Chapter 10

Auditing the Expenditure Cycle

REVIEW QUESTIONS
1.

Differentiate between a purchase requisition and a purchase order.

Response: A purchase order requisition is completed by the inventory control
department when a need for inventory items is detected. Purchase requisitions
for office supplies and other materials may also be completed by staff
departments such as marketing, finance, accounting, and personnel. The
purchasing department receives the purchase requisitions, and if necessary,
determine the appropriate vendor. If various departments have requisitioned the
same order, the purchasing department may consolidate all requests into one
order so that any quantity discounts and lower freight charges may be taken. In
any case, the purchasing department prepares the purchase order, which is sent
to the vendor, accounts payable department, and the receiving department (blind
copy).

2.

What purpose does a purchasing department serve?

Response: A purchasing department is able to research the quality and pricing
of various vendors. Their job is to monitor various supply sources and choose
the highest quality good for a given price which can be reliably delivered on time.
The purchasing department may also take advantage of quantity discounts,
especially when two or more manufacturing facilities are involved.

3.

Distinguish between an open accounts payable file and a vouchers payable file.
Response: An open accounts payable file contains all source documents,
including invoices, organized by payment date. As the due dates become close
to the current date, the invoices are pulled from the file and paid. Under the
voucher system, the accounts payable clerk prepares a cash disbursements
voucher upon receipt of all source documents. Each cash disbursements
voucher represents payment to one vendor. Multiple invoices may be paid with
one voucher. The voucher system allows better control over cash disbursements
since cash vouchers are assigned and tracked.

4.

What are the three logical steps of the cash disbursements system?
Response: The three logical steps of the cash disbursements system are:
a) authorization of cash disbursements for payment.
b) preparation & distribution of checks, and
c) preparation of summary information by cash disbursements and accounts
payable and sent to the general ledger clerk.

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5.

What general ledger journal entries are triggered by the purchases system?
From which departments do these journal entries arise?
Response:
Accounts Payable:
Inventory Control
Accounts Payable
Cash Disbursements:
Accounts Payable
Cash

6.

Debit
Credit

Debit
Credit

What two types of exposure can close supervision of the receiving department
reduce?
Response: The receiving clerk's responsibility is to inspect the quantities and
condition of the goods received. The two exposures are 1) failing to perform
his/her duty and 2) pilfering or stealing the inventory. Thus, the copy of the
purchase order which they use for this inspection should not contain quantities or
amounts. If the quantity is printed on the receiving clerk's copy of the purchase
order, he or she may be tempted to skip the physical inspection and the company
may be paying for inventory it did not receive or is damaged. A supervisor is
necessary to remove the packing slip which contains quantity information and to
make sure the receiving clerks actually inspect the goods. If the value of the
inventory is listed, the employee may be tempted to steal some of the inventory.
Close supervision should deter employees from stealing.

7.

How can a manual purchases cash disbursements be re-engineered to reduce

discrepancies, be more accurate, and reduce processing costs?
Response: By using a computer system to automatically search the accounts
payable files, early payment discounts will not be overlooked and potentially lost.
Checks are printed, signed, and distributed. EDI partners may receive their
payments electronically reducing check printing costs. The updates to the check
register file, accounts payable files, and general ledger are automatically made,
thus cutting down on clerical work and errors.

8.

What steps of independent verification does the General Ledger department

perform?
Response: The general ledger department receives journal vouchers from
inventory control, accounts payable, and cash disbursements. With these
summary figures, the general ledger clerk verifies that
1) total obligations recorded = total inventories received, and

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2) total reductions in accounts payable = total disbursements of cash.

9.

What is(are) the purpose(s) of maintaining a valid vendor file?

Response: Inventories should only be acquired from valid vendors. This control
procedure helps to deter the purchasing agent from buying inventories at
excessive costs and receiving kickbacks or from buying from an entity in which
the purchasing agent has a relationship, such a relative or a friend.

10.

How do computerized purchasing systems help to reduce the risk of purchasing

bottlenecks?
Response: Routine purchases can be automated, thus reducing the time lag
between the purchase requisition and the placement of the order, which also
reduces the amount of time to receive the inventory. Thus, routine orders which
may be automated should cause the ordering processing time to be reduced.

11.

What is a personnel action form?

Response: The personnel action form provides the payroll department with a list
of currently active employees, so that any submission of time cards by
supervisors for fictitious or ex-employees will not be processed.

12.

What tasks does a payroll clerk perform upon receipt of hours worked data from
the production department?
Response: The payroll clerk reconciles the information received from personnel
and production, calculates the payroll and distributes the paychecks. Further, the
payroll clerk sends summary information to the accounts payable clerk.

13.

What documents are included in the audit trail for payroll?

Response:
a. time cards, job tickets, and disbursement vouchers.
b. journal information which comes from the labor distribution summary and the
payroll register.
c. subsidiary ledger accounts (employee records and expense accounts).
d. general ledger accounts (payroll control, cash, and payroll clearing).

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DISCUSSION QUESTIONS
1.

What is the importance of the job ticket. Illustrate the flow of this document and
its information from inception to impact on the financial statements.
Response: The job ticket is used to allocate each labor hour of work to specific
WIP accounts. These job tickets are very important for cost accounting. The job
tickets are completed by production workers as they capture the total amount of
time that they spend on each production job. Upon completion, they route these
to the cost accountants who use them to post the labor costs to specific WIP
accounts such as direct labor, indirect labor and overhead. The cost accountant
prepares a labor distribution summary which contains the information for the
general ledger clerk to make the necessary entries to the general ledger
accounts.

2.

What three documents must accompany the payment of an invoice? Discuss

where these three documents originate from and the resulting control
implications.
Response: The three documents which must accompany the payment of an
invoice are the purchase requisition, purchase order, and receiving report (in
addition to the invoice itself). The purchase requisition originates from inventory
control and represents the inventory requirements.
The purchase order
originates from the purchasing department and represents an order placed. The
receiving report originates from the receiving department and represents the
quantity and types of goods received. Thus, the accounts payable must
determine 1) that the goods ordered were requested by some department (i.e.
inventory control) other than purchasing, 2) that purchasing ordered the goods
from a valid vendor, and 3) that the goods were actually received. If all three of
the conditions are met, then and only then should the invoice be paid. Further,
only those goods received in good shape should be paid.

4.

Discuss the importance of supervision controls in the receiving department and

the reasons behind "blind" fields on the receiving report such as quantity and
price.
Response: The receiving clerks have access to many of the firm's assets: their
inventory. Two exposures potentially exist: 1) the clerk failing to perform his/her
duty and 2) the clerk pilfering or stealing the inventory. Thus, the copy of the
purchase order which they use for this inspection should have the quantities and
amounts covered so that they may not be read. If the quantity is printed on the
receiving clerk's copy of the purchase order, he or she may be tempted to skip
the physical inspection and the company may be paying for inventory it did not
receive or is damaged. A supervisor is necessary to remove the packing slip

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which contains quantity information and to make sure the receiving clerks
actually inspect the goods. If the value of the inventory is listed, the employee
may be tempted to steal some of the inventory. Close supervision should deter
employees from stealing.
5.

Why do the Inventory Control, Cash Disbursements, and General Ledger

departments appear to "disappear" in computer-based purchasing systems
(Figure 5-14)? Are these functions no longer important enough to have their own
departments?
Response: These functions are very important, and that is one reason why they
are automated. Theses functions are crucial and thus automation can help to
increase efficiencies and reduce clerical errors.
The inventory control
department no longer has to keep track of the records to determine if inventories
are at the reorder point. The system will monitor the levels and flag any items
which need reordering. Thus, the chance that an item is overlooked is
eliminated. The entries for the general ledger are automatically created by the
system, thus errors are reduced since transcription from summary reports into
the general ledger is not necessary.

6.

How does the procedure differ between a basic batch processing system and a
batch processing with real-time data input of sales and receipts of inventory.
What about for the procedures used by the receiving department?
Response: A system which employs real-time data entry of sales will have the
inventory levels updated more frequently. Thus, when a sale depletes the
inventory level to the reorder point, the system will flag it for reorder more quickly
than if it had to wait for a batch update of the inventory records. The sooner the
item is ordered, the sooner it will be received. With respect to the real-time
receipt of inventory, the inventory will be updated immediately to show the
accurate amount which is on hand. Thus, a customer wishing to know how soon
they may have an item shipped will receive more accurate information regarding
the status of the firm's inventory levels. Thus, the customer benefits from better
stocking of inventory and better information regarding the inventory levels.
The receiving departments uses real-time data entry; they enter the
purchase order number and a receiving screen prompts the clerk for the
quantities of goods received. This system should cause less discrepancies due
to poor handwriting, carelessness, and loss of the receiving report form.

8.

Discuss the major control implications of batch systems with real-time data input.
What compensating procedures are available?
Response: The first control implication is that a fundamental separation between
authorization and transaction processing no longer exists. The computer
programs both authorize and process the orders and issue checks to the

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vendors. The compensating control is to provide transaction listings and

summary reports to management which describe the automated activities taken
by the system. In order for these controls to work, the managers must take the
time to carefully review these reports.
The second control implication is that the accounting records as well as the
computer programs reside on magnetic disks. These disks should not be
accessed by any individuals not authorized to access them in any fashion. The
compensating control is to employ hardware, software and procedural controls
over the data stores.
9.

Discuss some specific examples in which information systems can reduce time
lags and how the firm is positively affected by such time lags.
Response: One example is the reduction in the time it takes to record the receipt
of inventory into the inventory records which are used to inform customers
whether their requested item is available. Also, the inventory levels are also
reduced more quickly for those inventories which are being shipped and are a
reduction in the inventory levels. With reduced time lag, the risk that an item will
be promised to be shipped to another customer when it is not available is greatly
reduced. Further, the automated system will be less likely to pay an invoice too
early, while at the same time not missing the discount period. Thus, cash
management is improved.

11.

Payroll is often used as a good example of batch processing using sequential

files. Explain why.
Response: Sequential files are appropriate because most if not all payroll records
on the master payroll file are updated during the payroll processing run.

MULTIPLE CHOICE
1. B
2. A
3. C
4. B
5. D
6. C
7. B
8. D

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PROBLEMS (May not be the same as the current text)

I.

Explain how the processing procedures would differ, if at all, for the transactions
listed in problem 1 above if a computer-based system with
a) a basic batch processing system were implemented,
b) a batch processing system with real-time data input.
Response:
a) The entire inventory file would be searched at certain intervals, maybe twice a
day, by the computer to identify items at or below their reorder. The computer
would also check the quantity on order field to determine if an order has already
been placed. If an order is needed, the computer creates an open purchase
requisition record. The vendor file is also needed at this point.
The purchase requisition is sent to the purchasing department to fill out a
purchase order (some systems may automate this also). The purchase orders
for a certain period of time, maybe daily, are accumulated and processed
together in a batch and any open purchase requisitions which have a
corresponding purchase order are closed by the system.
The receiving reports are accumulated over a period of time and
processed together, at which time the inventory is updated on a batch basis, as
well as the open purchase orders. Any purchase orders which are filled are then
closed.
The vouchers are accumulated over time and processed together in a
batch and recorded in the voucher register.
b) If the system is processed with real-time data input, the inventory is
automatically scanned whenever a withdrawal from an inventory account is
made. If the item needs reordering, a record in the purchase requisition is
entered. After a specified period of time, the purchase requisitions are
consolidated according to vendor number. A valid vendor file is checked by the
system, and a purchase order is created by the system. When the goods are
received, the receiving report is entered into the system and the inventory
account is automatically updated to reflect the new inventory items which have
arrived and the logical field rec flag is set to true. When accounts payable
receives the invoice, the files are scanned to match the invoice with an open
purchase order, and the invoice field is set to true to indicate that the invoice
has been received. The open purchase order is checked to determine if the
goods have been received by checking the logical field rec flag. If no
discrepancies are noted by the system, a record is created in the open accounts
payable file. The system scans daily the accounts payable due dates to
determine which invoices will be made. The system then prepares the checks,
closes the corresponding accounts payable records and prepares a check
register, and transaction listing.

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II.

Using the flowchart presented in the text of a purchases system, identify six (6)
major control weaknesses in the system. Discuss each of the items that you
identify. Be specific as to the class of the control problem in accordance with
SAS 78.
Response:
Authorization. The purchases function is not authorized from inventory control
Accounting Records. Inventory records are updated based on the purchase
order rather than the Receiving Report or Invoice.
Accounting Records. The Accounts Payable Subsidiary ledger is updated
based only on the Invoice. There is no reconciliation with supporting documents.
Accounting Records. There is no Cash Disbursements Journal or Check
Register in use.
Accounting Records/Segregation of Functions. The receiving department
prepares the Receiving Report directly from the Packing Slip. A blind copy of the
Purchase Order should go to the receiving clerk to control this activity. A
supervisor should take possession of the packing slip that contains relevant data
and oversee the inspection process.
Accounting Records / Independent Verification.
The General Ledger
department should receive Journal vouchers or batch totals from Inventory
Control, Cash Disbursements, and Accounts Payable. These are used to keep
the General Ledger Control accounts current and to verify the overall accounting
accuracy of the process.

III.

Estimate the amount of money which could potentially be saved by the account
payable and cash disbursements departments if a basic batch processing system
were implemented. Assume that the clerical workers cost the firm $12.00/hour
and that 13,000 vouchers are prepared and 5,000 checks are written per year.
Assume that total cash disbursements to vendors amount to $5 million dollars
per year. Due to sloppy bookkeeping, the current system only takes advantage
of about 25% of the discounts offered by vendors for timely payments. The
average discount is 2% if payment is made within ten days. Payments are
currently made on about the 15th day after the invoice is received. Make your
own assumptions and state them regarding how long specific tasks will take.
Also discuss any intangible benefits of the system. (Don't worry about excessive
paper documentation costs.)
Response:
This firm processes approximately 52 vouchers/day and 20
checks/day. At a minimum, the firm would benefit from the purchase discounts
which would not be lost due to sloppy bookkeeping:
$5,000,000 * 75% = $3,750,000 * 2% discount = $75,000 savings per year
Even after deducting for any interest lost at 5% on the funds which remain in the
bank the extra 5 days: ($3,750,000*5%)*(5/365) = $2569. Thus, the net savings
would be $72,431. An added benefit may be that one less worker is needed. If

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this is true, the savings would be approximately $25,000 before considering

employee payroll taxes and costs of benefits.
Other benefits would include fewer errors, and thus fewer vendor
complaints and better control and reports over cash disbursements.