Chapter 5- The Expenditure Cycle

Objective: to convert cash into materials or human resources

Conceptual system

 Technology neutral
 Can be applied in manual system (there's a human involvement) or automated
 Focus on what is to be done and not how
 Documents can be physical or digital
 Objectives:
o Timely and correct payment to valid vendors
o Ensure that payments are not early or not too late
o Effects of early and late payment
 Too early- this may lead to opportunity cost (lost on interest income on fund
investment
 Too late- loss of cash discounts and may damage credit standing

Physical system

 How it is done: combination of human activities and technology

o Basic technology system
 More manual less technology
 Computers used are independent and not networked
 Longer process
 Audit trail is through hard copy document and files
 Purchase Processing System
 Inventory Control
 Purchasing Department
 Receiving Department
 AP Department
 GL Department
 Cash Disbursement System
 AP Department
 CD Department
 GL Department
o Advance integrated system
 More technology less manual
 Computers used are linked integrated systems
 Shorter process, more efficient
 Audit trail comes in digital files, called transaction logs, master files and
backups, hard copies
 Purchase Processing System
 Computer operations
 Purchasing department
 Receiving department
  AP department
 GL department
 Cash Disbursement System
 AP department
 Computer operations
 CD department

DFD Purchase System

1. Monitor inventory records

a. Activity starts when inventories are depleted
b. Purchase requisition (PR) will be generated by the inventory control department
c. PR is sent to prepare PO function (purchasing department)

Purchase Requisition form

 Internal document only
 Document that authorizes purchases
 PRs can be combined to a single PO depending on the company
 Contains the following:
o Suggested vendor
o Date of preparation and date when the goods are needed
o Inventory number
o Quantity, description, prices of goods, and total amount
o Prepared by, approved by
o Vendor’s account

Inventory subsidiary ledger- basis in preparing the PR

Valid vendor file
 Contains vendor mailing information
 Form of reference file which prevent fraud related purchases such as conflict of interest

2. Prepare purchase order

a. Performed by the purchasing department
b. When the PR is received, PO is prepared
c. Multiple copies of PO are prepared (4 copies) and sent to the following:
i. 1st copy- Vendor
ii. 2nd copy- AP function so that the AP knows there are purchase
iii. 3rd copy (blind copy of PO)- Receiving department
iv. 4th copy retained by purchasing department and forms part of open closed PO
file

Open/Closed PO file
 file is open when the last copy is filed
 PO file is closed when goods are received
 Purchase Requisition and Purchase Order
 PR and PO’s contents are the same
 PRs and POs served as internal controls specifically segregation of duties
 Difference:
o Purchase Requisition
 Prepared by the inventory control department
 Internal document
o Purchase Order
 Formal document prepared by purchase department
 External document
 A document that specifies item ordered from vendor or supplier
 Contains the following:
 Vendor, vendor number
 Date ordered and when it is needed
 Quantity, description, unit price, and total amount of goods
 Prepared by and approved by
 Key difference: Purchasing agent info., and terms of vendor

Inter-department Segregation of Duties

 Inventory control department through the PR authorizes purchase
 Purchasing department through the PO makes the actual purchase from the vendor

3. Receive goods
a. In the first two processes, there's no journal entry.
b. In this one, there's a related entry when receiving inventory.
c. Receiving clerk will count the goods and match it with the blind copy of PO
d. After receiving the goods, the Receiving Report is prepared
e. The Receiving Report is prepared in multiple copies:
i. Raw materials storeroom
ii. Purchasing department to close the open PO file
iii. AP function to indicate the goods are received
iv. Inventory control dept to update inventory subsidiary ledger
v. 5th copy retained by receiving dept. to be part of the Receiving Report file

Blind copy Purchase Order

 It has no indicated price or quantity
 Its purpose is to force the clerk to count the goods received.
 It is a form of control for missing goods, or incorrect count of goods received

Receiving report
 Lists quantity and condition of inventories
 Contains the following:
o Date received
o Actual quantity counted
 o Condition of goods
o People involved: received by, inspected by, delivered to

AP pending file- contains documents to set up AP

RR file- file of all RR prepared

4. Update inventory records

a. When the receiving report is received, inventory subsidiary ledger is updated
i. Standard cost system- uses predetermined standard value for inventory
ii. Actual cost inventory ledger- uses actual cost rather than the standard cost of
inventory
b. Inventory clerk prepares inventory account summary and sent to the GL function

Inventory account summary- contains the details of inventories received

5. Set up Accounts Payable

a. The basis is the supplier's invoice to recognize liability
i. Supplier's invoice- bill showing costs, taxes, freight and other charges
b. There's a lag time in recording liability
i. Goods received at period end. Meanwhile, supplier’s invoice is received at next
period
ii. To solve this at period end, the company should estimate liability
iii. When the SI is received, they will record the actual liability
iv. If the difference is material, there is an adjustment that will occur
c. Three-way match
i. Control that reconciles PO, RR, and SI
ii. Compares actual quantity ordered to the actual quantity received and actual
quantity to be paid
d. If they match the accounts payable is approved for payment
e. Result of 3-way match: AP packet
i. Consists of AP supporting documents (PO, RR, AND SI)
ii. Formal authority to record liability and authorization of payment
f. AP subsidiary ledger will be updated
i. AP SL- controls the cash disbursement system
ii. For actual system, AP clerk should send copy of supplier’s invoice to the inv
control
iii. For standard costing it is not required
g. Journal voucher is sent to the GL which contains journal entries

Vouchers payable system

 Alternative to normal AP system

 Main difference: It uses cash disbursement voucher and voucher register
 Cash disbursement vouchers

 Document evidencing payment

 Provide improved control over cash disbursements
 Can be prenumbered to monitor missing and duplicate CD vouchers
 Can consolidate various payments to a single vendor

Voucher register

 Reflects the firms AP

 Records all CD vouchers
 Transactions recorded chronologically

Vouchers payable file

 Collated files of CD vouchers

 Equivalent to the open AP file

6. Post to GL
a. GL clerk receives JV and inventory account summary
b. Posts to the GL based from entries on JV
c. Reconciles the inventory control account with the inventory account summary
d. Files the JV

In DFD, you can't determine if the process is whether manual or automated. It is applicable for
manufacturing and merchandising businesses.

Manufacturing- purchase of raw materials is requested and authorized by the production planning and
control function

Retail/ merchandising- purchase of raw materials is done by inventory control function

Cash disbursement system DFD

1. Identify liabilities due

a. AP clerk reviews AP file
b. AP file arranged by payment due
c. AP clerk sends payment approval (AP packet) to the cash disbursement department
2. Prepare cash disbursement
a. CD clerk receives and reviews the AP packet
b. Prepares check
c. Details are put in check register
i. Record of cash disbursement
ii. Also known as Cash Disbursement Journal
iii. Not all accounts in the CDJ pertain to AP
iv. Includes also payment to other accounts
 d. Additional approval may be needed by the department manager or treasurer
e. 3 copies of the check are prepared
i. Vendor
ii. Attached to AP packet
f. Filed in the CD department
g. Clerk marks the documents paid and returns to the AP clerk
h. Prepares JV and sends to the GL function
3. Update AP record
a. AP clerk updates the AP SL
b. AP clerk will remove the liabilities related to the Closed AP file: record of all APs paid
c. Prepares AP account summary and send to the GL function
4. Post to GL
a. GL clerk receives and reconciles the JV and AP account summary
i. JV- contains all deduction in AP and in cash based on the check register
ii. AP account summary- contains all the deduction in the AP based on each
deduction on the AP SL
b. Posts the journal entry to the GL
i. Dr. AP Cr. Cash
c. Files the JV in the approved JV file

Conceptual Payroll System

 Personnel Department
o uses personnel action forms to:
 Activate new employees
 Change the pay rate of employees
 Changes marital status and/or number of dependents
o Production employees fill out two forms:
 Job tickets – account for the time spent by the worker on each production job
 Timecards – used to capture the total time worked each pay period for payroll
calculation
o Both forms must be signed by the supervisor

 Cost Accounting Department

o Uses the job tickets to allocate labor costs to WIP accounts
o Summarizes charges in a labor distribution summary then forwarded to G/L dept.
 Payroll Department
o Receives the personnel action forms and timecards
o Uses to:
 Prepare the payroll register
 Enter the information into the employee payroll records
 Prepare paychecks
  Send paychecks to Cash Disbursements and a copy of the payroll register to
Accounts Payable
 Accounts Payable Department
o Prepares a cash disbursements voucher for the total amount of the payroll
o Send copies to the Cash Disbursement and G/L Depts.
 Cash Disbursement Department
o Review and signs the paychecks and forwards to paymaster for distribution to
employees
o Writes check for the payroll and deposits it into payroll imprest account
 General Ledger Department
o General ledger section receives;
 the labor distribution summary from cost accounting,
 the disbursement voucher from accounts payable,
 the journal voucher from cash disbursements.
o Debits and credits of the entries must be equal.
o Once equality been verified, the clerk files the voucher and labor distribution summary.

Internal Control

 It is a system designed, introduced and maintained by the company’s management and top-level
executives, to provide a substantial degree of assurance (reasonable) in:
o Achieving business objective,
o Complying with the policies and laws,
o Safeguarding the assets,
o Maintaining efficiency and effectiveness in regular operations
o Reliability of financial statements.

 Physical Controls- control the actions of people

Classes of Internal Control Activities

o Transaction Authorization
o Segregation of Duties
o Supervisions
o Accounting Records
o Access Control
o Independent verification

 IT Controls
o General Control
 Data security
 Physical security
 Operating system control
 Access control
 Operations
  System development methodology
 Database administration
 Telecommunication
 Physical security
 Disaster recovery
 Program management
o Application Control
 PEOPLE- Users, Clients, Customers, Technicians, Government, Companies
 INPUT- Data collected, capture
 PROCESSING- Working with information, changing, calculating, manipulating
 OUTPUT- Sending results, reporting, collecting data

Risk Associated with Expenditure Cycle

Threats Physical Controls IT Controls

 Unauthorized inventory
purchase
 Purchase unneeded items
 Request for goods and
services which is not
required by the business
 Perpetual Inventory
 Separate purchase
department
 Approval of Purchase Order
 Automated requisition
based on inventory level
 Automate routing for
approval by proper level of
authorized person(s)

 Receiving Incorrect Items  Segregation of duties  Use of product code

 Incorrect Quantities
 Damaged Goods
 Inaccurately Recording
Transactions in Journals &
Ledgers
 Purchases from vendors
are incorrectly calculated
 Accounts payable go
unrecorded or are
recorded in the wrong
period
 Vendor bills customers for
between the goods
receiving function and
purchase order preparation
function
 Supervision over inspection
of goods received and
check against approved PO
 Use of Blind PO to enforce
counting
 Independent verification by
the person who receive the
vendor’s billing against PO
and RR.
 Accounting records: verify
sequences number of RR
issued
 Independent verification:
reconciliation of AP sub-
ledger with control account
 Independent verification by
scanners in the receiving
department and warehouse
 Programmed procedure to
allow recording of receiving
transaction based on
existing PO information
only
 Programmed procedure to
match the recorded
vendor’s bill against PO and
RR and report any
difference to responsible
person.
 Automated recording of
purchases/payable upon
good received, based on
quantity received and PO
price.
 Programmed procedure to
 items they did not receive the person who receive the
vendor’s billing against PO
and RR.
 Issue checks only for
complete vouchers
packages RR, supplier’s
invoice and purchase order
match the recorded
vendor’s bill against PO and
RR
 Automated recording of
purchases/payable upon
good received, based on
quantity received and PO

 Vendor cash payments are  Accounting records: verify  Automated recording of

inaccurately posted to AP
or are posted to the wrong
vendor AP
 Summaries of purchases,
accounts payable, cash
disbursements, and
inventory levels are
incorrectly posted to their
respective GL accounts.
 Misappropriation of Cash
and Inventory
 Unauthorized Access to
Accounting Records &
Reports
sequences number of RR purchases/payable upon
issued good received.
 Independent verification:  Input control on the
reconciliation of AP sub- vendors assigned code
ledger with control account
 Independent verification:  Automated recording of
reconciliation of AP and purchases, payable and
Inventory sub-ledger with inventory.
control account and
corresponding Journals
 Supervision in the receiving  Automated 3-way match
department and payment approval
 Independent Verification-3  Multi-level Security
way match PO-RR and
Suppliers Invoice
 Segregation of duties-
Inventory Control from
Warehouse and AP to
Disbursement
 Access control  Password control
 Segregation of duties  Multi-Level Security

Generally, IT Controls on accounting records are:

1. Input data edits where an error message appears when inputting erroneous data about vendors,
inventory and purchases.

2. Automated posting where mapping was being done by the system

3. File backup for readily recovery in cases of untoward incidents

Reengineering Using EDI

Electronic Data Interchange- enable some functionalities/process to shorten which is very cost efficient
on the part of the company
The Need to have a Supply Chain Management where the receiving functions can be eliminated

 Ensure a continuous supply and avoid a service company’s delivery disruptions.

 Strengthen supplier relations for systematic synergy with suppliers.

 Enterprise spending management to assure procurement happens through the right suppliers
and reduces costs.

 Establishing a single comprehensive supplier view and deriving insightful procurement analytics.