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CHAPTER 13
THE EXPENDITURE CYCLE: PURCHASING TO CASH DISBURSEMENTS
Instructor’s Manual
Learning Objectives:
1. Describe the basic business activities and related information
processing operations performed in the expenditure cycle.
Questions to be addressed in this chapter include:
1. What must be done to ensure that AOE’s inventory records are
current and accurate to avoid unexpected components shortages
like those experienced at the Wichita plant?
2. How could the problems at the Dayton plant be avoided in the
future? What can be done to ensure timely delivery of quality
components?
Introduction
The expenditure cycle is a recurring set of business activities and
related data processing operations associated with the purchase of and
payment for goods and services.
Figure 11-1 on page 418 provides a context diagram of the expenditures
cycle. Note that the expenditures cycle involves the revenue cycle,
inventory cycle, various departments involved in requesting items to be
ordered, and receiving the items and the production cycle.
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Expenditure Cycle Business Activities
Figure 13-2 on page 373 provides a level 0 data flow diagram for
the expenditure cycle.
Three basic business activities in the expenditure cycle:
1. Ordering goods, supplies, and services
Order Goods
The first major business activity in the expenditure cycle (circle 1.0
in Figure 13-2) 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 as demonstrated in
the introductory AOE case:
1. Inaccurate inventory records
Alternative Inventory Control Methods
One of the key factors affecting the ordering process is the
inventory control method to be used.
We will consider three alternate approaches to inventory control:
economic order quantity (EOQ); just-in-time inventory (JIT); and
materials requirements planning (MRP).
1. Ordering Costs include all expenses associated with
processing purchase transaction.
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3. Stockout Costs are those cost that result from inventory
shortages, such as lost sales or production delays.
5. Optimal Order Size
EOQ =
C
DP2
D = Demand in units for a specified period
Materials Requirement Planning (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.
A major difference between MRP and JIT is the production
scheduling.
1. MRP systems schedule production to meet forecasted
sales; thereby creating a stock of finished goods
inventory.
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
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the goods; where they should be delivered; when they’re
needed; item numbers, descriptions, quantities, and prices;
a suggested supplier; and the department number and account
number to be charged.
The purchase requisition is received by a purchasing agent in the
purchasing department, who typically performs the purchasing
activity. The purchase requisition shown in Figure 13-4 on page
Figure 13-4 on page 379 shows a typical purchase requisition data
entry screen used in ERP systems.
Generating Purchase Orders
A crucial decision is the selection of supplier for inventory
items. Several factors should be considered in making this
decision:
1. Price
Once a supplier has been selected for a product, their identity
should become part of the product inventory master file. It’s
important to track and periodically evaluate supplier
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.
Improving Efficiency and Effectiveness
The major cost driver is the number of purchase orders processed.
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.
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Reverse auctions provide another technique to reduce purchasing-
related expenses. In reverse auctions, suppliers compete with one
another to need demand at the lowest price.
Receiving and Storing Goods
The Receiving Department accepts deliveries from suppliers. The
Receiving Department normally reports to the Warehouse Manager,
who reports to Vice President of Manufacturing. The Inventory
Stores Department, which also reports to the Warehouse Manager,
is responsible for the storage of the goods.
The receipt of goods must be communicated to the inventory
control function to update inventory records.
Verifying the quantity of delivered goods is important so the
company only pays for goods received and inventory records are
updated accurately. The receiving report, shown in Figure 13-6 on
page 385 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.
Three possible exceptions to this process are
1. Receiving a quantity of goods different from the amount
ordered
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2. Receiving damaged goods
3. Receiving goods of inferior quality that fail inspection
Improve Efficiency and Effectiveness
One way to improve the efficiency of the receiving process is to
require suppliers to bar-code their products.
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.
Paying for Goods and Services
There are two basic sub-processes involved in the payment process:
2. Actual payment of the invoices
Approve Vendor Invoices for Payment
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.
There are two basic approaches to processing vendor invoices:
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1. 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.
2. Voucher system—A disbursement voucher is also prepared
which identifies the supplier, lists outstanding
There are three advantages for using disbursement vouchers:
1. Several invoices may be paid at once (reducing number of
checks).
Accounting approves the invoice for payment by comparing the invoice
to the purchase order and receiving report. 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.
Pay Approved Invoices
The final activity in the expenditure cycle is the payment of
approved invoices.
Improving Efficiency and Effectiveness
The accounts payable process, which matches vendor invoices to
purchase orders and receiving reports, is a prime candidate for
automation.
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Using corporate credit cards for travel expenses further reduces the
number of invoices that need to be processed.
Preparing careful short-term cash budgets is useful in taking
advantage of early-payment discounts.
Finally, financial data electronic interchange (FEDI) can cut the
costs associated with paying suppliers by eliminating the need to
prepare and mail checks.
Focus 13-2 on page 389 shows dramatic improvements can often be made
simply by reengineering the accounts payable and cash disbursements
processes.
Medtronic had successfully used both Six Sigma and Lean
principles to streamline its work-flow activities and improve
product quality.
bottlenecks and redundancies.
Medtronic initiated a series of intensive 5-day projects, called
kaizen, to apply Six Sigma and Lean principles to improve
accounts payable.
Medtronic’s application of process improvement techniques yielded
a dramatic improvement in the efficiency and effectiveness of its
Accounts Payable function:
1. The time required to open the mail, sort, process, and
record vendor invoices dropped from 3 days to 1 day.
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Multiple Choice 1
The EOQ calculation that considers loss sales or production delays is:
a. carrying costs
Multiple Choice 2
The approach to managing inventory that is based on forecasted sales to
schedule production is:
a. IBM
Multiple Choice 3
Crucial operating decisions when selecting suppliers for inventory
items includes:
a. price
b. quality of materials
c. dependability of making decisions
d. all of the above
Multiple Choice 4
The document used to request that an item be ordered is the
a. purchase order
Multiple Choice 5
The major cost driver in the purchasing function is
a. the number of purchase orders processed
b. the price of the items purchased
c. the reputation of the supplier
d. none of the above.
Multiple Choice 6
A receiving report is typically not used for
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Expenditure Cycle Information Needs
The following information is needed for the following operational
tasks in the expenditure cycle:
1. Determine when and how much additional inventory to order.
2. Select the appropriate suppliers from whom to order.
The AIS needs to provide information to evaluate the following:
1. Purchasing efficiency and effectiveness
2. Supplier performance
Notice that these decisions require both financial and operating
data.
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.
Multiple Choice 7
The formula for the inventory turnover is __________ divided by the
_____.
a. net sales; inventory
Learning Objective Two
Discuss the key decisions to be made in the
expenditure cycle, and identify the information
needed to make those key business decisions.
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Control Objectives, Threats, And Procedures
In the expenditure cycle (or any cycle), a well-designed AIS should
provide adequate controls to ensure that the following objectives
are met:
1. All transactions are properly authorized.
3. All valid and authorized transactions are recorded.
5. Assets are safeguarded from loss or theft.
Order Goods
Threat 1—Stock-outs or Excess Inventory
Stockouts result in lost sales; excess inventory incurs
higher than necessary carrying costs.
Threat 2—Ordering Unnecessary Items
Companies must also beware of purchasing items that are not
currently needed.
Threat 3—Purchasing Goods at Inflated Prices
The cost of purchased components represents a substantial
portion of the total cost of many manufactured products.
Threat 4—Purchasing Goods of Inferior Quality
Sometimes purchasing goods at the lowest possible price
sacrifices quality of the goods.
Threat 5—Purchasing from Unauthorized Suppliers
Purchasing from unauthorized suppliers can result in
numerous problems. Items may be of inferior quality or
overpriced.
Threat 6—Kickbacks
Kickbacks are gifts from suppliers to purchasing agents for
the purpose of influencing their choice of suppliers.
EDI-Related Threats
Controls: Restriction of EDI access; verification and
authentication of EDI transactions; acknowledgment of EDI
Types of issues that occur when suppliers are linked to the
company’s POS system to automatically manage inventory:
1. At what point in the process can the order be
canceled?
2. Which party is responsible for the cost of return
freight if contract terms are not followed?
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3. Which party is responsible for errors in bar
codes, RFID tags, and labels?
Purchases of Services
Controls: Hold supervisors accountable for costs; compare
actual to budgeted expenses; review and audit contracts for
services.
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 7—Receiving Unordered Goods
Controls: Accept goods only when there’s an approved purchase
order.
Threat 8—Errors in Counting Received Goods
Controls: Bar-coding of ordered goods; quantities blanked out
Threat 9—Stealing Inventory
Controls: Secure storage locations for inventory;
Approve and Pay Vendor Invoices
The primary objectives of this process are to:
2. Safeguard cash.
Threat 10—Failing to Catch Errors in Vendors Invoices
Controls: Check mathematical accuracy; verify procurement card
Threat 11—Paying for Goods not Received
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Threat 12—Failing to Take Available Purchase Discounts
Controls: File and track invoices by due date; prepare cash
flow budgets.
Threat 13—Paying the Same Invoice Twice
Controls: Approve invoices only with complete voucher package;
Threat 14—Recording and Posting Errors in Accounts Payable
Controls: Data entry and processing controls; reconcile
supplier balances with control accounts.
Threat 15—Misappropriation of Cash, Checks, or EFT
Controls: Restrict access to cash, checks, and check signing
machines; use sequentially numbered checks and reconcile;
General Control Issues
Threat 16—Loss, Alteration, or Unauthorized Disclosure of Data
Threat 17—Performing Poorly
Controls: Performance reports.
Multiple Choice 8
Which of the following statements is not true?
a. Kickbacks are the most expensive form of employee corruption.
b. RFID technology is more efficient than bar codes.
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Multiple Choice 9
The following is(are) a red flag(s) that would identify suppliers
likely to represent potential problems:
a. The supplier’s address is on the invoices.
Multiple Choice 10
It is difficult to prevent fraudulent billing for services. One of the
most effective techniques is for the __________ function to
periodically conduct detailed reviews of contracts for services.
a. CPA firms
b. internal audit
c. internal control
d. accounts payable
