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218 PART II Transaction Cycles and Business Processes

The Conceptual System

OVERVIEW OF PURCHASES AND CASH DISBURSEMENTS ACTIVITIES
In this section we examine the expenditure cycle conceptually. Using data flow diagrams (DFDs) as a
guide, we will trace the sequence of activities through two of the processes that constitute the expenditure
cycle for most retail, wholesale, and manufacturing organizations. These are purchases processing and
cash disbursements procedures. Payroll and fixed asset systems, which also support the expenditure
cycle, are covered in Chapter 6.
As in the previous chapter, the conceptual system discussion is intended to be technology-neutral. The
tasks described in this section may be performed manually or by computer. At this point our focus is on
what (conceptually) needs to be done, not how (physically) it is accomplished. At various stages in the
processes, we will examine specific documents, journals, and ledgers as they are encountered. Again, this
review is technology-neutral. These documents and files may be physical (hard copy) or digital (computer
generated). Later in the chapter, we examine examples of physical systems.

Purchases Processing Procedures
Purchases procedures include the tasks involved in identifying inventory needs, placing the order, receiv-
ing the inventory, and recognizing the liability. The relationships between these tasks are presented with
the DFD in Figure 5-1. In general, these procedures apply to both manufacturing and retailing firms. A
major difference between the two business types lies in the way purchases are authorized. Manufacturing
firms purchase raw materials for production, and their purchasing decisions are authorized by the produc-
tion planning and control function. These procedures are described in Chapter 7. Merchandising firms
purchase finished goods for resale. The inventory control function provides the purchase authorization
for this type of firm.

MONITOR INVENTORY RECORDS. Firms deplete their inventories by transferring raw materials
into the production process (the conversion cycle) and by selling finished goods to customers (revenue
cycle. Our illustration assumes the latter case, in which inventory control monitors and records finished
goods inventory levels. When inventories drop to a predetermined reorder point, a purchase requisition
is prepared and sent to the prepare purchase order function to initiate the purchase process. Figure 5-2
presents an example of a purchase requisition.
Although procedures will vary from firm to firm, typically a separate purchase requisition will be pre-
pared for each inventory item as the need is recognized. This can result in multiple purchase requisitions
for a given vendor. These purchase requisitions need to be combined into a single purchase order (dis-
cussed next), which is then sent to the vendor. In this type of system, each purchase order will be associ-
ated with one or more purchase requisitions.

PREPARE PURCHASE ORDER. The prepare purchase order function receives the purchase requisi-
tions, which are sorted by vendor if necessary. Next, a purchase order (PO) is prepared for each vendor,
as illustrated in Figure 5-3. A copy of the PO is sent to the vendor. In addition, a copy is sent to the set up
accounts payable (AP) function for filing temporarily in the AP pending file, and a blind copy is sent to
the receive goods function, where it is held until the inventories arrive. The last copy is filed in the open/
closed purchase order file.
To make the purchasing process efficient, the inventory control function will supply much of the rou-
tine ordering information that the purchasing department needs directly from the inventory and valid ven-
dor files. This information includes the name and address of the primary supplier, the economic order
1
quantity of the item, and the standard or expected unit cost of the item. This allows the purchasing
department to devote its efforts to meeting scarce, expensive, or unusual inventory needs. To obtain the
best prices and terms on special items, the purchasing department may need to prepare detailed product
specifications and request bids from competing vendors. Dealing with routine purchases as efficiently as

1 The economic order quantity model and other inventory models are covered in Chapter 7.