CH 13 THE EXPENDITURE

CYCLE
expenditure cycle - A recurring set of business activities
and related data processing operations associated with the
purchase of and payment for goods and services
primary external exchange of information: suppliers
(vendors).
- information about the need to purchase goods and materials flows to the expenditure cycle from the revenue and
production cycles, inventory control, and various departments.
- Expense data also flow from the expenditure cycle to the general ledger and reporting function for inclusion in financial
statements and various management reports
primary objective: minimize the total cost of acquiring and maintaining
inventories, supplies, and the various services the organization needs to
function.
- To accomplish this objective, management must make the following key
decisions:
o What is the optimal level of inventory and supplies to carry?
o Which suppliers provide the best quality and service at the
best prices?
o How can the organization consolidate purchases across units
to obtain optimal prices?
o How can information technology (IT) be used to improve both
the efficiency and accuracy of the inbound logistics function?
o How can the organization maintain sufficient cash to take
advantage of any discounts suppliers offer?
o How can payments to vendors be managed to maximize cash
flow
four basic expenditure cycle activities:
1. Ordering materials, supplies, and services
2. Receiving materials, supplies, and services
3. Approving supplier invoices
4. Cash disbursements

EXPENDITURE CYCLE INFORMATION

SYSTEM
PROCESS
AOE uses an enterprise resource planning (ERP) system.
- AOE’s inventory control department has primary
responsibility for ensuring an adequate quantity of
materials and supplies, any department can submit a
request to purchase items
1. purchase request has been approved, the system searches the inventory master file to identify the preferred supplier
2. system creates a purchase order sent to the supplier via EDI. (If necessary, paper copies are printed and mailed.)
3. receiving department access the open purchase order file to plan for and verify the validity of deliveries
4. Accounts payable is notified of orders so that it can plan for pending financial commitments.
- The department that generated the purchase requisition is also notified that its request has been approved
5. Major suppliers send electronic notification of coming deliveries
- enables AOE to plan to have adequate staffing to process incoming shipments at its warehouses.
6. When a shipment arrives, the receiving-dock workers use the inquiry processing system to verify that an order is expected
from that supplier.
- Most suppliers bar-code or RFID (radio frequency identification) tag their products to facilitate the counting of the goods.
7. Receiving-dock workers inspect the goods and use an online terminal to enter information about the quantity and condition
of items received.
 - The system checks that data against the open purchase order, and any discrepancies are immediately displayed on the
screen so that they can be resolved.
- The exact time of the delivery also is recorded to help evaluate supplier performance.
8. Upon transfer of the goods to the warehouse, the inventory clerk verifies the count of items and enters that data system.
- For suppliers who do not send invoices, the system automatically schedules a payment according to the terms agreed
upon when the order was placed.
9. Accounts payable clerks enter information from suppliers who send EDI, and sometimes paper, invoices.
10. system then compares the supplier invoice with purchase order and receiving report to ensure accuracy and validity.
11. For

purchases of supplies or services that do not usually involve

purchase orders and receiving reports, the invoice is sent to the
appropriate supervisor for approval.
- The supplier invoice itself is also checked for mathematical
accuracy.
- The system automatically schedules invoices for payment by
due date.
12. AOE, like most companies, uses batch processing to pay its
suppliers.
- Each day, treasurer uses the inquiry processing system to
review the invoices that are due and approves them for
payment.
- AOE makes payments to some of its larger suppliers using
financial electronic data interchange (FEDI) but still prints
paper checks for many of its smaller suppliers.
13. electronic funds transfer (EFT) payment is authorized or a
check is printed, the system updates the accounts payable,
open-invoice, and general ledger files.
- For each supplier, the totals of all vouchers are summed, and that amount is subtracted from the balance field in that
supplier’s master file record.
14. The relevant purchase orders and receiving reports are flagged to mark that those transactions have been paid.
- The invoices that are paid are then deleted from the open-invoice file.
15. A remittance advice is prepared for each supplier, which lists each invoice being paid and the amounts of any discounts or
allowances taken.
- For payments made by EFT, the remittance data accompany the EFT payment as part of the FEDI package.
- For payments made by check, the printed remittance advice accompanies the signed check.
16. After all disbursement transactions have been processed, the system generates a summary journal entry and posts to the
general ledger.
17. The cashier reviews checks against the supporting documents and then signs them.
18. Checks above a specified amount also require a second signature by the treasurer or another authorized manager.
19. The cashier then mails the signed checks and remittance advices to the suppliers. EFT transactions are also performed by the
cashier and reviewed by the treasurer.

Threats and Controls

(1) Inaccurate or invalid master data.
 Errors in the supplier master data could result in ordering from unapproved suppliers, purchasing materials
of inferior quality, untimely deliveries, sending payments to the wrong address, and fraudulent
disbursements to fictitious suppliers.
 Errors in the inventory master data can result in production delays due to unanticipated shortages of key
materials or unnecessary purchases and excess inventory.
 Errors in the purchasing master data can result in unauthorized purchases and failure to take advantage of
negotiated discounts.
  Control:
a) use the various processing integrity controls (CH10) to minimize the risk of data input errors.
b) restrict access to expenditure cycle master data and configure the system so that only authorized
employees can make changes to master data
- changing the default configurations of employee roles in ERP systems to appropriately segregate
incompatible duties.
c) regularly produce a report of all changes to master data and review them to verify that the database
remains accurate
(2) Unauthorized disclosure of sensitive information
 banking information about suppliers and special pricing discounts offered by preferred suppliers.
 Control:
a) configure the system to employ strong access controls that limit who can view such information (limit
employees’ ability to use the system’s built-in query capabilities to access only those specific tables and
fields
b) sensitive data should be encrypted in storage to prevent IT employees who do not have access to the
ERP system from using operating system utilities to view sensitive information.
(3) loss or destruction of master data.
 Control:
a) employ the backup and disaster recovery procedures (CH10).
- A best practice is to implement the ERP system as three separate instances.
 Production - used to process daily activity.
 A second is used for testing and development.
 A third instance should be maintained as an online backup to the production system to provide
near real-time recovery
(4) Poor Performance.
 Control:
a) ERP system’s extensive reporting capabilities can be used to monitor the threat of poor performance
- key measure to evaluate inventory management is inventory turnover
b) Accurate master data enables management to better use an ERP system’s extensive reporting
capabilities to monitor performance

ORDERING MATERIALS, SUPPLIES, AND

SERVICES
Identifying What, When, and How Much to Purchase
PROCESS
economic order quantity (EOQ) - The optimal order size to minimize the sum
of ordering, carrying, and stockout costs
- traditional approach to managing inventory 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
 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 For high-cost or high-use items, (e.g., computer chips) ALL THREE TYPES of costs are included in the formula.
o For low-cost or low-usage items, (e.g., screws and Springs) ordering and carrying costs are usually ignored,
- the sole objective is to maintain sufficient inventory levels.
- The EOQ formula is used to calculate how much 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
- specifies when to order.
- 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 (MRP) - 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
just-in-time (JIT) inventory system - A system that minimizes or virtually eliminates inventories by purchasing and producing
goods only in response to actual, rather than forecasted, sales
- characterized by frequent deliveries of small amounts of materials, parts, and supplies directly to the specific locations that
require them when they are needed, rather than by infrequent bulk deliveries to a central receiving and storage facility

 major difference between MRP and JIT systems: production scheduling

MRP systems schedule production to meet forecasted sales,
thereby creating an “optimal” quantity of finished goods
inventory.
JIT systems schedule production in response to customer
demands, thereby virtually eliminating finished goods
inventory, but they require carrying sufficient quantities of
raw materials in order to quickly adjust production in
response to consumer demand.

 Both MRP and JIT systems can reduce costs and improve efficiency
MRP systems are more effectively used with products that JIT inventory systems are especially useful for products
have predictable patterns of demand, such as consumer that have relatively short life cycles and for which demand
staples. cannot be accurately predicted, such as toys associated with
specific movies.

- able to quickly speed up production to meet unanticipated

demand as well as to quickly stop production for product
no longer in demand

 A request to purchase goods or supplies is triggered either by the inventory control function or when employees notice a
shortage of materials
o purchase requisition - A document or electronic form that identifies the requisitioner; specifies the delivery
location and date needed; identifies the item numbers, descriptions, quantity, and price of each item requested;
and may suggest a supplier
Threats and Controls
(5) Inaccurate inventory records
(1) stockouts that lead to lost sales or to carrying excess inventory that increases cost negatively affect customer
perception
 Control:
a) perpetual inventory method should be used to ensure that information about inventory stocks is always
current
b) information technology - eliminate the need for manual data entry can improve the accuracy of
perpetual inventory records
(6) purchasing items that are not currently needed
 Control:
a) Accurate perpetual inventory record - ensure the validity of purchase requisitions that the inventory
control system automatically generates
b) Supervisors need to review and approve purchase requisitions
c) centralized purchasing function
Choosing Suppliers
PROCESS
 Several factors should be considered when selecting suppliers:
+ Price
- costs associated with supplier delivery performance
+ Quality of materials
- Companies incur costs, such as rework and scrap, related to the quality of the products purchased.
+ Dependability in making deliveries
- especially important for companies that use JIT systems because late deliveries can bring the entire system to
a halt.
purchase order - A document that formally requests a supplier to sell and deliver specified products at designated prices.
- It is also a promise to pay and becomes a contract once the supplier accepts it
- includes the names of the supplier and purchasing agent, the order and requested delivery dates, the delivery
location and shipping method, and information about the items ordered
blanket purchase order or blanket order - A commitment to purchase specified items at designated prices from a particular
supplier for a set time period, often one year.
- reduce the buyer’s uncertainty about reliable sources of raw materials and help the supplier plan its capacity
and operations more effectively.
 major cost driver in the purchasing function is the number of purchase orders processed.
- EDI reduces costs by eliminating the clerical work associated with printing and mailing paper documents.
o vendor-managed inventory (VMI) - Practice in which manufacturers and distributors manage a retail customer’s
inventory using EDI. The supplier accesses its customer’s point-of-sale system in order to monitor inventory
and automatically replenish products when they fall to agreed-upon levels
- Reverse auctions - suppliers compete with one another to meet demand at the lowest price expenses
- best suited to the purchase of commodity item
- Pre-award audits – internal auditor visits each potential supplier who has made the final cut in the contracting process to
verify the accuracy of its bid
 - typically used for large purchases that involve formal bids by suppliers.
Threats and Controls
(7) purchasing items at inflated price
 Control:
a) Price lists for frequently purchased items should be stored in the computer and consulted when orders are
made
b) Competitive, written bids should be solicited for high-cost and specialized products
c) Purchase orders should be reviewed
d) Budgets - Actual costs should be compared periodically with budget allowances.
(8) purchasing inferior-quality products.
 Substandard products can result in costly production delays.
 Control:
a) establish lists of approved suppliers known to provide goods of acceptable quality
b) Purchase orders should be reviewed to ensure that only these approved suppliers are being used
c) accounting information system should collect detailed product quality data
d) purchasing managers should be held accountable for the total cost of purchases
(9) unreliable performance by suppliers
 Control:
a) require that suppliers be certified as meeting international quality standards such as ISO 9000.
b) capture and track information about supplier performance
(10) Purchasing from unauthorized suppliers
 Control:
a) ERP systems should be configured to prevent issuing purchase orders to suppliers not in the approved
master file
b) All purchase orders should be reviewed to ensure that only approved suppliers are used

Numerous policy-related threats also arise with EDI. Examples of these types of issues include the following:
 At what point in the process can the order be canceled?
 Which party is responsible for the cost of return freight if contract terms are not followed?
Which party is responsible for errors in bar codes, RFID tags, and labels?
 What happens if errors in the purchasing company’s sales system cause additional errors in the amount of goods that
suppliers provide?
 Can suppliers ship more inventory than ordered if doing so reduces total freight costs because it results in a full,
rather than partial, truckload
(11) kickbacks - Gifts given by suppliers to purchasing agents for the purpose of influencing their choice of suppliers
 Control:
a) companies should prohibit purchasing agents from accepting any gifts
b) Job rotation - Purchasing agents should not deal with the same suppliers indefinitely
c) Purchasing agents should be required to sign annual conflict of interest statements
d) supplier audit
RECEIVING
PROCESS
- When a delivery arrives, a receiving clerk compares the purchase order
number referenced on the supplier’s packing slip with the open purchase
order file to verify that the goods were ordered.
- The receiving clerk then counts the quantity of goods delivered.
receiving report - A document that records details about each delivery, including
the date received, shipper, supplier, quantity received.
three possible exceptions to this process:
1. receiving a quantity of goods different from the amount ordered
2. receiving damaged goods,
3. receiving goods of inferior quality that fail inspection
debit memo - A document used to record a reduction to the balance due to a supplier
- accounts payable department is notified and adjusts the account balance owed to that supplier
- A copy of the debit memo accompanies the goods to the shipping department to authorize their return to the supplier.
To improve the efficiency of counting and recording inventory deliveries is to require suppliers to barcode or affix RFID tags to their
products
Threats and Controls
(12) Accepting delivery of unordered goods
 Control:
a) instruct the receiving department to accept only deliveries for which there is an approved purchase
order
(13) making mistakes in counting items receive
 Control:
 a) design the inquiry processing system so that when reviewing open purchase orders, receiving-dock
workers do not see the quantity ordered
- (If paper documents are still used, the quantity-ordered field is blacked out on the receiving
department’s copy of the purchase order.)
b) require receiving clerks not only to record the quantity received but also to sign the receiving report or
enter their employee ID numbers in the system
c) offer bonuses
d) use of bar codes and RFID tags
e) ERP system should be configured to automatically flag discrepancies between receiving counts and order
quantities that exceed a predetermined tolerance level so that they can be promptly investigated
(14) establishing that the services were actually performed
 Control:
a) Actual versus budgeted expenses should be routinely compared and any discrepancies investigated
- hold the appropriate supervisor accountable for all such costs incurred by that department.
b) internal audit function to periodically conduct detailed reviews of contracts for services
(15) Theft of inventory
 Control:
a) inventories should be stored in secure locations with restricted access
b) all transfers of inventory within the company should be documented
- documentation provides the necessary information for establishing accountability for any shortages,
thereby encouraging employees to take special care to record all inventory movements accurately
c) periodically count the inventory on hand and to reconcile those counts with the inventory
d) proper segregation of duties

APPROVING SUPPLIER INVOICES

PROCESS:
- accounts payable department approves supplier invoices for payment.
- A legal obligation to pay suppliers arises at the time goods
are received.
voucher package - The set of documents used to authorize payment
to a supplier.
- It consists of a purchase order, receiving report,
and supplier invoice.
nonvoucher system - A method for processing accounts payable in
which each approved invoice is posted to individual supplier
records in the accounts payable file and is then stored in an open
invoice file.
- Contrast with voucher system
voucher system - A method for processing accounts payable in which
a disbursement voucher is prepared instead of posting invoices
directly to supplier records in the accounts payable subsidiary ledger.
Contrast with non-voucher system.
- disbursement voucher - A document that
identifies the supplier, lists the outstanding
invoices, and indicates the net amount to be paid
after deducting any applicable discounts and
allowances.

Voucher systems offer three advantages over nonvoucher systems.

1. reduce the number of checks that need to be written, because several invoices may be included on one disbursement
voucher
2. it can be prenumbered to simplify tracking all payables
3. facilitates separating the time of invoice approval from the time of invoice payment

evaluated receipt settlement (ERS) - An invoiceless approach to accounts payable that replaces the three-way matching process
(supplier invoice, receiving report, and purchase order) with a two-way match of the purchase order and receiving report

Noninventory purchases for supplies provide perhaps the biggest opportunity to improve the efficiency of accounts payable and
cash disbursements

procurement card - A corporate credit card that employee scan use only at designated suppliers to purchase specific kinds of
items
- simplify accounts payable because the company receives one monthly statement (one time payment) that
summarizes noninventory purchases by account category
Threats and Controls
(16) errors on supplier invoices
  discrepancies between quoted and actual prices charged or miscalculations of the total amount due.
 Control:
a) mathematical accuracy of supplier invoices must be verified
b) For procurement card purchases, users should be required to keep receipts
c) ERS approach - eliminates the potential for errors in supplier invoices because companies pay by
matching counts of what they receive with prices quoted when the goods were ordered
d) control access to the supplier master file
e) internal audit periodically verify the accuracy of freight bills and invoices to ensure that the company is
not being charged for transportation costs that the supplier is supposed to pay
(17) Mistakes in recording and posting payments to suppliers
 additional errors in financial and performance reports that, in turn, can contribute to poor decision making.
 Control:
a) data entry and processing controls (CH10)
b) total of all supplier account balances (or unpaid vouchers) also should be reconciled periodically with
the amount of the accounts payable control account in the general ledger
CASH DISBURSEMENT
PROCESS:
- cashier, who reports to the treasurer, is responsible for paying suppliers.
o This segregates the custody function, performed by the cashier, from the authorization and recording functions,
performed by the purchasing and accounts payable departments, respectively.
- Payments are made when accounts payable sends the cashier a voucher package. Although many payments continue to
be made by check, the use of EFT and FEDI is increasing.
Threats and Controls
(18) Failing to take advantage of purchase discounts for prompt payment.
 Controls:
a) Approved invoices should be filed by due date, and the system should be designed to track invoice due
dates and print a periodic list of all outstanding invoices batch total.
b) cash flow budget that indicates expected cash inflows and outstanding commitments also can help
companies plan to utilize available purchase discounts

(19) paying for goods not received.

 Controls:
a) Inventory control department to verify the quantities on the receiving report before it can be used to
support payment of a supplier invoice
b) budgetary controls and careful review of departmental expenses
c) require employees to submit additional evidence, such as a conference agenda that identifies attendees, to
prove that they actually took a trip
d) require all employees to use corporate credit cards for travel
(20) Duplicate payments
 Controls:
a) invoices should be approved for payment only when accompanied by a complete voucher package
(purchase order and receiving report)
b) only the original copy of an invoice should be paid
c) the invoice and the voucher package should be canceled (marked “paid”) in a manner that would
prevent their resubmission
(21) theft or misappropriation of fund
 Controls:
a) access to cash, blank checks, and the check-signing machine should be restricted
b) Checks should be sequentially numbered and periodically accounted for by cashier
c) Strict access controls over all outgoing EFT transactions
- Passwords and user IDs should be used to specifically identify and monitor each employee
authorized to initiate EFT transactions.
- embedded audit modules, can be designed into the system to monitor all transactions and identify
any that possess specific characteristics.
d) designate a specific computer to be used for online banking
- Online banking transactions require constant monitoring
e) Consider placing Automated Clearing House (ACH) blocks, which instruct banks to not allow ACH
debits (outflows) from specific accounts.
f) Proper segregation of duties
g) Checks in excess of a certain amount, such as $5,000 to $10,000, should require two signatures
h) someone who did not participate in processing either cash collections or disbursements should reconcile
all bank accounts
i) Access to the approved supplier list should be restricted
j) restrict the ability to create one-time suppliers
k) petty cash fund managed by an employee who has no other cash-handling or accounting responsibilities
 - imprest fund - A cash account with two characteristics:
(1) It is set at a fixed amount, such as $100; and
(2) vouchers are required for every disbursement. At all times, the sum of cash plus
vouchers should equal the preset fund balance
l) internal auditor make periodic unannounced counts of the fund balance and vouchers and by holding the
person in charge of the petty cash fund accountable for any shortages discovered during those surprise
audits
(22) check alteration
 Controls:
a) Check-protection machines - reduce the risk of this threat by imprinting the amount in distinctive
colors, typically a combination of red and blue ink
b) Using special inks that change colors if altered and printing checks on special papers that contain
watermarks
c) Positive Pay involves sending a daily list of all legitimate checks to the bank, which will then clear only
checks appearing on that list
d) bank reconciliations
(23) cash flow problems
 Controls:
a) cash flow budget