Ch 13: Expenditure Cycle
CHAPTER 13
THE EXPENDITURE CYCLE:
PURCHASING AND CASH DISBURSEMENTS
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
13.1 In this chapter and in Chapter 12 the controller of AOE played a major role in
evaluating and recommending ways to use IT to improve efficiency and
effectiveness. Should the company’s chief information officer make these decisions
instead? Should the controller be involved in making these types of decisions? Why
or why not?
There are several reasons why accountants should be involved in decisions about investing in IT
and not leave such decisions solely to IS professionals.
Ch. 13: The Expenditure Cycle: Purchasing and Cash Disbursements
13.2 Companies such as Wal-Mart have moved beyond JIT to VMI systems. Discuss the
potential advantages and disadvantages of this arrangement. What special controls,
if any, should be developed to monitor VMI systems?
Vendor Managed Inventory (VMI) is essentially Electronic Data Interchange (EDI) where the
retailer has given their vendor access rights to their point-of-sale (POS) system. Some of the
potential advantages and disadvantages of moving to a VMI are:
Advantages:
• Lower cost. Retailers are able to “outsource” their inventory management to their vendors.
Disadvantages:
• Cost. Retailers and vendors must incur the costs of acquiring the technology and changing
the organization to a VMI arrangement.
Controls:
The following controls could be implemented to monitor VMI systems:
1. Monitor inventory levels. At least at first, and then periodically thereafter, the retailer
2. Analyze inventory costs. If VMI is working, then overall inventory costs should decline.
3. Intrusion detection systems. To determine if the vendor has compromised the security of
the retailer’s system.
Ch 13: Expenditure Cycle
13.3 Procurement cards are designed to improve the efficiency of small noninventory
purchases. What controls should be placed on their use? Why?
Since the primary benefit of procurement cards is to give employee’s the ability to make small
non-inventory purchases necessary for their area of responsibility — be it office supplies,
computer or office equipment, or meals and/or travel expenses — a formal approval process for all
purchases would negate the benefit of the procurement card. Therefore, the focus of procurement
card controls should be on the initial issuance of the card and subsequent reviews and audits of
purchases made by employees entrusted with procurement cards.
13.4 In what ways can you apply the control procedures discussed in this chapter to
paying personal debts (e.g., credit card bills)?
Many people do not keep their credit card receipts as evidenced by receipts left at “pay–at-the-
pump” gas stations. If consumers do not keep their receipts, how do they know whether their
credit card bill is accurate? Thus, consumers should verify each charge on their bill to each
receipt.
Ch. 13: The Expenditure Cycle: Purchasing and Cash Disbursements
13.5 Should every company switch from the traditional 3-way matching process
(purchase orders, receiving reports, and supplier invoices) to the 2-way match
(purchase orders and receiving reports) used in Evaluate Receipt Settlement (ERS)?
Why (not)?
Switching to ERS simplifies accounts payable and eliminates a major source of problems:
inconsistency between supplier invoices and prices quoted when placing the order. However,
ERS requires firm commitments to prices by suppliers – which may not be feasible for certain
types of products like commodities.
13.6 Should companies allow purchasing agents to start their own businesses that
produce goods the company frequently purchases? Why? Would you change your
answer if the purchasing agent’s company was rated by an independent service, like
Consumer Reports, as providing the best value for price? Why?
The primary issue here is conflict of interest. If a purchasing manager owns a business that
supplies goods to his employer, how does the employer know that they are receiving the best
quality goods for the lowest prices? By allowing a purchasing manager to own an independent
company that supplies his employer, the employer is in effect dis-aligning the interests of the
purchasing manager with the interests of the employer. The higher the prices the supply company
charges, the more money the purchasing manager makes.
Ch 13: Expenditure Cycle
SUGGESTED ANSWERS TO THE PROBLEMS
13.1 a. A purchasing agent orders materials from a supplier that he partially owns.
• Require a purchase requisition from an operating department as authorization for
preparation of all purchase orders.
b. Receiving-dock personnel steal inventory and then claim the inventory was sent
to the warehouse.
• Count all deliveries and record counts on a receiving report.
payment.
c. An unordered supply of laser printer paper delivered to the office is accepted
and paid for because the “price is right.” After jamming all of the laser printers,
however, it becomes obvious that the “bargain” paper is of inferior quality.
• The problem here is that office employees are seldom trained about proper procedures for
d. The company fails to take advantage of a 1% discount for promptly paying a
vendor invoice.
• File invoices by discount date
Ch. 13: The Expenditure Cycle: Purchasing and Cash Disbursements
e. A company is late in paying a particular invoice. Consequently, a second invoice
is sent, which crosses the first invoice’s payment in the mail. The second invoice
is submitted for processing and also paid.
• Review related supporting voucher package or records (receiving report and
purchase order) before approving an invoice for payment.
f. Inventory records show that an adequate supply of copy paper should be in
stock, but none is available on the supply shelf.
• Count physical inventory periodically.
g. The inventory records are incorrectly updated when a receiving-dock employee
enters the wrong product number at the terminal.
• Use closed loop verification – The item number is entered as input, the system displays
h. A clerical employee obtains a blank check and writes a large amount payable to
a fictitious company. The employee then cashes the check.
• Store unused blank company checks in a secure location.
Ch 13: Expenditure Cycle
i. A fictitious invoice is received and a check is issued to pay for goods that were
never ordered or delivered.
• Program the system so that it only prints checks to approved suppliers listed in the
database
• Restrict access to the supplier master data.
j. The petty cash custodian confesses to having “borrowed” $12,000 over the last
five years.
• Create a petty cash imprest fund and only replenish it based on receipts documenting how
k. A purchasing agent adds a new record to the supplier master file. The company
does not exist. Subsequently, the purchasing agent submits invoices from the
fake company for various cleaning services. The invoices are paid.
• Restrict access to the supplier master file
Ch. 13: The Expenditure Cycle: Purchasing and Cash Disbursements
l. A clerk affixes a price tag intended for a low-end flat panel TV to a top-of-the-
line model. The clerk’s friend then purchases that item, which the clerk scans at
the checkout counter.
• Restrict access to price tags so that cashiers do not have access to price tags
13.2 Match the terms in the left column with their appropriate definition in the right
column.
Terms
Definitions
1. _n__ economic order
quantity
a. A document that creates a legal obligation to buy
and pay for goods or services.
2. __f_ materials requirements
planning (MRP)
b. The method used to maintain the cash balance in
the petty cash account.
3. _e__ Just-in-time (JIT)
inventory system
c. The time to reorder inventory based on the
quantity on hand falling to predetermined level.
4. __g_ purchase requisition
accounts payable when merchandise is returned to
a supplier.
d. A document used to authorize a reduction in
5. __b_imprest fund
e. An inventory control system that triggers
production based upon actual sales.
6. __a_ purchase order
f. An inventory control system that triggers
production based on forecasted sales.
7. _s__ kickbacks
g. A document only used internally to initiate the
purchase of materials, supplies, or services.
8. __r_ procurement card
on a two-way match of the receiving report and
purchase order.
h. A process for approving supplier invoices based
order
on a three-way match of the purchase order,
receiving report, and supplier invoice.
9. __p_ blanket purchase
i. A process for approving supplier invoices based
10. _h__ evaluated receipts
settlement (ERS)
j. A method of maintaining accounts payable in
which each supplier invoice is tracked and paid
for separately.
voucher
generates one check to pay for a set of invoices
from the same supplier.
11. __m_ disbursement
k. A method of maintaining accounts payable which
12. _q_ receiving report
l. Combination of a purchase order, receiving
Ch 13: Expenditure Cycle
13. __d_ debit memo
m. A document used to list each invoice being paid
by a check.
stockout costs.
14. _o__ vendor managed
n. An inventory control system that seeks to
15. __l_ voucher package
o. A system whereby suppliers are granted access to
point-of-sale (POS) and inventory data in order to
automatically replenish inventory levels.
16. _j__ non-voucher system
p. An agreement to purchase set quantities at
specified intervals from a specific supplier.
17. _k__ voucher system
q. A document used to record the quantities and
condition of items delivered by a supplier.
supplies.
services.
Ch. 13: The Expenditure Cycle: Purchasing and Cash Disbursements
13.3 EXCEL PROJECT. Using Benford’s Law to Detect Potential Disbursements Fraud.
a. Read the article “Using Spreadsheets and Benford’s Law to Test Accounting
Data,” by Mark G. Simkin in the ISACA Journal, Vol. 1, 2010, available at
www.isaca.org.
b. Follow the steps in the article to analyze the following set of supplier invoices:
Invoice
Number
Amount
2345
$7,845
2346
$2,977
2347
$1,395
2348
$3,455
2349
$7,733
2350
$1,455
2351
$6,239
2352
$2,573
2353
$1,862
2354
$1,933
2355
$7,531
2356
$4,400
2357
$5,822
2358
$7,925
2359
$2,100
2364
$1,799
2365
$1,450
2366
$7,925
2367
$2,839
2368
$1,588
2369
$2,267
2370
$7,890
2371
$7,945
2372
$1,724
2373
$9,311
2374
$4,719
Invoice
Number
Amount
2360
$8,256
2361
$1,863
2362
$3,375
2363
$6,221
Ch 13: Expenditure Cycle
Hint: You may need to use the VALUE function to transform the results of using the LEFT function to parse the lead digit in
each invoice amount.
Ch 13: Expenditure Cycle
To apply Benford’s law, we need to write a formula that extracts the left-most digit from an invoice
number. Excel has a number of built-in functions that can parse characters in a string. The function
LEFT(cell, n) returns the left n characters from the specified cell. Thus, in our case, Left (C4,1) returns
the left-most digit from cell C4.
However, the various character-parsing functions (LEFT, RIGHT, MID) all return their results as
text. Therefore, we need to transform that result back into a number by using the VALUE
function.
Ch 13: Expenditure Cycle
13.4 Match threats in the first column to appropriate control procedures in the second
column. More than one control may be applicable.
Threat
Control Procedure
1. _d,e__ Failing to take available purchase
discounts for prompt payment.
a. Only accept deliveries for which an
approved purchase order exists.
2. _f__ Recording and posting errors in
accounts payable.
b. Document all transfers of inventory.
3. _l__ Paying for items not received.
c. Restrict physical access to inventory.
4. __h,o_ Kickbacks.
d. File invoices by due date.
5. _b,c,g_ Theft of inventory.
e. Maintain a cash budget.
6. _m,l_ Paying the same invoice twice.
7. _g,b,c_ Stockouts.
g. Adopt a perpetual inventory system.
8. __h,i,j,o_ Purchasing items at inflated
prices.
h. Require purchasing agents to disclose
financial or personal interests in suppliers.
9. __k,q_ Misappropriation of cash.
i. Require purchases to be made only from
approved suppliers.
10. _h,i,o,p__ Purchasing goods of inferior
quality.
j. Restrict access to the supplier master data.
11. __a_ Wasted time and cost of returning
unordered merchandise to suppliers.
k. Restrict access to blank checks.
12. __n_ Accidental loss of purchasing data.
l. Only issue checks for a complete voucher
13. __j_ Disclosure of sensitive supplier
information (e.g., banking data).
m. Cancel or mark “Paid” all supporting
documents in a voucher package when a
check is issued.
n. Regular backup of the expenditure cycle
database.
o. Train employees how to respond properly
to gifts or incentives offered by suppliers.
p. Hold purchasing managers responsible for
costs of scrap and rework.
other than the cashier.
Ch. 13: The Expenditure Cycle: Purchasing and Cash Disbursements
13.5 Use Table 13-2 to create a questionnaire checklist that can be used to evaluate
controls for each of the basic activities in the expenditure cycle (ordering goods,
receiving, approving supplier invoices, and cash disbursements).
a. For each control issue, write a Yes/No question such that a “No” answer
represents a control weakness. For example, one question might be “Are
supporting documents, such as purchase orders and receiving reports, marked
“paid” when a check is issued to the vendor?”
A wide variety of questions is possible. Below is a sample list:
Question
Yes
No
1. Is access to supplier master data restricted?
2. Are additions to supplier master data regularly reviewed and all changes
investigated?
3. Is sensitive data encrypted while stored in the database?
4. Does a backup and disaster recovery plan exist?
5. Have backup procedures been tested within the past year?
6. Are appropriate data entry edit controls used?
7. Is a perpetual inventory maintained?
8. Are physical counts of inventory taken regularly and used to adjust the
perpetual inventory records?
9. Are competitive bids used when ordering expensive items?
suppliers?
11. Are budgets set for service expenses and are variances investigated?
12. Is the system configured to generate purchase orders only to suppliers
listed in the database?
13. Are receiving dock employees trained to accept deliveries only when an
approved purchase order exists?
14. Are receiving dock employees trained about the importance of
accurately counting all items delivered?
15. Do receiving dock employees inspect all deliveries for quality?
10. Are purchasing agents required to disclose financial interests in
16. Do both receiving dock employees and inventory control employees
sign off on the transfer of items?
17. Is physical access to inventory restricted?
18. Are invoices only approved for payment when accompanied by both a
purchase order and receiving report?
19. Is supporting documentation cancelled or marked “Paid” when a check
is generated?
20. Are invoices filed by due date (adjusted for any discounts for early
payment)?
21. Is access to blank checks restricted?
22. Is access to the EFT system restricted?
issuing checks?
Ch 13: Expenditure Cycle
b. For each Yes/No question, write a brief explanation of why a “No” answer represents a
control weakness.
Question
Reason a “No” answer represents a weakness
1
Unrestricted access to supplier master data could facilitate fraud by allowing the creation of
fake suppliers to whom checks can be issued.
2
Failure to investigate all changes to supplier master data may allow fraud to occur because
unauthorized suppliers may not be detected.
3
Failure to encrypt sensitive data can result in the unauthorized disclosure of banking-related
information about suppliers.
5
If the backup plan is not tested regularly, it may not work.
6
Without proper data entry edit controls, errors in purchasing, receiving, and paying suppliers
can occur.
7
Without a perpetual inventory system, shortages and excess inventory is more likely.
8
Without periodic physical counts, the perpetual inventory records are likely to be incorrect.
9
Without competitive bids, purchases may be at higher than necessary prices.
10
kickbacks and other forms of fraud.
11
Without budgets and analyses of services expenses, these expenses can be fraudulently
inflated to cover up fraud.
Non-disclosure of personal interests in suppliers creates a conflict of interest and may lead to
14
Failure to count deliveries accurately will create errors in inventory records and may result in
paying for goods not received.
15
Failure to inspect the quality of goods at the receiving dock increases the risk of production
delays when the problem is discovered later.
16
assigning responsibility for any shortages.
Inadequate physical security increases the risk of theft of inventory.
Failure to cancel supporting documents can result in paying the same invoice twice.
20
Failure to file invoices by due date increases the risk of not taking advantage of discounts for
Unrestricted access to blank checks increases the risk of misappropriation of funds.
Unrestricted access to the EFT system increases the risk of misappropriation of funds.
Failure to acknowledge the transfer of goods increases the risk of loss and precludes
Ch 13: Expenditure Cycle
13.6 EXCEL PROJECT
a. Expand the cash budget you created in Problem 12.4 to include a row for expected cash outflows equal to 77% of the
current month’s sales.
b. Also add a row to calculate the amount of cash that needs to be borrowed, in order to maintain a minimum cash
balance of $50,000 at the end of each month.
Ch 13: Expenditure Cycle
Explanation of solution: