CHAPTER 9 SUMMARY

 Introduction to Expenditure Processes. When a purchase occurs, the information resulting from
that purchase must flow into the purchase recording systems, the accounts payable and cash
disbursement systems, and the inventory tracking systems. In IT accounting systems, these
recording and processing systems are called Transaction Processing Systems (TPS). Thus, there is a
set of processes within the company to conduct purchases and route purchasing information, and
there is a TPS within the IT system to record, summarize and report these purchase transactions.
The most common expenditures processes include: (1) prepare a purchase requisition and/or
purchase order for goods or services needed; (2) notify the vendor (supplier) of goods or services
needed; (3) receive goods or services, often via common carrier. A common carrier is a trucking, rail,
or air freight company.; (4) record the payable.; (5) pay the resulting invoice; (6) update the records
affected, such as accounts payable, cash, inventory and expenses.
 Purchase Processes. When a purchase is initiated, the appropriate purchase requisition form should
be prepared to document the need and request that the specific items and quantities be purchased.
A purchase requisition must then be authorized by a designated member of management. A
purchase order is prepared and it is the document issued to a seller by a buyer that indicates the
products, quantities, and agreed prices for products or services that the seller will provide to the
buyer. In manual systems, purchasing department personnel record the transaction in a purchases
journal, which is a chronological listing of all POs issued to vendors. As goods are received, they
should be counted and inspected by company personnel in the receiving area. A blind purchase
order copy includes information from the PO, but it omits data about the price and quantity of the
item(s) ordered. With a blind PO, the receiving clerk can make sure that the receipt represents a
valid PO, yet it still forces the performance of an independent check of the quantity and quality of
the delivery. A copy of the vendor’s bill of lading typically accompanies goods received from the
common carrier. The packing slip is intended to show quantities and descriptions of items included in
the shipment, but it does not generally include prices. A receiving report is then prepared by the
receiving clerk, detailing the contents and condition of the receipt. A receiving log should also be
maintained as a sequential listing of all receipts. The liability and the inventory receipt must be
recorded in the same period as the physical receipt of goods. If goods have arrived but the related
invoice is still outstanding at the end of the period, the accounts payable department should
determine (or estimate) the amount owed to the vendor in order to accrue the liability and
recognize the receipt of these inventory items in the proper period. The accounts payable
department will ensure that the correct vendor account is immediately adjusted for each purchase
transaction so that the company will know the correct amount owed to the vendor. An accounts
payable subsidiary ledger includes the detail of amounts owed to each vendor.
 Controls and Risks in Purchase Processes.
o Authorization of Transactions. The company should establish specific procedures to ensure that
POs have been properly authorized before the order is officially placed with a vendor. No
purchasing events should begin until the initial authorization occurs. In most organizations, the
approval of a purchase requisition is the initial approval that triggers the remaining purchase
processes. A company should have established guidelines for managing vendor relationships,
including securing competitive bids for purchase requisitions, negotiating payment terms, and
maintaining current price lists.

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Segregation of Duties. Authorization, record keeping and custody should be segregated. The
authority function includes approval of purchase transactions and certain information systems
tasks such as data entry, programming, IT operations and security. The custody function includes
inventory handling and receiving, as well as the related cash disbursement duties. The record
keeping function includes preparation of POs, as well as the general accounting reports such as
the purchases journals, the accounts payable subsidiary ledger, the inventory ledger, the general
ledger and financial statements. Ideal internal controls involve complete separation of inventory
custody from inventory accounting.
o Adequate Records and Documents. Files should be maintained for purchase requisitions, POs,
receiving reports, invoices, etc. These files should be organized either in chronological order by
due date, in numerical sequence by form number or inventory item number, or in alphabetical
order by vendor name.
o Security of Assets And Documents. Purchasing records and programs must be protected from
unauthorized access through the use of electronic controls, such as passwords, and physical
controls, such as locked storage cabinets. Physical controls should also be used in the company’s
storage warehouse and receiving area, in order to protect the items from theft.
o Independent Checks and Reconciliations. Periodic physical inventory counts should be
reconciled with the inventory ledger and general ledger control account to make sure inventory
is being properly accounted for. Independent reconciliation of the accounts payable subsidiary
ledger to the general ledger control account also helps ensure that transactions have been
properly posted
o Cost/Benefit Considerations. The company should evaluate risks prevalent in its system before
determining the mix of controls to execute.
 Purchase Return Processes. A company must have specific procedures in place for handling its
returns to a vendor. Once rejected goods are identified, management approval must be obtained in
order to formally make the decision to return the purchase. A debit memo should then be prepared.
A debit memo is the document that identifies the items being returned, along with relevant
information regarding vendor, quantity and price. After the debit memo is prepared, the goods can
be physically returned to the vendor. At that point, the company should prepare a record of the
return shipment, and keep a record of all shipping activity, whether it is related to sales or purchase
return transactions. It is also necessary to update inventory records so that the returned goods are
no longer recorded as company assets. Finally, the company will receive a refund or credit from the
vendor for the returned goods, and record the cash or credit.
 Risks and Controls In Purchase Return Processes.
o Authorization of Transactions. Special authorization should be required to officially reject and
return the items and initiate the preparation of a debit memo. All debit memos must be
approved by a member of management or other designated individual before the goods are
physically returned to the vendor.
o Segregation of Duties. The employee who prepares the debit memos should not also be
responsible for performing duties in the custody or authorization functions, including handling
inventory or cash, and approving purchases or return transactions.
o Adequate Records and Documents. Debit memos must include thorough descriptions regarding
the items being returned, including quantities and prices, as well as reference to the original
purchase invoice. Debit memos should include thorough descriptions regarding the items being
returned and should be issued in numerical sequence. Debit memos should be filed along with
supporting documentation such as the original purchase records. They should also be matched
with the refund or credit documentation received from the vendor.

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 oSecurity of Assets and Documents. Accounts payable records and data files should be restricted
to those specifically authorized to approve or record the related purchase return. Custody of the
returned goods should be controlled and limited to those in the shipping function or others
specifically designated to handle the goods.
o Independent Checks and Reconciliations. Controls must exist to check for possible unrecorded
purchase returns. Physical inventory counts can help detect unrecorded returns. Also, someone
independent of the accounting function should review supporting documents to verify that debit
memos represent actual returns.
o Cost/Benefit Considerations. Certain exposures may exist within a company that may warrant
the need to implement more extensive internal control procedures. A company should evaluate
whether the benefits achieved from its internal controls are worthwhile, given the related risks
and costs of implementation. A company might also consider the need for extensive internal
controls related to the purchase returns process when it processes a large volume of debit
memos.
 Cash Disbursement Processes. The accounts payable department is generally responsible for
notification of the need to make cash disbursements. In accounts payable, the purchase order,
receiving report, and invoice must be matched to make sure that a valid order was placed, the goods
were received in good condition, and that the vendor billed the correct quantities and prices. No
payments should be made until the documents are properly matched. If the files are arranged
chronologically, the system should consider any accelerated due dates caused by discounts. The
cash disbursements department must be notified so it can make the payment by the discount date.
When an invoice is due for payment, accounts payable personnel will retrieve the invoice from the
file and forward it to the cash disbursements department for preparation of the check detail.
Supporting documentation should be attached, including a copy of the PO and receiving report. The
checks usually include a check stub, or remittance advice. A cash disbursements clerk prepares
checks, the responsibility for signing the check is reserved for members of management. Once a
payment is made, the related invoice should be canceled to indicate that it has been paid.
 Controls and Risks in Cash Disbursement Processes.
o Authorization of Transactions. Only the accounts payable department should authorize the
processing of a cash disbursement transaction, based on the need to satisfy a vendor obligation.
In addition, designated members of management should be responsible for authorizing the
actual payments, through the use of their signatures on the face of the check. This means that
only one or a few people should have check-signing authority. Many companies establish special
cash disbursement authorization policies and procedures applicable to large checks whereby a
dual signature requirement is in place for checks over a specified dollar amount.
o Segregation of Duties. Purchasing, receiving, accounts payable, and cash disbursements
functions should be segregated. Cash disbursements department personnel should not have
check-signing authority and should not have access to the cash account or to the company’s
accounts payable records. In addition, information systems operations and programming related
to the cash disbursements and accounts payable departments should be separate from those
having responsibility for custody, authorization, or record keeping within those functions
o Adequate Records and Documents. An accounts payable subsidiary ledger and a cash
disbursements journal are fundamental records in the cash disbursements process. Also, the
practice of issuing checks on pre-numbered forms creates a record of the sequence of
transactions.
o Security of Assets and Documents. Access to cash should be limited to the authorized check
signers. Physical controls should be in place in the areas where cash is retained and disbursed.

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 Similarly, the company’s stock of unused checks should be protected and controlled. Access to
the records should be limited to designated persons within the accounts payable and cash
disbursements functions.
o Independent Checks and Reconciliations. The cash disbursements journal and accounts payable
subsidiary ledger should be reconciled to the general ledger control accounts on a regular basis.
Also, someone separate from the cash disbursements and accounts payable functions should be
responsible for reconciliation of the bank statement on a monthly basis.
o Cost/Benefit Considerations. When a company processes a large volume of cash
disbursements, it should consider the implementation of internal control procedures to ensure
the accuracy of those transactions. Some other considerations for increased controls include the
existence of complex vendor arrangements or discount terms, decentralized or widely dispersed
cash disbursements, cash disbursements via currency (rather than by check), high volumes of
purchase returns, or cash disbursements denominated in foreign currencies.
 IT Systems of Expenditure and Cash Disbursement Processes.
o Computer Based Matching. Automated matching is a computer software system in which the
computer software matches an invoice to its related purchase order and receiving report. The
system will not approve an invoice for payment unless the items and quantities match with the
packing slip, and the prices match the purchase order prices. This ensures that the vendor has
billed for the correct items, quantities, and prices. During the matching process, the system will
also check for mathematical errors and ensure that there are no previous payments that would
make this payment a duplicate payment. This automated matching system can reduce time,
costs, errors, and duplicate payments in invoice processing. These improvements over manual
matching can decrease the amount of time required to enter invoices and therefore give
management more timely information to forecast future cash outflows for payment of invoices.
In addition, the system can summarize detailed transactions into summary amounts that are
posted to general ledger accounts. Unauthorized access to the system increases the danger of
fraudulent or fictitious payments. Errors in system logic can cause systematic and repetitive
errors in matching. In simpler terms, if the system mistakenly matches documents, it will
mistakenly match documents repetitively. Any system break downs or interruptions can stop or
slow the processing of invoices and payments. Extreme delays in paying invoices could lead to
lost discounts, late fees, interest charges, or loss of a vendor.
o Evaluated Receipt Settlement. ERS is an invoice-less match in which a comparison takes place
by matching the purchase order to the goods received. If the PO matches the goods, payment is
made to the vendor. This eliminates the need for the vendor to send an invoice, since payment
is approved as soon goods are received (when they match a purchase order). If there is no
matching purchase order, the goods are refused and returned to the vendor. If there is a
matching purchase order, receiving employees enter a receiving record into the online database
and payment is processed based on the payment terms previously negotiated with the vendor.
The receiving procedures must be established to ensure that goods are only accepted when part
numbers and quantities match exactly. There is no reconciliation process later for substitutions,
overshipments, or partial shipments. Thus an organization that wishes to institute an invoice-
less matching process must also establish close working relationships with vendors and
negotiate firm prices prior to ordering. It is necessary to have authentication controls in order to
prevent unauthorized access to purchase-related files and to prevent fraudulent or fictitious
vendor payments. Errors in system logic can lead to repetitive errors in authorizing payments. A
system interruption or slowdown can halt all receiving activity

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E-Business and Electronic Data Interchange (EDI) Systems and The Risks and Controls.
Electronic exchange of transaction information is much the same for the buyer and seller. The
use of electronic links between buyer and seller cause risks of unauthorized access and hacking
or other network break-ins. Therefore it is important that all users, including trading partners
such as vendors, be authenticated when they access the system or records. Data entered by the
vendor, or transmitted by the vendor should be subject to input validation controls to ensure the
accuracy and completeness of the data. Interruptions to the system can cause critical problems
for companies that purchase and pay electronically.
o E-Payables. The newest technologies related to invoicing and payables are generally referred to
as e-payables. However, a more specific name for these electronic invoicing and payment
systems is Electronic Invoice Presentment and Payment or EIPP. Most EIPP systems take
advantage of the connectivity of the Internet to electronically send invoices or payments. This
means that an accounts payable process in an organization could receive invoices electronically
via the Internet, and make payment via the Internet.
o Procurement Cards. Procurement cards, often called p-cards, are credit cards that the
organization gives to certain employees to make designated purchases. These procurement
cards are normally not used to purchase raw materials or products, but are used for small dollar
amount purchases such as supplies or maintenance, and to pay for travel and entertainment
expenses. Using a procurement card can eliminate much time and cost associated with this
processing of small dollar purchases.
 Ethical Issues Related to Expenditure Processes. In expenditure processes, all ethical problems
cannot be completely eliminated, but management can reduce the chances of expenditure fraud or
ethics violations by maintaining good internal controls and enforcing ethical conduct. Policies such
as accepting only valid original receipts of travel would have helped prevent the duplicate travel
expense fraud. Employees and those who conduct business with the organization are also harmed
when changes (such as failure to grant pay raises and increased sales prices) are implemented in
efforts to recover losses from fraud. It is important to establish internal control policies and IT
controls to help prevent or detect such fraud, ethical lapses, or errors.
 Corporate Governance iIn Expenditure Processes. The functions within corporate governance are
management oversight, internal controls and compliance, financial stewardship, and ethical conduct.
While corporate governance is important for all business processes, it is particularly necessary in the
expenditure processes. Funds expended by an organization do not belong to managers. Managers
are stewards, or temporary managers of those funds. Corporate governance policy and procedures
must be in place to insure that funds are expended only to benefit the organization and its owners;
not to benefit the managers or employees personally. The systems, processes, and internal controls
described in this chapter are part of the corporate governance structure. When top management
acts ethically and encourages ethical behavior throughout the organization, stronger corporate
governance is the result.

53. (SO 2,3,4) Identify an internal control procedure that would reduce the
following risks in a manual
system:
a. The purchasing department may not be notified when goods need to be purchased.
Require that an inventory control department monitor inventory records and request purchases
(purchase requisition) when goods need to be reordered.
b. Accounts payable may not be updated for items received. Require that the receiving

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 department complete a receiving report for all goods received, and that a copy of the report is
forwarded to accounts payable.
c. Purchase orders may be prepared based on unauthorized requisitions. Require that the
appropriate manager approve each purchase requisition by signing the requisition form.

d. Receiving clerks may steal purchased goods. Require good physical security such as security
cameras and good supervision of receiving employees. Using a “blind” PO at receiving may also
help since constant shortages when goods are stolen is more likely to be noticed.

e. Payments may be made for items not received. Require a three-way match of the purchase
order, receiving report, and invoice before a payment can be approved.

f. Amounts paid may be applied to the wrong vendor account. Assuming that the payment was to
the correct vendor, but posted to the wrong account, it is very difficult to uncover this error. A
reconciliation of subsidiary ledge to the accounts payable account may not uncover this because
the total balance would be the same. It may be uncovered if someone notices that the records
show payments to a vendor are in excess of that owed. There is no method to completely
eliminate errors in posting.
g. Payments may be made for items previously returned. Require a debit memorandum be
completed for any goods returned, and that a copy of this be forwarded to accounts payable so
that the balance owed can be changed.
h. Receiving clerks may accept delivery of goods in excess of quantities ordered. First, there must
be a clear policy on overshipments that receiving personnel can apply. For example, a policy
may be written that overshipments under 5% can be accepted, but all others should be rejected
and returned. Second, there must be a policy that all received goods are compared against a
purchase order. Also, the use a “blind” PO to force receiving personnel to count goods and they
might therefore more easily detect overshipments.
i. Duplicate payments may be issued for a single purchase transaction. Require that payment
documentation be “cancelled’ when payment is made. This stamp on the documents should
help prevent duplicate payments.

54. (SO 2,3,4,5,6) Identify an internal control procedure that would reduce the
following risks in an automated fully integrated ERP systems such as Microsoft
Dynamics GP:
a. The purchasing department may not be notified when goods need to be purchased. In ERP
systems, the inventory records are integrated so that the purchasing department is automatically
notified when reorder points are reached.
b. Accounts payable may not be updated for items received. In ERP systems, receiving reports are
completed online so that the accounts payable records can be updated immediately.
c. Purchase orders may be prepared on the basis of unauthorized requisitions. In ERP systems, POs
require the electronic approval of the purchasing supervisor before the purchase can go forward.

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 d. Receiving clerks may steal purchased goods. In ERP systems, an electronic invoice from a vendor
would detect and signal the likely theft if there was not a match to a receiving report.
e. Payments may be made for items not received. Because of the automated matching of the PO,
receiving report, and vendor invoice, a payment would not be authorized if a receiving report was
not present.
f. Amounts paid may be applied to the wrong vendor account. Because of the integrated ERP
systems, vendors will not be misidentified.
g. Payments may be made for items previously returned. Because of the integrated ERP systems,
returns are automatically noted in the system so the invoice will be canceled.
h. Receiving clerks may accept delivery of goods in excess of quantities ordered. Because the
receiving report is completed online, it will be automatically and compared with the PO so that
discrepancies can be identified immediately.
i. Duplicate payments may be issued for a single purchase transaction. Because the vendor’s invoice
and cash disbursement are maintained online in an integrated system, the invoice will be canceled
once payment is made. This will prevent a duplicate payment.
j. The accounts payable clerk makes a check out to himself (assume the company utilizes automated
check signing functionality). Because the cash disbursements system is maintained online and
integrated with the accounts payable system, a payment cannot be made to an unauthorized party.

59.(SO 2,4) The following list presents statements regarding the expenditure processes. Each
statement is separate and should be considered to be from a separate company. For each statement,
determine whether it is an internal control strength or weakness, then describe why it is a strength or
weakness. If it is an internal control weakness, provide a method or methods to improve the internal
control.
a. A purchasing agent updates the inventory subsidiary ledger when an order is placed. This is an
internal control weakness. The purchasing agent is part of the authorization of orders. Therefore, he/she
should not have record keeping duties for those purchases. If one person has both duties, unauthorized
purchases can be initiated and records can be altered to cover up these unauthorized purchases. These
duties should be segregated and someone who does not authorize and does not have custody of
purchases should be assigned to the record keeping.

b. An employee in accounts payable maintains the accounts payable subsidiary ledger. This is an
internal control strength. The payable should be recorded when the invoice arrives and it matches a
purchase order and receiving report.

c. Purchasing agents purchase items only if they have received an approved purchase requisition. This
is an internal control strength. The purchasing agents cannot initiate purchases without proper approval
from a separate department or person.

d. The receiving dock employee counts and inspects goods and prepares a receiving document that is
forwarded to accounts payable. This is an internal control strength. The counting and inspecting of

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 goods ensures that goods are not damaged and that the proper amount was received. This count and
inspection prevents companies from paying full price for damaged goods or missing goods.
e. The receiving dock employee compares the packing list to the goods received and if they match,
forwards the packing list to accounts payable. This is an internal control weakness. Goods should not be
compared to the packing list, they should be compared to the purchase order. A comparison to the
packing list will not reveal any undershipments, overshipments, or product substitutions. The
improvement would be to compare the goods received to the purchase order and forward a receiving
report, not the packing list, to accounts payable.

f. An employee in accounts payable matches an invoice to a receiving report before approving a

payment of the invoice. This is an internal control weakness because there is one more document that
should be matched. The purchase order should also be matched to the invoice and receiving report.

g. A check is prepared in the accounts payable department when the invoice is received. This
represents two internal control weaknesses: 1) There is no document matching mentioned (PO, invoice,
and receiving report); 2) Accounts payable should authorize the payment, but should not write the
check. The matched documents should be forwarded to cash disbursements, and the check should be
prepared by cash disbursements.

64. (SO 8) Koler Manufacturing Company and EDI Controls. Required: Describe the IT controls
that Koler should include when it implements an internet EDI system. For each control you
suggest, describe the intended purpose of the control.

Since Koler will be sending data electronically using a computer system, there are many general and
application controls that should be a part of this IT system. Koler may not be able to afford all of the
general controls mentioned below, but they should implement as many as are cost effective. General
controls include: user IDs, passwords, log-in procedures, access levels, authority tables, firewalls,
encryption of data, vulnerability assessment, penetration testing, intrusion detection, software testing,
and computer logs, These general controls limit unauthorized access to the IT system. To help prevent
availability risks, general controls such as business continuity planning, backup data and backup systems,
firewalls, encryption of data, vulnerability assessment, intrusion detection, and penetration testing. The
purchasing software and the EDI translation software should also incorporate application input controls
such as field check, validity check, limit check, and reasonableness check.

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