CHAPTER THREE

THE REVENUE CYCLES:

SALES TO CASH COLLECTIONS
 Sales Order
 

• 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.
• The revenue cycle is the simplest form if the direct
exchange of finished goods or services is made on
cash in a single transaction between a seller and a
buyer and is more complex when sales is
processed on credit basis.
 Sales Order Cont…
• Many days or weeks may pass between sales
processing and the subsequent receipt of cash. This
time lag splits the revenue transactions into two
phases:
• the physical phase, involving the transfer of assets
or services from seller to the buyer
• the financial phase, involving the receipt of cash by
the seller in payment of the account receivable
• Hence, the revenue cycle actually consists of two
major subsystems (assuming sales on credit basis):
– the sales order processing system and
– the account receivable system
 Sales Order Processing

•  

• A sales order application system comprises the

procedures involved in accepting and shipping
customer orders and in preparing invoices that
•
describe products services, and assessment.
 

• The sales order is the interface between the

various function necessary to process a customer
order. These functions are sales order, credit,
finished goods, shipping, billing, accounts
receivable, and general Ledger.
 1. The Sales Department

• The sales process begins in the sales department with

the receipt of a customer order indicating the type and
quantity of merchandise being requested.
• The sales order captures such vital information as :
– the name and address of the customer making
the purchase;
– the customer’s account number;
– the name, number, and description of the items sold;
– the quantities and unit prices of each item sold, and
– other financial information such as taxes, discounts,
and freight charges.
 The Sales Department Cont…
• After processing sales order the sales department
produces multiple copies of sales order to distribute for:
– credit authorizations,
– packing slips,
– stock release documents,
– shipping notices,
– sales invoices, and
– ledger posting.
• In an actual system, the various sales order copies would
be numbered or color-coded to signify their purpose and
distribution.
 The Sales Department Cont…
• After preparing the sales order, the sales clerk
files one copy of it in the customer open order file
for future reference to facilitate communication
with customer in their order status.
• To facilitate customer inquiries, the open order
file should organize and filed alphabetically by
customer name.
 2. Credit Departments

• A credit department is responsible to determine

whether the customer is credit worthy or not before the
shipment of goods made.
• For regular customers, the credit check involves
determining that the total amount of credit granted
does not exceed management’s general or specific
authorization.
• For new customers, a credit check is necessary to
establish the terms of sale to the customer.
• The sales order function and credit valuation should be
separated to maintain good internal control system by
separation of duties.
 Credit Departments Cont…
• Once credit has been approved, the sales order
function distributes the sales order set.
– One copy of each sales order is forwarded to billing,
allowing the billing function to anticipate the receipt of
matching shipping advices from the shipping function.
– One copy-usually called the packing slip copy-is
forwarded to shipping. This copy authorizes shipping
to receive goods from finished goods for shipping.
– Another copy-usually called the stock copy-is
forwarded to finished goods. This copy authorizes
stores to release goods from its custody for shipment to
customers.
 Credit Departments Cont…
• In some cases, a customer’s order may require
that a production order be issued to produce the
goods, because the goods are not in stock.
• Such situations arise when the order is for a
special nonstick item or they are customized in
their nature.
 3. Finished Goods Department

• The sales department sends the stock release (also

called the picking ticket) copy of the sales order to the
warehouse. This document identifies which items of
inventory must be located and picked from the
warehouse shelves.
• It also provides formal authorization for the warehouse
clerk to release custody of the specified assets.
• After picking the stock, the clerk initials the stock
release copy to indicate that the order is complete and
accurate.
• Any out-of-stock items are noted on the stock release
copy.
 Finished Goods Department Cont…
• One copy of the stock release travels with the
goods to the shipping department, and
• the other is filed in the warehouse to provide a
record of the transaction.
• The clerk then adjusts the stock records to reflect
the reduction in inventory.
• The stock records are not the formal accounting
records for these assets.
• The inventory accounting records are kept in the
inventory control department.
 4. Shipping Department

• Before the arrival of the goods and the stock

release copy, the shipping department receives the
packing slip and shipping notice copies from the
sales department.
• The shipping notice informs the billing
department that the customer’s order has been
filled and shipped.
• This document contains such pertinent facts as the
date of shipment, items and quantities shipped the
carrier, and freight charges.
 Shipping Department Cont…
• Upon receiving the goods from the warehouse, the
shipping clerk reconciles the physical items with the stock
release documents, the packing slip, and the shipping
notice to verify the correctness of the order.
• This is an important step and the last opportunity to detect
errors before shipment. This shipping clerk packages the
goods, attaches the packing slip to the container, completes
the shipping notice, and prepares a bill of lading.
• The bill of lading is a formal contract between the seller
and the shipping company (carrier) that transports the
goods to the customer. This document establishes legal
ownership and responsibility for assets in transit.
 Shipping Department Cont…
• The shipping clerk transfers custody of the goods,
the packing slip, and two copies of the bill of
lading to the carrier, then performs the following
tasks:
– Records the shipment in the shipping log
– Sends the stock release document and the shipping
notice to the billing department as proof of shipment.
– Files one copy each of the bill of lading and the
shipping document
 5. Billing Department

• Shipping clerks forwards documentation of the

shipment to the billing function. This documentation is
termed the shipping advice and is usually the stock
copy of the sales order and a copy of the bill of lading.
• Billing pulls:
– the related open order documentation,
– verifies the order, then
– prepares the invoice by extending the charges for actual
quantities shipped, freight charges (if any) , and taxes
(if any).
• Invoices are mailed to customers.
 Billing Department Cont…
• Invoices are recorded in the sales journal and
posting copies are sent to accounts receivable.
• Sends the shipping document to the sales
department to close the open customer file.
• Periodically, a journal voucher is prepared and
forwarded to the general ledger function for
posting to the general ledger.
• The sales journal is a special journal for recording
sales transactions.
• Each sales invoice is entered in the journal as a
separate item.
 6. Accounts Receivable Department

• The accounts receivable department posts from

the ledger copy of the sales order to the customer
accounts in the accounts receivable subsidiary
ledger.
• Each ledger copy of the sales order increases a
customer’s account for the full amount of the sale.
• After posting, the A/R clerk files the ledger copy.
• Periodically, the clerk summarizes the individual
account balance into a single figure and sends this
to the general ledger.
 7. General Ledger Department

• By the close of the processing period, the general

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

Overview
• Accounts receivable represents that money
owed/payable by customers for merchandise sold or
services rendered.
• Since most of the sale in modern business made on
credit, accounts receivable often represents the
majority of an organization's working capital.
• Accounts receivable also maintains customer credit
and payment history information, which is useful in
the overall administration of company credit policies.
• Account receivable systems includes the followings.
 1. Cash Receipts Department

• The mail room under cash receipt department receives

customer’s check along with a source document called the
remittance advice.
• The remittance advice is a portion of the original invoice
used to bill the customer.
• When payment is made, the customer tears off the
remittance advice portion and return it to the seller with
the cash payment.
• The cashier verifies the accuracy and completeness of the
checks against the remittance advice.
• After reconciling, the cashier records the cash receipts in
the cash receipts journal.
 Cash Receipts Department Cont…
• Next, the clerk progress a bank deposit slip in
triplicate showing the total amount of the day’s
receipts and forwards the checks and two copies of the
deposit slip to the bank.
• Upon the deposit of the funds, the bank teller validates
the deposit slip and returns a copy to the controller.
• Customer remittance slips are then forwarded to
account receivable for posting from cash receipts
department.
• Accounts receivable does not have access to the cash
or checks that accompany customer remittance.
 2. Billing

• Invoices, credit memos, and other invoice

adjustments are routed to accounts receivable for
posting to the customer accounts. This maintains a
separation of functions.
• Billing does not have direct access to the accounts
receivable records.
 3. Accounts Receivable

• A company is responsible for maintaining the

subsidiary accounts receivable ledger.
• A control account is maintained in the general
ledger department.
• Periodic processing also includes the preparation
of an aged trial balance of the accounts receivable
subsidiary ledger for review by the credit
department.
• Other types of customer credit reports may be
prepared based on the needs of the company.
 4. Credit

• Credit department functions in an accounts

receivable application system include:
– approval of sales returns and allowances and
other adjustments to customer accounts,
– the review and approval of the aged trial
balance to ascertain customer’s credit
worthiness, and
– the initiation of write-off memos to charge
accounts to bad-debt expense.
 5. General Ledger

• General ledger maintains the accounts receivable

control account.
• Debits and credits are posted to the accounts
receivable control account from the journal
vouchers/control totals received from billing and
cash receipts.
• These amounts are reconciled to the control totals
sent to the general ledger directly from accounts
receivable, this reconciliation is an important
control in the accounts receivable application
system.
 6. Write-off of Accounts Receivable

• The central feature in a write-off procedure is an

analysis of past due accounts, usually done with
an aged trial balance.
• Numerous techniques are available to collect past
due accounts (e.g., follow-up letters, collection
agencies), but some accounts are ultimately
worthless.
• In this case the credit manager initiates a write-
off, which is approved by the treasure.
 Cash Receipts Application System

Overview
• This is an application system used to control the flow
of information and documents regarding cash receipts.
• Most of a company’s cash receipts are generated
though sales.
• Sales, of course, may be made either for cash or on
account.
• Although sales accounts are handled through the
company’s billing and collection system, the end
product of sales on account and subsequent billings is
the receipt of cash.
 1. Cash Received on Account Application System

• In order to have appropriate internal control on receipt of

cash the company should separate the followings
functions.
A. Mailroom
• Customer remittances on account are received in the
mailroom.
• The mail is opened and the checks and remittance
advices are separated.
• Checks are restrictively endorsed and totaled.
• A remittance list that documents the payments received
is prepared.
 B. Cash Receipts

• The basics objective in any cash receipts

application is to minimize exposure to loss.
• Procedures such as immediate deposit of receipts
intact centralization of cash handling, maintenance
of minimal cash balances and immediate recording
of cash transactions are fundamental control
techniques.
• Physical safeguards such as cash registers, vaults,
immediate endorsement of checks, and limited
access to cash areas are generally necessary as well.
 C. Accounts Receivable

• The remittance advices are posted to the accounts

receivable ledger.
• The postings to the ledger are totaled.
• The control total is balanced to the remittance list.
• The agreement of these amounts is approved.
• The remittance advices are sorted and filed by
customer.
• The remittance list and a copy of the control total of
postings are filed by date.
• A copy of the control total is forwarded to the general
ledger.
 D. General Ledger

• The journal voucher from cash receipts and the

control total received from accounts receivable are
compared.
• The amounts are then posted to the general ledger.
• The source of posting the general ledger is the
cashier’s journal voucher notification of the
amount of the deposit of the payments received.
• This amount must agree with the total of items
posted to the accounts receivable ledger.
• The journal voucher and the control total are filed
by date.
 E. Bank

• The bank accepts the deposit and validates a copy of

the deposit slip.
• The validated copy of the deposit slip is returned to
Internal audit.
• The validated deposit slip is filed by date.
F. Internal Audit
• Internal audit receives the periodic bank statement.
• Independent bank reconciliation is a significant
control in a cash-received on account application
system.
 Internal Audit Cont…

• To control incoming cash received through the mail, it is

important that no one in the mailroom (where the
correspondence is opened), in the cashier’s office (where the
money is summarized and a deposit prepared), or in the
accounts receivable section (where the assert reduction is
recorded) has complete control over the transaction.
• In many systems, the invoice or statement that is sent to a
customer is prepared in such a way that the portion with the
name and address of the customer is returned with the
payment.
• This is common with telephone, utility, and department store
invoices, and provides good documentation for the payment
 Internal Audit Cont…
• The source of posting the general ledger is the journal
voucher notification issued by the cashier indicating
the amount of the deposit of cash receipts.
• This amount must agree with the accumulated total of
the items posted to the subsidiary receivable file.
• Validated copies of the deposit slip go to the internal
auditor, who uses them when reconciling the bank
account.
• The control of actual cash (as opposed to checks)
received by mail relies largely on direct supervision.
 2. Cash Sales Application System

• The significant difference between a cash sales

application system and cash received on account
application system is that there is no previous asset
record (customer account balance) in a cash sales
system.
• The generation of initial documentation is thus the
focal point of the control system.
• Once a record has been prepared, cash sales are
subject to accounting control.
• The major feature of this system is the separation of
the following functions:
 a/ Finished Goods

• The finished goods department has custody of the

assets that are available for sale to customers.
• Sales to customers are documented on sales
orders.
• A sales order indicates the amount due for the
purchase as well as the inventory control numbers
of the items being sold.
 b/ Cash Receipts

• The customer takes a copy of the sales order to cash

receipts.
• The cash receipts department :
• records the sale in a cash register or other secure device,
• accepts the customer’s payment, and
• issues a sales receipt (two copies) to the customer.
• Number files the sales order.
• At the end of the day, the daily cash summary is generated
and includes a control total of the day’s cash sales.
• One copy of this total is forwarded to the general ledger:
the other copy is filed by date.
 c/ Billing

• Sales orders are reviewed by reasonableness and

posted to the sales journal.
• Any inventory control information contained on
sales could be processed at this point.
• A journal voucher is prepared to summarize cash
sales.
• The sales orders are filed by date.
• The journal voucher is forwarded to general
ledger.
 d/ General Ledger

• The journal voucher from the billing department and the

control total received from the cash receipts department are
compared.
• The amounts are then posted to the general ledger.
• Note that the source of posting the general ledger is the journal
voucher notification by billing indicating the amount of sales
orders received.
• This amount must agree with the total of the cash received
from customers by cash receipts.
• Finished goods do not release goods until the customer returns
from the cash receipts department with a sales receipt.
• The goods are released with the sales receipt.
• A copy of the sales receipt is filed in the finished goods
department.
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