MODULE 2

Run the Business? Do things Right!!

Introduction

In Module 1, you learned the transaction processes, where you were

given a discussion on the dynamics of transaction occurrence, processing and
the transaction cycles.

After having acquired the required background in processing

transactions of organizations, it is now time to take a closer look at one of the
transaction cycles, the revenue cycle.

The accounting information regarding revenue recognition cycle is

composed of five (5) segments / transactions:
1. Sales order
2. Credit Verification
3. Shipping
4. Billing / Accounts receivable
5. Cash receipts / collections

Activities involved in the revenue cycle are:

1. Sales order is taken from customers (regular or prospective).
2. Credit worthiness of the customers is evaluated by credit and
collection personnel.
3. Approved sales order is invoiced and shipped to customers.
4. Statement of accounts is sent to account customers.
5. Official receipt is issued for collection from customers.

Based on the foregoing activities, what happens if cash is not collected

from account customers? What happens to the revenue cycle flow? Will it stop
or move on?

Managers, auditors and accountants alike, what are your roles when it
comes to the efficiency and effectiveness of the revenue generation of the
company? Remember, it is the cash inflow that serves as the lifeblood of the
business.
Page 1 of 17
Learning Outcomes

At the end of this module, you should be able to:

1. Design a diagram showing the functional departments’ role in the

revenue cycle, together with the flow of activities, within the
organization.
2. Describe the documents, journals, ledgers and accounts necessary
for record keeping, audit trailing, financial and management
reporting and decision making.
3. Critically evaluate the operational and control implications of
technology as applied in reengineering and automating the revenue
cycle process.

I – The Sales Process

To give you a clear understanding of the revenue cycle, a

comprehensive illustration is provided for you:

“X Company sells imported computer parts and assembled personal

computer units in a thirty - day (30) credit term. The items which the
company sourced from China, usually take four (4) weeks to reach the
Philippines and the company warehouse. The company imports
computer units and parts in bulk. When the products arrive, the
receiving section of the company inspects and checks the quality,
condition and quantity of the items against the blank copy of their
purchase order (blind copy). When the items pass the inspection, the
receiving section personnel receives the products, signs the delivery
receipt and prepares receiving report of the items received.

Page 2 of 17
Customers of X Company most often, make phone call inquiry as to
placing their order of the computer parts or personal computer units.
Some would send customer’s order in hard copy form and others send
electronic messages through e- mail. Upon receipt of the customer’s
order, the sales employee of the sales department forwards the
customer’s order to credit department for credit verification. When the
credit department approves the customer’s order, it is returned to the
sales department, and the sales employee endorses the order to the
warehouse department together with the stock release document. The
warehouse personnel then processes the order by picking the specified
quantity of products desired by the customer, prepares the items and
then forwards the same to the shipping department. The shipping
department, before receipt of the physical goods, has already received
from the sales department the packing slip as well as the shipping
notice. The shipping department personnel reconciles the items received
from the warehouse to that of the stock release document, packing slip
and shipping notice. Afterwards, the shipping department personnel
packs the goods, attaches the packing slip and prepares the bill of
lading. Then the goods are delivered to the customer.

When the goods are already delivered to the customer, X Company then
bills him / her. The billing section personnel under the accounting office,
prepares the sales invoice to the customer upon receipt of the shipping
notice from the shipping department. Next, he / she records the sales
invoice in the sales journal, then updates accounts receivable
subsidiary file and the inventory records and finally, posts it to the
general ledger.

The company usually receives payment from the customer’s days

before the accounts become due. The customers pay directly to the

Page 3 of 17
 company, either through check or in cash. Whenever cash or check is
received, the cashier prepares a cash prelist, which is a summary of
cash and check, received for the day. It also prepares deposit slips and
makes the deposit to the company’s bank accounts. The cash prelist
and deposit slips are then transmitted to the accounting office for
reconciliation of cash prelist and deposit slip, then records it in the cash
receipts journal. After recording in the cash receipts journal, the
accounting office then updates the accounts receivable subsidiary file
and posts the summary of cash collections to the general ledger.

When customers return the product because of defects or incorrect

deliveries made by the seller, the sales personnel of X Company
receives the goods and together with the receiving personnel of the
warehouse department, they inspect the quality and condition of the
returned goods. The receiving personnel then prepares the sales return
document and transmits it to the sales personnel, who in turn, prepares
the credit memorandum. The billing section of the accounting office then
receives the credit memorandum, updates the sales returns and
allowances, and prepares journal vouchers for the returned transaction,
the inventory control account is updated together with the accounts
receivable subsidiary ledger, and the sales return journal voucher is
then posted to the general ledger.”

The illustration above describes to us the revenue cycle processes

from the point of the company receiving the customer’s order up to the point of
cash collection of the customer’s account created by the sales transaction. We
have to understand that the primary source of company’s cash flow and profit
contribution is the revenue cycle. Since this cycle supports profitability and
continuity objectives of the company, we shall be obtaining a thorough
understanding of this transactional process.

Page 4 of 17
 Essential to the understanding of the sales process is the ability to
identify the subsets of the revenue cycle. It is very important that we perform
the processes of the revenue cycle in its orderly manner because it will enhance
the operational accuracy, integrity and efficiency of the company’s system. As
mentioned, this cycle starts with the receiving of the customer’s order, verifying
the credit worthiness of the customer (for credit transactions), processing of
sales order, picking up of goods from the warehouse, shipping the goods to the
customer, billing the customer, and collecting the accounts due from the
customer. The diagram below graphically illustrates the process.

Figure 2 – 1 – The Revenue Process

Verify Credit
Worthiness

2
Customer Sales Receive
Order
1

Process Sales
Collect Accounts 3 Order
Due

7 4
Bill Customers 6 Ship Goods 5 Pick Goods

Most students of accounting and information systems would believe

that the sales process begins when the revenue is recognized, that is title to the
goods passes to the buyer from the seller. This is because we prepare formal
journal entry to record the accounts receivable created by the sales
transaction, and of course, we recognize the sales revenue account. However,

Page 5 of 17
the truth is the sales process is triggered by the receipt of the customer’s order.
When companies receive customer’s order, the sales process is initiated, and
the cycle starts. This, however, should not be confused with the revenue
recognition (from the standpoint of accounting or bookkeeping) but merely the
cycle means the Accounting Information System (AIS). The sales order is
critical to the overall AIS as it triggers the initial “step” in the overall business
process model.

The Subsets of the Revenue Process

When customers place their orders for the company’s products, the
sales department receives the purchase order (PO). The sales department then
processes the sales order. Before fulfilling the sales order further, the credit
worthiness of the customer is established. A copy of sales order is sent to the
credit department to validate the standing and the ability to pay of the
customer. The length of time that verification process of the credit department
would entail depends on whether one is a new customer of a patron. Usually,
new customers are subjected to stringent credit investigations, and are
required to submit acceptable proofs such as income tax return, statements of
account from credit card companies, copies of payslips, certificate of
employment and valid identification cards. For patrons, the usual process
involves checking the credit history and their timing of payment of accounts
due. When credit standing is determined and the customers are provided with
a credit file, with details pertaining to the credit limit, the approved copy of the
sales order is sent back to the sales function for further processing.

When an approved copy of sales order is received, the sales function

prepares the stock release document and sends it to the warehouse to facilitate
the picking – up of the goods, at the same time, it also sends to the shipping
department the packing slip and the shipping notice. Upon receipt of the stock

Page 6 of 17
release document, the warehouse clerk then picks up the goods specified in the
stock release document, records it in the stock records of the warehouse and
sends it to the shipping department. When the shipping clerk receives the
goods from the warehouse, the clerk reconciles the goods received from the
shipping notice and packing slip that it received from the sales function. After
reconciliation, the shipping clerk then packages the products, attaches the
packing slip and prepares the bill of lading, then records the shipment in the
shipping log of the shipping department and sends the goods to the customers.

After shipment, the shipping department then sends to the billing

department the shipping notice. The billing department then validates the
shipping notice with its copy of the sales order and the delivery receipt with the
receipt of goods signed by the customer, looking at the information such as
units ordered and unit price, taxes, freight charges and the likes. After
verification, the billing personnel prepares the customer’s sales invoice. At this
point, the function related to recording the sales in the journal is made and the
customer’s account receivable subsidiary file is updated together with the
inventory records through the stock release document. The general ledger is
subsequently updated through postings in the respective accounts after the
reconciliation of the journal vouchers made by the billing department and the
accounts receivable summary received from the accounts receivable
department. Although these functions are within the accounting department,
the origin of the documentation should be separate to enhance the control
mechanism of the entity. A process map below describes the flow of the
process.

Figure 2 – 2 – Process Map of the Sales Process

Customer
Place an Order Prepare Payment
Page 7 of 17
 Sales Process the Order
Department
NOT OK
Credit Verify Credit
Department Credit
?
OK
Warehouse Pick-up Goods
Department

Shipping Ship Goods

Department

Billing Bill the Customer

Department

After billing the customer, collection process now begins. If we put it

into this context, the beginning and the end of the sales process will always be
the customer. Recall that it is the customer who triggers the sales ordering
subset and the revenue cycle ends with customer payment of his account.
Oftentimes, the cashier in the cash department starts the cash receipts
procedure. Customers settle their accounts on or before maturity, such that
cash collections can occur even before the current accounts become due. When
customers pay, they bring with them the perforated bill or the statement of
account, the lower portion becomes the remittance advice. The cashier receives
cash or check when customers settle their accounts. Upon receipt of payment,
the cashier issues official receipts for the collections made, prepares the cash
collection summary also known as the remittance list. Before the day ends, all
cash and check collections are deposited in the company’s bank account, and
the deposit slip, together with the remittance advice and the remittance list, is
then sent to the accounting department for recording in the cash receipts
journal. Consequently, the remittance advice will be used to update the
customer’s accounts receivable subsidiary file. As the general ledger functions
receive the accounts receivable summary and the journal voucher from the
cash receipts, the general ledger is then updated by posting the cash collection
Page 8 of 17
transaction into the respective accounts affected (Debit Cash and Credit
Accounts Receivable for the amounts paid).

Figure 2 – 3 – Process Map of the Cash Receipts

Customer Makes Payment

Cash Receives Payment

Department

Accounting Records in Cash Updates Updates

Office Receipts Journal Customer AR File General Ledger

Activity 2 – 1
In the sales process, the origin of the transaction is the customer. In
the event when the customer is dissatisfied with the delivery of the products
ordered, or when defects were found in the deliveries, the customer returns
the products delivered. Such transaction affects the revenue cycle of the
company.
1. As this occurs, how do sales returns affect the revenue process?
2. Present or show your answer in item 1 through visual illustration,
either through a data flow diagram, a flowchart or a process map.
Activity 2 – 2
Mr. A is a customer who regularly buys products from the company,
and he always purchased these products on cash. He never had any accounts
due to the company. When the company transacts with Mr. A, the revenue
cycle immediately provides cash inflow. Using this scenario, answer the
following questions:
1. Is the sales process under this situation different from other on –
account sales process? Why?
2. Draw a graphical illustration of this cycle, using data flow diagram,
process map or document flowchart. Page 9 of 17
3. When sales return occurs in this scenario, what happens to revenue
cycle? Prepare a process map for this situation.
Automating the Revenue Cycle

The Sales Order Process

When the sales process is being automated, we have to remember that
the process itself remains the same. Only the procedures relative to the
processing of the customer order from the sales department up to the
subsequent collection of the customer’s account changes.

The procedures involved in the processing of the customer order when

sales process is being automated would vary depending on whether the
company processes the transactions either by batch or on real – time. Under
batch processing system, the customer’s order will be processed in the usual
manner, that is, it is received by the sales department, credit worthiness is
established and when credit approval is obtained, the sales order is then
released from the receive order function (sales department) to the warehouse
through the stock release document, then warehouse personnel picks up the
goods and transfers it to the shipping department. When the shipping notice is
received from the shipping department, automation commences. Take note that
it is the sales department that sends the shipping notice and the packing slip
to the shipping department even before the goods are received from the

Page 10 of 17
warehouse. Computer department staff converts or transcribes batches of
shipping notices into digital forms. These digital forms of shipping notice
become the transaction files of the sales order which are entered into the edit
run process. Erroneous sales order are separated and corrected while verified
sales order files are then posted to the accounts receivable subsidiary file,
inventory records file and the general ledger file through the direct access
update program. The process terminates when the processing reaches the end
of the transaction.

Figure 2 – 4 – Batch Technology of Sales Order Processing

Purchase Receives Goods

Customer
Order

Sales
Sales
Page 11 of 17
Order
 Department NOT OK

Credit Verifies
Credit Credi
Department
t
OK
Releases
Warehouse
Department
Stock

Shipping
Shipping Bill of
Notice
Department Lading

Transcribes
Shipping Notice AR File

Direct Access
Inventory
Computer Update
Department Sales Order File
File

Edited SO GL File
Edit Run
File

When processing is on real –time, the customer’s order is processed

when it is received separately. The sales clerk then accesses the sales order
system; checks the customer’s file that contains credit information and the
inventory records file to determine the availability of the ordered goods. When
credit is granted and there is available inventory, the sales clerk then updates
the customer’s record file to reflect the sales as well as the inventory subsidiary
file. The sales order then sends to the warehouse a digital copy of the stock
release document along with the shipping notice to the shipping department.
When the warehouse receives the digital copy of the stock release document, it
then prints the said document and picks up the goods then finally sends it to
the shipping department, together of course, with the printed stock release

Page 12 of 17
document copy. The verification begins when shipping personnel receives the
goods from the warehouse and checks it against the printed copy of the
shipping notice and the packing slip. Afterwards, the goods are then sent to the
customer, and the general ledger accounts of Sales, Cost of Sales and Inventory
are updated.

Figure 2 – 5 – Real – Time Method Using Computer Technology of Sales

Ordering Process
Purchase Receives Goods
Customer
Order

Sales Sales
Order
Department

Inventory
Subsidiary
Sales Order GL Update
Computer System and Billing
Department Customer
Data
GL Control
Accounts

Stock
Warehouse
Release
Department

Shipping Shipping Bill of

Department Notice Lading

Take note that under the real –time, updating of the accounts
receivable subsidiary record and the inventory records file are made at the
sales order system when the credit is approved and available inventory is
determined. Meanwhile, in the batch processing, updating is done usually after

Page 13 of 17
the shipping notices have been transcribed into digital form using the direct
access update.

The Cash Receipts Process

Figure 2 – 6 – Automated Cash Receipts System

Pays
Customer Receives
Customer Account
Bill OR

Receives
Official Cash Deposit
Cash
Department Payment
Receipt Prelist Slip

Accounting Updates AR
(AR)
Subsidiary
Department
File
Data Entry
Process Accounts
Receivable
Cash
Computer Receipts
Department Journal Cash Journal
Vouchers Receipts
Master File
Update Run
GL File

The collection process is usually updated through the batch

processing because cash receipts occurs discretely than that of the customer’s
order fulfilment. The usual process remains the same. The customer makes
payment to the cashier or to the authorized / designated payment center of the
company. When the accounting department (accounts receivable function)
receives the remittance advice and the remittance list (cash prelist) from the
cash department, the accounts receivable subsidiary record is then updated,
then computer processing begins for the postings of journal vouchers and cash

Page 14 of 17
receipts file into the master file. The control accounts of accounts receivable,
general ledger and the cash receipts journal are then updated.

Activity 2 – 3
We know that the company can actually expand or extend revenue
generation by taking advantage of the new technologies available. Selling
may take place using the internet aside from the traditional media.
Research and discuss the effect to the revenue cycle of the following trends
in information technology such as:
a. Process Re – engineering
b. Point – of – sale (POS) Systems
c. Electronic Data Interchange (EDI)
d. Electronic Commerce (E - Commerce)

Internal Control Implications in the Revenue Cycle

In doing the sales and revenue processes the right way, entities should
be able to establish measures that provide reasonable assurance that the
assets / resources, personnel and information are secured and safeguarded.
The revenue cycle, being the engine of cash inflow transactions in the ordinary
conduct of the business, has to have controlled activities that are conducted in
every stage of sales and collection processes to prevent the occurrence of fraud
and errors. Although internal control does not provide absolute assurance that
fraudulent activities and omissions will be eliminated, it however, deters such
occurrence, if it is appropriate and functioning as intended.

The Accounting Information System must provide adequate controls so

that the following objectives are met:
1. Transactions are properly authorized (Transaction Authorization).
2. Recorded transactions are valid and do exist or occur (Existence).

Page 15 of 17
 3. All valid, authorized transactions are accurately recorded
(Completeness).
4. Assets are safeguarded from loss or theft (Access / Physical Security).
5. Business activities are performed efficiently and effectively (Effectiveness
and Efficiency).

Required Readings:

1. Internal Control of Revenue Cycle. StudyMode.com. Retrieved August 25,

2013, from http://www.studymode.com/essays/Internal-Control-Of-
Revenue-Cycle-1423976.html

2. Internal Controls for Cash Receipts and Revenue. Amas.syr.edu.

Retrieved August 25, 2013, from
http://amas.syr.edu/AMAS/display.cfm?content_ID=%23%28%28%25-
%0A

3. Internal Control – Integrated Framework. COSO.org. Retrieved July 29,

2013.
http://www.coso.org/documents/990025P_Executive_Summary_final_m
ay20_e.pdf

4. Hall, J. (2010). The Revenue Cycle. Accounting Information Systems (pp.

163 - 205). Philippine Edition. Cengage Learning.

5. Hurt, R. (2010). Accounting Information System: Basic Concepts and

Current Issues. 2nd Edition. McGraw – Hill / Irwin (p 289-308).

Page 16 of 17
6. Simkin, M., et al (2013). Accounting Information Systems and Business
Processes: Part I. Accounting Information Systems. (pp. 179 - 206). 12 th
Edition. John Wiley & Sons, Inc.

Page 17 of 17