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228 PART II Transaction Cycles and Business Processes

EXPENDITURE CYCLE CONTROLS
This section describes the primary internal controls in the expenditure cycle according to the control
procedures specified in Statement on Auditing Standards No. 78. The main points are summarized in
Table 5-1.

Transaction Authorization
PURCHASES SUBSYSTEM. The inventory control function continually monitors inventory levels. As
inventory levels drop to their predetermined reorder points, inventory control formally authorizes replen-
ishment with a purchase requisition.
Formalizing the authorization process promotes efficient inventory management and ensures the legiti-
macy of purchases transactions. Without this step, purchasing agents could purchase inventories at their
own discretion, being in a position both to authorize and to process the purchase transactions. Unautho-
rized purchasing can result in excessive inventory levels for some items, while others go out of stock. Ei-
ther situation is potentially damaging to the firm. Excessive inventories tie up the organization’s cash
reserves, and stock-outs cause lost sales and manufacturing delays.

CASH DISBURSEMENTS SUBSYSTEM. The AP function authorizes cash disbursements via the
cash disbursement voucher. To provide effective control over the flow of cash from the firm, the cash dis-
bursements function should not write checks without this explicit authorization. A cash disbursements
journal (check register) containing the voucher number authorizing each check (see Figure 5-11) provides
an audit trail for verifying the authenticity of each check written.
Segregation of Duties
SEGREGATION OF INVENTORY CONTROL FROM THE WAREHOUSE. Within the pur-
chases subsystem, the primary physical asset is inventory. Inventory control keeps the detailed records of
the asset, while the warehouse has custody. At any point, an auditor should be able to reconcile inventory
records to the physical inventory.

TAB L E
5-1 SUMMARY OF EXPENDITURE CYCLE CONTROLS

Control Activity Purchases Processing System Cash Disbursements System
Transactions authorization Inventory control. AP authorizes payment.
Segregation of duties Inventory control separate from Separate AP subsidiary ledger, cash
purchasing and inventory custody. AP disbursements, and general ledger
subsidiary ledger separate from the functions.
general ledger.

Supervision Receiving area.
Accounting records AP subsidiary ledger, general ledger, Voucher payable file, AP subsidiary
purchases requisition file, purchase ledger, cash disbursements journal,
order file, receiving report file. general ledger cash accounts.
Access Security of physical assets. Limit access Proper security over cash. Limit access
to the accounting records above. to the accounting records above.

Independent verification AP reconciles source documents before Final review by cash disbursements.
liability is recorded. General ledger Overall reconciliation by general ledger.
reconciles overall accuracy of process. Periodic bank reconciliation by
controller.