 Hello and welcome to this session in which we will discuss the expenditure cycle. The expenditure cycle is one of the six cycles that we need to learn about whether we are an accounting information students or studying for the CPA exam. And those cycles are the revenue cycle, the expenditure cycle, the one that we're gonna be discussing in this topic, the financing cycle, the production manufacturing cycle, HR and payroll, reporting and general ledger cycle. Now what is expenditure or the expenditure cycle? What are we discussing here? Well, we're discussing cost or expenses incurred to run the company. The expenditure cycle encompasses or touches upon many aspects of the company, just like all the other cycles. All these cycles are basically interrelated, frankly. So how does the expenditure cycle relate to other cycles? Well, the expenditure cycle needs money from financing. So we need to bring money from financing. Then we're gonna buy material, raw material incurred expenses and that's gonna feed into the production process assuming we have a production process assuming we are a manufacturing company. Also the expenditure cycle will touch upon HR because when you have employees, you have to pay those employees and it goes through the expenditure cycle. Also the production process, assuming we have a production process feeds into the revenue. If you are manufacturing something, you need to sell it. Then also the expenditure cycle will feed into the general ledger. So simply put, all the cycles are interrelated. The point is to understand why are they important? How do they relate to each others? Now from a T account perspective, it's very important to understand from a T account or from a journal entry perspective how everything fits together. And to illustrate the point, remember when you have an expenditure cycle, first you're gonna buy something, you're gonna buy something, then you're gonna pay for it. So you buy something on credit. So what I'm gonna show you is how many things are affected or affect the accounts payable, which is buying on credit and then paying the expenditure cycle. Well, we might buy raw material. So we debit raw material, we credit accounts payable. Well, that's gonna affect the purchasing cycle. We might buy property, plant and equipment. Then that's gonna increase the payable. We might purchase prepaid expenses on credit. Now this is unusual, but that's fine. Sometime you might buy prepaid expenses and pay for them later. You might incur selling general and administrative expenses. You're gonna increase those and you're gonna accrue them. You might incur manufacturing overhead as a control account. Well, that's gonna go up and accounts payable will go up as well. So notice all these activities, that's a lot of activities within the company. They're going through the expenditure, the buying on credit and paying later cycle. Now we also have purchase discounts. When we have a purchase discounts, that's gonna reduce the accounts payable. We might also have a purchase returns and allowances that's also gonna reduce the accounts payable. And the big debit is paying the balance. When we pay the balance is, that's gonna be the big debit because we have to pay all of those now and we're gonna credit the cash. So notice, I ended the fight. One, two, three, four, five, six, seven, eight accounts revolves around buying stuff on credit. So the process is involved from a journal entry accounting perspective. Before we proceed any further, I have a public announcement about my company Farhat Lectures.com. Farhat Accounting Lectures is a supplemental educational tool that's gonna help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Myles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead, start today, no obligation, no credit card required. Now let's take a look at the expenditure cycle from an operating perspective. I'm gonna break the expenditure cycle into four steps just to make it easy for you to follow. First, there's a processing of purchase orders. We start with a purchase order, we want to buy stuff. Then we're gonna be receiving the goods or the services. We're gonna be recognizing a liability. Then we're gonna be making the payment or the disbursements and they go in order. First, you buy, you receive the goods, you create the liability, you make the payment. Now in this session, I'm gonna identify the risks and controls in each process and identify the documents. Now, when I mention a document, if you're not familiar with it, I'll explain it. I would suggest you Google it just to kind of take a look at it, it just makes it easier for your learning process. And if you know anything about my teaching, if I have a list of items, I'm gonna go through each step separately, identifying the risks, control, documents involved. Starting with the process purchase order. So this is processing purchase order, which is step one. When we want to buy something, first we will start by something called, a form called purchase requisition. And it's basically a form. So let's assume you wanna buy a tablet for one of your employees. You work in restaurant and you want them to take the order on a tablet. So you fill out this purchase requisition form, PR, asking to buy a tablet. So this is the purchase requisition. Form used to request authorization to purchase. So what you're asking for is, I want to buy it. Do you give me the permission to buy it? Let's assume we have a purchasing department. Now you will send this to the purchasing department. So it's a separate department, the purchasing department. And in the purchasing department, we have a purchasing agent or purchasing personnel. At this point, assuming your purchase requisition was approved by your supervisor, they will issue a purchase order. That means the tablet is approved by someone who has the authority to approve it. Now the purchase order, again, I'm highlighting the forms in yellow. It's a form used for order after it has been authorized. So first, the purchase requisition, it has to be authorized by someone. They'll put their initial on it, approved. Now all these documents, all the documents that I mentioned in this recording, they're old pre-number, sequentially used and accounted for. And we will have multiple copies because the forms, they go to different departments. Pre-number means every form has a unique number and it's number sequentially. So we know if we use purchase number order one, we cannot use it again because it has been used. Then the next, for the next purchase, we use purchase order number two. So we are working in sequence so we can easy account for that. Now the purchase order will go to the accounting department and to the receiving report. Now in some CPA review courses, in some textbook, they say a purchase order. Sometime they say the purchase requisition and the purchase order. It doesn't really matter whether it's the purchase requisition or the purchase order. Remember, they go together. No purchase order can be approved unless the purchase requisition is approved. I believe they're the same thing in a sense. A purchase order is an approved purchase requisition. But remember, they will send a document to the accounting department, documented the receiving department, telling them to expect this tablet and a copy to the accounting department telling them we initiated the process of buying those tablets. Now what are the risks involved in this step from an operating perspective? For one thing, we only need to be buying stuff or goods that we need. That's necessary for the company. The risk here is you could be buying stuff that we don't really need. Or we can buying stuff at inflated prices. How so? Using kickbacks, fraud, basically you're buying from your friends, you're buying from your relatives, you're buying from your spouse. And by doing so, you are buying it at inflated prices or there's some sort of a kickback where you'll get money from buying from us. What are some of the controls that you can implement at this process, at this stage in the process? Approval process for all vendors. So you can not just select any vendors and buy from them. Before the vendors is entered into the system, it has to be approved. And not anyone can add a vendor. So we have to have a review process before we can add a vendor. And sometimes vendors, vendors numbers, they could have a secret formula. For example, let's assume you work at a company and you want to enter a vendor into the system and automatically you just wanted to create a number, account number for a vendor and you did one, seven, eight, seven, five, just randomly selecting those numbers. Well, guess what? The computer system or your internal control could have a secret formula where every account number means something. Means what? For example, the account number, when you add one plus seven plus eight plus seven plus five, let's add them up. Just kind of, this is an illustration. I don't know what I'm going to come up with. One plus seven equal eight plus eight equal to 16. 16 plus seven is 23 plus five is 28. So when you add up all the digits, they have to be divisible by, let's assume three, okay? And this is not divisible by three. And the person that's entering those numbers, they will not know this. Now it won't only be divisible by three because if I put plus four, then we'd have 27 to be divisible by three and it will be an okay. All what I'm saying is you'll have some sort of a secret formula. This is just a simple illustration of it where when you add up all the digits, they have to mean something. And it's not that simple. It has to be so unique. So this is part of the controls at this process. Another control is you will make all your purchasing agents or purchasing department people have a disclosure telling you if they have any relationship with the vendor or just prohibiting any related party transaction. Look, if you are, if you have any relationship with the vendor, that's it. We can no longer buy from that vendor. So this is step one, risks control. And you can also, what you can do at this stage is analytics. What is analytics comparing costs to budget? So if we have a certain budget, let's see if the cost is more than the budget or we can't compare the prices that we are paying to market prices to see if we are paying fair prices. Also, we can run analytics on purchase agent trend. For example, if we can see an agent is buying more than others or an agent is buying more disproportionate amount from a specific vendor. So that's could be a red flag user analytics. Step two, after we purchase, after we process the purchase order, now we're gonna be receiving the goods. The receiving department would receive, would prepare from a blank receiving report. It means it's empty. What items that they received. So once the company that send us the item, the receiving department will prepare a report. We should not have the quantity there or anything. We should make them count and fill in the receiving report. So a blank receiving report is better. And here the form is the receiving report, prepared at the time of when the goods are purchased. And also there's an inspection report in case there's something wrong with the product. We will inspect it and add it there. At this point, we should match the purchase order. Now we have the purchase order. We filled out the receiving report, they should match. That's a form of control. What risks could appear in this department in the receiving department? We could be receiving goods for unordered goods. We never ordered them, now we receive them. We might prepare a receiving report. Now we have a liability to pay for them and we're not supposed to. Not counting received goods properly or inspecting the goods. So we received goods, we ordered 10, we received eight. The people that not counted, they say it's 10 and in actuality we received eight. What are some of the controls here? For one thing, segregation of duties. People that place the order should not be able to receive it. People that count, people that count and inspect should not be able to change the record or the change the record and the purchasing department. And here what you can do, you could automate the procedures. For example, you could have a relationship with your supplier. They will do the counting. They will give you a barcode with it or an RFID and you'll be able to scan the items and you would know exactly how many items based on their counting. So basically, you kind of transfer the control to them. The third step, now we receive the items. Now we have a liability. When do we record a liability? There's something called a three-way matching. Now it's a three-way or four-way. I'm gonna explain it why it could, but most CPA companies, most CPA prep firms they use the three-way. First, you have a vendor invoice. Again, it's in yellow. It means it's a document. A vendor invoice is something sent from the supplier, the seller, the vendor showing the amount owed. So let's assume we bought this tablet from Apple. Apple will send an invoice telling us you owe us, you know, 1500 for this tablet. Also, the accounting department, remember they receive a purchase order and a purchase requisition. So basically, I'm gonna count them as one. Okay, so purchase order. Three, we have a receiving report from the receiving department saying that we did receive the tablet. Then we match those three together. This is called the three-way matching indicating now we have a liability. Now some companies, once they have a purchase order and a receiving report, they do prepare the liability. Sometime you would wait for the vendor invoice. Also, in this step, we could have what's called a debit memo in case we return some items or the items were damaged. Then they would reduce the amount. This is called a debit memo showing the amount that's reduced. Now you need to understand what's a voucher file. A voucher file is those three items together. The file include all the documents mentioned thus far. Vendor invoice purchase order and receiving report. And simply put, it looks like a file, like literally a yellow file with the paperwork in it because when I was in practice, when I was an auditor, I worked a lot with a voucher file. So simply put, I will go when we'll do an audit, I will go to the bank statement and I would select a number from the disbursement, like I don't know, $3,460. We bought supplies, okay, that's fine. I'm gonna go and see if we have a vendor invoice, if we have a purchase order, if we have a receiving report, if we have those three, good. This disbursement is legitimate. So this is basically how you would check to see how the system work. And I remember I audited a German company, I'm not gonna name it, in the Lehigh Valley and they were very meticulous in their vendor invoices. It was so impressive the way everything was organized. But what are the risks in this step? Well, receiving invoices for goods never purchased. Well, we receive an invoice, we think we receive the goods, maybe someone in the receiving department preparing fake receiving reports sending it to us, that's a risk there. How about not paying, that's not really a risk. Why? Because if you don't pay for an item, because if you don't prepare a liability for an item, well, guess what? Apple or the supplier will contact you. What are some of the controls here? The three-way matching is a control here. Budgetary controls, basically, knowing that you are paying for too much. Analytics, looking for duplicate payments. That could be a problem. You're making the payment twice, looking for duplicate liabilities. Just running analytics on your APs. Segregation of duties. Again, the people that record the liability should not be able to place the order, should not be able to receive any items. Segregation of duties. Also the voucher system, which is the three-way matching, having all the documents in order before we make the cash payment. The last step is the cash payment or the cash disbursement. This is the most important step, because that's it. Once you send the check, it's gone. The money is gone. Again, the people that are in charge in this department, they will do the three-way matching again. They would look at everything, and this is high activity risk. High activity in this area, it's a lot of risk. Now I'm writing the check or sending the payment, okay? And the auditor, the document that auditor examined associated with this activity is a check. So when you are auditing, you'd look at the check and you go backward to see if there are supporting documents. What are the risks? Well, guess what? Paying the wrong amount. Now, if we pay more, no one's gonna complain. If we pay less, well, the vendor will complain. Make multiple payments for the same invoice. That could be a risk, because we did not close the voucher file. We did not stamp it as paid, because once it's paid, we have to stamp it. Not taking advantage of discount. That could be a risk. We are offered a discount. We're not taking advantage of that discount. What are some of the controls that we can implement? Automate the process. For example, if we are giving a discount, let's make sure the payment is cut within the discount period. Automate the process and the matching process. So if you have a computerized system where everything is electronically prepared, then the computer system will match the vendor invoice, will match their saving report, will match the purchase order. So you would automate the process. There is no room for mistake. Password for electronic fund transfer. Not everyone can do it. Only people with the appropriate authority. Again, segregation of duties. People that make the payment, make the cash payment. They cannot place the purchase order. They cannot receive the goods. They cannot record the liability. They can only review the material and cut the chat. What should you do now? Go to Farhat Lectures, Work Additional. Look at additional resources that can help you in understanding the business cycle. Good luck, study hard and stay safe.