UNIT 5: THE EXPENDITURE CYCLE

Contents
5.0. Introduction
5.1 Objectives
5.2 System Definition and Functions in Purchase Application System
5.3 Payroll System
5.4 Summary
5.5 Answers to Check Your Progress

5.0. INTRODUCTION

An organization's expenditure cycle includes the function required to acquire goods and
services that are utilized by the organization in conducting its operations. The expenditure
cycle includes the acquisition of goods for resale or use in production, the acquisition of
property and equipment and the acquisition of person service.

The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash
disbursement system and the applicable parts of the general ledger system.
Expenditure cycle Operations include:-
- The preparation and recording of purchase orders.
- The receipt of goods and the recording of the cost of inventory.
- The receipt of vendor invoices and the recording accounts payable.
- The preparation of employee pay-checks and the recording of payroll activities.
- The preparation and recording of cash disbursements, including payroll.

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 Purchasing
Accounts
payable cash
disbursement
system

Inventory
General Expenditure System
ledger
System Cycle

Payroll
system

The Over all Expenditure Cycle

5.1 OBJECTIVES

After careful reading of this unit the reader must be able to:
describe the major features and operations in a purchasing application system.
describe the major features of and operations in a payroll application system.

5.2 SYSTEM DEFINITION AND FUNCTIONS IN PURCHASE APPLICATION

SYSTEM

5.2.0 Overview
In some companies, all purchases of goods and services are channeled through and controlled
by centralized purchasing department. In others, the authority to place orders with vendors is
dispersed through out the company- a decentralized approach. Centralized purchasing may
yield increased quantity discounts stronger market position, better inventory control, buyer
specialization, and the like. Decentralized purchasing may yield similar benefits because of
the increased responsibilities placed on the ultimate user. For example, decentralized buyers

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may have greater knowledge of the use and specifications of the desired goods and thereby
maintain optimal inventory levels. As in any organizational decision, the choice is largely one
of management style and philosophy.
philosophy.

Objectives
After careful reading of this section, the reader must be able to:
describe the major features and operations in a purchasing application system

5.2.1 System definitions and functions

The purchasing (p) /accounts payable (AP) / cash disbursement (CD) system is an interacting
structure of people, equipment, methods, and controls that is designed to accomplish the
following primary functions:-

First the P/AP/CD Systems handle the repetitive work routines of the departments listed by
capturing and recording data related to the day-to-day operations of those departments. The
recorded data then may be used to generate source documents (such as purchase orders and
receiving reports) and to produce internal and external reports.

Second the P/AP/CD system prepares a number of reports those personnel at various levels
uses for different decisions will be used through out the paper: goods and services. Goods are
row materials, merchandise, supplies, fixed assets, or intangible assets. Services cover work
performed by outside vendors. Employee activities are a specialized for of service.

The information flows are representative of those related to the P/AP/CD system. However,
all information are not shown. For example purchase returns are not shown.

Description of Information flows

1- Purchase requisition sent from inventory control department to purchasing department.
2- Purchase requisitions from various other departments sent to purchasing department.
3- Purchase order sent to vendor.
4- Purchase order notification sent to various other departments or to inventory control
department.
5- Purchase order notification sent to receiving department.
6- Purchase order notification sent to accounts payable department.

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 7- Goods and Services received from vendor.
8- Receiving notification sent to accounts payable department.
9- Receiving notification sent to purchasing department.
10- Invoice received from vendor.
11- Approved voucher sent to cashier.
12- Accounts payable notification and inventory cost information sent to general ledger
system.
13- Check sent to vendor by cashier.
14- Paid voucher returned to accounts payable department.
15- Notification of the cash disbursement sent from cashier to general ledger system

The process associated with reordering inventory involve several important concept and
techniques, such as cyclical reordering, recorder point analysis, economic order quantity
(EOQ) analysis, and ABC analysis.

A purchase application system includes the five basic functions:

1/ Purchase requisition is prepared & approved.
2/ Purchase order issued.
3/ Materials received.
4/ Establish payable
5/ Checks are prepared.
1/ Purchase requisition
Someone outside the purchasing department determines that materials are needed and who
will be prepare and send the purchase requisition to the purchasing department.

2/ Order Goods and Services

In this section we look at the logical functions involved in ordering goods and services. The
first process involves vendor selection. A buyer (or purchasing agent) generally consults a
vendor master file to identify several suppliers. Once several candidates have been identified,
the buyer then evaluates each prospective vendor with respect to such factors as unit price,
quality, service, promised delivery dates, terms, reliability, and amount purchased from the
vendor to date.

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Buyers often attempt to combine as many orders as possible with the same vendor by using
blanket orders and/or annual agreements. If large expenditures for new or specially made
parts are involved, the buyer may need to obtain competitive bids by sending a request for
quotation (RFQ) to prospective vendors.

Vendor selection can have a significant impact on the success of an organization's inventory
control and manufacturing functions. One kind of Inventory control management is just in-
time (JIT) inventory management. With JIT inventory management, parts arrive when needed,
thus saving the interest cost associated with storing "excess" inventory and reducing the
possibility of inventory becoming obsolete. To use JIT systems effectively, organizations
must find and retain reliable vendors.

After vendor has been selected, the buyer then prepares a purchase order, which is an external
request for the purchase of goods or services from a vendor. Typically a purchase order
contains data regarding the needed quantities, expected unit prices, required delivery date,
terms, and other conditions. Because it is the basis for a contract between the buyer and the
seller, the purchase order should been some authorized signature, usually that of a purchasing
agent or buyer.

Cash maintained in demand deposit accounts is sufficient (but not excessive) to satisfy
expected cash disbursements. To accomplish this goal, many banks often to their commercial
customers a cash management service by which the bank transfers from the customer's money
market or other investment account into its checking account the exact amount needed to
cover the checks that clear each day.

For convenience in handling accounts payable, many companies have adopted the policy of
making payments twice per month. It is usually possible to make agreement with vendors
(Particularly if you are a high volume customer) so that the cash discount will be considered
earned of invoices received during the first half of the month (for instance) are paid on the
twentieth, and invoices received during the second half of the month are paid on the fifth of
the succeeding month.

The purchase order notifications could take a number of physical forms. when multipart paper
documents are used, it is not uncommon for the copy sent to the receiving department to be a

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blind copy, meaning that contain data are blanked out (i.e, blinded) for instance, the quantities
ordered might be blanked out so that the receiving personnel will not be influences by this
information when counting the goods price data may also be blinded because receiving
personnel have no need to know that information.

At some paint, the vendor uses a notification known as a vendor acknowledgement to inform
the purchaser that the purchase order has been received and is being processed
(See the data flow "vendor acknowledgement" in to bubble B). As a result of the vendor
acknowledgement, process B up dates the "purchase status" field in the purchase order master
file.
3. Receive Goods and Services
When good arrived at the receiving department, there is inspected and counted. This process
helps to insure that the right goods in a correct amount are received in acceptable condition.
Nonconforming goods are rejected (returned) to the supplier. Notation of rejected goods is
added to the vendor service record in the vendor master file.

Once the condition of the goods has been approved the process of complete receiving report
by noting the quantity received on the approved purchase order receiving notification. Once
annotated with the quantity received the purchase order receiving notification become a
receiving report, which is the document used to record merchandize receipts.

As in the case of the receipt of goods, services received also should be documented properly.
Some organizations use an acceptance report to acknowledge formally the satisfactory
completion of a service contract. The acceptance report supports the payment due to the
vendor in the same way as the receiving report.

4. Establish Payable
The first step in establishing the payable involves validating the vendor invoice. This process
is triggered by receipt of the vendor invoice, a business document that notifies the purchaser
of an obligation to pay the vendor for goods or services that were ordered by and shipped to
the purchaser.

The process comprises a number of steps. First, the vendor invoice is compared against data
on a copy of the purchase order (Po accounts payable notification) to make sure that (1) the

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purchase has been authorized and (2) invoices quantities, prices and terms conform to the
purchase order agreement. Next, the invoice is matched against the receiving report to
determine that the goods or services actually have been received and that goods have been
transferred to stores. Finally, the invoice is cheeked for accuracy of computed discounts,
extension, and total amount due.

If the data items do not agree, the invoice is rejected and follow up procedures are initiated
(see the reject stub emanating from bubble 3.1) If the data item agree, the invoice is approved
and the validated invoice is then used to record the payable. Note that the vendor master file is
also updated at this point to reflect purchase history data.

A payable is recognized and recorded by simultaneously:

 Creating a record on the accounts payable master file.
 Updating the inventory master file for the cost of the item received.
 Notifying the general ledger system of the amount of the payable that was recorded
( see the data flow "GL payable update")
The previous flow diagram assumes that a non-voucher system is used. Alternatively, a
voucher system might be employed. A disbursement voucher is designed to reflect formal
approval of the voucher for payment and to provide such added data as the account
distribution and the amounts to be debited. Several invoices from a single vendor are often
listed on one disbursement voucher so that fewer checks need to be written during the cash
disbursement procedure. In the section on "processing none invoiced Disbursements, "we
elaborate on the use of a voucher system.

To help achieve a third system goal, to optimize cash discounts, the responsibility for
ensuring saving through cash discounts, the responsibility for ensuring saving through cash
discounts includes (1) seeing that proper cash discount terms are incorporated in the order, (2)
securing invoices promptly from vendor, (3) processing invoices promptly and getting them to
the disbursing office within the discount period, and (4) when unavoidable delays are
encountered because of some fault of the seller, making sure that the discount privilege is not
waived and that the vendor is notified to this effect.

5. Make Payment

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 The payment schedule adopted will depend on the availability of any favorable discounts for
prompt payment and on the organizations current cash position. Some companies will pay
multiple invoices with one check to minimize the cost of processing invoices. Most cash
managers will attempt to optimize cash balances to help achieve a fourth system goal. that is
to insure that the amount of cash.

Data flow diagram for purchase application system.

6

Receiv
ing 7

5 3

Stores 1 Purcha Vendor

2 sing 10
4 11
9 13
A/P
Cash
Details 12 Payment

Vender
Data

Data flow key

1. Requisition
2. Acknowledgement
3. Purchase order
4. Purchase advice
5. Receiving advice
6. Shipment
7. Receiving advice
8. Receiving report
9. Notice of receipt
10. Invoice

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 11. Approved invoice
12. Voucher package
13. Payment

To initiate an adjustment for returned goods on for a price allowance in the case of otherwise
conforming goods someone usually prepares a debit memorandum and sends in to the vendor,
the vendor commonly acknowledges by returning a credit memorandum. a copy of the debit
memo is sent to the accounts payable department. In the case of return copies are also sent to
the storeroom and shipping department.

The merchandise to be returned is then released from the storeroom and sent to the shipping
department and shipped. The shipping department forwards its copy at the debit memo to the
accounts payable department.

PROCESSING NON INVOICED DISBURSEMENTS

Disbursements that are not typically supported by invoices such as, repayment of debt
obligation and interest and the like.
The following diagram is a logical data flow diagram that shows the processing of non-
invoiced payments under two different assumptions:
(1) A true vouches system is used in which all expenditures must be vouched that is,
formally approved for payments and recorded as a payable before they can be paid, and

(2) A non-voucher system is employed.

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1/ assuming a true voucher system is used.

Payment Disburse GL
requiest ment payable
Originating Prepar recor General ledger
Department System
e
d
disb
disb
urse
urse
ment
ment
vouc Vouchers
vouc
Payable
her Master File
her
GL cash
disburseme

Check
Payment
notification

Prepar Issue
e cheek
chec and
k recor Payee
d
Payment
pay
ment

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 2/ assuming a non-voucher system is used.

General
ledger system

GL cash
disbursement
up date
up Prepair
date
Payment Approve Approved check
paiment
request payment request

Originating Cash disbursement

departement transaction file Check

Payment Issue
check and
notification record
payment

Payee Payment

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Learning activity 1
1. Describe the major functions in purchase application system?
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
2. Distinguish between accounts receiving and stores
___________________________________________________________________________
___________________________________________________________________________

5.3 PAYROLL SYSTEM

5.3.0. Overview
A payroll / personnel system involves all phases of payroll processing and personnel
reporting. The system provides a means of promptly and accurately paying employees,
generating the necessary payroll reports, and supplying management with the required
employee skills information. The processing should include a deduction for with holding
taxes, specialized deductions, government reporting, and internal personnel requirements. An
efficient system is necessary to establish and maintain good employer- employee
relationships.

Payroll processing is extremely complex. In a large organization, it is often the most complex
procedure in operation. This is because of the social significance payrolls have assumed over
the last few decades. All levels of government impose payroll taxes of one sort or another;
regulations and rates are constantly changed, with the result that a payroll usually has a
relatively short life. The strategy here is to provide an overview of a typical payroll procedure
and discuss factors influencing the actual calculation of payroll. No attempt is made to
provide current tax rates: tax laws are arbitrary and change quite rapidly. Payroll processing is
one area in which the law imposes not only a fine but also a jail sentence for willful
negligence in maintaining adequate records. As with any law, ignorance is no excuse.

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5.3.0 Objectives
After careful reading of this section the reader must be able to:
describe the major features of and operations in a payroll application system.

Two data flows enter the payroll system from departmental managers and supervisor's
attendance time records and job time records. Attendance time records shows the time period
that employees are in attendance at the job site and available for work. These records are used
to calculate the gross amount of each employees pay. Job time records on the other hand
reflect that start and stop times on specific jobs. Their purpose is to allow the distribution of
payroll costs to jobs in process (or to other accounts).

Attendance time records maintained near the entrance of the workplace and after take the
physical form of time sheets that are stamped as employees come and go. Job time records are
prepared at the worksite by employees entering the time each job is started and stopped.

"Reconcile hours worked" compares the total hours of each works as shown by at the
attendance time record with the hours reflected on the job time records for that employee. The
hours should agree. This reconciliation's is one of the payroll system control plans.

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Data flow diagram for payroll application system (for manufacturing firm)
1
Personnel

Production

2 Payroll data

3 Details
Payee
Time Payroll
Keepin
g 10
6
12
Cash
4 5 Payment 11 Bank

Cost A/P
Distributio 14 13
n
8

G/L Interna
9
l audit

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Data flow key

1. authorization 8. voucher
2. job time summary 9. journal voucher
3. job time cards 10. paychecks
4. job time report 11. voucher check
5. payroll register 12. canceled checks
6. paychecks 13. bank statement
7. voucher check 14. control total

Personnel
The personnel office is responsible for placing people on the company’s payroll, specifying
rates of pay, and authorizing all deductions from pay. All changes such as adding, or deleting
employees, changing pay rates, or changing levels of deductions from pay must be authorized
by the personnel office. The personnel function is distinct from time keeping and from payroll
preparation function.

Time keeping
The time keeping function is responsible for the preparation and control of time reports and
job time tickets. In manufacturing firm, an hourly employee typically clocks on and off of the
job. At the end of the period, the employee's time card or time report indicates the amount of
time that the employee was on the job and the time that he or she expects to receive pay for.
Time keeping is responsible for collecting and maintaining time cards and reconciling these
data to job time summary reports that are received from production.

Payroll
The payroll department is responsible for the actual computation and preparation of payroll.
Note that preparing payroll is independent of preparation of the input data on which pay is
based, the time reports and personnel data. Personnel data are received from the personnel
office; time reports are received from time keeping. The payroll register details the
computation of net pay (gross pay less deductions from pay). Pay checks are sent cash

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payment for signature, review, and distributions. A copy of the payroll register is sent to
accounts payable to initiate the recording of a voucher for the payroll.

Learning activity 2
1. Describe the major features of and operations in a payroll application system
________________________________________________________________________
________________________________________________________________________

Answers to learning activities

Learning activity 1
1. Describe the major functions in purchase application system?
The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash
disbursement system and the applicable parts of the general ledger system.
Expenditure cycle Operations include:-
- The preparation and recording of purchase orders.
- The receipt of goods and the recording of the cost of inventory.
- The receipt of vendor invoices and the recording accounts payable.
- The preparation of employee pay-checks and the recording of payroll activities.
- The preparation and recording of cash disbursements, including payroll.

1. Distinguish between receiving and stores

When good arrived at the receiving department, there is inspected and counted. This process
helps to insure that the right goods in a correct amount are received in acceptable condition.
Nonconforming goods are rejected (returned) to the supplier. Notation of rejected goods is
added to the vendor service record in the vendor master file.

Once the condition of the goods has been approved the process of complete receiving report
by noting the quantity received on the approved purchase order receiving notification. Once
annotated with the quantity received the purchase order receiving notification become a
receiving report, which is the document used to record merchandize receipts.

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The stores department acknowledges receipt of the goods from receiving by signing the
receiving report and then forwarding the receiving report to accounts payable.

Learning activity 2
1. Describe the major features of and operations in a payroll application system
The HRM/payroll cycle is a recurring set of business activities and related data processing
operations associated with effectively managing the employee work force.
1. Update master payroll file
2. Update tax rates and deductions
3. Validate time and attendance data
4. Prepare payroll
5. Disburse payroll
6. Calculate employer-paid benefits and taxes
7. Disburse payroll taxes and other deductions
• The first activity in the HRM/payroll cycle involves updating the payroll master file to
reflect payroll changes such as new hires, terminations, changes in pay rates, or
changes in discretionary withholdings.
• It is important that all payroll changes are entered in a timely manner and are properly
reflected in the next pay period.
• The second activity in the HRM/payroll cycle involves updating information about tax
rates and other withholdings.
• These changes happen whenever updates about changes in tax rates and other payroll
deductions are received from various government units and insurance companies.
• The third activity in the payroll cycle is to validate each employee’s time and
attendance data.
• This information comes in various forms, depending on an employee’s status.
• The fourth activity in the payroll cycle involves preparing payroll.
• Data about the hours worked are provided by the department in which the employee
works.
• Pay rate information is obtained from the payroll master file.
• The person responsible for preparing paychecks cannot add new records to this file.

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 • The fifth activity is actual disbursement of paychecks to employees.
• Most employees are paid either by check or by direct deposit of the net pay amount
into the employee’s bank account.
• The six activity is calculating tax and benefits. Some payroll taxes and employee
benefits are paid directly by the employer.
• Federal and state laws require employers to contribute a specified percentage of each
employee’s gross pay to federal and state unemployment compensation insurance
funds.
• Employers often contribute to health, disability, and insurance premiums.
• The final activity in the payroll process involves paying the payroll tax liability and
the other voluntary deductions of each employee.
• An organization must periodically prepare checks or use electronic transfer to pay the
various tax liabilities incurred.

Check Your Progress

1. In a purchase application system, which of the following departments should normally be

responsible for the preparation of the purchase order?
A. Cash disbursement
B. Purchasing
C. Accounts payable
D. Stores
2. In a purchase application system, which of the following departments should normally be

responsible for the preparation of the requisitions?

A. Cash disbursement
B. Purchasing
C. Receiving
D. Stores
3. In order to provide accountability for purchasing, copies of purchase requisitions should be
sent to
A. The vendor

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 B. Cash disbursement
C. Accounts payable
D. Receiving
4. In payroll application system, which of the following should be responsible for payroll
register?
A. Personnel department
B. Payroll department
C. Cash payment department
D. Time keeping department.
5. In a payroll application system, which of the following should be responsible for the
authorization of pay rates for employees?
A. Personnel department
B. Payroll department
C. Cash disbursement
D. Time keeping department

5.4 SUMMARY

The general P/AP/CD system entails several different files. The accounts payable master file
is a repository of all unpaid vendor invoices. In creating the records that compose typical
accounts payable master file information to be captured should be limited to data that lead to
accomplishing the goals of the system. The file designee should consider how the file would
be processed when the cash manager is deciding what payment to make. For example, the
manager may want to merge vender invoices so that the total amount due each vendor can be
accumulated. Alternatively, the manager might want to select specific invoices for payment.

Purchasing personnel when selecting an appropriate vendor usually accesses the vender
master file. During processing, vender data are retrieved to prepared purchase orders and to
issue payments. In addition to storing identification data the file is used by management to
evaluate vender performance and to make various ordering decisions.

The purchase order master file is a compilation of open purchase orders and includes the
status of each item on order. To keep track of a purchase, the purchasing department generally

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creates a record in the purchase order, including information about the status of each item on
order. The order is closed only on receipt and acceptance of all goods detailed on the order.

The other file appearing in the data flow diagrams are:

(a) The inventory master file. This file contains a record of each inventory item that is
stoked in the warehouse or is regularly ordered from a vendor. These records are used
to manage the inventory and to support the inventory in the general ledges.
(b) Recording report file. This is a transaction file of receiving report documents.
physically, the reserving reports is often a duplicate copy of the purchase order
document. Therefore, a typical receiving report would comprise a heeder section-
containing the same information as a purchase order header-and one or more receiving
report lines-showing each item's identification card, description, quantity ordered
(unless the bylined copy was used), quantity received, and data received.

(c) Cash disbursements transaction file. the purchase of this file to show in chronological
sequence the details of each cash payment made. Accordingly each record in this file
normally would show the date the payment is recorded, vendor identification,
disbursement voucher number (if the voucher system is used), vendor invoice number
and gross invoice amount, cash discount taken on each invoice, net invoice amount,
check amount and check number.

The payroll system, as you might guess, has need for its own files. The employee/payroll
master file contains employee identification data as well as data used for the computation of
employee paychecks. Employee payroll records are keyed by an employee identification code.
The employee code can be designed so as to reflect certain employee attributes, such as
departments, factory and positions. Such code numbers can be used to provide management
with labor-cost distribution.

5.5 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS

1. B. 2. D. 3. C. 4. B. 5. A.

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