CHAPTER 5: THE EXPENDITURE CYCLE

Part I: Purchases and Cash Disbursements Procedures

Objective of the Expenditure Cycle:

- Convert the organization’s cash into physical materials and the human resources
it needs to conduct business.

The Conceptual System of Expenditure Cycle

- These are the concepts and steps needed to be done to manage the expenditure
of the business and examine specific documents needed for the processes.

Purchasing Processing Procedures

- Includes tasks involved in identifying inventory needs, placing the order, receiving
the inventory, and recognizing the liability.

- These are the steps that a firm follows to acquire goods and services.

1. Monitor Inventory Records – As the inventories of a firm or business drop to a

predetermined reorder point, a purchase requisition is prepared and sent to
prepare the purchase order function to start the purchase process.

o Reorder point (ROP) – it is the minimum inventory or stock for a product

that initiates the reordering of that product.

o Purchase requisition – a document used to request a purchase of a

product or services.
2. Prepare Purchase Order – its function is to receive the purchase requisition and
sorted by a vendor if necessary.

A purchase order (PO) is prepared for each vendor. It is a document issued by a

buyer to a seller (vendor) indicating the types, quantities, agreed prices for the
products or services that the buyer intend to purchase.
Valid Vendor File

- Consists of name and address of the primary supplier, the economic order quantity
of the item and the standard and expected unit cost of the item.

Steps in Preparing Purchase Order:

1. Receive the purchase requisition
2. Prepare a Purchase Order (PO)
3. Send a copy of Purchase Order to the vendor &
4. Send a copy of Purchase Order to set up Accounts Payable (AP) Function

The last copy of Purchase Order will be filed in the Open/Closed Purchase Order
File to record the transaction.

3. Receive Goods – As the goods arrived from the vendor, it is accompanied with
the Blind Copy of the PO.

o Upon the completion of physical count and inspection of the goods arrive,
the receiving clerk prepares a Receiving Report stating the quantities and
conditions of the inventories.
 o A copy of Receiving Report is sent to:

i. Warehouses/Storage areas
ii. Open/Closed PO File
iii. Accounts Payable department to be files at AP pending file
iv. Inventory control department
v. Placed in Receiving Report File

4. Update Inventory Records – The Inventory Control Department updates the

inventory records as they receive the receiving report file.

There are two inventory valuation methods used by different

organization/business firms:

 STANDARD COST SYSTEM

o It consist of quantity of the items or goods received at predetermined cost.

 ACTUAL COST SYSTEM

o Similar to Standard Cost System but it contains other cost that is included
by the vendor when they are sending the invoice to the buyer.
5. Set Up Accounts Payable –

 The Accounts Payable clerk will record the transaction when the supplier’s
invoice is received.

 The AP clerk will match the purchase order and receiving report file to the
supplier’s invoice to determine if the items purchased and received are fairly
priced.

 The AP clerk will record the transaction in the purchases journal and posted
to the supplier’s account in the Accounts Payable Subsidiary Ledger.

 The AP clerk will send a copy of supplier’s invoice to the Inventory Control
when the firm uses the Actual Cost System.

 All of the source documents were will be transferred to OPEN AP FILE after
recording the liability.

 Finally, the AP clerk will summarize the entries in the purchases journal for the
period (or batch) and prepares a Journal Voucher for the General Ledger
Function.
- involves receiving and temporarily filing copies of the PO and receiving report. The
organization incurs an obligation to pay for the goods received from the vendor,
but the liability is not recorded until the invoice arrives. The AP clerk reconciles the
financial information with the receiving report and PO to ensure that what was
ordered was received and is fairly priced, and records the transaction in the
purchases journal and supplier's account in the AP subsidiary ledger. The source
documents are transferred to the open AP file, organized by payment due date
and scanned daily to ensure debts are paid on time. Finally, the AP clerk
summarizes the entries in the purchases journal for the period and prepares a
journal voucher for the general ledger function.

The Accounts Payable clerk needs to send a copy of the supplier's invoice to the
Inventory control department when using the Actual cost system because the
Actual cost method values inventory based on the actual cost of goods received,
which includes the cost of the products as well as any associated costs, such as
freight and handling fees. To ensure that the inventory control system is updated
with the correct cost information, a copy of the supplier's invoice is required. This
allows the Inventory control department to accurately track the cost of inventory
and update the inventory valuation accordingly.
Voucher Payable System

- Used by other firms to manage and organized the accounts payable in an efficient
manner.
- Under this system, the AP department uses cash disbursement vouchers and
maintains a voucher register
- Vouchers are used to consolidate the accounts payable in chronological order to
reduce multiple checks to be written.
- Vouchers are subject for approval of the management.
- Voucher Register reflects the AP liability of the firm
- The AP clerk will files the cash disbursement voucher along with supporting
documents in the Vouchers Payable File

The voucher payable system is a method used by organizations to process and manage
accounts payable. In this system, a voucher is created for each invoice received from a
supplier. The voucher typically includes information such as the supplier name, invoice
number, invoice date, and the amount owed. The voucher is then approved by an
authorized individual, such as a manager or department head, to ensure that the invoice
is valid and the amount owed is accurate.

Once approved, the voucher is entered into the accounting system, and a payment is
issued to the supplier. The voucher payable system allows organizations to track and
manage their accounts payable in an organized and efficient manner, ensuring that
payments are made on time and that the organization maintains positive relationships
with its suppliers. It also helps to prevent duplicate payments and fraudulent invoices by
requiring approval before payment is issued.
6. Post to General Ledger –
 The general ledger function receives a journal voucher from the AP
department and an account summary from inventory control.

 Then the journal voucher, inventory and AP control accounts, reconciled

inventory control account and inventory subsidiary summary, were posted
to the General Ledger.

 The approved journal vouchers are posted to the journal voucher file.
Other info:

Bill and invoice are similar in that they both represent a request for payment for goods or
services provided. However, there are some subtle differences between the two:

 A bill is generally used to refer to a request for payment before the payment is due,
while an invoice is typically used to refer to a request for payment after the payment
is due.

 Bills are commonly used in everyday transactions such as at restaurants, while

invoices are typically used in business-to-business transactions.

 An invoice typically includes more detailed information about the goods or services
provided, such as the quantity, unit price, total price, and any taxes or discounts
applied.
  Overall, while bill and invoice can be used interchangeably in some contexts, they
do have some distinctions in meaning and usage.

CASH DISBURSEMENTS SYSTEMS

- Processes the payment of obligations in the purchase system.

- It is important internal control system as it prevent errors, fraud, and misuse of

funds. Only the valid creditors receive payments timely and correctly.

When an organization pays its bills early, it is essentially paying its vendors or suppliers
before the payment due date. By doing so, the organization forgoes the opportunity to
hold onto its cash and earn interest income on that cash until the payment due date
arrives. This is because when the organization pays early, it is effectively transferring its
cash to the vendor or supplier, and the cash is no longer available for investment or other
uses.

For example, let's say an organization has a bill due in 30 days for $10,000. If the
organization pays the bill early, say in 10 days, it will not have the use of that $10,000 for
the remaining 20 days until the payment due date. If the organization had instead invested
that $10,000 in an interest-bearing account, it could have earned interest income during
that 20-day period.

However, there may be other reasons why an organization chooses to pay its bills early,
such as to take advantage of early payment discounts, maintain good relationships with
vendors, or to simply reduce the administrative burden of managing and tracking
payments. Ultimately, the decision to pay bills early or not depends on a variety of factors,
including the organization's cash flow needs, investment opportunities, and financial
goals.
PROCESSES IN CASH DISBURSEMENT SYSTEM

1. Identify Liabilities Due

- Items that come due in the AP department must be identified. AP function

looks on the open AP file (vouchers payable file).

- Creates a voucher packet (voucher and supporting documents) as

payment approval and sent to the cash disbursements department

2. Prepare Cash Disbursement

- The cash disbursement clerk receives the voucher packet and examines it
to verify its completeness.

- The cash disbursement clerk prepares a check and records the check
number, amount to be paid, voucher number, and other relevant data to
the Check register (cash disbursements journal).
- Once the check is approved by CD department manager, the supplier
receives the check.

- A copy of the check is attached to the voucher packets as proof of

payment, marks the voucher packets paid, and returned to the AP file.

- Cash disbursement clerk created a journal voucher to the general ledger

department with the following entry:
3. Update AP Record

- AP clerk removes the liability by debiting the AP subsidiary account or

recording the check number and payment date in the voucher register.

- Voucher packet is filed in the closed voucher file

- Account summary is filed in the general ledger function.

4. Post to General Ledger

- Journal voucher from the cash disbursements department and the

Account summary from Accounts Payable department are received by the
general ledger department and updates the general ledger.
Documents in Cash Disbursement System:
PHYSICAL SYSTEMS: MANUAL SYSTEM OF PURCHASE SYSTEM

 Inventory Control
 Purchasing Department
 Vendor
 Receiving Department
 Accounts Payable Department
 General Ledger Department

PHYSICAL SYSTEMS: MANUAL SYSTEM OF CASH DISBURSEMENT SYSTEMS

 Accounts Payable Department

 Cash Disbursements Department
 General Ledger Department
Internal Control Summary (Purchase and Cash Disbursements System)

1. Transaction Authorization

 Purchase system
o monitors inventory levels
o formally authorize the purchase requisition

Risks:

- Unauthorized purchasing can result to excessive inventory levels.

 Cash disbursement System

o Accounts Payable function authorizes cash disbursements via cash
disbursement voucher
o Only the AP function is authorized to create checks.

Risk:

- Unauthorized check and cash disbursements vouchers

2. Segregation of Duties

 Purchase System
- Inventory control keeps detailed records of assets
- Warehouses has the custody of the assets.
- auditor compares inventory records to the physical inventory
 Cash Disbursement System
- Separate AP subsidiary ledger, cash disbursements, and general ledger
function to avoid fraud. If there is only one person is responsible and
 authorize for creating checks, posting to designated accounts in the
general ledger, and maintain the accounts payable function, that
employee can manipulate all the records that is used in audit trails.

- "Kaya ng iisang tao na manipulahin ang lahat ng records at kayang

makagawa ng fraudelent transactions."

3. Supervision
- Receiving areas should have supervisors to check the goods received
from the vendor. This reduce the risks of failure in inspecting the
physical count of the assets and theft of assets.

- Inspection of assets is needed to verify that the actual number of the

goods received (physical count) is matched according to the purchased
order. That is why the receiving clerk is receiving blind purchase order
copy because it will force him to manually check the actual amount of
goods received.

- Inspection on the assets is important to avoid theft. Improper inspections

along with inadequate supervision can lead to the theft or loss in the
inventories while being transported to the warehouse.

4. Accounting Records

 Both for Purchase and Cash Disbursement System

- Accounting records such as Accounts Payable Subsidiary Ledger,
General Ledger, voucher register, and check register are used to create
an audit trail for internal control.
 - These accounting records should be kept so it can be used to check
unrecorded transactions or misstated financial information.
5. Access Control
- Cash and inventories should be accessed only by the authorized
personnel. Direct access controls include the use of alarms, locks, and
restricted access.

- The firm must limit access to the documents that controls its physical
assets, such as purchase requisition, Purchase order form, etc. Having
this documents unsecured can lead to fraud because the documents
are legitimate.

6. Independent Verification

 Purchase System
- Accounts Payable clerk must compare the source documents and the
records that he receive such as Purchase order, receiving report, and
supplier's invoice.
 Cash Disbursement
- General Ledger function compares the journal vouchers and summary
reports from inventory control. By this, the GL function can verify the
total obligations recorded are equal to the total inventories received, and
the total reductions in Accounts Payable are equal to total cash
disbursements.

- "Kinukumpara yung records kung tugma or balance yung amounts nila"

THE PAYROLL SYSTEM

- Payroll processing is actually a special-case purchases system in which

the organization purchases labor rather than raw materials or finished
goods for resale.

- Used to control employee pay, including wages, salaries, bonuses,

deductions, and net pay. Calculating and distributing employee pay as
well as managing taxes, benefits, and other withholdings are all part of it.

SPECIALIZED PROCEDURES OF PAYROLL SYSTEM

- It has different procedures to apply for hourly employees, salaried employees,

piece workers, and commissioned employees.
- Payroll activities are discrete events that occurs, weekly, biweekly, or monthly.
- Writing checks to employees requires special controls.

The Conceptual Payroll System

1. Personnel Department
- Prepares and submits personnel action form to prepare the payroll
function.

Personnel action form is a Human Resource department form that is

used to update the information of an employee and the transactions that
the employee made during his employment.
2. Production Department
- Prepares the job tickets and time cards
- Job tickets records how long did the individual workers spend on each
production job. “oras na kinonsumo ng isang manggagawa sa isang
production (per piece, per unit)”

- Time cards records how long is the time the employee is at work. “gaano
katagal nagtatrabaho ang isang manggagawa.”

- Cost accounting department have Work-in Progress (WIP) accounts

that allocates the direct labor charges.

3. Update WIP Accounts

- After cost accounting allocates labor costs to the WIP accounts, the
charges are summarized in a labor distribution summary and forwarded
to the general ledger function.

4. Preparation of Payroll
- The data from personnel and production department such as pay rate,
hours-worked data of employees
- The payroll department do the following tasks:

i. Prepares the payroll register that shows gross pay, deductions,

overtime pay, and net pay of an employee.

ii. This information is entered into the employee payroll records.

iii. Sends the paychecks to the distribute paycheck function

iv. Files the time cards, personnel action form, and copy of the payroll
register.
5. Distribution of Paychecks
- Payroll fraud includes submitting time sheets for fictitious workers. To
avoid this, many companies disburse paychecks to employees through a
paymaster.

- The paymaster is not a part of the payroll authorization or preparation

process; they are not a part of the payroll process. In the event that a
legitimate employee fails to claim their check, the paymaster returns the
check to payroll. The reason why the check was not cashed can then be
looked into.

6. Prepares the Accounts Payable

- The accounts payable (AP) clerk reviews the payroll register for
correctness and prepares copies of a cash disbursement voucher for the
amount of the payroll.

- The clerk records the voucher in the voucher register and submits the
voucher packet (voucher and payroll register) to cash disbursements.

- A copy of the disbursement voucher is sent to the general ledger function.

7. Preparation of Cash Disbursement

- Upon receipt of the voucher packet, the cash disbursements function
prepares a single check for the entire amount of the payroll and deposits it
in the payroll imprest account.

- Payroll imprest account is where the employee paychecks are drawn,

which is only for payroll.
 - Funds must be transferred from the general cash account to this imprest
account before the paycheck can be cashed.

- The clerk sends a copy of the check along with the disbursement voucher
and the payroll register to the AP department, where they are

- Finally, a journal voucher is prepared and sent to the general ledger

function.

8. Updating the General Ledger

- The general ledger function receives the labor distribution summary from
cost accounting, the disbursement voucher from AP, and the journal
voucher from cash disbursement.

- With this information, the general ledger clerk makes the accounting
entries:
 From the labor Distribution Summary
 From Disbursement voucher

- The debits and credits from these entries must equal. If they do not, there
is an error in the calculation of either labor distribution charges or payroll.
When the equality has been verified, the clerk files the voucher and labor
distribution summary.
Other Info:

A payroll system is a process that a company uses to manage employee

compensation, including wages, salaries, bonuses, deductions, and net pay. It
involves calculating and distributing employee payments, as well as handling
taxes, benefits, and other withholdings.

A typical payroll system includes several steps:

1. Collecting employee time and attendance data

2. Calculating employee gross pay based on hours worked and pay rate

3. Deducting taxes, benefits, and other withholdings from gross pay

4. Calculating net pay, which is the final amount an employee receives after all
deductions are made

5. Issuing payments to employees through direct deposit or check

6. Recording payroll transactions in the company's financial records and reporting

payroll expenses to government agencies.

Payroll systems can be managed in-house or outsourced to a third-party

provider. Automated payroll systems can streamline the process, reduce errors,
and save time and money for the company. Additionally, accurate and timely
payroll processing is crucial to maintaining employee satisfaction and compliance
with government regulations.
Documents in Payroll System:
PHYSICAL SYSTEM: MANUAL SYSTEM OF PAYROLL SYSTEM

- Production Department
- Cost Accounting Department
- Payroll Department
- Accounts Payable Department
- Cash Disbursements Department
- General Ledger Department

1. Payroll authorization and hours worked enter the payroll department from two
different sources:

- personnel and production.

2. The payroll department reconciles this information, calculates the payroll, and
distributes paychecks to the employees.

3. Cost accounting receives information regarding the time spent on each job from
production. This is used for posting to work - in process (WIP) account.

4. AP receives payroll summary information from the payroll department and authorizes
the cash disbursements department to deposit a single check, in the amount of the total
payroll, in a bank imprest account on which the payroll is drawn.

5. The general ledger department reconciles summary information from cost accounting
and AP. Control accounts are updated to reflect these transactions.
PAYROLL INTERNAL CONTROLS

 Transaction Authorization
- To prevent this, the personnel action form helps payroll keep the employee
records current. This document describes additions, deletions, and other
changes to the employee file and acts as an important authorization control
to ensure that only the time cards of current and valid employees are
processed.

 Segregation of Duties
- The time-keeping function and the personnel function should be separated.

- The personnel function provides payroll with pay rate information for authorized
hourly employees. Typically, an organization will offer a range of valid pay rates
based on experience, job classification, seniority, and merit. If the production
(time-keeping) department provided this information, an employee might submit a
higher rate and perpetrate a fraud.

- AP reviews the work done by payroll (payroll register) and approves payment.

- Cash disbursements then writes the check to cover the total payroll.

- None of the employee paychecks is a negotiable instrument until the payroll

check is deposited into the imprest account

 Supervision
- Sometimes employees will clock in for another worker who is late or
absent. Supervisors should observe the time-keeping process and
reconcile the time cards with actual attendance.
 Accounting Records
- The audit trail for payroll includes the following documents:

1. Time cards, job tickets, and disbursement vouchers.

2. Journal information, which comes from the labor distribution

summary and the payroll register.

3. Subsidiary ledger accounts, which contain the employee records

and various expense accounts.

4. The general ledger accounts: payroll control, cash, and the

payroll clearing (imprest) account.

 Access Controls
- The assets associated with the payroll system are labor and cash. Both
can be misappropriated through improper access to accounting records. A
dishonest individual can misrepresent the number of hours worked on the
time cards and thus embezzle cash. Similarly, control over access to all
journals, ledgers, and source documents in the payroll system is
important, as it is in all expenditure cycle systems.

 Independent Verification
- The following are examples of independent verification controls in the
payroll system:

1. Verification of time. Before sending time cards to payroll, the

supervisor must verify their accuracy and sign them.
2. Paymaster. The use of an independent paymaster to distribute
checks (rather than the normal supervisor) helps verify the
existence of the employees. The supervisor may be party to a
payroll fraud by pretending to distribute paychecks to nonexistent
employees.

3. Accounts payable. The AP clerk verifies the accuracy of the

payroll register before creating a disbursement voucher that
transfers funds to the imprest account.

4. General ledger. The general ledger department provides

verification of the overall process by reconciling the labor
distribution summary and the payroll disbursement voucher.
FIXED ASSETS SYSTEM

- Processes transactions such as acquisition, maintenance, and disposal of

fixed assets.

- The fixed asset system is designed to process the acquisition of fixed

assets, maintain accurate accounting records, provide management with
information, and properly record the retirement and disposal of fixed
assets.

ASSETS ACQUISITION

 Asset acquisition usually begins with the departmental manager (user)

recognizing the need to obtain a new asset or replace an existing one.
Authorization and approval procedures over the transaction will depend on the
asset's value.

 Department managers typically have authority to approve purchases below a

certain materiality limit.

 Capital expenditures above the limit will require approval from the higher
management levels.

 Once the request is approved and a supplier is selected, the receiving

department delivers the asset into the custody of the user.

 Second, the fixed asset department performs the record-keeping function.

ASSET MAINTENANCE

 Asset maintenance involves adjusting the fixed asset subsidiary account

balances as the assets (excluding land) depreciate over time or with usage.

 Standard depreciation methods in use are straight line, sum-of-the-years' digits,

double-declining balance, and production units. The method of depreciation and
the period used should reflect, as closely as possible, the asset's actual decline
in utility to the firm.

 The depreciation of fixed assets used to manufacture products is charged to

manufacturing overhead and then allocated to WIP.

 An important record used to initiate this task is the depreciation schedule. It will
be prepared by the system for each fixed asset in the fixed asset subsidiary
ledger. A depreciation schedule shows when and how much depreciation to
record. It also shows when to stop taking depreciation on fully depreciated
assets.

 Asset maintenance also involves adjusting asset accounts to reflect the cost of
physical improvements that increase the asset's value or extend its useful life.
Finally, the fixed asset system must promote accountability by keeping track of
the physical location of each asset.

 When one department transfers custody of an asset to another department,

information about the transfer should be recorded in the fixed asset subsidiary
ledger. Each subsidiary record should indicate the current location of the asset.
The ability to locate and verify the physical existence of fixed assets is an
important component of the audit trail.
ASSET DISPOSAL

 When an asset has reached the end of its useful life or when management
decides to dispose of it, the asset must be removed from the fixed asset
subsidiary ledger.

 It begins when the responsible manager issues a request to dispose of the asset.
Like any other transaction, the disposal of an asset requires proper approval.

 The disposal options open to the firm are to sell, scrap, donate, or retire the asset
in place.

 A disposal report describing the final disposition of the asset is sent to the fixed
asset accounting department to authorize its removal from the ledger.
INTERNAL CONTROLS IN FIXED ASSETS SYSTEM:

 Transaction Authorization
o Fixed asset acquisitions should be formal and authorized by a written
request from the user or department, with an independent approval
process that evaluates the merits of the request on a cost-benefit basis.

 Supervision
o Management supervision is essential for the physical security of fixed
assets, as they are more susceptible to theft and misappropriation than
inventories in a warehouse.

o Supervisors must ensure that fixed assets are being used in accordance
with the organization's policies and business practices, such as
microcomputers, company vehicles, and personal use.

 Independent verification
o The internal auditor should review asset acquisition and approval
procedures, verify the location, condition, and fair value of fixed assets,
and review automatic depreciation charges for accuracy and
completeness.