THE EXPENDITURE CYCLE

A Hypothetical Manufacturing Firm

➢ Recurring set of business activities and related data processing operations associated with the purchase of and payment for goods and
services.
➢ The objective of the expenditure cycle is to convert the organization’s cash into the physical materials and the human resources it
needs to conduct business
I. PURCHASING SYSTEM
A. Monitor Inventory Records (Warehouse)
▪ Firms deplete their inventories by transferring raw materials into the production process (conversion cycle) and by
selling finished goods to customers (revenue cycle).
▪ When inventories drop to a predetermined reorder point, a purchase requisition is prepared and sent to the
Purchasing Department to initiate the purchase process.
▪ For control purposes, a materials requisition form includes:
• Name of supplier
• Primary address of supplier
• Order quantity of the item
• Standard or expected unit price of the item
▪ A valid vendor file provides an important control by listing only approved vendors. Having this file reduce certain
vendor fraud schemes such as:
• An agent buying from suppliers with whom he/ she has a relationship
• Buying at excessive prices from vendors in exchange for a kickback.
• Buying from a non- existent vendor (Billing Schemes)
B. Prepare Purchase Order (Purchasing Department)
▪ The prepare purchase order function receives the purchase requisitions, which are sorted by vendor if necessary.
▪ A purchase order (based on the purchase requisition) is prepared for each vendor.
• A copy of the purchase order is sent to the vendor which will be processed to become a sales order, as
discussed in the revenue cycle.
• A second copy of the purchase order is sent to the accounts payable function for filing temporarily in the
AP pending file (for 3 way matching).
• A blind copy of the purchase order is sent to the receive goods function, where it is held until the
inventories arrive.
• The last copy is filed in the open/closed purchase order file (pending until Receiving Report from
receiving department is received).
C. Receive Goods (Receiving Department)
▪ The next event in the expenditure cycle is the receipt of ordered inventory.
▪ Goods arriving from the vendor are reconciled with the blind copy of the purchase order.
• A blind purchase order contains no quantity or price information about the products being received.
• The purpose of the blind purchase order is to force the receiving clerk to count and inspect inventories
prior to completing the receiving report.
▪ Upon completion of the physical count and inspection, the receiving clerk prepares a receiving report stating the
quantity and condition of the inventories.
• A copy of the receiving report together with the ordered goods will be forwarded to the warehouse
(increases the inventory record for warehouse management).
• Another copy is sent to Purchasing Department and is filed in the open/closed purchase order file to
close out the purchase order (order received).
• A third copy is sent to the set up accounts payable function (used for 3 way matching).
• A fourth copy is sent to the inventory control for updating the inventory records (increases the
accounting records of inventory).
• Finally, a copy of receiving report is placed in the receiving report file (filing).
D. Update Inventory Records (Inventory Control)
▪ Increases the inventory level as evidenced by the Receiving Report.
▪ Depending on the inventory valuation method used by the company (such as FIFO, Weighted Average, Moving
Average, etc.), the inventory control procedures may vary among firms.
▪ Organizations that use a Standard Cost system carry their inventories at a predetermined standard value regardless
of the actual price paid to the vendor.

1|Page
 ▪ Organizations that use an Actual Cost system carry their inventories at their actual cost, thus, a copy of Sales
Invoice (which contains the actual price, freight charges, etc.) from the seller should be filed together with the
Receiving Report before recording.
E. Set Up Accounts Payable (Accounts Payable Department)
▪ As mentioned in the transactions discussed above, the set up AP function has now received a purchase order and a
receiving report.
▪ At this point, the organization has received inventories from the vendor and has incurred an obligation to pay for
the goods, however, the firm has not received the supplier’s invoice containing the financial information needed to
record the transaction.
▪ The firm will thus defer recording the liability until the invoice arrives.
• This common situation creates a slight lag in the recording process, during which time the firm’s
liabilities are technically understated.
• This misstatement is a problem only at period end when the firm will prepare financial statements.
• In this case, at year end, the accountant needs to estimate the value of the obligation until the invoice
arrives. An adjusting entry is required when the invoice is received.
▪ When the supplier’s invoice arrives, the AP clerk reconciles the financial information with the receiving report
and PO.
• This procedure verifies that what was ordered was received and is fairly priced. (Three-way match)
▪ The transaction is recorded in the purchases journal and posted to the supplier’s account in the AP subsidiary
ledger.
▪ After recording the liability, the AP clerk transfers all source documents (PO, RR, Invoice) to an open AP file,
which means that liabilities should be paid within the stated due date
▪ If the firm is using the actual cost method (the opposite of standard costing), the AP clerk will send a copy of the
supplier’s invoice to inventory control.
▪ Finally, the AP clerk summarizes the entries in the purchases journal for the period and prepares a journal
voucher for the general ledger function.
F. Post to General Ledger
▪ The GL function receives a journal voucher from the AP department and an account summary from inventory
control department.
▪ The general ledger function posts the data contained in the journal voucher to the inventory and AP control
accounts and reconciles the inventory control account with the inventory subsidiary summary.
• Inventory (Dr)
• Accounts Payable (Cr)

II. Cash Disbursement System

o The cash disbursements system processes the payment of obligations created in the purchases system
o The principal objective of this system is to ensure that only valid creditors receive payment and that the amounts paid are
timely and correct.
▪ If the system makes payments too early, the firm forgoes interest income that it could have earned on the funds.
▪ If the obligations are paid late, the firm will lose purchase discounts, may damage its credit rating, or will pay
additional penalties
A. Identify Liabilities due
▪ The disbursement process begins in the AP department, where each day the AP clerk reviews if there are certain
liabilities that should be paid.
▪ The AP clerk sends payment for approval in a form of the voucher packet (AP packet consist of PO, receiving
report, and invoice) to the cash disbursement department.
B. Prepare Cash Disbursement
▪ The cash disbursement clerk receives the voucher packet and reviews the documents for completeness and clerical
accuracy.
▪ For each disbursement, the clerk prepares a check and records the check number, amount and other pertinent
data, in the check register, which is also the cash disbursement journal.
▪ Level of approvals for disbursement may vary among organizations.
▪ The check is mailed to the supplier, a copy is attached to the voucher packet as proof of payment, and a check
copy is filed in the department.
▪ The clerk marks the documents in the voucher packet paid and returns them to the AP clerk.
▪ The cash disbursement clerk summarizes the entries made to the check register and sends a journal voucher to
the General Ledger function.
C. Update Accounts Payable Record
▪ Upon receipt of the paid voucher packet, the AP clerk removes the liability by debiting the vendor’s AP subsidiary
ledger account.

2|Page
 ▪ The voucher packet is then filed in the closed AP file (paid accounts payable file) and an account summary is
prepared and sent to the general ledger function.
D. Post to General Ledger
▪ The general ledger function receives the journal voucher from cash disbursement and the AP account summary
from accounts payable.
• Accounts Payable (Dr)
• Cash (Cr)
E. Reconcile Cash Disbursement
▪ Same as reconciliation of cash receipts (Revenue cycle), a clerk from the controller’s office reconciles cash
disbursement by comparing related documents and records to the bank statement.

III. Threats and Controls in Expenditure Cycle

ACTIVITIES THREAT CONTROLS

General issues throughout
entire expenditure cycle
Ordering
Receiving
1. Inaccurate or invalid master data
2. Unauthorized disclosure of sensitive
information
3. Loss or destruction of data
4. Poor performance
5. Stockouts and excess inventory
6. Purchasing items not needed
7. Purchasing at inflated prices
8. Purchasing goods of inferior quality
9. Unreliable suppliers
10. Purchasing from unauthorized
suppliers
11. Kickbacks
12. Accepting unordered items
13. Mistakes in counting
14. Verifying receipt of services
15. Theft of inventory
1.1 Restriction of access to master data
1.2 Review of all changes to master data
2.1 Access controls
2.2 Encryption
3.1 Backup and disaster recovery procedures
4.1 Managerial reports
5.1 Perpetual inventory system
5.2 Bar coding or RFID tags
5.3 Periodic physical counts of inventory
6.1 Perpetual inventory system
6.2 Review and approval of purchase requisitions
6.3 Centralized purchasing function
7.1 Price lists
7.2 Competitive bidding
7.3 Review of purchase orders
7.4 Budgets
8.1 Purchasing only from approved suppliers
8.2 Review and approval of purchases from new suppliers
8.4 Tracking and monitoring product quality by supplier
8.3 Holding purchasing managers responsible for rework
and scrap costs
9.1 Requiring suppliers to possess quality certification (e.g.,
ISO 9000)
9.2 Collecting and monitoring supplier delivery
performance data
10.1 Maintaining a list of approved suppliers and
configuring the system to
permit purchase orders only to approved suppliers
10.2 Review and approval of purchases from new suppliers
11.1 Prohibit acceptance of gifts from suppliers
11.2 Job rotation and mandatory vacations
11.3 Requiring purchasing agents to disclose financial and
personal interests in suppliers
11.4 Supplier audits
12.1 Requiring existence of approved purchase order prior
to accepting any delivery
13.1 Do not inform receiving employees about quantity
ordered
13.2 Require receiving employees to sign receiving report
13.3 Incentives
13.4 Use of bar codes and RFID tags
13.5 Configuration of the ERP system to flag discrepancies
between received and ordered quantities that exceed
tolerance threshold for investigation
14.1 Audits
15.1 Restriction of physical access to inventory

3|Page

Approving supplier invoices
Cash disbursements
15.2 Documentation of all transfers of inventory between
receiving and inventory employees
15.3 Periodic physical counts of inventory and
reconciliation to recorded quantities
15.4 Segregation of duties: custody of inventory versus
receiving
16. Errors in supplier invoices 16.1 Verification of invoice accuracy
17. Mistakes in posting to accounts 16.2 Requiring detailed receipts for procurement card
payable purchases
16.3 Restriction of access to supplier master data
16.4 Verification of freight bill and use of approved
delivery channels
17.1 Data entry edit controls
17.2 Reconciliation of detailed accounts payable records
with the general ledger control account
18. Failure to take advantage of discounts 18.1 Filing of invoices by due date for discounts
for prompt payment 18.2 Cash flow budgets
19. Paying for items not received 19.1 Requiring that all supplier invoices be matched to
20. Duplicate payments supporting documents that are acknowledged by both
21. Theft of cash receiving and inventory control
22. Check alteration 19.2 Budgets
23. Cash flow problems 19.3 Requiring receipts for travel expenses
19.4 Use of corporate credit cards for travel expenses
20.1 Requiring a complete voucher package for all
payments
20.2 Policy to pay only from original copies of supplier
invoices
20.3 Cancelling all supporting documents when payment is
made
21.1 Physical security of blank checks and check-signing
machine
21.2 Periodic accounting of all sequentially numbered
checks by cashier
21.3 Use of dedicated computer and browser for online
banking
21.4 Separation of check-writing function from accounts
payable
21.5 Requiring dual signatures on checks greater than a
specific amount
21.6 Regular reconciliation of bank account with recorded
amounts by someone
independent of cash disbursements procedures
21.7 Restriction of access to supplier master file
21.8 Limiting the number of employees with ability to
create one-time suppliers and to process invoices from
one-time suppliers
21.9 Running petty cash as an imprest fund
21.10 Surprise audits of petty cash fund
22.1 Check-protection machines
22.2 Use of special inks and papers
22.3 “Positive Pay” arrangements with banks
23.1 Cash flow budget

IV. Identifying What, When, and How Much to Purchase

➢ Inaccurate inventory records can create significant problems for organizations; therefore, accountants and systems professionals need
to understand best practices for managing inventory.
➢ The traditional approach to managing inventory is to maintain sufficient stock so that production can continue without interruption
even if inventory use is greater than expected or if suppliers are late in making deliveries
o This traditional approach is often called the economic order quantity (EOQ) approach because it is based on calculating an
optimal order size to minimize the sum of ordering, carrying, and stockout costs
▪ EOQ is the optimal order size to minimize the sum of ordering, carrying, and stockout costs

4|Page
 ▪ Ordering costs include all expenses associated with processing purchase transactions.
▪ Carrying costs are those associated with holding inventory.
▪ Stockout costs are those that result from inventory shortages, such as lost sales or production delays.
o The EOQ formula is used to calculate how much to order; the reorder point specifies when to order
▪ Reorder point specifies the level to which the inventory balance of an item must fall before an order to replenish
stock is initiated.
o Companies typically set the reorder point based on delivery time and desired levels of safety stock to handle unexpected
fluctuations in demand
➢ Materials Requirements Planning
o An approach to inventory management that seeks to reduce required inventory levels by improving the accuracy of
forecasting techniques to better schedule purchases to satisfy production needs
o MRP seeks to reduce required inventory levels by improving the accuracy of forecasting techniques to better schedule
purchases to satisfy production needs.
➢ Just in Time Inventory System
o Virtually eliminates inventories by purchasing and producing goods only in response to actual, rather than forecasted, sales
o JIT attempts to minimize, if not totally eliminate, finished goods inventory by purchasing and producing goods only in
response to actual sales
➢ A major difference between MRP and JIT systems is production scheduling
o MRP systems schedule production to meet forecasted sales, thereby creating an “optimal” quantity of finished goods
inventory.
o JIT systems schedule production in response to customer demands, thereby virtually eliminating finished goods inventory

END

Prepared by:
EUREZE LHOED G. TABAR
CPA,MBA,CrFA

Sources:
➢ Accounting Information System Ninth Edition by James A. Hall
➢ Accounting Information System Thirteenth Edition by Marshall Romney, Paul John Steinbart

5|Page