AUDITING THE

EXPENDITURE CYCLE
R E P O R T E R : W E N D E LY N T U T O R
 3 MAIN SECTIONS:

A. Expenditure Cycle Activities and Technologies

B. Expenditure Cycle Audit Objectives, Controls, and Tests of
Controls
C. Substantive Tests of Expenditure Cycle Accounts
A.EXPENDITURE CYCLE ACTIVITIES
AND TECHNOLOGIES
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
PURCHASES AND CASH DISBURSEMENT PROCEDURES
USING BATCH PROCESSING TECHNOLOGY
ALTERNATIVE INVENTORY
ORDERING PROCEDURES
ALTERNATIVE 1
ALTERNATIVE 2
ALTERNATIVE 3
REENGINEERING THE PURCHASES/CASH
DISBURSEMENT SYSTEM
AUTOMATED VERSUS REENGINEERED SYSTEM
(ADVANTAGES AND CONTROL IMPLICATIONS)

• The Automated • The Reengineered System

System • Advantages
• •Improved Inventory • • it uses real-time procedures and direct-access files to
Control shorten the lag time in recordkeeping;
• • • it eliminates routine manual procedures through
•Better Cash Management
automation; and
• •Less Time Lag
• • it achieves a significant reduction in paper
• •Better Purchasing Time
documents by using electronic communications between
Management
departments and by storing records on direct-access media
• •Reduction of Paper
Documents • Control Implications
• • Segregation of Duties
• • Accounting Records and Access Controls
 OVERVIEW OF PAYROLL PROCEDURES

Drawbacks when payroll checks are processed through the regular accounts
payable and cash disbursements system:

• • General expenditure procedures that apply to all vendors will not

apply to employees
• • Writing checks to employees requires special controls
• • General expenditure procedures are designed to accommodate a
relatively smooth flow of transactions
 REENGINEERING THE PAYROLL SYSTEM
Human Resource
Management (HRM)
System
• - captures and processes a wide
range of personnel-related data,
including employee benefits,
labor resource planning,
employee relations, employee
skills, personnel actions (pay
rates, deductions, and so on), as
well as payroll.
This system differs from the simple
automated system described previously
in the following ways:
(1) operations departments transmit
transactions to data processing via terminals,
(2) direct access files are used for data
storage, and
(3) many processes are now performed in real
time. We discuss the key operating features of
this system as follows:
• Personnel.
• Cost Accounting.
• Timekeeping.
• Data Processing.
 B. EXPENDITURE CYCLE AUDIT
OBJECTIVES, CONTROLS, AND TESTS OF
CONTROLS
 CONTROLS

• 1. Input Controls
• 2. Process Controls
• 3. Output Controls
 INPUT CONTROLS

Input controls are designed to ensure that transactions are valid,

accurate, and complete.

• a) Data Validation Controls

• b) Batch Controls
• c) Purchases Authorization Controls
• d) Employee Authorization
A) DATA VALIDATION CONTROLS

Input validation controls are intended to detect transcription errors in

transaction data before they are processed. Tests of validation controls
provide evidence about the accuracy assertion.

General types of validation tests are:

• • Missing data checks
• • Numeric-alphabetic data checks
• • Limit checks
• • Range checks
• • Validity checks
• • Check digit
 B)BATCH CONTROLS

Batch controls are used to manage high volumes of transaction data through
a system. Tests of batch controls provide the auditor with evidence relating to
the assertions of completeness and accuracy.

Periodic reconciliation provides assurance of the following:

• • All invoices that were entered into the system were processed.
• • No invoices were processed and paid more than once.
• • All invoices entered into the system are accounted for as either
successfully processed or rejected because of errors.
 C) PURCHASES AUTHORIZATION
CONTROLS

• Purchases authorization actually occurs in the revenue cycle when goods

are sold to customers. At that time, the system compares the quantity-on-
hand with the reorder point to determine if the inventory needs to be
reordered.
• Tests of purchases authorization controls provide evidence pertaining to
the accuracy and valuation assertions.
 D) EMPLOYEE AUTHORIZATION

• The authorization of employees should be done to help prevent fraud like

creating checks for “ghost” employees.
• Tests of employee authorization provide evidence pertaining to the
existence, accuracy, valuation, and rights and obligation assertions.
 PROCESS CONTROLS

Process controls include computerized procedures for updating files and

restricting access to data.

a) A) File Update Controls

b) b) Access Controls
c) c) Physical Controls
 A) FILE UPDATE CONTROLS

Run-to-run controls use batch control data discussed in the previous section
to monitor the batch as it moves from one programmed procedure (run) to
another. These controls ensure that each run in the system processes the batch
correctly and completely.
Tests of file update controls provide the auditor with evidence relating to the
management assertions of existence, completeness, rights and obligations,
and accuracy.

• • Sequence Check Control.

• • Liability Validation Control
• • Valid Vendor File
 B)ACCESS CONTROLS

Access controls prevent and detect unauthorized and illegal access to the firm’s assets.
Evidence gathered about the effectiveness of access controls tests the management assertions
of existence, completeness, accuracy, valuation and allocation, rights and obligations, and
presentation and disclosure.

The following are examples of risks specific to the expenditure cycle:

• • An individual with access to the AP subsidiary ledger (and supporting documents) could
add his or her account (or someone else’s) to the file. Once recognized by the system as a
legitimate liability, the account will be paid even though no purchase transaction transpired.
• • Access to employee attendance cards may enable an unauthorized individual to trigger
an unauthorized paycheck.
• • An individual with access to both cash and accounts payable records could remove cash
from the firm and record the act as a legitimate disbursement.
• • An individual with access to physical inventory and inventory records can steal products
and adjust the records to cover the theft.
 C) PHYSICAL CONTROLS

Physical controls include manual activities and human actions to initiate computer
procedures to safeguard the assets of the organization. Evidence gathered by reviewing the
segregation of duties can be used to test all of the management assertions.

The relevant physical controls for the purchases and payroll systems are the following:
• • Purchases System Controls
• a. Segregation of inventory control from the warehouse
• b. Segregation of the general ledger and accounts payable from cash disbursements
• c. Supervision of receiving department. (Inspection of assets & Theft of assets).
• d. Reconciliation of supporting documents (The purchase order, The receiving report & The supplier’s
invoice)

• • Payroll System Controls

• a. Verification of timecards
• b. Supervision
• c. Paymaster
• d. Payroll imprest account
 OUTPUT CONTROLS

Output controls are designed to ensure that information is not lost,

misdirected, or corrupted and that system processes function as intended.
Evidence gathered through tests of output controls relates to the
completeness and accuracy assertions.
 THE FOLLOWING ARE EXAMPLES OF
AUDIT TRAIL OUTPUT CONTROLS:

• a) Accounts Payable Change Report - This document is a summary report that

shows the overall change to accounts payable.
• b) Transaction Logs - Every transaction successfully processed by the system
should be recorded on a transaction log, which serves as a journal.
• c) Transaction Listing - the system should produce a (hard copy) transaction
listing of all successful transactions.
• d) Log of Automatic Transactions - To maintain an audit trail of these
activities, all internally generated transactions must be placed in a transaction
log, and a listing of these transactions should be sent to the appropriate manager
for review.
• e) Unique Transaction Identifiers - Each transaction processed by the system
must be uniquely identified with a transaction number.
• f) Error Listing - A listing of all error records should go to the appropriate user
to support error correction and resubmission.
 C. SUBSTANTIVE TESTS OF
EXPENDITURE CYCLE ACCOUNTS
EXPENDITURE CYCLE RISKS
AND AUDIT CONCERNS
 UNDERSTANDING DATA

• Inventory File
• The Inventory file contains quantity, price, supplier, and warehouse location data
for each item of product inventory.
• Purchase Order File
• This file contains records of purchases placed with suppliers.
• Purchase Order Line Item File
• The Line Item file contains a record of every item ordered.
• Receiving Report File
• When the ordered items arrive from the supplier, they are counted and inspected,
and receiving documents are prepared.
• Disbursement Voucher File.
• Based on the supplier’s terms of trade and the company’s payment policy, the
payment due date is determined and placed in the disbursement voucher record.
 TESTING THE ACCURACY AND
COMPLETENESS ASSERTIONS
• Review Disbursement Vouchers for Unusual Trends and
Exceptions
• a) ACL’s Stratify and Classify
• O The stratify function groups financial data into specific strata.
• O The classify function forms strata based on nonfinancial (and nonnumeric) data.

• Reviewing for Accurate Invoice Prices

• O ACL allows the auditor to compare the prices charged on every invoice in the
file for the period under review.
REVIEWING FOR ACCURATE INVOICE PRICES
REVIEWING FOR ACCURATE INVOICE PRICES
 TESTING THE COMPLETENESS, EXISTENCE, AND
RIGHTS AND OBLIGATIONS ASSERTIONS

• Searching for Unrecorded Liabilities

• Searching for Unauthorized Disbursement Vouchers
• Review for Multiple Checks to Vendors
• Auditing Payroll and Related Accounts
• SEARCHING FOR UNRECORDED
LIABILITIES
 TESTING THE COMPLETENESS, EXISTENCE, AND
RIGHTS AND OBLIGATIONS ASSERTIONS

• Searching for Unrecorded Liabilities

• Searching for Unauthorized Disbursement Vouchers
• Review for Multiple Checks to Vendors
• Auditing Payroll and Related Accounts
END 