiving and processing a
customer order, filling the order and shipping products to the customer, billing the
customer at the proper time, and correctly accounting for the transaction.
Receive Order. The sales process begins with the receipt of a customer order
indicating the type and quantity of merchandise desired. At this point, the customer
order is not in a standard format and may or may not be a physical document. Orders
may arrive by mail, by telephone, or from a field representative who visited the
customer. When the customer is also a business entity, the order is often a copy of the
customer’s purchase order. A purchase order is an expenditure cycle document.
Because the customer order is not in the standard format that the seller’s order
processing system needs, the first task is to transcribe it into a formal sales order.
The sales order captures vital information such as the customer’s name,
address, and account number; the name, number, and description of the items sold;
and the quantities and unit prices of each item sold. At this point, financial information
such as taxes, dis-counts, and freight charges may or may not be included. After
creating the sales order, a copy of it is placed in the customer open order file for future
reference. The customer record in the open order file is updated each time the status of
the order changes such as credit approval, on back-order, and shipment. The open
order file thus enables customer service employees to respond promptly and accurately
to customer questions.
Check Credit. Before processing the order further, the customer’s
creditworthiness needs to be established. The circumstances of the sale will determine
the nature and degree of the credit check. For example, new customers may undergo a
full financial investigation to establish a line of credit. Once a credit limit is set, however,
credit checking on subsequent sales may be limited to ensuring that the customer has a
history of paying his or her bills and that the current sale does not exceed the pre-
established limit.
The credit approval process is an authorization control and should be performed
as a function separate from the sales activity. The receive-order task sends the sales
order (credit copy) to the check-credit task for approval. The returned approved sales
order then triggers the continuation of the sales process by releasing sales order
information simultaneously to various tasks.
 Pick Goods. The receive order activity forwards the stock release document (also
called the picking ticket) to the pick goods function, in the warehouse. This document
identifies the items of inventory that must be located and picked from the warehouse
shelves. It also provides formal authorization for warehouse personnel to release the
specified items. After picking the stock, the order is verified for accuracy and the goods
and verified stock release document are sent to the ship goods task. If inventory levels
are insufficient to fill the order, a warehouse employee adjusts the verified stock release
to reflect the amount actually going to the customer. The employee then prepares a
back-order record, which stays on file until the inventories arrive from the supplier (not
shown in this diagram). Back-ordered items are shipped before new sales are
processed.
Finally, the warehouse employee adjusts the stock records to reflect the reduction in
inventory. These stock records are not the formal accounting records for controlling
inventory assets. They are used for warehouse management purposes only.
Ship Goods. Before the arrival of the goods and the verified stock release document,
the shipping department receives the packing slip and shipping notice from the receive
order function. The packing slip will ultimately travel with the goods to the customer to
describe the contents of the order. The shipping notice will later be forwarded to the
billing function as evidence that the customer’s order was filled and shipped. This
document conveys pertinent new facts such as the date of shipment, the items and
quantities actually shipped, the name of the carrier, and freight charges. In some
systems, the shipping notice is a separate document prepared within the shipping
function.
The ship goods function thus serves as an important independent verification control
point and is the last opportunity to detect errors before shipment. The shipping clerk
packages the goods, attaches the packing slip, completes the shipping notice, and
prepares a bill of lading. This document establishes legal ownership and responsibility
for assets in transit. Once the goods are transferred to the carrier, the shipping clerk
records the shipment in the shipping log, forwards the shipping notice to the bill
customer function as proof of shipment, and updates the customer’s open order file.
 Bill Customer. The shipment of goods marks the completion of the economic
event and the point at which the customer should be billed. Billing before shipment
encourages inaccurate record keeping and inefficient operations. When the customer
order is originally prepared, some details such as inventory availability, prices, and
shipping charges may not be known with certainty. In the case of back-orders, for
example, suppliers do not typically bill customers for out-of-stock items. Billing for goods
not shipped causes confusion, damages relations with customers, and requires
additional work to make adjustments to the accounting records.
To prevent such problems, the billing function awaits notification from shipping
before it bills. Shows that upon credit approval, the bill customer function receives the
sales order (invoice copy) from the receive order task. This document is placed in an
S.O. pending file until receipt of the shipping notice, which describes the products that
were actually shipped to the customer. Upon arrival, the items shipped are reconciled
with those ordered and unit prices, taxes, and freight charges are added to the invoice
copy of the sales order. The completed sales invoice is the customer’s bill, which
formally depicts the charges to the customer. In addition, the billing function performs
the following record keeping–related tasks:

Records the sale in the sales journal.

Forwards the ledger copy of the sales order to the update accounts receivable task.
Sends the stock release document to the update inventory records task.
The sales journal is a special journal used for recording completed sales transactions.
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, which is sent to the
general ledger task for posting to the following accounts:
DR CR
Accounts Receivable—Control XXXX.XX
Sales XXXX.XX

Each journal voucher represents a general journal entry and indicates the general
ledger accounts affected. Summaries of trans-actions, adjusting entries, and closing
entries are all entered into the general ledger via this method. The journal voucher
system eliminates the need for a formal general journal, which is replaced by a journal
voucher file.
Update Inventory Records. 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. Each stock release document reduces the
quantity on hand of one or more inventory accounts. Periodically, the financial value of
the total reduction in inventory is summarized in a journal voucher and sent to the
general ledger function for posting to the following accounts:
DR CR
Cost of Goods Sold XXX.XX
Inventory—Control XXX.XX

Update Accounts Receivable. 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. An example of an AR subsidiary ledger record. Periodically, the
individual account balances are summarized in a report that is sent to the general
ledger.

Post
to General Ledger. By the close of the transaction processing period, the general
ledger function has received journal vouchers from the billing and inventory control
tasks andan account summary from the AR function. This information set serves two
purposes. First, the general ledger uses the journal vouchers to post to the following
control accounts:
DR CR
Accounts Receivable Control XXXX.XX
Cost of Goods Sold XXX.XX
Inventory Control XXX.XX
 Sales XXXX.XX
Because general ledger accounts are used to prepare financial statements, they contain
only summary figures (no supporting detail) and require only summary posting
information. Second, this information supports an important independent verification
control. The AR summary, which the AR function independently provides, is used to
verify the accuracy of the journal vouchers from billing. The AR summary figures should
equal the total debits to AR reflected in the journal vouchers for the transaction period.
By reconciling these figures, the general ledger function can detect many types of
errors.
Sales Return Procedures
An organization can expect that a certain percentage of its sales will be returned. This
occurs for a number of reasons, some of which may be:
The company shipped the customer the wrong merchandise.
The goods were defective.
The product was damaged in shipment.
The buyer refused delivery because the seller shipped the goods too late or they were
delayed in transit.
When a return is necessary, the buyer requests credit for the unwanted products. This
involves reversing the previous transaction in the sales order procedure.
Prepare Return Slip. When items are returned, the receiving department employee
counts, inspects, and prepares a return slip describing the items. The goods, along with
a copy of the return slip, go to the warehouse to be restocked. The employee then
sends the second copy of the return slip to the sales function to prepare a credit memo.
Prepare Credit Memo. Upon receipt of the return slip, the sales employee prepares a
credit memo. This document is the authorization for the customer to receive credit for
the merchandise returned. Note that the credit memo similar in appearance to a sales
order. Some systems may actually use a copy of the sales order marked credit memo.
In cases where specific authorization is required (that is, the amount of the return or
circumstances surrounding the return exceed the sales employee’s general authority to
approve), the credit memo goes to the credit manager for approval. However, if the
clerk has sufficient general authority to approve the return, the credit memo is sent
directly to the billing function, where the customer sales transaction is reversed.
Approve
Credit Memo. The credit manager evaluates the circumstances of the return and
makes a judgment to grant (or disapprove) credit. The manager then returns the
approved credit memo to the sales department.
Update Sales Journal. Upon receipt of the approved credit memo, the transaction is
recorded in the sales journal as a contra entry. The credit memo is then forwarded to
the inventory control function for posting. At the end of the period, total sales returns are
summarized in a journal voucher and sent to the general ledger department.
Update Inventory and AR Records. The inventory control function adjusts the
inventory records and forwards the credit memo to accounts receivable, where the
customer’s account is also adjusted. Periodically, inventory control sends a journal
voucher summarizing the total value of inventory returns to the general ledger update
task. Similarly, accounts receivable submits an AR account summary to the general
ledger function.
Update General Ledger.Upon receipt of the journal voucher and account summary
information, the general ledger function reconciles the figures and posts to the following
control accounts:
DR CR
Inventory—Control XXX.XX
Sales Returns and Allowances XXXX.XX
Cost of Goods Sold XXX.XX
Accounts Receivable—Control XXXX.XX
Cash Receipts Procedures
The sales order procedure described a credit transaction that resulted in the
establishment of an account receivable. Payment on the account is due at some future
date, which the terms of trade determine. Cash receipts procedures apply to this future
event. They involve receiving and securing the cash; depositing the cash in the bank;
matching the payment with the customer and adjusting the correct account; and
properly accounting for and reconciling the financial details of the transaction.
Open Mail and Prepare Remittance Advice. A mail room employee opens
envelopes containing customers’ payments and remittance advices. Remittance advices
contain information needed to service individual customers’ accounts. This includes
payment date, account number, amount paid, and customer check number. Only the
portion above the perforated line is the remittance advice, which the customer removes
and returns with the payment. In some systems, the lower portion of the document is a
customer statement that the billing department sends out periodically. In other cases,
this could be the original customer invoice, which was described in the sales order
procedures.
Mail room personnel route the checks and remittance advices to an
administrative clerk who endorses the checks “For Deposit Only” and reconciles the
amount on each remittance advice with the corresponding check. The clerk then
records each check on a form called a remittance list (or cash prelist), where all cash
received is logged. In this example, the clerk prepares three copies of the remittance
list. The original copy is sent with the checks to the record and deposit checks function.
The second copy goes with the remittance advices to the update AR function. The third
goes to a

reconciliation task.
 Record and Deposit Checks. A cash receipts employee verifies the accuracy
and completeness of the checks against the prelist. Any checks possibly lost or
misdirected be-tween the mail room and this function are thus identified. After
reconciling the prelist 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.
Next, the clerk prepares a bank deposit slip showing the amount of the day’s
receipts and forwards this along with the checks to the bank. Upon deposit of the funds,
the bank teller validates the deposit slip and returns it to the company for reconciliation.
At the end of the day, the cash receipts employee summarizes the journal entries and
sends the following journal voucher entry to the general ledger function.
DR CR
Cash XXXX.XX
Accounts Receivable Control
XXXX.XX

Update Accounts Receivable. The remittance advices are used to post to the
customers’ accounts in the AR subsidiary ledger. Periodically, the changes in account
balances are summarized and forwarded to the general ledger function.
Update General Ledger. Upon receipt of the journal voucher and the account sum-
mary, the general ledger function reconciles the figures, posts to the cash and AR
control accounts, and files the journal voucher.
Reconcile Cash Receipts and Deposits. Periodically (weekly or monthly), a clerk from
the controller’s office (or an employee not involved with the cash receipts procedures)
rec-onciles cash receipts by comparing the following documents: (1) a copy of the
prelist, (2) deposit slips received from the bank, and (3) related journal vouchers.
FUNCTIONS OF EACH DEPARTMENT
REVENUE CYCLE
1. Sales Department - Primary objective is to increase entity’s sales. Receiving and
processing a customer order, filling the order and shipping products to the customer,
billing the customer at the proper time, and correctly accounting for the transaction.

2. Credit Department- Primary objective is to minimize exposure to high-risk customers.

Before processing the order further, the customer’s creditworthiness needs to be
established. The circumstances of the sale will determine the nature and degree of the
credit check. The credit approval process is an authorization control and should be
performed as a function separate from the sales activity. The returned approved sales
order then triggers the continuation of the sales process by releasing sales order
information simultaneously to various tasks.

3. Inventory Control Department- Primary objective is to control transfers of inventory in

and out of storage areas, monitor inventory levels, and report slow moving or damaged
items. It reviews and approved sales order received from credit department and monitor
the availability of goods ordered. It also authorizes the issuance of goods to the
shipping department and forwards the approved sales order to shipping department.

4. Shipping Department- Primary objective is to provide reasonable assurance that all

shipments are authorized and customers are billed. It compares sales order from sales
department with goods and approved sales order from inventory control and prepares
goods for shipment. It also notifies sales department that goods have been shipped and
forwards shipping documents and approved sales order to billing department.

5. Billing Department- Primary Objective is to provide reasonable assurance that all

billings are shipped. The shipment of goods marks the completion of the economic
event and the point at which the customer should be billed. the items shipped are
reconciled with those ordered and unit prices, taxes, and freight charges are added to
the invoice copy of the sales order. The completed sales invoice is the customer’s bill,
which formally depicts the charges to the customer.

6. Accounting Department-
 A. Update Inventory Records. 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 4-5. Each stock
release document reduces the quantity on hand of one or more inventory accounts.
Periodically, the financial value of the total reduction in inventory is summarized in
a journal voucher and sent to the general ledger function for posting.

B. Update Accounts Receivable. 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 4-6 presents an example of an AR
subsidiary ledger record. Periodically, the individual account balances are summarized
in a report that is sent to the general ledger.

C. Post to General Ledger. By the close of the transaction processing period, the
general ledger function has received journal vouchers from the billing and
inventory control tasks and an account summary from the AR function.
RECEIPT CYCLE
1. Mail room/ Receptionist- A mail room employee opens envelopes containing
customers’ payments and remittance advices. Remittance advices contain information
needed to service individual customers’ accounts. They prepare list of receipts,
endorses checks and list of receipts to the treasury department.

2. Treasury Department- Verifies the accuracy and completeness of the checks against
the prelist. Any checks possibly lost or misdirected between the mail room and this
function are thus identified. All cash receipts transactions, including cash sales,
miscellaneous cash receipts, and cash received on account, are recorded in the cash
receipts journal. Next, the clerk prepares a bank deposit slip showing the amount of the
day’s receipts and forwards this along with the checks to the bank. Upon deposit of the
funds, the bank teller validates the deposit slip and returns it to the company for
reconciliation.

3. Accounting Department-
 A. Update Accounts Receivable. The remittance advices are used to post to the
customers’ accounts in the AR subsidiary ledger. Periodically, the changes in
account balances are
summarized and forwarded to the general ledger function.

B. Update General Ledger. Upon receipt of the journal voucher and the account
summary, the general ledger function reconciles the figures, posts to the cash and
AR control accounts, and files the journal voucher.

C. Reconcile Cash Receipts and Deposits. Periodically (weekly or monthly), a clerk

from the controller’s office (or an employee not involved with the cash receipts
procedures) reconciles cash receipts by comparing the following documents: (1) a
copy of the prelist, (2) deposit slips received from the bank, and (3) related journal
vouchers.
POSSIBLE CONTROL
Transaction Authorization- The objective of transaction authorization is to ensure that
only valid transactions are processed. In the following sections, we see how this
objective applies in each of the three systems.
Credit Check. Credit checking of prospective customers is a credit department
function. This department ensures the proper application of the firm’s credit
policies. The principal concern is the creditworthiness of the customer. In making this
judgment, the credit department may employ various techniques and tests. The
complexity of credit proce?dures will vary depending on the organization, its
relationship with the customer, and the materiality of the transaction. Credit
approval for first-time customers may take time. Credit decisions that fall within a sales
employee’s general authority (such as verifying that the current transaction does
not exceed the customer’s credit limit) may be dealt with very quickly. Whatever
level of test is deemed necessary by company policy, the transaction should not
proceed further until credit is approved.

Return Policy. Because credit approval is generally a credit department function,

that department authorizes the processing of sales returns as well. An approval
determination is based on the nature of the sale and the circumstances of the
return. The concepts of specific and general authority also influence this activity.
Most organizations have spe?cific rules for granting cash refunds and credits to
customers based on the materiality of the transaction. As materiality increases,
credit approval becomes more formal.
 Remittance List (Cash Prelist). The cash prelist provides a means for verifying
that customer checks and remittance advices match in amount. The presence of
an extra remittance advice in the AR department or the absence of a customer’s
check in the cash receipts department would be detected when the batch is
reconciled with the prelist. Thus, the prelist authorizes the posting of a remittance
advice to a customer’s account.
Segregation of Duties- Segregating duties ensures that no single individual or
department processes a transaction in its entirety. The number of employees and the
volume of transactions being processed influence how to accomplish the segregation.
Recall from Chapter 3 that three rules guide systems designers in this task:
1. Transaction authorization should be separate from transaction processing.
- The importance of this separation is clear when one considers the potential
conflict in objectives between the individual salesperson and the organization.
By acting in an independent capacity, the credit department may objectively detect
risky customers and disallow poor and irresponsible sales decisions.
2. Asset custody should be separate from the task of asset record keeping.
- The physical assets at risk in the revenue cycle are inventory and cash, hence
the need to separate asset custody from record keeping. To combine these
tasks would open the door to fraud and material errors. A person with combined
responsibility could steal or lose inventory and adjust the inventory records to
conceal the event.
3. The organization should be structured so that the perpetration of a fraud requires
collusion between two or more individuals.
- An individual with total record-keeping responsibility, in collusion with someone
with asset custody, is in a position to perpetrate fraud. By separating these
tasks, collusion must involve more people, which increases the risk of detection
and therefore is less likely to occur.

Supervision- Some firms have too few employees to achieve an adequate separation
of functions. These firms must rely on supervision as a form of compensating control.
By closely supervising employees who perform potentially incompatible functions, a firm
can compensate for this exposure.

Accounting Records- This control is also an important operational feature of well-

designed accounting systems. Sometimes transactions get lost in the system. By
following the audit trail, management can discover where an error occurred. Several
specific control techniques contribute to the audit trail.
Pre- numbered Documents. Are sequentially numbered by the printer and allow
every transaction to be identified uniquely. This permits the isolation and tracking of a
single event (among many thousands) through the accounting system. Without a
unique tag, one transaction looks very much like another. Verifying financial data
and tracing transactions would be difficult or even impossible without pre-
numbered source documents.

Special Journals. By grouping similar transactions together into special journals,

the system provides a concise record of an entire class of events. For this purpose,
revenue cycle systems use the sales journal and the cash receipts journal.

Subsidiary Ledgers. Two subsidiary ledgers are used for capturing transaction
event details in the revenue cycle: the inventory and AR subsidiary ledgers. The
sale of products reduces quantities on hand in the inventory subsidiary records and
increases the customers’ balances in the AR subsidiary records. The receipt of cash
reduces customers’ balances in the AR subsidiary records. These subsidiary
records provide links back to journal entries and to the source documents that
captured the events.

General Ledgers. The general ledger control accounts are the basis for financial
statement preparation. Revenue cycle transactions affect the following general
ledger accounts: sales, inventory, cost of goods sold, AR, and cash. Journal
vouchers that summarize activity captured in journals and subsidiary ledgers flow
into the general ledger to update these accounts. Thus we have a complete audit trail
from the financial statements to the source documents via the general ledger,
subsidiary ledgers, and special journals.

Files. The revenue cycle employs several temporary and permanent files that
contribute
to the audit trail.
Access Controls- Access controls prevent and detect unauthorized and illegal access
to the firm’s assets. The physical assets at risk in the revenue cycle are inventories and
cash.
Independent Verification- The objective of independent verification is to verify the
accuracy and completeness of tasks that other functions in the process perform. To be
effective, independent verification must occur at key points in the process where errors
can be detected quickly and corrected. Independent verification controls in the revenue
cycle exist at the following points:

1. The shipping function verifies that the goods sent from the warehouse are correct
in type and quantity. Before the goods are sent to the customer, the stock release
document and the packing slip are reconciled.

2. The billing function reconciles the original sales order with the shipping notice to
ensure that customers are billed for only the quantities shipped.

3. Prior to posting to control accounts, the general ledger function reconciles journal
vouchers and summary reports prepared independently in different function areas.
The billing function summarizes the sales journal, inventory control summarizes
changes in the inventory subsidiary ledger, the cash receipts function summarizes
the cash receipts journal, and accounts receivable summarizes the AR subsidiary
ledger.

Reference:
Transaction Cycle and Business Practices, JAMES A. HALL (Peter E. Bennett Chair in
Business and Economics Lehigh University)