The Expenditure Cycle:

Purchasing and Cash

Disbursements

Anup Kumar Saha 12-1

 Learning Objectives

1. Describe the basic business activities and

related data processing operations
performed in the expenditure cycle.
2. Discuss the key decisions to be made in
the expenditure cycle, and identify the
information needed to make those
decisions.
3. Document an understanding of the
expenditure cycle activities.

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 Learning Objectives

4. Identify major threats in the expenditure

cycle, and evaluate the adequacy of
various control procedures for dealing with
those threats.
5. Read and understand a data model (REA
diagram) of the expenditure cycle.

Anup Kumar Saha 12-3

 Introduction

 Linda Spurgeon, Alpha Omega

Electronics’ (AOE) president, asked
Elizabeth Venko, the controller, to
address the following issues:
 What must be done to ensure that
AOE’s inventory records are current
and accurate?
 What can be done to ensure timely
delivery of quality components?

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 Introduction

 Is it possible to reduce AOE’s

investment in materials inventories?
 What must be done to ensure that
available discounts are taken?
 How could the information system
provide better information to guide
planning and production?
 How could IT be used to reengineer
expenditure cycle activities?

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 Learning Objective 1

 Describe the basic business activities

and related data processing
operations performed in the
expenditure cycle.

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 Expenditure Cycle:
Main Objective
 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.
 The primary objective of the expenditure
cycle is to minimize the total cost of
acquiring and maintaining inventories,
supplies, and the various services
necessary for the organization to function.

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 Expenditure Cycle:
Key Decisions
 What is the optimal level of inventory and
supplies to carry?
 Which suppliers provide the best quality and
service at the best prices?
 Where should inventories and supplies be
held?
 How can the organization consolidate
purchases across units to obtain optimal
prices?

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 Expenditure Cycle:
Key Decisions
 How can information technology be used to
improve both the efficiency and accuracy of
the inbound logistics function?
 Is sufficient cash available to take
advantage of any discounts suppliers offer?
 How can payments to vendors be managed
to maximize cash flow?

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 Expenditure Cycle:
Business Activities
 What are the three basic business
activities in the expenditure cycle?
1. Ordering goods, supplies and
services
2. Receiving and storing goods,
supplies and services
3. Paying for goods, supplies and
services

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 Ordering Goods, Supplies
And Services
 The first major business activity in the
expenditure cycle is ordering
inventory or supplies.
 The traditional inventory control
method (often called economic order
quantity [EOQ]):
• This approach is based on calculating an
optimal order size so as to minimize the
sum of ordering, carrying, and stockout
costs.

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 Ordering Goods, Supplies
And Services
 Alternative inventory control methods:
– MRP (material requirement planning)
• This approach seeks to reduce required
inventory levels by scheduling production,
rather than estimating needs.
– JIT (just in time)
• JIT systems attempt to minimize both
carrying and stockout costs.

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 Ordering Goods, Supplies
And Services
 What is a major difference between MRP
and JIT?
 MRP systems schedule production to meet
estimated sales need, thereby creating a
stock of finished goods inventory.
 JIT systems schedule production to meet
customer demands, thereby virtually
eliminating finished goods inventory.

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 Ordering Goods, Supplies
And Services
 Documents and procedures:
 The purchase requisition is a
document that identifies the following:
– requisitioner and item number
– specifies the delivery location and
date needed
– specifies descriptions, quantity, and
price of each item requested
– may suggest a vendor
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 Ordering Goods, Supplies
And Services
 What is a key decision?
– determine vendor
 What factors should be considered?
– price
– quality of materials
– dependability in making deliveries

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 Ordering Goods, Supplies
And Services
 Documents and procedures:
 The purchase order is a document that
formally requests a vendor to sell and
deliver specified products at designated
prices.
 It is also a promise to pay and becomes a
contract once it is accepted by the vendor.
 Frequently, several purchase orders are
generated to fill one purchase requisition.

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 Receiving and Storing Goods,
Supplies and Services
 The second major business activity
involves the receipt and storage of
ordered items.
 Key decisions and information needs:

 The receiving department has two

major responsibilities:
1 Deciding whether to accept a delivery
2 Verifying quantity and quality
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 Receiving and Storing Goods,
Supplies and Services
 Documents and procedures:
 The receiving report documents
details about each delivery, including
the date received, shipper, vendor,
and purchase order number.
 For each item received, it shows the
item number, description, unit of
measure, and count of the quantity
received.

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 Pay for Goods and Services:
Approve Vendor Invoices
 The third activity entails approving
vendor invoices for payments.
 The accounts payable department
approves vendor invoices for payment
 The cashier is responsible for making
the payment

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 Pay for Goods and Services:
Approve Vendor Invoices
 The objective of accounts payable is
to authorize payment only for goods
and services that were ordered and
actually received.
 There are two ways to process
vendor invoices:
1. Nonvoucher system
2. Voucher system

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 Pay for Goods and Services:
Improving Accounts Payable
Processing efficiency can be improved
by:
 Requiring suppliers to submit invoices
electronically, either by EDI or via the
Internet
 Eliminating vendor invoices. This
“invoiceless” approach is called
evaluated receipt settlement (ERS).

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 Pay for Goods: Pay
Approved Invoices
 The cashier approves invoices
 The combination of vendor invoice
and supporting documentation is
called a voucher package.
 A key decision in the cash
disbursement process is determining
whether to take advantage of
discounts for prompt payment.

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 Learning Objective 2

 Discuss the key decisions that

need to be made in the
expenditure cycle, and identify the
information needed to make those
decisions.

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 Information Needs

 The third function of the AIS is to

provide information useful for decision
making.
 Usefulness in the expenditure cycle
means that the AIS must provide the
operational information needed to
perform the following functions:
 Determine when and how much
additional inventory to order.

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 Information Needs

AIS must provide the operational information

needed to perform the following functions
(con’t):
 Select the appropriate vendors from whom to
order.
 Verify the accuracy of vendor invoices.
 Decide whether purchase discounts should
be taken.
 Monitor cash flow needs to pay outstanding
obligations.

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 Information Needs

 What are examples of additional information

The AIS should provide?
– Efficiency and effectiveness of the
purchasing department
– Analyses of vendor performance such as on-
time delivery, quality, etc.
– Time taken to move goods from the
receiving dock into production
– Percentage of purchase discounts taken

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 Learning Objective 3

 Document your understanding of the

expenditure cycle.

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 Expenditure Cycle
Reorder point
Request
Various Inventory
goods
departments control

Order goods

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 Expenditure Cycle
Back Orders
Revenue
Order goods cycle

Purchase
order Needs

Inventory Vendor Production

cycle

Receiving report Receive Receipt of goods

goods

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 Expenditure Cycle
RECEIVING

From purchasing From suppliers

Purchase Order Packing slip

Verify order,
A count, and
inspect
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 Expenditure Cycle
ACCOUNTS PAYABLE

From From From

vendor purchasing stores

Purchase Receiving
Invoice order report

Compare, review,
verify N
accuracy
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 Expenditure Cycle
Cashier
From A/P A

Batch totals
Invoice
Receiving
report Compare and
Purchase reconcile
order
Disbursement Review and
voucher compute Batch
batch total total
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 Learning Objective 4

 Identify major threats in the

expenditure cycle and evaluate
the adequacy of various control
procedures for dealing with
those threats.

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 Control: Objectives,
Threats, and Procedures
 Another function of a well-designed AIS is to
provide adequate controls to ensure that
the following objectives are met:
 Transactions are properly authorized.
 Recorded transactions are valid.
 Valid, authorized transactions are recorded.
 Transactions are recorded accurately.

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 Control: Objectives,
Threats, and Procedures
 Assets (cash, inventory, and data) are
safeguarded from loss or theft.
 Business activities are performed efficiently
and effectively.

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 Control: Objectives,
Threats, and Procedures
 What are some threats?
– stockouts
– purchasing too many or unnecessary
goods
– purchasing goods at inflated prices
– purchasing goods of inferior quality
– purchasing from unauthorized vendors
– kickbacks
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 Control: Objectives,
Threats, and Procedures
– receiving unordered goods
– errors in counting goods
– theft of inventory
– failure to take available purchasing
discounts
– errors in recording and posting
purchases and payments
– loss of data

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 Control: Objectives,
Threats, and Procedures
 What are some control procedures?
– inventory control system
– vendor performance analysis
– approved purchase requisitions
– restricted access to blank purchase
requisitions
– price list consultation
– budgetary controls
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 Control: Objectives,
Threats, and Procedures
– use of approved vendor lists
– approval of purchase orders
– prenumbered purchase orders
– prohibition of gifts from vendors
– incentives to count all deliveries
– physical access control
– recheck of invoice accuracy
– cancellation of voucher package
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 Learning Objective 5

 Read and understand a

data model (REA diagram)
of the expenditure cycle.

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 Expenditure Cycle Data
Model
 The REA data model integrates both
traditional accounting transactions data
with other operational data.
 What are some examples?
– the date and amount of each purchase
– information about where items are stored
– vendor performance measures, such as
delivery date

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 Expenditure Cycle Data
Model
Partial REA Diagram of the Expenditure Cycle
Request
(1, N) goods
Request inventory (1, 1)
(1, N)
Fills
(1, N)
(1, N) (1, N) Order
Inventory Order inventory goods
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 Expenditure Cycle Data
Model
 The REA diagram models the relationship
between the request goods and order
goods events as being many-to-one.
 Why?
 The company sometimes issues purchase
orders for individual purchase requests.
 At other times it takes advantage of volume
discounts by issuing one purchase order for
a set of requests.

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 Expenditure Cycle
Data Model
Partial REA Diagram of the Expenditure Cycle

Order
goods
(0, N)

Order/Receive

(1, N)
(1, N) Receive Receive
Inventory inventory goods
(1, N)
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 Expenditure Cycle Data
Model
 Why is there a many-to-many relationship
between the order goods and receive goods
events?
 Vendors sometimes make several separate
deliveries to fill one purchase order.
 Other times, vendors fill several purchase
orders with one delivery.
 Sometimes, vendors make a delivery to fill
a single purchase order in full.

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 Case Conclusion
 What are the key points that Elizabeth
Venko proposed?
1 Online terminals in each of AOE’s
departments
2 JIT inventory system
3 Use of EDI to send purchase orders to
vendors
4 Use of EFT as much as possible
5 Implementation of a relational data base

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 End

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