Auditing the Expenditure Cycle 5. Appropriate reports are transmitted to A.P.

and cash disbursements departments for

PURCHASES: BATCH PROCESSING review
 Step 1: Data processing department – inventory control  Control implications
 Purchasing Department 1. General in nature
 Step 2: Data processing department – P.O. 2. Similar to those of Chapter 9
 Receiving Department BATCH AUTOMATED SYSTEM VS. MANUAL BATCH
 Step 3: Data processing department – batch update of inventory  Improved inventory control
 Accounts Payable  Better cash management
 Step 4: Data processing department – validates vendors  Less time lag
CASH DISBURSEMENT: BATCH PROCESSING  Better purchasing time management
 Step 5: Data processing department – scans for items due and prints checks for items  Reduction of paper documents
received REENGINEERED SYSTEM VS. BATCH AUTOMATED SYSTEM
 Step 6: Cash disbursements department – reconciles checks, submits checks to management  Segregation of duties
for signature  Accounting records and access controls
 Step 7: Accounts payable – matches copies of checks with open vouchers, closes them and PAYROLL PROCEDURES
files documents  Drawbacks to using regular A.P. and cash disbursements systems to do payroll
 Concludes expenditure cycle  General expenditure procedures that apply to all vendors will not apply to employees
CASH DISBURSEMENT: REENGINEERED—FULLY AUTOMATED  Writing checks to employees requires special controls
 Data processing steps performed automatically:  General expenditure procedures are designed to accommodate relatively smooth flow
1. Inventory file scanned for items and reorder points of transactions
2. Purchase requisition record for all items needing replenishment REENGINEERED PAYROLL SYSTEM
3. Consolidate requisitions by vendor  Often integrated with H.R.
4. Retrieve vendor mailing information  Differs from previous automate system
5. P.O. prepared and sent to vendor (EDI)  Operations departments transmit transactions to D.P. electronically
6. Open P.O. record added for each transaction  Direct access to files are used for data storage
7. List of P.O. sent to purchasing department  Many processes are now performed in real time
 Goods arrive at receiving department  Personnel
 Quantities received entered per item  Cost accounting
 Data processing steps performed automatically:  Timekeeping
1. Quantities keyed matched to open P.O. record  Data processing
2. Receiving report file record added  Labor costs are distributed to accounts
3. Update inventory subsidiary records  Online labor distribution summary
4. G.L. inventory updated  Online payroll register
5. Record removed from open P.O. file and added to open A.P. file, due date  Employee records are updated
established  Payroll checks are prepared and signed
 Each day, due date filed of A.P. are scanned for items where payment is due  Disbursement system generates check to fund the payroll imprest account
 Data processing steps performed automatically:  G.L. updated
1. Checks are printed, signed and distributed to mailroom (unless EDI/EFT) EXPENDITURE CYCLE AUDIT OBJECTIVES
2. Payments are recorded in check register file  Input controls
3. Items paid are transferred from open A.P. to closed A.P. file  Data validation controls
4. G.L.- A.P. and cash accounts are updated  Testing validation controls
 Batch controls
  Testing batch controls  Logs of automatic transactions
 Purchases authorization controls  Unique transaction identifiers
 Testing purchases authorization controls  Error listing
 Employee authorization  Testing output controls
 Testing employee authorization procedures EXPENDITURE CYCLE SUBSTANTIVE TESTS
 Process controls  Risks and audit concerns
 File update controls  Understanding data
 Sequence check control  Inventory file
 Liability validation control  Purchase order file
 Valid vendor file  Purchase order line item file
 Testing file update controls  Receiving report file
 Access controls  Disbursement voucher file
 Warehouse security  File preparation procedures
 Moving assets promptly when received  Testing accuracy and completeness assertions
 Paying employees by check vs. cash  Review disbursement vouchers for unusual trends and exceptions
 Risks  Accurate invoice prices
 Employees with access to A.P. subsidiary file  Testing completeness, existence, rights and obligations assertions
 Employees with access to attendance records  Searching for unrecorded liabilities
 Employees with access to both cash and A.P. records  Searching for unauthorized disbursement vouchers
 Employees with access to both inventory and inventory records  Review of multiple checks to vendors
 Testing access controls  Auditing payroll and related records
 Process controls
 Physical controls Chapter 15–Auditing the Expenditure Cycle
 Purchase system controls Expenditure cycle–consists of activities related to the acquisition of and payment for plant assets
 Segregation of inventory control from warehouse and goods and services. Two major transaction classes:
 Segregation of G.L. and A.P. from cash disbursements 1–purchases transactions
 Supervision of receiving department 2-cash disbursements
 Inspection of assets For our purposes here, it does not involve payroll transactions, the purchase or sale of another
 Theft of assets entity’s securities, or the entity’s own securities.
 Reconciliation of supporting documents: P.O., receiving Audit Objectives
report, supplier’s invoice Consider Fig. 15-2 on page 628 of your textbook. This table presents transaction class and
 Payroll System controls account balance audit objectives in relation to the 5 management assertions for the expenditure
 Verification of timecards cycle.
 Supervision Materiality
 Paymaster Transactions in the expenditure cycle often affect more financial statement accounts than other
 Payroll imprest account cycles combined. The auditor often seeks a low level of risk of material misstatements in the
Testing of physical controls financial statements due to expenditure cycle transactions. The allocation of materiality to accounts
 Process controls affected by this cycle will vary according to the likelihood of misstatements in the account and the
 Output controls probable cost of verifying the account. For example, misstatements are more likely to exist in
 A.P. change report inventories than plant assets, and it usually costs more to audit inventories than plant assets.
 Transaction logs Inherent and Control Risks
 Transaction listing Let us consider factors that may lead to misstatement of expenditure cycle transaction:

The auditor must remember inherent limitations of internal control, including the possibility of
management override, collusion, errors due to fatigue or misunderstandings, and failure to adapt
the control structure to changed conditions (e.g., rapid growth).
Audit Strategy
Use of either the lower assessed level of control risk approach or primarily substantive approach,
or a combination of the two, may be appropriate for auditing the expenditure cycle. For example,
the lower assessed level of control risk approach is more efficient for a situation involving a high
volume of transactions.
Consideration of Internal Controls
Let us look at the components of internal control as applied to the expenditure cycle.
1-Control Environment
Integrity and ethics are critical here due to many opportunities for employee fraud in doing
purchase and cash disbursements. Client firm organizational structure and assignment of authority
and responsibility of expenditure cycle activities should be stated clearly.
2-Risk Assessment
Auditors should consider such factors as:
3-Information and Communication
Fig. 15-4 is an overview flowchart that shows the features of manual and computerized accounting
systems for processing purchases and cash disbursements. This chapter assumes the use of a
voucher system for recording purchases.
4-Monitoring
The auditor should know about feedback from the client’s suppliers concerning payment or delivery
problems and communications from external auditors about weaknesses in internal controls or
reportable conditions.
Initial Assessment of Control Risk
Auditing procedures to obtain an understanding of the 4 IC elements noted above extend only to
the design of policies and procedures. The initial assessment of control risk must be set at the
maximum based on information from understanding of these elements only. Tests of controls are
often done at the same time as procedures to obtain an understanding. Evidence from concurrent
tests of controls may justify a reduction in the initial assessment of control risk for certain related
assertions. It can be reduced to slightly below the maximum.
Control Activities–Purchases Transactions
Various Common Documents and Records
Purchase requisition–written request by an employee to the purchasing department
Receiving report–a report prepared on the receipts of goods showing the kinds and quantities of
goods received from vendors
Voucher–a form indicating the vendor, amount due, and payment date for purchases received.
Usually considered an authorization for recording and paying a liability.
Purchases transactions files–computer file containing data for approved vouchers for purchases
that have been received. Used to update the A/P, inventory, and general ledger master file.
Functions
The following functions should be assigned to different individuals or departments:
1-requisitioning goods and services
Capital expenditures and lease contracts require specific approvals. Purchase requisition forms
should be signed by a supervisor who has budgetary responsibility for the expenditure category.
This represents the start of the transaction trail in support of the existence or occurrence assertion
for purchase transactions.
2–preparing purchase orders
Purchase orders should be prenumbered and signed by an authorized purchasing agent. Copies
are distributed internally to the receiving department, the vouchers payable department, and the
originating department. Quantity ordered is wiped out on the receiving department copy.
3-receiving the goods
A prenumbered receiving report should be prepared for each order received. The receiving report
supports the existence or occurrence assertion for purchase transactions.
4-storing goods received for inventory
Obtaining initials on a copy of the receiving report provides evidence for the existence or
occurrence assertion.
5-preparing the payment voucher
The controls over this function and the assertions to which they relate include:
Establishing the agreement of the details of vendors’ invoices with receiving reports and purchase
orders and determining the mathematical accuracy of vendors’ invoices.
Copies of contracts may be required when the voucher relates to leased assets or long-term
suppliers of services or goods. In a computerized system, programmed edit checks are made for
valid vendor numbers and reasonableness of amounts.
6-recording the liability
In computerized systems, the purchases transactions file is used to update the A/P, inventory, and
G/L master files. In any type of system, an accounting supervisor should check the timeliness of
recording by comparing the dates of voucher register entries with dates on the copies of the
vouchers.
Illustrative System for Purchase Transactions
Fig. 15-6 is a flowchart of a system for processing purchases transactions. You should be able to
understand and interpret this flowchart.
Obtaining the Understanding and Assessing Control Risk
Prior experience with the client, inquiry, observation and inspection of documents are the means by
which the auditor obtains an understanding of the control activities component of the internal
control aspect (for purchase transactions).
Fig. 15-5 has a list of potential misstatements, controls and account balance audit objectives for
purchases. Tests of controls provide the means for ascertaining the effectiveness of such controls.
Remember, the extent of tests of controls will vary inversely with the auditor’s planned level of
control risk.
The direction of testing must be compatible with the specific audit objective to which the test
relates–vouching for existence or occurrence and tracing for completeness. Certain tests may be
done as dual purpose tests (e.g., preparing the payment voucher and recording the liability).
A final assessment of control risk can be made and documented for each assertion related to
purchase transactions based on evidence collected from procedures to obtain an understanding.
Computer-Assisted Tests of Controls
Tests of effectiveness must be done for any controls that lead to a control risk assessment below
the maximum. For general controls over changes to programs and master files, the auditor makes
inquiries and inspects documentation.
Application controls tests involve the use of test data to find out whether results produced by the
client’s program for unpaid vouchers are as expected. Generalized audit software may be used to
perform sequence checks and print list of purchase orders, receiving reports, or vouchers with
missing numbers.
Control Activities–Cash Disbursement Transactions
Common Documents and Records
Cash disbursements transaction file–information on payments by check to vendors and others.
Used for posting to the A/P and general ledger master files.
There are two cash disbursement functions:
1–paying the liability
In a computerized system, the vouchers payable department submits batches of vouchers due for
payment to EDP or enters the data on vouchers via terminals. Checks and a check summary are
produced. Payment data are entered into a cash disbursements transaction file. Checks should be
physically matched with supporting vouchers. Various controls over the preparation and signing of
checks and related audit objectives include:
–Independent checks of the agreement of the total of the issued checks with a batch total of the
vouchers processed for payment.
–Authorized check signers should ascertain that each check is accompanied by a properly
approved unpaid voucher and that the name of the payee and check amount agree with the
voucher.
–The check signer should control the mailing of the checks.
–Prenumbered checks should be used.
–A voucher and supporting documents should be stamped or canceled to avoid double payments.
Recording Cash Disbursements
The cash disbursements file created when checks are prepared is used to update the accounts
payable master file and general ledger accounts in computerized systems. Controls over the
recording of cash disbursements include:
Illustrative System for Cash Disbursements Transactions
A representative system for processing cash disbursements transactions is shown in Fig. 15-8 on.
As clerks key in each voucher number, the cash disbursements program is used to prepare a
check based on information in the A/P master file. The program enters the payment data in a cash
disbursements transaction file and produces a check summary which is compared with the batch
total prepared in vouchers payable. In the treasurer’s department, an independent check is made
to determine the existence of an approved voucher for each check and agreement of the payee’s
name and the check amount with the voucher. The supporting documents are then stamped paid
and the check is signed and mailed with the remittance advice. The cash disbursements update
program is then used to update the accounts payable and G/L master files based on data in the
cash disbursements transaction file.
Obtaining the Understanding and Assessing Control Risk
Fig. 15-7 contains a partial listing of potential misstatements, necessary controls, and account
balance audit objectives for cash disbursements transactions to which each relates.
Test data can be used to test edit checks and other programmed controls pertaining to the
preparation and recording of checks. A final assessment of control risk is made based on collecting
the evidence acquired from procedures to obtain an understanding of relevant portions of all five
components of IC and related tests of controls.
Substantive Tests of Accounts Payable Balances
A/P is high volume and therefore susceptible to misstatements. The audit of payables places more
emphasis on collecting evidence about the completeness assertion relative to the E or O assertion.
Determining Detection Risk
Detection risk for payables assertions is affected by inherent and control risk factors related to both
the purchases transactions and cash disbursements transactions classes. Fig. 15-9 specifies risk
levels for IR, AR, DR, and CR and various combinations for the five management assertions
related to payables. The completeness and V or A assertions for payables need more evidence
than the other assertions.
Designing Substantive Tests
Fig. 15-10 contains a list of possible substantive tests that could be applied to A/P. Each of the
tests is keyed to one or more of the specific account balance audit objectives for A/P contained in
Fig. 15-2.
Initial Procedures
The starting point for substantive tests is tracing the beginning balance of A/P to the prior year’s
working papers. Other initial activities include reviewing activity in the general ledger for unusual
entries and obtaining a listing of amounts owed at the balance sheet date. Ordinarily, the listing is
prepared by the client from the unpaid voucher file or the accounts payable subsidiary ledger or
master file. The auditor must determine the mathematical accuracy of the listing by refooting the
total and verifying that it agrees with the underlying accounting records and the general ledger
control account balance.
Analytical Procedures
Several analytical procedures that can be performed to provide evidence about accounts payable
are shown in Fig.15-10. An abnormal increase in the accounts payable turnover ratio, or
unexpected decreases in the percentage of accounts payable to total current liabilities or in one or
more expense account balances, could indicate the possibility of unrecorded accounts payable.
Tests of Details of Transactions
We consider four substantive tests of A/P transactions. The extent of use of each test varies based
on acceptable levels of detection risk. The four tests are:
1. Vouch Recorded Payables to Supporting Documentation
In this test, credit entries to A/P are vouched to supporting documents in the client’s files such as
vouchers, vendor invoices, and purchase orders. Debits are vouched to documentation of cash
disbursements transactions, such as paid checks.
2. Perform Purchases Cutoff Test
This test involves ascertaining that purchases transactions occurring near the balance sheet date
are recorded in the proper period. This is accomplished by tracing dated receiving reports to
voucher register entries and vouching recorded entries to supporting documentation. The test
usually covers a period of 5 to 10 business days before and after the balance sheet date. The E or
O and completeness assertions are the ones addressed by this test.
Do not forget to accord due consideration to goods in transit at the balance sheet date. Goods
shipped FOB shipping point must be included in the inventory and A/P of the buyer. Goods shipped
FOB destination point should remain in the inventory of the seller and be left out of the buyer’s
inventory and A/P (until receipt by the buyer).
3. Perform Cash Disbursements Test
Evidence for the cash disbursements cutoff test may be obtained by personal observation and
review of internal documentation. Tracing of the evidence for the last checks written to the
accounting records is necessary. The auditor should also trace canceled checks dated within a
period of several days before and after the balance sheet date to the dates the checks were
recorded.
4. Perform Search for Unrecorded Payables
A review of subsequent payments consists of examining the documentation for checks issued or
vouchers paid after the balance sheet date. If evidence purports to show payment for an obligation
that existed at the balance sheet date, it should be traced to the A/P listing to ascertain whether it
was included. This is an important test for finding out whether payables have been understated or
left out.
Other auditing procedures that may indicate unrecorded payables include: (1) checking unmatched
purchase orders; (2) inquiring of accounting and purchasing personnel about unrecorded A/P; and
(3) reviewing capital budgets, work orders, and construction contracts.
Tests of Details of Balances
1. Confirm A/P
Confirmation of A/P is optional because a confirmation offers no assurance that unrecorded
payables will be uncovered and external evidence such as invoices and vendor monthly
statements should be available to substantiate the balances. Confirmation of A/P is recommended
when detection risk is low or a firm is having trouble in meeting its obligations. The positive form of
confirmation should be used if this test is used. The test provides evidence for all A/P assertions.
2. Reconcile Unconfirmed Payables to Vendor Statements
In many cases, vendors provide monthly statements that are available in client files. In such cases,
amounts owed to vendors per the client’s listing of payables can be reconciled to those statements.
Chapter 10
Auditing the Expenditure Cycle
REVIEW QUESTIONS
1. Differentiate between a purchase requisition and a purchase order.
Response: A purchase order requisition is completed by the inventory control department when a need
for inventory items is detected. Purchase requisitions for office supplies and other materials may also
be completed by staff departments such as marketing, finance, accounting, and personnel. The
purchasing department receives the purchase requisitions, and if necessary, determines the
appropriate vendor. If various departments have requisitioned the same order, the purchasing
department may consolidate all requests into one order so that any quantity discounts and lower freight
charges may be taken. In any case, the purchasing department prepares the purchase order, which is
sent to the vendor, accounts payable department, and the receiving department (blind copy).
2. What purpose does a purchasing department serve?
Response: A purchasing department is able to research the quality and pricing of various vendors.
Their job is to monitor various supply sources and choose the highest quality good for a given price
which can be reliably delivered on time. The purchasing department may also take advantage of
quantity discounts, especially when two or more manufacturing facilities are involved.
3. Distinguish between an open accounts payable file and a vouchers payable file.
Response: An open accounts payable file contains all source documents, including invoices, organized
by payment date. As the due dates become close to the current date, the invoices are pulled from the
file and paid. Under the voucher system, the accounts payable clerk prepares a cash disbursements
voucher upon receipt of all source documents. Each cash disbursements voucher represents payment
to one vendor. Multiple invoices may be paid with one voucher. The voucher system allows better
control over cash disbursements since cash vouchers are assigned and tracked.
4. What are the three logical steps of the cash disbursements system?
Response: The three logical steps of the cash disbursements system are:
a) Authorization of cash disbursements for payment.
b) Preparation & distribution of checks, and
c) Preparation of summary information by cash disbursements and accounts payable and sent to the
general ledger clerk.
5. What general ledger journal entries are triggered by the purchases system? From which
departments do these journal entries arise?
Response:
Accounts Payable:
Inventory Control Debit
Accounts Payable Credit
Cash Disbursements:
Accounts Payable Debit
Cash Credit
6. What two types of exposure can close supervision of the receiving department reduce?
Response: The receiving clerk's responsibility is to inspect the quantities and condition of the goods
received. The two exposures are 1) failing to perform his/her duty and 2) pilfering or stealing the
inventory. Thus, the copy of the purchase order which they use for this inspection should not contain
quantities or amounts. If the quantity is printed on the receiving clerk's copy of the purchase order, he or
she may be tempted to skip the physical inspection and the company may be paying for inventory it did
not receive or is damaged. A supervisor is necessary to remove the packing slip which contains
quantity information and to make sure the receiving clerks actually inspect the goods. If the value of the
inventory is listed, the employee may be tempted to steal some of the inventory. Close supervision
should deter employees from stealing.
7. How can a manual purchases cash disbursements be re-engineered to reduce discrepancies, be
more accurate, and reduce processing costs?
Response: By using a computer system to automatically search the accounts payable files, early
payment discounts will not be overlooked and potentially lost. Checks are printed, signed, and
distributed. EDI partners may receive their payments electronically reducing check printing costs. The
updates to the check register file, accounts payable files, and general ledger are automatically made,
thus cutting down on clerical work and errors.
8. What steps of independent verification does the General Ledger department perform?
Response: The general ledger department receives journal vouchers from inventory control, accounts
payable, and cash disbursements. With these summary figures, the general ledger clerk verifies that 1)
total obligations recorded = total inventories received, and 2) total reductions in accounts payable =
total disbursements of cash.
9. What is (are) the purpose(s) of maintaining a valid vendor file?
Response: Inventories should only be acquired from valid vendors. This control procedure helps to
deter the purchasing agent from buying inventories at excessive costs and receiving kickbacks or from
buying from an entity in which the purchasing agent has a relationship, such a relative or a friend.
10. How do computerized purchasing systems help to reduce the risk of purchasing bottlenecks?
Response: Routine purchases can be automated, thus reducing the time lag between the purchase
requisition and the placement of the order, which also reduces the amount of time to receive the
inventory. Thus, routine orders which may be automated should cause the ordering processing time to
be reduced.
11. What is a personnel action form?
Response: The personnel action form provides the payroll department with a list of currently active
employees, so that any submission of time cards by supervisors for fictitious or ex-employees will not
be processed.
12. What tasks does a payroll clerk perform upon receipt of hours worked data from the production
department?
Response: The payroll clerk reconciles the information received from personnel and production,
calculates the payroll and distributes the paychecks. Further, the payroll clerk sends summary
information to the accounts payable clerk.
13. What documents are included in the audit trail for payroll?
Response:
a. time cards, job tickets, and disbursement vouchers.
b. journal information which comes from the labor distribution summary and the payroll register.
c. subsidiary ledger accounts (employee records and expense accounts).
d. general ledger accounts (payroll control, cash, and payroll clearing).
DISCUSSION QUESTIONS
1. What is the importance of the job ticket? Illustrate the flow of this document and its information from
inception to impact on the financial statements.
Response: The job ticket is used to allocate each labor hour of work to specific
WIP accounts. These job tickets are very important for cost accounting. The job tickets are completed
by production workers as they capture the total amount of time that they spend on each production job.
Upon completion, they route these to the cost accountants who use them to post the labor costs to
specific WIP accounts such as direct labor, indirect labor and overhead. The cost accountant prepares
a labor distribution summary which contains the information for the general ledger clerk to make the
necessary entries to the general ledger accounts.
2. What three documents must accompany the payment of an invoice? Discuss where these three
documents originate from and the resulting control implications.
Response: The three documents which must accompany the payment of an invoice are the purchase
requisition, purchase order, and receiving report (in addition to the invoice itself). The purchase
requisition originates from inventory control and represents the inventory requirements. The purchase
order originates from the purchasing department and represents an order placed. The receiving report
originates from the receiving department and represents the quantity and types of goods received.
Thus, the accounts payable must determine 1) that the goods ordered were requested by some
department (i.e. inventory control) other than purchasing, 2) that purchasing ordered the goods from a
valid vendor, and 3) that the goods were actually received. If all three of the conditions are met, then
and only then should the invoice be paid. Further, only those goods received in good shape should be
paid.
4. Discuss the importance of supervision controls in the receiving department and the reasons behind
"blind" fields on the receiving report such as quantity and price.
Response: The receiving clerks have access to many of the firm's assets: their inventory. Two
exposures potentially exist: 1) the clerk failing to perform his/her duty and 2) the clerk pilfering or
stealing the inventory. Thus, the copy of the purchase order which they use for this inspection should
have the quantities and amounts covered so that they may not be read. If the quantity is printed on the
receiving clerk's copy of the purchase order, he or she may be tempted to skip the physical inspection
and the company may be paying for inventory it did not receive or is damaged. A supervisor is
necessary to remove the packing slip which contains quantity information and to make sure the
receiving clerks actually inspect the goods. If the value of the inventory is listed, the employee may be
tempted to steal some of the inventory. Close supervision should deter employees from stealing.
5. Why do the Inventory Control, Cash Disbursements, and General Ledger departments appear to
"disappear" in computer-based purchasing systems (Figure 5-14)? Are these functions no longer
important enough to have their own departments?
Response: These functions are very important, and that is one reason why they are automated. Theses
functions are crucial and thus automation can help to increase efficiencies and reduce clerical errors.
The inventory control department no longer has to keep track of the records to determine if inventories
are at the reorder point. The system will monitor the levels and flag any items which need reordering.
Thus, the chance that an item is overlooked is eliminated. The entries for the general ledger are
automatically created by the system, thus errors are reduced since transcription from summary reports
into the general ledger is not necessary.
6. How does the procedure differ between a basic batch processing system and a batch processing
with real-time data input of sales and receipts of inventory. What about for the procedures used by the
receiving department?
Response: A system which employs real-time data entry of sales will have the inventory levels updated
more frequently. Thus, when a sale depletes the inventory level to the reorder point, the system will flag
it for reorder more quickly than if it had to wait for a batch update of the inventory records. The sooner
the item is ordered, the sooner it will be received. With respect to the real-time receipt of inventory, the
inventory will be updated immediately to show the accurate amount which is on hand. Thus, a customer
wishing to know how soon they may have an item shipped will receive more accurate information
regarding the status of the firm's inventory levels. Thus, the customer benefits from better stocking of
inventory and better information regarding the inventory levels. The receiving department uses real-time
data entry; they enter the purchase order number and a receiving screen prompts the clerk for the
quantities of goods received. This system should cause fewer discrepancies due to poor handwriting,
carelessness, and loss of the receiving report form.
8. Discuss the major control implications of batch systems with real-time data input. What
compensating procedures are available?
Response: The first control implication is that a fundamental separation between authorization and
transaction processing no longer exists. The computer programs both authorize and process the orders
and issue checks to the vendors. The compensating control is to provide transaction listings and
summary reports to management which describe the automated activities taken by the system. In order
for these controls to work, the managers must take the time to carefully review these reports. The
second control implication is that the accounting records as well as the computer programs reside on
magnetic disks. These disks should not be accessed by any individuals not authorized to access them
in any fashion. The compensating control is to employ hardware, software and procedural controls over
the data stores.
9. Discuss some specific examples in which information systems can reduce time lags and how the firm
is positively affected by such time lags.
Response: One example is the reduction in the time it takes to record the receipt of inventory into the
inventory records which are used to inform customers whether their requested item is available. Also,
the inventory levels are also reduced more quickly for those inventories which are being shipped and
are a reduction in the inventory levels. With reduced time lag, the risk that an item will be promised to
be shipped to another customer when it is not available is greatly reduced. Further, the automated
system will be less likely to pay an invoice too early, while at the same time not missing the discount
period. Thus, cash management is improved.
11. Payroll is often used as a good example of batch processing using sequential files. Explain why.
Response: Sequential files are appropriate because most if not all payroll records on the master payroll
file are updated during the payroll processing run.
PROBLEMS (May not be the same as the current text)
I. Explain how the processing procedures would differ, if at all, for the transactions listed in problem 1
above if a computer-based system with
a) a basic batch processing system were implemented,
b) a batch processing system with real-time data input.
Response:
a) The entire inventory file would be searched at certain intervals, maybe twice a day, by the computer
to identify items at or below their reorder. The computer would also check the quantity on order field to
determine if an order has already been placed. If an order is needed, the computer creates an open
purchase requisition record. The vendor file is also needed at this point. The purchase requisition is
sent to the purchasing department to fill out a purchase order (some systems may automate this also).
The purchase orders for a certain period of time, maybe daily, are accumulated and processed together
in a batch and any open purchase requisitions which have a corresponding purchase order are closed
by the system. The receiving reports are accumulated over a period of time and processed together, at
which time the inventory is updated on a batch basis, as well as the open purchase orders. Any
purchase orders which are filled are then closed.
The vouchers are accumulated over time and processed together in a batch and recorded in the
voucher register.
b) If the system is processed with real-time data input, the inventory is automatically scanned whenever
a withdrawal from an inventory account is made. If the item needs reordering, a record in the purchase
requisition is entered. After a specified period of time, the purchase requisitions are consolidated
according to vendor number. A valid vendor file is checked by the system, and a purchase order is
created by the system. When the goods are received, the receiving report is entered into the system
and the inventory account is automatically updated to reflect the new inventory items which have
arrived and the logical field rec flag is set to true. When accounts payable receives the invoice, the files
are scanned to match the invoice with an open purchase order, and the invoice field is set to true to
indicate that the invoice has been received. The open purchase order is checked to determine if the
goods have been received by checking the logical field rec flag. If no discrepancies are noted by the
system, a record is created in the open accounts payable file. The system scans daily the accounts
payable due dates to determine which invoices will be made. The system then prepares the checks,
closes the corresponding accounts payable records and prepares a check register, and transaction
listing.
II. Using the flowchart presented in the text of a purchases system, identify six (6) major control
weaknesses in the system. Discuss each of the items that you identify. Be specific as to the class of the
control problem in accordance with SAS 78.
Response:
Authorization. The purchases function is not authorized from inventory control
Accounting Records. Inventory records are updated based on the purchase
order rather than the Receiving Report or Invoice.
Accounting Records. The Accounts Payable Subsidiary ledger is updated
based only on the Invoice. There is no reconciliation with supporting documents.
Accounting Records. There is no Cash Disbursements Journal or Check
Register in use.  reconciles the inventory amount with the account summary received from inventory
Accounting Records/Segregation of Functions. The receiving department control
prepares the Receiving Report directly from the Packing Slip. A blind copy of the Purchase Order Manual Cash Disbursements System
should go to the receiving clerk to control this activity. A supervisor should take possession of the  Periodically, A/P searches the open vouchers payable file for items with payments due:
packing slip that contains relevant data and oversee the inspection process.  A/P sends the voucher and supporting documents to Cash Disbursements
Accounting Records / Independent Verification. The General Ledger department should receive Journal  A/P updates the accounts payable subsidiary ledger
vouchers or batch totals from Inventory Control, Cash Disbursements, and Accounts Payable. These  Cash Disbursements:
are used to keep the General Ledger Control accounts current and to verify the overall accounting  prepares the cheque
accuracy of the process.  records the information in a cheque register (cash disbursements journal)
 returns paid vouchers to accounts payable, mails the cheque to the supplier
 sends a journal voucher to G/L:
Goals of the Expenditure Cycle Accounts Payable DR
 The goal of providing needed resources to organization can be broken down into several Cash CR
objectives:  G/L department receives:
 purchase from reliable vendors  the journal voucher from cash disbursements
 purchase high quality items  a summary of the accounts payable subsidiary ledger from A/P
 obtain best possible price  The journal voucher is used to update the general ledger.
 purchase only items that are properly authorized  The accounts payable control account is reconciled with the subsidiary summary.
 have resources available when they are needed
 receive only those items ordered Computer-Based Accounting Systems
 ensure items are not lost, stolen, or broken  CBAS technology can be viewed as a continuum with two extremes:
 pay for the items in a timely manner  automation - use technology to improve efficiency and effectiveness
. A Manual Purchases System  reengineering – use technology to restructure business processes and firm
 Begins in Inventory Control when inventory levels drop to reorder levels organization
 A purchase requisition (PR) is prepared and copies to sent to Purchasing and Accounts Levels of Automating and Reengineering Ordering
Payable (A/P)  Computer generates PR
 Purchasing prepares a purchase order (PO) for each vendor and sends copies to Inventory  Purchases manually generates PO
Control, A/P, and Receiving  Computer generates PO (no PR needed)
 Upon receipt, Receiving counts and inspects the goods.  PO not sent until manually reviewed
 A blind copy of the PO is used to force workers to count the goods.  Computer-generated PO is automatically sent without manual review
 A receiving report is prepared and copies sent to the raw materials storeroom, Purchasing,  Electronic Data Interchange (EDI)
Inventory Control, and A/P.  Computer-to-computer communication without PO
 A/P eventually receives copies of the PR, PO, receiving report, and the supplier’s invoice. Expenditure Cycle Database
 A/P reconciles these documents, posts to the purchases journal, and records the liability in the  Master Files
accounts payable subsidiary ledger.  supplier (vendor) master file
 A/P periodically summarizes the entries in the purchases journal as a journal voucher which is  accounts payable master file
sent to the General Ledger (G/L) department.  merchandise inventory master file
Inv-Control or Purchases DR  Transaction and Open Document Files
Accts Payable-Control CR  purchase order file
 A/P also prepares a cash disbursements voucher and posts it in the voucher register.  open purchase order file
 G/L department:  supplier’s invoice file
 posts from the accounts payable journal voucher to the general ledger  open vouchers file
  cash disbursements file  Accounts payable
 Other Files  General ledger
 supplier reference and history file  Requisitioning
 buyer file  Purchases
 accounts payable detail file  Purchases returns and allowances
Computer-Based Purchases  Cash disbursements
 A Data Processing dept. performs routine accounting tasks. Manual Segregation of Functions
 Purchasing - a computer program identifies inventory requirements  Custody of the asset, inventory, by the Warehouse must be separate from recordkeeping for
 The following methods are used for authorising and ordering inventories: the assets by the Inventory Control.
 ALT1: the system prepares POs and sends them to Purchases for review, signing,  Custody of the asset, cash, by Cash Disbursements must be kept separate from
and distributing recordkeeping for the asset by A/P.
 ALT2: the system distributes POs directly to the vendors and internal users, Computer-Based Segregation of Functions
bypassing Purchases  Extensive consolidation by the computer of tasks traditionally segregated
 ALT3: the system uses electronic data interchange (EDI) and electronically places the  computer programs authorise and process purchase orders
order without POs  computer programs authorise and issue cheques to vendors
 Other tasks performed automatically by the computer: Manual Supervision
 updates the inventory subsidiary file from the receiving report  Within the expenditure cycle, supervision is of highest importance in the Receiving
 calculates batch totals for general ledger update department, where the inventory arrives and is logged in by a receiving clerk. Need to
 closes the corresponding records in the open PO file to the closed PO file minimize:
 validates the voucher records against valid vendor files  failures to properly inspect the assets
Computer-Based Cash Disbursements  theft of the assets
 Tasks performed automatically by the computer: Computer-Based Supervision
 the system scans for vouchers currently due  Automation often leads to a collapsing of the traditional segregation of duties.
 prints cheques for these vouchers  requires greater supervision
 records these cheques in the cheque register  Supervision takes on new aspects as technology advances.
 batch totals are prepared for the general ledger update procedure  electronic monitoring
Manual Authorisation Controls  Supervision because more difficult as the workplace becomes more sophisticated.
 Purchases of inventory should be authorised by the Inventory Control department, not by  employees may have advanced IT training
purchasing agents Manual Accounting Records
 Accounts Payable authorises the payments of bills, not the cash disbursements clerk, who  Must maintain adequate records for:
writes the cheques  accounts payable
Computer-Based Authorization Controls  vouchers payable
 Authorisations are automated.  cheques
 programmed decision rules must be debugged  general ledger
 Automating inventory in EDI and JIT  subsidiary ledgers
 faulty inventory model can lead to over-purchasing or under-purchasing Computer-Based Accounting Records
 Cash disbursements may automate cheque printing and signing.  Accounting records rest on the reliability and security of stored digitalized data.
 programming logic must be flawless  Accountants should be skeptical about the accuracy of hard-copy printouts.
 automated signing only below a dollar threshold  Backups - the system needs to ensure that backups of all files are continuously kept
Traditional Segregation of Duties  Most automated systems still have a lot of paper documents.
 Warehouse (stores)  This is good for audit trail purposes but is often inefficient.
 Inventory control
  As the system becomes increasing paperless, maintaining an audit trail becomes
more difficult.

Manual Independent Verification

• Accounts Payable dept. verifies much of the work done within the expenditure cycle.
– PR, PO, receiving reports, and suppliers’ invoices must be checked and verified by
A/P.
• General Ledger dept. verifies:
– the total obligations recorded equal the total inventories received
– the total reductions in accounts payable equal the total disbursements of cash

Computer-Based Independent Verification

• Automating the accounting function reduces the need for verification by reducing the chances
of fraud and error in the expenditure cycle.
• However, the need for verification shifts to the computer program and the programmers where
fraud and error may still be present.