Date Class # Topic#

9/18/2012 11 Revenue Cycle

Revenue Cycle Background Reading: 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 primary objective of the revenue cycle is to provide the right product in the right place at the right time at the right price. To meet this 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 and service? Should credit be extended to customers? If so, what credit terms should be offered? How much credit should be extended to individual customers? How can customer payments be processed to maximize cash flow? In addition, management must monitor & evaluate the efficiency and effectiveness of revenue cycle processes. This requires easy access to detailed data about the resources employed in the revenue cycle, the events that affect those resources & the agents who participate in those events. In general, the revenue cycle is made up of: (1) Sales order process (2) Cash receipts process (3) Sales return process Sales Order Process: Includes the tasks involved in receiving and processing a customer order, filling the order & shipping products to the customer, billing the customer at the proper time & correctly accounting for the transaction.

Sales Order Process - Risks and controls

Cash Receipts Process: For the revenue cycle processes discussed in cash, we assume that sales are made on credit. That is, customers order and receive the goods first, and pay for them later. The cash receipts procedures relate to this payment at a future date. 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

Cash Receipts Risks and Controls:

Sales Return Process: Organizations expect a certain percentage of sales will be returned. Returns can occur because: The company shipped the wrong merchandise The goods were defective The product was damaged in shipment The buyer refused delivery b/c the goods were shipped too late or were delayed in transit

When a return occurs, the buyer requests credit for the unwanted products. This involves reversing the previous transaction in the sales order procedure. Sales Returns Risks and Controls:

Automating the Revenue Cycle: Authorizations and data access can be performed through computer screens. There is a decrease in the amount of paper. The manual journals and ledgers are changed to disk or tape transaction and master files. Input is still typically from a hard copy document and goes through one or more computerized processes. 4

 Processes store data in electronic files (the tape or disk) or prepare data in the form of a hardcopy report. Revenue cycle programs can include: formatted screens for collecting data edit checks on the data entered instructions for processing and storing the data security procedures (passwords or user IDs) steps for generating and displaying output The documents and the files used as input sources must contain the data necessary to generate the output reports. Using Real-Time Technology Manual procedures and physical documents are replaced by interactive computer terminals. Advantages: Shortens the cash cycle of the firm by reducing the time between the order date and billing date Better inventory management which can lead to a competitive advantage Fewer clerical errors, reducing incorrect items being shipped and bill discrepancies Reduces the amount of expensive paper documents and their storage costs POS Systems Point of sale systems are used extensively in retail establishments. Customers pick the inventory from the shelves and take them to a cashier. The clerk scans the universal product code (UPC). The POS system is connected to an inventory file, where the price and description are retrieved. The inventory levels are updated and reorder needs can immediately be detected. The system computes the amount due. Payment is either cash, check, ATM or credit card in most cases. No accounts receivables If checks, ATM or credit cards are used, an on-line link to receive approval is necessary. At the end of the day or a cashiers shift, the money and receipts in the drawer are reconciled to the internal cash register tape or a printout from the computers database. Cash over and under must be recorded EDI: Electronic Data Interchange helps to expedite transactions. The customers computer: determines that inventory is needed selects a supplier with whom the business has a formal business agreement dials the suppliers computer and places the order The exchange is completely automated. 5

 No human intervention or management

Revenue Cycle CLASS NOTES: There are 3 main sub-processes of the revenue cycle: (1) (2) (3) The Sales Order Process is made up of several tasks: (1) (2) (3) (4) (5) The Sales Order Process:

(1) Receive the order from the customer Receipt of customer order i. Type & Quantity of merchandise requested 7

Completion of formal sales order i. Customer name, address, account # ii. Item #, Item name, Description, Qty sold, unit price File information in Customer Open Order File

Perform a Credit Check Before processing an order, must assess a customers creditworthiness 1. First Time Customer Full-blown credit check to establish credit limits 2. Repeat Customers Does the customer have a history of paying on time? Does the current order exceed the credit limit? What type of control is a credit check? ______________________________________ Who should perform it? ___________________________________________________ 8

 What is the output from the process? ________________________________________ (2) Filling the customer order: Pick Goods Once the approved sales order is received it triggers the Picking Ticket (e.g., stock release doc) o Identifies the items that must be picked from the warehouse shelves o Provides formal authorization to release the specific items o The order must be verified for accuracy Warehouse employees adjust stock records to reflect the reduction in inventory levels o Records are for inventory mgmt only What if there isnt enough inventory available? o Prepare a back-order

(3) Shipping Goods: The packing slip & the shipping notice are triggered by the previous sub-processes The packing slip travels with the goods to the customer The shipping notice forwarded to billing as evidence that the goods were shipped o Includes: date of shipment, items & qty shipped, name of carrier, freight charges When the shipping clerk receives the goods, he reconciles the physical items with the picking ticket & the shipping notice o Shipping function provides an independent verification Shipping clerk packages the goods, attaches the packing slip, completes the shipping notice & prepares the bill of lading. 9

o Bill of Lading: formal contract between the seller & the carrier to transport the goods o Once goods are transferred, the shipping clerk (1)records the shipment in the shipping log, (2) forwards the shipping notice to the billing function & (3) updates the customer file.

(4) Billing the Customer After the goods are shipped, it is time to bill the customer i. Billing function is notified of shipment by the shipping department The billing clerk prepares a sales invoice (the bill) to send to the customer Other functions performed by the billing clerk: i. Records the sale in the sales journal ii. Forwards a copy of the sales order to update AR iii. Sends the stock release document to update inventory

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The company must record the sale in the sales journal & update the inventory records:
SALES JOURNAL Cost of Goods Sold 51000 0

Dat e

Customer

Invoice / Document #

A/R Acct #

Accounts Receivable 121000

Sales 410000

Invento ry 145000

Sales Journal Special journal used to record completed sales Details of sales are recorded At the end of the period, entries are summarized into a sales journal voucher Sent to the accountants to be posted to the GL Accounts Receivable Sales XXX XXX

Inventory control is responsible for managing inventory Update the inventory subsidiary ledger with info from the picking ticket In a perpetual inventory system, each item is recorded in the inventory subsidiary ledger Periodically, the financial records are updated: Cost of Goods Sold Inventory PERPETUAL INVENTORY SUBSIDIARY LEDGER 145000 - R130056 Merlot Transaction Date Description Quantity Cost Balance 12/15 Forward XXXX XXXX

Extended Cost

Quantity on Hand 83,484

Total Balance 385,696.08 11

(5) Accounting for the transactions Customer records (AR subsidiary ledger) are updated from information in the sales ledger Every customer has an account record in the AR ledger: Includes: (1) customer name, (2) customer address, (3) current AR balance, (4) available credit, (5) transaction dates, (6) invoice #s, (7) credits for payments, returns, and allowances Periodically, individual accounts are summarized & update the GL

When the transaction processing period closes, journal vouchers are sent from the billing & inventory control departments The following entries are posted to the GL: AR XXX COGS XXX Inventory XXX Sales XXX

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CASH RECIEPTS PROCESS Cash Receipts Flowchart:

Open Mail & Prepare Remittance List Mail is opened in the mailroom Mail includes customer payments & remittance advices Remittance advices include: payment date, account number, amount paid, customer check # Mail clerks forward checks & remittance advices to a clerk who endorses the check FOR DEPOSIT ONLY Clerk records receipts on a remittance list all the receipts are logged & each check is listed as a separate item 3 copies of the list are prepared 1 goes with the checks to be deposited at the bank 1 goes with the remittance advices to update AR 1 goes into the reconciliation process

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Record & Deposit Checks A clerk verifies the accuracy & completeness of the checks against the remittance list How does this act as a control? After reconciling the list to the checks, the clerk records the check in the cash receipts journal Includes: cash sales, misc. cash receipts, cash received Clerk prepares the bank deposit slip Sent to the bank with the checks Cash receipts clerk prepares the following JEs: Cash XXXX AR XXX Cash Receipts Journal
CASH RECEIPTS JOURNAL Accounts Receivable 121000 Sales Discoun A/R Transacti t Acct on Sales 420000 # Amount 410000

Other Account GL Acct # Transacti on Amount Post Ref *

Dat e

Descripti on

Cash 111000

Deposit Slip

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 Remittance advices are used to update customer accounts in the AR sub ledger Periodically, the AR voucher is sent to the GL the accounts are reconciled transactions are posted to the cash & AR accounts Periodically, a clerk from the controllers function reconciles cash receipts by comparing the following: Copy of the remittance list Copy of the deposit slip from the bank Related journal vouchers SALES RETURN PROCESS Sales Return Flowchart:

When a return is needed, the buyer requests credit & Previous transactions must be reversed (1) Prepare a return slip Receiving department counts, inspects and prepares return slip, which describes items Goods & a copy of the slip go to the warehouse. 15

 2nd copy of the slip goes to the sales function where the credit memo is generated 2. Sales prepares the credit memo when they receive the return slip Credit memo authorizes the customer to receive credit for the returned merchandise Credit memos are (generally) approved by the credit manager (sometimes it may be done by the billing clerk) 3. Approve the credit memo Credit manager (or clerk) approves the return and the approved credit memo is sent to sales Update the sales journal With the approved CM, the transaction is posted to the Inventory control also updates the inventory ledger

4. sales journal Credit Memo

5. Update inventory and AR records Inventory control updates the inventory records and forwards the credit memo to AR (and adjusts the customers records) Periodically, inventory control & AR summarize the transactions and send it to GL 6. Update the GL Using the periodic summaries Inventory XXXX Sales Returns & Allowances XXXX COGS XXXX AR XXXX

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Revenue Cycle Controls Transaction Authorization : Ensures only valid transactions are processed Credit Check Return Policy Remittance List Segregation of Duties : no single individual or dept processes an entire transaction 1. Transaction authorization should be separate from transaction processing Credit department is segregated 2. Asset custody must be separate from record keeping Inventory is kept in the warehouse, but inventory control (an acct. function) records inventory levels Cash is managed by the cash receipts dept (e.g. TREASURY), while A/R (an acct function) records the cash 3. Company must be organized such that fraud requires (at least) 2 ppl. Supervision Must closely monitor/ supervise individuals with incompatible duties. Accounting Records provides audit trail Prenumbered documents every document is uniquely identified Special journals provides concise records facilitating audit trail. Subsidiary ledgers link to the journal entries and the source documents General ledgers basis for Financial Stmt prep. Files open sales order file, shipping longs, credit records, back-order file

Access Controls - prevent & detect unauthorized & illegal access to assets What are the physical assets at risk? Inventory Cash How can they be controlled? Warehouse security Depositing cash in the bank daily Using a safe or night deposit box Lock Boxes Locking cash drawers and safes Independent Verification- verifies the accuracy & completeness of tasks that other functions in the process perform 1. Shipping verifies that the goods sent from the warehouse are correct (type & qty) Stock release documents & packing slip are reconciled 2. Billing function reconciles the sales order with the shipping notice 17

3. GL is reconciled to the journal vouchers and independently prepared summaries CPA Review Question: Which of the following most likely would be the result of ineffective controls in the revenue cycle? A. Final authorization of credit memos by personnel in the sales department could permit an employee defalcation scheme B. Fictitious transactions could be recorded, causing an understatement of revenues and an overstatement of receivables C. Irregularities in recording transactions in the subsidiary accounts could result in a delay in goods shipped. D. Omission of the shipping documents could go undetected, causing an understatement of inventory.

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