Expenditure Cycle (Purchase and Cash Disbursement Processing)

- PURCHASING SYSTEM
o Monitor Inventory Records (Warehouse)
 Firms deplete their inventories by transferring raw materials into the production process
(conversion cycle) and by selling finished goods to customers (revenue cycle).
 When inventories drop to a predetermined reorder point, a purchase requisition is
prepared and sent to the Purchasing Department to initiate the purchase process.
 For control purposes, a materials requisition form includes:
 Name of supplier
 Primary address of supplier
 Order quantity of the item
 Standard or expected unit price of the item
 A valid vendor file provides an important control by listing only approved vendors. Having
this file reduce certain vendor fraud schemes such as:
 An agent buying from suppliers with whom he/ she has a relationship
 Buying at excessive prices from vendors in exchange for a kickback.
 Buying from a non- existent vendor (Billing Schemes)
 A copy of the purchase requisition is sent to Purchasing.
o Prepare Purchase Order (Purchasing Department)
 A purchase order (based on the purchase requisition) is prepared for each vendor.
 A copy of the purchase order is sent to the vendor which will be processed to
become a sales order, as discussed in the revenue cycle.
 A second copy of the purchase order is sent to the accounts payable function for
filing temporarily in the AP pending file (for 3 way matching).
 A blind copy of the purchase order is sent to the receive goods function, where it is
held until the inventories arrive.
 The last copy is filed in the open/closed purchase order file (pending until
Receiving Report from receiving department is received).
o Receive Goods (Receiving Department)
 The next event in the expenditure cycle is the receipt of ordered inventory.
 Goods arriving from the vendor are reconciled with the blind copy of the purchase order.
 A blind purchase order contains no quantity or price information about the
products being received.
 The purpose of the blind purchase order is to force the receiving clerk to count and
inspect inventories prior to completing the receiving report.
 Upon completion of the physical count and inspection, the receiving clerk prepares a
receiving report stating the quantity and condition of the inventories.
 A copy of the receiving report together with the ordered goods will be forwarded
to the warehouse (increases the inventory record for warehouse management).
 Another copy is sent to Purchasing Department and is filed in the open/closed
purchase order file to close out the purchase order (order received).
 A third copy is sent to the set up accounts payable function (used for 3 way
matching).
 A fourth copy is sent to the inventory control for updating the inventory records
(increases the accounting records of inventory).
 Finally, a copy of receiving report is placed in the receiving report file (filing).
o Update Inventory Records (Inventory Control)
  Increases the inventory level as evidenced by the Receiving Report.
 Depending on the inventory valuation method used by the company (such as FIFO,
Weighted Average, Moving Average, etc.), the inventory control procedures may vary among
firms.
 Organizations that use a Standard Cost system carry their inventories at a predetermined
standard value regardless of the actual price paid to the vendor.
 Organizations that use an Actual Cost system carry their inventories at their actual cost, thus,
a copy of Sales Invoice (which contains the actual price, freight charges, etc.) from the seller
should be filed together with the Receiving Report before recording.
o Set Up Accounts Payable (Accounts Payable Department)
 As mentioned in the transactions discussed above, the set up AP function has now received
a purchase order and a receiving report.
 At this point, the organization has received inventories from the vendor and has incurred an
obligation to pay for the goods, however, the firm has not received the supplier’s invoice
containing the financial information needed to record the transaction. The firm will thus
defer recording the liability until the invoice arrives.
 This common situation creates a slight lag in the recording process, during which
time the firm’s liabilities are technically understated.
 This misstatement is a problem only at period end when the firm will prepare
financial statements.
 In this case, at year end, the accountant needs to estimate the value of the
obligation until the invoice arrives. An adjusting entry is required when the invoice
is received.
 When the supplier’s invoice arrives, the AP clerk reconciles the financial information with
the receiving report and PO. This procedure verifies that what was ordered was received and
is fairly priced. (Three-way match)
 The transaction is recorded in the purchases journal and posted to the supplier’s account in
the AP subsidiary ledger.
 If the firm is using the actual cost method (the opposite of standard costing), the AP clerk
will send a copy of the supplier’s invoice to inventory control.
 Finally, the AP clerk summarizes the entries in the purchases journal for the period and
prepares a journal voucher for the general ledger function.
o Post to General Ledger
 The GL function receives a journal voucher from the AP department and an account
summary from inventory control department.
 The general ledger function posts the data contained in the journal voucher to the
inventory and AP control accounts and reconciles the inventory control account with the
inventory subsidiary summary.
 Inventory (Dr)
 Accounts Payable (Cr)

- Cash Disbursement system

o Identify Liabilities due
 The disbursement process begins in the AP department, where each day the AP clerk
reviews if there are certain liabilities that should be paid.
 The AP clerk sends payment for approval in a form of the AP packet (AP packet consist of
PO, receiving report, and invoice) to the cash disbursement department.
o Prepare Cash Disbursement
 The cash disbursement clerk receives the AP packet and reviews the documents for
completeness and clerical accuracy.
 For each disbursement, the clerk prepares a check and records the check number, amount
and other pertinent data, in the check register, which is also the cash disbursement journal.
 Level of approvals for disbursement may vary among organizations.
 The check is mailed to the supplier, a copy is attached to the AP packet as proof of payment,
and a check copy is filed in the department.
 The clerk marks the documents in the packet paid and returns them to the AP clerk.
  The cash disbursement clerk summarizes the entries made to the check register and sends a
journal voucher to the General Ledger function.
o Update Accounts Payable Record
 Upon receipt of the paid AP packet, the AP clerk removes the liability by debiting the
vendor’s AP subsidiary ledger account.
 The AP packet is then filed in the closed AP file (paid accounts payable file) and an account
summary is prepared and sent to the general ledger function.
o Post to General Ledger
 The general ledger function receives the journal voucher from cash disbursement and the
AP account summary from accounts payable.
 Cash (Cr)
 Accounts Payable (Dr)
o Reconcile Cash Disbursement
 Same as reconciliation of cash receipts (Revenue cycle), a clerk from the controller’s office
reconciles cash disbursement by comparing related documents and records to the bank
statement.

Auditing the Expenditure Cycle

Threats Control
Lack of control over purchases and unrecorded liabilities. Pre numbered purchase requisition and purchase order.
Checks should be in numerical sequence.
Purchase for unauthorized purpose. Verification of employee authorization code to enter
order.
Fictitious vendor Compare vendor to vendor master file
Accepting goods that were not ordered Check validity of purchase order
Payment of invoice twice Stamp paid to the paid invoice

END

Sources:
Accounting Information System Ninth Edition by James A. Hall
Various websites