Overview of Revenue Cycle Activities

The revenue cycle consists of various processes that organizations, particularly in retail, wholesale, and
manufacturing, follow to manage their revenue-related tasks. The primary activities involved are sales order
procedures, sales return procedures, and cash receipts procedures. While different industries (e.g., service
companies like hospitals, insurance companies, and banks) may have specific variations, the conceptual framework for
these processes remains similar.

This discussion is technology-neutral, meaning it applies to both manual and computerized systems, focusing on the
conceptual tasks and not the specific technology used to carry them out. Documents, journals, and ledgers can either
be physical or digital and are referenced throughout this discussion.

Sales Order Procedures

The sales order procedures involve receiving and processing customer orders, filling and shipping the orders, billing
customers, and ensuring the transactions are accurately recorded. Below are the key activities in the process:

1. Receive Order

o The sales cycle begins when a customer places an order, typically specifying the type and quantity of
products desired. The order could be received in various formats (mail, telephone, or directly from a
field representative).

o If the order is not in a standardized format, it must be transcribed into a formal sales order that
captures essential information: customer details, items, quantities, unit prices, and potentially financial
details (taxes, discounts, etc.).

o Once created, a copy of the sales order is placed in the open order file for tracking purposes. This file
is updated as the order progresses (e.g., credit approval, back-ordered items, or shipment status).

2. Check Credit

o Before further processing the order, the customer’s creditworthiness must be verified. For new
customers, a thorough credit check might be performed to establish a credit limit. For existing
customers, the credit check may focus on ensuring their current order does not exceed their
established limit.

o This credit check is a separate task from the sales order process and serves as an authorization
control. If approved, the sales order moves forward in the process. Once credit approval is given, the
order details are forwarded to various departments to continue processing (e.g., stock release, packing
slip, shipping notice, etc.).

3. Pick Goods

o The stock release document (or picking ticket) is created from the sales order and sent to the
warehouse, where it authorizes the picking of items for the order. Warehouse employees use this
document to locate and pick the necessary items.

o After the items are picked, they are verified for accuracy. If the inventory is insufficient, a back-order
record is created and stored until the required goods arrive. These back-ordered items will be shipped
when new stock becomes available.

o The warehouse staff updates the inventory records (used for warehouse management purposes) but
does not maintain the formal accounting inventory records to ensure the segregation of duties for
internal control.

4. Ship Goods

o The shipping department receives the, which outline the contents and the details of the shipment.
These documents are used to ensure that the correct items are shipped.

o The shipping clerk reconciles the physical items against the stock release, packing slip, and shipping
notice. This step acts as an independent verification to ensure no errors before shipment.

o The goods are packaged, the packing slip is attached, and a bill of lading is prepared. The bill of
lading acts as a contract between the seller and the carrier, transferring ownership and responsibility
for the goods in transit.

o Once the shipment is handed over to the carrier, the shipping clerk records the shipment in the
shipping log, forwards the shipping notice to the billing department, and updates the open order
file to reflect the status of the order.
Key Documents and Control Points in the Sales Order Process:

● Sales Order: Captures the customer’s order details.

● Stock Release/Picking Ticket: Authorizes the warehouse to pick goods.

● Packing Slip: Describes the contents of the order and accompanies the goods.

● Shipping Notice: Contains shipment details, sent to the billing department.

● Bill of Lading: Serves as a contract between the seller and the shipping company and documents the transfer
of ownership and responsibility.

● Open Order File: Tracks the status of customer orders, enabling customer service to respond to inquiries
regarding order progress.

The sales order procedures ensure the correct processing, authorization, and fulfillment of customer orders. These
procedures incorporate key control points such as credit checks, inventory verification, and shipping accuracy. By
using well-organized documents and maintaining segregation of duties, these processes help prevent errors and fraud
while ensuring that sales are efficiently processed from the initial order to final shipment.

5. Bill Customer Process:

The Bill Customer function marks the completion of the economic event and is an essential part of the sales order
cycle. Billing should only occur once the goods have been shipped to the customer. Billing before shipment can lead to
several issues, including inaccurate record-keeping, customer confusion, and operational inefficiencies. For example,
billing for items that are out-of-stock or on back-order can result in unnecessary adjustments and customer
dissatisfaction.

To avoid these issues, the billing process is designed to wait for confirmation from the shipping department. The
following describes the steps involved in the Bill Customer process:

1. Sales Order Pending File:

o After the credit approval of the sales order, the billing department receives a copy of the sales order
(invoice copy).

o This copy is placed in an S.O. pending file where it remains until the shipment of goods is confirmed.
This prevents premature billing before the goods are shipped.

2. Reconciliation with Shipping Notice:

o Once the goods are shipped, the shipping department sends the shipping notice to the billing
department.

o The billing department then reconciles the items shipped against the items ordered in the sales
order. The unit prices, taxes, and freight charges are also added to the invoice. This ensures that the
billing is accurate, reflecting what was actually shipped to the customer.

o The completed sales invoice is then prepared, which becomes the official bill to the customer.

3. Record-Keeping Tasks: After preparing the sales invoice, the billing department performs several key
record-keeping functions:

o Record the sale in the sales journal: The sales journal is used to document completed sales
transactions.

o Forward the ledger copy of the sales order: This is sent to the update accounts receivable
task to adjust the customer’s account balance.

o Send the stock release document to the inventory control function: This updates the inventory
records to reflect the reduction in stock as a result of the sale.

6. Updating Inventory and Accounts Receivable:

1. Update Inventory Records:

 o The inventory control function uses the information on the stock release document to update the
inventory subsidiary ledger. This ledger tracks the quantity and financial value of each inventory
item.

o In a perpetual inventory system, the inventory records are updated immediately as goods are
shipped, reducing the quantity on hand for each affected item. A journal voucher summarizing the
reduction in inventory is then sent to the general ledger for posting.

2. Update Accounts Receivable (AR):

o The customer’s record in the accounts receivable (AR) subsidiary ledger is updated using the
information from the sales order (ledger copy).

o Each customer has an account in the AR subsidiary ledger that includes critical data like the
customer’s name, address, current balance, available credit, transaction dates, invoice numbers, and
credits for payments, returns, and allowances.

o This ledger is used to track outstanding balances for each customer and ensure accurate billing and
payment tracking.

7. Post to General Ledger:

At the end of the transaction processing period, the general ledger is updated using the information from the sales
journal, inventory control, and accounts receivable functions.

1. Journal Vouchers from Billing and Inventory Control:

o The sales journal entries, which include details from the completed sales invoices, are summarized
into journal vouchers. These journal vouchers represent general journal entries that are posted to
the general ledger control accounts.

o In addition, the inventory control function sends a journal voucher summarizing the reduction in
inventory.

2. AR Summary:

o The accounts receivable function provides a summary of the individual customer balances (as
recorded in the AR subsidiary ledger). This AR summary is also sent to the general ledger for posting.

o The AR summary helps verify the accuracy of the sales transactions by ensuring that the total debits to
AR (from the journal vouchers) match the AR summary figures.

3. Independent Verification Control:

o The comparison of the AR summary with the journal vouchers from billing serves as an important
independent verification control. This reconciliation ensures the accuracy of the sales entries and
helps identify any discrepancies between the AR subsidiary ledger and the billing records.

o This step is crucial for detecting errors and maintaining the integrity of the financial records.

Summary of Key Documents in the Billing Process:

● Sales Order (Invoice Copy): Used as the basis for billing and is kept in the pending file until goods are
shipped.

● Shipping Notice: Confirms what was shipped and is used to complete the sales invoice.

● Sales Invoice: The official bill to the customer, summarizing the goods shipped, prices, taxes, and freight.

● Sales Journal: A special journal used to record all completed sales transactions.

● Journal Voucher: A summary of sales transactions and inventory adjustments sent to the general ledger.

● Inventory Subsidiary Ledger: Tracks the quantity and financial value of inventory items.

● Accounts Receivable Subsidiary Ledger: Tracks customer balances and payment information.
This process ensures that customers are only billed for goods that have been shipped, and it maintains accurate
financial records by updating the general ledger, inventory, and accounts receivable. By performing these tasks with
appropriate verification and segregation of duties, organizations can maintain strong internal controls and reduce the
risk of errors or fraud.

Sales Return Procedures:

Sales returns are a common part of business operations, and organizations must establish procedures to handle them
efficiently. The reasons for returns can vary and include issues such as incorrect shipments, defective goods, damage
during transit, or late deliveries. When a customer returns merchandise, the sales transaction needs to be reversed,
and the appropriate adjustments must be made to inventory, accounts receivable, and the general ledger.

The Sales Return Procedure involves several key steps, as outlined below:

1. Prepare Return Slip:

● Receiving Department’s Role:

o When items are returned, the receiving department is responsible for inspecting the goods, counting
them, and preparing a return slip.

o The return slip describes the items being returned and provides essential details like the reason for the
return.

o The goods, along with a copy of the return slip, are sent to the warehouse to be restocked (if
applicable).

o The second copy of the return slip is forwarded to the sales department for processing.

2. Prepare Credit Memo:

● Sales Department’s Role:

o Upon receiving the return slip, the sales employee prepares a credit memo.

o The credit memo serves as authorization for the customer to receive credit for the returned
merchandise.

o The credit memo typically looks similar to a sales order. In some cases, a copy of the sales order may
be marked as a credit memo.

o The credit memo may require approval from the credit manager if the circumstances of the return
are exceptional (e.g., large returns or unusual reasons for return). If the return is within the sales
employee’s authority, the credit memo is sent directly to the billing function for further processing.

3. Approve Credit Memo:

● Credit Manager’s Role:

o If the return exceeds the sales employee’s authority, the credit manager evaluates the return
circumstances to decide whether credit should be granted.

o Once approved, the credit memo is sent back to the sales department. If the credit manager
disapproves, no further action is taken, and the customer is not credited.

4. Update Sales Journal:

● Sales Department’s Role:

o Upon receiving the approved credit memo, the sales transaction is recorded as a contra entry in the
sales journal. This reduces the total sales figure by the value of the returned merchandise.

o The credit memo is then forwarded to the inventory control function to update inventory records.
 o At the end of the period, the total sales returns are summarized in a journal voucher, which is sent
to the general ledger for posting.

5. Update Inventory and Accounts Receivable Records:

● Inventory Control’s Role:

o The inventory control function adjusts the inventory records to reflect the returned items.

o The value of the returned goods is recorded in the inventory subsidiary ledger and sent to the general
ledger at the end of the period via a journal voucher.

● Accounts Receivable’s Role:

o The accounts receivable (AR) function also updates the customer’s account. The returned items
reduce the customer’s balance, and the AR subsidiary ledger is adjusted accordingly.

o Similarly, the AR account summary is periodically submitted to the general ledger function for
reconciliation.

6. Update General Ledger:

● General Ledger’s Role:

o Upon receiving the journal voucher and AR summary from the inventory and AR functions, the general
ledger function reconciles these figures.

o The general ledger posts the necessary adjustments to the control accounts for sales returns and
accounts receivable. This ensures that the general ledger reflects accurate financial information
after returns are processed.

Key Documents in Sales Return Procedures:

● Return Slip: Prepared by the receiving department, it describes the returned items and serves as the basis
for processing returns.

● Credit Memo: Issued by the sales department, it authorizes credit for the returned goods. It may require
approval from the credit manager depending on the circumstances.

● Sales Journal: Used to record the contra entry for sales returns.

● Inventory Control Record: Adjusted to reflect the returned merchandise.

● Accounts Receivable Record: Adjusted to reflect the return of merchandise and the reduction in the
customer’s balance.

● Journal Voucher: A document used to summarize sales return transactions and post the necessary
adjustments to the general ledger.

Summary of the Sales Return Process:

The sales return procedure ensures that returns are handled appropriately by reversing the original sales transaction.
This process involves multiple steps, including preparing return documentation, approving credit memos, updating
inventory and accounts receivable records, and reconciling figures in the general ledger. By following these
procedures, the company can maintain accurate records, prevent fraudulent returns, and ensure that customer
relationships remain intact even when returns occur.

This process serves as an essential part of the revenue cycle, ensuring that inventory is properly managed, accounts
receivable are adjusted, and the general ledger reflects the appropriate figures for financial reporting.

Cash Receipts Procedures:

Cash receipts procedures are essential to ensure that payments on accounts receivable are properly recorded,
deposited, and accounted for. These procedures apply to transactions where the customer has a balance due, and the
payment is made at a future date based on the terms of trade. The cash receipts procedures involve multiple tasks,
such as receiving and securing the cash, depositing it into the bank, updating accounts receivable, and reconciling the
financial details of the transaction.

The data flow diagram (DFD) in Figure 4-9 shows the relationship between these tasks, which are detailed as follows:

1. Open Mail and Prepare Remittance Advice:

● Mail Room Employee’s Role:

o The mail room employee opens the envelopes containing customer payments (checks) and
remittance advice.

o A remittance advice contains crucial information for processing payments, such as:

▪ Payment date

▪ Customer account number

▪ Amount paid

▪ Customer check number

o The remittance advice serves as a turnaround document, which helps avoid errors and inefficiencies
in identifying the customer’s account.

o The employee routes the checks and remittance advices to the administrative clerk for further
processing.

2. Endorse Checks and Record on Remittance List:

● Administrative Clerk’s Role:

o The clerk endorses each check as "For Deposit Only" to ensure it is deposited into the correct account.

o The clerk reconciles the amount on each remittance advice with the corresponding check.

o The clerk records the checks on a remittance list (also called a cash prelist), which logs all cash
received.

o Multiple copies of the remittance list are made:

▪ The original copy is sent with the checks to the record and deposit checks function.

▪ A second copy accompanies the remittance advices to the update accounts receivable
(AR) function.

▪ The third copy goes to the reconciliation task to help with periodic verification.

3. Record and Deposit Checks:

● Cash Receipts Employee’s Role:

o A cash receipts employee verifies the accuracy and completeness of the checks against the prelist.
This ensures no checks are lost or misdirected between the mail room and the deposit function.

o Once verified, the employee records the checks in the cash receipts journal. All cash receipts,
whether from customer payments, cash sales, or miscellaneous cash receipts, are logged in this
journal.
 o Bank Deposit Slip: The employee prepares a bank deposit slip for the total amount of the day's
receipts and sends it along with the checks to the bank for deposit.

o After depositing the checks, the bank teller validates the deposit slip and returns it to the company
for reconciliation.

o At the end of the day, the cash receipts employee prepares a journal voucher summarizing the day's
journal entries and sends it to the general ledger function.

4. Update Accounts Receivable:

● Accounts Receivable Clerk’s Role:

o The remittance advices are used to post payments to individual customer accounts in the accounts
receivable (AR) subsidiary ledger.

o Periodically, the changes in the AR subsidiary ledger balances are summarized and forwarded to the
general ledger function for further reconciliation and posting.

5. Update General Ledger:

● General Ledger’s Role:

o The general ledger function receives the journal voucher and the AR account summary.

o It reconciles the figures and posts the necessary adjustments to the cash and accounts receivable
control accounts.

o The journal voucher is filed for documentation and auditing purposes.

6. Reconcile Cash Receipts and Deposits:

● Controller’s Office or Reconciliation Clerk’s Role:

o On a periodic basis (typically weekly or monthly), a clerk from the controller’s office (or another
employee not involved in the cash receipts process) performs a reconciliation of cash receipts.

o This reconciliation compares:

1. A copy of the prelist (the list of checks recorded by the mail room and administrative clerk).

2. Deposit slips received from the bank, showing the total funds deposited.

3. Related journal vouchers, which summarize the daily cash receipts transactions.

o This reconciliation helps ensure that all cash receipts have been accurately recorded and deposited,
and it verifies that the amounts in the general ledger match the actual funds deposited.

Key Documents in Cash Receipts Procedures:

● Remittance Advice: A document containing customer payment details that helps match the payment with
the correct customer account.

● Remittance List (Cash Prelist): A log of all checks received, recorded by the administrative clerk to track
payments.

● Bank Deposit Slip: A document prepared by the cash receipts employee to summarize the day's deposits
and submitted to the bank for validation.

● Cash Receipts Journal: A record of all cash receipts transactions, including payments on account, cash sales,
and miscellaneous receipts.

● Journal Voucher: A document used to summarize cash receipts and post the entries to the general ledger.
 ● AR Account Summary: A summary of changes to customer accounts, forwarded periodically to the general
ledger.

● Deposit Slips from the Bank: Used to verify the total cash deposited and to reconcile with the cash receipts
journal.

Summary of the Cash Receipts Process:

The cash receipts procedures ensure that customer payments on accounts are properly handled, recorded, and
deposited. This involves several tasks, such as opening mail, preparing remittance advices, recording payments in the
cash receipts journal, depositing checks in the bank, and updating the accounts receivable ledger. The process also
includes regular reconciliation to ensure that cash receipts are accurately reflected in the general ledger.

By following these procedures, the company can maintain accurate financial records, ensure cash is properly
accounted for, and prevent discrepancies in the accounting system. This is crucial for maintaining internal control and
safeguarding against fraud or errors in the cash handling process.

Revenue Cycle Controls Overview

The revenue cycle, which involves the movement of goods, services, and payments within an organization, requires
robust internal controls to ensure accuracy, prevent fraud, and ensure financial reporting integrity. Chapter 3 outlined
six essential classes of internal control activities: transaction authorization, segregation of duties, supervision,
accounting records, access control, and independent verification. These controls, summarized below, provide
the necessary framework to mitigate risks in the revenue cycle.

1. Transaction Authorization

The goal of transaction authorization is to ensure that only valid, approved transactions are processed. This
reduces errors and prevents unauthorized activities.

Credit Check

● Credit checks are performed by the credit department to assess the creditworthiness of customers. The
department employs various methods to determine whether the customer is likely to fulfill payment
obligations.

● First-time customers may undergo a more detailed check, whereas ongoing customers may only need
verification that they are within their credit limit before a sale is approved.

Return Policy

● The credit department typically approves sales returns based on the nature of the transaction and the
reason for the return.

● Approval procedures often depend on the materiality of the return, with more formal approval needed for
larger or significant transactions.

Remittance List (Cash Prelist)

● A remittance list ensures that payments and remittance advices match before transactions are posted to
customer accounts.

● Discrepancies between the remittance advice and checks would be flagged, allowing for resolution before
posting to accounts.

2. Segregation of Duties

Segregation of duties ensures that no single person is responsible for all aspects of a transaction, helping to
prevent fraud and errors.

Key Principles of Segregation:

1. Transaction Authorization vs. Transaction Processing

 o The credit department is separate from the sales staff to ensure independent judgment in credit
approval. This prevents conflicts of interest where sales staff might prioritize sales over
creditworthiness.

2. Asset Custody vs. Record Keeping

o Inventory is physically controlled by the warehouse, while the accounting function maintains records.
This separation prevents theft and manipulation of inventory records.

o Similarly, the cash receipts department handles cash, but the accounts receivable department is
responsible for maintaining records of customer payments.

3. Collusion Prevention

o By separating record-keeping and asset custody, fraud requires collusion between multiple
individuals, making it harder to conceal fraudulent activities.

Journals and Ledgers

● Special Journals (e.g., sales journal, cash receipts journal) are used to summarize transactions
efficiently, while subsidiary ledgers (e.g., accounts receivable and inventory ledgers) capture
transaction event details.

● General Ledger control accounts aggregate transaction data for financial statement preparation, ensuring
all activities are captured in the audit trail.

3. Supervision

In organizations with fewer employees, where full segregation of duties may not be possible, supervision is critical as
a compensating control.

● Supervisors monitor employees to ensure that incompatible duties are not being performed without
oversight. For example, in the mailroom, employees may have access to both cash and remittance advices,
which can create an opportunity for theft. Close supervision can prevent such activities and provide an early
warning for potential fraudulent behavior.

4. Accounting Records

Accounting records form the audit trail that tracks transactions and ensures accountability across the revenue cycle.

Prenumbered Documents

● Prenumbering of source documents (e.g., sales orders, shipping notices, remittance advices) helps
uniquely identify each transaction. This enables tracking of individual transactions and aids in verifying the
integrity of the process.

Journals and Ledgers

● Special Journals such as the sales journal and cash receipts journal summarize similar transactions,
while subsidiary ledgers track details of individual customer accounts or inventory levels.

● General Ledger accounts are used to consolidate and summarize revenue cycle transactions for reporting
purposes, forming the foundation of financial statements.

5. Access Control

Access control mechanisms are essential to ensure that only authorized individuals can access critical assets or
sensitive information, preventing unauthorized use or manipulation.

Asset Access

● Warehouse security, including fences, alarms, and guards, ensures the physical safety of inventory.

● Cash is safeguarded by depositing it promptly in the bank, locking cash drawers and safes, and using night
deposit boxes.
Information Access

● Access to source documents, journals, and ledgers must be restricted to authorized individuals to prevent
tampering with records. Examples of potential risks include:

o Unauthorized access to the accounts receivable subsidiary ledger, allowing someone to manipulate
records or remove accounts.

o Unauthorized access to sales orders, which could trigger unauthorized shipments.

6. Independent Verification

Independent verification ensures that tasks are checked for accuracy and completeness, reducing the risk of errors
and fraud.

Verification Points in the Revenue Cycle:

1. Shipping Function Verification:

o Before shipment, the stock release document and packing slip are reconciled to ensure that the
correct goods are shipped in the correct quantity.

2. Billing Function Verification:

o The billing department reconciles the sales order and shipping notice to ensure that customers
are billed only for goods that were shipped.

3. General Ledger Verification:

o Prior to posting to the general ledger, journal vouchers and summary reports from various
functions (e.g., sales journal, inventory control, cash receipts) are reconciled. Discrepancies
trigger error resolution before final posting to the general ledger.

Conclusion

By implementing transaction authorization, segregation of duties, supervision, accounting records, access

control, and independent verification, companies can significantly reduce the risk of fraud and ensure the accurate
processing of transactions within the revenue cycle. These controls create a comprehensive audit trail and support
effective financial reporting.

Physical Systems Overview

In this section, we examine the physical system for managing the revenue cycle, starting with a discussion of
manual procedures before progressing to computer-based systems. The use of manual systems, even in the age
of technology, is still relevant for several reasons, which include their effectiveness as a training tool, their
demonstration of segregation of duties, and their value in understanding the evolution of computer-based
systems.

Manual Systems in the Revenue Cycle

Manual systems involve various departments handling physical documents throughout the revenue cycle. These
departments rely on physical source documents to perform tasks and ensure a complete audit trail. The following
sections break down the procedures used in a manual sales order system, sales return process, and cash receipts
procedures.

Sales Order Processing

Document Flowchart for Sales Order Processing: The following outlines the manual steps involved in processing
a sales order:

1. Sales Department:

o A customer contacts the sales department via phone, mail, or in person. The sales department
records order details on a sales order.

o The sales order is filed pending credit approval.

2. Credit Department Approval:

o The credit department independently evaluates the customer’s creditworthiness, ensuring

segregation of duties.
 o After approval, the sales order is released to the billing, warehouse, and shipping departments.

o The order and credit approval are added to the open order file.

3. Warehouse Procedures:

o The warehouse receives the stock release copy of the sales order and uses it to locate inventory.

o The inventory is sent to shipping, and the warehouse clerk records the inventory reduction in the
stock records.

4. Shipping Department:

o The shipping clerk reconciles the products received with the shipping notice to ensure accuracy.

o Once verified, the clerk prepares the bill of lading, packages, and ships the products.

o The shipping transaction is entered into the shipping log, and the shipping notice is forwarded to
the billing department.

5. Billing Department:

o The shipping notice triggers the billing process. The billing clerk prepares an invoice, entering
product prices, handling charges, taxes, and any discounts.

o The sales journal is updated, and the sales information is sent to accounts receivable and
inventory control.

6. Accounts Receivable (AR), Inventory Control, and General Ledger:

o The AR and inventory control departments update their respective subsidiary ledgers.

o Journal vouchers and account summaries are sent to the general ledger department for
reconciliation and posting to control accounts.

Sales Return Procedures

Document Flowchart for Sales Returns:

1. Receiving Department:

o When products are returned, the receiving clerk inspects the goods and prepares a return slip.

o The return slip is sent to the sales department for processing.

2. Sales Department:

o The sales clerk creates a credit memo upon receiving the return slip.

o Depending on the circumstances, credit department approval may be required.

3. Processing the Credit Memo:

o The sales return is recorded, and inventory control debits the returned items.

o The accounts receivable department credits the customer’s account.

4. General Ledger Department:

o Journal vouchers and account summaries are periodically sent to the general ledger for reconciliation
and control account posting.

Cash Receipts Procedures

Document Flowchart for Cash Receipts:

1. Mail Room:

o Customer payments and remittance advices arrive at the mail room.

o Checks are sent to the cash receipts department, and remittance advices are sent to accounts
receivable.

2. Cash Receipts Department:

o The cashier records the checks and prepares the deposit slip, sending it to the bank.
 o A journal voucher is periodically prepared and sent to the general ledger.

3. Accounts Receivable:

o The AR clerk uses the remittance advices to update the customer accounts, reducing the balance in
line with the payment.

o The AR clerk sends the account summary to the general ledger department.

4. General Ledger Department:

o Upon receiving the journal voucher and account summary from cash receipts and accounts
receivable, the general ledger clerk reconciles and posts the data to control accounts.

5. Controller’s Office:

o Given the liquid nature of cash, the controller’s office performs periodic bank reconciliations to
ensure accuracy.

Concluding Remarks on Manual Systems

1. Cost and Inefficiency:

o Manual systems generate significant amounts of paper documents, leading to high operating costs
related to the purchase, storage, and handling of documents.

o Tasks are more labor-intensive and error-prone, which increases the cost of system operation.

2. Internal Controls:

o Many key functions in manual systems are located in separate, physically distinct departments, which
helps achieve segregation of duties.

o However, these functions are still clerical tasks, prone to human error. The separation of duties
and independent verification processes are essential in mitigating these errors, but they still
require significant effort in a manual system.

3. The Transition to Computer-Based Systems:

o Computer-based systems offer significant advantages over manual systems by automating tasks,
reducing human error, and eliminating the need for physical documents.

o The roles of various departments may still exist, but their focus shifts from routine transaction
processing to financial analysis and handling exception-based problems, making the system more
efficient and less prone to errors.

In summary, while manual systems offer useful insight into traditional processes and controls, the high cost and
inefficiency of physical document handling and labor-intensive tasks underscore the benefits of transitioning to
modern computerized systems.

Computer-Based Accounting Systems: Automation vs. Reengineering

In the context of Accounting Information Systems (AIS), technological innovation can be seen as a continuum
ranging from automation at one end to reengineering at the other.

1. Automation: Refers to using technology to improve the efficiency and effectiveness of a task. It typically
involves digitizing existing manual processes without fundamentally changing the workflow.

2. Reengineering: Involves a more radical transformation, focusing on rethinking business processes and
workflows. The goal is to reduce costs and improve operational performance by eliminating tasks that
don’t add value and replacing traditional processes with innovative solutions.

In this section, we discuss how both automation and reengineering are applied in accounting processes, particularly
in sales order processing and cash receipts systems, and examine the use of Point-of-Sale (POS) systems,
Electronic Data Interchange (EDI), and the Internet for reengineering.

Automating Sales Order Processing with Batch Technology

The following is a description of an automated sales order processing system, which leverages batch processing to
automate various accounting and operational tasks.

Key Data Elements in the Automated System

 ● Sales Order File: Contains records with fields like Sales Order Number, Account Number, and Inventory
Number.

o Sales Order Number: This is the Primary Key (PK), ensuring each sales order is uniquely
identifiable.

o Account Number and Inventory Number: These are Secondary Keys (SK), which help locate
corresponding records in the Accounts Receivable (AR) and Inventory Master Files, but do not
uniquely identify individual sales orders.

Batch Processing System Overview

In a batch processing system, operations like billing, inventory control, accounts receivable, and general
ledger are automated, significantly improving efficiency and reducing errors. However, tasks like sales order taking,
credit checking, warehousing, and shipping are still manually performed in this system.

Sales Order System Process with Automation

1. Sales Department:

o A customer contacts the sales department, placing an order. The sales clerk records the order
details and prepares multiple copies of the sales order, which are kept pending credit approval.

2. Credit Department Approval:

o Once the credit approval is granted, the sales department releases the sales order to the billing,
warehouse, and shipping departments.

o The customer order and credit approval are placed in the open order file.

3. Warehouse Procedures:

o The warehouse clerk receives the stock release copy of the sales order to pick the items and
prepares the goods for shipment. The inventory details are then sent to the shipping department.

4. Shipping Department:

o The shipping clerk reconciles the products received from the warehouse with the shipping notice.

o If everything is in order, the shipping clerk prepares the bill of lading, packages the products, and
ships them to the customer. The shipping notice is sent to the computer department for further
processing.

5. Keystroke Input:

o The keystroke clerk converts the hard-copy shipping notices to digital form, creating a
transaction file that contains the sales order details. This process is carried out multiple times during
the day, with batches of shipping notices being transcribed into the system.

6. Edit Run:

o The edit program is executed periodically to validate all transaction records in the batch. This step
ensures that the data is correct by performing a series of checks, such as:

▪ Field checks: Ensuring the data fits the correct format.

▪ Limit and range tests: Verifying that the data falls within appropriate limits.

▪ Price-time extensions: Validating mathematical calculations like price * quantity.

o Errors detected during these tests are removed from the batch and stored in an error file for
correction before being resubmitted.

7. Update Procedures:

o Once the transaction file passes the validation checks, the update program posts the transactions to
the relevant inventory and AR subsidiary records using the secondary keys (Inventory Number
and Account Number).

o The system records these transactions in the journal and updates general ledger accounts after
each batch.
 8. Management Reports:

o The system generates various management reports such as sales summaries, inventory status
reports, transaction listings, journal voucher listings, and budget performance reports.

o These reports help management monitor and control operations effectively, ensuring that internal
controls are functioning properly.

Benefits of Automating Sales Order Processing

● Cost Savings: By automating tasks like billing, inventory control, and general ledger updating, businesses can
reduce their clerical staff and minimize the operational costs of manual processes.

● Error Reduction: Automation significantly lowers the likelihood of human error in repetitive tasks, leading to
more accurate data processing.

Key Features of Automation in Sales Order Systems

● Batch Processing: This technology allows the system to process multiple records in batches, improving
efficiency and ensuring consistency across transactions.

● Validation and Error Checking: Built-in edit programs check for errors during processing, ensuring data
accuracy.

● Direct Updates: The system performs direct updates to the master files (e.g., inventory and AR records)
after processing the transactions.

Reengineering Opportunities

Although automation improves the efficiency of many tasks, reengineering offers even greater potential by
rethinking processes to eliminate nonvalue-added tasks. In reengineering, traditional procedures may be
replaced with entirely new approaches, leading to significant operational improvements and cost reductions.

In summary, automating sales order processing using batch technology enhances efficiency, reduces errors, and
leads to cost savings, while reengineering the entire workflow can provide even more dramatic improvements by
eliminating unnecessary tasks and adopting more innovative methods.

Reengineering Sales Order Processing with Real-Time Technology

Real-time technology can significantly enhance the efficiency and accuracy of sales order processing by automating
manual tasks and enabling instantaneous updates across different systems. In this section, we discuss how real-time
processing transforms sales order systems and provides numerous advantages over traditional batch processing
systems.

Transaction Processing Procedures in a Real-Time System

In a real-time sales order system, interactive computer terminals replace many of the manual procedures and physical
documents seen in traditional batch systems. The real-time system processes each transaction as it occurs, providing
immediate updates and responses.

Sales Procedures in Real-Time Processing

1. Order Entry:

o The sales clerk uses a computer terminal to process customer orders as they are received. The
system performs the following tasks in real-time:

▪ Inventory Check: The system checks the availability of inventory by accessing the inventory
subsidiary file.

▪ Credit Check: The system retrieves the customer's credit data from the accounts
receivable (AR) file to assess their creditworthiness. This file contains details like credit limit,
 current balance, and payment history. Based on predefined rules, the system either approves
or denies credit.

2. Update Records:

o If the credit is approved, the system:

▪ Updates the customer's current balance in the AR file.

▪ Reduces the inventory to reflect the quantities of items sold, ensuring accurate and up-to-
date inventory levels.

3. Document Transmission:

o The system automatically generates and sends digital documents:

▪ A stock release document is sent to the warehouse.

▪ A shipping notice is sent to the shipping department.

▪ The sale is recorded in the open sales order file, with a CLOSED field to track the order’s
status. Initially, this field is set to "N" (not closed). Once the goods are shipped, it changes to
"Y" (closed).

Warehouse Procedures

● The warehouse clerk receives a hard-copy printout of the stock release document, which was
electronically transmitted from the sales system.

● The clerk picks the goods, prepares them for shipment, and sends them along with the stock release document
to the shipping department.

Shipping Department

● The shipping clerk reconciles the received goods with the stock release document and prepares the goods
for shipment.

● After preparing the shipment, the clerk:

o Selects a carrier and prepares the shipment.

o Transmits a shipping notice containing the shipping date and freight charges to the system.

o The system updates the sales order record in real-time, marking the CLOSED field as "Y," indicating
that the order has been shipped and is now closed.

General Ledger Update Procedures

At the end of the day, a batch program is run to update the general ledger. This batch process:

● Searches for closed sales orders in the open sales order file and updates the Inventory—Control, Sales,
AR—Control, and Cost of Goods Sold accounts.

● Inventory subsidiary and AR subsidiary records were already updated in real-time during the sales order
process.

● The batch program also prepares and mails customer bills and transfers the closed sales orders to the sales
journal (closed sales order file).

Advantages of Real-Time Processing in Sales Order Systems

Real-time processing offers several key advantages over traditional batch systems, particularly in terms of efficiency,
accuracy, and customer satisfaction.

1. Reduced Cash Cycle:

 o Real-time processing significantly shortens the cash cycle. Unlike batch systems, where there can be
several days of delays between taking an order and billing the customer, real-time systems enable
orders to be processed and shipped in a single day. This results in same-day billing and faster cash
receipts.

2. Competitive Advantage:

o By maintaining current inventory information, sales staff can instantly check stock availability and
provide accurate information to customers. This enhances customer satisfaction and increases
sales, as customers are less likely to face backorders or uncertain delivery dates.

3. Error Reduction:

o Real-time processing helps reduce clerical errors such as incorrect account numbers, invalid
inventory numbers, and price miscalculations, which are common in batch systems.

o Many errors are identified and corrected immediately, rather than after the transaction has been
processed, thus preventing costly mistakes like shipping incorrect products or charging the wrong
price.

4. Reduced Paper Usage:

o Real-time systems drastically reduce the reliance on physical documents. While batch systems
typically generate a significant number of paper records, real-time systems use digital documents,
which are more efficient, effective, and sufficient for audit purposes. This reduces both the costs and
complexity of maintaining hard-copy records.

Automated Cash Receipts Procedures

While sales order processing can benefit greatly from real-time technology, cash receipts procedures typically work
better as batch systems. The cash receipts process handles discrete events, such as customer payments and
remittance advices, which are received in batches.

Mail Room Procedures

● The mail room clerk separates the checks and remittance advices, preparing a remittance list. The checks
and remittance list are sent to the cash receipts department, while the remittance advices and list are sent
to the AR department.

Cash Receipts Department

● The cash receipts clerk reconciles the checks with the remittance list and prepares the deposit slips.

● Using the terminal, the clerk creates a journal voucher that records the total cash received and files the
remittance list and a copy of the deposit slip.

Accounts Receivable Department

● The AR clerk receives and reconciles the remittance advices and remittance list. The clerk then creates
the cash receipts transaction file from the remittance data and files the documents.

Data Processing Department

● At the end of the day, a batch program reconciles the journal voucher with the cash receipts
transaction file and updates the AR subsidiary records and general ledger control accounts (AR—
Control and Cash).

● A transaction listing is generated for reconciliation by the AR clerk.

Reengineered Cash Receipts Procedures

Traditional cash receipts procedures in many organizations involve labor-intensive tasks such as opening envelopes,
comparing remittance advices with checks, and manually posting payments to customer accounts. These manual
steps can be costly, error-prone, and introduce significant control risks. However, many organizations have
reengineered their cash receipts procedures using automation to reduce these issues and improve efficiency.

Automated Mail Room Procedures

The mail room, which traditionally handles the opening and processing of incoming payments, can be significantly
reengineered using automation. Here's how the new process works:
 1. Envelope Opening and Separation:

o The mail room clerk places batches of unopened envelopes into a machine that automatically opens
them.

o The system separates the contents of each envelope into two parts: remittance advices and
customer checks. This is achieved using automated technology that identifies the order of
documents. The remittance advice (containing the payee's address) is identified as the first document,
and the check is recognized as the second.

2. Transaction Validation:

o The system uses transaction validation software, which may include artificial intelligence (AI)
capable of reading handwriting on remittance advices and checks.

o The AI validates that the dollar amounts on both the remittance advice and the check match and
ensures that the check is properly signed.

o Any documents that cannot be read or do not meet validation criteria are flagged for manual
processing.

3. Computer-Readable File:

o The system then creates a computer-readable file of cash receipts, which is sent for posting to the
appropriate customer accounts and general ledger accounts.

4. Sending Checks for Deposit:

o The batches of checks are sent to the cash receipts department for deposit in the bank.

o Transaction listings are generated and sent to management in the Accounts Receivable (AR),
cash receipts, and general ledger departments for review and audit.

Benefits of Reengineering Cash Receipts Procedures

The use of automation in the mail room and validation software brings several advantages:

1. Improved Control:

o Automated validation ensures that checks and remittance advices match, reducing the potential for
errors such as overpayments, underpayments, or misapplied payments.

2. Cost Reduction:

o By automating tasks like envelope opening, document separation, and transaction validation,
organizations reduce the need for manual labor, which in turn reduces operating costs.

3. Faster Processing:

o The automation of the mail room and transaction processing streamlines the workflow, speeding up
the overall cash receipts process and allowing for quicker posting to customer accounts and the
general ledger.

4. Manual Processing for Exceptions:

o While most documents are processed automatically, the system is designed to flag inconsistencies,
such as partial payments, multiple payments in one check, or clerical errors. These items can be
manually reviewed and corrected, ensuring that the system handles exceptions properly.

Point-of-Sale (POS) Systems

Point-of-sale (POS) systems are used in retail businesses, such as grocery stores, department stores, and other outlets
where customers pay for goods immediately, often with cash, checks, or credit cards. Unlike businesses that extend
credit to customers, POS systems do not require maintaining accounts receivable since transactions are completed
on the spot.

Daily Procedures in a POS System

1. Scanning Items:

o The checkout clerk uses a laser scanner (or UPC scanner) to scan the universal product code
(UPC) label on each item being purchased. The scanner may be handheld or mounted on the checkout
counter.

o The POS system retrieves product pricing information from the inventory file and displays it on the
clerk’s terminal.
 o The inventory quantity is updated in real-time to reflect the items sold, and the system may
automatically reorder products when inventory falls below a predefined threshold.

2. Calculating Total Sale:

o The system calculates the total sale, including applicable taxes, discounts, and the cost of the items
sold.

o For credit card transactions, the clerk obtains approval from the credit card issuer via an online
connection. Once approved, the clerk prepares a credit card voucher for the customer to sign. A
copy is given to the customer, and another is kept in the cash drawer.

3. Recording the Sale:

o The sale is entered into the POS system and automatically recorded in the sales journal in real-time.
Key data such as date, time, terminal number, total sale amount, sales tax, and discounts are
stored for later processing.

o A two-part paper tape is generated, with one copy given to the customer as a receipt and the other
retained within the register for internal records.

4. Shift End Procedures:

o At the end of the clerk’s shift, the supervisor unlocks the register and retrieves the internal tape and
cash drawer.

o The cash drawer is then taken to the cash room (treasury), where it is reconciled against the
internal tape.

o The cash receipts clerk ensures that the contents of the drawer, including cash and credit card
vouchers, match the sale total recorded on the tape.

5. Cash Discrepancies:

o If discrepancies occur, organizations may handle them according to their policies. For example, sales
clerks may be required to cover shortages via payroll deductions, or discrepancies within a certain
threshold may be recorded but not deducted from the employee’s pay.

o Significant discrepancies may require disciplinary action.

End-of-Day Procedures

1. Preparing Bank Deposit:

o At the end of the day, the cash receipts clerk prepares a three-part deposit slip for the total
amount of cash received.

o One copy of the deposit slip is filed internally, and the remaining two copies are sent with the cash to
the bank. Armed guards may be used for security when transporting cash to the bank.

2. Batch Program for General Ledger Updates:

o A batch program summarizes the daily sales and cash receipts journals, prepares a journal
voucher, and posts the appropriate transactions to the general ledger accounts (e.g., Cash, Sales
Revenue, Sales Tax Payable).

o In some organizations, credit card sales are treated as cash transactions, while in others, they are
posted as accounts receivable until funds are received from the card issuer.

Advantages of Reengineered POS Systems

1. Efficiency:

o By automating the sales and payment processes, POS systems significantly reduce the time it takes to
complete transactions, benefiting both customers and employees.

2. Inventory Management:

o The integration of inventory tracking within the POS system ensures that real-time updates are made
when items are sold, helping retailers maintain accurate stock levels and streamline their inventory
management.

3. Enhanced Accuracy:
 o Real-time data entry and automated calculations reduce the chances of human error, particularly with
respect to pricing, taxes, and discounts.

4. Improved Customer Experience:

o Faster and more accurate checkout processes enhance the customer experience, making it easier for
customers to complete purchases and receive accurate receipts.

In summary, both automated cash receipts procedures and POS systems play a critical role in enhancing the
efficiency, control, and customer satisfaction in revenue cycle management. By reengineering traditional processes
with automation, organizations can significantly reduce costs, improve accuracy, and streamline their operations.

The passage you provided discusses the use of Electronic Data Interchange (EDI) and the Internet to reengineer
business processes, particularly in sales order processing. It also addresses control considerations for computer-based
systems in the context of transaction authorization, segregation of duties, supervision, access control, and maintaining
the integrity of accounting records. Below is a breakdown and summary of the key points discussed in the passage:

Reengineering Using EDI

EDI Overview:

● EDI streamlines transactions between buyers and sellers by connecting their computers directly. This allows
automatic transmission and processing of orders without human involvement.

● The process is automated based on predefined agreements (e.g., prices, quantities, delivery times, and
payment terms). No individual authorization is required for each transaction once the agreement is set.

Control Issues with EDI:

● Valid Transactions: Ensuring that only valid transactions are processed without explicit authorization.

● Unauthorized Access: The risk that a trading partner or unauthorized party could access sensitive
accounting records or engage in fraudulent activity.

Reengineering Using the Internet

Internet Business Models:

● Many organizations now sell products via the Internet, where customers browse products and make orders
using credit cards. Orders are processed through email, and employees verify them before entering the
transactions into the system.

● This process can be slower compared to phone orders due to the need for human intervention to review and
verify orders.

Risks and Security:

● Unlike EDI, which relies on formal agreements, the Internet connects organizations to a vast pool of potential
partners, raising concerns about fraud, hacking, and viruses.

● To mitigate these risks, organizations implement security measures such as encryption, passwords, and
firewalls.

Control Considerations for Computer-Based Systems

Authorization:

● Transaction authorization is automated in real-time systems, but it is critical to ensure the accuracy of decision
rules in the system.

● In Point-of-Sale (POS) systems, credit card transactions require online approval from the credit card company,
and clerks must verify the customer’s signature.

Segregation of Duties:

● In computer systems, tasks like inventory control, accounts receivable updating, and billing are often
consolidated into one program, raising concerns about the integrity of the system.
 ● Proper controls must ensure that the application logic is correct, and no unauthorized changes have been
made to the system.

Supervision:

● Supervision is critical to prevent fraud, such as in POS systems where both cash and inventory are at risk.

● Cash handling should be monitored through systems like surveillance cameras and internal registers that track
transactions.

Access Control:

● Unauthorized access to accounting records, especially in digital formats, is a significant risk. Systems must
implement access controls to prevent fraud and errors.

● In POS systems, restricting access to cash registers, locking cash drawers, and monitoring inventory are
common control measures.

Accounting Records Integrity:

● Digital Journals and Ledgers: Accountants must be cautious about the reliability of computer-generated
reports, as they depend on the quality of controls over the system.

● File Backup: Backup procedures are essential for safeguarding accounting records from physical loss or
corruption.

Independent Verification:

● As computer systems automate many tasks, traditional independent verification methods are reduced. Batch
control balancing and management reports can restore some level of independent verification and oversight.

PC-Based Accounting Systems

PC-based accounting systems are widely used by both small and larger companies, especially those with decentralized
operations. These systems are designed to be cost-effective, modular, and flexible, offering a range of accounting
functionalities. Below is a breakdown of key points regarding these systems:

Overview of PC-Based Accounting Systems

● General-Purpose Nature: Unlike mainframe and client-server systems, which are often custom-designed for
specific user needs, PC-based accounting systems are typically general-purpose. This allows for mass
production, lower costs, and fewer errors.

● Popular Among Small Firms: These systems are particularly beneficial for smaller firms that aim to replace
manual processes and enhance efficiency. Larger companies with decentralized operations also use PC
systems.

● Modular Design: These systems are often modular, meaning they offer various business modules like sales
order processing, accounts receivable, inventory control, cash receipts, and payroll. Users can select and tailor
these modules based on their specific needs, making them flexible and adaptable.

● Industry-Specific Solutions: Some vendors target specific industries (e.g., health care, transportation, and
food services) with specialized versions of their products. While this reduces flexibility, it allows firms to focus
on niche market needs.

System Architecture

● Central Control Program: PC-based accounting systems typically have a central control program, which
provides the user interface. This control program allows users to access and invoke various application
modules.

● Data Integration: Many commercial systems integrate the modules fully, so data is transferred automatically
between modules. For instance, when transactions are entered into the sales module, the system ensures that
these are balanced and posted to the appropriate subsidiary and general ledger accounts before generating
financial reports.
PC Control Issues

PC-based systems, while offering flexibility and affordability, come with unique control risks, which accountants must
address:

1. Segregation of Duties

o Inadequate Segregation: In small firms, it’s common for a single employee to have too much
authority, performing multiple tasks such as entering sales orders, cash receipts, invoices, and
disbursements. This creates a risk of fraud or error, as this person might have too much control over
the accounting process.

o Compounded Risk: The risk is further heightened when the same person is also responsible for
modifying or programming the accounting software.

o Solutions: In such cases, effective supervision, regular independent verification, and detailed
management reports (e.g., transaction listings) are essential. Supervisors should regularly reconcile
transaction details with subsidiary and control accounts to minimize these risks.

2. Access Control

o Inadequate Security: Many PC systems lack robust access controls to protect accounting data. While
some systems offer password protection, this can often be circumvented if users access data files
directly via the operating system.

o Solutions: Security measures such as data encryption, disk locks, and physical security devices (e.g.,
locked cabinets or safes) can help mitigate the risk of unauthorized access to sensitive data.

3. Accounting Records and Data Loss

o Data Loss: PC-based systems are more vulnerable to data loss due to hardware failure (e.g.,
computer disk failure). If the data is lost, recovery can be difficult or even impossible.

o Backup Procedures: Unlike mainframe environments, where backups are often automated, PC
systems rely on users to manually back up their data. If users neglect this responsibility, it could lead
to irreparable loss of important accounting records.

o Solutions: Formal backup procedures should be established and followed regularly. Educating users
on the importance of backing up data files and programs is crucial to avoid this risk.

Key Takeaways:

● Flexibility and Affordability: PC-based accounting systems are popular due to their modular design and
ability to serve a wide range of business needs.

● Control Risks: These systems pose unique risks due to inadequate segregation of duties, access controls, and
potential for data loss. Addressing these issues requires strong supervision, independent verification, and the
implementation of robust security and backup protocols.

● Supervision and Backup: Effective internal controls, including detailed management reports, regular
reconciliations, and formal backup procedures, are essential to mitigating risks in PC-based accounting
systems.

In summary, while PC-based accounting systems are a valuable tool for automating accounting tasks and improving
efficiency, they require diligent oversight and security practices to minimize the inherent risks associated with their
use.