Chapter 14: The Revenue Cycle: Sales to Cash Collections

The answers to those questions guide how an organization performs the four basic revenue cycle activities depicted in Figure 14-3:

1. Sales order entry. 2. Shipping. 3. Billing. 4. Cash collections.

cycle billing

Producing monthly statements for subsets of customers at different times. For example, each week monthly statements would be prepared for one-fourth of the customers.

revenue cycle

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

The second basic activity in the revenue cycle is filling customer orders and shipping the desired merchandise. As Figure 14-12 shows, this process consists of two steps:

(1) picking and packing the order and (2) shipping the order.

The revenue cycle's 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:

-To what extent can and should products be customized to individual customers' needs and desires? -How much inventory should be carried, and where should that inventory be located? -How should the merchandise be delivered to customers? -Should the company perform the shipping function itself or outsource it to a third party that specializes in logistics? -What are the optimal prices for each product or service? -Should credit be extended to customers? If so, what credit terms should be offered? How much credit should be extended to individual customers? -How can customer payments be processed to optimize cash flow?

Cash Collections: Threats and Controls Segregation of duties is the most effective control procedure for reducing the risk of such theft

1. Handling cash or checks and posting remittances to customer accounts. A person performing both of these duties could commit the special type of embezzlement called lapping that was discussed in Chapter 8. Therefore, only the remittance data should be sent to the accounts receivable department, with customer payments being sent to the cashier. Such an arrangement establishes two mutually independent control checks. First, the total credits to accounts receivable recorded by the accounting department should equal the total debit to cash representing the amount deposited by the cashier. Second, the copy of the remittance list sent to the internal audit department can be compared with the validated deposit slips and bank statements to verify that all checks the organization received were deposited. Finally, the monthly statements mailed to customers provide another layer of control because customers would notice the failure to properly credit their accounts for payments remitted. 2. Handling cash or checks and authorizing credit memos. A person performing both of these duties could conceal theft of customer payments by creating a credit memo equal to the amount stolen. The theft is concealed because the credit memo reduces the customer's balance by the amount stolen, so the customer is unlikely to notice and complain. 3. Handling cash or checks and reconciling the bank statement. An important detective control is reconciliation of the bank account statement with the balance of cash recorded in the company's information system. Having this reconciliation performed by someone who does not have access to cash or customer remittances provides an independent check on the cashier and prevents manipulation of the bank statement to conceal the theft of cash. Otherwise, the employee performing the bank reconciliation could record miscellaneous bank fees equal to the amount of cash stolen.

Cash collections Threats: 17. Theft of cash 18. Cash flow problems

17.1 Segregation of duties—the person who handles (deposits) payments from customers should not also: a. Post remittances to customer accounts b. Create or authorize credit memos c. Reconcile the bank account 17.2 Use of EFT, FEDI, and lockboxes to minimize handling of customer payments by employees 17.3 Obtain and use a UPIC to receive EFT and FEDI payments from customers 17.4 Immediately upon opening mail, create list of all customer payments received 17.5 Prompt, restrictive endorsement of all customer checks 17.6 Having two people open all mail likely to contain customer payments 17.7 Use of cash registers 17.8 Daily deposit of all cash receipts 18.1 Lockbox arrangements, EFT, or credit cards 18.2 Discounts for prompt payment by customers 18.3 Cash flow budgets

cash flow budget

A budget that shows projected cash inflows and outflows for a specified period.

back order

A document authorizing the purchase or production of items that is created when there is insufficient inventory to meet customer orders.

credit memo

A document, approved by the credit manager, authorizing the billing department to credit a customer's account. Usually issued for sales returns, for allowances granted for damaged goods kept by the customer, or to write off uncollectible accounts.

universal payment identification code (UPIC)

A number that enables customers to remit payments via an ACH credit without requiring the seller to divulge detailed information about its bank account.

Another way to speed up the processing of customer payments involves the use of a lockbox arrangement with a bank A lockbox is:

A postal address to which customers send their remittances. This Post Office box is maintained by the participating bank, which picks up the checks each day and deposits them to the company's account. The bank sends the remittance advices, an electronic list of all remittances, and digital copies of all checks to the company.

accounts receivable aging report

A report listing customer account balances by length of time outstanding. The report provides useful information for evaluating current credit policies, for estimating bad debts, and for deciding whether to increase the credit limit for specific customers.

factoring

Selling accounts receivable at a discount to a firm that specializes in collections of past-due accounts. Typically, the cost of factoring is 1%1% to 2%2% of the account balances, which may be cheaper than drawing on a line of credit.

Maintain Accounts Receivable: Threats and Controls Errors in maintaining customer accounts (threat 15 in Table 14-1) can lead to the loss of future sales and also may indicate possible theft of cash. Threat 16 listed in Table 14-1 is that an employee may issue credit memos to write-off account balances for friends or to cover up the theft of cash or inventory.

The data entry edit checks discussed in Chapter 13 can minimize the risk of errors in maintaining customer accounts (control 15.1). Proper segregation of duties (control 16.1) can reduce the risk of this threat. To prevent employees from stealing inventory by making sales to friends who are then written off, the ERP system should be configured so that the person who can issue credit memos does not also have rights to enter sales orders or to maintain customer accounts. To prevent theft of cash, the person who handles cash should not be able to issue credit memos

Maintain Accounts Receivable: Process

The two basic ways to maintain accounts receivable are the open-invoice and the balance-forward methods. The two methods differ in terms of when customers remit payments, how those payments are applied to update the accounts receivable master file, and the format of the monthly statement sent to customers.

Traditionally, customer orders were entered into the system by employees. Increasingly, organizations seek to leverage IT to have customers do more of the data entry themselves. One way to accomplish this is to have customers complete a form on the company's website. Another is for customers to use: Electronic Data Interchange (EDI)

The use of computerized communications and a standard coding scheme to submit business documents electronically in a format that can be automatically processed by the recipient's information system.

After counting the goods delivered from the warehouse, the shipping clerk enters the sales order number, item number(s), and quantities in the system. This process updates the quantity-on-hand field in the inventory master file. It also produces a packing slip and multiple copies of the bill of lading.

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All customer remittances should be deposited, intact, in the bank each day

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Another important decision concerns the location of distribution centers. Increasingly, many customers are asking suppliers and manufacturers to deliver products only when needed. Consequently, suppliers and manufacturers must use logistics software tools to identify the optimal locations to store inventory in order to minimize the total amount of inventory carried and to meet each customer's delivery requirements

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One important decision that needs to be made when filling and shipping customer orders concerns the choice of delivery method. Traditionally, many companies have maintained their own truck fleets for deliveries. Increasingly, however, manufacturers are outsourcing this function to commercial carriers such as DHL, Federal Express, Ryder System, Inc., Schneider Logistics, UPS, and YRC. Outsourcing deliveries reduces costs and allows manufacturers to concentrate on their core business activity (the production of goods)

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Sales forecasts (control 8.5 in Table 14-1) are another tool to help companies better predict inventory needs and thereby reduce the risk of stockouts or carrying excess inventory. Accountants can also prepare reports that enable sales managers to identify the need to adjust those forecasts.

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Ship the Order: Process After the merchandise has been removed from the warehouse, it is shipped to the customer.

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The primary external exchange of information is with customers.

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To be effective, credit approval must occur before the goods are released from inventory and shipped to the customer.

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Billing Threats: 13. Failure to bill 14. Billing errors 15. Posting errors in accounts receivable 16. Inaccurate or invalid credit memos

13.1 Separation of billing and shipping functions 13.2 Periodic reconciliation of invoices with sales orders, picking tickets, and shipping documents 14.1 Configuration of system to automatically enter pricing data 14.2 Restriction of access to pricing master data 14.3 Data entry edit controls 14.4 Reconciliation of shipping documents (picking tickets, bills of lading, and packing list) to sales orders 15.1 Data entry controls 15.2 Reconciliation of batch totals 15.3 Mailing of monthly statements to customers 15.4 Reconciliation of subsidiary accounts to general ledger 16.1 Segregation of duties of credit memo authorization from both sales order entry and customer account maintenance 16.2 Configuration of system to block credit memos unless there is either corresponding documentation of return of damaged goods or specific authorization by management

Usually, two copies of the invoice are mailed to the customer, who is requested to return one copy with the payment. This copy is a turnaround document called a remittance advice

A copy of the sales invoice returned with a customer's payment that indicates the invoices, statements, or other items being paid.

monthly statement

A document listing all transactions that occurred during the past month and informing customers of their current account balance.

remittance list

A document listing names and amounts of all customer payments received in the mail.

packing slip

A document listing the quantity and description of each item included in a shipment.

sales invoice

A document notifying customers of the amount of a sale and where to send payment.

Once inventory availability has been determined, the system then generates a picking ticket

A document that lists the items and quantities ordered and authorizes the inventory control function to release that merchandise to the shipping department. The picking ticket is often printed so that the item numbers and quantities are listed in the sequence in which they can be most efficiently retrieved from the warehouse.

bill of lading

A legal contract that defines responsibility for goods while they are in transit. It identifies the carrier, source, destination, shipping instructions, and the party (customer or vendor) that must pay the carrier.

General issues throughout entire revenue cycle Threat: 1. Inaccurate or invalid master data 2. Unauthorized disclosure of sensitive information 3. Loss or destruction of data 4. Poor performance

Controls: 1.1 Data processing integrity controls 1.2 Restriction of access to master data 1.3 Review of all changes to master data 2.1 Access controls 2.2 Encryption 2.3 Tokenization of customer personal information 3.1 Backup and disaster recovery procedures 4.1 Managerial reports

Sales order entry Threat: 5. Incomplete/inaccurate orders 6. Invalid orders 7. Uncollectible accounts 8. Stockouts or excess inventory 9. Loss of customers

Controls: 5.1 Data entry edit controls (see Chapter 13) 5.2 Restriction of access to master data 6.1 Digital signatures or written signatures 7.1 Credit limits 7.2 Specific authorization to approve sales to new customers or sales that exceed a customer's credit limit 7.3 Aging of accounts receivable 8.1 Perpetual inventory control system 8.2 Use of bar codes or RFID 8.3 Training 8.4 Periodic physical counts of inventory 8.5 Sales forecasts and activity reports 9.1 CRM systems, self-help websites, and proper evaluation of customer service ratings

Shipping Threats: 10. Picking the wrong items or the wrong quantity 11. Theft of inventory 12. Shipping errors (delay or failure to ship, wrong quantities, wrong items, wrong addresses, duplication)

Controls: 10.1 Bar-code and RFID technology 10.2 Reconciliation of picking lists to sales order details 11.1 Restriction of physical access to inventory 11.2 Documentation of all inventory transfers 11.3 RFID and bar-code technology 11.4 Restrict ability to cancel sales 11.5 Control creation of and shipments to "one-time" customers 11.6 Periodic physical counts of inventory and reconciliation to recorded quantities 12.1 Reconciliation of shipping documents with sales orders, picking lists, and packing slips 12.2 Use RFID systems to identify delays 12.3 Data entry via bar-code scanners and RFID 12.4 Data entry edit controls (if shipping data entered on terminals) 12.5 Configuration of ERP system to prevent duplicate shipments

open-invoice method

Method for maintaining accounts receivable in which customers typically pay according to each invoice.

balance-forward method

Method of maintaining accounts receivable in which customers typically pay according to the amount shown on a monthly statement, rather than by individual invoices. Remittances are applied against the total account balance, rather than specific invoices.

How then, does the accounts receivable function identify the source of any remittances and the applicable invoices that should be credited?

One method involves mailing the customer two copies of the invoice and requesting that one be returned with the payment. This remittance advice is then routed to accounts receivable, and the actual customer payment is sent to the cashier An alternative solution is to have mailroom personnel prepare a remittance list, which is a document identifying the names and amounts of all customer remittances, and send it to accounts receivable. Yet another alternative is to photocopy all customer remittances and send the copies to accounts receivable while forwarding the actual remittances to the cashier for deposit.

Pick and Pack the Order: Threats and Controls

One potential problem is the risk of picking the wrong items or in the wrong quantity. The automated warehousing technologies described earlier can minimize the chance of such errors. Bar-code and RFID scanners, in particular, virtually eliminate errors when they are used by the system to automatically compare the items and quantities picked by warehouse workers with the information on sales orders. Another threat involves the theft of inventory (threat 11). In addition to a loss of assets, theft also makes inventory records inaccurate, which can lead to problems in filling customer orders

Invoicing: Threats and Controls One threat associated with the invoicing process is a failure to bill customers (threat 13 in Table 14-1), which results in the loss of assets and erroneous data about sales, inventory, and accounts receivable. Billing errors (threat 14 in Table 14-1), such as pricing mistakes and billing customers for items not shipped or on back order, represent another potential threat

Segregating the shipping and billing functions (control 13.1) reduces the risk that this occurs intentionally. To reduce the risk of unintentional failure to bill, ERP systems need to be configured to regularly compare sales orders, picking tickets, and shipping documents with sales invoices to produce reports of shipments for which an invoice has not been created Billing errors (threat 14 in Table 14-1), such as pricing mistakes and billing customers for items not shipped or on back order, represent another potential threat

customer relationship management systems (CRM)

Software that organizes information about customers in a manner that facilitates efficient and personalized service.

financial electronic data interchange (FEDI)

The Combination of EFT and EDI that enables both remittance data and funds transfer instructions to be included in one electronic package.

Customer order data are recorded on a sales order document. Sales Order

The document created during sales order entry listing the item numbers, quantities, prices, and terms of the sale.

credit limit

The maximum allowable credit account balance for each customer, based on past credit history and ability to pay

electronic funds transfer (EFT)

The transfer of funds through use of online banking software. EFT also reduces the time lag before the bank makes the deposited funds available to the company. EFT is usually accomplished through the banking system's Automated Clearing House (ACH) network. EFT, however, involves only the transfer of funds. To properly credit customer accounts, companies also need additional data about each remittance, such as invoice numbers and discounts taken

Threats and Controls in the Revenue Cycle

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Cash Collections Because cash and customer checks can be stolen so easily, it is important to take appropriate measures to reduce the risk of theft. As discussed more fully in the section on controls, this means that the accounts receivable function, which is responsible for recording customer remittances, should not have physical access to cash or checks. Instead, the cashier, who reports to the treasurer (see Figure 14-1), handles customer remittances and deposits them in the bank.

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Companies can also speed the collection process by accepting credit cards or debit cards. The benefits are that the card issuer usually transfers the funds within two days of the sale and the selling company avoids the risk of uncollectible accounts. These benefits must be weighed against the costs of accepting such cards, which typically range from 2%2% to 4%4% of the gross sales price.

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Duplicate shipments result in increased costs associated with shipping and then processing the return of merchandise. To mitigate this threat, ERP systems should be configured to "block" the line items on sales orders once shipping documents are printed (control 12.5) to prevent using that same sales order to authorize another shipment of the same goods to the same customer.

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In addition to checking a customer's credit, salespeople also need to determine whether sufficient inventory is available to fill the order, so that customers can be informed of the expected delivery date.

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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, FEDI, or credit cards for customer payments (control 17.2), which totally eliminates employee access to customer payments.

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Invoicing Accurate and timely billing for shipped merchandise is crucial. The invoicing activity is just an information processing activity that repackages and summarizes information from the sales order entry and shipping activities. It requires information from the shipping department identifying the items and quantities shipped and information about prices and any special sales terms from the sales department.

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Maintain Accounts Receivable The accounts receivable function, which reports to the controller, performs two basic tasks: It uses the information on the sales invoice to debit customer accounts and subsequently credits those accounts when payments are received.

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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. It also results in a more uniform flow of cash collections throughout the month. A disadvantage of the open-invoice method is the added complexity required to maintain information about the status of each individual invoice for each customer. Consequently, the open-invoice method is typically used by business whose customers are primarily other businesses because the number of individual transactions is relatively small and the dollar value of those transactions is high.

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Pick and Pack the Order: Process The picking ticket generated by the sales order entry process triggers the pick and pack process. Warehouse workers use the picking ticket to identify which products, and the quantity of each product, to remove from inventory and then record the quantities of each item actually picked. The inventory is then transferred to the shipping department.

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Retail stores and organizations that receive cash directly from customers should use cash registers that automatically produce a written record of all cash received

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Ship the Order: Process The shipping department should compare the physical count of inventory with the quantities indicated on the picking ticket and with the quantities indicated on the sales order. Discrepancies can arise either because the items were not stored in the location indicated on the picking ticket or because the perpetual inventory records were inaccurate.

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The basic document created in the billing process is the sales invoice (Figure 14-16), which notifies customers of the amount to be paid and where to send payment. Like many companies, AOE still prints paper invoices that it mails to many of its smaller customers. Larger customers, however, receive invoices via EDI. EDI not only eliminates printing and postage costs, but also the labor involved in performing those tasks.

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The first step in filling a customer order involves removing the correct items from inventory and packaging them for delivery.

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The objective is to retain customers (threat 9 in Table 14-1). 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.

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The third basic activity in the revenue cycle (circle 3.0 in Figure 14-3) involves billing customers

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Therefore, a list of all checks received should be prepared immediately after opening the mail

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The revenue cycle begins with the receipt of orders from customers. The sales department, which reports to the vice president of marketing (refer to Figure 14-1), typically performs the sales order entry process, but increasingly customers are themselves entering much of this data through forms on a company's website storefront.

the sales order entry process entails three steps: taking the customer's order, checking and approving customer credit, and checking inventory availability important related event that may be handled either by the sales order department or by a separate customer service department (which typically also reports to the vice president of marketing): responding to customer inquiries.

Ship the Order: Threats and Controls two potential problems are theft (threat 11) and shipping errors (threat 12).

various controls to reduce the threat of theft: Regular reconciliation of information about shipments with sales orders (control 12.1) enables timely detection of delay or failure to ship goods to customers. In addition, RFID systems (control 12.2) can provide real-time information on shipping status and thus provide additional information about possible delays. controls to reduce the threat of shipping errors: to minimize the risk of shipping errors, ERP systems like the one depicted in Figure 14-4 should be configured to compare the quantities and item numbers entered by shipping employees to the information on the sales order and to display a warning about any discrepancies so that the problem can be corrected prior to shipment. Of course, the effectiveness of this control depends upon the accuracy of the information collected about outgoing shipments. To reduce data entry errors by shipping employees, bar codes and RFID tags should be used whenever possible. If shipping data must be entered manually at a terminal, data entry controls such as field checks, limit or range checks, and completeness tests are necessary.

electronic lockbox

​A lockbox arrangement (see ​lockbox​) in which the bank electronically sends the company information about the customer account number and the amount remitted as soon as it receives payments.​