Chapter 10

Auditing the Expenditure Cycle

A Summary
Aparicio, Cagape, Tagaytay

The examination of audit procedures associated with expenditure cycle.

3 main sections:

1. Review of computer technologies used in both legacy and modern systems.

2. Discusses the expenditure cycle audit objectives, controls, and tests of controls that an auditor
would normally perform to gather the evidence needed to limit the scope, timing, and extent of
substantive test.
3. Describes substantive tests in relation to expenditure cycle audit objectives that can be
performed using ACL software.

EXPENDITURE CYCLE ACTIVITIES AND TECHNOLOGIES

Examines alternative information technologies used to support expenditure cycle activities
 purchases and cash disbursements
 Review the operational features of a modern system that employs real-time processing and uses
direct access files or databases.

Purchases and Cash Disbursement Procedures Using Batch Processing Technology

Data Processing Department: Step 1
 The purchasing process begins in the data processing department, where inventory control
function is performed.
 System determines if the affected items in the inventory subsidiary file have fallen to their
reorder point.
Purchasing Department

 Upon receipt of the purchase requisition, the purchasing department prepares a five- part
purchase order. Copies go to the vendors, accounts payable, receiving, data processing, and the
purchasing department’s own file.

Alternative approaches for authorizing and ordering inventories:

 Alternative one – the system advances the procedures one-step further. This system prepares
the purchase order documents and sends them to the purchasing department for review and
signing. The purchasing agent then mails the approved purchase orders to the vendors and
distributes copies to the other internal users.
 Alternative two – expedites the ordering process by distributing the purchase orders directly to
the vendors and internal users
 Alternative three – represents a reengineering system that uses electronic data interchange. This
method produces no physical documents (purchase orders or sales orders).

Data Processing Department: Step 2

Receiving Department

When goods arrive, the receiving clerk prepares a receiving report. Copies go to purchasing, accounts
payable, and data processing.

Data Processing Department: Step 3

 Runs a batch job that updates the inventory subsidiary file from the receiving reports and
removes “On Order” flag from the inventory records. The system calculates batch totals of
inventory receipts for the general ledger update procedure and then closes the corresponding
records in the open purchase order file to the closed purchase order file.

Accounts Payable

When clerk received the supplier’s invoice, he reconciles it with the supporting documents that were
previously placed in the accounts payable pending file. He then prepares a voucher, files it in the open
voucher file, and sends a copy of the voucher to data processing.

Data Processing Department: Step 4

Validates the voucher records against the valid vendor file, adds them to the voucher register and
prepares batch totals for posting to the AP control account in the general ledger.

Cash Disbursement: Data Processing Department

 The system scans the due date field of the voucher register for items due. Checks are printed for
these items, and each check is recorded in the check register (cash disbursement journal). The
check number is recorded in the voucher register to close the voucher and transfer the items to
the closed AP file. The checks, along with a transaction listing, are sent to the cash
disbursements department. Finally, batch totals of closed accounts payable and cash
disbursements are prepared for the general ledger update procedure
 Batch totals of open (unpaid) and closed (paid) accounts payable, inventory increases, and cash
disbursements are posted to the accounts payable control, inventory control, and cash accounts
in the general ledger. The totals of closed accounts payable and cash disbursements should
balance.

Cash Disbursement: Cash Disbursement Department

 The clerk reconciles the checks with the transaction listing and submits the negotiable portion of
the checks to management for signing. The checks are then mailed to the suppliers. One copy of
each check goes to accounts payable, and the other copy is filed in cash disbursements along
with the transaction listing.

Cash disbursement: Accounts Payable

 Upon receipt of the check copies, the clerk matches them with open vouchers and transfers
these closed items to the closed voucher file. The expenditure cycle file concludes with this step.
Reengineering the Purchases/Cash Disbursement System

 The automated system just described simply replicates many of the procedures in a manual
system. In particular, the accounts payable task of reconciling supporting documents with
supplier invoices is labor intensive and costly.

Data Processing

The following tasks are performed automatically

1. The inventory file is searched for items that have fallen to their reorder point.
2. A record is entered in the purchase requisition file for each item to be replenished.
3. Requisitions are then consolidated according to vendor number.
4. Vendor mailing information is retrieved form the valid vendor file.
5. Purchase orders are prepared and sent to the vendor. Alternatively, these may be transmitted
using EDI technology.
6. A record of each transaction is added to the open purchase order file
7. A transaction of purchase orders is sent to the purchasing department for review.

Receiving Department

When goods arrive, the clerk accesses the open purchase order file in real time by entering the purchase
order number taken from the packing slip.

Data Processing

The following tasks are performed automatically by the system:

1. Quantities of items received are matched against the open purchase order record, and a “Y”
value is placed in a logical field to indicate the receipt of inventories.
2. A record is added to the receiving report file.
3. The inventory subsidiary records are updated to reflect the receipt of the inventory items.
4. The general ledger inventory control account is updated.
5. The record is removed from the open purchase order file and added to the open AP file, and a
due date for payment is established.

The following procedures are performed for the selected due date field of the accounts payable records

1. Checks are printed, signed, and distributed to the mailroom for mailing to vendors. EDI vendors
receive payment electronically.
2. The payments are recorded in the check register file.
3. Items paid are transferred from the open accounts payable file to the closed AP file.
4. The general ledger accounts payable and cash accounts are updated.
5. Reports detailing these transactions are transmitted via terminal to the accounts payable and
cash disbursements departments for management review and filing.

Control Implications: Automated Versus Reengineered System

The Automated System

 Improved Inventory Control

 Better Cash Management
 Less Time Lag
 Better Purchasing Time Management
 Reduction of Paper Documents

The Reengineered System

 Segregation of Duties
 Accounting Records and Access Controls

Overview of Payroll procedures

1. General expenditures that apply to all vendors will not apply to employees.
2. Writing checks to employees requires special controls
3. General expenditure procedures are designed to accommodate a relatively smooth flow
of transactions

Reengineering the Payroll System

Payroll processing is often integrated within the human resource management (HRM) system.

This system differs from the simple automated system described previously in the following ways:

1. Operations departments transmit transactions to data processing via terminals

2. Direct access files are used for data storage and
3. Many processes are now performed in real time.
Personnel- this department makes changes to the employee file in real time via terminals. These
changes include additions of new employees, deletions of terminated employees, changes in
dependents, changes in withholding, and changes in jog status (pay rate).
Cost Accounting- this department enters job cost data to create the labor usage file
Time keeping – upon receipt of the approved timecards from the supervisor at the end of the
week, the timekeeping department creates the current attendance file. At the end of the work
period, the following tasks are performed in a batch process
1. Labor costs are distributed to various work-in –process, overhead, and expense accounts.
2. An online labor distribution summary file is created. Copies of the file go to the cost accounting
and general ledger departments.
3. An online payroll register is created from the attendance file and the employee file. Copies of the
files go to the accounts payable and cash disbursements departments.
4. The employee records file is updated.
5. Payroll checks are prepared and signed. They are sent to the treasurer for review and
reconciliation with the payroll register. The paychecks are then distributed to the employees.
6. The disbursement voucher file is updated and a check is prepared for the funds transfer to the
payroll imprest account. The check and a hard copy of the disbursement voucher to cash
disbursements. One copy of the voucher goes to the general ledger department, and the final
copy goes to accounts payable.
7. At the end of processing, the system retrieves the labor distribution summary file and the
disbursements voucher file and updates the general ledger file.

EXPENDITURE CYCLE AUDIT OBJECTIVES, CONTROLS, AND TEST OF CONTROLS

Management Assertions and Expenditure Cycle Audit Objectives

Existence or Occurrence – verify if balance represents actual amount in the balance sheet date

Completeness – determine if accounts represent all amounts

Accuracy – if transactions are accurately computed

Rights and Obligations – if recorded accounts represent the legal obligation of the org.

Valuation or Allocation- verifies that accounts payable are stated at correct amounts owed.

Presentation and Disclosure – ensure that accounts reported for the period are properly described and
classified in the FS.

INPUT CONTROLS

 Data Validation Controls

 Testing Validation Controls
 Batch Controls
 Testing Batch Controls
 Purchases Authorization Controls
 Testing Purchases Authorization Controls
 Employee Authorization
 Testing Employee Authorization Procedures

PROCESS CONTROLS

 File Update Controls

 Sequence Check Control
 Liability Validation Control
 Valid Vendor File
 Testing File Update Controls
 Access Controls
 Testing Access Controls
 Physical Controls
 Purchases System Controls
 Payroll System Controls
 Testing Physical Controls

OUTPUT CONTROLS

 Accounts Payable Change Report

 Transaction Logs
 Transaction Listing
 Log of Automatic Transactions
 Unique Transaction Identifiers
 Error Listing
 Testing Output Controls

SUBSTANTIVE TESTS OF EXPENDITURE CYCLE ACCOUNTS

Expenditure Cycle Risks and Audit Concerns

Broader operational audit concerns, however, include process efficiency, fraud, and losses due to
errors. Consideration of overstatement of liabilities and related expenses are also important.

Understanding Data

1st – the auditor must verify that he or she is working with the correct version of the file to be analyzed.
To do so, the auditor must understand the file backup procedures and, whenever possible, work with the
original files

2nd – read most sequential files and relational database tables directly, but esoteric and/or complex file
structures may require flattening before they can be analyzed.

Inventory File

The inventory files contain quantity, price, supplier, and warehouse location data for each item of
product inventory. The purchasing process begins with a review of the inventory records to identify
inventory items that need to be ordered.

Purchase Order File

This file contains records of purchases placed with suppliers. The record remains open until the inventory
arrives. Placing the receiving report number in the dedicated field closes the record.

Purchase Order Line Item File

The line item file contains a record of every item ordered. They also provide links to related records in
the Purchase order and inventory files.

Receiving File

The system automatically performs the following tasks.

1. Increases the quantity on hand field in the inventory record.

2. Removes the reorder condition by resetting the PO-number field to its normal blank state
3. Creates a receiving report record of the event
4. And closes the purchase order record by placing the receiving report number in the designed
field.
Disbursement Voucher File and Check Register File

The disbursement voucher file provides two important pieces of information for the auditor:

1. It is a record of the timing and amount of vendor invoices received

2. And at any point in time, the open items (unpaid vouchers) in the file constitute the company’s
outstanding accounts payable balance.

File Preparation Procedures

Through a series of easy-to-use pop-up menus, the auditor specifies the name of the file and where it
resides on the mainframe of PC. ACL then prompts the auditor to define the file’s structure in terms of
the length of each field and the data type contained in each field (numeric, character, date)

Testing the Accuracy and Completeness Assertions

Refer to Cabrera Book for audit procedures.

Review Disbursement Vouchers for Unusual Trends and Exceptions

A useful audit procedure for identifying potential audit risks involves scanning data files for unusual
transactions and account balances.

Reviewing for Accurate Invoice Prices

Comparing prices on supplier invoices to original purchase order prices provides evidence for testing the
management assertion of accuracy.

Testing the Completeness, Existence, and Rights and Obligations Assertions

Inventories received from valid suppliers in response to authorized purchase orders constitute liabilities.

The search for unrecorded liabilities described provides evidence that tests the completeness, existence,
and rights and obligations assertions.

Searching for Unrecorded Liabilities

The search for unrecorded liabilities involves the Disbursement Voucher and Receiving Report Files.

Review for Multiple Checks to Vendors

The auditor can test for duplicate records in a large file.

Auditing Payroll and Related Accounts

The auditor should test the mathematical accuracy of payroll summaries and trace totals to the payroll
records and to the general ledger accounts.