Chapter 5: The Expenditure Cycle

risks of EDI technology

1) ensuring only valid transactions are processed 2) trading partner will access the accounting records in a way that is unauthorized by the trading partner agreement

objectives of physical systems

1) illustrate AIS functionality and work flow patterns under different levels of technology 2) demonstrate how the internal control profile changes as technology/human mix changes

Primary risks associated with expenditure cycle transactions

1) unauthorized inventory purchase 2) receiving the wrong items, incorrect quantities, or damaged goods 3) inaccurately recording purchases and cash disbursement transactions in journals and accounts 4) misappropriation of cash and inventory 5) unauthorized access to accounting records and confidential records

controls: Risk of misappropriation of cash and inventory

Supervision: inadequate supervision can create and environment conducive to the theft of inventories in transit independent verification: three-way match of the purchasing order, the receiving report, and the supplier's invoice segregation of duties--inventory control from the inventory warehouse: physical custody of inventory must be separate from recording inventory segregation of duties--accounts payable from cash disbursements: writing and recording checks MUST be separate automated three-way match and payment approval: multilevel security: allows multiple individuals to simultaneously access a system but provides segregation of duties to limit access privileges

internal controls: Risk of unauthorized inventory purchases

Transaction authorization: ensure that only valid transactions are processed Automated purchase approval: to prevent unauthorized purchases from unapproved vendors (lists of approved vendors, passwords, encryptions, overrides)

controls: Risk of unauthorized access to accounting records and reports

access control: limiting access to documents that control physical assets segregation of duties: record-keeping tasks such as the subsidiary ledgers, journals, and general journals must be kept separate (collusion must only be possible through two or more individuals in dissimilar responsibilities password control: password control policy multi-level security: limiting access privileges

Risk of unauthorized access to accounting records and reports

accounting information is at risk due to 1) attempts to perpetrate vendor fraud 2) theft of physical inventory: access to inventory records allows the perpetrator to conceal the theft 3) malicious acts such as corrupting or deleting financial data

physical phase

acquisition of the physical resource

check register

also known as the cash disbursements journal

vouchers payable system

an alternative to the AP procedures AP department uses cash disbursement vouchers and maintains a voucher register vouchers provide improved control over cash disbursements and allow firms to consolidate several payments to the same supplier on a single voucher (reducing number of checks written)

standard cost system

carry their inventories at a predetermined standard value regardless of the price actually paid to the vendor

Basic technology: expenditure cycle

computers in the system are independent firm relies on communication through physical documentation, which are key for the audit trail

blind copy

contains no quality or price information about the products being received. The purpose of the blind copy is to force the receiving clerk to count and inspect inventories prior to completing the receiving report important control to reduce risk. many people are so flustered with receiving they neglect to count

supplier invoice

contains the financial information needed to record the action (must recognize as a liability until the invoice arrives)

purpose of physical controls

control the actions of people AASSIT access controls accounting records segregation of duties supervision independent verification transaction authorization

EDI technology

devised to expedite routine transaction processing between manufacturers, wholesalers, and retailers by connecting buyer and seller computers via a private network or the internet implementation of a trading partner agreement to eliminate the discrepancies that require human involvement to solve level of personnel needed decreases

financial phase

disbursement of cash

risk of inaccurately recording transactions in journals and ledgers

examples include: purchases from vendors being incorrectly stated accounts payable go unrecorded or recorded in the incorrect period vendor bills customers for items they did not receive

Risk of receiving incorrect items, quantities or damaged goods

failure to inspect, count large quantities of valuable assets that arrive from vendors places the firm at risk

physical model

how something is accomplished every business has a different _____________ model

purchases procedures

include the tasks involved in identifying inventory needs, placing the order, receiving the inventory, and recognizing the liability (applies both to manufacturing and retailing firms

internal controls: Risk of receiving incorrect items, quantities or damaged goods

independent verification: the receiving clerk receives a blind copy of the PO from purchasing , physical count and inspection of goods supervision: critical to ensure that the clerks are properly carrying out important duties (supervisor must take custody of packing slips and receiving clerks should count and inspect goods) scanner technology: reduce the risk of human error in receiving and storing incorrect products

computer application controls

input controls, processing controls, output controls

advanced technology: expenditure cycle

integrates accounting and other business functions through a common information system: operational performance increases and costs decrease

valid vendor file

name and address of the primary supplier, the economic order quantity, and the standard or expected unit cost of the item allows to deal with routine purchases as efficiently as good control permits and to devote primary efforts to nonroutine problems ensure coming from authorized vendors

Risk of misappropriation of cash and inventory

possibility of fraudulent payments to individuals posing as vendors or erroneous payments for items not ordered or not received

purchase requisition

prepare purchase order function to initiate purchase process

the cash disbursements system

processes the payment of obligations created in the purchases system

supplier's invoice

provides the financial information needed to record the obligation as an accounts payable

AP packet

reconciled AP supporting documents (PO, receiving report, and invoice)

voucher register

reflects the AP liability of the firm: the sum of the unpaid vouchers in the register is the firm's total AP balance

Purchasing order

shows that the purchasing agent ordered only the needed inventories from a valid vendor

receiving report

states the quantity and condition of the inventories proves legitimate obligation to pay four copies: 1) raw materials (physical assets) 2) open/closed PO 3) set up account payable function (AP pending file) 4) receiving report file

objective of expenditure cycle

to convert the organization's cash into the physical materials and human resources it needs to conduct business

objective of cash disbursements system

to ensure that only valid creditors receive payment and that the amounts paid are timely and correct paid early: loses out on interest income paid late: bad credit

objective of internal control

to mitigate the risk from errors and fraud

controls: risk of inaccurately recording transactions in journals and ledgers

transaction authorization: to provide effective control over the flow of cash from the firm, the cash disbursement function should not write checks without this explicit authorization accounting records: to maintain an audit trail adequate for tracing a transaction from its source documents to financial statements independent verification: general ledger function provides an important step in the system because it verifies that the total obligations recorded equal the total inventories received and that the total reductions in AP equal the total disbursement of cash Input data edits: edits that focus on the integrity of transaction data being entered (controls including checks for missing data, check digit control will provide control over accessing the wrong accounts) error messages: mismatched conditions produce error messages automated postings to subsidiary and GL accounts: eliminate human element to reduce likelihood of fraud file backup: to attack against physical loss, corruption or destruction of source documents KEY accounts: AP subsidiary ledger, check register, general ledger

three way match

verifies what is ordered was received and is fairly priced

conceptual model

what needs to be done; is intended to be technology-neutral (can be performed manually or automated via technology) using physical hard copies or digital computer produced documents. businesses may have similar __________ models

Risk of unauthorized inventory purchases

what to buy, when to buy, and whom to buy from excessive inventories tie up cash reserves and stock outs prevent sales and lead to manufacturing delays