Chapter 11 the expenditure cycle: purchasing and cash disbursements




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Accounting Information Systems

CHAPTER 11


THE EXPENDITURE CYCLE:

PURCHASING AND CASH DISBURSEMENTS


SUGGESTED ANSWERS TO DISCUSSION QUESTIONS


11.1 There are several reasons why accountants should be involved in decisions about investing in IT and not leave such decisions solely to IS professionals. First, the economic merits of proposed IT investments need to be subjected to the same kind of detailed analysis as any other major capital investment (e.g., plant expansions). Accountants are skilled in making such analyses. Second, the operational feasibility of IT investments must also be evaluated. How will the investment affect daily operating procedures? Will the system be able to adapt as the company changes the nature of its operations? As one of the major users of the information system, accountants need to participate in these analyses. Third, at what stage of the life cycle is the proposed system? In other words, will the system soon become obsolete? Fourth, what are the risks that either employees or customers will be unhappy with the new system? Finally, what is the long-run viability of the proposed supplier? Here again accountants can make a valuable contribution by analyzing the long-run economic viability of proposed vendors.


11.2 The 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 essentially “outsource” their inventory management to their vendors.

Potentially reduced lost sales – provided that the vendors are able to meet product demand.

More accurate forecasts – since vendors have more data from the retailers, they are able to more accurately forecast and meet demand for their products.


Disadvantages:


Cost – the retailers and vendors must expend the resources necessary to acquire the technology and incur the costs of changing the organization to a VMI arrangement.


Security – The vendors have significant access to retailer data. The retailer puts one of their most valuable assets, their sales data, in the hands of their vendors. Such access opens the door to a myriad of data and system security issues such as data alteration and deletion, unauthorized access to non-sales related data, inadvertent loss of data or even corporate espionage.


Over supply – the vendor could ship more inventory than the retailer needs to meet demand.


Controls:


The following are a list of potential controls that could be implemented to monitor VMI systems:


  1. At least at first and then periodically thereafter, the retailer should monitor inventory levels to determine whether the vendor is sending enough inventory to prevent stock outs but not too much inventory that is slow to sell.

  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.

  4. Unauthorized access attempts to non-VMI related areas of the retailer’s system.



11.3 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, meals and/or travel expenses, a formal approval process for all purchases would negate the benefit of the procurement card. Therefore, the controls for procurement cards should be focus on the initial issuance of the card and subsequent reviews and audits of purchases made by employees entrusted with procurement cards. Employees receiving cards must be properly trained in their proper use and in the procurement card controls implemented by the organization. If employees know that any purchase they make can be the subject of subsequent review and audit, they are more likely to make legitimate purchases. Subsequent reviews and audits must also require proper documentation related to each purchase made with the procurement card. During procurement card training, it should be emphasized that employees will be required to produce original receipts or other formal documentation for all items purchased.


11.4 This question should generate significant discussion and allow the instructor to counsel students on personal debt, credit cards, interest, and the personal problems that debt can cause. Many people do not keep their credit card receipts as evidence by receipts left at the “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. In addition, credit card bill should be reviewed for accurate refunds for returned merchandise or cancelled services. Instructors may also want to talk to students about running up a large balance on their credit cards and then only making the minimum payments. Students should be warned about identify theft and the dangers of paying for goods and services with credit cards through un-protected channels.


11.5 A firm’s use of technology to improve its expenditure cycle activities (inbound logistics) can help suppliers to improve their outbound logistics (shipping) in several ways. For example, if a company adopts the use of bar-coding or RFID (radio frequency identification) tags to expedite the handling of inventory, its vendors can streamline their shipments by adopting similar technology. In addition, EDI can be used by vendors to notify customers that shipments are on their way, so that the customer’s warehouse receiving function can be prepared. EDI and satellite technology also enable both the supplier and customer to track the status and location of all shipments in transit. By using shipping companies whose trucks are equipped with data terminals linked to satellites, it is possible to track the exact location and to redirect trucks in case of an urgent need in another location. Truck drivers also can be directed to certain loading docks that would be available for unloading thereby shortening truck turnaround time.


Customers have an incentive to share innovations with their suppliers because this may both further improve the efficiency of the customer’s inbound logistics activities and also enable suppliers to lower prices.


11.6 This question should generate good discussion on inventory management, anticipating demand, and vendor relations. The primary risk of minimizing or eliminating inventory is the risk of not being able to meet demand. If a business does not have enough inventory on-hand or not be able to acquire enough inventory to meet demand, then the business is likely to lose sales to competitors who do have enough inventory to meet demand. In addition, at a basic level, if a business carries insufficient inventory or no inventory, why would a customer buy from them? Could a customer simply bypass the business and go directly to the manufacturer and presumably eliminate the markup of the intermediary?


11.7 This question should generate significant discussion on business practices, vendor relations, non-compete agreements with employees, and business ethics. 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 in that the higher the prices the supply company charges the more money the purchasing manager makes and the less money the higher the costs that employer pays for goods and services. The employer may find some comfort if the purchasing manager’s supply business is reviewed or audited by some independent organization, however, independent rating organizations cannot audit every transaction. Since the purchasing manager has intimate knowledge of the employer’s operations and cost structure, he has the ability to structure transactions that could conceal purchases that were favorable to the purchasing manager’s business and unfavorable to the employer. Given the degree of oversight that any prudent employer would have to implement to make sure the purchasing manager provided the best quality for the best price, why would an employer want to allow such an arrangement?

^ SUGGESTED ANSWERS TO THE PROBLEMS


11.1 a. Require a purchase requisition from an operating department as authorization for preparation of all purchase orders. Before approving a purchase order, the purchasing manager should review the related purchase requisition. The purchasing manager also needs to ensure that orders are placed only with approved vendors. Also, company policy should require that purchasing agents disclose any financial interest or position which they hold in supplier companies, though this may be difficult to enforce. In addition, the purchasing manager should check to ensure that purchasing agents do not have investments in vendors on the approved vendor list.

b. Warehouse personnel should be required to count goods received and acknowledge receipt of the specified quantity by signing a copy of the receiving report. This copy of the receiving report would then be reviewed by accounts payable personnel prior to approval of payment. In on-line systems, the warehouse personnel would enter receipt of goods into the system. The system would then match that receiving report with the purchase order and vendor invoice prior to approving payment.


c. Receiving department personnel should be required to verify that a purchase order exists prior to accepting a shipment. Also, invoices should be compared to purchase order records prior to approval of the invoices for payment.


d. Proper invoice filing by payment date and proper cash budgeting.


e. When an invoice is approved for payment, the related supporting records (receiving report and purchase order) must be reviewed. At the conclusion of this process, the status of both the invoice and its supporting records should be changed, for example from "pending" to "paid." In this way the supporting records cannot be used twice to support payment of a duplicate invoice.


f. Periodic physical inventories should be taken, and the resulting counts used to correct system records.


g. Most effective here would be closed loop verification in which the item number is entered as input, and the system displays the corresponding item description and then asks the user to verify that this is the desired item.


h. Unused blank company checks should be stored in a secure location. In addition, the person signing checks should be different from the person authorizing disbursements and preparing checks, and the check signer should review the documentation (purchase order and receiving report) supporting each disbursement prior to signing each check.

i. Supporting documentation reviewed by the person who authorizes disbursements should include both a purchase order and a receiving report. In addition, the person signing checks should be different from the person authorizing disbursements and preparing checks, and the check signer should review the documentation (purchase order and receiving report) supporting each disbursement prior to signing each check.



  1. Surprise counts of cash on hand in the petty cash fund should be made periodically, and the total of cash plus receipts should equal the fund amount.



  1. Restrict access to supplier master files, require a thorough background check, and proper approvals by management before a supplier could be added to the approved supplier list.



  1. This scenario requires collusion between an employee and a customer. Thus, the best control to hire honest and ethical employees by conducting effective interviews, checking references, and even conducting background checks if cost effective. To help honest employees stay honest, the store could restrict access to price tags in that cashiers should not have access to price tags and stocking clerks should not work as cashiers. In addition, sales data could be evaluated using analytical procedures to screen for significant price variances. This analytical procedure combined with linking the cashier/sales person who conducted the transaction to the transaction would likely detect the fraud and also act as a deterrent to other employees.



11.2 Parts a. and b.:


Document

Source

# of copies

Purpose

Vendor Invoice

External

2

1 - part of voucher pkg.

2 - remittance advice

Purchase order

Internal

5

1 - vendor

2 - accounts payable

3 - receiving

4 - requesting department

5 - purchasing

Purchase requisition

Internal

2

1 - purchasing

2 - requesting department

Packing slip

External

1

1 - accompanies delivery

Receiving report

Internal

3

1 - to accounts payable via inventory stores

2 - purchasing

3 - files in receiving

Check

Internal

2

1 - original to vendor

2 - copy in voucher pkg.

Disbursement voucher

Internal

1

authorizes payment of invoice(s)


c. A large number of controls are possible, including:


Document

Application Controls

Purchase Order

Validity checks on item number and vendor number; limit checks on amount; completeness check


Purchase Requisition

Validity checks on item, clerk, and supervisor numbers; completeness checks; reasonableness test comparing date needed to date requested


Receiving Report

Validity checks on vendor, item, and employee numbers; completeness check


Check

Sequence check on check number; validity check on vendor, invoice, and employee numbers; limit check on amount


Disbursement voucher


Validity checks on purchase order, receiving report, and vendor numbers

Vendor Invoice

Cross-foot total amount with extensions; compare invoice price to P.O. price; compare invoice quantity to receiving report quantity


Packing Slip

None necessary



11.3 parts b & c




Vendor table referenced on the purchase order.



Product list referenced on the purchase order.




11.4 Types of controls used at various steps in the expenditure cycle.

Process/Activity

Threat

Type of Controls (P = preventive, D = detective, C = corrective)

Order goods

1. Preventing stockouts and/or excess inventory


2. Requesting unnecessary items


3. Purchasing goods at inflated prices


4. Purchasing goods of inferior quality


5. Purchasing from unauthorized suppliers


6. Kickbacks



Inventory control systems P; perpetual inventory records D; bar code technology P; periodic counts of inventory D and C


Accurate perpetual inventory records P; approval of purchase requisitions P


Solicit competitive bids P; use of approved suppliers P; approval of purchase orders P; budgetary controls D and C


Use of approved vendors P; approval of purchase orders P; monitor vendor performance D and C; budgetary controls D and C


Approval of purchase orders P; restrict access to supplier master file P


Policies P; require purchasing employees to disclose financial interests in suppliers P; vendor audits D and C

Receive and store goods

7. Receiving unordered goods


8. Making errors in counting


9. Stealing inventory

Require receiving to verify existence of valid purchase order P


Use of bar coding technology P; document employee performance D and C; incentives for accurate counts P


Physical access controls P; periodic counts of inventory and reconciliation of physical counts to records D and C; document all transfers of inventory D


Approve and pay vendor invoices

10. Failing to catch errors in vendor invoices


11. Paying for goods not received


12. Failing to take available purchase discounts


13. Paying the same invoice twice


14. Recording and posting errors in accounts payable


15. Misappropriating cash, checks, or EFTs


Double-check invoice accuracy D; training of accounts payable staff P; use of ERS P


Only pay invoices supported by original receiving report P; use of ERS P; budgetary controls D and C


Proper filing P; cash flow budgets P


Only pay invoices supported by original voucher package P; cancellation of voucher package upon payment P; use of ERS P; control access to supplier master file P


Various data entry and processing edit controls P, D and C


Restrict access to blank checks, check signing machine, and EFT transfer terminals ^ P; segregation of duties of accounts payable and cashier P; reconciliation of bank account by someone independent of cash disbursement process D; check protection measures including Positive Pay P; regular review of EFT transactions D and C

General control issues

16. Losing data


17. Performing poorly


Backup and disaster recovery plans P; physical and logical access controls P


Development and periodic review of appropriate performance reports D and C



11.5

Refer to Table 11.1 in the text for a list of threats and related controls. Students will likely create a variety of checklists, thus a template with a few example questions is listed below. Requirement b solutions will depend on the question(s) include on part a.


Expenditure Cycle Controls Checklist


No.

Question

Yes

No

1.

Are supporting documents, such as purchase orders and receiving reports, marked “paid” when a check is issued to the vendor?







2.

Is approval from a supervisory authority obtained for all purchase orders?







3.

Is inventory kept in a secure location?







4.

Are the receiving and purchasing functions segregated?







5.

Are validity checks performed on all vendor numbers?








11.6


12 Month Cash Budget

January

February

March

April

May

June




























Cash: Beginning Balance

350,000

(1,500,000)

(1,868,500)

(1,240,685)

(306,592)

636,842























































Sales




5,000,000

5,050,000

5,100,500

5,151,505

5,203,020

5,255,050




























Cash Collections




2,000,000

3,520,000

4,555,200

4,900,752

4,949,760

4,999,257




























Expected Cash Outflows

(3,850,000)

(3,888,500)

(3,927,385)

(3,966,659)

(4,006,325)

(4,046,389)




























Projected Loans




1,550,000

1,918,500

1,290,685

356,592

0

0




























Cash Flows from Loans

1,550,000

1,918,500

1,290,685

356,592

0

0




























Cumulative Loans

1,550,000

3,468,500

4,759,185

5,115,777

5,115,777

5,115,777




























Maximum Loan Payment

0

0

0

0

(586,842)

(1,539,711)




























Actual Loan Payment

0

0

0

0

(586,842)

(1,539,711)




























Loan Outstanding

1,550,000

3,468,500

4,759,185

5,115,777

4,528,935

3,576,066























































Cash: Ending Balance Prior to Loan Payment

(1,500,000)

(1,868,500)

(1,240,685)

(306,592)

636,842

1,589,711




























Cash: Ending Balance

50,000

50,000

50,000

50,000

50,000

50,000



12 Month Cash Budget

July

August

September

October

November

December




























Cash: Beginning Balance

1,589,711

2,552,108

3,524,129

4,505,870

5,497,429

6,498,903























































Sales




5,307,601

5,360,677

5,414,284

5,468,426

5,523,111

5,578,342




























Cash Collections




5,049,250

5,099,742

5,150,740

5,202,247

5,254,269

5,306,812




























Expected Cash Outflows

(4,086,853)

(4,127,721)

(4,168,998)

(4,210,688)

(4,252,795)

(4,295,323)




























Projected Loans




0

0

0

0

0

0




























Cash Flows from Loans

0

0

0

0

0

0




























Cumulative Loans

5,115,777

5,115,777

5,115,777

5,115,777

5,115,777

5,115,777




























Maximum Loan Payment

(2,502,108)

(3,474,129)

(4,455,870)

(5,447,429)

(6,448,903)

(7,460,392)




























Actual Loan Payment

(2,502,108)

(3,474,129)

(4,455,870)

0

0

0




























Loan Outstanding

2,613,669

1,641,648

659,907

0

0

0























































Cash: Ending Balance Prior to Loan Payment

2,552,108

3,524,129

4,505,870

5,497,429

6,498,903

7,510,392




























Cash: Ending Balance

50,000

50,000

50,000

5,497,429

6,498,903

7,510,392
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