Chapter 4: The Revenue Cycle This Chapter is organized into two primary

sections.

The first section presents the conceptual

Learning Objectives:
revenue cycle.
After studying this chapter, we should be able
CONCEPTUAL REVENUE CYCLE
to
 It provides an overview of key
 Understand the fundamental tasks
activities, the logical tasks, sources
 Be able to identify functional
and uses of information, and the
departments
movement of accounting information
 Be able to specify the documents,
through the organization.
journals, and accounts
 Understand the risks The second section examines physical
 Be aware of the operational and revenue cycle systems.
control
PHYSICAL REVENUE CYCLE SYSTEMS
Economic enterprises, both for-profit and
 All physical systems are composed, to
not-for-profit, generate revenues through
varying degrees, of technology and
business processes that constitute their
human activity. This section reviews
revenue cycle. In its simplest form, the
system options that lie at different
revenue cycle is the direct exchange of
points on the technology/human
finished goods or services for cash in a single
continuum.
transaction between a seller and a buyer.
Two objectives drive this discussion.
There are 2 phases splits in the revenue
transaction: The first is to illustrate system functionality,
efficiency issues, and workflow characteristics
1. Physical Phase
of different technologies.
- Involving the transfer of assets or
services from the seller to the The second is to demonstrate how internal
buyer. control issues differ between systems at
2. Financial Phase various points on the technology/human
- Involving the receipt of cash by continuum.
the seller in payment of the
As part of this discussion, we examine in
accounts receivable.
detail basic technology systems, advanced
As a matter of processing convenience, most integrated systems, and point-of-sale (POS)
firms treat each phase as a separate systems. We conclude this chapter with an
transaction. Hence, the revenue cycle actually introduction to electronic data interchange
consists of two major subsystems: (EDI) and Internet sales system.

2 major subsystems:

1. The sales order processing subsystem

2. Cash receipts subsystem
THE CONCEPTUAL SYSTEM Explanation: Receive Order

Overview of Revenue Cycle Activities - Orders may arrive by mail, by

telephone, or from a field
In this section, we examine the revenue cycle
representative who visited the
conceptually. Using data flow diagrams as a
customer.
guide, we will trace the sequence of activities
- The sales order captures vital
through three processes that constitute the
information tulad ng customer’s
revenue cycle for most retail, wholesale, and
name, address nila, account
manufacturing organizations. These are:
number, yung item’s name,
1. Sales Order Procedures number and description na
2. Sales Return Procedures nabenta, yung quantities and unit
3. Cash Receipts Procedures prices of each item sold. Pwede
rin dito I include yung financial
Service companies such as hospitals, information such as taxes,
insurance companies, and banks would use discounts, and freight charges.
different industry-specific methods. - After creating the sales order, a
Under Sales Order Procedures copy of it is placed in the
customer order file for future
 It includes the tasks involved in reference. The task of filling an
receiving and processing a customer order and getting the product to
order, filling the order and shipping the customer may take days or
products to the customer, billing the even weeks. During this period,
customer at the proper time, and customers may contact their
correctly accounting for the suppliers to check the status of
transaction. their orders. The customer order
 The relationship between these tasks file is updated each time the
are presented with the Data Flow status of the order changes, such
Diagram and described in the as credit approval, on back-order,
following section. and shipment. The customer
RECEIVE ORDER order file thus enables customer
service employees to respond
 The sales process begins with the promptly and accurately to
receipt of a customer order indicating customer questions.
the type and may or may not be a
CHECK CREDIT
physical document. At this point, the
customer order is not in a standard  Before processing the order further,
format and may or may not be a the customer’s creditworthiness
physical document. needs to be established. The
 Because the customer order is not in circumstances of the sale will
the standard format that the seller’s determine the nature and degree of
order processing system needs, the the credit check.
first task is to transcribe it into a  The credit approval process is an
formal sales order. authorization control and should be
 performed as a function separate from BILL CUSTOMER
the sales activity.
 The shipment of goods marks the
 In our conceptual system, the receive
completion of the economic event
order task sends the sales order
and the point at which the customer
(credit copy) to the check credit task
should be billed. Billing before
for approval. The returned approved
shipment encourages inaccurate
sales order then triggers the
record keeping and inefficient
continuation of the sales process by
operations. When the customer order
releasing sales order information
is originally prepared, some details
simultaneously to various tasks.
such as inventory availability, prices,
PICK GOODS and shipping charges may not be
known with certainty. In the case of
 The receive order activity forwards
back-orders, for example, suppliers do
the stock release document to the
not typically bill customers for outof-
pick goods function in the warehouse.
stock items. Billing for goods not
This document identifies the items of
shipped causes confusion, damages
inventory that must be located and
relations with customers, and
picked from the warehouse shelves. It
requires additional work to make
is also provides formal authorization
adjustments to the accounting
for warehouse personnel to release
records.
the specified items.
UPDATE INVENTORY RECORDS
SHIP GOODS
 The inventory control function
 Before the arrival of the goods and the
updates inventory subsidiary ledger
verified stock release document, the
accounts from information contained
shipping department receives the
in the stock release document. In a
packing slip and shipping notice from
perpetual inventory system, every
the receive order function. The
inventory item has its own record in
packing slip will ultimately travel with
the ledger containing, at a minimum,
the goods to the customer to describe
the data depicted in the figure.
the contents of the order. The
shipping notice will later be UPDATE ACCOUNTS RECEIVABLE
forwarded to the billing function as RECORDS
evidence that the customer’s order
 Customer records in the accounts
was filled and shipped. This
receivable (AR) subsidiary ledger are
document conveys pertinent new
updated from information provided
facts such as the date of shipment, the
by the sales order (ledger copy). Every
items and quantities actually shipped,
customer has an account record in the
the name of the carrier, and the
AR subsidiary ledger containing, at
freight charges. In some systems, the
minimum, the following data:
shipping notice is a separate
customer name; customer address;
document prepared within the
current balance; advance credit;
shipping function.
transaction date; invoice numbers;
 and credits for payments, returns, and Prepare Return Slip.
allowances.
 When items are returned, the
POST TO GENERAL LEDGER receiving department employee
counts, inspects, and prepares a
 By the close of the transaction
return slip describing the items. The
processing period, the general ledger
goods, along with a copy of the return
function has received journal
slip, go to the warehouse to be
vouchers from the billing and
restocked. The employee then sends
inventory control tasks and an
the second copy of the return slip to
account summary from the AR
the sales function to prepare a credit
function. This information set serves
memo.
two purposes.
 First, the general ledger uses the PREPARE CREDIT MEMO
journal vouchers to post to the
 Upon receipt of the return slip, the
following control accounts. Second,
sales employee prepares a credit
this information supports an
memo. This document is the
important independent verification
authorization for the customer to
control.
receive credit for the merchandise
 The AR summary figures should
returned. Note that the credit memo
equal the total debits to AR reflected
illustrated in Figure 4-8 is similar in
in the journal vouchers for the
appearance to a sales order. Some
transaction period. By reconciling
systems may actually use a copy of the
these figures, the general ledger
sales order marked credit memo.
function can detect many types of
errors. We examine this point more APPROVE CREDIT MEMO
fully in a later section dealing with
revenue cycle controls.  The credit manager evaluates the
circumstances of the return and
makes a judgment to grant (or
disapprove) credit. The manager then
SALES RETURN PROCEDURES
returns the approved credit memo to
 An organization can expect that a the sales department.
certain percentage of its sales will be
UPDATE SALES JOURNAL
returned. This occurs for a number of
reasons, some of which are as follows:  Upon receipt of the approved credit
- The company shipped the memo, the transaction is recorded in
customer the wrong merchandise. the sales journal as a contra entry. The
- The goods were defective. credit memo is then forwarded to the
- The product was damaged in inventory control function for
shipment. posting.
- The buyer refused delivery
because the seller shipped the UPDATE INVENTORY AND A/R RECORDS
goods too late or they were  The inventory control function
delayed in transit. adjusts the inventory records and
 forwards the credit memo to accounts avoided and operational efficiency is
receivable, where the customer’s greatly improved when using
account is also adjusted. remittance advices.
 Mail room personnel route the checks
UPDATE GENERAL LEDGER
and remittance advices to an
 Upon receipt of the journal voucher administrative clerk who endorses the
and account summary information, checks “For Deposit Only” and
the general ledger function reconciles reconciles the amount on each
the figures and posts to the following remittance advice with the
control accounts. corresponding check. The clerk then
records each check on a form called a
CASH RECEIPTS PROCEDURES remittance list (or cash prelist), where
 The sales order procedure described a all cash received is logged.
credit transaction that resulted in the
establishment of accounts receivable. RECORD AND DEPOSIT CHECKS
Payment on the account is due at
some future date, which the terms of  A cash receipts employee verifies the
trade determine. Cash receipts accuracy and completeness of the
procedures apply to this future event. checks against the prelist. Any checks
They involve receiving and securing possibly lost or misdirected between
the cash, depositing the cash in the the mail room and this function are
bank, matching the payment with the thus identified. After reconciling the
customer and adjusting the correct prelist to the checks, the employee
account, and properly accounting for records the check in the cash receipts
and reconciling the financial details journal. All cash receipts transactions,
of the transaction. including cash sales, miscellaneous
cash receipts, and cash received on
Open Mail and Prepare Remittance List account, are recorded in the cash
 A mail room employee opens receipts journal.
envelopes containing customer’s UPDATE ACCOUNT RECEIVABLE
payment and remittance advices. RECORDS
 The remittance advice is a form of a
turnaround document, its  The remittance advices are used to
importance is most apparent in firms post to customers’ accounts in the AR
that process large volumes of cash subsidiary ledger. Periodically, the
receipts daily. This task is greatly changes in accounts balances are
simplified when the customer summarized and forwarded to the
provides the necessary account general ledger function.
number and posting information.
UPDATE GENERAL LEDGER
Because of the possibility of
transcription errors and omissions,  Upon receipt of the journal voucher
however, sellers do not rely on their and the account summary, the general
customers to provide this information ledger function reconciles the figures,
directly on their checks. Errors are posts to the cash and AR control
 accounts, and files the journal (1) illustrate AIS functionality and
voucher. workflow patterns under different
levels of technology, and
RECONCILE CASH RECEIPTS AND
(2) demonstrate how the internal
DEPOSITS
control profile changes as the
 Periodically, a clerk from the technology/human mix changes.
controller’s office (or an employee not
BASIC TECHNOLOGY REVENUE CYCLE
involved with the cash receipts
procedures) reconciles cash receipts  This section presents examples of
by comparing the following basic technology revenue cycle
documents: (1) a copy of the prelist, systems. The computers used in these
(2) deposit slips received from the systems are independent personal
bank, and (3) related journal computers. Therefore, information
vouchers. flows between departments are
communicated via hard-copy
documents. In addition, in such
systems, maintaining physical files of
source documents is critical to the
PHYSICAL SYSTEMS audit trail. As we walk through the
various flowcharts notice that in
 Physical accounting information
many departments, after an
systems are a combination of
individual completes his or her
computer technology and human
assigned task, documents are filed as
activity. This technology/human mix
evidence that the tasks were
creates a continuum of alternative
performed.
design options. At one end of the
continuum are systems that employ
minimal technology and rely heavily
on human involvement and manual
procedures. At the other end are
advanced technology systems, which,
to a great extent, replace human
activity with automated processes. As
a general rule, smaller businesses
tend to rely less on technology and
more on manual procedures, whereas
larger companies tend to employ
advanced technologies. The nature of
the technology/human mix employed
in a particular system has a direct
bearing on the nature of internal
controls needed to control the
system.
 The objectives of this section are to