UNIT 5: THE EXPENDITURE CYCLE

Contents
5.0. Introduction
5.1 Objectives
5.2 System Definition and Functions in Purchase Application System
5.3 Payroll System
5.4 Summary
5.5 Answers to Check Your Progress

5.0. INTRODUCTION

An organization's expenditure cycle includes the function required to acquire goods and services that
are utilized by the organization in conducting its operations. The expenditure cycle includes the
acquisition of goods for resale or use in production, the acquisition of property and equipment and the
acquisition of person service.

The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash disbursement
system and the applicable parts of the general ledger system.
Expenditure cycle Operations include:-
- The preparation and recording of purchase orders.
- The receipt of goods and the recording of the cost of inventory.
- The receipt of vendor invoices and the recording accounts payable.
- The preparation of employee pay-checks and the recording of payroll activities.
- The preparation and recording of cash disbursements, including payroll.
 Purchasing
Accounts
payable cash
disbursement
system

Inventory
General Expenditure System
ledger
System Cycle

Payroll
system

The Over all Expenditure Cycle

5.1 OBJECTIVES

After careful reading of this unit the reader must be able to:
describe the major features and operations in a purchasing application system.
describe the major features of and operations in a payroll application system.

5.2 SYSTEM DEFINITION AND FUNCTIONS IN PURCHASE APPLICATION SYSTEM

5.2.0 Overview
In some companies, all purchases of goods and services are channeled through and controlled by
centralized purchasing department. In others, the authority to place orders with vendors is dispersed
through out the company- a decentralized approach. Centralized purchasing may yield increased
quantity discounts stronger market position, better inventory control, buyer specialization, and the like.
Decentralized purchasing may yield similar benefits because of the increased responsibilities placed on
the ultimate user. For example, decentralized buyers may have greater knowledge of the use and
specifications of the desired goods and thereby maintain optimal inventory levels. As in any
organizational decision, the choice is largely one of management style and philosophy.
philosophy.

Objectives
After careful reading of this section, the reader must be able to:
describe the major features and operations in a purchasing application system

5.2.1 System definitions and functions

The purchasing (p) /accounts payable (AP) / cash disbursement (CD) system is an interacting structure
of people, equipment, methods, and controls that is designed to accomplish the following primary
functions:-

First the P/AP/CD Systems handle the repetitive work routines of the departments listed by capturing
and recording data related to the day-to-day operations of those departments. The recorded data then
may be used to generate source documents (such as purchase orders and receiving reports) and to
produce internal and external reports.

Second the P/AP/CD system prepares a number of reports those personnel at various levels uses for
different decisions will be used through out the paper: goods and services. Goods are row materials,
merchandise, supplies, fixed assets, or intangible assets. Services cover work performed by outside
vendors. Employee activities are a specialized for of service.

The information flows are representative of those related to the P/AP/CD system. However, all
information are not shown. For example purchase returns are not shown.

Description of Information flows

1- Purchase requisition sent from inventory control department to purchasing department.
2- Purchase requisitions from various other departments sent to purchasing department.
3- Purchase order sent to vendor.
4- Purchase order notification sent to various other departments or to inventory control
department.
5- Purchase order notification sent to receiving department.
6- Purchase order notification sent to accounts payable department.
7- Goods and Services received from vendor.
8- Receiving notification sent to accounts payable department.
9- Receiving notification sent to purchasing department.
 10- Invoice received from vendor.
11- Approved voucher sent to cashier.
12- Accounts payable notification and inventory cost information sent to general ledger system.
13- Check sent to vendor by cashier.
14- Paid voucher returned to accounts payable department.
15- Notification of the cash disbursement sent from cashier to general ledger system

The process associated with reordering inventory involve several important concept and techniques,
such as cyclical reordering, recorder point analysis, economic order quantity (EOQ) analysis, and ABC
analysis.

A purchase application system includes the five basic functions:

1/ Purchase requisition is prepared & approved.
2/ Purchase order issued.
3/ Materials received.
4/ Establish payable
5/ Checks are prepared.
1/ Purchase requisition
Someone outside the purchasing department determines that materials are needed and who will be
prepare and send the purchase requisition to the purchasing department.

2/ Order Goods and Services

In this section we look at the logical functions involved in ordering goods and services. The first
process involves vendor selection. A buyer (or purchasing agent) generally consults a vendor master
file to identify several suppliers. Once several candidates have been identified, the buyer then evaluates
each prospective vendor with respect to such factors as unit price, quality, service, promised delivery
dates, terms, reliability, and amount purchased from the vendor to date.

Buyers often attempt to combine as many orders as possible with the same vendor by using blanket
orders and/or annual agreements. If large expenditures for new or specially made parts are involved, the
buyer may need to obtain competitive bids by sending a request for quotation (RFQ) to prospective
vendors.

Vendor selection can have a significant impact on the success of an organization's inventory control and
manufacturing functions. One kind of Inventory control management is just in-time (JIT) inventory
management. With JIT inventory management, parts arrive when needed, thus saving the interest cost
associated with storing "excess" inventory and reducing the possibility of inventory becoming obsolete.
To use JIT systems effectively, organizations must find and retain reliable vendors.

After vendor has been selected, the buyer then prepares a purchase order, which is an external request
for the purchase of goods or services from a vendor. Typically a purchase order contains data regarding
the needed quantities, expected unit prices, required delivery date, terms, and other conditions. Because
it is the basis for a contract between the buyer and the seller, the purchase order should been some
authorized signature, usually that of a purchasing agent or buyer.

Cash maintained in demand deposit accounts is sufficient (but not excessive) to satisfy expected cash
disbursements. To accomplish this goal, many banks often to their commercial customers a cash
management service by which the bank transfers from the customer's money market or other
investment account into its checking account the exact amount needed to cover the checks that clear
each day.

For convenience in handling accounts payable, many companies have adopted the policy of making
payments twice per month. It is usually possible to make agreement with vendors (Particularly if you
are a high volume customer) so that the cash discount will be considered earned of invoices received
during the first half of the month (for instance) are paid on the twentieth, and invoices received during
the second half of the month are paid on the fifth of the succeeding month.

The purchase order notifications could take a number of physical forms. when multipart paper
documents are used, it is not uncommon for the copy sent to the receiving department to be a blind
copy, meaning that contain data are blanked out (i.e, blinded) for instance, the quantities ordered might
be blanked out so that the receiving personnel will not be influences by this information when counting
the goods price data may also be blinded because receiving personnel have no need to know that
information.

At some paint, the vendor uses a notification known as a vendor acknowledgement to inform the
purchaser that the purchase order has been received and is being processed
(See the data flow "vendor acknowledgement" in to bubble B). As a result of the vendor
acknowledgement, process B up dates the "purchase status" field in the purchase order master file.
3. Receive Goods and Services
When good arrived at the receiving department, there is inspected and counted. This process helps to
insure that the right goods in a correct amount are received in acceptable condition. Nonconforming
goods are rejected (returned) to the supplier. Notation of rejected goods is added to the vendor service
record in the vendor master file.

Once the condition of the goods has been approved the process of complete receiving report by noting
the quantity received on the approved purchase order receiving notification. Once annotated with the
quantity received the purchase order receiving notification become a receiving report, which is the
document used to record merchandize receipts.

As in the case of the receipt of goods, services received also should be documented properly. Some
organizations use an acceptance report to acknowledge formally the satisfactory completion of a
service contract. The acceptance report supports the payment due to the vendor in the same way as the
receiving report.

4. Establish Payable
The first step in establishing the payable involves validating the vendor invoice. This process is
triggered by receipt of the vendor invoice, a business document that notifies the purchaser of an
obligation to pay the vendor for goods or services that were ordered by and shipped to the purchaser.

The process comprises a number of steps. First, the vendor invoice is compared against data on a copy
of the purchase order (Po accounts payable notification) to make sure that (1) the purchase has been
authorized and (2) invoices quantities, prices and terms conform to the purchase order agreement. Next,
the invoice is matched against the receiving report to determine that the goods or services actually have
been received and that goods have been transferred to stores. Finally, the invoice is cheeked for
accuracy of computed discounts, extension, and total amount due.

If the data items do not agree, the invoice is rejected and follow up procedures are initiated (see the
reject stub emanating from bubble 3.1) If the data item agree, the invoice is approved and the validated
invoice is then used to record the payable. Note that the vendor master file is also updated at this point
to reflect purchase history data.

A payable is recognized and recorded by simultaneously:

Creating a record on the accounts payable master file.
Updating the inventory master file for the cost of the item received.
 Notifying the general ledger system of the amount of the payable that was recorded ( see the
data flow "GL payable update")
The previous flow diagram assumes that a non-voucher system is used. Alternatively, a voucher system
might be employed. A disbursement voucher is designed to reflect formal approval of the voucher for
payment and to provide such added data as the account distribution and the amounts to be debited.
Several invoices from a single vendor are often listed on one disbursement voucher so that fewer
checks need to be written during the cash disbursement procedure. In the section on "processing none
invoiced Disbursements, "we elaborate on the use of a voucher system.

To help achieve a third system goal, to optimize cash discounts, the responsibility for ensuring saving
through cash discounts, the responsibility for ensuring saving through cash discounts includes (1)
seeing that proper cash discount terms are incorporated in the order, (2) securing invoices promptly
from vendor, (3) processing invoices promptly and getting them to the disbursing office within the
discount period, and (4) when unavoidable delays are encountered because of some fault of the seller,
making sure that the discount privilege is not waived and that the vendor is notified to this effect.

5. Make Payment
The payment schedule adopted will depend on the availability of any favorable discounts for prompt
payment and on the organizations current cash position. Some companies will pay multiple invoices
with one check to minimize the cost of processing invoices. Most cash managers will attempt to
optimize cash balances to help achieve a fourth system goal. that is to insure that the amount of cash.

Data flow diagram for purchase application system.

6

Receiv
ing 7

5 3

Stores 1 Purcha Vendor

2 sing 10
4 11
9 13
A/P
Cash
Details 12 Payment
Vender
Data

Data flow key

1. Requisition
2. Acknowledgement
3. Purchase order
4. Purchase advice
5. Receiving advice
6. Shipment
7. Receiving advice
8. Receiving report
9. Notice of receipt
10. Invoice
11. Approved invoice
12. Voucher package
13. Payment

To initiate an adjustment for returned goods on for a price allowance in the case of otherwise
conforming goods someone usually prepares a debit memorandum and sends in to the vendor, the
vendor commonly acknowledges by returning a credit memorandum. a copy of the debit memo is sent
to the accounts payable department. In the case of return copies are also sent to the storeroom and
shipping department.

The merchandise to be returned is then released from the storeroom and sent to the shipping department
and shipped. The shipping department forwards its copy at the debit memo to the accounts payable
department.

PROCESSING NON INVOICED DISBURSEMENTS

Disbursements that are not typically supported by invoices such as, repayment of debt obligation and
interest and the like.
The following diagram is a logical data flow diagram that shows the processing of non-invoiced
payments under two different assumptions:
(1) A true vouches system is used in which all expenditures must be vouched that is, formally
approved for payments and recorded as a payable before they can be paid, and

(2) A non-voucher system is employed.

1/ assuming a true voucher system is used.

Payment Disburseme GL
requiest nt vocher payable

Originating Prepar recor General ledger

Department System
e
d
disb
disb
urse
urse
ment
ment
Vouchers
vouc
vouc
Payable
her Master File
her GL cash
disbursement
update
Check
Payment
notification

Prepar Issue
e cheek
chec and
k recor Payee
d
Payment

pay
ment
 2/ assuming a non-voucher system is used.

General
ledger system

GL cash
disbursement
up date
up date
Payment Approved Prepair
Approve
check
request paiment payment request

Originating Cash disbursement

departement transaction file Check

Payment Issue
notification check and
record
payment

Payee Payment

Learning activity 1
1. Describe the major functions in purchase application system?
___________________________________________________________________________________
___________________________________________________________________________________
___________________________________________________________
2. Distinguish between accounts receiving and stores
___________________________________________________________________________________
___________________________________________________________________

5.3 PAYROLL SYSTEM

5.3.0. Overview
A payroll / personnel system involves all phases of payroll processing and personnel reporting. The
system provides a means of promptly and accurately paying employees, generating the necessary
payroll reports, and supplying management with the required employee skills information. The
processing should include a deduction for with holding taxes, specialized deductions, government
reporting, and internal personnel requirements. An efficient system is necessary to establish and
maintain good employer- employee relationships.

Payroll processing is extremely complex. In a large organization, it is often the most complex
procedure in operation. This is because of the social significance payrolls have assumed over the last
few decades. All levels of government impose payroll taxes of one sort or another; regulations and rates
are constantly changed, with the result that a payroll usually has a relatively short life. The strategy
here is to provide an overview of a typical payroll procedure and discuss factors influencing the actual
calculation of payroll. No attempt is made to provide current tax rates: tax laws are arbitrary and
change quite rapidly. Payroll processing is one area in which the law imposes not only a fine but also a
jail sentence for willful negligence in maintaining adequate records. As with any law, ignorance is no
excuse.

5.3.0 Objectives
After careful reading of this section the reader must be able to:
describe the major features of and operations in a payroll application system.
Two data flows enter the payroll system from departmental managers and supervisor's attendance time
records and job time records. Attendance time records shows the time period that employees are in
attendance at the job site and available for work. These records are used to calculate the gross amount
of each employees pay. Job time records on the other hand reflect that start and stop times on specific
jobs. Their purpose is to allow the distribution of payroll costs to jobs in process (or to other accounts).

Attendance time records maintained near the entrance of the workplace and after take the physical form
of time sheets that are stamped as employees come and go. Job time records are prepared at the
worksite by employees entering the time each job is started and stopped.

"Reconcile hours worked" compares the total hours of each works as shown by at the attendance time
record with the hours reflected on the job time records for that employee. The hours should agree. This
reconciliation's is one of the payroll system control plans.
Data flow diagram for payroll application system (for manufacturing firm)
1
Personnel

Production

2 Payroll data

3 Details
Payee
Time Payroll
Keepin
g 10
6
12
Cash
4 5 Payment 11 Bank

Cost A/P
Distributio 14 13
n
8

G/L Interna
9
l audit

Data flow key

 1. authorization 8. voucher
2. job time summary 9. journal voucher
3. job time cards 10. paychecks
4. job time report 11. voucher check
5. payroll register 12. canceled checks
6. paychecks 13. bank statement
7. voucher check 14. control total

Personnel
The personnel office is responsible for placing people on the companys payroll, specifying rates of
pay, and authorizing all deductions from pay. All changes such as adding, or deleting employees,
changing pay rates, or changing levels of deductions from pay must be authorized by the personnel
office. The personnel function is distinct from time keeping and from payroll preparation function.

Time keeping
The time keeping function is responsible for the preparation and control of time reports and job time
tickets. In manufacturing firm, an hourly employee typically clocks on and off of the job. At the end of
the period, the employee's time card or time report indicates the amount of time that the employee was
on the job and the time that he or she expects to receive pay for. Time keeping is responsible for
collecting and maintaining time cards and reconciling these data to job time summary reports that are
received from production.

Payroll
The payroll department is responsible for the actual computation and preparation of payroll. Note that
preparing payroll is independent of preparation of the input data on which pay is based, the time reports
and personnel data. Personnel data are received from the personnel office; time reports are received
from time keeping. The payroll register details the computation of net pay (gross pay less deductions
from pay). Pay checks are sent cash payment for signature, review, and distributions. A copy of the
payroll register is sent to accounts payable to initiate the recording of a voucher for the payroll.

Learning activity 2
1. Describe the major features of and operations in a payroll application system
 ________________________________________________________________________________
________________________________________________________________

Answers to learning activities

Learning activity 1
1. Describe the major functions in purchase application system?
The expenditure cycle embodies all activities in the purchasing /accounts payable/ cash disbursement
system and the applicable parts of the general ledger system.
Expenditure cycle Operations include:-
- The preparation and recording of purchase orders.
- The receipt of goods and the recording of the cost of inventory.
- The receipt of vendor invoices and the recording accounts payable.
- The preparation of employee pay-checks and the recording of payroll activities.
- The preparation and recording of cash disbursements, including payroll.

1. Distinguish between receiving and stores

When good arrived at the receiving department, there is inspected and counted. This process helps to
insure that the right goods in a correct amount are received in acceptable condition. Nonconforming
goods are rejected (returned) to the supplier. Notation of rejected goods is added to the vendor service
record in the vendor master file.

Once the condition of the goods has been approved the process of complete receiving report by noting
the quantity received on the approved purchase order receiving notification. Once annotated with the
quantity received the purchase order receiving notification become a receiving report, which is the
document used to record merchandize receipts.

The stores department acknowledges receipt of the goods from receiving by signing the receiving
report and then forwarding the receiving report to accounts payable.

Learning activity 2
1. Describe the major features of and operations in a payroll application system
The HRM/payroll cycle is a recurring set of business activities and related data processing
operations associated with effectively managing the employee work force.
 1. Update master payroll file
2. Update tax rates and deductions
3. Validate time and attendance data
4. Prepare payroll
5. Disburse payroll
6. Calculate employer-paid benefits and taxes
7. Disburse payroll taxes and other deductions
The first activity in the HRM/payroll cycle involves updating the payroll master file to reflect
payroll changes such as new hires, terminations, changes in pay rates, or changes in
discretionary withholdings.
It is important that all payroll changes are entered in a timely manner and are properly reflected
in the next pay period.
The second activity in the HRM/payroll cycle involves updating information about tax rates and
other withholdings.
These changes happen whenever updates about changes in tax rates and other payroll
deductions are received from various government units and insurance companies.
The third activity in the payroll cycle is to validate each employees time and attendance data.
This information comes in various forms, depending on an employees status.
The fourth activity in the payroll cycle involves preparing payroll.
Data about the hours worked are provided by the department in which the employee works.
Pay rate information is obtained from the payroll master file.
The person responsible for preparing paychecks cannot add new records to this file.

The fifth activity is actual disbursement of paychecks to employees.

Most employees are paid either by check or by direct deposit of the net pay amount into the
employees bank account.
The six activity is calculating tax and benefits. Some payroll taxes and employee benefits are
paid directly by the employer.
Federal and state laws require employers to contribute a specified percentage of each
employees gross pay to federal and state unemployment compensation insurance funds.
Employers often contribute to health, disability, and insurance premiums.
The final activity in the payroll process involves paying the payroll tax liability and the other
voluntary deductions of each employee.
 An organization must periodically prepare checks or use electronic transfer to pay the various
tax liabilities incurred.

Check Your Progress

1. In a purchase application system, which of the following departments should normally be

responsible for the preparation of the purchase order?
A. Cash disbursement
B. Purchasing
C. Accounts payable
D. Stores
2. In a purchase application system, which of the following departments should normally be

responsible for the preparation of the requisitions?

A. Cash disbursement
B. Purchasing
C. Receiving
D. Stores
3. In order to provide accountability for purchasing, copies of purchase requisitions should be sent to
A. The vendor
B. Cash disbursement
C. Accounts payable
D. Receiving
4. In payroll application system, which of the following should be responsible for payroll register?
A. Personnel department
B. Payroll department
C. Cash payment department
D. Time keeping department.
5. In a payroll application system, which of the following should be responsible for the authorization of
pay rates for employees?
A. Personnel department
B. Payroll department
C. Cash disbursement
D. Time keeping department
5.4 SUMMARY

The general P/AP/CD system entails several different files. The accounts payable master file is a
repository of all unpaid vendor invoices. In creating the records that compose typical accounts payable
master file information to be captured should be limited to data that lead to accomplishing the goals of
the system. The file designee should consider how the file would be processed when the cash manager
is deciding what payment to make. For example, the manager may want to merge vender invoices so
that the total amount due each vendor can be accumulated. Alternatively, the manager might want to
select specific invoices for payment.

Purchasing personnel when selecting an appropriate vendor usually accesses the vender master file.
During processing, vender data are retrieved to prepared purchase orders and to issue payments. In
addition to storing identification data the file is used by management to evaluate vender performance
and to make various ordering decisions.

The purchase order master file is a compilation of open purchase orders and includes the status of each
item on order. To keep track of a purchase, the purchasing department generally creates a record in the
purchase order, including information about the status of each item on order. The order is closed only
on receipt and acceptance of all goods detailed on the order.

The other file appearing in the data flow diagrams are:

(a) The inventory master file. This file contains a record of each inventory item that is stoked in the
warehouse or is regularly ordered from a vendor. These records are used to manage the
inventory and to support the inventory in the general ledges.
(b) Recording report file. This is a transaction file of receiving report documents. physically, the
reserving reports is often a duplicate copy of the purchase order document. Therefore, a typical
receiving report would comprise a heeder section-containing the same information as a
purchase order header-and one or more receiving report lines-showing each item's identification
card, description, quantity ordered (unless the bylined copy was used), quantity received, and
data received.

(c) Cash disbursements transaction file. the purchase of this file to show in chronological sequence
the details of each cash payment made. Accordingly each record in this file normally would
show the date the payment is recorded, vendor identification, disbursement voucher number (if
 the voucher system is used), vendor invoice number and gross invoice amount, cash discount
taken on each invoice, net invoice amount, check amount and check number.

The payroll system, as you might guess, has need for its own files. The employee/payroll master file
contains employee identification data as well as data used for the computation of employee paychecks.
Employee payroll records are keyed by an employee identification code. The employee code can be
designed so as to reflect certain employee attributes, such as departments, factory and positions. Such
code numbers can be used to provide management with labor-cost distribution.

5.5 ANSWERS TO CHECK YOUR PROGRESS QUESTIONS

1. B. 2. D. 3. C. 4. B. 5. A.