IT Concepts &

Systems Analysis
Expenditure Cycle - Internal Control

What is common expenditure cycle

process?

What are the typical of internal controls

set-up in expenditure cycle?

What are the benefits of automated system

for expenditure process?
What is the expenditure cycle?

Receiving/
Purchasing
Inspection

Expenditure
Cycle
(Subsystem)

Cash Accounts
Disbursement Payable
 What is the expenditure cycle?

Receiving/ Purchase procedures include the tasks

Purchasing
Inspection involved in:
1. identifying inventory needs,
2. placing the order,
3. receiving the inventory, and
Expenditure
4. recognizing the liability
Cycle
(Subsystem)

Cash Accounts
Disbursement Payable
 What are the important activities in each
subsystem?
Purchase procedures include the tasks involved in:
1. identifying inventory needs,
Key decisions in this process involve identifying what, when, and how much to purchase and from
whom. Weaknesses in inventory control can create significant problems with this process. One of the
key factors affecting this process is the inventory control method to be used.

We will consider three alternate approaches to inventory control:

✓Economic Order Quantity (EOQ) - is the traditional approach to managing inventory. Goal is
maintain enough stock so that production doesn’t get interrupted
✓Just in Time Inventory (JIT) - seeks to reduce inventory levels by improving the accuracy of
forecasting techniques and carefully scheduling production and purchasing around that forecast.
✓Materials Requirements Planning (MRP) -attempt to minimize or eliminate inventory by purchasing
or producing only in response to actual (as opposed to forecasted) sales.
 What are the important activities in each
subsystem?
Purchase procedures include the tasks involved in:
1. identifying inventory needs,
2. placing the order,
1) The need to purchase goods typically results in the creation of a purchase requisition. The purchase
requisition is a paper document or electronic form that identifies:
• Who is requesting the goods
• Where they should be delivered
• When they’re needed
• Item numbers, descriptions, quantities, and prices
• Possibly a suggested supplier
• Department number and account number to be charged
This PR is prepared and copies to send to Purchasing and Accounts Payable (A/P)
2) A purchase order is a document or electronic form that formally requests a supplier to sell and deliver specified
products at specified prices. Purchasing prepares a purchase order (PO) for each vendor and sends copies to
Inventory Control, A/P, and Receiving
 What are the important activities in each
subsystem?
Purchase procedures include the tasks involved in:
1. identifying inventory needs,
2. placing the order,
3. receiving the inventory, and
1) Upon receipt, Receiving counts and inspects the goods. A blind copy of the PO is used to force workers to count
the goods. The receiving department accepts deliveries from suppliers. The two major responsibilities of the
receiving department are:
✓ Deciding whether to accept delivery – validity of purchased goods
✓ Verifying the quantity and quality of delivered goods – completeness and accuracy of purchased goods
2) The receiving report is the primary document used in this process:
• It documents the date goods received, shipper, supplier, and PO number
• Shows item number, description, unit of measure, and quantity for each item
• Provides space for signature and comments by the person who received and inspected
A receiving report is prepared and copies sent to the raw materials storeroom, Purchasing, Inventory Control, and
A/P.
 What are the important activities in each
subsystem?
Purchase procedures include the tasks involved in:
1. identifying inventory needs,
2. placing the order,
3. receiving the inventory, and
4. recognizing the liability
Objective of accounts payable: Authorize payment only for goods and services that were ordered and actually received.
1) A/P eventually receives copies of the PR, PO, receiving report, and the supplier’s invoice.
2) A/P reconciles these documents, posts to the purchases journal, and records the liability in the accounts payable subsidiary
ledger. Requires information from:
Purchasing—about existence of valid purchase order
Receiving—for receiving report indicating goods were received
3) A/P periodically summarizes the entries in the purchases journal as journal voucher a which is sent to the General Ledger (G/L)
department.
4) A/P also prepares a cash disbursements voucher and posts it in the voucher register
5) G/L department: a) posts from the accounts payable journal voucher to the general ledger b) reconciles the inventory amount
with the account summary received from inventory control
 What is the expenditure cycle?

Receiving/ The cash disbursements system processes

Purchasing
Inspection the payment of obligations created in the
purchases system. The principal objective
of this system is to ensure that only valid
creditors receive payment and that
Expenditure
amounts paid are timely and correct.
Cycle
(Subsystem) Tasks include:
1. Identifying liabilities due
2. Prepare cash disbursement
Cash Accounts 3. Update AP record
Disbursement Payable 4. Post to General Ledger
 Internal Control
System
The internal control system comprises policies, practices,
and procedures employed by the organization to achieve
four broad objectives
What are the different types of Internal Control applicable
for expenditure cycle?

Chapter 3 defined six classes of

internal control activities that guide us
in designing and evaluating transaction
processing controls. They are
transaction authorization, segregation
of duties, supervision, accounting
records, access control, and
independent verification.
What are the different types of Internal Control applicable
for expenditure cycle?
Transaction Authorization

The objective of transaction authorization is to

ensure that only valid transactions are processed.

a) Purchase - The inventory control function

continually monitors inventory levels. As
inventory levels drop to their predetermined
reorder points, inventory control formally
authorizes replenishment with a purchase
requisition. Formalizing the authorization
process promotes efficient inventory
management and ensures the legitimacy of
purchases transactions.
b) Cash Disbursement - The AP function
authorizes cash disbursements via the cash
disbursement voucher. To provide effective
control over the flow of cash from the firm, the
cash disbursements function should not write
checks without this explicit authorization. A
cash disbursements journal (check register)
containing the voucher number authorizing
each check provides an audit trail for verifying
the authenticity of each check written.
What are the different types of Internal Control applicable
for expenditure cycle?
Segregation of Duties

Segregating duties ensures that no single

individual or department processes a transaction in
its entirety.

a) Inventory controls from warehouse - Within

the purchases subsystem, the primary
physical asset is inventory. Inventory control
keeps the detailed records of the asset, while
the warehouse has custody. At any point, an
auditor should be able to reconcile inventory
records to the physical inventory.
b) General Ledger and Accounts Payable from
Cash Disbursement - The asset subject to
exposure in the cash disbursements
subsystem is cash. The records controlling this
asset are the AP subsidiary ledger and the
cash account in the general ledger. An
individual with the combined responsibilities of
writing checks, posting to the cash account,
and maintaining AP could perpetrate fraud
against the firm.
What are the different types of Internal Control applicable
for expenditure cycle?

Supervision

In the expenditure cycle, the receiving department

is the area that most benefits from supervision.
Large quantities of valuable assets flow through
this area on their way to the warehouse. Close
supervision here reduces the chances of two types
of exposure:
1) failure to properly inspect the assets and
2) the theft of assets.
What are the different types of Internal Control applicable
for expenditure cycle?

Accounting Records

The control objective of accounting records is to

maintain an audit trail adequate for tracing a
transaction from its source document to the
financial statements.

The expenditure cycle employs the following

accounting records:
1) AP subsidiary ledger,
2) voucher register, check register, and
3) general ledger.

The auditor’s concern in the expenditure cycle is

that obligations may be materially understated on
financial statements because of unrecorded
transactions.
What are the different types of Internal Control applicable
for expenditure cycle?

Access

Direct Access - In the expenditure cycle, a firm

must control access to physical assets such as
cash and inventory. Direct access controls include
locks, alarms, and restricted access to areas that
contain inventories and cash.

Indirect Access - A firm must limit access to

documents that control its physical assets. For
example, an individual with access to purchase
requisitions, purchase orders, and receiving
reports has the ingredients to construct a
fraudulent purchase transaction. With the proper
supporting documents, a fraudulent transaction
can be made to look legitimate to the system and
could be paid.
What are the different types of Internal Control applicable
for expenditure cycle?

Independent Verifications

a) By Accounts Payable - The AP function plays

a vital role in the verification of the work others
in this system have done. Copies of key source
documents flow into this department for
review and comparison. Each document
contains unique facts about the purchase
transaction, which the AP clerk must reconcile
before the firm recognizes an obligation.
b) By General Ledger Department - The
general ledger function provides an important
independent verification in the system. It
receives journal vouchers and summary
reports from inventory control, AP, and cash
disbursements. From these sources, the
general ledger function verifies that the total
obligations recorded equal the total inventories
received and that the total reductions in AP
equal the total disbursements of cash.
 How to automate Revenue Cycle?
Here are the following activities that can be automated for expenditure process:

✓ Authorizations and data access can be performed through computer screens.

✓ There is a decrease in the amount of paper.
✓ The manual journals and ledgers are changed to disk or tape transaction and master files.
✓ Input is still typically from a hard copy document and goes through one or more
computerized processes.
✓ Processes store data in electronic files (the tape or disk) or prepare data in the form of a
hardcopy report.
 How to automate expenditure Cycle?

Computer-Based Accounting Systems is the technological innovation used for business

processing.

CBAS technology can be viewed as a continuum with two extremes:

✓ automation - use technology to improve efficiency and effectiveness. Too often,
however, the automated system simply replicates the traditional (manual) process that it
replaces.
✓ reengineering – use technology to restructure business processes and firm
organization. The objective of reengineering is to improve operational performance and
reduce cost by identifying and eliminating non–value-added tasks.
 What are the benefits of automated system for
expenditure process?

1) Improved Inventory Control - The greatest advantage of the automated system over its manual
counterpart is improved ability to manage inventory needs. Inventory requirements are detected as
they arise and are processed automatically. As a result, the risks of accumulating excessive
inventory or of running out of stock are reduced. However, monitoring automated decisions is
extremely important. A well-controlled system should provide management with adequate summary
reports about inventory purchases, inventory turnover, spoilage, and slow-moving items.
2) Better Cash Management - The automated system promotes effective cash management by
scanning the voucher file daily for items due, thus avoiding early payments and missed due dates.
In addition, by writing checks automatically, the firm reduces labor cost, saves processing time, and
promotes accuracy. In addition, procedures are placed to offset the risk automated signing of
checks. To offset this exposure, firms set a materiality threshold for check writing. Checks in
amounts below the threshold are signed automatically, while those above the threshold are signed
by an authorized manager or the treasurer.
3) Time Lag - A lag exists between the arrival of goods in the receiving department and recording
inventory receipts in the inventory file. Depending on the type of sales order system in place, this
lag may negatively affect the sales process. When sales clerks do not know the current status of
inventory, sales maybe lost.
 What are the benefits of automated system for
expenditure process?

4) Purchasing Bottleneck- In this automated system, the purchasing department is directly involved
in all purchase decisions. For many firms this creates additional work, which extends the time lag in
the ordering process.
5) Excessive Documents- The automated system is laden with paper documents. All operations
departments create documents, which are sent to data processing, and which data processing must
then convert to magnetic media. Paper documents add costs because they must be purchased,
stored, prepared, handled by internal mail carriers, and converted by data processing personnel.
Organizations with high volumes of transactions benefit considerably from reducing or eliminating
paper documents in their systems.
Reference: Accounting Information Systems, James Hall