Which transaction cycles include the receiving report purchase order and vendor invoice?

The expenditure cycle is a recurring set of business activities and related information processing operations associated with the purchase of and payment for goods and services. This focuses on the acquisition of raw materials, finished goods, supplies and services.

In the expenditure cycle, the primary external exchange of information is with suppliers (vendors). Expense data also flow from the expenditure cycle to the general ledger and reporting function for inclusion in financial statements and various management reports. The primary objective in the expenditure cycle is to minimize the total cost of acquiring and maintaining inventories, supplies, and the various services the organization needs to function.

The four basic expenditure cycle activities

1. Ordering materials, supplies, and services

2. Receiving materials, supplies, and services

3. Approving supplier invoices

4. Cash disbursements

We begin by describing the design of the expenditure cycle information system and the basic controls necessary to ensure that it provides management with reliable information to assess operational efficiency and effectiveness.

The linkages between the buyer’s expenditure cycle activities and the seller’s revenue cycle activities have important implications for the design of both parties’ accounting information system.

The first major business activity in the expenditure cycle is ordering inventory, supplies, or services. This involves first identifying what, when, and how much to purchase, and then choosing from which supplier to purchase. Accountants and systems professionals need to understand best practices for managing inventory.

The traditional approach to managing inventory is to maintain sufficient stock so that production can continue without interruption even if inventory use is greater than expected or if suppliers are late in making deliveries. This traditional approach is often called the economic order quantity (EOQ) approach because it is based on calculating an optimal order size to minimize the sum of ordering, carrying, and stock out costs. Ordering costs include all expenses associated with processing purchase transactions. Carrying costs are those associated with holding inventory. Stockout costs are those that result from inventory shortages.

The EOQ formula is used to calculate how much to order. The reorder point specifies when to order. Companies typically set the reorder point based on delivery time and desired levels of safety stock to handle unexpected fluctuations in demand. The traditional EOQ approach to inventory control often results in carrying significant amounts of inventory. The money invested in carrying inventory earns nothing.

Materials requirements planning (MRP) seeks to reduce required inventory levels by improving the accuracy of forecasting techniques to better schedule purchases to satisfy production needs. MRP systems reduce uncertainties about when raw materials are needed and therefore enable companies to carry less inventory.

A just in time (JIT) inventory system attempts to minimize finished foods inventory by purchasing and producing goods only in response to actual sales. JIT systems are characterized by frequent deliveries of small amounts of materials, parts, and supplies directly to the specific locations that require them when they are needed.

A major difference between MRP and JIT systems is production scheduling. MRP systems schedule production to meet forecasted sales, thereby creating an optimal quantity of finished goods inventory. JIT systems schedule production in response to customer demands. MRP systems are more effectively used with products that have predictable patterns of demand. JIT inventory systems are especially useful for products that have relatively short life cycles and for which demand cannot be accurately predicted.

The need to purchase goods or supplies often results in the creation of a purchase requisition that identifies the requisitioner. The requisitioner specifies the delivery location and date needed. It identifies the item numbers, descriptions, quantity, and price of each item requested.

One threat is that inaccurate inventory records can result in stock outs that lead to lost sales or to carrying excess inventory that increases costs. To reduce the risk of these problems, the perpetual inventory method should be used to ensure that information about inventory stocks is always current. Using information technology to eliminate the need for manual data entry can improve the accuracy of perpetual inventory records.

Another threat is purchasing items that are not currently needed. Accurate perpetual inventory records ensure the validity of purchase requisitions that the inventory control system automatically generates.

The next step is to select a supplier. Purchasing agents usually perform this task. The crucial operating decision in the purchasing activity is selecting suppliers for inventory items. Several factors should be considered:

• Price

• Quality of materials

• Dependability in making deliveries

A purchase order is a document or electronic form that formally requests a supplier to sell and deliver specified products at designated prices. It also promise to pay and becomes a contract once the supplier accepts it.

Many companies maintain special purchasing arrangements with important suppliers. A blanket purchase order is a commitment to purchase specified items at designated prices from a particular supplier for a set time period, often one year.

Vendor managed inventory programs provide another means of reducing purchase and inventory costs. A vendor-managed inventory program essentially outsources much of the inventory control and purchasing function. Suppliers are given access to sales and inventory data and are authorized to automatically replenish inventory when stocks fall to predetermined reorder points.

A threat is a kickback. Kickbacks are gifts from suppliers to purchasing agents for the purpose of influencing their choice of suppliers. To prevent kickbacks, companies should prohibit purchasing agents from accepting any gifts from potential or existing suppliers. These policies should apply not only to gifts of tangible goods, but also to services.

The second major business activity in the expenditure cycle is the receipt and storage of ordered items. The receiving department is responsible for accepting deliveries from suppliers. Information about the receipt of ordered merchandise must be communicated to the inventory control function to update the inventory records.

When a delivery arrives, a receiving clerk compares the purchase order number referenced on the supplier’s packing slip with the open purchase order file to verify that the goods were ordered.

The receiving report documents about each delivery, including the date received, shipper, supplier, and purchase order number. The receiving report also contains space to identify the persons who received and inspected the goods as well as for remarks concerning the quality of the items received.

In the case of damaged or poor-quality goods, a debit memo is prepared after the supplier agrees to take back the goods or to grant a price reduction. The debit memo records the adjustment being requested.

The third main activity is approving supplier invoices for payment. The accounts payable department approves supplier invoices for payments. A legal obligation to pay suppliers arises at the time goods are received. When a supplier’s invoice is received, the accounts payable department is responsible for matching it with a corresponding purchase order and receiving report. This combination of the suppliers invoice and associated supporting documentation creates what is called a voucher package.

There are two ways to supplier invoices, referred to as non-voucher or voucher systems.

1. Non-voucher system. Each approved invoice is posted to individual supplier records in the accounts payable file and is then stored in an open invoice file. When a check is written to pay for an invoice, the voucher package is removed from the open-invoice file to the paid-invoice file.

2. Voucher system. An additional document (disbursement voucher) is also created when a supplier invoice is approved for payment. The disbursement voucher identifies suppliers, lists the outstanding invoices, and indicates the net amount to be paid after deducting any applicable discounts and allowances.

Voucher systems offer three advantages over non-voucher systems. First, they reduce the number of checks that need to be written, because several invoices may be included on one disbursement voucher. Second, because the disbursement voucher is an internally generated document, it can be prenumbered to simplify tracking all payables. Third, because the voucher provides an explicit record that a vendor invoice has been approved for payment, it facilitates separating the time of invoice approval from the time of invoice payment.

As soon as receipt of goods or services is verified, all the information required to pay the supplier is already know. The invoiceless approach is called evaluated receipt settlement (ERS). ERS replaces the traditional three-way (vendor invoice, receiving report, and purchase order) matching process with a two-way match of the purchase order and receiving report.

Procurement cards provide one way to eliminate the need for accounts payable to process many such small invoices. A procurement card is a corporate credit card that employees can use only at designated suppliers to purchase specific kinds of items.

The final activity is paying suppliers. The cashier, who reports to the treasurer, is responsible for paying suppliers. Payments are made when accounts payable sends the cashier a voucher package. Although many payments continue to be made by check, the use of EFT and FEDI is increasing.

It is often more convenient to pay for minor purchases, such as coffee or pencils, in cash. The pretty cash fund should be set up as an imprest fund. An imprest fund has two characteristics: it is set at a fixed amount and it requires vouchers for every disbursement. The sum of the cash plus vouchers should equal the preset fund balance.

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