Chapter 5

The Expenditure Cycle

Part I: Purchases and
Cash Disbursements
Procedures

Objectives for Chapter 5

Tasks that constitute the purchases and cash disbursement
process
Departments involved in purchases and cash disbursement
activities and the flow of these transactions through the
organization
Documents, journals, and accounts that provide audit trails,
promote the maintenance of records, and support decision
making and financial reporting
Exposures associated with purchase and cash disbursements
activities and the controls that reduce these risks
Operational features and the control implications of technology
used in purchases and cash disbursement systems

P u rc h a s e R e q u is itio n

P u rc h a s in g

2
PR O C U R EM EN T C Y C LE
(S U B S Y S T E M )

C a s h D is b u rs e m e n ts
5

A c c o u n ts P a y a b le
4

R e c e iv in g /
In s p e c tio n
3

Goals of the Expenditure Cycle

The goal of providing needed resources to organization
can be broken down into several objectives:

purchase from reliable vendors

purchase high quality items
obtain best possible price
purchase only items that are properly authorized
have resources available when they are needed
receive only those items ordered
ensure items are not lost, stolen,
or broken
pay for the items in a timely manner

DFD of Purchases System

A Manual Purchases System

The purchases cycle begins in the Inventory
Control department when inventory levels drop
to reorder levels.
A clerk prepares a purchase requisition and
sends copies to Purchasing and Accounts
Payable.
The Purchasing department prepares a
purchase order for each vendor and sends
copies to Inventory Control, Accounts Payable,
Receiving (blind copy), and the vendor.

A Manual Purchases System

Upon receipt of the goods, the Receiving
department counts and inspects the goods.
One of the purposes of the blind copy of the
purchase order is to force the workers to count
the goods.

A worker then prepares the receiving

report and sends copies to the raw
materials storeroom, Purchasing, Inventory
Control, and Accounts Payable.

A Manual Purchases System

The Accounts Payable department has now received
copies of the purchase requisition, purchase order,
and receiving report.
Upon receipt of the suppliers invoice, Accounts
Payable reconciles all documents, posts to the
purchases journal, and records the liability in the
accounts payable subsidiary ledger.
Periodically, the entries in the purchases journal are
summarized in a journal voucher which is sent to
the General Ledger department.

A Manual Purchases System

The journal voucher is prepared by
Accounts Payable and sent to the General
Ledger department:
Inv-Control or Purchases DR
Accts Payable-Control
CR
Accounts Payable also prepares a cash
disbursements voucher and posts it in the
voucher register.

A Manual Purchases System

The General Ledger department:
posts from the accounts payable
journal voucher to the general ledger
reconciles the inventory amount with
the account summary received from
inventory control

Manual Purchases System

DFD of Cash Disbursements System

Manual Cash Disbursements

System
Periodically, usually daily, Accounts
Payable searches the open vouchers
payable file for items with payments due:
AP sends the voucher and supporting
documents to Cash Disbursements
AP updates the accounts payable
subsidiary ledger

Manual Cash Disbursements

System
The Cash Disbursements department
prepares the check
records the information in a check register
(cash disbursements journal)
returns paid vouchers to accounts payable,
mails the check to the supplier
sends a journal voucher to General Ledger:
Accounts Payable DR
Cash
CR

Manual Cash Disbursements

System
The General Ledger department receives:
the journal voucher from cash
disbursements
a summary of the accounts payable
subsidiary ledger from Accounts Payable

The journal voucher is used to update the

general ledger.
The accounts payable control account is
reconciled with the subsidiary summary.

Cash Disbursements System

The Expenditure Cycle

The time lag splits the expenditure
transaction cycle into two phases:
physical phase (purchasing cycle)
financial phase (cash disbursements)

Expenditure Cycle Database

Master Files

Other Files

supplier (vendor) master file

accounts payable master file
merchandise inventory master
file

Transaction and Open

Document Files
purchase order file
open purchase order file
suppliers invoice file
open vouchers file
cash disbursements file

supplier reference and

history file
buyer file
accounts payable detail file

The Purchase Requisition

A need for an item starts the expenditure cycle
based on reorder point or reorder quantity
manual: to initiate a credit purchase, someone in the
organization recognizes a need for a good or service;
an authorized person requests the good or service
using a purchase requisition form
computerized: to initiate a credit purchase,
someone in the organization recognizes a need for a
good or service; an authorized person requests the
good or service using a terminal and a purchase
requisition screen

Computer-Based Expenditure
Applications--Purchases
Incorporates a data processing department which performs
many of the routine accounting tasks
purchasing - a computer program identifies inventory
requirements and can use one of the following methods for
authorizing and ordering inventories
the system prepares the POs and sends them to the
purchasing department for review, signing, and
distributing
the system distributes the POs directly to the vendors
and internal users, bypassing the purchasing
department
the system uses EDI and electronically places the order

Computer-Based Expenditure
Applications--Purchases
Other tasks performed by the computer:
updates the inventory subsidiary file from the
receiving report, calculates batch totals for the
general ledger update procedure and then
closes the corresponding records in the open
PO file to the closed PO file
a program validates the voucher records
against the valid vendor file, adds them to the
voucher register, and prepares batch totals for
posting to the general ledger

Computer-Based Expenditure
Applications--Cash Disbursements
Tasks performed by the computer:
the system scans for vouchers
currently due
prints checks for these vouchers
records these checks in the check
register
batch totals are prepared for the
general ledger update procedure

Levels of Automating and

Re-Engineering Ordering
Computer generates purchase requisition
purchase department manually generates
purchase order

Computer generates purchase order (no

P.R. needed)
not sent until manually reviewed

Computer-generated P.O. is automatically

sent
EDI--no P.O.

CUSTOMER (PURCHASES CYCLE)

Internal Data Flows

EDI

External Data Flows

SELLER (REVENUE CYCLE)

External Data Flows Internal Data Flows

Purchase
Order

Customer
Order
Sales
Order

Shipping
Documents

Receiving
Report

Goods
Vendors
Invoice

Check

Sales
Invoice

Check

or EFT

or EFT

Advantages of Real-Time Data Input &

Processing Over Batch Processing
Shortens the time-lag in record-keeping;
hence, records are more current
Eliminates much of the routine manual
procedures, such as transcribing
information onto paper documents
Eliminates much of the storage and
shuffling of paper documents
Reduces data entry correction procedures

Summary of Internal Controls

General Internal Controls

Organization controls
segregation of duties

Documentation
Asset Accountability Controls
Management Practices
Data Center Operations Controls
Authorization Controls
Access Controls

Manual
Authorization Controls
Purchases of inventory should be
authorized by the Inventory Control
department, not by purchasing agents
Accounts Payable authorizes the
payments of bills, not the cash
disbursements clerk, who writes the
checks
How do these controls change in a CB environment?

Computer-Based Authorization
Controls
Authorizations are automated.
programmed decision rules must be debugged

Automating inventory in EDI and JIT

faulty inventory model can lead to over-purchasing
or under-purchasing

Cash disbursements may automate check

printing and signing.
programming logic must be flawless
automated signing only below a dollar threshold

Segregation of Duties

Warehouse (stores)
Inventory control
Accounts payable
General ledger
Requisitioning
Purchases
Purchases returns and allowances
Cash disbursements

Manual
Segregation of Functions
Custody of the asset, inventory, by the
Warehouse must be separate from
recordkeeping for the assets by the
Inventory Control department
Custody of the asset, cash, by Cash
Disbursements must be kept separate
from recordkeeping for the asset by the
Accounts Payable department
How do these controls change in a CB environment?

Computer-Based Segregation
of Functions
Extensive consolidation by the
computer of tasks traditionally
segregated
computer programs authorize and
process purchase orders
computer programs authorize and
issue checks to vendors

Manual
Supervision
Within the expenditure cycle,
supervision is of highest importance in
the Receiving department, where the
inventory arrives and is logged in by a
receiving clerk. Need to minimize:
failures to properly inspect the assets
theft of the assets
How do these controls change in a CB environment?

Computer-Based Supervision
Automation often leads to a collapsing of the
traditional segregation of duties.
requires greater supervision

Supervision takes on new aspects as

technology advances.
electronic monitoring

Supervision because more difficult as the

workplace becomes more sophisticated.
employees may have advanced IT training

Manual
Accounting Records
Must maintain adequate records for:
accounts payable
vouchers payable
checks
general ledger
subsidiary ledgers

How do these controls change in a CB environment?

Computer-Based
Accounting Records
Maintaining an audit trail becomes more difficult.
Accounting records rests on reliability and security of
magnetically stored data.
Be skeptical about accepting, on face value, the accuracy of
computer produced hard-copy printouts of journals and ledgers.

The system needs to ensure that backup of all files is

continuously kept.
Traditional automated systems still have a lot of paper
documents. This is good for audit trail purposes but is often
inefficient.
As IS becomes increasing paperless, notice the conflict with
SAS 78 objectives.

Manual
Access Controls
Access to:
inventories (direct)
cash (direct)
accounting records
(indirect)

How do these controls change in a CB environment?

Computer-Based
Access Controls
Magnetic records are vulnerable to both
authorized and unauthorized exposure
and should be protected
must have limited file accessibility
programs must be safeguarded and
monitored

Manual
Independent Verification
The Accounts Payable department verifies much of
the work done within the expenditure cycle.
Purchase requisitions, purchase orders, receiving
reports, and suppliers invoices must be checked and
verified by Accounts Payable.

The General Ledger department verifies:

the total obligations recorded equal the total inventories
received
the total reductions in accounts payable equal the total
disbursements of cash
How do these controls change in a CB environment?

Computer-Based
Independent Verification
Automating the accounting function
reduces the need for verification by
reducing the chances of fraud and error
in the expenditure cycle.
However, the need for verification shifts
to the computer program and the
programmers where fraud and error may
still be present.