The revenue cycle for many companies is considered the primary source to earn revenue from the sale of goods or service. Good controls must be established to maintain the effectiveness of receivables and credit sales, not doing so can harm the company and might be costly to the business. Six classes of internal controls guides us in evaluating and designing transaction processing. They are authorization, supervision, segregation of duties, access control, independent verification, and accounting records. We will discuss each department that is involved in the revenue cycle, it’s activities, and control activities.The first section discusses the departments that make the revenue cycle , starting with Sales Department and ending with Billing Department, knowingly that collections must be received and adjustments must be made. The second section discusses the six activities mentioned earlier.
The revenue cycle is composed of five independent (in activities and personnel) departments that are required to make function and make a sale. Each department carry out it’s own, and every department depends on the the preceding department in order to function properly. An additional two activities must be considered in the revenue cycle are collection of receivables and adjustments to sales and receivables.
Every sales process starts with receiving a customer purchase order- by mail, in person, or telephone. Thus controlling the customer’s orders is carefully done, and operating procedures must be maintained in an adequate manners. The department then identifies and reviews items and quantities to determine whether the order can be placed, then they prepare The Sales Order. The sales order is not the standard format that the seller’s order processing system needs.
The sales order has vital information, such as the customer’s name account number, description of the items sold quantities, and prices. A copy of sales order is placed in the open order file, the customer getting the ordered goods might take days or even weeks. The customer might check about the status of his or her order, order file is updated every time the status of the order changes .It also sets instructions to guide various divisions and department, including credit, finished goods, shipping, billing, and accounts receivable units.
Credit Approval Department
To provide independence to the credit authorization process, the credit department is organizationally and physically separate from the Sales Department. The credit approval department receives a copy of the sales order from the sales department. The document received serves as an authorization to preform a client credit check. The check includes investigating new customers’ ability to pay and creditworthiness, and a line of credit is established. Typically new checking new customers take time more that existing customers. A good control activity is a limit test, which measures the customer have unused credit. This process set an upper limit that the customer must not pass, if passing it the purchase order by the customer will be denied.
After a credit check has been performed and approved, and a sales order is received. The warehouse is responsible of issuing merchandise and items that were mentioned in the sales order to the shipping department. In a typical company that have finished goods in it’s inventory, this inventory is supervised and controlled by a storekeeper. He is responsible for issuing the goods. Another control activity must be done is updating the inventory records by the accountant, not by the storekeeper. This separation of duty prevents theft of inventory.
The Shipping department
When receiving the finished goods from the warehouse, the shipping clerk must reconcile the products received from the warehouse with the products mentioned in the sales order. This is an important control activity, which ensures send the right products and quantities to the customer who ordered them. Then this department prepares shipping documents , such as the bill of lading as they are loaded into the carrier- cars, trucks etc. These documents numerically controlled and are entered in a shipping register before being forwarded to the billing department. A gate control is done when shipments are made by truck, this ensure that goods have been recorded as shipments. The clerk enters these transaction and sends a shipping notice and stock release to the billing department.
The Billing Department
Upon receiving the Shipping notice and stock release from the shipping department, a sales invoice with any relevant information about the transactions and bills the customer. Billing departments are responsible of serially numbered shipping documents, comparing documents received from other departments, entering data from sales orderers and purchase order on the sales invoice, applying prices and discount to the invoice, make extensions and footing, accumulating total amounts. Controls should be done to ensure the accuracy of sales invoice before sending them to the customer, such as a second person review. The billing clerk enters the transaction into the sales journal and send the documents to the account receivables and inventory control department.
Collection of Receivables
Most receivables are either consisted of checks, and remittance advice and collected through the mail. The cashier is responsible for checks and depositing them, and the remittance advice will be forwarded to the account receivable or the data processing department, which will be recorded in the appropriate accounts. Reductions in the AR are posted periodically to the general ledger control account.
Adjustments to Sales and Receivables
All adjustments to sales for allowances, returns, and write-offs of account receivables should be supported by a credit memo which is serially numbered. This memo must be signed by an employee having no cash handling duties or maintenance over the customers’ ledger. Good Internal controls require that goods must be checked and examined before a credit is given, and the memo should have the serial number of the receiving report on the returned shipment. The treasurer give grant the credit manager the authorization to initiate the process of uncollectible receivable write off.
Updating Inventory Records
The inventory control function updates the inventory subsidiary from the information included in the stock release document which was prepared by the the warehouse. In a typical perpetual system, every item has it’s own record in the ledger containing data, such as units sold, units received m reorder point, EOQ, and standard cost. The stock release document decrease the amount of the inventory. Over a period of time the total reduction in inventory is summarized in a journal voucher and sent to the general ledger function.
Revenue Cycle controls
As mention earlier every department of the revenue cycle must have it’s own controls over is activities, doing so might prevent theft, error, fraud, and enhancing the it’s operations. Six controls are to be covered in this section regarding various department and activities in the revenue cycle
Transaction authorization this ensure that valid transactions are processed only, and it include credit check and return policy for sales processing and remittance list for cash receipts. Credit Check as mentioned is function carry out by the credit department. This department might uses various test and techniques to determine if the customer is trust worthy or not. Different procedures and done to do credit check, depending on the organization, its relationship with the customer, and the materiality of the transactions. Approving for a new customer might take longer time that existing customer, and a decision that falls within the employee authority may be done quickly.
However credit check must be done with consistency of the company’s policy. Return Policy is also a credit department task, the returns must be authorized by this department before receiving them. the nature of the sales and the circumstances determine the authorization granted. Again policies set by the organization, such as cash refunds, must be taken into consideration for granting returns. Remittance List verifies that customers checks and remittance advice match. This reconciliation might detect errors, such as an extra remittance advice or and absence of a customers’ check, it also might detect a difference between checks and remittances. This list authorizes the posting of a remittance advice to a customer’s account.
Segregation of Duties it ensure that separate individual and department processes the transactions. The size and type of an organization affect this type of control, for instance a personally own small business might not need this kind of control, because the owner is the management. The revenue cycle has three rules about the system designers. First, transaction authorization should be separate from transaction processing, such as the warehouse department. The warehouse department cannot issue goods without the confirmation of the credit and the sales department. Second, asset custody should be separate from the task of asset record keeping.
For instance, the warehouse department has physical custody over it’s inventory, but the inventory control is in charge of maintaining the record of inventory levels. Last, the organization must be structured so that fraud require collision between two or more individuals. This means that task should be separated, such as different record keeping individuals. An employee with a total record keeping responsibility, in a collusion with an other employee with custody might commit fraud. Separating task needs more people to commit fraud.
Supervision is considered a compensating control for companies who have little number of employees to make a segregation of duties. Supervising those employees detects error made, and inadequate functions. This tool is used also in system with a good segregation function. For instance the mail room is a good place to commit theft for check received, cashing it, and destroying and evidence relating to the theft. Although this might be detected when complaints made by a customer about billing him again, but the best solution is preventing it from the beginning. Therefor a good supervision over employees is considered a good prevention control.
Accounting Records this control activity describes how a firm’s documents, journals, and ledgers form the system in various stages of processing. It’s also an important feature of well-designed accounting systems. Prenumbered Documents, are sequentially numbered documents that allow every transaction to be uniquely identified. Tracking event related to documents through t system is easy. Special Journals, The revenue cycle uses a specific journals, such as sales journal and the cash receipts journal.
Special journal groups similar transactions into a specific journal. Subsidiary Ledgers, there’s two subsidiary ledgers in the revenue cycle, the inventory and accounts receivables subsidiary ledgers. They provide links to the documents used to capture the events related to each subsidiary. General Ledgers, these are the basis for every accounting system, and for the preparation of every financial statement. Sales, Inventory, Cost of goods sold, AR, and cash are affected by the revenue cycle’s transactions. Files, temporary and permanent files are opened as a result from the revenue cycle. Some examples are, sales order files, shipping log, credit records file, back order file, journal vouchers, .
Access Controls it’s used to grant authorization and permission to employee and access to the firm’s assets, such as the physical assets, cash and inventories. Ways in protecting these assets are: warehouse security, Daily cash deposits, safe/night deposit box, using safes. Access control over information involves restricting access to documents that control physical assets, such as journals and ledgers. Examples of the access risk: Removing one’s account from Account receivables ledger, do so he company can’t send the customer monthly statements. Access to sales order might trigger unauthorized shipment of a product. Access to general ledger and cash might steal and cover it up by adjusting the ledgers.
Independent Verification the main reason independent verification is to verify and assure how accurate and complete the tasks are. Independent verification occur at various point is the process, so that errors are detected and dealt with quickly. Independent Verification in the revenue cycle occur at the following points. First, The shipping department reconciled the goods sent from warehouse with the quantity and type ordered by the customer. this is done by reconciling the stock release document with the packing slip. Second, The billing department reconciles sales ordered with the shipping notice to ensure sending the right invoice with the quantities and prices ordered by the customer. Last, Before posting to any control accounts, the general ledger function reconciles various journal vouchers and summary reports which were prepared independently.
Other Controls include verifying approved buyer, this is not frequently used, but sometimes a purchase order might be completed and signed by and unauthorized person from the client company. Stamp approval on sales order. It is possible for sales orders to be fraudulently routed around the credit department and sent to the warehouse,s o an approval stamp to be used on each sales order. Prenumber sales order forms. Only prenumbered sales order documents should be used. By doing so, the company can track which sales order numbers did not reach the billing department, which may indicate that a delivery was not invoiced. Lock up unused sales order forms. It is possible for someone to enter an order to a shell company on an unused sales order form, fraudulently stamp it as approved by the credit department, and route it to the warehouse as authorization for a delivery.
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