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www.downloadslide.net Accounting Information Systems Applications Pa r t III Chapter 12 The Revenue Cycle: Sales to Cash Collections Chapter 13 The Expenditure ­Cycle: ­Purchasing to Cash Disbursements Chapter 14 The Production Cycle Chapter 15 The Human Resources ­Management and Payroll Cycle Chapter 16 General Ledger and Reporting System 337 www.downloadslide.net Chapter 12 The Revenue Cycle: Sales to Cash Collections Learning Objectives After studying this chapter, you should be able to: 1. Describe the basic business activities and related information processing operations performed in the revenue cycle. 2. Discuss the key decisions that need to be made in the revenue cycle, and identify the information needed to make those decisions. 3. Identify major threats in the revenue cycle, and evaluate the adequacy of various control procedures for dealing with those threats. In tegrat i ve Case Alpha Omega Electronics Alpha Omega Electronics (AOE) manufactures a variety of inexpensive consumer electronic products, including calculators, digital clocks, radios, pagers, toys, games, and small kitchen appliances. Like most manufacturers, AOE does not sell its products directly to individual consumers, but only to retailers. Figure 12-1 shows a partial organization chart for AOE. Linda Spurgeon, president of AOE, called an executive meeting to discuss two pressing issues. First, AOE has been steadily losing market share for the past three years. Second, cash flow problems have necessitated increased short-term borrowing. At the executive meeting, Trevor Whitman, vice president of marketing, explained that one reason for AOE’s declining market share is that competitors are apparently providing better customer service. When Linda asked for specifics, however, Trevor admitted that his opinion was based on recent conversations with two major customers. He also admitted that he could not readily identify AOE’s 10 most profitable customers. Linda then asked Elizabeth Venko, the controller, about AOE’s cash flow problems. Elizabeth explained that the most recent accounts receivable aging schedule indicated a significant increase in the number of past-due customer accounts. Consequently, AOE has had to increase its short-term borrowing because of delays in collecting customer payments. In addition, the Best Value Company, a retail chain that has been one of AOE’s major customers, recently went bankrupt. Elizabeth admitted that she is unsure whether AOE will be able to collect the large balance due from Best Value. Linda was frustrated with the lack of detailed information regarding both issues. She 338 ended the meeting by asking Elizabeth and Trevor to work with Ann Brandt, vice president of www.downloadslide.net President Linda Spurgeon Vice President Marketing Trevor Whitman Director of Sales Faith Weber Receiving Joe Schmidt Vice President Manufacturing LeRoy Williams Plant Manager Leon Malone Inventory Control Melissa Brewster Vice President Information Systems Ann Brandt Director of Purchasing Ryan McDaniel Figure 12-1 Director Internal Audit Paul Reinhardt Vice President Finance Stephanie Cromwell Controller Elizabeth Venko Shipping Jack Kent Vice President Human Resources Peter Wu Partial Organization Chart for Alpha Omega Electronics Treasurer Frank Stevens Dir. Budget Ali Hussam Cashier Bill Black Taxes Carol Jones Credit Manager Sofia Lopez General Accounting Mike Turno information systems, to develop improved reporting systems so that AOE could more closely monitor and take steps to improve both customer service and cash flow management. Specifically, Linda asked Elizabeth, Trevor, and Ann to address the following issues: 1. How could AOE improve customer service? What information does marketing need to perform its tasks better? 2. How could AOE identify its most profitable customers and markets? 3. How can AOE improve its monitoring of credit accounts? How would any changes in credit policy affect both sales and uncollectible accounts? 4. How could AOE improve its cash collection procedures? The AOE case shows how deficiencies in the information system used to support revenue cycle activities can create significant problems for an organization. As you read this chapter, think about how a well-designed information system can improve both the efficiency and effectiveness of an organization’s revenue cycle activities. 339 www.downloadslide.net 340 Part III Accounting Information Systems Applications Introduction revenue cycle - The ­recurring set of business ­activities and data processing operations ­associated with ­providing goods and services to ­customers and collecting cash in payment for those sales. The revenue cycle is a recurring set of business activities and related information processing operations associated with providing goods and services to customers and collecting cash in payment for those sales (Figure 12-2). The primary external exchange of information is with customers. Information about revenue cycle activities also flows to the other accounting cycles. For example, the expenditure and production cycles use information about sales transactions to initiate the purchase or production of additional inventory to meet demand. The human resources management/payroll cycle uses information about sales to calculate sales commissions and bonuses. The general ledger and reporting function uses information produced by the revenue cycle to prepare financial statements and performance reports. 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 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 maximize cash flow? ● ● ● ● ● ● The answers to those questions guide how an organization performs the four basic revenue cycle activities depicted in Figure 12-3: 1. 2. 3. 4. Sales order entry Shipping Billing Cash collections This chapter explains how an organization’s information system supports each of those activities. We begin by describing the design of the revenue cycle information system and Figure 12-2 Deposits The Context Diagram of the Revenue Cycle Bank Statements Inquiries Orders Payments Customer Sales Bill of Lading Bill of Lading Carrier Packing Packing Slip Slip Responses to Inquiries General Ledger and Reporting System Revenue Cycle Commissions Invoices Information About Goods Available Information About Goods Available Expenditure Cycle Production Cycle Production and Purchasing Needs (Back Orders) Human Resources Management/ Payroll Cycle www.downloadslide.net CHAPTER 12 The Revenue Cycle: Sales to Cash Collections 341 Figure 12-3 Human Resources Management/ Payroll Cycle Commissions Inquiries 1.0 Sales Order Entry Response to Inquiries Orders Sales Orders Sales Order Sales Order Production and Purchasing Needs Information About Goods Available Expenditure Cycle Information About Goods Available Inventory Production Cycle Customer Back Orders Packing Slip Customer Bill of Lading Carrier Packing Slip 2.0 Shipping Bill of Lading Bill of Lading Invoice 3.0 Billing Payments Deposits Bank Statements 4.0 Cash Collections Cash Receipts Customer Sales Sales General Ledger and Reporting System the basic controls necessary to ensure that it provides management with reliable information. We then discuss in detail each of the four basic revenue cycle activities. For each activity, we, describe how the information needed to perform and manage those activities is collected, processed, and stored. We also explain the controls necessary to ensure not only the reliability of that information but also the safeguarding of the organization’s resources. Revenue Cycle Information System Like most large organizations, AOE uses an enterprise resource planning (ERP) system. ­Figure 12-4 shows the portion of the ERP system that supports AOE’s revenue cycle business activities. Process AOE’s customers can place orders directly via the Internet. In addition, salespeople use portable laptops to enter orders when calling on customers. The sales department enters customer orders received over the telephone, by fax, or by mail. Regardless of how an order is initially received, the system quickly verifies customer creditworthiness, checks inventory availability, Level 0 Data Flow Diagram: Revenue Cycle www.downloadslide.net 342 Part III Accounting Information Systems Applications Figure 12-4 Overview of ERP System Design to Support the Revenue Cycle Shipping Web Storefronts Packing Slips & Bill of Lading Internet Orders Customer Account Information Shipping Sales Order Processing Sales Customer Remittances Integrated Database: Customers, Inventory, Pricing, Sales Orders, Shipping, Invoices Billing and Accounts Receivable Cash Collection Processing Inv oic es Accounting Accounts Receivable Warehouse Picked Items Sales Order Entry Customer Accounts Picking Tickets Cashier Customer Payments Sales Invoice Banks Inquiries and Reports Customers Customer Remittances Inventory Status Sales and Profitability Reports Customer Account Inventory Control Marketing Customer Service and notifies the warehouse and shipping departments about the approved sale. Warehouse and shipping employees enter data about their activities as soon as they are performed, thereby updating information about inventory status in real time. Nightly, the invoice program runs in batch mode, generating paper or electronic invoices for customers who require invoices. Some of AOE’s customers still send checks to one of the regional banks with which AOE has established electronic lockboxes, but an increasing number use their bank’s online bill paying service. Each day, the bank sends AOE a file containing remittance data, which the cashier uses to update the company’s cash account balances and the accounts receivable clerk uses to update customer accounts. Threats and Controls Figure 12-4 shows that all revenue cycle activities depend on the integrated database that contains information about customers, inventory, and pricing. Therefore, the first general threat listed in Table 12-1 is inaccurate or invalid master data. Errors in customer master data could result in shipping merchandise to the wrong location, delays in collecting payments because of sending invoices to the wrong address, or making sales to customers that exceed their credit limits. Errors in inventory master data can result in failure to timely fulfill customer orders due to unanticipated shortages of inventory, which may lead to loss of future sales. Errors in pricing master data can result in customer dissatisfaction due to overbilling or lost revenues due to underbilling. Control 1.1 in Table 12-1 shows that one way to mitigate the threat of inaccurate or invalid master data is to use the various processing integrity controls discussed in Chapter 10 to minimize the risk of data input errors. It is also important to use the authentication and authorization controls discussed in Chapter 8 to restrict access to that data and configure the system www.downloadslide.net CHAPTER 12 The Revenue Cycle: Sales to Cash Collections 343 Table 12-1 Threats and Controls in the Revenue Cycle Activity Threat Controls (first number refers to the corresponding threat) General issues throughout entire revenue cycle 1. Inaccurate or invalid ­master data 2. Unauthorized disclosure of sensitive information 3. Loss or destruction of data 4. Poor performance 1.1 1.2 1.3 2.1 2.2 3.1 4.1 Data processing integrity controls Restriction of access to master data Review of all changes to master data Access controls Encryption Backup and disaster recovery procedures Managerial reports Sales order entry 5. Incomplete/inaccurate orders 6. Invalid orders 7. Uncollectible accounts 8. Stockouts or excess inventory 9. Loss of customers 5.1 Data entry edit controls (see Chapter 10) 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 Web sites, and proper evaluation of customer service ratings Shipping 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) 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 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 Billing 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 Cash collections 17. Theft of cash 18. Cash flow problems 17.1 Segregation 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 www.downloadslide.net 344 Part III Accounting Information Systems Applications so that only authorized employees can make changes to master data (control 1.2 in ­Table 12-1). This requires changing the default configurations of employee roles in ERP systems to appropriately segregate incompatible duties. For example, sales order entry staff should not be able to change master pricing data or customer credit limits. Similarly, the person who maintains customer account information should not be able to process cash collections from customers or issue credit memos to authorize writing off sales as uncollectible. However, because such preventive controls can never be 100% effective, Table 12-1 (control 1.3) also indicates that an important detective control is to regularly produce a report of all changes to master data and review them to verify that the database remains accurate. A second general threat in the revenue cycle is unauthorized disclosure of sensitive information, such as pricing policies or personal information about customers. Table 12-1 (control 2.1) shows that one way to mitigate the risk of this threat is to configure the system to employ strong access controls that limit who can view such information. It is also important to configure the system to limit employees’ ability to use the system’s built-in query capabilities to access only those specific tables and fields relevant to performing their assigned duties. In addition, sensitive data should be encrypted (control 2.2) in storage to prevent IT employees who do not have access to the ERP system from using operating system utilities to view sensitive information. The organization should also design its Web sites to use SSL to encrypt information requested from customers while that information is in transit over the Internet. A third general threat in the revenue cycle concerns the loss or destruction of master data. The best way to mitigate the risk of this threat is to employ the backup and disaster recovery procedures (control 3.1) that were discussed in Chapter 10. A best practice is to implement the ERP system as three separate instances. One instance, referred to as production, is used to process daily activity. A second is used for testing and development. A third instance should be maintained as an online backup to the production system to provide near real-time recovery. Accurate master data enables management to better use an ERP system’s extensive reporting capabilities to monitor performance (see threat 4 in Table 12-1). Accountants should use their knowledge about the underlying business processes to design innovative reports (control 4.1) that provide management with insights beyond those provided by traditional financial statements. For example, companies have always closely monitored sales trends. Additional information is needed, however, to identify the causes of changes in that measure. Metrics such as revenue margin1 can provide such information. Revenue margin equals gross margin minus all expenses incurred to generate sales, including payroll, salesforce-related travel, customer service and support costs, warranty and repair costs, marketing and advertising expenses, and distribution and delivery expenses. Thus, revenue margin integrates the effects of changes in both productivity and customer behavior. Growth in revenue margin indicates that customers are satisfied (as reflected in repeat sales), productivity is increasing (reflected in reduced costs per sale), or both. Conversely, a declining revenue margin indicates problems with customer retention, productivity, or both. Revenue margin is a metric to evaluate overall performance of revenue cycle activities. As we will see in the following sections, accountants can help managers design detailed reports and metrics that are relevant to evaluating each business activity. Sales Order Entry 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 12-1), typically performs the sales order entry process, but increasingly customers are themselves entering much of this data through forms on a company’s Web site storefront. Figure 12-5 shows that the sales order entry process entails three steps: taking the customer’s order, checking and approving customer credit, and checking inventory availability. The concept of revenue margin was developed by James B. Hangstefer, “Revenue Margin: A Better Way to Measure Company Growth,” Strategic Finance (July 2000): pp. 40–45. 1 www.downloadslide.net CHAPTER 12 The Revenue Cycle: Sales to Cash Collections Figure 12-5 Orders 1.1 Take Order Customer Rejected Orders 5 Level 1 Data Flow Diagram: Sales Order Entry (annotated to identify threats) Customer 6 Orders Ac Response 1.2 Approve Credit led ow kn Inquiries 345 nt me ge 7 Approved Orders 1.3 Check Inventory Availability Customer 8 Inventory 9 Sales Order 1.4 Respond to Customer Inquiries 9 Sales Order Shipping Sales Order Billing Picking Ticket Warehouse Back Orders Purchasing Figure 12-5 also includes an 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. Taking Customer Orders Customer order data are recorded on a sales order document. In the past, organizations used paper documents; today, as Figure 12-6 shows, the sales order document is usually an electronic form displayed on a computer monitor screen (interestingly, many ERP systems continue to refer to these data entry screens as documents). Examination of Figure 12-6 reveals that the sales order contains information about item numbers, quantities, prices, and other terms of the sale. Process In the past, 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 Web site. Another is for customers to use electronic data interchange (EDI) to submit the order electronically in a format compatible with the company’s sales order processing system. Both techniques improve efficiency and cut costs by eliminating the need for human involvement in the sales order entry process. Focus 12-1 describes how another recent IT development, QR codes, can further improve the efficiency and effectiveness of interacting with customers. Besides cutting costs, Web sites also provide opportunities to increase sales. One technique, used by many Internet retailers, is to use sales history information to create marketing messages tailored to the individual customer. For example, once an Amazon.com customer selects a book, the Web site suggests related books that other customers have purchased when they bought the one the customer has already selected. Amazon.com and other Internet sales order - The document created during sales order entry listing the item numbers, quantities, prices, and terms of the sale. 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. www.downloadslide.net 346 Part III Accounting Information Systems Applications Figure 12-6 Example of a Sales Order Document (Order Entry Screen) Customer's Purchase Order Number Clerk enters item number and quantity,system retrieves other information Source: 2010 © NetSuite Inc. retailers also use sales history data to create customized electronic coupons that they periodically send to customers to encourage additional purchases. Another technique involves the use of interactive sales order entry systems that allow customers to customize products to meet their exact needs. For example, visitors to Dell Computer’s Web site can try numerous combinations of components and features until they find a configuration that meets their needs at a price they can afford. Such interactive sales order entry systems not only increase sales, but also help improve cash flow in two ways. First, because many sales are built to order, less capital needs to be tied up in carrying a large inventory of finished goods. Second, the build to order model allows companies to collect all or part of the payment in advance, possibly even before they have to pay for the raw materials. The effectiveness of a Web site depends largely on its design, however. Therefore, companies should regularly review records of customer interaction on their Web sites to quickly identify potential problems. A hard-to-use Web site may actually hurt sales by frustrating customers and creating ill will. Conversely, a well-designed Web site can provide useful insights. For example, when managers at National Semiconductor noticed a marked increase in Focus 12-1 Using QR Codes to Improve Interactions with Customers QR codes are two-dimensional bar codes that can be scanned with a smartphone. They provide potential customers with access to multimedia anywhere at anytime. For example, consider a charity fund-raising event such as an outdoor concert. QR codes can be printed on posters, displayed on video screens, and included in the program. When attendees scan the code, they are directed to a mobile website where they can make a donation via their smartphone. Such a process is likely to result in a higher percentage of attendees actually donating, because they can do so at the time of the event, rather than hoping that when they get home where they can use their laptop or desktop to access the charity’s website. QR codes can also increase sales by enhancing customer service. For example, in South Korea the grocery chain Tesco places display cases stocked with commonly purchased items at subway stops. Consumers can scan the QR codes next to the items they want, then enter their account number, and the groceries are delivered to their home within an hour. QR codes also facilitate real-time changes to advertising: the seller need only log in to their account, change the content at that one central location, and every subsequent time that a potential customer scans a QR code in a magazine, transportation stop, or other location, they will see the new updated information.