The Expenditure Cycle:

Purchasing to Cash Disbursements

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

• Discuss the key decisions to be made in the

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

• Identify major threats in the expenditure cycle,

and evaluate the adequacy of various control
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procedures for dealing with those threats. 13-2
 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.
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 Basic Expenditure Cycle Activities

1. Order materials, supplies, and services

2. Receive materials, supplies, and services
3. Approve supplier (vendor) invoice
4. Cash disbursement

• These activities mirror the activities in the

revenue cycle.

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

• Weaknesses in inventory control can create

significant problems with this process

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 • 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)

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 • 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
 Stock out 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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 • MRP seeks to reduce inventory levels by
improving the accuracy of forecasting
techniques and carefully scheduling production
and purchasing around that forecast.

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 • 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.

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 • Differences between MRP and JIT:
▫ Scheduling production and inventory
accumulation
▫ Nature of products

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 • 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.

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 • 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.
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 • 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.

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 • Once a supplier has been selected for a product,
their identity should become part of the product
inventory master file so that the selection
process does not have to be carried out for every
purchase.
▫ A list of potential alternates should also be
maintained.
▫ For products that are seldom ordered, the
selection process may be repeated every time.

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 • It’s important to track and periodically
evaluate supplier performance, including data
on:
▫ Purchase prices
▫ Rework and scrap costs
▫ Supplier delivery performance
• The purchasing function should be evaluated
and rewarded based on how well it minimizes
total costs, not just the costs of purchasing the
goods.

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 • 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

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 • 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

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 • 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

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 Ordering Goods/Services
Threats Controls
1. Stockouts and excess 1 a. Perpetual inventory system
inventory b. Bar-coding, RFID
c. Physical inventory counts
2. Purchasing items not needed 2 a. Perpetual inventory system
3. Purchasing items at inflated b. Review purchase requisitions
prices c. Centralized purchasing
4. Purchasing goods of poor 3 a. Price lists
b. Competitive bids
quality
c. Review of purchase orders
d. Budgets
4 a. Use approved suppliers
b. Review purchases from
new suppliers
c. Track and monitor product
quality
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responsible for rework and
 Ordering Goods/Services
Threats Controls
5. Unreliable suppliers 5 a. Require quality certification
6. Purchasing from b. Monitor supplier
unauthorized suppliers performance
7. Kickbacks 6 a. Purchase from approved
suppliers
b. Review purchases from
new suppliers
c. EDI-specific controls
7 a. Prohibit gifts
b. Job rotation and
mandatory vacation
c. Require purchasing agents
to disclose interest in
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d. Supplier audits
 Receiving Process
• 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.
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 Receiving Process
• 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.

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 Receiving Process
• The receiving report is the source 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.

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 Receiving Process
• 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

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 Receiving Process
• 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.

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 Receiving Process
• IT can help improve the efficiency and
effectiveness of the receiving activity:
▫ Bar-coding
▫ RFID
▫ EDI and satellite technology

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 Receiving Goods or Services

Threats Controls
1. Accepting unordered items 1 a. Verify purchase order
before receiving goods
2. Mistakes in counting
2 a. Do not provide quantity info.
3. Verifying receipt of services b. Require employee signature on
4. Inventory theft receiving report
c. Incentives
d. Bar codes or RFID
e. ERP configuration
3 a. Budget controls
b. Audits
4 a. Restrict access to inventory
b. Document inventory transfers
c. Periodic inventory counts
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d. Segregation of duties 13-27
 Approve Supplier Invoice
• 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.

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 Approve Supplier Invoice

• Match the supplier invoice to:

▫ Purchase order
▫ Receiving report

• supplier invoice + purchase order + receiving report = voucher

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 Approve Supplier Invoice
• 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.

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 Approve Supplier Invoice
• 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.

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 Approve Supplier Invoice
• 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)
▫ Using procurement cards for non-inventory
purchases

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 Approve Supplier Invoice

Threats Control
1. Errors in supplier invoice 1 a. Verify invoice accuracy
2. Mistakes in posting to b. Require detailed receipts
accounts payable c. ERS
d. Restrict access to supplier
master data
e. Verify freight bills
2 a. Data entry edit controls
b. Reconcile accounts
payable to the general
ledger accounts payable
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 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.

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 Cash Disbursements
• 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

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 Cash Disbursements
Threats Controls
1. Failure to take discounts 1 a. File invoices by due date
b. Cash flow budgets
2. Pay for items not received 2 a. 3 way match
3. Duplicate payments b. Budgets (for services)
4. Theft of cash c. Require receipts for travel
d. Corporate card for travel
3 a. Require voucher package
b. Pay only original invoices
c. Cancel supporting document
4 a. Physical security of checks
b. sequence test of checks
c. access controls
d. use of dedicated computer for
online banking
e. Automated clearing house (ACH)
blocks
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f. Segregation of duties
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 Cash Disbursements
Threats Controls
4. Theft of cash 4 g. Dual signatures
5. Check alteration h. Reconcile bank accounts
6. Cash flow problems i. Restrict access to supplier
master file
j. Controls for adding
one-time suppliers
k. Run petty cash as imprest
fund
l. Surprise audits of petty cash
5 a. Check protection machines
b. Use of special inks and
papers
c. “positive pay” arrangements
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6 a. Cash flow budget