ACCOUNTING INFORMATION SYSTEMS

Lecture 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 entry o Shipping o Billing o 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 is needed 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 cycles o Human Resources/ Payroll cycle o General ledger and reporting function

THE REVENUE CYCLE

It is a recurring set of business activities and related information processing operations associated with: o Providing goods and services to customers o 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 real o Whether debts are collectible o 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 entry o Shipping o Billing o 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 order o Checking a customers credit o Checking the availability of inventory o Responding to a customers inquiry May be done by customer service or a sales order entry

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

Essentially a document for internal instruction purposes

(See Lecture Slides for an example)

APPROVING CREDIT

Credit sales should be approved before the order is processed any further There are two types of credit authorization o General authorization o Specific authorization For existing customers below their credit limit who do not have past-due balances Credit limit varies between customers based on their past history and ability to pay General authorisation involves checking the customer master file to verify the customers account and status For customers who are: o New; or o Existing but with past due balances or orders which would exceed their credit limit Specific authorisation is given by the credit manager, who reports to the treasurer.

General authorisation

Specific authorisation

MONITORING ACCOUNTS RECEIVABLE

Question: How can we ensure that credit limits are being followed? Some customers will end up not paying off their accounts An Accounts Receivable Aging Report is useful in monitoring AR o Lists customer account balances by length of time outstanding o (See Figure 12-7 in Romney (at 360)) Need to ensure: o Regular basis creditworthiness of creditors o Procedures on what to do should customers fail to pay up o 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 the customer of the delivery date The sales order cleck can usually reference a screen displaying: o Quantity on hand o Quantity already committed to others o Quantity on order If there are enough units to fill the order:

Complete the sales order

Update the quantity available field in the inventory file

Notify the following departments of the sales: -Shipping -Inventory -Billing

Send an acknowledgement to the customer

CUSTOMER ENQUIRIES
There is also a need to respond to customer inquiries: o May occur before or after the order is made o The quality of this customer service can be critical to the companys success IT should be used to automate responses to routine customer requests. E.g.,: o Providing telephone menus or websites that lead customers 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 order o 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

The picking ticket is printed by sales order entry and triggers the pick-and-pack process The picking ticket identifies: o Which products to pick o What quantity Warehouse workers record the quantities picked on the picking ticket, which may be a paper or 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 perpetual inventory records: o Bar code scanners and RFID systems o Conveyer belts o Wireless technology- workers can receive instructions without returning to dispatch o 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.

SHIPPING

The shipping department compares the following quantities: o Physical count of inventory o Those indicated on the picking ticket o Those on the sales order The shipment is accompanied by: o Packing slip o 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 shipping instructions; who pays the carrier (customer or vendor) A document stating how much a customer pays the carrier NB: Sometimes the freight bill doubles as a bill of lading 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

Freight bill Delivery order

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

Examples:

For filing and shipping, there are a few important decisions to be made, i.e.: Some companies maintain a fleet of trucks Companies increasingly outsource to commercial carriers Customers want suppliers to deliver products only when needed JIT model E.g., tax and regulations E.g., efficiency of different modes of transportation (rail v truck)

Choice of delivery method Location of distribution centres Potential complications

BILLING

Ths activity involves two tasks o Invoicing o 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 Department on items and quantities shipping o Sales on prices and other sales terms

INVOICING
The basic document created is a sales invoice The invoice notifies customers of: o The amount to be paid o Where to send payment Invoices may be sent/received: o In paper form o By EDI Common for larger companies Faster and cheaper than snail mail

Example:

MAINTAINING ACCOUNTS RECEIVABLE

The accounts receivable function reports to the controller Function performs two basic tasks: o Debits customer accounts for the amount the customer is invoiced o Credits customer accounts for the amount of customer payments Two ways to maintain accounts receivable o Open-invoice method o Balance forward method

OPEN INVOICE M ETHOD

Customers pay according to each invoice Two copies are typically sent to the customer o Customer is asked to return one copy with payment o This copy is a turnaround document called a remissence advice Disadvantage More complex to maintain

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

BALANCE FORWARD METHOD

Customers pay according to the amount on their monthly statement, rather than by invoice o 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 Disadvantage Uneven flow of cash collections o Need larger working capital

Advantage More efficient and reduces costs o Need not account for each indiv sale More convenient for cust to make one mthly paymt

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 accounts o Digital images of customer remittances and accounts are store electronically Exception procedures: Accounts adjustments and write-offs o 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 Internal Memo Given to a client NOT sent to client E.g., If repeated attempts to collect payment fail, the credit manager may issue a credit memo to write off an account.

Distribution of external credit memos: o One copy to accounts receivable to adjust customers account o One copy to customer (only for sales return/ errors/ damaged goods) NOT for internal write-offs

Example of a external credit memo:

CASH COLLECTION
The final activity in the revenue cycle Cashier: o Reports to the treasurer o 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 Mail-room opens customer envelopes and forwards to AR forwarded to accounts either: receivable o Remittance advices o Photocopies of such advices o A remittance list prepared by them Lockbox arrangements Cust remits payments to banks P.O. box (with bank) Bank then sends company: o Remittance advices o Electronic list of remittances o Copies of checks Advantages o Prevents theft by company staff o 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 immediately sends a electronic notification to the company, incl: o Customer account number o Amount remitted Electronic funds Customers remit payment electronically to companys bank transfer and bill o Eliminates mailing delays

payment

Financial electronic data interchange (FEDI)

Accept credit cards or procurement cards from customers

Typically done through banking systems Automated Clearing House network o NB: Some banks dont have EDI and EFT capabilities, which complicates the task of crediting the customers account on a timely basis 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 banks Speeds collection because credit card issuer usually transfers funds within two days Typically costs 2-4% of gross sales price

NB: EDI = Electronic Data Interchange; EFT = Electronic Funds Transfer

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

Example:

BANK DEPOSIT SLIP/ BANK-IN SLIP

Banks also issue notes when you bank-in cash Example:

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 Responds to customers requests/inquiries Picks the order Packs the order Ships the order Invoices customers Maintains customers accounts o Increases AR when sales are made o Decreases AR when payments are made Approves credit for new customers/ existing ones with issues Authorises credit for customers for write-offs, returns, allowances Deposits cash received from customers

Customer Service Warehouse Shipping

Billing Accounts Receivable

Credit Manager

Cashier

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 Proper authorisation limits/ channels o Credit limits o General v specific authorisation Read-only access to cust data (for sales) Updating list of cust balances/ credit limits Signed purchase order o Digital signature; certificates CVC code (back of credit card) Paypal E-mail confirmations of transactions Accurate inventory ctrl + sales forecast sys Online changes recorded in real-time Periodic physical checks Regular review of sales forecasts 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 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 Segregate shipping + billing functions Sequentially numbering docs Ensure every shipment is recorded Retrieve prices from inv master file Avoid qty errors; check against packing slip Bar code scanners 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 Segregation of duties o Handling cash v posting to a/c o Handling cash v aut credit memos o 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

Sales to cust with poor credit o Uncollectible sales

Illegitimate orders o Cannot make gd decisions

Stockouts, carrying costs, markdowns o Run out of goods; lose sales o Excess; carrying costs Shipping errors o Lost sales; custs unhappy o Loss of assets

Shipping

Theft of inventory o Loss of assets o Inaccurate inv records

Billing

Failure to bill custs o Loss of assets and rev o Inaccurate data Billing errors o Loss of assets o Cust unhappy Errors in maintaining cust accts o Cust unhappy; loss of sales o Encourages theft

Cash Collection

Theft o

Loss of cash

General

Loss or alteration or unauthorised disclosure o Errors in ex/int reporting o Companys existence (AR) o Confidentiality

Poor performance

Depositing cash in bank daily Bank recon done by independent party Sales files etc. backed up regularly Disks and tapes have ext and int files Access controls to data minimised o E.g., read-only o Encryption of sensitive info SSL for secure customer comm Parity checks, ack measures etc. Prepare and review performance report