Chapter 5

CHAPTER 5
• Most business entities operate on a credit basis and do not pay for resources until after
acquiring them. The time lag between these events splits the procurement process into two
phases:
o the physical phase, involving the acquisition of the resource
o the financial phase, involving the disbursement of cash.
• This chapter examines the principal features of the two major subsystems that constitute the
expenditure cycle:
o the purchases processing subsystem
o the cash disbursements subsystem
The Conceptual System
OVERVIEW OF PURCHASES AND CASH DISBURSEMENTS ACTIVITIES
o In this section, we examine the expenditure cycle conceptually.

o Using data flow diagram (DFD) as a guide, will trace the purchases processing cash
disbursements procedures.
o Chapter 4, the conceptual system discussion is intended to be technology-neutral
PURCHASES PROCESSING PROCEDURES
Purchases procedures include the tasks involved in identifying inventory needs, placing the order,
receiving the inventory, and recognizing the liability.
o Manufacturing firms purchase raw materials for production, and their purchasing decisions
are authorized by the production planning and control
o Merchandising firms purchase finished goods for resale. The inventory control function
provides the purchase authorization for this type of firm.
1. 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).
• When inventories drop to a predetermined reorder point, a purchase requisition is
prepared and sent to the prepare purchase order (PO) function to initiate the purchase
process.
• For efficiency and control purposes, the purchase requisition contains routine ordering
information taken from the inventory subsidiary ledger and valid vendor file. This includes
the name and address of the primary supplier, the economic order quantity of the item, and
the standard or expected unit cost of the item.
• The valid vendor file provides an important control by listing only approved vendors. This
helps to reduce certain vendor fraud schemes such as an agent buying from suppliers with
whom he or she has a relationship (a relative or friend) or buying at excessive prices from
vendors in exchange for a kickback or bribe.
2. PREPARE PURCHASE ORDER

a. The prepare purchase order function receives the purchase requisitions, which are then
sorted by the vendor if necessary.
b. Next a purchase order (PO), which is illustrated in Figure 5-3, is prepared for each
vendor.
c. A copy of the PO is sent to the vendor. In addition, a copy is sent to the set up accounts
payable (AP) function for filing temporarily in the AP pending file,
d. and a blind copy is sent to the receive goods function, where it is held until the
inventories arrive.
e. The last copy is filed in the open/closed purchase order file.
3. RECEIVE GOODS
a. Most firms encounter a time lag (sometimes a significant one) between placing the
order and receiving the inventory. During this time, the copies of the PO reside in
temporary files in various departments.
b. Note that no economic event has yet occurred. At this point, the firm has received no
inventories and incurred no financial obligation.
c. Hence, there is no basis for making a formal entry into any accounting record.
Companies will often, however, make memo entries of pending inventory receipts and
associated obligations.
d. The blind copy, contains no quantity or price information about the products being
received.
e. The purpose of the blind copy is to force the receiving clerk to count and inspect
inventories prior to completing the receiving report.
f. The blind copy is an important control in reducing this ris
g. Upon the completion of the physical count and inspection, the receiving clerk prepares a
receiving report, stating the quantity and condition of the inventories.
h. Receiving report accompanies the physical inventories to either the raw materials
storeroom or finished goods warehouse for safekeeping.
i. Another copy is filed in the open/closed PO file to close out the PO.
j. The third copy of the receiving report is sent to the set up account payable function,
where it is filed in the AP pending file.
k. The fourth copy of the receiving report is sent to inventory control for updating the
inventory records.
l. Finally, a copy of the receiving report is placed in the receiving report file.
4. UPDATE INVENTORY RECORDS

a. Depending on the inventory valuation method in place, the inventory control procedures
may vary somewhat among firms.
b. Organizations that use a standard cost system carry their inventories at a predetermined
standard value regardless of the price actually paid to the vendor.
c. Posting to a standard cost inventory ledger requires only information about the
quantities received.
d. Updating an actual cost inventory ledger requires additional financial information, such
as a copy of the supplier's invoice when it arrives.
5. 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.
• When the invoice arrives, the AP clerk reconciles the financial information with the receiving
report and PO in the AP pending file. This is called a three-way match, which verifies that
what was ordered was received and is fairly priced.
• Once the reconciliation is complete, the AP clerk prepares an AP packet, which consists of
the supporting documents (PO, receiving report, and invoice), and files the AP packet in the
open AP file.
• Once reconciled, the AP packet is the formal authority to record the liability and to
subsequently make payment.
• AP CLERK- Perpetual Inventory Method: DEBIT: INVENTORY-CONTROL, CREDIT: AP
CONTROL
• PERIODIC: DEBIT: PURCHASES, CREDIT: AP CONTROL
VOUCHERS PAYABLE SYSTEM
• As an alternative to the AP procedures described in the previous section, some firms use a
vouchers payable system.
• Under this system, the AP department uses cash disbursement vouchers and maintains a
voucher register.
• After the AP clerk performs the three-way match, he or she prepares a cash disbursement
voucher to approve payment.
• Vouchers provide improved control over cash disbursements and allow firms to consolidate
several payments to the same supplier on a single voucher.
• The voucher register reflects the AP liability of the firm; the sum of the unpaid vouchers in the
register (those with no check numbers and paid dates) is the firm’s total AP balance.
• The AP clerk files the cash disbursement voucher, along with supporting source documents, in
the voucher payable file.
• Voucher Payable File: this file is equivalent to the open AP File.
1. POST TO GENERAL LEDGER

a. The general ledger function receives a journal voucher from the AP department and an
account summary from inventory control.
b. The general ledger function posts the data contained in the journal voucher to the
inventory and AP control accounts and reconciles the inventory control account.
THE CASH DISBURSEMENTS SYSTEM
• The cash disbursements system 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.
1. IDENTIFY LIABILITIES DUE.

a. The cash disbursements process begins in the AP department, where each day the AP
clerk reviews the open AP file for items due for payment.
b. AP FILE: this file is organized by payment due date to ensure that debts are paid on the
last possible date with out missing due dates and losing discounts.
c. The clerk sends payment approval in the form of the AP packet (PO, receiving report,
and supplier’s invoice) to the cash disbursements department.
2. PREPARE CASH DISBURSEMENT

a. The cash disbursements clerk receives the AP packet and reviews the documents for
completeness and clerical accuracy.
b. For each disbursement, the clerk prepares a check and records the check number, dollar
amount, and other pertinent data in the check register, which is also called the cash
disbursements journal.
c. Depending on the organization’s materiality threshold, the check may require additional
approval by the cash disbursements department manager or treasurer (not shown in
Figure 5-10)
d. The negotiable portion of the check is mailed to the supplier, a copy of it is attached to
the Ap packet as proof of payment; and a check copy is filed in the department.
e. The clerk marks the documents in the packet paid and returns them to the AP clerk.
f. Finally, the cash disbursements clerk summarizes the entries made to the check register
and sends a journal voucher with the following journal entry in to the general ledger
function:
DEBIT: ACCOUNTS PAYABLE
CREDIT: CASH
3. UPDATE AP RECORD
a. Upon receipt of the paid AP packet, the AP clerk removes the liability by debiting the
vendor’s AP subsidiary ledger account.
b. The AP packet is then filed in the closed AP file, and an account summary is prepared
and sent to the general ledger function.
4. POST TO GENERAL LEDGER
a. The general ledger function receives the journal voucher from cash disbursements and
the AP account summary from accounts payable.
b. The voucher shows the total reductions in the firm’s obligations and cash account as a
result of payments to suppliers.
c. These numbers are reconciled with the AP summary, and the AP control and cash
accounts in the general ledger are updated accordingly.
d. The approved journal voucher is then filed.
e. This concludes the cash disbursements procedures.

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Chapter 5

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CHAPTER 5

The Conceptual System

OVERVIEW OF PURCHASES AND CASH DISBURSEMENTS ACTIVITIES

o In this section, we examine the expenditure cycle conceptually.

PURCHASES PROCESSING PROCEDURES

2. PREPARE PURCHASE ORDER

4. UPDATE INVENTORY RECORDS

5. SET UP ACCOUNTS PAYABLE

VOUCHERS PAYABLE SYSTEM

1. POST TO GENERAL LEDGER

THE CASH DISBURSEMENTS SYSTEM

1. IDENTIFY LIABILITIES DUE.

2. PREPARE CASH DISBURSEMENT

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