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ACCOUNTING INFORMATION SYSTEMSLecture 3: Revenue Cycle: Sales and Cash Collections

READING MATERIALS

Romney Chapter 12.

SUMMARY OF KEY LEARNING POINTS Basic business activities and data processing operations in the revenue cycle, including:

o Sales order entryo Shippingo Billingo Cash Collection

How IT can improve the efficiency and effectiveness of those processes. [Major threats in the revenue cycle, and evaluate the adequacy of various control procedures

for dealing with those threats]

INTRODUCTION

Questions to be answered:o What are the basic business activities and data processing operations that are

performed in the revenue cycle?

o What decisions need to be made in the revenue cycle, and what information isneeded to make these decisions?

o What are the major threats in the cycle and the controls related to those threats? Information about revenue cycle activities flow to other accounting cycles, e.g.:

o Expenditure and production cycleso Human Resources/ Payroll cycleo General ledger and reporting function

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THE REVENUE CYCLE

It is a recurring set of business activities and related information processing operationsassociated with:

o Providing goods and services to customerso Collecting their cash payments

The primary objective of the revenue cycle is to:o Provide the right amount in the right place at the right time for the right price

The primary external exchange of information is with customers The types of threats one may encounter during the revenue cycle include:

o Whether sales are realo Whether debts are collectibleo How one can safeguard cash during its influx during the revenue cycle

Four basic business activities are performed in the revenue cycle:o Sales order entryo Shippingo Billingo Cash collection

SALES ORDER ENTRY Sales order entry is performed by the sales order department Steps in the sales order entry process include:

o Taking a customers ordero Checking a customers credito Checking the availability of inventoryo Responding to a customers inquiry

May be done by customer service or a sales order entry

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The sales order form (paper or electronic) indicates:o The items code (item number)o Quantitieso Priceso Salesperson

(See Lecture Slides for an example)

Essentially a document for

internal instructionpurposes

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APPROVING CREDIT

Credit sales should be approved before the order is processed any further There are two types of credit authorization

o General authorizationo Specific authorization

General authorisation For existing customers below their credit limit who do not havepast-due balances

Credit limit varies between customers based on their past historyand ability to pay

General authorisation involves checking the customer master fileto verify the customers account and status

Specific authorisation For customers who are:o New; oro Existing but with past due balances or orders which

would exceed their credit limit

Specific authorisation is given by the credit manager, whoreports to the treasurer.

MONITORING ACCOUNTS RECEIVABLE

Question: How can we ensure that credit limits are being followed? Some customers will end up not paying off their accounts AnAccounts Receivable Aging Reportis useful in monitoring AR

o Lists customer account balances by length of time outstandingo (See Figure 12-7 in Romney (at 360))

Need to ensure:o Regular basis creditworthiness of creditorso Procedures on what to do should customers fail to pay upo Methods of reducing risks or enhancing liquidity

CHECKING INVENTORY

The next step is to ensure that there is sufficient inventory to fill the order and advise thecustomer of the delivery date

The sales order cleck can usually reference a screen displaying:o Quantity on hando Quantity already committed to otherso Quantity on order

If there are enough units to fill the order:

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CUSTOMER ENQUIRIES

There is also a need to respond to customer inquiries:o May occur before or after the order is madeo The quality of this customer service can be critical

to the companys success

IT should be used to automate responses to routinecustomer requests. E.g.,:

o Providing telephone menus or websites that leadcustomers to answers about:

Account balances Order status FAQs

o Online chat or instant messaging These methods free up customer service reps to deal with

less routine issues

SHIPPING

The process consists of two steps:o Picking and packing the ordero Shipping the order

The warehouse typcially picks the order The shipping department packs and ships the order Both functions include custody of inventory and ultimately report to the VP of

Manufacturing

PICK&PACK

Complete the sales

order

Update thequantity available

field in theinventory file

Notify thefollowingdepartments of thesales:

-Shipping

-Inventory

-Billing

Send anacknowledgementto the customer

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The picking ticket is printed by sales order entry and triggers the pick-and-pack process The picking ticket identifies:

o Which products to picko What quantity

Warehouse workers record the quantities picked on the picking ticket, which may be a paperor electronic document.

The picked inventory is then transferred to the shipping department

Example:

Technology can speed the movement of inventory and improve the accuracy of perpetualinventory records:

o Bar code scanners and RFID systemso Conveyer beltso Wireless technology- workers can receive instructions without returning to dispatcho Radio frequency identification (RFID) tags:

Eliminate the need to align goods with scanner Allow inventory to be tracked as it moves through the warehouse Can store up to 128 bytes of data NB: For companies that handle large volumes of merchandise, like Federal

Express and UPS, RFID's ability to reduce by even a few seconds the time it

takes to process each package can yield enormous cost savings.

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SHIPPING

The shipping department compares the following quantities:o Physical count of inventoryo Those indicated on the picking ticketo Those on the sales order

The shipment is accompanied by:o Packing slipo Shipping documents (these are all or)

Bill of lading A legal contract that defines responsibility of goods in transit

E.g., carrier; source; destination; any special shippinginstructions; who pays the carrier (customer or vendor)

Freight bill A document stating how much a customer pays the carrier

NB: Sometimes the freight bill doubles as a bill of ladingDelivery order Order given by an owner of goods to a person in possession of

them (the carrier or warehouseman) directing that person to

deliver the goods to a person named in the order

Other copies of the shipping documents (e.g., bill of lading) are:o One is kept in shipping to track and confirm deliveryo Sent to billing to trigger an invoiceo Retained by the freight carrier.

Proof of delivery

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Examples:

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For filing and shipping, there are a few important decisions to be made, i.e.:Choice of delivery method Some companies maintain a fleet of trucks

Companies increasingly outsource to commercial carriersLocation of distribution centres Customers want suppliers to deliver products only when needed

JIT modelPotential complications E.g., tax and regulations

E.g., efficiency of different modes of transportation (rail v truck)BILLING

Ths activity involves two taskso Invoicingo Updating accounts receivable

Accurate and timely billing is crucial Billing is an information processing activity that repackages and summarises information

from the sales order entry and shipping activities Requires information from:

o Shipping Departmenton items and quantities shippingo Sales on prices and other sales terms

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INVOICING

The basic document created is a sales invoice The invoice notifies customers of:

o The amount to be paido Where to send payment

Invoices may be sent/received:o In paper formo By EDI

Common for larger companies Faster and cheaper than snail mail

Example:

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MAINTAININGACCOUNTSRECEIVABLE

The accounts receivable function reports to the controller Function performs two basic tasks:

o Debits customer accounts for the amount the customer is invoicedo Credits customer accounts for the amount of customer payments

Two ways to maintain accounts receivableo Open-invoice methodo Balance forward method

OPEN INVOICE METHOD

Customers pay according to each invoice Two copies are typically sent to the customer

o Customer is asked to return one copy with paymento This copy is a turnaround documentcalled a remissence advice

Advantage Disadvantage

Conducive to offering early-payment discounts Results in a more uniform flow of cash collections More complex to maintain

BALANCE FORWARD METHOD

Customers pay according to the amount on their monthly statement, rather than by invoiceo Customers are asked to return stub (which serves as the remittance advice)o Remittances are applied against the total balance rather than a specific invoice

Advantage Disadvantage

More efficient and reduces costso Need not account for each indiv sale

More convenient for cust to make one mthly paymt Uneven flow of cash collections

o Need larger working capital

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Example for Balance Forward Method:

Cycle billing is commonly used with the balance method. Monthly statements are prepared for subsets of customers at different times

Example:

Bill customers according to the following schedule:

1st week of monthLast names beginning with A-F 2nd week of monthLast names beginning with G-M 3rd week of monthLast names beginning with N-S 4th week of monthLast names beginning with T-Z

Image processing can improve the efficiency of managing customer accountso Digital images of customer remittances and accounts are store electronically

Exception procedures: Accounts adjustments and write-offso Adjustments to customer accounts may need to be made for:

Returns

Allowances for damaged goods Write-offs as uncollectible

o These adjustments are handled by the credit manager Credit memos are issued by the credit manager:

o To authorise crediting a customers account (returns, errors, dmged goods) o Credit memos of this type are external documents

External Memo Given to a client

Internal Memo NOT sent to client

E.g., If repeated attempts to collect payment fail, the creditmanager may issue a credit memo to write off an account.

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Distribution ofexternal credit memos:o One copy to accounts receivable to adjust customers accounto One copy to customer (only for sales return/ errors/ damaged goods)

NOT for internal write-offsExample of a external credit memo:

CASH COLLECTION

The final activity in the revenue cycle Cashier:

o Reports to the treasurero

Handles customers remittances and deposits them in the bank As cash and cheques are highly vulnerable, controls should be in place to discouage theft

o Accounts receivable personnel should not have access to cash (including cheques) Possible approaches to collecting cash:

Turnaround documents

forwarded to accounts

receivable

Mail-room opens customer envelopes and forwards to AReither:

o Remittance adviceso Photocopies of such adviceso A remittance list prepared by them

Lockbox arrangements

(with bank) Cust remits payments to banks P.O. box Bank then sends company:

o Remittance adviceso Electronic list of remittanceso Copies of checks

Advantageso Prevents theft by company staffo Improves cash flow mgmt

Lockboxes are regional (reduces time in mail Checks are deposited immediately on receipt Foreign banks can be utilized for intl cust

Electronic lockboxes Upon receiving and scanning cheques, bank immediatelysends a electronic notification to the company, incl:

o Customer account numbero Amount remitted

Electronic funds

transfer and bill Customers remit payment electronically to companys bank

o Eliminates mailing delays

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payment Typically done through banking systems Automated ClearingHouse network

o NB: Some banks dont have EDI and EFT capabilities,which complicates the task of crediting the

customers account on a timely basis

Financial electronic

data interchange (FEDI)

Integrates EFT with EDI Remittance data and fund transfer instructions are sent

simultaneously by the customer

Requires both the buyer and seller to use EDI-capable banksAccept credit cards or

procurement cards

from customers

Speeds collection because credit card issuer usually transfersfunds within two days

Typically costs 2-4% of gross sales priceNB: EDI = Electronic Data Interchange; EFT = Electronic Funds Transfer

CASHRECEIPT

Cash receipt note may be issued to payee for receipt of cash Numbered codes used for cash book recording of cash receiptExample:

BANKDEPOSITSLIP/BANK-INSLIP

Banks also issue notes when you bank-in cashExample:

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PARTIAL ORG CHART FOR UNITS INVOLVED IN REVENUE CYCLE

Sales Order Takes customers orders Authorises credit for existing customers with good standing Checks availability of inventory

Customer Service

Responds to customers requests/inquiries

Warehouse Picks the orderShipping Packs the order

Ships the orderBilling Invoices customersAccounts Receivable Maintains customers accounts

o Increases AR when sales are madeo Decreases AR when payments are made

Credit Manager Approves credit for new customers/ existing ones with issues Authorises credit for customers for write-offs, returns, allowances

Cashier Deposits cash received from customers

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THREATS DURING THE REVENUE CYCLE

Sales Order

Entry Incomplete/ inaccurate cust orders

o Inefficient; custs unhappy Data entry ctls (completeness checks) Automatic ref of data Reasonable tests (e.g., qty) against past orders

Sales to cust with poor credito Uncollectible sales Proper authorisation limits/ channelso Credit limits

o General v specific authorisation Read-only access to cust data (for sales) Updating list of cust balances/ credit limits

Illegitimate orderso Cannot make gd decisions Signed purchase ordero Digital signature; certificates

CVC code (back of credit card) Paypal E-mail confirmations of transactions

Stockouts, carrying costs, markdownso Run out of goods; lose saleso Excess; carrying costs

Accurate inventory ctrl + sales forecast sys Online changes recorded in real-time Periodic physical checks Regular review of sales forecasts

Shipping Shipping errorso Lost sales; custs unhappyo Loss of assets

Enter qty being shipped before actual shipment Bar-code scanners + RFID Application ctrls in data entry Packing slip and bill of lading printed after

accuracy has been verified

Theft of inventoryo Loss of assetso Inaccurate inv records

Keeping inv in safe location with restricted access Transfers to be documented Released for shipping only w approved orders Sign-in/ out for those handling inv Wireless + RFID for real-time tracking Physical counts made periodically Hold employees accountable for shortages

Billing Failure to bill custso Loss of assets and revo Inaccurate data

Segregate shipping + billing functions Sequentially numbering docs Ensure every shipment is recorded

Billing errorso Loss of assetso Cust unhappy

Retrieve prices from inv master file Avoid qty errors; check against packing slip Bar code scanners

Errors in maintaining cust acctso Cust unhappy; loss of saleso Encourages theft

Edit checks (validity checks etc.) Batch totals to detect posting errors Compare no. of a/c updated w no. of cheques Recon performed by independent party Mthly statements to every customer

Cash

Collection Theft

o Loss of cash Segregation of dutieso Handling cash v posting to a/co Handling cash v aut credit memoso Aut credit memo v posting to a/c

Use lockbox arrangements, EDI, EFT etc. Prompt documentation/ rest endorsements Two people opening mail Remittance data sent to AR while cash sent to

cashier

Balancing Cr to AR with Dr to Cash Sending Remittance list to internal auditing Cust mthly statemt+ benefits to check receipts Cash registers

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Depositing cash in bank daily Bank recon done by independent party

General Loss or alteration or unauthoriseddisclosure

o Errors in ex/int reportingo Companys existence (AR)o Confidentiality

Sales files etc. backed up regularly Disks and tapes have ext and int files Access controls to data minimised

o E.g., read-onlyo Encryption of sensitive info

SSL for secure customer comm Parity checks, ack measures etc.

Poor performance Prepare and review performance report