The Expenditure Cycle: Purchasing

to Cash Disbursements
Chapter 7

7-1
Learning Objectives
1.  Explain the basic business activities and
related information processing operations
performed in the expenditure cycle.

2.  Discuss the key decisions to be made in the

expenditure cycle, and identify the information
needed to make those decisions.

3.  Identify major threats in the expenditure cycle,

and evaluate the adequacy of various control
procedures for dealing with those threats.
7-2
INTRODUCTION
•  The primary external exchange of information is with
suppliers (vendors).
•  Information flows to the expenditure cycle from other
cycles, e.g.:
▫  The revenue cycle, production cycle, inventory control, and
various departments provide information about the need to
purchase goods and materials.
•  Information also flows from the expenditure cycle:
▫  When the goods and materials arrive, the expenditure cycle
provides information about their receipt to the parties that
have requested them.
▫  Information is provided to the general ledger and reporting
function for internal and external financial reporting.
3
 13-4

The Expenditure Cycle

Expenditure Cycle Activities
•  Basic Expenditure Cycle Activities
▫  Order materials, supplies, and services
▫  Receive materials, supplies, and services
▫  Approve supplier (vendor) invoice
▫  Cash disbursement
•  Primary objective:
▫  Minimize the total cost of acquiring and
maintaining inventories, supplies, and the various
services the organization needs to function

5
Level 0 Data Flow
Diagram for the
Expenditure Cycle

6
7
8
Basic Expenditure Cycle Activities

•  Order materials, supplies, and services

•  Receive materials, supplies, and services
•  Approve supplier (vendor) invoice
•  Cash disbursement

13-9
Level 0 Data Flow
Diagram for the
Expenditure Cycle

10
Expenditure Cycle General Threats & Control

Threats Controls
1.  Inaccurate or invalid master 1.a Data processing integrity
data controls
2.  Unauthorized disclosure of 1.b Restriction of access to
sensitive information master data
3.  Loss or destruction of data 1.c Review of all changes to
4.  Poor performance master data
2.a Access controls
2.b Encryption
3.a Backup and disaster recovery
procedures
4.a Managerial reports

11
1.Order Goods (Materials/Supplies) or
Services Processing Steps
•  Identify what, when, and how much to purchase
▫  Source document: purchase requisition
•  Choose a supplier
▫  Source document: purchase order

12
13
14
Order
Goods

15
Identify what, when, and how much to
purchase
•  Key decisions in this process involve
identifying what, when, and how much to
purchase and from whom.
•  Weaknesses in inventory control can create
significant problems with this process:
▫  Inaccurate records cause shortages.
•  One of the key factors affecting this process is
the inventory control method to be used.

16
Identify what, when, and how much to
purchase
•  Alternate Inventory Control Methods
▫  We will consider three alternate approaches to
inventory control:
–  Economic Order Quantity (EOQ)
–  Materials Requirements Planning (MRP)
–  Just in Time Inventory (JIT)

17
Identify what, when, and how much to purchase
•  EOQ is the traditional approach to managing
inventory.
▫  Goal: Maintain enough stock so that production doesn’t
get interrupted.
▫  Under this approach, an optimal order size is calculated
by minimizing the sum of several costs:
–  Ordering costs
–  Carrying costs
–  Stockout costs
▫  The EOQ formula is also used to calculate reorder point,
i.e., the inventory level at which a new order should be
placed.
▫  Other, more recent approaches try to minimize or
eliminate the amount of inventory carried.
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Identify what, when, and how much to purchase

•  MRP seeks to reduce required inventory levels by

improving the accuracy of forecasting techniques to better
schedule purchases to satisfy production needs.
•  JIT systems attempt to minimize or eliminate inventory
by purchasing or producing only in response to actual (as
opposed to forecasted) sales.
•  These systems have frequent, small deliveries of
materials, parts, and supplies directly to the location
where production will occur.
•  A factory with a JIT system will have multiple receiving
docks for their various work centers.
19
Identify what, when, and how much to
purchase
•  Differences between MRP and JIT:
▫  Scheduling production and inventory accumulation:
–  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

▫  Nature of products
–  MRP are useful with predictable patterns of demand
product
–  JIT are useful for products that have relatively short life
cycles and for which demand cannot be accurately
predicted 20
Identify what, when, and how much to
purchase
•  Whatever the inventory control system, the order
processing typically begins with a purchase request
followed by the generation of a purchase order.
•  A request to purchase goods or supplies is triggered
by either:
▫  The inventory control function; or
▫  An employee noticing a shortage.
•  Advanced inventory control systems automatically
initiate purchase requests when quantity falls below
the reorder point.

21
Identify what, when, and how much to
purchase
•  The need to purchase goods typically results in the
creation of a purchase requisition. The purchase
requisition is a paper document or electronic form
that identifies:
▫  Who is requesting the goods
▫  Where they should be delivered
▫  When they’re needed
▫  Item numbers, descriptions, quantities, and prices
▫  Possibly a suggested supplier
▫  Department number and account number to be charged
•  Most of the detail on the suppliers and the items
purchased can be pulled from the supplier and
inventory master files.
22
Choosing Suppliers
•  A crucial decision is the selection of supplier.
•  Key considerations are:
▫  Price
▫  Quality
▫  Dependability
–  Especially important in JIT systems because late or
defective deliveries can bring the whole system to a halt.
–  Consequently, certification that suppliers meet ISO 9000
quality standards is important. This certification
recognizes that the supplier has adequate quality control
processes.

23
Choosing Suppliers
•  A purchase order is a document or
electronic form that formally requests a
supplier to sell and deliver specified products
at specified prices.
•  The PO is both a contract and a promise to
pay. It includes:
▫  Names of supplier and purchasing agent
▫  Order and requested delivery dates
▫  Delivery location
▫  Shipping method
▫  Details of the items ordered
24
Choosing Suppliers
•  Multiple purchase orders may be completed for one
purchase requisition if multiple vendors will fill the
request.
•  The ordered quantity may also differ from the
requested quantity to take advantage of quantity
discounts.
•  A blanket order is a commitment to buy specified
items at specified prices from a particular supplier
for a set time period.
▫  Reduces buyer’s uncertainty about reliable material sources
▫  Helps supplier plan capacity and operations

25
CHOOSING SUPPLIERS
• IT can help improve efficiency and
effectiveness of purchasing function.
▫  The major cost driver is the number of
purchase orders processed. Time and cost
can be cut here by:
–  Using EDI to transmit purchase orders
–  Using vendor-managed inventory (VMI) systems
–  Reverse auctions
–  Pre-award audits

26
Ordering Goods/Services
Threats Controls
5.  Stockouts and 5.1 Perpetual inventory system
excess inventory 5.2 Bar coding or RFID tags
6.  Purchasing 5.3 Periodic physical counts of
items not inventory
needed 6.1 Perpetual inventory system
7.  Purchasing 6.2 Review and approval of purchase
items at inflated requisitions
prices
6.3 Centralized purchasing function
7.1 Price lists
7.2 Competitive bidding
7.3 Review of purchase orders
7.4 Budgets
27
Ordering Goods/Services
Threats Controls
8.  Purchasing 8.1 Purchasing only from approved
goods of poor suppliers
quality 8.2 Review and approval of purchases
9.  Unreliable from new suppliers
suppliers 8.4 Tracking and monitoring product
quality by supplier
8.5 Holding purchasing managers
responsible for rework and scrap costs
9.1 Requiring suppliers to possess
quality certification (e.g., ISO 9000)
9.2 Collecting and monitoring supplier
delivery performance data
28
Ordering Goods/Services
Threats Controls
10.  Purchasing from 10.1 Maintaining a list of approved suppliers
unauthorized
and configuring the system to permit purchase
suppliers
orders only to approved suppliers
11.  Kickbacks 10.2 Review and approval of purchases from
(Gifts given by new suppliers
suppliers to 10.3 EDI-specific controls {access, review of
Purchasing
agents orders, encryption, policy)
for the purpose 1 1.1 Prohibit acceptance of gifts from
of influencing suppliers
their choice of 1 1.2 Job rotation and mandatory vacations
suppliers)
11.3 Requiring purchasing agents to disclose
financial and personal interests in suppliers
11.4 Supplier audits 29
2. Receiving Process
•  Goods arrive
▫  Verify goods ordered against the purchase order
(what, how much, quality)
▫  Source document: receiving report

30
Receiving Process

Level1 Data
Flow
Diagram:
Receiving

31
32
Receiving And Storing Goods
• The receiving department accepts
deliveries from suppliers.
▫  Normally reports to warehouse manager,
who reports to VP of Manufacturing.
• Inventory typically stores the goods.
▫  Also reports to warehouse manager.
• The receipt of goods must be
communicated to the inventory control
function to update inventory records.
33
Receiving And Storing Goods
•  The two major responsibilities of the
receiving department are:
▫  Deciding whether to accept delivery
▫  Verifying the quantity and quality of delivered
goods
•  The first decision is based on whether there is
a valid purchase order.
▫  Accepting un-ordered goods wastes time, handling
and storage.

34
Receiving And Storing Goods
•  Verifying the quantity of delivered goods is important so:
▫  The company only pays for goods received
▫  Inventory records are updated accurately
•  The receiving report is the primary document used in this
process:
▫  It documents the date goods received, shipper, supplier, and PO
number
▫  Shows item number, description, unit of measure, and quantity
for each item
▫  Provides space for signature and comments by the person who
received and inspected
•  Receipt of services is typically documented by supervisory
approval of the supplier’s invoice.

35
RECEIVING AND STORING GOODS
•  When goods arrive, a receiving clerk compares the
PO number on the packing slip with the open PO file
to verify the goods were ordered.
▫  Then counts the goods
▫  Examines for damage before routing to warehouse or
factory
•  Three possible exceptions in this process:
▫  The quantity of goods is different from the amount ordered
▫  The goods are damaged
▫  The goods are of inferior quality

36
RECEIVING AND STORING GOODS
•  If one of these exceptions occurs, the purchasing
agent resolves the situation with the supplier.
▫  Supplier typically allows adjustment to the invoice for
quantity discrepancies.
▫  If goods are damaged or inferior, a debit memo is
prepared after the supplier agrees to accept a return or
grant a discount.
–  One copy goes to supplier, who returns a credit memo in
acknowledgment.
–  One copy to accounts payable to adjust the account payable.
–  One copy to shipping to be returned to supplier with the actual
goods.

37
RECEIVING AND STORING GOODS
•  IT can help improve the efficiency and
effectiveness of the receiving activity:
▫  Bar-coding
▫  RFID
▫  EDI and satellite technology
▫  Audits

38
Receiving Goods or Services
Threats Controls

12.1 Requiring existence of approved purchase

12. Accepting order prior to accepting any delivery
unordered items
13.1 Do not inform receiving employees about
quantity ordered
13. Mistakes in
13.2 Require receiving employees to sign receiving
counting
report
13.3 Incentives
13.4 Use of bar codes and RFID tags
13.5 Configuration of the ERP system to flag
discrepancies between received and ordered
quantities that exceed tolerance threshold for
investigation
39
Receiving Goods or Services
Threats Controls

14.1 Budgetary controls

14. Verifying
14.2 Audits
receipt of
services 15.1 Restriction of physical access to inventory
15.2 Documentation of all transfers of
15. Theft of inventory between receiving and inventory
inventory employees
15.3 Periodic physical counts of inventory and
reconciliation to recorded quantities
15.4 Segregation of duties: custody of
inventory versus receiving

40
3. Approving Supplier Invoices
•  Approval of vendor invoices is done by the accounts
payable department, which reports to the controller.
•  The legal obligation to pay arises when goods are
received.
▫  But most companies pay only after receiving and
approving the invoice.
▫  This timing difference may necessitate adjusting entries
at the end of a fiscal period.
•  Match the supplier invoice to:
▫  Purchase order
▫  Receiving report
•  Approve supplier invoice for payment
▫  Source document: disbursement voucher
41
Approving Supplier Invoices

• Objective of accounts payable:

▫  Authorize payment only for goods and
services that were ordered and actually
received.
• Requires information from:
▫  Purchasing—about existence of valid
purchase order
▫  Receiving—for receiving report indicating
goods were received
42
Approving Supplier Invoices
•  Two basic approaches to processing vendor
invoices:
▫  Non-voucher system
–  Each approved invoice is posted to individual
supplier records in the accounts payable file and is
then stored in an open-invoice file.
–  When a check is written to pay for an invoice, the
voucher package is removed from the open-invoice
file, the invoice is marked paid, and then the voucher
package is stored in the paid-invoice file.

43
Approving Supplier Invoices
•  Two basic approaches to processing vendor
invoices:
▫  Voucher system
–  Disbursement voucher is also created when a
supplier invoice is approved for payment.
–  Identifies the supplier, lists the outstanding
invoices, and indicates the net amount to be paid
after deducting any applicable discounts and
allowances.

44
Approving Supplier Invoices
•  Processing efficiency can be improved by :
▫  Requiring suppliers to submit invoices by EDI
▫  Having the system automatically match invoices to
POs and receiving reports
▫  Eliminating vendor invoices through Evaluated
receipt settlement (ERS)- “invoiceless" approach
–  ERS replaces the traditional three-way matching
process (supplier invoice, .receiving report, and
purchase order) with a two-way match of the
purchase order and receiving report
▫  Using procurement cards for non-inventory
purchases
45
Traditional three-way matching Two-way matching

46
Approve Supplier Invoice
Threats Control

16.  Errors in 16.1 Verification of invoice accuracy

supplier 16.2 Requiring detailed receipts for
invoice procurement card purchases
16.3 Evaluated receipt settlement (ERS)
17.  Mistakes 16.4 Restriction of access to supplier master
in posting data
to 16.5 Verification of freight bill and use of
accounts approved delivery channels
payable 17.1 Data entry edit controls
17.2 Reconciliation of detailed accounts payable
records with the general ledger control account

47
4.CASH DISBURSEMENTS
•  Payment of the invoices is done by the cashier, who
reports to the treasurer.
•  The cashier receives a voucher package, which consists of
the vendor invoice and supporting documentation, such
as purchase order and receiving report.
•  This voucher package authorizes issuance of a check or
EFT to the supplier.
•  Processing efficiency can be improved by:
▫  Using company credit cards and electronic forms for travel
expenses
▫  Preparing careful cash budgets to take advantage of
early-payment discounts
▫  Using FEDI to pay suppliers
48
Cash Disbursements
Threats Controls
18.1 Fling of invoices by due date for discounts
18. Failure to 18.2 Cash flow budgets
take 19.1 Requiring that all supplier invoices be matched
disbursements to supporting documents that are acknowledged by
advantage of both receiving and inventory control
19.2 Budgets (for services)
discounts for
19.3 Requiring receipts for travel expenses
prompt 19.4 Use of corporate credit cards for travel
payment expenses
19. Paying for 20.1 Requiring a complete voucher package for all
items not payments
received 20.2 Policy to pay only from original copies of
20. Duplicate supplier invoices
payments 20.3 Cancelling all supporting documents when
payment is made
49
Cash Disbursements
Threats Controls

21.1 Physical security of blank checks and check-

21. Theft of signing machine
cash 21.2 Periodic accounting of all sequentially
numbered checks by cashier
21.3 Access controls to EFT terminals
21.4 Use of dedicated computer and browser for
online banking
21.5 ACH blocks on accounts not used for payments
21.6 Separation of check-writing function from
accounts payable
21.7 Requiring dual signatures on checks greater
than a specific amount
21.8 Regular reconciliation of bank account with
recorded amounts by someone independent of cash
disbursements procedures
50
Cash Disbursements
Threats Controls

21.9 Restriction of access to supplier master file

21. Theft of 21.10 Limiting the number of employees with ability
cash to create one-time suppliers and to process invoices
from one-time suppliers
22. Check
21.11 Running petty cash as an Imprest fund
alteration
21.12 Surprise audits of pretty cash fund
23. Cash flow 22.1 Check-protection machines
problems 22.2 Use of special inks and papers
22.3 "Positive Pay" arrangements with banks
23.1 Cash flow budget

51
Key Terms

•  Expenditure cycle •  Vendor-managed inventory

•  Economic order quantity •  Kickbacks
(EOQ) •  Receiving report
•  Reorder point •  Debit memo
•  Materials requirement •  Voucher package
planning (MRP) •  Non-voucher system
•  Just-in-time (JIT) inventory •  Voucher system
system •  Disbursement voucher
•  Purchase requisition •  Evaluated receipt settlement
•  Purchase order (ERS)
•  Blanket purchase order •  Procurement card
•  Imprest fund
52