CHAPTER 5

The Expenditure Cycle

Part I: Purchases and
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Cash Disbursements
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Procedures
BY: GROUP 4
 •• Recognize
Recognize the
the fundamental
fundamental tasks
tasks that
that constitute
constitute the
the
purchases
purchases and
and cash
cash disbursements
disbursements process.
process.
•• Identify
Identify the
the functional
functional areas
areas involved
involved in
in purchases
purchases and
and cash
cash
disbursements
disbursements activities
activities and
and trace
trace the
the flow
flow ofof these
these
transactions
transactions through
through the
the organization.
organization.
•• Specify
Specify the
the documents,
documents, journals,
journals, and
and accounts
accounts that
that provide
provide
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audit
audit trails,
trails, promote
promote the
the maintenance
maintenance ofof historical
historical records,
records,
and
and support
support internal
internal decision
decision making
making andand financial
financial
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reporting
reporting..
•• Understand
Understand thethe exposures
exposures associated
associated with
with purchases
purchases and
and
cash
cash disbursements
disbursements activities
activities and
and recognize
recognize the
the controls
controls that
that
reduce
reduce these
these risks.
risks.
•• Be
Be aware
aware ofof the
the operational
operational features
features and
and the
the control
control
implications
implications ofof technology
technology used
used in
in purchases
purchases and
and cash
cash
disbursements
disbursements systems.
systems.
 Objective of the Expenditure Cycle
- to convert the organization’s cash into the physical
materials and the human resources it needs to
conduct business.
Most business entities operate on a credit basis and do

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not pay for resources until after acquiring them.

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The time lag between these events splits the

procurement process into two phases:

(1) the physical phase, involving the acquisition of the

resource and
(2) the financial phase, involving the disbursement of
cash.
 This Chapter
This chapter examines the principal features of the
two major subsystems that constitute the
expenditure cycle:
(1) the purchases processing subsystem and

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(2) the cash disbursements subsystem.

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The chapter is organized into two main sections.

• The first section provides an overview of the
conceptual system, including the logical tasks, the
key entities, the sources and uses of information,
and the flow of key documents through an
organization.
• The second section deals with the physical system.
 The Conceptual System
Purchases Processing Procedures
Purchases procedures include the tasks involved in
identifying inventory needs, placing the order,

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receiving the inventory, and recognizing the liability.
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In general, these
procedures apply to both
manufacturing and
retailing firms.
 The Conceptual System
Purchases Processing Procedures
Purchases procedures include the tasks involved in
identifying inventory needs, placing the order, receiving the

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inventory, and recognizing the liability.
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In general, these
procedures apply to
both manufacturing
and retailing firms.
 Process
Monitor Inventory Records- Firms deplete their inventories by
transferring raw materials into the production process (the conversion
cycle) and by selling finished goods to customers (revenue cycle).
Purchase Requisition

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Prepare Purchase Order

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Receive Goods

Update Inventory Records

Set Up Accounts Payable

Cash Disbursement
 Purchase Requisition
-prepared and sent to the prepare purchase order function to initiate the
purchase process. To notify the purchasing department of items it
needs to order, their quantity, and the timeframe. 

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 Prepare Purchase Order
-is a commercial document and first official offer issued by a buyer
to a seller indicating types, quantities, and agreed prices for
products or services.

The last copy is filed in the

open/closed purchase order

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file.

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To make the purchasing

process efficient, the inventory
control function will supply
much of the routine ordering
information that the
purchasing department needs
directly from the inventory
and valid vendor files.
 Prepare Purchase Order
-is a commercial document and first official offer issued by a buyer
to a seller indicating types, quantities, and agreed prices for
products or services.

The last copy is filed in the

open/closed purchase order

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file.

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To make the purchasing

process efficient, the inventory
control function will supply
much of the routine ordering
information that the
purchasing department needs
directly from the inventory
and valid vendor files.
 Receive Goods
The next event in the expenditure cycle is the receipt of the
inventory. Goods arriving from the vendor are reconciled with the blind
copy of the PO.
The purpose of the blind copy is to force the receiving clerk to count
and inspect inventories prior to completing the receiving report.

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Upon completion of the physical count and inspection, the
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receiving clerk prepares a receiving report stating the quantity

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Four copies are made:

1. For raw materials storeroom or finished goods warehouse for
safekeeping
2. For open/closed PO file to close out the purchase order.
3. To be filed in the AP pending file
4. To be placed in the receiving report file.
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 Update Inventory Records
Organizations that use a standard cost system carry their
inventories at a predetermined standard value regardless of the price
actually paid to the vendor.
Updating an actual cost inventory ledger requires additional
financial information, such as a copy of the supplier’s invoice when it
arrives.

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 Set Up Accounts Payable
During the course of this transaction, the set-up AP function has
received and temporarily filed copies of the PO and receiving report.
At this point in the process, however, the firm has not received the
supplier’s invoice2 containing the financial information needed to
record the transaction.
Once the reconciliation is complete, the transaction is

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recorded in the purchases journal and posted to the supplier’s

account in the AP subsidiary ledger.

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After recording the liability, the AP clerk transfers all source

documents (PO, receiving report, and invoice) to the open AP
file.
 Vouchers Payable System
AP department uses cash disbursement vouchers and maintains a
voucher register.
Each voucher is recorded in the voucher register.
The AP clerk files the cash disbursement voucher, along with
supporting source documents, in the vouchers payable file.

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 Cash
Disbursement
Voucher

Voucher
Register

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Post to General Ledger.

 The Cash Disbursements Systems
-processes the payment of obligations created in the purchases
system. The principal objective of this system is to ensure that
only valid creditors receive payment and that amounts paid are
timely and correct.

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 Steps in Cash Disbursement System
1st Identify Liabilities Due
-identifying items that have come due.
2nd Prepare Cash Disbursement
-reviews the documents for completeness and clerical accuracy
-prepares a check and records the check number, dollar amount,

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voucher number, and other

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pertinent data in the check

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register, which is also called

the cash disbursements journal.

3rd Update AP Record

-removes the liability
-The voucher packet is filed in the closed voucher file
4th Post to General Ledger
-The voucher packet is filed in the closed voucher file
 Steps in Cash Disbursement System
1st Identify Liabilities Due
-identifying items that have come due.
2nd Prepare Cash Disbursement
-reviews the documents for completeness and clerical accuracy
-prepares a check and records the check number, dollar amount,

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voucher number, and other

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pertinent data in the check

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register, which is also called

the cash disbursements journal.

3rd Update AP Record

-removes the liability
-The voucher packet is filed in the closed voucher file
4th Post to General Ledger
-The voucher packet is filed in the closed voucher file
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 Transaction Authorization
Purchases Subsystem.
The inventory control function continually monitors inventory levels
Cash Disbursements Subsystem
To provide effective control over the flow of cash from the firm,
the cash disbursements function should not write checks without

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this explicit authorization.

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Segregation of Duties

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Segregation of Inventory Control from the Warehouse

should be able to reconcile inventory records to the physical
inventory.
Segregation of the General Ledger and Accounts Payable from
Cash Disbursements
An individual with the combined responsibilities of writing
checks, posting to the cash account, and maintaining AP could
perpetrate fraud against the firm.
 Supervision
Inspection of Assets
Receiving clerks must inspect items for proper quantities and
condition (damage, spoilage, and so on)
Theft of Assets
Improper inspection procedures coupled with inadequate
supervision can create a situation that is conducive to the theft

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Accounting Records
The control objective of accounting records is to maintain

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an audit trail adequate for tracing a transaction from its

source document to the financial statements.
Access Controls
Direct Access
a firm must control access to physical assets such as cash and
inventory
Indirect Access
A firm must limit access to documents that control its physical
assets.
 Independent Verification
Independent Verification by Accounts Payable
The AP function plays a vital role in the verification of
the work others in this system have done.
1. This document should reconcile with the purchase
requisition.

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2. The reconciliation of this document with the PO

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signifies that the organization has a legitimate

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obligation.
3. The reconciliation of this document with the PO
signifies that the organization has a legitimate
obligation.
Independent Verification by the General Ledger Department.
The general ledger function provides an important
independent verification in the system
 Physical System
This begins with a review of manual procedures and then moves on
to deal with several forms of computer-based systems.
A Manual System
Inventory Control
When inventories drop to a predetermined reorder point, the

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clerk prepares a purchase requisition

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One copy of the requisition is sent to the purchasing

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department, and one copy is placed in the open purchase

requisition file.
Purchasing Department
The purchasing department receives the purchase
requisitions, sorts them by vendor, and prepares a
multipart purchase order (PO) for each vendor.
The clerk files the last copy along with the purchase
requisition in the open PO file.
 Receiving
Goods arriving from the vendor are reconciled with the blind copy
of the PO
The clerk closes the open PO by filing the purchase requisition, the
PO, and the receiving report in the closed PO file.
AP Department
The AP clerk reconciles the financial information with the

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documents in the pending file, records the transaction in the

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purchases journal, and posts it to the supplier’s account in the

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AP subsidiary ledger (voucher register).

The AP clerk transfers the source documents (PO, receiving
report, and invoice) to the open vouchers payable (AP) file.
General Ledger Department
The general ledger department receives a journal voucher from
the AP department and an account summary from inventory
control.
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 The Cash Disbursements Systems
AP Department
Each day, the AP clerk reviews the open vouchers payable (AP)
file for items due and sends the vouchers and supporting
documents to the cash disbursements department
Cash Disbursements Department
The check, along with the supporting documents, goes to

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the cash disbursements department manager, or treasurer,

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for his or her signature.

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AP Department
Upon receipt of the voucher packet, the AP clerk removes the
liability by recording the check number in the voucher register
and filing the voucher packet in the closed voucher file.
General Ledger Department
Based on the journal voucher from cash disbursements and the
account summary from AP, the general ledger clerk posts to the
general ledger control accounts and files the documents.
Computer-Based Purchases and Cash Disbursements
Applications
Automating Purchases Procedures Using Batch Processing
Technology
Data Processing Department: Step 1
The purchasing process begins in the data processing

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department, where the inventory control function is
performed.

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the system determines if the affected items in the inventory
subsidiary file have fallen to their reorder points.
 Purchasing Department
Upon receipt of the purchase requisition, the purchasing
department prepares a multipart PO. Copies are sent to the
vendor, AP, receiving, data processing, and the purchasing
department’s file.
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Data Processing Department: Step 2
a copy of the PO is sent to data processing and used to create a
record in the open PO file
 Receiving Department
When the goods arrive from vendors, the receiving clerk
prepares a receiving report and sends copies to purchasing,
AP, and data processing.

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Data Processing Department: Step 3

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The data processing department creates the receiving report

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file from data provided by the receiving report documents
 Accounts Payable
When the AP clerk receives the supplier’s invoice, he or
she reconciles it with the supporting documents that were
previously placed in the AP pending file.
Data Processing Department: Step 4
The voucher file is created from the voucher documents
Cash Disbursements Procedures
Data Processing Department
The check number is recorded in the voucher register to
close the voucher and transfer the items to the closed AP
file.

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The cash disbursements clerk reconciles the checks with

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the transaction listing and submits the negotiable portion
of the checks to management for signing.
Accounts Payable Department
Upon receipt of the check copies, the AP clerk matches
them with open vouchers and transfers these now closed
items to the closed voucher file. This concludes the
expenditure cycle process.
Reengineering the Purchases/Cash Disbursements System
Data Processing The following tasks are performed
automatically.
1. The inventory file is searched for items that have fallen
to their reorder points.
2. A record is entered in the purchase requisition file for

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each item to be replenished.

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3. Requisitions are consolidated according to vendor

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number.
4. Vendor mailing information is retrieved from the valid
vendor file.
5. Purchase orders are prepared and added to the open PO
file.
6. A transaction listing of purchase orders is sent to the
purchasing department for review.
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Receiving Department
When the goods arrive, the receiving clerk accesses the open
PO file in real time by entering the PO number taken from
the packing slip.
Data Processing The following tasks are performed automatically by the
system.
1. Quantities of items received are matched against the open PO record, and a
Y value is placed in a logical field to indicate the receipt of inventories.
2. A record is added to the receiving report file.
3. The inventory subsidiary records are updated to reflect the receipt of the
inventory items.
4. The general ledger inventory control account is updated.

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5. The record is removed from the open PO file and added to the open AP file,

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and a due date for payment is established.

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The following procedures are performed for the selected items.
1. Checks are automatically printed, signed, and distributed to the mail room
for mailing to vendors. EDI vendors receive payment by electronic funds
transfer (EFT). EFT is discussed in the appendix to Chapter 12.
2. The payments are recorded in the check register file.
3. Items paid are transferred from the open AP file to the closed AP file.
4. The general ledger AP and cash accounts are updated.
5. Reports detailing these transactions are transmitted via terminal to the AP
and cash disbursements departments for management review and filing
Control Implications
The Automated System
Improved Inventory Control. The greatest advantage of the
automated system over its manual counterpart is improved
ability to manage inventory needs.
Better Cash Management. The automated system promotes
effective cash management by scanning the voucher file daily

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for items due, thus avoiding early payments and missed due
dates. In addition, by writing checks automatically, the firm

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reduces labor cost, saves processing time, and promotes
accuracy.
Time Lag. A lag exists between the arrival of goods in the
receiving department and recording inventory receipts in the
inventory file.
Purchasing Bottleneck. In this automated system, the
purchasing department is directly involved in all purchase
decisions.
 Excessive Paper Documents. The automated system is laden with
paper documents. All operations departments create documents,
which are sent to data processing and which data processing must
then convert to magnetic media.
The Reengineered System The reengineered system addresses
many of the operational weaknesses associated with the

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automated system. Specifically, the improvements in this system

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(1)it uses real-time procedures and direct access files to shorten
the lag time in record keeping,
(2)it eliminates routine clerical procedures by distributing
terminals to user areas, and
(3)it achieves a significant reduction in paper documents by
utilizing digital communications between departments and by
digitally storing records.
Segregation of Duties. This system removes the physical
separation between authorization and transaction
processing.
Accounting Records and Access Controls. Advanced
systems maintain accounting records on digital storage

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media, with little or no hard-copy backup. Sarbanes-

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Oxley legislation requires organization management to
implement adequate control security measures to protect

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accounting records from unauthorized access and
destruction.