Hall SM-CH05

CHAPTER 5
THE EXPENDITURE CYCLE PART I:
PURCHASES AND CASH
DISBURSEMENTS PROCEDURES
REVIEW QUESTIONS
1. A purchase requisition is completed by the inventory control department when a
need for inventory items is detected. Purchase requisitions for office supplies and
other materials may also be completed by staff departments such as marketing,
finance, accounting, and personnel. The purchasing department receives the
purchase requisitions, and if necessary, determines the appropriate vendor. If
various departments have requisitioned the same item, the purchasing department
may consolidate all requests into one order so that any quantity discounts and
lower freight charges may be taken. In any case, the purchasing department
prepares the purchase order, which is sent to the vendor, accounts payable
department, and the receiving department (blind copy).
2. A purchasing department is able to research the quality and pricing of various
vendors. Their job is to monitor various supply sources and choose the highest
quality good for a given price that can be reliably delivered on-time. The
purchasing department may also take advantage of quantity discounts, especially
when two or more manufacturing facilities are involved.
3. An open accounts payable file contains all source documents, including invoices,
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Chapter 5 page 134
organized by payment date. As the due dates become close to the current date,
the invoices are pulled from the file and paid. Under the voucher system, the
accounts payable clerk prepares a cash disbursements voucher upon receipt of all
source documents. Each cash disbursements voucher represents payment to one
vendor. Multiple invoices may be covered by one voucher. The voucher system
thus allows fewer checks to be written and provides better control over cash
disbursements since cash vouchers are assigned and tracked.
4. The three logical steps of the cash disbursements system are:
a. authorization of cash disbursements for payment,
b. preparation and distribution of checks, and
c. preparation of summary information by cash disbursements and accounts payable,
which are sent to the general ledger clerk.
5. Accounts Payable:
Inventory Control Debit
Accounts Payable Credit
Cash Disbursements:
Accounts Payable Debit
Cash Credit
6. The receiving clerk’s responsibility is to inspect the quantity and condition of the
goods received. The two exposures that are reduced by close supervision are: 1.
failing to properly inspect the assets 2. pilfering or stealing the inventory. Thus, the
copy of the purchase order which he/she uses for this inspection should not
Chapter 5 page 135
contain quantities or prices. If the quantity is printed on the receiving clerk’s copy of
the purchase order, he/she may be tempted to skip the physical inspection and the
company may be paying for inventory it did not receive or that is damaged. A
supervisor is necessary to remove the packing slip that contains quantity
information and to make sure the receiving clerks actually inspect the goods. If the
value of the inventory is listed, the employee may be tempted to steal some of the
inventory. Close supervision should deter employees from stealing.
7. A comparison of transaction details between the Purchase Order (which
established that the item was ordered), the Receiving Report (which showed that it
was received), and the Invoice (which contains prices and other charges) is called
a three-way match. Upon reconciliation of these documents, a company typically
will record the liability.
8. The general ledger department receives journal vouchers from inventory control,
accounts payable, and cash disbursements. With these summary figures, the
general ledger clerk verifies that:
1. total obligations recorded = total recoded increases in inventories, and
2. total reductions in accounts payable = total recorded disbursements of cash.
9. Inventories should only be acquired from valid vendors. This control procedure
helps to deter the purchasing agent from buying inventories at excessive costs and
receiving kickbacks, or from buying from an entity in which the purchasing agent
has a relationship, such as a relative or a friend. A valid vendor file also provides
for a more efficient purchasing process when dealing with routine purchases.
10. Many companies engaged in business-to-business (B2B) transactions use the

Chapter 5 page 136
vendor invoice file as a substitute for the traditional purchases journal and
accounts payable subsidiary ledger. The invoices in the file provide a chronological
record of total purchases for the period (equivalent to the purchases journal), and
the unpaid invoices at any point in time constitute the organization’s accounts
payable.
11. The blind copy contains no quantity or price information about the products being
received. The purpose of the blind copy is to force the receiving clerk to count and
inspect inventories to complete the receiving report.
12. Vouchers provide improved control over cash disbursement, and they allow firms
to consolidate several payments to the same supplier on a single voucher, thus
reducing the number of checks written.
DISCUSSION QUESTIONS
1. The three documents of the AP packet are the purchase requisition, purchase
order, and receiving report (in addition to the invoice itself). The purchase
requisition originates from inventory control and represents the inventory
requirements. The purchase order originates from the purchasing department and
represents an order placed. The receiving report originates from the receiving
department and represents the quantity and types of goods received. Thus, the
accounts payable must determine 1. that the goods ordered were requested by a
user-department (i.e. inventory control), 2. that the purchasing department ordered
the goods from a valid vendor, 3. that the goods were actually received in good
condition, and 4. that the invoice price is correct. If all conditions are met, then the
Chapter 5 page 137
invoice should be paid.
2. The purchase requisition file is created during the sales activity when the
inventories dropped to their predetermined reorder point.
3. The receiving clerks have access to many of the firm’s assets: their inventory. Two
exposures potentially exist: 1. the clerk failing to perform his/her duty and 2. the
clerk pilfering or stealing the inventory. Thus, the copy of the purchase order used
for this inspection should have the quantities and amounts covered so that they
may not be read. If the quantity is printed on the receiving clerk’s copy of the
purchase order, he or she may be tempted to skip the physical inspection and the
company may be paying for inventory it did not receive or that is damaged. A
supervisor is necessary to remove the packing slip which contains quantity
information, and to make sure the receiving clerks actually inspect the goods. If the
value of the inventory is listed, the employee may be tempted to steal some of the
inventory. Close supervision should deter employees from stealing.
4. These functions are often automated because of their importance. Automation can
help to increase efficiencies and reduce clerical errors. In an automated
environment inventory control no longer has to physically maintain inventory
records to determine if inventories are at the reorder point. The system
automatically monitors the levels and flags items that need reordering. Thus, the
chance that an item is overlooked is eliminated. Control over cash can be
maintained by automating validation procedures that ensure accuracy between
vendor invoice amounts and checks written in payment. Entries for the general
ledger are automatically created by the system, thus errors are reduced since
transcription from summary reports into the general ledger is not necessary.
Chapter 5 page 138
5. In the advanced technology system, the three way match is automated. When the
AP clerk receives the supplier’s invoice, the clerk accesses the system and adds a
record to the vendor invoice file. This act prompts the system to automatically
create a virtual AP packet by linking the vendor invoice to the associated purchase
order and receiving report records, using the PO number as a common attribute.
The application then reconciles the supporting documents, using programmed
criteria for assessing discrepancies. Items that fall within limits are automatically
approved and paid on their due date. Discrepancies in excess of the threshold are
submitted to management for review and manual approval. Through the virtual AP
packet screen, management may view the supporting documents and exercise an
override of the system controls to force payment. The override should be
performed only by authorized management and should be fully documented in
management reports.
6. A key element of successful EDI is the implementation of a trading partner
agreement to eliminate the discrepancies that require human involvement to
resolve.
7. Some organizations have taken reengineering even further by eliminating the
receiving function entirely. The objective of this is to send goods directly to the
production department and thus bypass the receiving area and avoid
production delays and the associated handling costs. An accounting and
auditing problem that must be overcome is how to account for inventory
receipts when there is no receiving function and no receiving report. One way
of dealing with this is to calculate the number of parts received based on the
Chapter 5 page 139
products produced in which the parts are components. Supplier payments are
distributed based on production (part usage), and by having only one supplier
per part, the question of which supplier to pay is self-evident. An additional
problem to deal with is accounting for scrap in the production process. Since
scrap does not end up in finished production, it will not be counted, and
vendors will not be paid for materials that were scrapped. Separate accounting
procedures need to be implemented to record and monitor scrap.
8. Multilevel security is a means of achieving segregation of duties in an integrated
data processing environment where multiple users simultaneously access a
common central application. Two methods for achieving multilevel security are the
access control list (ACL) and role-based access control (RBAC). Through these
techniques, purchasing, receiving, accounts payable, cash disbursements, and
general ledger personnel are limited in their access based on the privileges
assigned to them
9. The Receiving Report is evidence that the items have been received and a liability
has been realized. If the Invoice did not come in by end-of-year, then the liability
may not have been recognized in the period under review.
10. An undetected program error may affect thousands or even millions of transactions
with devastating consequences to the financial statements. An organization’s
systems development and program change process is therefore critical to ensuring
that computer applications do what they are intended to do when they are placed
into service and are protected from accidental, malicious, or fraudulent
modifications over their service lifetime.
Chapter 5 page 140
MULTIPLE CHOICE
1. B
2. A
3. C
4. B
5. D
6. C
7. D
8. D
9. C
10. C
PROBLEMS
1. a. A purchase requisition is created when an item of inventory is needed (e.g.,
fallen below the reorder point) and authorizes its purchase. A purchase order
is created from requisitions to the same vendor. Thus, one purchase order
may contain many purchase requisitions.
b. The system shown in alternative two expedites the ordering process by
distributing the purchase orders directly to the vendors and internal users, thus
bypassing the purchasing department completely. This shortens the time
between recognizing the need for inventory and mailing the PO to the vendor.
Consequently, inventory safety stock levels can be reduced, thus reducing
inventory carrying costs.
c. Alternative one provides additional control over the ordering process. For
example, the purchasing agent could manually detect unusual order quantities or
Chapter 5 page 141
frequency caused by a computer error. Managers whose systems lack reliable
computer controls, and who wish to compensate with human independent
verification, may prefer this alternative. The price of this added control is
excessive inventory carrying costs.
2. (See the forms on the following pages.)
Solution to Problem 2
Chapter 5 page 142
a. No journal entry necessary; a purchase requisition and purchase are
Chapter 5 page 143
completed.
b. No journal entry necessary unless year-end closing accrual is made; receiving
report and inventory records are completed.
c. Journal entry necessary when the invoice is received:
Inventory (4,737.019) 90.00
Raw Material Variance (4,737.001) 4.74
Freight-In 6.00
Accounts Payable 100.74
Journal entry necessary when the invoice is paid:
Accounts Payable 100.74
Purchase Discounts Taken (4737.02).01 .95
Cash 99.79
A disbursements voucher is completed.
3. The purchase requisition should originate from the inventory control department
after someone has reviewed the records to determine if and how much of an
inventory item needs to be ordered. If purchasing agents are allowed to authorize
purchase requisitions, they might be tempted to buy items not needed in order to
reap benefits and/or kickbacks from the vendor. The purchase order that is sent to
receiving is not indicated as a “blind copy,” and this might cause employees to
either shirk their responsibilities and not count the inventory or to steal some units
since they know their value. Further, receiving should retain a copy of the receiving
report in their files along with the purchase order and packing slip. The inventory
control department should not prepare a journal voucher to send to the general
Chapter 5 page 144
ledger department; rather, they should prepare summary information that the
general ledger department can use to reconcile the inventory control account with
inventory subsidiary summary. The accounts payable department needs to post
the liability to the accounts payable subsidiary ledger. The subsidiary accounts
payable ledger will not balance with the control account in the general ledger if
these postings are not made.
4. Open Purchase Order File Purchasing
Purchase Requisition File Inventory Control
Open Purchase Requisition File Inventory Control
Closed Purchase Requisition File Inventory Control
Inventory Inventory Control
Closed Purchase Order File Purchasing
Valid Vendor File Purchasing
Voucher Register Accounts Payable
Open Voucher File Accounts Payable
Receiving Report File Receiving
Closed Voucher File Accounts Payable
Check Register (Cash Disburse Jour) Cash Disbursements
5. First, the Inventory Master file is searched to determine if the Quantity on Hand is
less than or equal to the Reorder point, which is a predetermined point at which
the firm orders more inventory. If it is less than or equal to the reorder point and the
quantity on order is not flagged as true, then the EOQ (a predetermined optimal
order amount) is used to order the Inventory Number item, which is an assigned
Chapter 5 page 145
number and described by the Description field. The item is ordered from a
specified Vendor in the Vendor file, and this information is stored in the Inventory
Master file. A Purchase Requisition is filled out and a Purchase Requisition
number is assigned to the requisition. The inventory number, quantity on order,
vendor number, and unit standard cost are recorded. The vendor address,
terms of trade, and lead time are obtained from the vendor file. If the lead time is
too long, a different vendor may need to be chosen, or the price paid may be
higher than the predetermined standard cost for the item. At this point, the date
of last order field in the vendor file is updated.
The Purchasing Department then completes a purchase order and places it into
the open purchase order file until the order is completed. First, the purchasing
clerk assigns a purchase order number and fills in the corresponding purchase
order number. The following information is also copied to the purchase order file
from the above-mentioned records: purchase requisition number, inventory
number, quantity on order, vendor number, vendor address, and standard
cost. The expected invoice amount is determined by multiplying the expected
price by the quantity ordered. At this point, the date of last order field in the
vendor file is updated.
When the inventory is received, the inventory master file is updated: the quantity
on hand is increased by the number of units received and the total inventory
cost is updated. In the open purchase order file, the field Rec flag is checked to
indicate that the goods have been received.
Chapter 5 page 146
When the vendor’s invoice is received, the invoice flag field in the purchase
order file is checked to indicate that the invoice has been received. Further, the
accounts payable department completes a journal voucher that is recorded in the
voucher register. This voucher is assigned a voucher number, and the following
information is recorded in the above-mentioned records: purchase order
number, purchase requisition number, inventory number, quantity on
order, vendor number, address, standard cost, and expected invoice
amount. The invoice due date is also noted so that the disbursement may be
made as close to the due date as possible without missing any discounts offered.
6. IT application controls:
a. Automated Purchase Approval. Computer logic, not a human being,
decides when to purchase, what to purchase, and from which vendor. The
key attributes needed to execute this logic come from the purchase
requisition file and the valid vendor file. The objective is to prevent
unauthorized purchases from unapproved vendors.
b. Automated Three-Way Match and Payment Approval. When the AP
clerk receives the supplier’s invoice, the clerk accesses the system and
adds a record to the vendor invoice file. This act prompts the system to
automatically create a virtual AP packet by linking the vendor invoice to the
associated purchase order and receiving report records, using the PO
number as a common attribute. The application then reconciles the
supporting documents, using programmed criteria for assessing
discrepancies. Discrepancies in excess of the threshold are submitted to
Chapter 5 page 147
management for review and manual approval.
c. Multilevel Security. Multilevel security is a means of achieving segregation
of duties in an integrated data processing environment where multiple users
simultaneously access a common central application. Two methods for
achieving multilevel security are the access control list (ACL) and role-
based access control (RBAC). Through these techniques, purchasing,
receiving, accounts payable, cash disbursements, and general ledger
personnel are limited in their access based on the privileges assigned to
them.
d. Automated Posting to Subsidiary and GL Accounts. All of the record
keeping function, are automated in the advanced technology system. In the
advanced technology system, a computer application, which is not subject
to human failings such as yielding to situational pressures and/or lacking
ethical standards, decides which accounts to update and by how much. By
eliminating the human element from accounting activities, the potential for
errors and opportunities for fraud are significantly reduced. Also, since
these are labor intensive activities, automating them greatly improves
efficiency of operations.
7. Transaction Authorization. Purchases are not authorized by inventory control.
Accounting Records. Inventory records are updated based on the purchase
order rather than the Receiving Report or Invoice.
Chapter 5 page 148
Accounting Records. The Accounts Payable Subsidiary ledger is updated
based only on the Invoice. There is no reconciliation with supporting documents
(purchase order and receiving report).
Accounting Records. There is no Cash Disbursements Journal or Check
Register in use.
Accounting Records/Segregation of Functions. The receiving department
prepares the Receiving Report directly from the Packing Slip. A blind copy of the
Purchase Order should go to the receiving clerk to control this activity. A
supervisor should take possession of the packing slip that contains relevant data
and oversee the inspection process.
Accounting Records/Independent Verification. The General Ledger
department should receive Journal vouchers or batch totals from Inventory
Control, Cash Disbursements, and Accounts Payable. These are used to keep
the General Ledger Control accounts current and to verify the overall accounting
accuracy of the process.
8. IT application controls that apply.
a. Automated Purchase Approval. Computer logic, not a human being,
decides when to purchase, what to purchase, and from which vendor. The
key attributes needed to execute this logic come from the purchase
requisition file and the valid vendor file. The objective is to prevent
unauthorized purchases from unapproved vendors.
b. Automated Three-Way Match and Payment Approval. When the AP
Chapter 5 page 149
clerk receives the supplier’s invoice, the clerk accesses the system and
adds a record to the vendor invoice file. This act prompts the system to
automatically create a virtual AP packet by linking the vendor invoice to the
associated purchase order and receiving report records, using the PO
number as a common attribute. The application then reconciles the
supporting documents, using programmed criteria for assessing
discrepancies. Discrepancies in excess of the threshold are submitted to
management for review and manual approval.
c. Automated Posting to Subsidiary and GL Accounts. All of the record
keeping functions are automated in the advanced technology system. In the
advanced technology system, a computer application, which is not subject
to human failings such as yielding to situational pressures and/or lacking
ethical standards, decides which accounts to update and by how much. By
eliminating the human element from accounting activities, the potential for
errors and opportunities for fraud are significantly reduced. Also, since
these are labor intensive activities, automating them greatly improves
efficiency of operations.
9. Solution to Part A:
Chapter 5 page 150
Inventory Control Receiving Account Payable
Reviews and Vendor

Updates Inventory Prints PO
Inventory
Vendor
Invoice
Accounting
System
Purchase
Purchase Packing
Order
Order Slip
Purchase Reconcile
Orders And Post
Vendor
Reconcile
Receiving Create Rec Rp
Report Voucher
Invoice
AP Sub
Ledger
Open
Purchases AP
Journal
Reviews
and
Cash Prepares
Checks
Vendor
Check
Solution to Part B:
Transaction Authorization
Inventory Control clerk approves PO and make purchase
Supervision
There is no supervision in the receiving area.
Accounting Records
Receiving clerk prepares receiving report from packing slip
No blind copy of purchase order goes to Receiving Department
Segregation of Duties
Accounts payable clerk approves AP and writes the check
Access Control
All users of the networked system have full access to all database records. This
might result in transaction corruption, document destruction and various forms of

Chapter 5 page 151
fraud including vendor fraud.
10. a. the inventory control department
b. purchase requisition
c. accounts payable, receiving, and inventory control departments
d. vendor’s invoice, purchase order, and receiving report
e. a bill of lading
11. Term FOB shipping point:
a. Yes
b. The best evidence is provided by the Purchase Order and Bill of Lading
Purchase Order—is evidence that the item was ordered, but does not indicate
when it was shipped.
Bill of Lading—reviewed post-period; will indicate when the goods were shipped
Receiving Report—prepared post-period; establishes possession but may not
indicate when goods were shipped
c. June 15
d. July 10
Term FOB destination:
e. No
f. N/A
g. July 5
h. July 15

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CHAPTER 5

THE EXPENDITURE CYCLE PART I:

PURCHASES AND CASH

other materials may also be completed by staff departments such as marketing,

finance, accounting, and personnel. The purchasing department receives the

purchase requisitions, and if necessary, determines the appropriate vendor. If

department, and the receiving department (blind copy).

2. A purchasing department is able to research the quality and pricing of various

purchasing department may also take advantage of quantity discounts, especially

when two or more manufacturing facilities are involved.

source documents. Each cash disbursements voucher represents payment to one

disbursements since cash vouchers are assigned and tracked.

4. The three logical steps of the cash disbursements system are:

a. authorization of cash disbursements for payment,

b. preparation and distribution of checks, and

c. preparation of summary information by cash disbursements and accounts payable,

which are sent to the general ledger clerk.

Inventory Control Debit

Accounts Payable Credit

Accounts Payable Debit

supervisor is necessary to remove the packing slip that contains quantity

inventory. Close supervision should deter employees from stealing.

7. A comparison of transaction details between the Purchase Order (which

a three-way match. Upon reconciliation of these documents, a company typically

will record the liability.

general ledger clerk verifies that:

1. total obligations recorded = total recoded increases in inventories, and

2. total reductions in accounts payable = total recorded disbursements of cash.

10. Many companies engaged in business-to-business (B2B) transactions use the

inspect inventories to complete the receiving report.

to consolidate several payments to the same supplier on a single voucher, thus

reducing the number of checks written.

requisition originates from inventory control and represents the inventory

user-department (i.e. inventory control), 2. that the purchasing department ordered

inventories dropped to their predetermined reorder point.

supervisor is necessary to remove the packing slip which contains quantity

inventory. Close supervision should deter employees from stealing.

help to increase efficiencies and reduce clerical errors. In an automated

environment inventory control no longer has to physically maintain inventory

records to determine if inventories are at the reorder point. The system

chance that an item is overlooked is eliminated. Control over cash can be

maintained by automating validation procedures that ensure accuracy between

The application then reconciles the supporting documents, using programmed

override of the system controls to force payment. The override should be

performed only by authorized management and should be fully documented in

6. A key element of successful EDI is the implementation of a trading partner

agreement to eliminate the discrepancies that require human involvement to

7. Some organizations have taken reengineering even further by eliminating the

production delays and the associated handling costs. An accounting and

auditing problem that must be overcome is how to account for inventory

per part, the question of which supplier to pay is self-evident. An additional

procedures need to be implemented to record and monitor scrap.

8. Multilevel security is a means of achieving segregation of duties in an integrated

data processing environment where multiple users simultaneously access a

techniques, purchasing, receiving, accounts payable, cash disbursements, and

may not have been recognized in the period under review.

with devastating consequences to the financial statements. An organization’s

systems development and program change process is therefore critical to ensuring

into service and are protected from accidental, malicious, or fraudulent

modifications over their service lifetime.

may contain many purchase requisitions.

b. The system shown in alternative two expedites the ordering process by

bypassing the purchasing department completely. This shortens the time

Consequently, inventory safety stock levels can be reduced, thus reducing