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hello and welcome to the session this is Professor for hat and the session we're going to look at the revenue cycle and specifically we're gonna identify the accounts that are involved in the classes of transaction so now this focus we're gonna focus on the transaction we're gonna have a few sessions about the revenue cycle so this is just an introduction but it's very important to understand the introduction in order to understand more advanced concept or more details information about the cycle so let's go ahead and look at the five transaction psych transactions in the sales cycle now we have to understand before we start also that all's always when we are dealing with sales or revenue which are the same thing we always we have to assume there's the risk of fraud is present two reasons one it's as we said in the prior session revenue is one of the largest account or the profit and loss statement on the income statement and revenues subject a lot of subjectivity and estimates so that's why we have to be very careful when were auditing sales and / account receivable but in this cycle we're gonna be focusing on sales so that's why I will spend more time on the sales cycle the five classes of transactions we make a sale the sale could be for cash or on credit then then we would receive the cash then sometimes the customer may not like some of the product we may give them they may return it or sometimes they may be unhappy we may give them an allowance sometime we might write off accounts for customers that don't pay us and at the end of the period we have to account for bad debt expense so those are the five classes of transaction that you would usually see in sales that you would usually see in sales and what I did I'm gonna go over a few transactions just to kind of make sure you understand what do you remember how the entries go for example when you make a sale on cash or on credit you debit account receivable or cash and you credit sales this is when you process the sale again we're gonna be dealing with account receivable assuming we don't have cash then when the customer pays their money we debit cash credit account receivable we debit cash to receive the money credit account receivable if the customer doesn't like the product they can return them the entries debit sales returns and allowances credit accounts receivable if we write off an account this is what we do we debit allowance for doubtful accounts we credit account receivable here we are assuming we're using allowance the allowance method not the direct write-off method and at the end of the period we might have to write estimate our bad debt expense using the allowance method we debit bad debt expense we credit allowance so those are the typical entries in a sales cycle the typical entries in a sales cycle and this is another picture of which accounts are involved and how are they affected for example when we make a sale we credit sales and if it's a cash sales we debit cash if we make a sale on account we credit sales and we debit account receivable this is the beginning balance and receivable which will be given when we make a sales return we credit account receivable and we debit sales returns and allowances when we write off an account we credit the receivable and we debit allowance for doubtful accounts achill e the same thing that I showed you but this is a picture of it when we estimate bad debt expense we'd never bet that expense and we credit allowance for doubtful accounts and when we receive the cash I'm going to receive the cash we're gonna debit cash we're gonna debit cash when we receive the cash when we receive the cash we're gonna debit cash credit the receivable and if there is a discount we're gonna debit any discount given if we given the customer a discount so those are basically be the typical journal entries and this session once again we're going to focus on sales we're gonna have a separate session focusing on account receivable notice many many most of the transaction goes through the account receivable but I'm gonna be focusing on sales as far as this as far as this session so there are a business function within sales and specifically I'm gonna also after the sales we're gonna look at the collection of sales know what I'm gonna do I'm gonna go through the process show shows you what would happen when we make a silver on eight functions that occur and we're going to go through each function separately now when we go over to the function I'm gonna explain who's involved in the function and specifically the documents why this is important for for an auditor it's extremely important because the documents are the evidence of the of the action so you have to understand what evidence is used what documents are used and what part of the process who starts the document and how are they handled so that's very important now you're gonna see I'm gonna put things in different color so this way you see that I'm dealing with a document and where does it go starting with when the customer place an order so customer could place the order via email telephone fax phone and purchase it doesn't matter send us a purchase order once that happens we create a sales order so this is the first document notice in red it's the sales order now the sales order usually there are pre numbered and this is gonna help us figure on with something called completeness and existence so this way we know that the transaction took place because it's it's it's part of our sales order and it's we accounted for all of them when we count them all when accounting for all of them so first we create a sales order now once we create the sales order for example the customer wants to buy five units of of iPads five units of tablets five tablets so what we do from that sales order we send one to the shipping department so notice the green is that apart the one we're gonna what we're going to be sending the document the sales order we'll send one for the shipping one to the billing and accounting now billing an accounting could be one department altogether okay in some companies they are separate and in some companies they are the same we're gonna assume that they are the same billing and accounting we're gonna assume they are the same for our sake okay so this is what a sales order would look like basically they want to for example buy five quantity five tablets okay description unit price is unit price is $500 total two thousand five hundred no taxes two thousand five hundred so this is basically a sales order okay now obviously we will send this document to the shipping so the shipping department will send it out and we'll send this this document that the building can accounting to record the transaction they don't they don't they don't record the transaction now we're gonna see when they record the transaction but we send them this information so they know that we have a sales in process a sales in process now once we're done with this step once we are done with once once the once we've repaired the sales order oh I forgot to mention we don't just we don't just process the sale there's a second step which is it's a granting the credit what is granting the credit it means we need to check if see this customer is credit worthy in other words would assume we're selling on credit so in other words we need to know aren't we supposed to sell this customer are we supposed to sell them the five tablets at $2,500 on credit okay so what we do here is is this an approved customer and usually the if it's an existing customer it's easy to determine because we will have a history for with that customer and we would know if we should sell them or not now this is a good control why it's a good control because you don't want to sell to anyone on credit why because it's gonna affect your allowance for bad debt in other words you may sell them on credit but if you cannot collect your money it's it's useless selling on credit is easy but collecting the money is what matters so that's why and we'll talk about allowance for bed that later so this is a good control that we have with somebody checks the credit now computer might might process this step so basically once we input the customers ID or account number the computer will check their credit and our balance and they will see if they would end our balance and if they have a good history with us we will we will we will let the sales proceed okay or it could be a person checking the credit now remember this person should be different than the sales person so the sales person or the salesman or the sales person should not be approving the credit somebody else should be approving the credit so we receive this order from XYZ customer we're gonna call the credit department saying can we sell this individual on credit and the credit department will check XYZ credit to determine if we should do it or not so this is the second basically the second step obviously the third step once we have the once we have the sales order once it has been approved again the approval takes place before now remember the shipping department got a receiving it get got a sales order now they're gonna ship it now we're gonna prepare a company this is what the company gives up the asset when the company ship ships the asset and this is we're gonna prepare something called ship in document or it's called sometime bill of lading is a bill of lading is a form of a ship and document but we're gonna call it shipping document that will explain what bill of lading is in a moment so whoever ships the product whoever ships the five tablets will prepare this ship in document saying we ship them obviously our ship in documents they have there are three numbered so also they would help in the completeness and the existence this way we know that we ship something we have a ship in document with a pre numbered and at the end of the period we could account for all of them this missus will help us for the completeness now at this point the ship in document it gives the signal to build the customer this should not be in red building the customer is not a document so just yes I wrote down build the customer like I have to warn you that once you ship once you have the ship in document ready completed it means the product the ship now we can it send signals to the accounting and the building to ship to build the customer so now what we do is we send the ship and document to the billing and accounting department and we send obviously one copy to the customer and this is where the Bill of Lading takes place when you receive a box when you buy something from Amazon or online you would receive a box telling you when you open the box there's a piece of paper with it's usually it's called the Bill of Lading and I'd be doing a I have one of them in here so basically it tells you how many units you know what are the units for example it says five it will say five tablets okay that's that's what the Bill of Lading which oh it's a form of it's a form of a shippin document okay now the Bill of Lading usually doesn't show you the price of it because it this is the the Bill of Lading is basically what you give the D for example FedEx or UPS but it doesn't matter but this is it's a form of shipping document so once the product is shipped guess what we are ready to process the accounting part of the transaction now bear in mind in some places what happened electronic ship and document may be generated so basically the person that's sending the five tablets the person will scan them and once they scan them automatically the system knows that we are will they are being shipped therefore it will create a sales invoice and entries in the sales journal in some companies it's the process as done electronically okay so this is basically the first three steps and I'm going to show you a picture of the first three steps using a document so this is where we are right now we are up to this point so basically we receive a customer order as I showed you the first thing we do for example for this company the order clerk is Pam receives the order the president approves it so before we make a sale the president must approve this as the credit rate the credit granting step so we prepare a document the customer order this is a document we prepare a sales order we prepare a sales order and the sale we have multiple copies of it we have a multiple copies of the sales order one goes to the customer one goes to the accounting department one goes to the shipping so on and so forth okay then then we have the shipping department Harry here is gonna receive the order and they're gonna go ahead and ship it again they're gonna BLS the bill of lading they're gonna prepare several bill of lading one goes to the customer and one goes obviously to the accounting department this is data processing we're going to assume this is accounting and billing for the purpose of the illustration so this is this is what we're singing here so we receive thee we process the order it gets shipped so those are the multiple shipping documents or bill of lading then we're gonna get to the accounting okay now we're gonna see the accounting process tax so step four we're going to go into the accounting billing / accounting once again we're gonna assume it's one department this department will bills the customer and create the newly serial numbered wood sales invoice so here what they do is they create a sales invoice and this is what goes actually to the customer okay and who obviously the accounting department will keep a copy and one copy will go to the customer because the customer needs to know that they need to pay us okay now here the billing department or the accounting department role is important because what happen is remember the billing departing and the billing department have the original invoice that they have the sales invoice they have the original sales order and they have the ship and document what they do is they match all those three to make sure everything is good we received an order we should be ordered now we can invoice the customer they also check the math the earth Matic the pricing the discount so on and so forth so this is an important step okay what are they make what do they make sure what is the why is the why is the billing and the accounting department is important because they make sure that all shipment are billed so every shipment that we make when we receive the shipping report we build them because we want to make sure we're gonna be paid right so this this has to do with completeness we are billing all everything that we are shipping no shipment has been billed more than once so we want to make sure that we don't build the customer more than once this is for occurrence so we only build them for shipment that actually were made by my processing those steps up up top and each customer is built for the proper amount and we make sure from the math we are checking for accuracy and by the way this billing this this is not a document this is not a department this part here I know it's in green but only the Department is the customer and the accountant who gets the who gets the who gets the document at this point at this point account receivable is created or the subsidiary ledger of the person is updated based on the matching document remember we checked everything before we we do so from various sources and the sales journal the sales journal is a is an accounting record it's also updated to make sure that we recorded the sale and the sales journal therefore it's in the account receivable it's in the sales journal organization and it's gonna be in a few other places it's gonna go into a few other places at this point the goods are shipped and the customer is billed at this point basically the goods left us and the transaction is on the record now let's take a look at pitch let's take a look at let's take a look at a picture of this so this is where we are now we're dealing basically in this process here this process basically once we ship it we send a bill of lading to the accountant we said this is accounting and billing they're gonna they're gonna put this in the sales transaction the sales transaction update the sales transaction file it will update the account receivable it will update that we're gonna get a print print reports and it's gonna go to the sales journal and it's gonna go to the subsidiary ledger for each client will will have their own account so what updating the sales the sales record and the account receivable record so those are the additional record that we have for the transactions okay so this is where we are and obviously we create multiple copies we have multiple copies of things in the accounting department and one of them goes to the customer one of them goes to the customer now once we built the customer guess what now we're gonna be waiting obviously for the money for the money this is the good news now we receive the money now who opens the mail when you receive the money here we're assuming will receive an obviously cash here little processing and recording cash receipts and mone with cash receipts is checks would not receive an actual cash okay here the risk is theft the risk of theft so what we do is usually the customer when they send their bill they send something called remittance advice again this is a document that's why it's in red and this is what the remittance advice would look like they'll tell us how much the customer is paying what is the payment number or account number the date and usually what are they what are they paying for so this is the invoice number the purchase number invoice they the amount the previous amount that they pay and the current amount so this is called pretty madness advice again this is a document this is a document to show that the customer paid and how much they paid now if the customer sends a check without without without this document we're supposed to prepare one and you're gonna see why in a moment because this is the evidence that's gonna go to the accounting and billing what's that what other evidence comes with this remittance advice obviously the check came with it okay so we have the check and we have treatment the remittance advice so if they only send the cheque whoever receives the cheque will meet to prepare one of those okay so this way we have a record of it then what do we do next we prepare a pre listing of cash receipts basically that's another document it's pre listing of cash receipts basically a list of every trend oldham of the money that we received with the account number and name okay prepared by someone with no record-keeping responsibilities so basically whoever prepares this doesn't have access to the record okay so they prepared this list this is the verified that how much cash was received that tells us how much cash was received then we send this free listing of cash receipts to the accounting department guess what the accounting department is not a fight to update the record in the general accounting record so if ABC customer or John Doe paid their bill on that pre listing of cash receipts we'll see John Doe paid or what whoever this customer was discussed the ABC limited ABC limited paid 4370 what we do in the accounting department we reduced for accounts receivable by that amount which was I believe 4370 would reduced her account by 4370 and we would reduce overall receivable by 4370 obviously also would increase cash by 4370 so this is what the accounting department would do this is when we update the books but notice they don't get they don't get access to the checks the accounting department don't ex don't get access to the checks the checks on the other hand remember we have the checks and we have the remittance advice no stone no stone commingled this goes to accounting and billing and this goes to the cashier okay the cashier basically is the person that handles the cash the cashiers gonna prepare a deposit slip for the Treasury the cashier include the Treasury and we're gonna take this deposit slip and take the money to the bank and we're gonna get also a receipt from the bank that we made this deposit and so if we made it if we made a deposit of 4370 that day our cash should go up on the record by 4370 and our AR should go down by 4370 at this point a third party usually the controller what they would do they would check to make sure they 4370 the cash received match what we have on the record so everything is is accounted for as appropriate okay again this is segregation of duties again we'll talk about this little bit more later when we talk about internal control this is just to give you an introduction of the cycle I know I'm like giving you a little bit more than just introduction but it's it's helpful now another way for company to avoid all this is to have a lot box system as an alternative way to receive money what is a log box system is when the company opens a p.o box at the bank and they will ask the bank to the one to receive the payment on their behalf so the customer when you send your payment your cellphone payment you're gonna receive it two P o box five five two you know the city and state usually that P o box is located inside the bank the bank opened the P o box and they will deposit the cheque and they will send basically a free listing of cash receipts who pain and for how much to the company and the company will update directly this way company don't have access to the cash this way there's no reason there's no there's no motivation to commit fraud and the bank don't have access to the company's record therefore they have no incentive to steal the money because they cannot cover their tracks now all well it's better if the if the customer sends the money electronically through an electronic fund transfer okay what what source documents are involved here as we saw from that picture cash receipts transaction file include all cash receipts transaction process by the accounting system for a period of of week over day or week sames as same as the sales transaction another document that could be involved here is the cash receipt journal generated from the cash receipt transaction file so this is the cash receipt journal generated from this file and include all transaction for the time period and include all relevant information such as name of the customer their address their information this is this is basically more detailed information about the customer and this is what we are looking at here we receive the check the receptionist received the check and once we receive the check a proper internal control the store strip restrict Li endorsed the check basically turning to check on its back and stamp it for deposit only so we were strictly restrict Li staying the check for deposit only this way nobody can do anything with it we prepare a pre listing of the checks see that the list goes to it to a separate place than the checks the checks goes to the cashier or the Treasury who prepare a deposit slip and then the deposit slips eventually makes it to the bank that we have multiple deposit slip but the deposits that makes it in the bank the pre listing of the the record goes to the accounting department did update the cash journal ended up and we have a list of the pre-listing to match it with the deposits level also the pre list update the accounting record as I showed you this is basically a picture of what happened of what happened okay let's go next what are the sixth step in the sales cycle processing and recording sales returns and allowances this is basically when a customer returned the product the company prepared receiving report again the receiving report has to be pre number so we can account for them all and the reason why because if a customer returns something the company might hide the return because remember returns what do returns do returns reduces sales returned reduces sales so there's a risk that the and this happened in the past were the company asks the customers to send a return for example the company have a way they're operating here and they ask the customer to return the product sampling to return to make the return another place so this way the customers when the customers makes a sales return they will send it at this place it doesn't send it to the company actually this place is a company place but it's not where the auditor knows about it so this we don't want the auditor knows that they're having returned so that's why it's important to have it receiving report and make sure what accounting for this otherwise company could reduce your sale could could increase your sales indirectly by not reporting the return if that makes sense okay now recorded sales returns and allowances in a transaction file as well as an account receivable so once we have a return we need to reduce our sales and we need to reduce the account receivable for the customers which is in turn reduce our overall account receivable and we have to prepare something called a credit memo again everything in red is as a source document here credit memo are issued for returns and allowances to aid in maintaining control and to facilitate record-keeping so the customer gets some sort of a receipt that they're being given credit for the return or sometimes it could be a return or could be an allowance allowances when the customer is not happy to receive the product late they receive the wrong size the wrong color we give them a we give them some credit okay this is to support the reduction and account receivable rather than so basically don't think about credit or given them something we're reducing our account receivable okay because we need to know why that account receivable goes down show me the source document it will show you the credit memo that this customer got that $5 for 10 for 10 units that we ship to them for $50 this way we know that account receivable went down by $50 we have a record of it it's a credit memo so we know what happened it's the evidence behind the system the step 7 what could happen in the sales cycle we we may need to write off in collectable account again each company will have some type of a form before we write off an account we need to have a fill out a form now this form when do we write off an account it all depends on the company own internal policies for example a company could have once the customer file for a bankruptcy order of the amount is over 180 days past due or once we turn it to a collection agency this is when we write off the account so we have to have a proper control because we don't want somebody writing off receiving cash hiding the cash and writing off the account - hi Dirk hide the door theft okay so we prepare a and an in collectable authorization form I don't I don't have a copy of it because each company is different okay then the last thing we need to do is providing for bad debt at the end of the period after we have credit sales the company will know that they cannot collect 100% so what they do to comply with the matching principle remember expenses have to be reported in the same period that sales took place therefore we have to debit that expense and we have to credit the allowance so basically to estimate how much bad that expense we're gonna have and this transaction usually goes into the general ledger in a general journal and this is the rightness that's the record of it so those are the eight steps in the sales cycle here's a summary of what happens at every cycle and what documents are involved for example and and when we make a sale it's the accounts involved sales and account receivable we process the customer's order we grant credit we ship the document and we build the customer and record the sale here are the documents that are involved when we receive the cash we debit cash credit receivable processing and recording cash this is what we do we receive the cash we prepare a deposit slip we we deposit the money here's the document that are involved a remittance advice the pre-listening of cash receipt the cash receipt transaction file the cash receipt journalist thing this is important because later on as an auditor you have to know what am I looking for and what what's the source document sales returns and allowances again sales returns allowances an account receivable processing and recording sales and allowance this is the business function the credit memo is the evidence and the sales return and allowance journal will show you what sales return that we have dried off again accounts that are involved in the the source document so this is really a good picture of the of the source document the activity which is the business function which accounts are involved and the classes of transaction I'm sure I'm hope I hope you notice although we call this a sales Oh although we call this a sales cycle which is the sales cycle but notice account receivable is used in many in many places in the sales cycle especially when you are selling on account but here were focusing on sales we've got a look at account receivable separately so don't worry would look at this and this is another complete picture of how the company run the operation now I did not go specifically in these forms because I don't want to confuse you more if you're not familiar with what these how to read these charts so that's that the next thing I'm gonna do is to understand internal control and design and perform tests of control for specifically the sales in yes I will do the sales and I will do the cash collection separately cash collection separately then after the internal control out look at the substantive testing for sales and the substantive testing for for cash collection if you have any questions any comments by all means email me or see me in class and if you're studying for your CPA exam always always always study hard