INTRODUCTION TO ACCOUNTING INFORMATION

1
TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

Module 004 Transaction Cycle, Business

Processes and Its Associated Controls – Part I
(Sales to Receivable Cycle)

LEARNING OBJECTIVES (LO)

After completing this module, the student is expected to:

1. Understand the concept of revenue cycle system

2. Identify the business processes involve in the sales to receivable cycle
and the departments involved in processing the business activities of
sales to receivable cycle
3. Specify the supporting documents of the sales to receivable cycle
4. Understand the associated controls in each activity of revenue cycle
system

Course Module
LO 1
Revenue Cycle System

As discussed in Module 002, revenue cycle involves the sales processing system (SPS) and cash
receipts processing system (CPS).

To reiterate what has been discussed in Module 002, revenue cycle begins when a customer places
an order. On the SPS, it is where sales orders are being processed. Moreover, aside from
processing sales order, SPS also involves handling the following transactions:

• granting credit to customers, if the sales are on credit

• shipping products to customers, if the company is a merchandising firm or a
manufacturing firm
• rendering of a service to customers, if the company is a service firm
• billing customers, if sales or the rendering of service is on credit
• recording the transaction in the accounts of:
▪ accounts receivable,
▪ inventory,
▪ expenses, and
▪ sales

After processing the transactions under the SPS, the CPS will follow. CPS handles the following
transactions:

• collecting cash,
• depositing cash in the bank,
• and recording these events in the accounts of:
▪ accounts receivable and
▪ cash.
 INTRODUCTION TO ACCOUNTING INFORMATION
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

On this module, we will first focus on the first phase of the revenue cycle, the sales processing
system. Cash receipts processing system will be further discussed on the next module, Week006
Module (Module 005).

Transaction Cycle, Business Processes and Associated Controls of Sales to

LO
2, 3,
Receivable Cycle
&4

Generally speaking, revenue cycle system undergoes the following business processes. These are:

• sales order procedures,

• cash receipts procedures (to be discussed on Week 006 Module: Module 005)

Moreover, the functional departments that are involved on this process are:

• Operations Department
• Controller’s Department or the Accounting Department
• Treasury Department

To properly illustrate the step by step process of the business activity in the revenue cycle system,
depicted below is the system flowchart of the sales to receivable subsystem. Further, this assumes
manufacturing and/or merchandising business activities since this involves inventory accounts.
Thus, if a company is a service firm, the only thing that will differ is the handling of inventory
accounts since service industries do not maintain inventories. On this case, inventory handling
activity will be replaced by rendering of service activity.

Moreover, detailed discussion of the step by step process as illustrated in the system flowchart is
further discussed below.

Course Module
Sales Order Procedures
Sales order procedures involves the following tasks:
1. receiving and processing a customerorder,
2. fillingthe order and shipping products to the customer,
3. billing the customer at the proper time, and
4. correctlyaccounting for the transaction.

Receiving and Processing a Customer Order

The sales process begins with the receipt of a customer order indicating the type and
quantity of merchandise desired. The order is often a copy of the customer’spurchase
order.

Then, the company will ask the customer to fill-up a sales order form in order to
process such order.
 INTRODUCTION TO ACCOUNTING INFORMATION
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

The sales order, as shown in Figure 1, captures vital information such as:

• the customer’s name, address, and account number;

• the name, number, and description of the items sold; and
• the quantities and unit prices of each item sold.

After creating the sales order, a copy of it is placed in the customer open order file
forfuturereference. The customer record in the open order file is updated each time the
status of the order changes such as credit approval, on back-order, and shipment.
FIGURE 1
(excerpted from Accounting Information System by James Hall)

Filling the Order and Shipping Products to the Customer

Course Module
Filling the Order
Before further processing the order further, the customer’s creditworthiness needs
to be established, if the transaction is on credit, of which is the usual business setup,
since sales on cash is very seldom to happen. Thus, on sales on credit, the
circumstances of the sale will determine the nature and degree of the credit check.

The credit approval process is an authorization control and should be performed as

a function separate from the sales activity. The receive-order task sends the sales
order (Credit Department’s copy) to the check-credit task for approval. The
returned approved sales order then triggers the continuation of the sales process by
releasing sales order information simultaneously to various tasks.

Upon release of the approved sales order by the Credit Department, the receive
order activity forwards the stock release document (also called the picking ticket) to
the pick goods function, in the warehouse.

Stock release document or the picking ticket is a document which identifies the
items of inventory thatmust be located and picked from the warehouse shelves.It
also provides formal authorization for warehouse personnel to release the specified
items.

After picking the stock, the order is verified for accuracy and the goods and verified
stock release document are sent to the ship goods task. Then, the warehouse
employee adjusts the stock records to reflect the reduction in inventory.

Shipping Products to the Customer

Before the arrival of the goods and the verified stock release document, the shipping
department receives the packing slip and shipping notice from the receive order
function. The packingslip will ultimately travel with the goods to the customer to
describe the contents of the order.
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

The shipping notice will later be forwarded to the billing function as evidence that
the customer’s order was filled and shipped.This document conveys pertinent new
facts such as:
• the date of shipment,
• the items and quantities actually shipped,
• the name of the carrier, and
• freight charges.

Upon receiving the goods from the warehouse, the shipping clerk reconciles the
physical items with the stock release, the packing slip, and the shipping notice to
verify that the order is correct.

The shipping clerk packages the goods, attaches the packing slip,completes the
shipping notice, and prepares a bill of lading.

The bill of lading, as shown in Figure 2, isa formal contract between the seller and
the shipping company (carrier) to transport the goods to the customer.This
document establishes legal ownership and responsibility for assets in transit. Once
the goods are transferred to the carrier, the shipping clerk records the shipment in
the shipping log, forwards the shipping notice and the stock release to the bill-
customer function
as proof of shipment, and updates the customer’s open order file.

Course Module
 FIGURE 2
(excerpted from Accounting Information System by James Hall)

Billing the Customer at the Proper Time

The shipment of goods marks the completion of the economic event and the pointat
which the customer should be billed.

Billing before shipment is being discourage since it will produce inaccurate record
keepingand inefficient operations.

Upon credit approval, the bill-customer function receives the sales order (invoice copy)
from the receive order task. This document is placed in a sales order (S.O.) pending file
 INTRODUCTION TO ACCOUNTING INFORMATION
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

until receipt of the shipping notice, which describes the products that were actually
shipped to the customer.

Upon arrival, the items shipped are reconciled with those ordered and unit prices,
taxes, and freight charges are added to the invoice copy of the sales order.

The completed sales invoice is the customer’s bill, which formally depicts the charges
to the customer.

Correctly Accounting for the Transaction

The accounting department, then performs the following record keeping–related tasks:

• Records the sale in the sales journal.

• Sends the stock release document to the update inventory records task.
• Forwards the ledger copy of the sales order to the update accounts receivable
task.

Records the sale in the sales journal

The sales journal is a special journal used for recording completed sales
transactions. The details of sales invoices are entered in the journal individually.
At the end of the period, these entries are summarized into a sales journal
voucher, which is sent to the general ledger task for posting to the following
accounts:

DR CR
Accounts Receivable—Control XXXX.XX
Sales XXXX.XX
Each journal voucher, as shown in Figure 3, represents a general journal entry
andindicates the general ledger accounts affected. Summaries of transactions,
adjusting entries, and closingentries are all entered into the general ledger via this
method.

Course Module
 FIGURE 3
(excerpted from Accounting Information System by James Hall)

Sends the stock release document to the update inventory records task

The inventory control function updates inventory subsidiary ledger accounts from
information contained in the stock release document. In a perpetual inventory
system, every inventory item has its own record in the ledger containing, at a
minimum, the data depicted as shown in Figure 4.

Each stock release document reduces the quantity on hand of one or more
inventoryaccounts. Periodically, the financial value of the total reduction in
inventory is summarized in a journal voucher and sent to the general ledger
function for posting to the following accounts:

DR CR

Cost of Goods Sold XXX.XX

Inventory—Control XXX.XX
 INTRODUCTION TO ACCOUNTING INFORMATION
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

FIGURE 4
(excerpted from Accounting Information System by James Hall)

Forwards the ledger copy of the sales order to the update accounts receivable task

Customer records in the accounts receivable (AR) subsidiary ledger are updated
from information the sales order (ledger copy) provides.

Every customer has an account record in the AR subsidiary ledger containing, at

minimum, the following data:

• customer name;
• customer address;
• current balance;
• available credit;
• transaction dates;
• invoice numbers; and
• credits for payments, returns, and allowances.

Figure 5 presents an example of an AR subsidiary ledger record.

FIGURE 5

Course Module
 (excerpted from Accounting Information System by James Hall)

Periodically, the individual account balances are summarized in a report that is sent
to the general ledger.

By the close of the transaction processing period, the general ledger function has
received journal vouchers from the billing and inventory control tasks and an
account summary from the AR function. This information set serves two purposes.

• First, the general ledger uses the journal vouchers to post to the following
control accounts:
DR CR
Accounts Receivable Control XXXX.XX
Cost of Goods Sold XXX.XX
Inventory Control XXX.XX
Sales XXXX.XX
Because general ledger accounts are used to prepare financial statements, they
contain only summary figures (no supporting detail) and require only summary
posting information.

• Second, this information supports an important independent verification

control. The AR summary, which the AR function independently provides, is
used to verify the accuracy of the journal vouchers from billing. The AR
summary figures should equal the total debits to AR reflected in the journal
vouchers for the transaction period. By reconciling these figures, the general
ledger function can detect many types of errors.

Associated Controls in Each Activity of Sales to Receivable Cycle

LO 5
 INTRODUCTION TO ACCOUNTING INFORMATION
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

❖ Authorization
▪ Customer
▪ Sales
▪ Credit
▪ Billing
❖ Custody
▪ Shipping
▪ Warehouse
❖ Recording
▪ Inventory Control
▪ Accounts Receivable
▪ General Ledger

BUSINESS ACTIVITY EMBEDDED CONTROL

1. Sales Department receives a customer Reconciles sequentially numberedSO to
order and prepares a sales order ensure that customer orders are valid and
(SO),and forward it to Credit existing.
Department
2. CreditDepartment performs a credit Ensures thatgoods are shipped only to
check on thecustomer. actual customers and that the account is
If the customer is creditworthy, Credit unlikely to become delinquent.
Department approves the SO
3. Credit Department sends the approved Notifies these departments that a valid sale
SOto the following departments: has been made.
✓ Sales,
✓ Warehouse,
✓ Shipping,
✓ Billing and
✓ Inventory Control

Course Module
4. Uponreceipt of an approved SO, Sales The customer’s expectation ofreceiving
Department sends an goods reduces the chance of misrouting or
acknowledgement to the customer. misappropriation
5. Upon receipt of approved SO, Ensures thatmerchandise is removed from
Warehouse Department pulls the Warehouse only as part of a valid sale.
merchandise, prepares a packing
slipand forwards both to Shipping.
6. Shipping Department verifiesthat the Ensures that the correctgoods are shipped.
goods received from Warehouse match
the approved SO. Then, prepares a bill
of ladingand sends the shipment to the
customer.
7. ShippingDepartmentforwards the Notifies these departments that the goods
packing slipand bill of ladingto have actually been shipped.
Inventory Control Departmentand
BillingDepartment.
8. Upon receiptof the packing slipand bill Ensures that inventoryunit counts are
of lading, Inventory Control updated once goods are shipped.
Departmentmatchesthem with the
approved SO and updates the
inventory records.
9. Upon receiptof the packing slipand Ensure that customers are billed for all
bill of lading, Billing goodsand only to goods that were actually
Departmentmatches them with shipped.
approved SO, thenprepares an Reconciling sequentially numbered invoice
invoiceand sends it to the transactions help
customer. preventsmisappropriation of goods.
If the invoice is paperbased, a
remittance advice isusually included to
be used in cash receipts cycle.
10. Sales Departmentreceives theinvoice Prevents doubleshipment of completed
from Billing Department and updates orders and allows followup of partially
the sales order file. filled orders.
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

11. ARreceives the invoicefrom Billing Ensuresthat customer accounts are kept
Department and posts a journal entry updated.
to the AR file.
12. AR prepares invoice summary for the UpdatingAR and GL files
day andforwards it to General Ledger separatelyprovides an additional
to update GL file. accounting controlwhen they are
periodically reconciled.

FIGURE 5
(excerpted from Accounting Information System by James Hall)

Transaction Authorization
Course Module
 The objective of transaction authorization is to ensure that only valid transactions are
processed.
Credit Check
Credit checking of prospective customers is a credit department function.
This department ensures the proper application of the firm’s credit policies.
The principal concern is the creditworthinessof the customer.

Segregation of Duties
The objective of segregating duties is to ensure that no single individual or
departmentprocesses a transaction in its entirety.
The number of employees and the volume of transactions being processed influence how to
accomplishthe segregation.
Transaction authorization should be separate from transaction processing.
Within the revenue cycle, the credit department is segregated from the rest
of the process, so formal authorization of a transaction is an independent
event.
Asset custody should be separate from the task of asset record keeping.
The physical assets at risk in the revenue cycle are inventory and cash, hence
the need to separate asset custody from record keeping.

The inventory warehouse has physical custody of inventory assets,

butinventorycontrol (an accounting function) maintains records of inventory
levels.

To combine these taskswould open the door to fraud and material errors. A
person with combined responsibility could steal orlose inventory and adjust
the inventory records to conceal the event.

The organization should be structured so that the perpetration of a fraud

requirescollusion betweentwo or more individuals.
As mentioned in the previous module, the record-keeping tasks need to be
carefully separated. Specifically, the subsidiary ledgers (AR andinventory),
the journals (sales and cash receipts), and the general ledger should be
separately maintained.
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

An individual with total record-keeping responsibility, in collusion

withsomeone with asset custody, isin a position to perpetrate fraud. By
separating these tasks, collusion must involve more people, whichincreases
the risk of detection and therefore is less likely to occur.

Supervision
Some firms have too few employees to achieve an adequate separation of functions. These
firms must rely on supervision as a form of compensating control. By closely supervising
employees who perform potentially incompatible functions, a firm can compensate for this
exposure.

Accounting Records
Prenumbered documents
Sales orders, shipping notices, remittanceadvices, and the like are sequentially
numbered by the printer and allow every transaction to be identifieduniquely.

This permits the isolation and tracking of a single event (among many
thousands)through the accounting system. Without a unique tag, one transaction
looks very much like another.

Verifyingfinancial data and tracing transactions would be difficult or even

impossible without prenumberedsource documents.

Special Journals
Using special journals providesa concise record of an entire class of events.
For revenue cycle systems, salesjournal and the cash receipts journal are being used.

Subsidiary Ledgers

Course Module
 Two subsidiary ledgers are used for capturing transaction event details inthe
revenue cycle:
• the inventory ledger and
• AR subsidiary ledgers.
The sale of products reduces quantities onhand in the inventory subsidiary records
and increases the customers’ balances in the AR subsidiaryrecords.

The receipt of cash reduces customers’ balances in the AR subsidiary records. These
subsidiaryrecords provide links back to journal entries and to the source documents
that captured the events.

General Ledgers
The general ledger control accounts are the basis for financial statement
preparation.
Revenue cycle transactions affect the following general ledger accounts:
• sales,
• inventory,
• cost of goodssold,
• accounts receivable, and
• cash
Files
✓ Open sales order file
- shows the status of customer orders.
✓ Shipping log
- specifies orders shipped during the period.
✓ Credit records file
- provides customer credit data.
✓ Sales order pending file
- contains open orders not yet shipped or billed.
✓ Back-order file
- contains customer orders for out-of-stock items.
✓ Journal voucher file
- is a compilation of all journal vouchers posted to the general ledger.
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

Access Controls
Access controls prevent and detect unauthorized and illegal access to the firm’s assets. The
physicalassets at risk in the revenue cycle are inventories and cash.
Limiting access to these items includes:
• Warehouse security, such as fences, alarms, and guards.
• Depositing cash daily in the bank.
• Using a safe or night deposit box for cash.
• Locking cash drawers and safes in the cash receipts department.

The following are examples of access risks in the revenue cycle:

1. An individual with access to the AR subsidiary ledger could remove his or her account
(or someoneelse’s) from the books. With no record of the account, the firm would not
send the customer monthlystatements.
2. Access to sales order documents may permit an unauthorized individual to trigger the
shipmentof a product.
3. An individual with access to both cash and the general ledger cash account could
remove cashfrom the firm and adjust the cash account to cover the act.

Independent Verification
The objective of independent verification is to verify the accuracy and completeness of
tasks that otherfunctions in the process perform. To be effective, independent verifications
must occur at key points inthe process where errors can be detected quickly and corrected.

Independent verification controls in therevenue cycle exist at the following points:

1. The shipping function verifies that the goods sent from the warehouse are correct in
type andquantity. Before the goods are sent to the customer, the stock release
document and the packing slipare reconciled.
2. The billing function reconciles the original sales order with the shipping notice to
ensure that customersare billed for only the quantities shipped.

Course Module
3. Prior to posting to control accounts, the general ledger function reconciles journal
vouchers andsummary reports prepared independently in different function areas.
a. The billing function summarizesthe sales journal,
b. inventory control summarizes changes in the inventory subsidiary ledger,
c. the cashreceipts function summarizes the cash receipts journal, and
d. accounts receivable summarizes theAR subsidiary ledger.
 INTRODUCTION TO ACCOUNTING INFORMATION
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TRANSACTION CYCLE, BUSINESS PROCESSES AND ITS ASSOCIATED CONTROLS – PART I
(SALES TO RECEIVABLE CYCLE)

Shown below is the detailed illustration of the system flowchart of Sales Order Processing System
FIGURE 6
(excerpted from Accounting Information System by James Hall)

END OF MODULE

Course Module
References and Supplementary Materials

Books and Journals

1. Hall, James A (2016). Accounting Information System (9th ed). Boston City: Cengage
Learning.
2. Gleim, Irvin N (2018). Gleim CIA Review. Gainesville, FL: Gleim Publications, Inc.