CHAPTER 4:

The Revenue Cycle

REVIEW QUESTIONS

1. What document initiates the sales process?

 The sales process is initiated with the receipt of a customer order that
indicates the type and quantity of merchandise desired. At this point, the
customer order is not in a standard format and may or may not even be a
physical document.

2. Distinguish between a packing slip, a shipping notice and a bill of lading. 

 A packing slip and shipping notice are the two documents received by the
shipping department before the arrival of goods and the verified stock release
document. A packing slip is a document that will ultimately travel with the goods
to the customer to describe the contents of the order, while a shipping notice is
a document forwarded to the billing function as evidence that the customer’s
order was filled and shipped. The shipping notice also conveys pertinent new
facts like the date of shipment, the items and quantities actually shipped, the
name of the carrier, and freight charges.

Finally, a bill of lading is a formal contract between the seller and the
shipping company (carrier) to transport the goods to the customer and
establishes legal ownership and responsibility for assets in transit. In summary,
the difference between the three documents are their functions. A packing slip is
used to describe the order, a shipping notice is an evidence of filling and
shipment of an order, while a bill of lading is a formal contract that establishes
legal ownership of assets in transit.

3. What function does the receiving department serve in the revenue cycle? 

 The receiving department is where the sales return process begins. This is
where personnel receive, count, inspect for damage, and send returned products
 to the warehouse. A return slip is prepared by the receiving clerk, which is
forwarded to the warehouse for restocking and to the sales department for
issuance of a credit memo. 

4. The general ledger clerk receives summary data from which departments? What form of
summary data?

 The general ledger clerk receives summary data from the billing and
inventory control departments, as well as, from the accounts receivable
department. Specifically, the summary data received from the billing and
inventory departments are in the form of journal vouchers, and the summary
data received from the accounts receivable department are in the form of an
account summary. The general ledger clerk reconciles the information and posts
to the control account. 

5. What are three authorization controls? 

 The three transaction authorization controls include credit check, return

policy and remittance list (cash prelist). Credit check entails ensuring the proper
application of the firm’s credit policies and the principal concern is the
creditworthiness of the customer.
Return policy pertains to authorizing the processing of sales returns.
Lastly, the remittance list provides a means for verifying that customer checks
and remittance advices match in amount. 

6. What are the three rules that ensure no single employee or department processes a
transaction in its entirety? 

 The first rule that ensures no single employee or department processes a

transaction in its entirety is ‘Transaction authorization should be separate from
transaction processing.’ This is because within the revenue cycle, the credit
department is segregated from the rest of the process, which is why formal
authorization of a transaction is an independent event. The importance of this is
clear in the consideration of the potential conflict in objectives between a person
and the business. The second rule is ‘Asset custody should be separate from the
task of asset record keeping.’ This means that there is a need to separate asset
custody from record keeping, because the physical assets at risk in the revenue
cycle are inventory and cash.
 The inventory warehouse has physical custody of inventory assets, while
inventory control maintains the records of inventory levels. To combine these
tasks would open the door to fraud and material errors. The third and last rule is
‘The organization should be structured so that the perpetration of a fraud
requires collusion between two or more individuals.’ This means that
recordkeeping tasks need to be carefully separated, because an individual with
total recordkeeping, in collusion with someone with asset custody, is said to be
in a position to perpetrate fraud. 

7. At which points in the revenue cycle are independent verification controls necessary? 

 Independent verification controls are necessary at the three points. The

first point is during the time where the shipping function verifies that the goods
sent from the warehouse are correct in type and quantity. The stock release
document and the packing slip are reconciled first before the goods are sent to
the customer. The second point is during the moment the billing function
reconciles the original sales order with the shipping notice to ensure that
customers are billed only for the quantities shipped.

The third and last point is when the general ledger function reconciles
journal vouchers and summary reports prepared independently in different
function areas prior to posting to control accounts. (The billing function
summarizes the sales journal. The inventory control summarizes changes in the
inventory subsidiary ledger. The cash receipts function summarizes the cash
receipts journal. The accounts receivable summarizes the AR subsidiary ledger.) 

8. What is automation and why is it used?

 Automation involves the creation and application of technology in order

to control and monitor the production and delivery of various goods and services
and involves the performance of tasks previously performed by humans.

Automation is used in order to improve the efficiency and effectiveness

of a task. It is used to achieve higher production rates and increased
productivity, more efficient use of materials, better product quality, improved
safety, shorter workweeks for labor, among others. 
9. What is the objective of reengineering? 

 The objective of reengineering is to improve operational performance

and reduce costs by identifying and eliminating non value-added tasks. This
means that traditional procedures are replaced with procedures that are
innovative and often very different from those that previously existed. 

10. Distinguish between an edit run, a sort run, and an update run. 

 An edit run or an edit program is the first run in the batch process. This
validates transactions by testing each record for the existence of clerical or
logical errors. A sort run is done at a point where the sales order file is in no
useful sequence. The sort run rearranges the sales order file by order of the
secondary key – account number.

Finally, an update run is done for various purposes. One is for AR update
where the program posts to AR by sequentially matching the account number
key in each sales order record with the corresponding record in the AR subsidiary
master file. Another is for sort update program which sorts the sales order file on
the secondary key – inventory number. There is also the inventory update
program which reduces the quantity on hand field in the affected inventory
records by the quantity sold field in each sales order record. Lastly, is the general
ledger update run where the journal vouchers are sorted by general ledger
account number and posted to the general ledger in a single run, and a new
general ledger is created. 

11. What are the key features of a POS system? 

 A point of sale system, or POS, is the place where a customer pays for
products or services in a store. Simply put, every time a customer makes a
purchase in a store, they are completing a point of sale transaction. A key
feature of this system is it immediately records both cash and credit transactions
and the corresponding inventory changes.
Other key features of a POS system include maintaining no accounts
receivable, keeping inventory on the store’s shelves and not in a separate
warehouse, and having customers personally pick the items they wish to buy and
carry them to the checkout location, where the transaction happens. 
12. How is the primary key critical in preserving the audit trail? 

 The primary key provides the link between the magnetic records stored
on a computer disk and the physical source documents as well as business
events that they represent. This ensures that system resources have not been
harmed by hackers, insiders, disgruntled employees, and technical problems that
may arise. 

13. What are the advantages of real-time processing? 

 Real-time processing has been shown to significantly reduce operational

costs while increasing revenues. Here are the advantages of real-time
processing. First, it greatly shortens the cash cycle of the firm. For instance, lags
inherent in batch systems can cause delays of several days between taking an
order and billing the customer. These lags can be reduced or eliminated by real-
time systems with remote terminals, which can permit same-day billing of
customers.

Second, it can give the firm competitive advantage in the market. By

maintaining current inventory information, sales staff can determine
immediately whether the inventories are on hand. This enhances the firm’s
ability to maximize customer satisfaction, which translates into increased sales.
Third, clerical errors tend to be produced in manual procedures, like incorrect
account numbers, invalid inventory numbers, and price–quantity extension
miscalculations, which may not be detected in batch systems until the source
documents reach data processing. By this time, damage may have already been
done. In real-time processing, these errors are identified as they occur, which
greatly improves the efficiency and effectiveness of operations.

Fourth and last, the amount of paper documents in a system is reduced

in Realtime processing. The permanent storage of hardcopy documents can
become a financial and operational burden, as they are expensive to produce
and clutter the system. Digital documents are more efficient, effective, and
adequate for audit trail purposes. 

14. Why does billing receive a copy of the sales order when the order is approved but does
not bill until the goods are shipped? 
  This is because the billing before shipment encourages inaccurate record
keeping and inefficient operations. When the customer order is originally
prepared, some details, like inventory availability, prices and shipping charges
are not known with certainty. Billing for goods not yet shipped causes confusion,
damages relations with customers, and requires additional work to adjust the
accounting records. To prevent such problems, this is why the billing function
awaits notification from shipping before it bills. 

15. Why was EDI devised? 

 EDI was devised to expedite or to speed up routine transactions between

manufacturers and wholesalers, and between wholesalers and retailers. The
customer’s computer and the seller’s computer are directly connected through
telephone lines.

Every time the customer’s computer detects the need to order inventory,
it automatically transmits an order to the seller. The order is then received by
the seller’s system and is automatically processed. In this system, there is little to
no need of human involvement. 

16. What types of unique control problems are created by the use of PC accounting
systems? 

 For instance, one employee may have the responsibility for entering all
transaction data, including sales orders, cash receipts, invoices, and
disbursements. Controlling the PC environment requires a high degree of
supervision, adequate management reports (such as detailed listings of all
transactions), and frequent independent verification. Another is that PC systems
generally provide inadequate control over access to data files. Although some
applications achieve modest security through password control to files, accessing
data files directly via the operating system can often circumvent this control.
Solutions for dealing with the problem include data encryption, disk locks, and
physical security devices.

Lastly, data losses that threaten accounting records and audit trails afflict
the PC environment. The primary cause of data loss is computer disk failure,
wherein recovery of data stored on the disk may be impossible. This threat may
be reduced considerably through formal procedures for creating backup copies
 of data files and programs. In the mainframe environment, backup is provided
automatically. Backup of PC data files relies on a conscious action by the users,
who too often fail to appreciate its importance. 

17. In a manual system, after which event in the sales process should the customer be
billed? 

 A manual system is a bookkeeping system where records are maintained

by hand, without using a computer system. Instead, transactions are written in
journals, from which the information is manually rolled up into a set of financial
statements. In a manual system, the customer should be billed after the shipping
notice is sent by the shipping department to the billing department. 

18. What is a bill of lading? 

 A bill of lading is a formal contract between the seller and the shipping
company (carrier) to transport the goods to the customer. This document
establishes legal ownership and responsibility for assets in transit. The bill of
lading is a legally binding document providing the driver and the carrier all the
details needed to process the freight shipment and invoice it correctly. 

19. What document initiates the billing process? 

 The shipping notice is the document that serves as a proof that the
customer’s order was filled and shipped. This is the document that the billing
function awaits before it bills. This is the trigger document that initiates the
billing process. 

20. Where in the cash receipts process does supervision play an important role? 

 Supervision plays an important role in the mail room, which is a point of

risk in most cash receipts system. Here, the individual opening the mail has
access to both the cash (the asset) and the remittance advice (the record of the
transaction). This opportunity can be used to steal the check, cash it and destroy
the remittance advice, thus leaving no evidence of the transaction.

DISCUSSION QUESTIONS
1. Why do firms have separate departments for warehousing and shipping? What about
warehousing and inventory control? Doesn’t this just create more paperwork? 

 The reason why firms have separate departments for warehousing and
shipping is because both are focused on different tasks. The main task of the
warehousing department is to offer appropriate space to stock merchandise
safely from the elements. While the shipping department focuses mainly on
movement of inventory that is both incoming and outgoing.

The separation of the two assists in the segregation of duties and

enhances the efficiency and effectiveness of handling assets during the revenue
cycle. The warehouse maintains the inventory section of inventory control, and
the two main approaches applicable for inventory control under emergency
situations which are reorder level policy and reorder cycle policy. Another key
difference is that the warehousing responsibility is separated from record-
keeping functions.

Keeping the accounting records of the items in the inventory is the

responsibility of the inventory control department. This does create additional
paperwork; however, this is considered as a minor and a necessary cost for the
added benefit of control over the inventory. This process mitigates opportunities
for theft and deception in the business.

2. Distinguish between the sales order, billing, and AR departments. Why can’t the sales
order or AR departments prepare the bills? 

 The sales order department’s function is to take the order from

customers and process it into a specific format. This department stores
information like the name of customer, address, a/c no, quantities and units of
each product, discounts, etc. and helps in determining the possible shipping
date. The billing department is the one that receives a copy of the sales order
from the sales order department. As soon as it receives the shipping notice and
the stock release document, it then starts preparing the sales invoice, which is
the bill of the customer that charges them for shipping other than tax and
discounts.
 The AR department’s function is to receive the sales order from the sales
department and enter it into the accounts receivable subsidiary ledger. Upon
receiving payment suggestions, these will be noted down to the customer’s
account in the accounts receivable subsidiary ledger. The sales order department
should not prepare the bills as there could be chances of collaboration with
customers and a lower amount could be negotiated with them. AR department
should also not prepare the bills as billing could be postponed or amount
charged could be reduced by the department for the customers favored by the
staff. Finally, since both sales order and AR departments are in direct contact
with customers, it is appropriate that they are segregated from the billing
function. 

3. Explain the purpose of having mail room procedures. 

 These procedures are important because mail room procedure in relation

with cash receipts involves proper recording of cash and checks received from
accounts receivables which are sent through mails. The purpose of this
procedure is to minimize and reduce possible errors and frauds in relation with
the received payment. The checks received in payment for accounts receivable
are a crucial asset for the firm.

These checks must be protected from individuals who might try to

deposit these checks into their own accounts. The process of having a member
of the mail room personnel open the mail and record all checks received before
they are routed to the cashier or the accounts receivable department is to
ensure that the accounts receivable personnel do not engage in such activities as
lapping the accounts receivable accounts. 

4. In a manual accounting system, what advantage does the journal voucher system have
over the traditional general journal system? 

 The function of the traditional general journal system is to record

nonrecurring, infrequent, and dissimilar transactions. General journals only have
columns that are not specific, which permit the recording of any type of
transaction that are arranged not by account, but chronologically. On the other
hand, a journal voucher is a special source document that contains single journal
entries that specify what accounts are affected. These are used to record
summaries of routine and non-routine transactions which makes it more
 convenient. Because of this, the need for the formal general journal is eliminated
by the journal voucher system. 

5. How could an employee embezzle funds by issuing an unauthorized sales credit memo if
the appropriate segregation of duties and authorization controls were not in place? 

 If the appropriate segregation of duties and authorization controls are

not in place, an employee may embezzle funds by generating debt under the
name of someone else, and steal/take the money for himself. An employee may
also buy goods as this false person, then consequently return the goods and
issue a credit memo, and afterwards eventually intercept the checks. 

6. What task can the AR department engage in to verify that all customers’ checks have
been appropriately deposited and recorded? 

 An account summary, listing invoices and amounts paid by check number

and date, should be sent by the company to each customer periodically or
perhaps monthly. This form permits the customer to check and verify the
accuracy of the records. In case there are unrecorded payments, the company
will then be notified by the customer of the discrepancy. The accounts receivable
clerk or the cashier should not handle these reports. 

7. Why is access control over revenue cycle documents just as important as the physical
control devices over cash and inventory? 

 The reason why access control to the billing and accounts receivable
records that are part of the revenue cycle is just as important as the physical
control devices over cash and inventory, is because these records affect the
collectability of an asset— accounts receivable—which should eventually be
converted into cash. In instances where these records are not adequately
controlled, inventory may not be ultimately converted into the cash amount
deserved by the firm. 

8. How can reengineering of the sales order processing subsystem be accomplished using
the Internet? 
  With the advent of the internet, it has become much easier to transfer
data. In today’s generation, the internet has become an integral part of our
everyday lives. In the business context, the internet’s ability to quickly gather
needed data greatly improves a firm’s margin of error. Because of the rise of
both technology and the internet, sales processing can be done much faster.

A customer can order products through the internet as a medium and

can receive a bill almost instantly. This reduces the rate of error of businesses to
oversell an item or have backorder items since the entire system would be
automated. Additionally, this would also lessen the overall cost businesses may
possibly incur due to such problems. Ultimately, the internet has been beneficial
to both the customers and the businesses for it has provided the latter with the
power to process large amounts of information in a matter of seconds. 

9. What financial statement misrepresentations may result from an inconsistently applied

credit policy? Be specific.

 Financial misrepresentations happen when the financial position of a

company is presented to be healthier than what is in actuality. This happens
when the financial figures of a business is manipulated, such that assets are
overstated and/or liabilities are understated. Credit policy pertains to how credit
memos are sent to the customer by the business. This may be because of
defective or returned merchandise, and price changes.

A possible result of an inconsistent application of a credit policy is the

overstatement of accounts receivable. An overstatement of an accounts
receivable, which is an asset, will ultimately lead to the misrepresentations in the
financial statements causing them to appear higher than their actual value. 

10. Give three examples of access control in a POS system. 

 One example would be to assign each salesclerk to a separate cash

register for an entire shift and give them a physical lock and key or a password
for the cash register that only they know, so as to prevent unauthorized access.
Another would be having physical security over the inventory such as steel
cables to secure expensive leather coats to the clothing rack; locked showcases
to display jewelry and costly electronic equipment; magnetic tags attached to
merchandise that will sound an alarm when removed from the store. Third
 example would be to have an internal cash register tape that can be accessed
only by the manager. 

11. Discuss the trade-off in choosing to update the general ledger accounts in real time. 

 Real-time data processing involves continuous input and output of data.

In real-time processing, information is always up to date. This gives the
organization the ability to take immediate action when responding to an event,
issue or scenario in the shortest possible span of time. However, there are also
trade-offs in choosing this type of data processing.

Firstly, it’s more expensive and complex. Second, it is a bit tedious and
more difficult for auditing. Lastly, using real-time processing brings the need for
implementation of daily data backups and the necessity to ensure the retention
of the most recent data transaction. The decision to select the best data
processing system is dependent on the current system in your business, and
whatever system suits your business best should be chosen. 

12. Discuss how the nature of the necessary internal control features is affected by
switching from a manual system to (1) a large-scale computer-based accounting system
or (2) a PC-based accounting system. 

 The separation of duties is the first internal control procedure that will be
affected when switching from a manual system to a more advanced system. It
will be affected in such a way that some jobs become irrelevant and new ones
are opened. Because of this, the need to change or reassign people in the
business arises. Due to the changes in the segregation of duties, changes also
happen to other procedures such as the accounting system access controls,
physical audit of assets, and authority requirements. Finally, the change in
systems also affect financial documentation and periodic reconciliations. 

13. Under what circumstances will automated mail room procedures provide the most
benefit? The least benefit? 

 An automated mail process is done using technology to digitize and

automate the classification and distribution of information or checks within an
organization. The benefits from this would be a reduction of paper costs,
efficient data tracking, rationalization of information, and most importantly,
 reducing the decision cycle which then leads to improved customer service.
However, automated mailroom procedures also come with disadvantages. One
disadvantage is the elimination of paper trails which will be used to ensure the
verifiability of the information gathered. An automated system will also need
much more trained individuals to manage and operate, which translates to the
incurrence of higher costs.

14. What makes POS systems different from revenue cycles of manufacturing firms? 

 POS systems are different from manufacturing firms because in this

system, the customers literally have possession of the items bought, which
means inventory is on hand. POS systems are widely used in grocery stores,
department stores, among others, and only generally accepts cash, checks and
bank credit cards, which means there is no maintenance of customer accounts
receivable. Unlike some manufacturing firms, inventory is kept on the store's
shelves, not in a separate warehouse.

The customers personally pick the items they wish to buy and carry them
to the checkout location, where the transaction begins. Shipping, packing, bills of
lading, etc. are not relevant to POS systems. In manufacturing firms, the order is
placed and the good is shipped to the customer at some later time period. Thus,
updating inventory at the time of sale is necessary in point-of-sale systems since
the inventory is changing hands, while it is not necessary in manufacturing firms
until the goods are actually shipped to the customer. In manufacturing firms, the
organization maintains customer accounts receivable and inventory is kept in a
separate warehouse. 

15. Is a POS system that uses bar coding and a laser light scanner foolproof against
inaccurate updates? Discuss. 

 Although the use of a POS system with bar coding and a laser light
scanner can generate the most accurate records because of its ability to update
inventory quantity on hand in real time to reflect the items sold, it does not
guarantee foolproofness against inaccurate updates. This is because small
discrepancies can still often exist due to errors in making changes for the
customers. 

16. How is EDI more than technology? What unique control problems may it pose? 
  Electronic Data Interchange (EDI) is more than just technology, such that
it represents a business arrangement between the buyer and seller in which they
agree, in advance, to the terms of their relationship. One example is when 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. There are

unique control problems that EDI poses. One problem is ensuring that, in the
absence of explicit authorization, only valid transactions are processed. Another
risk is that a trading partner, or someone masquerading as a trading partner, will
access the firm’s accounting records in a way that is unauthorized by the trading
partner agreement. 

17. Discuss the key segregation of duties related to computer programs that process
accounting transactions. 

 In computer programs, tasks that are segregated in manual systems are

often consolidated. An instance would be a computer application performing
seemingly incompatible tasks like inventory control, AR updating, billing, as well
as general ledger posting. Answers to the concerns that arise with regards to the
integrity of these computer programs lie in the quality of general controls over
segregation of duties related to the design, maintenance and operation of
computer programs. Programmers who write the original computer programs
should not also be responsible for making program changes, both of these
functions should be separate from the daily task of operating the system

MULTIPLE-CHOICE QUESTIONS

1. Which document is NOT prepared by the sales department?

a. packing slip

b. shipping notice
 c. bill of lading

d. stock release

2. Which document triggers the update of the inventory subsidiary ledger?

a. bill of lading

b. stock release

c. sales order

d. shipping notice

3. Which function should the billing department NOT perform?

a. record the sales in the sales journal

b. send the ledger copy of the sales order to accounts receivable

c. send the stock release document and the shipping notice to the billing department as
proof of shipment

d. send the stock release document to inventory control

4. When will a credit check approval most likely require specific authorization by the credit
department?

a. when verifying that the current transaction does not exceed the customer’s credit
limit

b. when verifying that the current transaction is with a valid customer

c. when a valid customer places a materially large order

d. when a valid customer returns goods

5. Which type of control is considered a compensating control?

a. segregation of duties

b. access control
 c. supervision

d. accounting records

6. Which of the following is NOT an independent verification control?

a. The shipping department verifies that the goods sent from the warehouse are correct
in type and quantity.

b. General ledger clerks reconcile journal vouchers that were independently prepared in
various departments.

c. The use of prenumbered sales orders.

d. The billing department reconciles the shipping notice with the sales invoice to ensure
that customers are billed for only the quantities shipped.

7. Which function or department below records the decrease in inventory due to a sale?

a. warehouse

b. sales department

c. billing department

d. inventory control

8. Which situation indicates a weak internal control structure?

a. the AR clerk authorizes the write off of bad debts

b. the record-keeping clerk maintains both AR and AP subsidiary ledgers

c. the inventory control clerk authorizes inventory purchases

d. the AR clerk prepares customer statements every month

9. The bill of lading is prepared by the

a. salesclerk.

b. warehouse clerk.
 c. shipping clerk.

d. billing clerk.

10. Which of following functions should be segregated?

a. opening the mail and recording cash receipts in the journal

b. authorizing credit and determining reorder quantities

c. shipping goods and preparing the bill of lading

d. providing information on inventory levels and reconciling the bank statement