Chapter 9

Auditing the Revenue Cycle

Review Questions:

1. What document initiates the sales process?

Response: A customer order, usually in the form of a purchase order, initiates the sales process.

2. Distinguish among a packing slip, a shipping notice, and a bill of lading.

Response: The packing slip travels with the goods to the customer, and it describes the contents on the order. Upon filling the order, the
shipping department sends the shipping notice to the billing department to notify it that the order has been filled and shipped. The shipping notice
contains additional information that the packing slip may not contain, such as shipment date, carrier, and freight charges. The bill of lading is a
formal contract between the seller and the transportation carrier; it shows legal ownership and responsibility for assets in transit.

3. What are three input controls?

Response:
 Authorization procedures
 Credit check procedures
 Validation controls
 Batch controls

4. What are the three rules that ensure that no single employee or department processes a transaction in its entirety?
Response: The three rules that ensure segregation of functions are as follows:
a. Transaction authorization should be separate from transaction processing.
b. Asset custody should be separate from asset record keeping.
c. The organization structure should be such that the perpetration of a fraud requires collusion between 2 or more individuals.

5. What is automation, and why is it used?

Response: Automation involves using technology to improve the efficiency and effectiveness of a task. Automation of the revenue cycle is
typically used to reduce overhead costs, make better credit granting decisions, and collect outstanding accounts receivable better.

6. What is the objective of reengineering?

 Response: The objective of reengineering is to greatly reduce costs by identifying and eliminating nonvalue-added tasks and by
streamlining necessary existing processes.

7. Distinguish among an edit run, sort run, and update run.

Response: An edit run is the first run; it detects most data entry errors. Only clear data progresses to the sort run. The sort run sequences the
transaction records according to its primary key field and possibly a secondary key field. Once the data are sorted, the update program posts the
transactions to the appropriate corresponding records in the master file. During a sequential update, each record is copied from the original master
file to the new master file, regardless of the effect on the balance.

8. How is the record’s primary key critical in preserving the audit trail?
Response: The primary key provides the link between the magnetic records stored on a computer disk and the physical source documents
and business events that they represent. In database systems the primary key of one table’s record is the embedded foreign key in related table
records. For example, the invoice primary key (Invoice Number) is a foreign key in the related line item detail records, thus forming an audit trail.

9. What are the advantages of real-time processing?

Response: Real-time processing greatly shortens the cash cycle of the firm. Lags inherent in traditional systems can cause delays of several
days between taking an order and billing the customer. Real-time processing can give a firm a competitive advantage in the marketplace. Manual
procedures tend to produce clerical errors, such as incorrect account numbers, invalid inventory numbers, and price–quantity extension
miscalculations. Real-time processing reduces the amount of paper documents in a system.

10. Why does billing receive a copy of the sales order when the order is approved but does not bill until the goods are shipped?
Response: The billing department’s receipt of the sales order occurs in most instances before the goods are actually shipped; thus, the
economic event is not complete. Since credit checks need to result include credit already extended for orders not yet shipped, the billing
department (and other departments) receive copies of the sales order once credit is approved. Of course, some of the goods may not be available to
ship; thus, the customer is not billed until the shipping department sends the shipping notice to the billing department.

11. How do tests of controls relate to substantive tests?

Response: Tests of controls and substantive tests are auditing techniques used for reducing total audit risk. Substantive tests traditionally
follow tests of controls because the results of tests of controls are used to determine the nature, timing, and extent of the substantive tests.

12. In a manual system, after which event in the sales process should the customer be billed?
Response: Billing occurs after the product is shipped to the customer (and the shipping department sends a shipping notice to the billing
department).
13. What is a bill of lading?
Response: A bill of lading is a formal contract between the seller and the shipping company (carrier) to transport the goods to the customer.
The bill of lading establishes legal ownership and responsibility for assets in transit.

14. What document initiates the billing process?

Response: The billing process is initiated by the shipping notice, which signals the shipment of the goods to the buyer.

15. Where in the cash receipts process does supervision play an important role?
Response: Supervision plays an important role in the mail room where both the check (asset) and remittance advice (accounting record) are
in the hands of one person. Mail room fraud can result, which involves stealing the check and destroying the remittance advice to cover the theft.

16. List the revenue cycle audit objectives derived from the “existence or occurrence” management assertion.
Response:
 Verify that the accounts receivable balance represents amounts actually owed to the organization at the balance sheet data.
 Establish that revenue from sales transactions represent goods shipped and services rendered during the period covered by the financial
statements.

17. List the revenue cycle audit objectives derived from the “completeness” management assertion.
Response:
 Determine that all amounts owed to the organization at the balance sheet date are reflected in accounts receivable.
 Verify that all sales for shipped goods, all services rendered, and all returns and allowances for the period are reflected in the final
statements.

18. List the revenue cycle audit objectives derived from the “accuracy” management assertion.
Response:
 Verify that revenue transactions are accurately computed and based on current prices and correct quantities.
 Ensure that AR subsidiary ledger, the Sales Invoice file, and the Remittance file are mathematically correct and agree with the general
ledger accounts.
Discussion Questions

1. Distinguish among the sales, billing, and accounts receivable departments. Why can’t the sales or accounts receivable departments prepare the
bills?
Response: The principles of segregation of duties apply to these departments.
The sales order department (included in the sales department in the text) is responsible for taking the customer order and placing it into a
standard format. This department records information such as the customer’s name, address, account number, quantities and units of each item,
discounts, freight preferences, etc. The sales order processing may, in some instances, play a role in verifying or determining the promised
shipping date. The billing department receives a copy of the sales order from the sales department. Upon receipt of the shipping notice and the
stock release documents, the billing department prepares the sales invoice, which is the customer’s bill reflecting charges for items shipped, which
may be different from items ordered, taxes and freight and any discounts offered. The sales order department should not prepare the bills because
the salespeople may bill their favorite clients less than they should be billed. The salespeople place the order and thus start the wheels in motion
for inventory to be shipped. Further, the salespeople should not be allowed to determine how much the customers pay for their inventory, because
they may be tempted to charge lower prices and receive kickbacks.
The accounts receivable department receives the sales orders and posts them to the accounts receivable subsidiary ledger. As remittance
advices are received, they are posted to the customer’s account in the accounts receivable subsidiary ledger. The accounts receivable department
should not be allowed to prepare the bills because this department has custody over the accounts receivable assets. It records customer payments
and tracks customers’ unpaid bills. If it was allowed to prepare the bills, it might not bill certain customers and receive a kickback from the
customers for the free goods.

2. Explain the risks associated with mailroom procedures.

Response: The checks received in payment for accounts receivable are a crucial asset for the firm. The mailroom is a point of exposure for
any firm. The individual who opens the mail has access both to cash (the asset) and to the remittance advice (the record of the transaction). A
dishonest employee may use this opportunity to steal the check, cash it, and destroy the remittance advice, thus leaving no evidence of the
transaction. Ultimately, this sort of fraud will come to light when the customer receives another bill and, in response, produces the canceled check.
However, by the time the firm gets to the bottom of this problem, the perpetrator may have committed the crime many times over and left the
organization. Detecting crimes after the fact accomplishes little. Prevention is the best solution. The deterrent effect of supervision can provide an
effective preventive control.

3. How could an employee embezzle funds by issuing an unauthorized sales credit memo if the appropriate segregation of duties and authorization
controls were not in place?
Response: An employee who has access to incoming payments, either cash or check, as well as the authorization to issue credit memos may
pocket the cash or check of a payment for goods received. The employee could then issue a credit memo to the customer’s account so that the
account does not show a balance due.
4. What task can the accounts receivable department engage in to verify that all checks sent by the customers have been appropriately deposited
and recorded?
Response: The company should periodically, perhaps monthly, send an account summary to each customer listing invoices and amounts
paid by check number and date. This form allows the customer to verify the accuracy of the records. If any payments are not recorded, the
customer can notify the company of the discrepancy. These reports should not be handled by the accounts receivable clerk or the cashier.

5. Why is access control over revenue cycle documents just as important as the physical control devices over cash and inventory?
Response: Access control to the billing and accounts receivable records that are part of the revenue cycle is just as important as the physical
control devices over cash and inventory because these records affect the collectibility of an asset—accounts receivable—that should eventually be
converted into cash. If these records are not adequately controlled, inventory may not be ultimately converted into the cash amount the firm
deserves.

6. For a batch processing system using sequential files, describe the intermediate and permanent files that are created after the edit run has
successfully been completed when processing the sales order file and updating the accounts receivable and inventory master files.
Response: After the edit program tests each record for clerical or logical errors, it writes the correct records to a clean transaction file and
the records with errors to an error file. Both of these files are considered intermediate or temporary files. The error file is considered to be a
temporary file because the records will be resubmitted after they have been reviewed and corrected. The clean transaction file is considered to be
an intermediate file because it will be sorted and written to a new tape. The old, unsorted transaction file will not be used in further processing
once a sorted transaction file is made.

7. Why has the use of magnetic tapes as a storage medium declined in recent years? What are their primary uses currently?
Response: Both tapes and disks can be used as the physical storage medium for such systems. However, the use of tapes has declined
considerably in recent years. For day-to-day operations, tapes are inefficient because they must be physically mounted on a tape drive and then
dismounted when the job ends. This approach is labor intensive and expensive. The constant decline in the cost of disk storage in recent years has
eliminated the economic advantage once associated with tapes. Most organizations that still use sequential files store them on disks that are
permanently connected (online) to the computer system and require no human intervention. The operational features of sequential files described
earlier are the same for both tape and disk media. Today, tapes are used primarily as backup devices and for storing archive data. For these
purposes, they provide an efficient and effective storage medium for a large system.

8. Discuss both the tangible and intangible benefits of real-time processing.

Response: Real-time processing yields the following tangible benefitsReal-time processing greatly shortens the cash cycle of the firm. Lags
inherent in traditional systems can cause delays of several days between taking an order and billing the customer. Real-time processing can give a
firm a competitive advantage in the marketplace. Manual procedures tend to produce clerical errors, such as incorrect account numbers, invalid
inventory numbers, and price–quantity extension miscalculations. Real-time processing reduces the amount of paper documents in a system.
Further, real-time processing may also achieve the following intangible benefits. It may increase customer satisfaction through faster
operation response time to requests and inquiries, decreased lag time between order date and shipment date, and more accurate records with fewer
corrections requested.

9. Distinguish between positive and negative confirmations.

Response:Positive confirmations ask recipients to respond whether their records agree or disagree with the amount stated. Positive
confirmations are particularly useful when the auditor suspects that a large number of accountsmay be in dispute. They are also usedwhen
confirming unusual or large balances or when a large proportion of total accounts receivable arises froma small number of significant customers.
A problem with positive confirmations is poor response rate. Customers who do not dispute the amount shown in the confirmation letter may not
respond. The auditor cannot assume, however, that lack of response means agreement. To obtain the highest response rate possible, second and
even third requests may need to be sent to nonrespondents.
Negative confirmations request the recipients to respond only if they disagree with the amount shown in the letter. This technique is used
primarily when accounts receivable consist of a large number of low-value balances and the control risk of misstatement is considered to be low.
The sample size for this type of test is typically large and may include the entire population. Evidence from nonreturned negative confirmations
selected from a large population provides indirect evidence to support the auditor’s expectation that accounts receivable are not materially
misstated. Responses to negative confirmations, particularly if they are widespread in a large population, may indicate a potential problem. Since
the negative confirmations approach does not prove that the intended recipients actually received and reviewed the confirmation letters, evidence
of individual misstatements provided by returned responses cannot be projected to the entire population. In other words, responses to negative
confirmations cannot be used as a basis for determining the total dollar amount of the misstatement in the account. Such evidence can be used,
however, to reinforce the auditor’s prior expectation that the account balance may be materially misstated and that additional testing of details is
needed to determine the nature and amount of the misstatement.

10. What is the purpose of analytical reviews in the audit of revenue cycle accounts?
Response:
Auditors often precede substantive tests of details with an analytical review of account balances. In the case of the revenue cycle, an analytical
review will provide the auditor with an overall perspective for trends in sales, cash receipts, sales returns, and accounts receivable. In addition,
analytical procedures can provide assurance that transactions and accounts are reasonably stated and complete and may thus permit the auditor to
reduce substantive tests of details on these accounts.

11. Explain the open-invoice system. What effect might it have on confirmation responses?
Response: Under this approach, invoices are recorded individually rather than summarized or grouped by creditor. In this environment, no
accounts payable subsidiary ledger exists. Each invoice is paid (closed) as it comes due. For financial reporting purposes, total accounts payable is
calculated simply by summing the open (unpaid) invoices. Determining the liability due to a particular creditor, which may consist of multiple
open invoices, is not such a simple task. The auditor should not assume that an organization that uses this approach would invest the time needed
to respond to the confirmation request. The confirmation process may thus be ineffective.

12. What financial statement misrepresentations may result from an inconsistently applied credit policy? Be specific.
Response:
Accounts receivable may be overstated because allowance for doubtful accounts is understated due to poor credit policy.
Bad debt expense may be understated.

13. Give three examples of access control in a POS system.

Response: The following are examples:
Steel cables to secure expensive leather coats to the clothing rack.
Locked showcases to display jewelry and costly electronic equipment.
Magnetic tags attached to merchandise, which will sound an alarm when removed from the store.
Password log-in to cash registers.

Note to Instructor: Some physical security devices could also be classified as supervision.

14. What makes POS systems different from revenue cycles of manufacturing firms?
Response: In point-of-sale systems, the customer literally has possession of the items purchased, thus the inventory is in-hand. Typically,
for manufacturing firms, the order is placed and then the good is shipped to the customer at some later time period. Thus, updating inventory at the
time of sale is necessary in point-of-sale systems since the inventory is changing hands, while it is not necessary in manufacturing firms until the
goods are actually shipped to the customer.

15. Is a POS system that uses bar coding and a laser light scanner foolproof against inaccurate updates? Discuss.
Response: No, the bar-codes are not read with 100% accuracy. Another potential error can occur if the wrong bar-coded stickers are
attached to the merchandise, which can occur in some discount retail stores that do not update the database; they just print out bar-coded stickers
and attach them to the merchandise. Devious customers may switch stickers on price tags. In addition, an error can be made when entering the bar-
codes into the system, thus the wrong item rings up when the tag is scanned.
Multiple Choice
1. C
2. B
3. C
4. B
5. C
6. C
7. D
8. A
9. C
10. A

Problems

1. Process Description
Describe the procedures, documents and departments involved when insufficient inventory is available to fill a customer’s approved order.

Response:
When insufficient inventory is available to fill a customer’s approved order, the warehouse clerk places these items on back order. The back-order
status is reported to the sales department where either a new sales order for the outstanding item(s) is prepared or the existing sales order is copied
and adjusted to reflect the missing product(s). The stock release document is noted to reflect the amounts that are being shipped to the customer.
The customer is typically not billed until the goods are shipped.

2. Process Description
Refer to Figure 9-1 presented in the text and explain where the batch totals come from and which accounts in the general ledger are affected by the
end-of-day batch process.

Response: In a batch system, the general ledger master file is not updated every time a batch is processed; rather, the general ledger is typically
updated at the close of each day. Each of the systems, such as accounts payable, accounts receivable, cash receipts, cash disbursement, and
inventory control, accumulate totals for all of its batches run since the last general ledger update. The totals are sorted by the general ledger
account number, and the general ledger is updated in a single run.

3. Flowchart Analysis
Use the flowchart for Problem 3 to answer these questions:
a. What accounting document is represented by symbol A?
b. What is an appropriate name for the department labeled B?
c. What would be an appropriate description for process C?
d. What is the location represented by symbol D?
e. What accounting record is represented by symbol E?
f. What is an appropriate name for the department labeled H?
g. What device is represented by symbol F?
h. What device is represented by symbol G?
i. What accounting record is represented by symbol G?

Response:
a. Cash prelist or remittance list
b. Cash Receipts department
c. Post to Cash Receipts Journal and deposit checks or Process Cash Receipt
d. Bank
e. Cash Receipts Journal
f. Accounts Receivable Department
g. Computer terminal
h. Computer disk
i. Accounts Receivable file
4. Internal Control Evaluation
Identify the control weaknesses depicted in the flowchart for Problem 4.

Response:
 Sales clerk should not record sales in the Sales Journal before the economic event (shipping the goods) has occurred. Billing should
perform this role.
 No credit check is performed.
 Billing department bills customer before the goods are shipped and without confirmation of shipment and quantity shipped. A shipping
notice should trigger the billing process.
 Accounts Receivable should not process cash receipts and maintain the AR subsidiary records.
 Warehouse clerk, who controls the physical inventory, should not also maintain the inventory subsidiary records.
 The general ledger department should receive journal vouchers and account summaries from AR, Cash Receipts, Billing, and Inventory
control. Instead they inappropriately use source documents to update GL accounts.

5. Segregation of Functions
Which, if any, of the following situations represent improper segregation of functions?
a. The billing department prepares the customers’ invoices, and the AR department posts to the customers’ accounts.
b. The sales department approves sales credit memos as the result of product returns, and subsequent adjustments to the customer
accounts are performed by the AR department.
c. The shipping department ships goods that have been retrieved from stock by warehouse personnel.
d. The general accounting department posts to the general ledger accounts after receiving journal vouchers that are prepared by the billing
department.

Response:
All are proper segregation of functions except b. The sales department should not be allowed to approve credit memos since it could potentially
overstate sales in one period to meet quotas and boost bonuses and reverse them in a subsequent period. The receiving report indicating that goods
have been received by the receiving department should be the source document for credit memos and it should be authorized by someone
independent of the sales department.

6. Internal Controls (CMA 688 5-2)

Jem Clothes, Inc., is a twenty-five-store chain, concentrated in the Northeast, that sells ready-to-wear clothes for young men and women. Each
store has a full-time manager and an assistant manager, both of whom are paid a salary. The cashiers and sales personnel are typically young
people working part time who are paid an hourly wage plus a commission based on sales volume. The Problem 6 flowchart presented in the text
depicts the flow of a sales transaction through the organization of a typical store. The company uses unsophisticated cash registers with four-part
sales invoices to record each transaction. These sales invoices are used regardless of the payment type (cash, check, or bank card).
On the sales floor, the salesperson manually records his or her employee number and the transaction (clothes, class, description, quantity,
and unit price), totals the sales invoice, calculates the discount when appropriate, calculates the sales tax, and prepares the grand total. The
salesperson then gives the sales invoice to the cashier, retaining one copy in the sales book.
The cashier reviews the invoice and inputs the sale. The cash register mechanically validates the invoice by automatically assigning a
consecutive number to the transaction. The cashier is also responsible for getting credit approval on charge sales and approving sales paid by
check. The cashier gives one copy of the invoice to the customer and retains the second copy as a store copy and the third for a bank card, if a
deposit is needed. Returns are handled in exactly the reverse manner, with the cashier issuing a return slip.
At the end of each day, the cashier sequentially orders the sales invoices and takes cash register totals for cash, bank card, and check sales,
and cash and bank card returns. These totals are reconciled by the assistant manager to the cash register tapes, the total of the consecutively
numbered sales invoices, and the return slips. The assistant manager prepares a daily reconciliation report for the store manager’s review.
Cash, check, and bank card sales are reviewed by the manager, who then prepares the daily bank deposit (bank card sales invoices are
included in the deposit). The manager makes the deposit at the bank and files the validated deposit slip.
The cash register tapes, sales invoices, and return slips are then forwarded daily to the central data processing department at corporate
headquarters for processing. The data processing department returns a weekly sales and commission activity report to the manager for review.

Required:
a. Identify six strengths in the Jem Clothes system for controlling sales transactions.
b. For each strength identified, explain what problem(s) Jem Clothes has avoided by incorporating the strength in the system for controlling
sales transactions.

Response:
Strengths Problems Avoided
• All 25 stores use the same • Avoids difficulty in auditing the stores
system for controlling sales and incorporating chainwide
transactions. improvements.

• The assistant manager and manager • Avoids subjectivity in sales

are paid on a salary basis. and commission allocations.
• Reduces subjectivity for credit
and check approvals.
• Cashiers and salespeople • Minimizes the possibility of fraud.
are separated for completing • Helps mitigate sales invoice errors.
sales invoices and returns. • Prevents the salespeople from taking the
returns for their own use

• Automatic sequential numbering • Eliminates subjective consecutive

is done by the cash register. numbering, minimizing employee theft.
register. • Avoids the undetected loss of an invoice.
• Provides an audit trail for invoices.

• The multi-part invoices are sequentially • Prevents the omission of an invoice.

ordered. • Avoids possible fraudulent payment
shortage.
• Provides a distribution of copies of the
invoice throughout the system.

• The reconciliation of cash receipts, • Reduces the possibility of theft or fraud.

checks, bank cards, returns, and cash • Provides another opportunity to catch
register tapes is performed. errors.

7. Stewardship
Identify which department has stewardship over the following journals, ledgers, and files:
a. Customer open order file
b. Sales journal
c. Journal voucher file
d. Cash receipts journal
e. Inventory subsidiary ledger
f. AR subsidiary ledger
g. Sales history file
h. Shipping report file
i. Credit memo file
j. Sales order file
k. Closed sales order file

Response:
a. Sales
b. Billing
c. General ledger
d. Cash receipts
e. Warehouse/Inventory control
f. Accounts receivable
g. Sales
h. Shipping
i. Sales
j. Sales
k. Sales

8. Control Weaknesses
For the past 11 years, Elaine Wright has been an employee of the Star-Bright Electrical
Supply store. Elaine is a very diligent employee who rarely calls in sick and takes her vacation days staggered throughout the year so that no one
else gets bogged down with her tasks for more than one day. Star-Bright is a small store that employs only four people other than the owner. The
owner and one of the employees help customers with their electrical needs. One of the employees handles all receiving, stocking, and shipping of
merchandise. Another employee handles the purchasing, payroll, general ledger, inventory, and accounts payable functions. Elaine handles all of
the point-of-sale cash receipts and prepares the daily deposits for the business. Furthermore, Elaine opens the mail and deposits all cash receipts
(about 30 percent of the total daily cash receipts). Elaine also keeps the AR records and bills the customers who purchase on credit.

Required:
a. Point out any control weaknesses you see in the above scenario.
b. List some recommendations to remedy any weaknesses you have found working under the constraint that no additional employees can be
hired.

Response:
a. Elaine performs many incompatible tasks. She opens the mail, deposits all cash and check receipts, and keeps the accounts receivable records.
She could easily keep checks and alter the accounts receivable to cover her theft. Furthermore, she records the bills, so she could potentially bill a
customer, not record it in the books, and keep the money when the check is received. Even more troublesome is the fact that she handles the point-
of- sale receipts and prepares the daily deposits, which are a substantial amount of sales (30 percent). Elaine never takes enough vacation time so
that anyone else can perform her duties long enough to check the books.
The employee who handles the inventory and accounts payable function also has incompatible tasks. This employee could be making
payments to a family or friend for inventory not received. The employee who handles all receipts, stocking, and shipping of inventory is also
performing incompatible tasks and could be pilfering some inventory as it comes in and shipping it to himself or herself.

b. Close supervision is needed for the employee working in the receiving, stocking, and shipping department. This employee needs to be kept from
stealing inventory. Close supervision should help reduce this risk. Prenumbered shipping forms that must be accounted for may deter this
employee from shipping any goods to himself or herself or friends. The accounting function should be redistributed among the remaining two
employees and close supervision should be exercised. One possible reallocation of tasks would be:
Employee 1 Employee 2
• record point-of-sale receipts • prepare the daily cash deposits and
• update the accounts receivable reconcile to daily cash sales
account records open the mail and make a list of all
• prepare the bills for accounts incoming checks—prepare deposit
receivable accounts payable
• inventory • general ledger purchasing
• payroll

This system is not perfect and close supervision is important.

9. Internal Control
Iris Plant owns and operates three floral shops in Magnolia, Texas. The accounting functions have been performed manually. Each of the shops
has a manager who oversees the cash receipts and purchasing functions for the shop. All bills are sent to the central shop and are paid by a clerk
who also prepares payroll checks and maintains the general journal. Iris is seriously considering switching to a computerized system. With so
many information systems packages on the market, Iris is overwhelmed.

Required:
Advise Iris as to which business modules you think her organization could find beneficial. Discuss advantages, disadvantages, and internal control
issues.

Response: Iris needs to consider whether she wishes to purchase one microcomputer system or three. Assuming that she wishes to purchase only
one microcomputer for the central shop, she should definitely consider an accounting software package that has an accounts payable and general
ledger module. The purchase of a payroll module will depend upon the number of employees paid each period. Iris will need to determine if the
time saved is worth the cost.
The payroll module may also help with year-end forms such as W-2’s and 1099’s. Iris may also wish to consider centralizing the purchasing
function in order to obtain quantity discounts by placing larger orders. If she wishes to do this, then an inventory control module may be
appropriate. As the system is currently designed, Iris has no good way to determine whether the managers are purchasing the right mix of
inventory items, or if items are being used efficiently. Floral shops, because of the perishability of inventory and need to respond to unexpected
orders, may not lend themselves to centralized purchasing and/or centralized inventory control.
If Iris wishes to purchase a computer for each store, she should consider purchasing software that can process point-of-sale transactions and
balance the cash receipts at the end of the day. Inventory control software might be considered as it helps track the profitability and spoilage of
certain items as well as aids the managers in their purchasing decisions. The system could then provide summary reports for Iris so that she may
examine the inventory purchasing and usage decisions of the managers.
The cash receipts system should provide better management over cash receipts errors than the manual system, and if the correct controls are
included, control may increase. For example, a notice might be placed over the cash register saying “If you do not get a receipt from the computer,
your order is free.” The information system then will limit the possibility that a customer pays cash and the employee or manager keeps the money
by not ringing up the sale.
Iris may be able to find software packages specifically designed for florists. She should examine them to see if they will suit her partially
decentralized management. With the correct system, Iris should see increased control over cash receipts and maybe even over inventory purchases
and usage. A disadvantage is that the managers may feel that they are being watched more closely and this may cause some resentment.

10. Internal Control

You are investing your money and opening a fast-food Mexican restaurant that accepts only cash for payments. You plan on periodically issuing
coupons through the mail and in local newspapers. You are particularly interested in access controls over inventory and cash.

Required:
Design a carefully controlled system and draw a document flowchart to represent it. Identify and discuss the key control issues.

Response: The document flowchart is illustrated below.

One key control issue is that all sales are recorded. Merchandise should not be given to a customer and the sale not entered into the system:
an employee could pocket the money received for the sale. Another issue is reconciling physical coupons with the number of coupons entered into
the system. Again, an employee should not be able to ring up a sale at the lower price for a customer without a coupon, charge the customer full
price, and keep the difference. Another concern is that employees will steal inventory by giving away free food to their friends and relatives. The
system should track all food items prepared and related waste. The flowchart presented provides checks and balances for ensuring that employee
theft of cash received from customers is prevented.
11. Data Processing
The computer processing portion of a sales order system is represented by the Problem 11 flowchart presented in the text. Answer the following
questions:

Required:
a. What type of data processing system is this? Explain, and be specific.
b. The auditor suggests that this system can be greatly simplified by changing to direct access files. Explain the major operational changes
that would occur in the system if this were done.
c. The auditor warns of control implications from this change that must be considered. Explain the nature of the control implications.
d. Sketch a flowchart (the computerized portion only) of the proposed new system. Use correct symbols and label the diagram.

Response:
a. This is a batch processing system that uses direct access storage devices rather than sequential tapes, but the records are stored in sequential
files. The transactions are keyed in, and the batch totals are calculated. The batch totals accompany the sales order file through all the data
processing runs that follow. The edit run is used to test each record for the existence of clerical or logical errors. Any records with errors are
removed and written to an error file to be corrected later by an authorized person. The batch totals are recalculated for the clean transactions. The
edited file is then sorted based on the primary customer account number. The batch totals are used to verify the integrity of the sorted database file.
The sorted file is used to update the accounts receivable file. The original accounts receivable file remains intact and is used for backup. The
newly created accounts receivable becomes the new master file. The customers’ invoices are processed during the update and billing run. The sales
order file is sorted on the inventory number so that the inventory master file can be updated. The original inventory file remains intact and is used
for backup. The newly created inventory file becomes the new master file. The batch totals are still used to verify the completeness and accuracy
of the transaction file. At the end of the day, the batch totals are sorted and used to update the general ledger. The original general ledger remains
intact and is used for backup. The newly created general ledger becomes the new master file.

b. If the sequentially stored data files are not used and real-time processing of data using indexed direct access files are used instead, the editing
and sort runs are no longer necessary. Transactions will be immediately checked for input errors, and the accounts receivable file and inventory
files will automatically be updated as each transaction is processed. Thus, batch totals will no longer be used. Accumulators may be used to
accumulate values that are periodically posted to the general ledger. The accounts affected by each transaction in the master file will be
overwritten with each transaction that is processed.

c. Because the computers will be performing tasks that individuals used to perform, such as inventory controls, the control procedures over
program code need to be secured from unauthorized access. The master files are overwritten each time a record is processed. Controls should be
put into place for periodically making a backup copy of the master file, so that the records may be covered in case the current working copy of a
master file is destroyed or incorrectly overwritten.
d. See diagram on next page.
d.d. d.dd

12. System Configuration

The flowchart for Problem 12 represents the computer processing portion of a sales order system. Answer the following questions.
a. What type of data processing system is this? Explain, and be specific.
b. The marketing manager suggests that this system can be greatly improved by processing all files in real time. Explain the major
operational changes that would occur in the system if this were done.
c. The auditor warns of operational efficiency implications from this change that must be considered. Explain the nature of these
implications.
 d. Sketch a flowchart of the proposed new system. Use correct symbols and label the diagram.

Response:
a. This system uses real-time data collection and real-time updating of critical records (subsidiary accounts that are unique to the transaction).
General ledger accounts that are common to all transactions are processed in batch mode.
b. As each transaction is received, all records associated with it will need to be updated immediately. This would eliminate the batch-processing
step and the sales order transaction file from the current system. A new real-time update program will be required. Sales summaries, currently
prepared periodically, can now be extracted on demand by the marketing manager directly from his/her terminal.
c. Updating all general ledger accounts in real-time may cause operational delays. Each customer will need to wait until the previous customer’s
transaction is completely processed, including general ledger accounts that are common to all customers. The extent of the delays will depend in
part on transaction volume and the number of simultaneous transactions executed.
d. Please refer to the diagram on the following page.
Solution to problem 9-12
Internal Control Cases

1. Solution Smith’s Market

a), b) See diagrams on the following pages.

c) Internal Control Weaknesses

1) Access to the cash drawers by sales clerks requires more accountability. Each drawer is accessed by various clerks
throughout the day and cash may be withdrawn by any of them.

2) The internal cash register tape should be used as a control to determine how much cash (including checks, and credit card
vouchers) should be in the register drawer.

3) The shift supervisor does not sign for the specific amount of cash received or returned at the end of the day. He simply logs
the drawers in and out.

4) The treasury clerk is unsupervised in the counting of cash.

5) The treasury clerk has asset custody and responsibility for recording sales and cash in the journal and General Ledger.
 Custome
Custome Credit Check
rr Card Credit

Sales
Approv
al
Cash or Process
Check Sale Cash, Check,
Credit Card
Log,Receipt Sales
Cash Receipt, Credit Card Count, Journal
Receipt Signatu Record
Cash
re and Total
In/Out
Deposit Sales
Log
Amount General
Ledger

Bank Deposi
Bank
Cash, Check, t Slip
File
Credit Card
Receipt and
Smith’s Market Sales Order Deposit Slip
DFD
 Custo Sales and Treasury
Bank Shift
mer Check Out Clerk
Cash Card Superv
/ Comp isor
Cred 3 Sig
Chec any ns
k it Proc Cash
1 Cas Cred
/
Card ess h In
Sale Ca Checit
Cred Cash and
sh Card
k
it /Cred Out
In Vou
Card Checit /O cher
Vou
Rece kCard ut 4
cher
ipt Vou Lo Count,
cher 2 g Recor
d, and
Dep Depos Sale
Shift
osit it cash s
Superv
Slip Jour
isor Cash 5
/ nal
Gen
Cred
Checit eral
k
Card Led
VouDep ger
Smith’s Market cherosit
Slip
Sales System
Flowchart Bank
2. Solution to Spice is Right

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses

1) No credit check

2) Inventory control function is performed by warehouse clerk.

3) Accounting department bills customer, updates the AR account, and records sales in the Sales Journal thus reducing the
opportunity to detect discrepancies between total sales and AR postings.

4) Customer is billed before order is actually shipped

5) Remittance List should be prepared in the mailroom

6) No journal voucher prepared by cash receipts clerk.

7) Cash receipts clerk does not prepare a deposit slip.

 Shipping Notice, Packing Ship Goods
CustomerCustomer Order
Customer Slip

SO 2, Stock Pick Shippin

SO release Goods g
Prepare SO
3 Notice
SN File
Stock
SO File SO Sales releas
1 Journal e Prepare
Invoice BOL
Customer
and Post SO 2 Stock Release
Invoice AR Ledger
SR File
Journal
Vouche Update SO 2
Sales and r Inventory
Inventory
Inventory Update GL Summary
Data SO File
General Inventory
Ledger J V, Ledger
Inventory
Summary BOL
File
Carrier
Carrier Packing
Slip
Spice is Right, DFD Sales Order
System
 RA File
Customer
Customer
Remittance Advice

Remittan Prepare
Reconcile
ce Advice Remit List
and
Check, and Update
Separate
Remittance AR
Advice AR Ledger
Remittan
ce List
Bank
Bank
Receive and
Check
Reconcile
Cash AR
Record and Summary
Check Check
Deposit
Cash
Cash Rec Data Cash Receipts Update
Data GL
Cash Rec
Journal General Ledger
AR
Summary
Spice is Right, DFD Cash Receipts SystemFile
 Sales Accounting Warehouse Shipping
Department
Customer Sales A
Sales
Order Order Shipping
Customer Stock Notice
Order Prepare release
Packing
invoice
1 Slip
Sales Pick
Prepare Invoice Order Goods
SO Stock
release
Customer
Stock Customer Record sale Sales Stock
release
Order Order release
Packing 4 Prepare BOL
Slip
Shipping Sales journal
Notice 2
Sales Update Stock
Order AR Inventory release
Sales
BOL
A Order Journal 3 Inventory
Sales Voucher BOL
Order
Sales
Gen Ledger Summary
Order

Gen Ledger
Carrier
Spice is Right Revenue Cycle Flow Chart -- Sales
Order System (Page 1)
General Ledger Department

Acct Dept Warehouse

Journal
Voucher
Summary

Post to General
Ledger

Gen ledger

Journal
Voucher
Summary

Spice is Right Revenue Cycle Flow Chart -- Sales Order System

(Page 2)
 Mail Room Accounting Cash Receipts General Ledger
Department Dept
Customer Remit Remit A
Advice List
Check Prepare Check
Remit
Advice Remittance
List 5
Reconcile
and Summary
Reconcile and Remit Remit Endorse
Separate Advice List

Check Post to General

Ledger
Check
Remit Update AR
Advice Record Cash
Rec Gen ledger
AR
Remit Cash Rec
A Journal
Advice Summary
Check 6
Summary
7
Bank

Spice is Right Revenue Cycle Flow Chart --

Cash Receipts System d) Flowchart of revised system
Student responses will vary for this part of the assignment. The following issues, however, need to be addressed.
 Upgrade stand-alone computers to a networked environment
 The internal control problems already covered that need to be corrected in the new system.
  A system configuration similar to figure 4-18 would be appropriate.

3. Solution to ABE Plumbing

a), b) See diagrams on the following pages.
c) Internal Control Weaknesses
1) No Credit check is performed.
2) The sales clerk closes the open sales order causing the sale to be recorded before the goods are actually shipped.
3) The warehouse clerk has asset custody and should not also update the inventory records.
4) The shipping clerk does not reconcile the stock release with the original order. This allows for the wrong items and or
quantities to be shipped.
5) Customer is billed before the goods are shipped. Billing should be triggered by shipping notice. Instead, the customer invoice
is printed from the closed sales order, which was prepared before the goods were shipped.
 Invoice
1 AR
Custo Charg Sub
Bill es
mer Closed File
Order Custo
Custome
Custome File
Customer mer
rr Data
Invoic
Invoice e File
Item,
Prepar 2
quanti Open/Clo
Sales ty,
Order e sedOrder Updat
Custo
Order mer e GL
Open Order
Accou
Item nts
Picke
Pick Stock
d GL File
Item Goods Release 1 Close
andInvent SO
Quant
ity ory
Sub BOL,
File Stock Release 2 Ship Stock Dept
Goods Releas
e File

B
OL
Carrier
Carrier
ABE Plumbing DFD
d) Flowchart of revised system
Student responses will vary for this part of the assignment. The following issues, however, need to be addressed.
 The internal control problems already covered that need to be corrected in the new system.
 A system configuration similar to figure 4-18 would be appropriate.
4. Solution to Walker Books

a), b), See diagrams on the following pages.

c) Internal Control Weaknesses

Sales Processing:

1) The credit check is performed by the sales representative

2) The sales department should not be maintain the sales journal

3) The warehouse should not be updating inventory subsidiary ledger

Cash Receipts

4) Mail room workers have access to both check and remittance advices. This situation requires a reduced span of control and
separate mail room procedures for customer payments and routine mail.

5) The accounts receivable clerk has access to both the checks and the customer accounts
 Shi
p
Not
ice 3
1
Inv
Sub
Ledg
er

Releas
e BOL

Jour
nal
Vouc
her
Shi
p 2
Not B
ice
2
Jour
nal
Vou 1
che B
r

Jour
nal
Vou
che
r
 A

4 5
Rem
it
List

A
d) Revised System Walker Books System

Student responses will vary for this part of the assignment. Notwithstanding the internal control issues already covered that need to be
addressed, Walker Book’s automated system design could reflect features similar to those in figures 9-4 and 9-5.
5. Solution to AV Safety, Inc.
a), b), d) See diagrams on the following pages.

c) Internal Control Weaknesses

1) No credit check is performed
2) Sales journal is updated before the goods are shipped
3) Warehouse clerk has access to inventory and also update the inventory ledger
4) Mailroom clerk has access to both the remittance advice and the checks, no remittance list id prepared.
5) AR clerk has access to both the checks and the remittance advices

Stock rel

Prepare SO Prepare Pick good Prepare

Stock rel
Sales Order Invoice and Update BOL and
Cust Ledger ship
Customer Order
Order
File Journal
Inventory Pack Slip,
Voucher BOL
Sales Journal
Invoice
Journal Voucher
Carrier

Summary
Update AR Update GL GL

AR Ledger
Journal Bank
Check, Voucher
Remit Advice
Check
Update CR Check Deposit
Journal Check
Check, Deposit
Check, Remit
Slip
Advice
Open Mail

Customer CR Journal

AV Safety Revenue Cycle DFD

 Sales Department Billing Department Warehouse Shipping

Stock A
Sales Rep Sales Release
Order
2
Packing
Customer Slip
Order Pick Stock
Prepare Sales Goods Release
Invoice Journal

Prepare
Sales Stock Review /
Order Sales Journal Release Prepare
1 Invoice
Order Voucher BOL
3
Sales
Order Update
Stock
Packing Ledger
B Customer C Release
Slip
Stock
Inv Sub
Release
Ledger
A Customer
Order Stock
Release Packing
Slip
Inventory BOL
Summary

AV Safety Sales Order System Flow Chart Page 1

C Carrier
 Account Receivable General Ledger

B C
E

Sales Journal
Order Voucher
D
Inventory Journal
Summary Voucher
AR Sub
Update AR Ledger AR
Summary

Sales AR
Order Summary General
Update GL Ledger

Journal
Voucher
Inventory
Summary
Journal
Voucher
AR
Summary

AV Safety Sales Order System Flow Chart Page 2

Mail Room Accounts Receivable Cash Receipts

Customer Check
Check
Remit
Advice
Check
Remit
Advice AR Sub
5
Ledger
Update CR
Update AR Journal CR Journal
Open
Mail
4

Journal
Remit AR Voucher
Check Advice Summary
Remit
Advice

D E
Checks

Checks
Prepare
Deposit Checks
Slip Deposit
Slip
AV Cash Receipts System Flow Chart

Bank
d). Revised AV Safety System

Student responses will vary for this part of the assignment.

Notwithstanding the internal control issues already covered that need to be
addressed, AV Safety’s new system design should reflect feature similar to
those in figure 9-4 and 9-5.
6. Solution to Premier Sports Memorabilia

a), b), d) See diagrams on the following pages.

c) Internal Control Weaknesses:

1) Transaction is recorded in Sales Journal before goods are shipped.

2) Warehouse and Shipping functions are combined. This removes control over picking and shipping the wrong products.

3) Mail room clerk should prepare a remittance list to control remittance advices and checks

4) Although not stated in the case as a problem, the auditor should evaluate network access controls (passwords, access

privileges) to ensure a proper segregation of duties.

 Invoice
File

Sales Order
Sales
Journal

Pick Goods
Approval
Receive Sales Order Sales
/Rejection
Customer Order
Check Credit Prepare Sales
Order
Order

Ship Notice
Sales Order
Customer Order

File
Batch Totals
Sales Order
Approval/ Reconcile and
Rejection Bill Customer
Customer
Sales Order

Batch Totals File

Update
Check
Post to Cash General Ledger
Rec Journal
Check
Remit Advice
Batch Totals

Receive Bank
Customer Check
Payment
Invoice Copy

Remit Advice
Update Accts
Receivable

Premier Sports Revenue Cycle DFD

 Sales Department Central Computer Server Warehouse Billing Department

On Line Sales
Customer Orders On Line A
Sales Order
Order Credit Check Order
2

Sales Pick Reconcile B

Enter Sales System Goods
Order and
Prepare
Docs Sales
Prepares Order
B
Rejectio Sales Invoice
Sales Journal Sales
n or Order Ship Notice Order
Sales Invoice
AR Sub
Order BOL
CR Journal
1 Gen Ledger Packing
Enter Sales Slip
Order C
Order Customer
Rejection
Sales
Order Carrier

Customer
Prepare
Ship Notice
Sales
Order
Sales
Order B
Sales
Order

Premier Sports Revenue Cycle System Flowchart

A
Page 1
 Mail Room AR Department Cash Receipts Department

C
Check

Remit Remit Check

Invoice
Advice Advice

B Post to CR
B Update AR Journal
Open
and
Separate
Check
Invoice
Deposit
3 Remit
Remit Slip
Advice
Advice

Bank

Check

Premier Sports Revenue Cycle System Flowchart

Page 2

In page 1, the feedback from the sales system to the sales department letting them know if they are processing an approved order or a

rejection needs to be identified.

D) Student solutions to this part of the case will vary. The solution should address the control issues identified in part C, and the

design should reflect features similar to those found in figures 9-4 and 9-5.
7. Solution to Bait ‘n Reel

Internal Control Weaknesses

1) The sales clerk performs the credit check this is a segregation of duties and transaction authorization problem.
2) Warehouse should not update the inventory and General ledger control accounts.
3) AR Clerk should not update the general ledger.
4) Billing and AR are combined. This structure will mask discrepancies between what was billed and what was recorded as a
sale.
5) Supervision is needed in the mailroom because employees who open the mail have access to both cash and the remittance
advice.
5) The cash receipts clerk has access to the assets (cash) and is responsible for updating the general ledger.
6) See 3 above.
 Sales Network Server Warehouse Shipping A/R

Customer A
Shipping
4
Retrieve SO
Slip
Stock
Customer Release
Order Shipping
1 Shipping Slip
Stock
Reconcile
Slip
Credit History
Stock Release Prepare
Terminal Release Invoice
Bill of
Sales Lading 3
System Customer
Sales Journal File Bill of
Lading 2
Customer Bill of
Order Pick Sales
Lading 1
Goods Pack Invoice
Inv. Subsidiary
Ledger Slip Stock
A Release
File Shipping
Slip
General Ledger Shipping Stock
Slip Release Terminal
Stock Carrier
Release A
AR Sub. Ledger

3 Stock
Cash Rec. Release
Shipping
Journal
Slip
File
Update
Records

Bait ’n Reel Superstore Sales Order System

Flowchart
 Mailroom Cash Receipts A/R

Customer Check
B
Remit.
List 2
Check 6
5 Remit.
Advice
Remit.
Advice Remit.
Reconcile &
Prepare Post To A List 1
D. Slips Accounts

Reconcile
Check & Reconcile
R.A. Signed & Terminal
Check Update

Check
Remit.
List 2 7
Remit.
Deposit A
Remit. Advice
Slip 3
Advice Remit.
Deposit List 1
Remit. Slip 2
List 2
Deposit
Remit. Slip 1
List 1

File
B
File
Bank

Bait ’n Reel Superstore Cash Receipts System

Flowchart
Bait ’n Reel Superstore Sales Order DFD Credit
Records
Customer
Information
1 Approved Credit Update
Customer Order Customer Information 3 4 Customer
Take Customer Order
Customer Perform Prepare Records
Customer
Credit Customer
Order
Check Order

Electronic Sales Order

5 7 Inventory
Prepare 6 Verify Sub. Ledger
Electronic Stock Release & Goods, Stock Release, &
SR & Collect Goods &
Sales Order Shipping Slip Shipping Slip
Shipping Goods Update
Slip Ledger
General
Ledger

Goods, Stock Release, & Shipping Slip

11 Sales
Sales Information Update Journal
8
Reconcile 9 Sales
Sales Order & Stock Journal
& Prepare
Release
Print BOLs Stock
SO Release Sales & Customer 12
10 Information General
Update
Goods & Bill Ledger
General
Shipping Slip Bills of Customer
Ledger
Lading
13
Carrier Update
Customer Information
A/R A/R
Subsidiary Sub. Ledger
Sales Invoice Ledger
Customer 20
Update A/R Subsidiary
A/R Ledger
Subsidiary
Remittance Advice 19 Remittance Ledger
& Remittance List Reconcile Advice
Check &
14 Docu-
Remittance
Prepare ments 21
Advice
Remitt- Update
ance General General Ledger
Lists Ledger

Checks &
Remittance
List

15 Signed Checks & 16 Signed Checks &

Reconcile Remittance List Prepare Deposit Slips
Bank
Docu- Deposit
ments Slip

Cash Receipts
Information

17
18
Update
Update
Cash
General
Receipts
Ledger
Journal

Cash Receipts General

Journal Ledger Bait ’n Reel Superstore Cash Receipts DFD
 Computer
Sales Operations Warehouse Shipping

Customer Inventory Printer

Records Credit A
History Stock
Release

Customer Stock
Credit & Release
Order
Inventory Printer
Check

Reconcile
Terminal Goods & Packing
Docs. Slip
Approved Pick Raw
Sales Orders
Mats. &
A Make Stock
Goods Release
Packing
Slip

Update
Records Stock
Release Bill of
File Lading 2
Bill of
A/R Subsidiary Lading 1
Inv. Subsidiary Ledger
Ledger

Sales
Journal
General Ledger

Carrier

Customer Manage.
Invoice Reports

Customer Management

Bait ’n Reel Superstore Revised Sales Order

System Flowchart
Mailroom Computer Operations Cash Receipts

Read & Printer

Customer Reconcile

Deposit
Check
Slip
Remit. Cash Receipts A/R Subsidiary
File Ledger Check
Advice

Machine General Ledger

Manage-
ment
Reports
Bank

Management

Bait ’n Reel Superstore Revised Cash Receipts

System Flowchart
8. Solution to Green Mountain

a), b), d) See diagrams on the following pages.

c) Internal Control Weaknesses

Sales Order System
1) The sales department performs the credit check.

2) Billing receives no shipping notice prior to billing the customer.

3) The warehouse clerk has asset custody and updated the inventory records.

4The shipping department fails to notify billing that the good have been shipped.

Cash Receipts
5) The mail room clerk has access to both the cash (asset) and the remittance advice
(record).

6) Cash receipts department is also doing the job of the accounts receivable
department. The cash receipts department has custody of the physical asset (cash)
and keeps the accounting records.
Sales Billing

1
Cre Sale
dit s
Che Hist
ck ory

Approv
ed
Custom
er
Order

Approv
ed
Custom
er
Order

File
Cop
y

Green Mountain Sales Order

Procedures. Page 1
Warehouse Shipping

Stock
Releas
e

3
Update
Inventory

Invent
ory
Sub
Ledger

Journal Stock
Vouche Releas
r e

Gener Green Mountain Sales Order

al
Ledge
Procedures. Page 2
r
Billing Accounts General Ledger
Dept Receivable

Reconcile and
Update the
GL Accounts

General
Ledger

Green Mountain Sales

Order Procedures. Page
3
Mail Room Accounts Receivable

Green Mountain Cash Receipts System,

Page 1
 Update GL

General
Ledger

Green Mountain Cash Receipts System, Page 2

Revised Green Mountain System

Student responses will vary for this part of the assignment. Notwithstanding the
internal control issues already covered that need to be addressed, Green
Mountain’s batch oriented system is inappropriate for their type of business.
Student solutions should reflect this with system designs similar to those in figure
9-4 and 9-5.