CHAPTER 12

THE REVENUE CYCLES: SALES TO CASH COLLECTIONS

Learning Objectives:
1. Describe the basic business activities and related information
processing operations performed in the revenue cycle.
2. Discuss the key decisions that need to be made in the revenue
cycle, and identify the information needed to make those
decisions.
3. Identify major threats in the revenue cycle, and evaluate the
adequacy of various control procedures for dealing with those
threats.
Questions to be addressed in this chapter include:
1. How could AOE improve customer service? What information does
marketing need to perform its tasks better?
2. How could AOE identify its most profitable customers and markets?
3. How can AOE improve its monitoring of credit accounts? How would
any changes in credit policy affect both sales and uncollectible
accounts?
4. How could AOE improve its cash collection procedures?

Introduction
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.
Refer to Figure 12-2 on page 332 for the context diagram of the
revenue cycle

Revenue Cycle Business Activities

Figure 10-3 on page 372 shows the four basic business activities
performed in the revenue cycle.
1. Sales order entry
2. Shipping
3. Billing
4. Cash collections

Sales Order Entry

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The revenue cycle begins with the receipt of orders from

customers.
Figure 12-5 on page 337 shows that the sales order entry process
entails four steps:
1. Taking the customers order
2. Checking and approving customer credit
3. Checking inventory availability
4. Respond to customer inquiries
Taking Customer Orders
Normally, this order document is electronically displayed on a
computer monitor screen.
Orders can be received in the store, by mail, by phone, over
a Web site, or by a salesperson in the field.
Web sites provide another way to automate sales order entry.
Online order information can be automatically routed to the
warehouse to generate picking and shipping instructions.
Of course, once you order from a company over the Internet,
you will most likely start receiving subsequent commercials
via e-mail.
If you have ever ordered from Amazon.com; when you bring up
their Web site, it should have your personal page that
displays items you have purchased and items you may be
interested in.
Figure 12-6 on page 338 provides a typical sales order entry
screen.
Credit Approval
Most business-to-business sales are made on credit. Credit
sales should be approved before they are processed.
Each customer will have a credit limit. Credit limit is the
maximum allowable account balance for each customer based on
the customers past credit history and ability to pay.
Figure 12-7 on page 340 shows the information typically
available for this purpose: the customers credit limit,
current balance, and age of any outstanding unpaid invoices.
Checking Inventory Availability
The next step is to determine if there is sufficient
inventory available to fill the order.
Figure 12-9 on page 341 shows an example of the information
that is usually available to the sales order entry clerk

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When there are not sufficient items on hand to fill the

customers order, a back order is created
Once the item(s) become available, a picking ticket is
created.
The picking ticket authorizes the inventory control
function to release merchandise to the shipping
department.
The accuracy of inventory records is important because
customers may become justifiably upset when unexpected
delays occur in filling their orders.
Responding to Customer Inquiries
Step 1.4 in Figure 12-5 back on page 337 shows that the
sales order entry process includes responding to customer
inquiries.
Customer services is so important that many companies use
special software packages, called Customer Relationship
Management (CRM) systems, to support this vital process.
The goal of customer relationship management is to retain
customers.
This is important because a general marketing rule of
thumb is that it costs at least five times as much to
attract and make a sale to a new customer as it does
to make a repeat sale to an existing customer.
Transaction processing technology can also be used to
improve customer relationships. For example, many commercial
POS systems can link not only with the inventory file but
also with the customer master file.
This not only automatically updates accounts
receivable balances but provides an opportunity to
print customized coupons and personal messages on each
sales receipt, such as Thank you.
Information technology can be used to automate responses to
many customer routine inquiries.
Web sites provide a cost-effective alternative to
traditional toll-free telephone customer support, automating
that process with a list of frequently asked questions
(FAQs).
Discussion boards can also be provided so that customers can
share information and useful tips with one another.
Web sites also enable customers to use personal
identification numbers (PINs) to directly access their
account information and to check on the status of orders.

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Shipping
The second basic activity in the revenue cycle is filling
customer orders and shipping the desired merchandise. Refer
to circle 2 in Figure 12-3 back on page 333.
Figure 12-11 on page 344 provides a data flow diagram for
shipping
Shipping consists of the following two steps:
1.

Picking and packing the order

2.

Shipping the order

Pick and Pack the Order

The picking ticket printed by sales order entry
triggers the pick and pack process.
Some of the investments companies have in automated
warehouse systems include computers, bar-code
scanners, conveyer belts, and communications
technology
Radio-Frequency Identification (RFID) replaces the bar
codes. The RFID tag eliminates the need to align items
with scanners; instead, the tags can be read as the
inventory moves throughout the warehouse.
Ship the Order
The shipping department compares the physical count of
inventory with the quantities indicated on the picking
ticket and with the quantities indicated on the copy of
the sales order that was sent directly to shipping from
sales order entry.
The packing slip lists the quantity and description of
each item included in the shipment.
The bill of lading is a legal contract that defines
responsibility for the goods in transit.
Figure 12-13 on page 347 provides a sample of a bill of
lading.
If the customer is to pay the shipping charges, the copy
of the bill of lading may serve as a freight bill, to
indicate the amount the customer should pay to the
carrier.
One major decision that needs to be made when filling and
shipping customer orders concerns the choice of delivery
method.

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Another important decision concerns the location of

distribution centers.
RFID systems can provide real-time information on
shipping status and thus provide additional value to
customers.
Billing
The third basic activity in the revenue cycle, shown in
circle 3.0 in figure 12-3 on page 333, involves billing
customers.
Figure 12-14 on page 348 provides a data flow diagram of
invoicing and accounts receivable.
Invoicing
The document created in the billing process is the
sales invoice, which notifies customers of the amount
to be paid and where to send payment.
Figure 12-15 on page 349 provides an example of an
invoice.
The Grocery Manufacturers of America and the National
Association of Convenience Stores found that switching
from paper to electronic invoices cut the time it took
a convenience store manager to process each invoice
from 5 minutes to 30 seconds.
Over the course of a year, this could save more
than $100,000 in labor costs.
Maintain Accounts Receivable
The accounts receivable function uses the information
on the invoice to debit the customers accounts for
credit purchases and credit the customers accounts
when payment is received.
Under the open-invoice method, customers normally pay
according to each invoice.
The customer is asked to return a copy of the invoice
when mailing in their payment. This return copy is
referred to as the remittance advice.
Under the balance-forward method, customers typically
pay according to the amount shown on a monthly
statement.
A monthly statement lists all transactions, including
both sales and payments.
Figure 12-16 on page 351 provides an example of a
monthly statement.

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Bell Atlantic uses image processing to reduce the cost

of processing customer payments.
Bell Atlantic processes more than 11 million
customer remittances each month
They use a scanner for these remittances
in which they scan the checks.
This system costs Bell Atlantic $8
million. However, they are able to payback
this cost in only two years; achieved
through reducing costs for clerical work
and improving the accuracy of this
process.
One advantage of the open-invoice method is that it is
conducive to offering discounts for prompt payment, as
invoices are individually tracked and aged.
A disadvantage of the open-invoice method is the added
complexity required to maintain information about the
status of each individual invoice for each customers.
Under cycle billing, monthly statements are prepared
for subsets of customers at different times. For
example, the customer master file might be divided
into four parts, and each week monthly statements
would be prepared for one-fourth of the customers.
Exceptions: Account Adjustments and Write-offs
This involves either the return of merchandise by
customers for credit or the write of customers who do
not pay their bill.
Figure 12-17 on page 352 provides an example of a
credit memo.
After repeated attempts (at least three attempts in
three month period) to collect payment have failed,
may be necessary to write off a customers account.
such cases, the credit manager issues a credit memo
authorize the write-off.

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Cash Collections
The final step in the revenue cycle is cash
collections. Refer to circle 4.0 in Figure 12-3 back
on page 333.
The cashier handles customer remittances and deposits
them in the bank.
A remittance list provides the names and amounts of
all customer remittances, and sends it to accounts
receivable.
A lockbox is a postal address to which customers send
their remittances. The participating bank picks up the
checks from the post office box and deposits them to
the companys account.
Under an electronic lockbox arrangement, the bank
electronically sends the company information about the
customer account number and the amount remitted as
soon as it receives and scans those checks.
With electronic funds transfer (EFT), customers send
their remittances electronically to the companys bank
and thus eliminate the delay associated with the time
the remittance is in the mail system.
EFT is usually accomplished through the banking
systems Automated Clearing House (ACH) network.
EFT only involves the transfer of funds. Although
every bank can do EFT through the ACH system, not
every bank possesses the EDI capabilities necessary to
process the related remittance data. As shown in the
top panel of Figure 12-18 on page 355, many companies
have to separate the EFT and EDI components of
processing customer payments.
Electronic date interchange (EDI) is the use of
computerized communication to exchange business
data electronically in order to process
transactions.
Financial electronic data interchange (FEDI)
integrated the exchange of electronic funds transfer
(EFT) with the exchange of the remittance data;
electronic data interchange (EDI).
Figure 12-18 on page 355 provides a picture of the
difference between EDI and EFT and FEDI.
When dealing with customers who are not FEDI capable, or
with individual consumers, companies can also speed the
collection process by accepting credit cards or procurement
cards (a special type of credit card discussed in Chapter
13).

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The revenue cycles primary objective is to provide the right

product in the right place at the right time for the right price.
To accomplish that objective, management must make the
following key decisions:
1. To what extent can and should products be customized
to individual customers needs and desires?
2. How much inventory should be carried, and where should
that inventory be located?
3. 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?
4. What are the optimal prices for each product or
service?
5. Should credit be extended to customers?
6. How much credit should be given to individual
customers?
7. What credit terms should be offered?
8. How can customer payments be processed to maximize
cash flow?

Control Objectives, Threats, and Procedures

In the revenue cycle, a well-designed accounting information
system should provide adequate controls to ensure that the
following objectives are met:
1. All transaction are properly authorized.
2. All recorded transactions are valid (actually occurred).
3. All valid, authorized transactions are recorded.
4. All transactions are recorded accurately.
5. Assets, (cash, inventory, and data) are safeguarded from
loss or theft.
6. Business activities are performed efficiently and
effectively.
Table 10-1 on page 392 lists the major threats in the revenue
cycle and the appropriate control procedures that should be in
place to mitigate them.

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Sales Order Entry

The primary objectives of the sales order entry process are
to accurately and efficiently process customer orders,
ensure that the company gets paid for all credit sales and
that all sales are legitimate, and to minimize the loss of
revenue arising from poor inventory management.
The following is Threats 1 through 4 listed for sales order
entry in Table 10-1.
Threat 1: Incomplete or Inaccurate Customer Orders
Incomplete or inaccurate information about the customer and
their order could prove embarrassing because most likely you
will need to call that customer to get the correct
information.
Threat 2: Credit Sales to Customers with Poor Credit
A second threat in sales order entry is the possibility of
making sales that later turn out to be uncollectible.
Requiring proper authorization for each credit sale
diminishes this threat.
Segregation of duties:
Credit manager sets credit policies and approves
extension of credit to new customers and increases the
credit limit for existing customers.
Sales staff can have general authorization to approve
additional credit sales to existing customers as long
as it doesnt exceed the customers approved credit
limit.
Sales order entry checks should be granted read-only
access to information about customer credit limits.
Customer credit approval must occur before releasing
the goods from the inventory.
Threat 3: Legitimacy of Orders
Threat 4: Stockouts, Carrying Costs, and Markdowns
Sales could be lost due to stock outs.
Excess inventory means additional carrying costs and
potential markdowns.

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Shipping
The primary objective of the shipping function is to fill
customer orders efficiently and accurately, and to safeguard
inventory.
Threat 5: Shipping Errors
Shipping the wrong items or quantities of merchandise and
shipping to the wrong locations are serious errors because
they can significantly reduce customer satisfaction and thus
future sales.
Online systems can reduce the risk of shipping errors if
shipping personnel are required to enter the quantities of
items being sent before the goods are shipped.
A comparison of the shipping data to the sales order
can reduce this risk.
Threat 6: Theft of Inventory
This is the threat that an employee or customer could steal
the merchandise.
Exide, Inc., reported a loss of $3.5 million due to
employee theft.
Also, inventory can be stolen in transit. The losses are
estimated to be approximately $10 billion each year.
Several control procedures can reduce the risk of inventory
theft:
1. Inventory should be kept in a secure location and
access should be limited to responsible personnel
only.
2. All inventory transfers should be documented.
3. Inventory should be released to shipping employees
based on approved sales orders.
4. Both warehouse and shipping employees should sign
the transfer document when goods are transferred
from the warehouse to shipping.
Inventory shrinkage, a combination of employee theft,
shoplifting, vendor fraud, and administrative error, cost the
nations retailers $31.3 billion last year, according to the just
released National Retail Security Survey, which analyzed theft
incidents from 118 of the largest U.S. retail chains.
Billing and Accounts Receivable

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The primary objectives of the billing and accounts receivable

functions are to ensure that customers are billed for all sales
that invoices are accurate and that customer accounts are
accurately maintained.
Threat 7: Failure to Bill Customers
Failure to bill customers for items shipped results in the
loss of assets and erroneous data about sales, inventory,
and accounts receivable.
Segregating the shipping and billing functions can reduce
this threat.
Threat 8: Billing Errors
Billing errors, such as pricing mistakes and billing
customers for items not shipped or on back order, represent
another potential threat.
Pricing mistakes can be avoided by retrieving the data
from the master file.
Shipping the wrong quantities can be avoided by
reconciling the quantities listed on the packing slips
to that on the sales order.
Threat 9: Error in Maintaining Customer Accounts
The following edit checks should be used to ensure accuracy
in updating customer accounts:
1. Validity checks on the customer and invoice numbers
2. Closed-loop verification to ensure that the proper
account is being credited
3. A field check to ensure that only numeric values are
entered for payment amounts
Previously on an audit, we encountered a bookkeeper that
made several errors in accounts receivable. This resulted in
several accounts in which the organization could not collect
because of the inaccurate records. It ended up that several
of the customers did not have to have their balances owed.
The organization lost several thousand dollars and the
bookkeeper was fired. This is not the end of the story;
after two years and several court hearings, the organization
had to hire back this employee with back pay and all
applicable promotions. Not bad, at two years paid vacation!

Cash Collections

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The primary objective of the cash collections function is to

safeguard customer remittances.
Threat 10: Theft of Cash
The following segregation of duties should be used to reduce
this risk:
1. Handling cash or checks and posting remittances to
customer accounts
2. Handling cash or checks and authorizing credit memos
3. Issuing credit memos and maintaining customer accounts
In general, the handling of money and checks within the
organization should be minimized.
The optimal methods are a bank lockbox arrangement or
the use of EFT or FEDI for customer payments.
One main segregation is to ensure that the individual that
handles the cash does not record its collection
(remittance).
Also, dont let the cash or checks lay around the
organization too long. Get it to the bank as soon as
possible.
Segregating the recording and custody functions as follows
provides additional control:
1. Only the remittance data should be sent to the
accounts receivable department
2. With customer payments being sent to the cashier
Retail stores and organizations that receive cash directly
from customers should use cash registers that automatically
produce a written record of all cash received.
Finally, the employee who reconciles the bank statement
should be independent of all other activities involved in
handling or recording the receipt of cash.
General Control Issues
Two general objectives pertaining to all revenue cycle
activities are that accurate data be available when needed
and that all activities be performed efficiently and
effectively.

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Threat 11: Loss, Alteration, or Unauthorized Disclosure of

Data
Loss of all accounts receivable data could threaten a
companys continued existence.
Unauthorized disclosure of confidential business data, such
as marketing plans, can jeopardize the companys
competitiveness.
The master accounts receivable, sales, and cash receipts
files must be backed up regularly.
Access controls are also important. Unauthorized access
increases the risk of damage to important data files and of
disclosure of sensitive information.
Threat 12: Poor Performance
In addition to ensuring accuracy and safeguarding assets,
another objective of internal controls is to encourage
efficient and effective performance of duties.

Revenue Cycle Information Needs

Effective management of revenue cycle activities requires
timely access to accurate information.
Operational data are needed to monitor performance and to
perform the following recurring tasks:
1.

Respond to customer inquiries about account balances

and order status.

2.

Decide whether to extend credit to a particular

customer.

3.

Determine inventory availability.

4.

Select methods for delivering merchandise.

In addition, current and historical information is needed to

enable management to make the following strategic decisions:
1. Setting prices for products and services
2. Establishing policies regarding sales returns and
warranties
3. Deciding what types of credit terms to offer
4. Determining the need for short-term borrowing
5. Planning new marketing campaigns

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The accounting information system must also supply the

information needed to evaluate performance of the following
critical processes:
1.

Response time to customer inquiries

2.

Time required to fill and deliver orders

3.

Percentage of sales that required back orders

4.

Customer satisfaction rates and trends

5.

Analyses of market share and sales trends

6.

Profitability analyses by product, customer, and

sales region

7.

Sales volume in both dollars and number of customers

8.

Effectiveness of advertising and promotions

9.

Sales staff performance

10. Bad-debt expenses and credit policies

11. Days receivables outstanding
12. Remittances processed daily
Figure 12-8 on page 341 provides a sample of an accounts
receivable aging report.
Of the total accounts receivable of $198,900, 74 percent
are current. However, only 36 percent of Bakers total
balance owed of $7,060 is current. Since, Baker does not
have any balances owed that are 1 to 30 days past due, it
appears as though the $4,500 aged 31 to 60 days past due
might be a disputed balance owed.
Revenue margin equals gross margin minus all selling
costs:
1.

Payroll

2.

Commissions

3.

Salesforce travel expense reimbursements

4.

Customer service and support costs

5.

Warranty expenses

6.

Marketing and advertising expenses

7.

Distribution and delivery expenses

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Net sales minus cost of goods sold = gross margin

Support costs includes such departments and activities as
accounting and human resources.
The value of revenue margin as a metric/measurement is that
it integrates the effects of changes in sales, pricing, and
the costs associated with generating sales on overall
company operating profits.
Growth in revenue margins indicates that customers are
satisfied, productivity is increasing, or both.

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