The Expense Cycle:
Purchasing to Cash Payments
Chapter 11
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Questions Addressed
 What
are the basic business activities
and data processing operations that are
performed in the expenditure cycle?
 What
decisions need to be made in the
expenditure cycle, and what information
is needed to make these decisions?
 What
are the major threats in the
expenditure cycle and the controls
related to those threats?
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Introduction
The expense cycle is a recurring set of
business activities and related
information processing operations
associated with the purchase of and or
payment for good and services.
Primary external exchange of
information is with suppliers.
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Expense Cycle Objective
The expense cycle’s primary objective
is to minimize the total cost of
acquiring and maintaining inventories,
supplies, and the various services the
organization needs to function
To accomplish that objective,
management must make many key
decisions:
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Key Decisions: Expense Cycle

What is the optimal level of inventory and supplies to carry?

Which suppliers provide the best quality and service at the
best prices?

Where should inventories and supplies be held?

How can the organization consolidate purchases across units
to obtain optimal prices?

How can IT be used to improve both the efficiency and accuracy
of the inbound logistics function?

Is sufficient cash available to take advantage of any
discounts suppliers offer?

How can payments to vendors be managed to maximize cash
flow?
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AIS basic functions
There are 3 basic functions of the AIS in
the expense cycle: (same for all cycles)
(1) capturing and processing data about
business activities,
(2) storing and organizing that data to
support decision making,
(3) providing controls: ensure reliability of
data & safeguard resources.
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Expense Cycle Business
Activities
Three basic business activities
performed in the expense cycle:
1.
Ordering goods, supplies and services;
2.
Receiving and storing goods, supplies
and services;
3.
Paying for goods, supplies and services.
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Order Goods
The first major business activity in the expenditure
cycle is ordering inventory or supplies.

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 inventory records and
◦ inventory shorts resulting in production delays caused by
late delivery or substandard components delivered
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Order Goods: Alternative
Inventory Control Methods
We consider three alternate
approaches to inventory control:
1.
economic order quantity (EOQ);
2.
materials requirements planning(MRP);
and
3.
just in time inventory (JIT).
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EOQ

Economic Order Quantity (EOQ) is the traditional approach to
managing inventory. The goal is to maintain enough stock so that
production doesn’t get interrupted. An optimal order size is
calculated by minimizing the sum of ordering costs, carrying
costs, and stockout costs. A reorder point is also calculated.

Ordering Costs includes all expenses associated with processing
purchase transaction.

Carrying Costs are those associated with holding inventory.

Stockout Costs are those cost that result from inventory shortages,
such as lost sales or production delays.

The Reorder Point is when to order based on delivery time and
safety stock levels.

Optimal Order Size : EOQ = (2DP / C) ^1/2
D = Demand in units for a specified period
P = Relevant ordering cost per purchase order
C = Relevant carrying cost of one unit in stock for the time period used for D.
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Materials Requirement
Planning (MRP)
(MRP) seeks to reduce inventory levels by
improving the accuracy of forecasting
techniques to better schedule purchases to
satisfy production needs. This schedule
identifies the quantities of raw materials,
parts and supplies needed in production
and the point in time when they will be
needed.
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Just-in-Time (JIT)
(JIT) systems attempt to minimize, if not totally
eliminate, carrying inventory by only purchasing
and producing goods in response to actual sales.
These systems have frequent, small deliveries of
materials, parts, and supplies directly to the
location where production will occur.
 A major difference between MRP and JIT is the
production scheduling.
◦ MRP systems schedule production to meet forecasted
sales; thereby creating a stock of finished goods inventory.
◦ JIT systems schedule production in response to customer
demands; thereby virtually eliminating finished goods
inventory.
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Purchase Requests


Whatever the inventory control system, the order
processing typically begins with a purchase
request followed by the generation of a purchase
order. The purchase requisition is triggered by
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.
The purchase requisition is received by a
purchasing agent in the purchasing department,
who typically performs the purchasing activity. The
purchasing agent next makes a purchase order
(PO).
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Generating Purchase
Orders
A crucial decision is the selection of supplier
for inventory items. Several factors should
be considered in making this decision:
◦ Price
◦ Quality of materials
◦ Dependability in making deliveries
The PO is both a contract and a promise to pay. Multiple
purchase orders may be completed for one purchase requisition
if multiple vendors will fill the request. A blanket purchase
order is a commitment to buy specified items at specified prices
from a particular supplier for a set time period.
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Improving Efficiency and
Effectiveness of Purchasing
The major cost driver is the number of purchase
orders processed.
Ways to reduce costs:





Using EDI is one way to improve the purchasing process. EDI
reduces costs by eliminating the clerical work associated with
printing and mailing paper documents.
Vendor-managed inventory programs provide anther means
of reducing purchase and inventory costs.
Reverse auctions, suppliers compete with one another to
meet demand at the lowest price.
conduct a pre-award audit, normally involving large
purchases that involve bids, the internal auditor verifies the
accuracy of the bids.
RFID allows for specific identification method for inventories.
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Receiving and Storing
Goods
The two major responsibilities of the receiving
department are:
(1) deciding whether to accept delivery
(based on whether there is a valid
purchase order) and
(2) verifying the quantity and quality of
delivered goods.
The receiving report is the primary document used in this
process. The receiving report includes the date received,
shipper, supplier and purchase order number. For each item
received, it shows the item number, description, unit of measure
and quantity. It also provides space for signature and comments
by the person who receives and inspects the goods.
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Receiving 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. The receiving
clerk counts the goods, and examines them for
damage before routing to warehouse or factory.
If items are damaged, defective, or missing the
purchasing department must resolve the situation
with the supplier.
In the case of damaged or poor quality goods, a
debit memo is prepared after the supplier agrees
to take back the goods or grant a price reduction.
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Improve Efficiency and
Effectiveness: Receiving





Require suppliers to bar-code their products.
Bar-coding enables receiving clerks to scan in the product
number, description and quantity of all items received,
eliminating data errors.
Radio frequency identification (RFID) tags are attached to
each crate of goods and emit a signal that a receiving unit
embedded in the gates near a company’s warehouse unit can
read.
EDI and satellite technology provide another way to
improve the efficiency of inbound logistics. EDI advance
shipping notices inform companies when products have been
shipped.
Finally, audits may identify opportunities to cut freight costs.
For example, many companies have negotiated significant
savings with specific carriers.
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Paying For Goods And
Services
There are two basic sub-processes
involved in the payment process:
1.
Accounts payable department approves vendor
invoices and
2.
Cashier makes actual payment of the invoices.
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Approve Vendor Invoices for
payment
Most companies record A/P only after receipt
and approval—means the EoP adj. JEs
need to be made.
Objective of A/P is to approve payment only
for goods that actually were ordered and
receives.
Two ways to process vendor invoices:
(1) non-voucher system, and
(2) voucher system--prepare a
disbursement voucher.
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Non-voucher system
In a Non-voucher system each approved
invoice is posted in the supplier’s records in
accounts payable, filed and is then stored in
an open invoice file.
When a check is written, the invoice is
removed from the open invoice file, marked
“paid” and then stored in a paid invoice file.
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Voucher System
In a voucher system--A disbursement voucher is
also prepared which identifies the supplier, lists
outstanding invoices and net amount to be paid after
discounts and allowances.
There are three advantages from using
disbursement vouchers:
1.
2.
3.
several invoices may be paid at once (reducing number of
checks);
vouchers can be pre-numbered, which simplify tracking all
payables; and
the voucher provides a record that a vendor invoice has
been approved for payment and facilitates invoice
approval separate from invoice payment. This makes it
easier to schedule both activities to maximize efficiency.
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Pay Approved Invoices
A voucher package, which contains the approved
invoice, and supporting purchase order and receiving
report, is sent to the cashier. This voucher package
authorizes issuance of a check or EFT to the supplier.
The cashier reviews the voucher package, approves
the payment, prepares the check for payment and
signs the check. Sends check on its way.
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Improving Efficiency and
Effectiveness
Processing efficiency can be improved by: requiring suppliers to
submit invoices by EDI and having the system automatically
match invoices to purchase orders and receiving reports.

Another option is to eliminate vendor invoices. This
“invoiceless” approach is called evaluated receipt settlement
(ERS). ERS replaces the traditional three-way matching
process with a two-way match of the purchase order and
receiving report.

Procurement cards provide one way to eliminate the need for
accounts payable to process many small noninventory
invoices. A procurement card is a corporation credit card that
employees can use only at designated suppliers to purchase
specific kinds of items. Using corporate credit cards for travel
expenses further reduces the number of invoices that need to
be processed.
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Improving Efficiency and
Effectiveness



Preparing careful short-term cash budgets is useful in taking
advantage of early-payment discounts. For example, if the
corporation purchased an item for $100,000 with the terms
2/10, n/30; the amount of the discount that could be realized
by paying within ten days is $2,000. Even more important, if
the corporation did not pay within the ten days; the 2%
discount represents an annual interest rate of 36 percent
(2% X 360/20).
Finally, financial data electronic interchange (FEDI) can
cut the costs associated with paying suppliers by eliminating
the need to prepare and mail checks.
Medtronic example on page 431 shows dramatic
improvements can often be made simply by reengineering the
accounts payable and cash disbursements processes.
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Information Processing
Procedures
Many companies are (have) replacing their
AIS systems with ERP systems. New ERP
systems allow sharing of data (better
communication) between activities and
increase integration.
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ERP efficiencies
ERP systems improve the efficiency and
effectiveness of its expenditure cycle activities in
the following ways:
 Reduced amount of paper documents processed.
 More timely and accurate information enables
company to take advantage of discounts.
 Inventory records are more accurate and timely.
 The warehouse and receiving departments can
better plan activities.
 Reports and performance measures are timelier.
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Control Objectives,
Threats, And Procedures
The six threats for ordering goods are:
Threat No. 1 — Stock-outs and/or Excess Inventory
Stockouts result in lost sales; excess inventory
incurs higher than necessary carrying costs.
Controls: Accurate inventory control and sales
forecasting; use of perpetual inventory method;
supplier performance reports; recording of
inventory changes in real time; bar-coding
inventory; and periodic physical counts.
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Control Objectives,
Threats, And Procedures
Threat No. 2 — Ordering Unnecessary Items
Controls: Integrate databases of various divisions
and produce reports that link item descriptions to
part numbers to allow consolidation of orders.
Threat No. 3 — Purchasing Goods at Inflated Prices
Controls: Price lists for frequently-purchased
items; use of catalogs for low-cost items;
solicitation of bids for high-cost and specialized
products; review of purchase orders; budgetary
controls and responsibility accounting; and
performance review.
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Control Objectives,
Threats, And Procedures
Threat No. 4 — Purchasing Goods of Inferior Quality
Controls: Use of approved supplier list; review of
purchase orders; tracking of supplier performance;
purchasing accountability for rework and scrap.
Threat No. 5 — Purchasing from Unauthorized
Suppliers
Controls: review of purchase orders; restriction of
access to supplier list; periodic review of supplier
list; and coordination with procurement card
providers to restrict acceptance of cards.
Threat No. 6 — Kickbacks
Controls: “no-gift” policy, vendor audit, rotate.
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Control Objectives,
Threats, And Procedures
Receive and Store Goods
The primary objectives of this process are to verify
the receipt of ordered inventory and safeguard the
inventory against loss or theft.
Threat No. 7 — Receiving Unordered Goods
Controls: Accept goods only when there’s an
approved purchase order.
Threat No. 8 — Errors in Counting Received Goods
Controls: Bar-coding of ordered goods; quantities
blanked out on receiving forms; signature of
receiving clerks; bonuses for catching
discrepancies; re-counting of items by inventory
control.
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Control Objectives,
Threats, And Procedures
Receive and Store Goods (continued)
Threat No. 9 — Stealing Inventory
Controls: Secure storage locations for inventory;
documentation of intra-company transfers; periodic
physical counts; segregation of duties.
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Control Objectives,
Threats, And Procedures
Approve and Pay Vendor Invoices
Threat No. 10 — Failing to Catch Errors in Vendors Invoices
Controls: Check mathematical accuracy; verify
procurement card charges; adopt Evaluated
Receipt Settlement; train staff on freight
terminology; use common carrier.
Threat No. 11 — Paying for Goods Not Received.
Controls: Compare invoice quantities to quantities
reported by receiving and inventory control; use
tight budgetary controls.
 Threat No. 12 — Failing to Take Available
Purchase Discounts
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Control Objectives,
Threats, And Procedures
Threat No. 13 — Paying the Same Invoice Twice
Controls: Approve invoices only with complete voucher
package; pay only on original invoices; cancel invoices once
paid; use internal audit to detect and recover overpayments;
control access to accounts payable master file.
Threat No. 14 — Recording and Posting Errors in Accounts Payable
Controls: Data entry and processing controls; reconcile
supplier balances with control accounts.
Threat No. 15 — Misappropriation of Cash, Checks, or EFT
Controls: Restrict access to cash, checks, and check signing
machines; use sequentially numbered checks and reconcile;
segregate duties; two signatures on checks over a certain
limit; restrict access to supplier list; cancel all documents;
have independent bank reconciliation; use check protection
measures and/or positive pay; provide strict logical and
access controls for EFT.
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Control Objectives,
Threats, And Procedures
General Control Issues
Threat No. 16 — Loss, Alteration, or Unauthorized
Disclosure of Data
Controls: File backups, use of file labels; strict
access controls; alter default settings on ERP
modules; encrypt data; and use message
acknowledgment techniques.
Threat No. 17 — Performing Poorly
Controls: Performance reports.
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Expense Cycle Information
Needs
The following information is needed for the
expenditure cycle:

Determine when and how much additional inventory to order.

Select the appropriate suppliers from whom to order.

Verify the accuracy of vendor invoices.

Decide if purchase discounts should be taken.

Monitor cash flow needs to pay outstanding obligations.
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Expense Cycle Information
Needs
The AIS needs to provide information to
evaluate the following:
1) purchasing efficiency and effectiveness;
2) supplier performance;
3) time taken to move goods from receiving to
production; and
4) percent of purchase discounts taken.
Notice that these decisions require both financial and
operating data.
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Inventory Turnover
Because inventory represents a sizable
investment of working capital, reports that
help manage inventory are especially
valuable. A key inventory measure is the
inventory turnover.
Inventory Turnover =
CoGs / ending inventory
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