Chapter 5: The Expenditure Cycle 4.

A copy is sent to the set up accounts payable (AP) function for filing
Part I: Purchases and Cash Disbursements Procedures temporarily in the AP pending file
5. A blind copy is sent to the receive goods function, where it is held
Objective of the Expenditure Cycle until the inventories arrive.
- to convert the organization’s cash into the physical materials and the 6. The last copy is filed in the open/ closed purchase order file.
human resources it needs to conduct business
1. Physical Phase Inventory control function: will supply much of the routine ordering
- acquisition of the resource information that the purchasing department needs directly from the
2. Financial Phase inventory and valid vendor files.
- disbursement of cash
i. name and address of the primary supplier
Principal Features ii. the economic order quantity of the item
1. Purchases Processing Subsystem iii. standard or expected unit cost of the item.
2. Cash Disbursements Subsystem
Purchasing Department
I. Purchases Processing Procedures - allows to devote its efforts to meeting scarce, expensive, or unusual
- include the tasks involved in inventory needs.
a. identifying inventory needs - To obtain the best prices and terms on special items, may need to
b. placing the order prepare detailed product specifications and request bids from
c. receiving the inventory competing vendors.
d. recognizing the liability. - Dealing with routine purchases as efficiently as good control permits
is desirable in all organizations.
Difference between Manufacturing and Retailing Firms
- the way purchases are authorized. Valid Vendor File
- contributes to both control and efficiency by listing only those
1. Manufacturing vendors approved to do business with the organization
- purchase raw materials for production - helps to reduce certain vendor fraud schemes discussed
Purchasing authorization: production planning and control function
c. Receive Goods
2. Merchandising firms Time lag between placing the order and receiving the inventory
- purchase finished goods for resale - the copies of the PO reside in temporary files in various departments.
Purchase authorization: inventory control function - make memo entries of pending inventory receipts and associated
obligations.
Process
1. Monitor Inventory Records 7. Goods arriving from the vendor are reconciled with the blind copy
2. Prepare Purchase Order of the PO.
3. Receive Goods
4. Update Inventory Records Blind Copy
5. Set Up Accounts Payable - contains no quantity or price information about the products being
6. Post to General Ledger received
- force the receiving clerk to count and inspect inventories prior to
a. Monitor Inventory Records completing the receiving report
Deplete inventories by:
a. transferring raw materials into the production process (the - may be tempted to accept deliveries on the basis of this information
conversion cycle) alone, rather than verify the quantity and condition of the goods.
b. selling finished goods to customers (revenue cycle) - Shipments that are short or contain damaged or incorrect items must
be detected before the firm accepts and places the goods in inventory.
Inventory control
- monitors and records finished goods inventory levels. 8. The receiving clerk prepares a receiving report stating the quantity
and condition of the inventories.
Purchase Requisition 9. One copy of the receiving report accompanies the physical
- when inventories drop to a predetermined reorder point inventories to either the raw materials storeroom or finished goods
- is prepared and sent to the prepare purchase order function to warehouse for safekeeping.
initiate the purchase process 10. Another copy is filed in the open/closed PO file to close out the
PO.
Separate purchase requisition 11. A third copy of the receiving report is sent to the AP department,
- will be prepared for each inventory item as the need is recognized where it is filed in the AP pending file.
- can result in multiple purchase requisitions for a given vendor. 12. A fourth copy of the receiving report is sent to inventory control
- need to be combined into a single purchase order (discussed next), for updating the inventory records.
which is then sent to the vendor. 13. Finally, a copy of the receiving report is placed in the receiving
report file.
b. Prepare Purchase Order
1. receives the purchase requisitions, which are sorted by vendor if d. Update Inventory Records
necessary. Standard cost system
2. Next, a purchase order (PO) is prepared for each vendor. - carry their inventories at a predetermined standard value regardless
3. A copy of the PO is sent to the vendor. of the price actually paid to the vendor.
- requires only information about the quantities received.

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 - equivalent to the open AP file discussed earlier and also is organized
Actual Cost Inventory Ledger by due date.
- requires additional financial information, such as a copy of the
supplier’s invoice when it arrives. f. Post to General Ledger
19. The general ledger function receives a journal voucher from the
e. Set Up Accounts Payable AP department and an account summary from inventory control.
- has received and temporarily filed copies of the PO and receiving
report. 20. The general ledger function posts from the journal voucher to the
inventory and AP control accounts and reconciles the inventory
14. Defer recording (recognizing) the liability until the invoice arrives. control account and the inventory subsidiary summary.

Time lag between receipt of inventories and invoice 21. The approved journal vouchers are then posted to the journal
- misstatement is a problem only at period-end when the firm voucher file.
prepares financial statements.
- To close the books, the accountant will need to estimate the value THE CASH DISBURSEMENTS SYSTEMS
of the obligation until the invoice arrives. - processes the payment of obligations created in the purchases
- If the estimate is materially incorrect, an adjusting entry must be system.
made to correct the error. - ensure that only valid creditors receive payment and that amounts
paid are timely and correct
15. When the invoice arrives, the AP clerk reconciles the financial
information with the receiving report and PO in the pending file. Early: firm forgoes interest income that it could have earned on the
funds
Three-Way Match Late: lose purchase discounts or may damage its credit standing
- invoice, receiving report and purchase order
- verifies that what was ordered was received and is fairly priced. Process
1. Identify Liabilities Due
16. Once the reconciliation is complete, the transaction is recorded in 2. Prepare Cash Disbursement
the purchases journal and posted to the supplier’s account in the AP 3. Update AP Record
subsidiary ledger. 4. Post to General Ledger

Actual cost method: the AP clerk would send a copy of the supplier’s a. Identify Liabilities Due
invoice to inventory control. - AP department identifying items that have come due.
1. Each day, the AP function reviews the open AP file (or vouchers
Standard costing: this step is not necessary. payable file) for such items

17. After recording the liability, the AP clerk transfers all source 2. Sends payment approval in the form of a voucher packet (the
documents (PO, receiving report, and invoice) to the open AP file. voucher and/or supporting documents) to the cash disbursements
department.
AP file
- organized by payment due date and scanned daily to ensure that b. Prepare Cash Disbursement
debts are paid on the last possible date without missing due dates and 3. The cash disbursements clerk receives the voucher packet and
losing discounts. reviews the documents for completeness and clerical accuracy.

18. Finally, the AP clerk summarizes the entries in the purchases 4. For each disbursement, the clerk prepares a check and records the
journal for the period (or batch) and prepares a journal voucher for check number, dollar amount, voucher number, and other pertinent
the general ledger function data in the check register

Vouchers Payable System Cash Disbursements Journal

- AP department uses cash disbursement vouchers and maintains a - contains the check number, dollar amount, voucher number, and
voucher register. other pertinent data
- After the AP clerk performs the three-way match, he or she prepares
a cash disbursement voucher to approve payment. Depending on the organization’s materiality threshold, the check may
require additional approval by the cash disbursements department
Vouchers manager or treasurer.
- provide improved control over cash disbursements
- allow firms to consolidate several payments to the same supplier on 5. The negotiable portion of the check is mailed to the supplier, and
a single voucher, thus reducing the number of checks written. a copy of it is attached to the voucher packet as proof of payment.

Voucher Register 6. The clerk marks the documents in the voucher packets paid and
- reflects the AP liability of the firm. returns them to the AP clerk.
- The sum of the unpaid vouchers in the register (those with no check
numbers and paid dates) is the firm’s total AP balance. 7. Finally, the cash disbursements clerk summarizes the entries made
to the check register and sends a journal voucher
Vouchers Payable File
- The AP clerk files the cash disbursement voucher, along with c. Update AP Record
supporting source documents

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8. Upon receipt of the voucher packet, the AP clerk removes the Cash Disbursements Function
liability by debiting the AP subsidiary account or by recording the - should not write checks without this explicit authorization.
check number and payment date in the voucher register.
9. The voucher packet is filed in the closed voucher file, and an A cash disbursements journal (check register) containing the voucher
account summary is prepared and sent to the general ledger function. number authorizing each check provides an audit trail for verifying the
authenticity of each check written.
d. Post to General Ledger
10. The general ledger function receives the journal voucher from 2. Segregation of Duties
cash disbursements and the account summary from AP. SEGREGATION OF INVENTORY CONTROL FROM THE WAREHOUSE.
Primary Physical Asset: Inventory
The voucher shows the total reductions in the firm’s obligations and
cash account as a result of payments to suppliers. Inventory control: keeps the detailed records of the asset,
Warehouse: custody.
11. These numbers are reconciled with the AP summary, and the AP
control and cash accounts in the general ledger are updated At any point, an auditor should be able to reconcile inventory records
accordingly. to the physical inventory.

12. The approved journal voucher is then filed. SEGREGATION OF THE GENERAL LEDGER AND ACCOUNTS PAYABLE
FROM CASH DISBURSEMENTS.
Expenditure Cycle Controls Asset subject to exposure in the cash disbursements subsystem: cash

Control Activity Purchases Processing Cash Disbursements The records controlling this asset are the AP subsidiary ledger and the
System System cash account in the general ledger.
Transaction Inventory control AP authorizes payment
authorization
Supervision Receiving area An individual with the combined responsibilities of writing checks,
Accounting • AP Subsidiary • Voucher Payable posting to the cash account, and maintaining AP could perpetrate
records Ledger File fraud against the firm.
• General Ledger • AP Subsidiary 1. could withdraw cash and then adjust the cash account accordingly
• Purchases Ledger to hide the transaction
Requisition File • Cash
2. could establish fraudulent AP (to an associate in a nonexistent
• Purchase Order Disbursements
File Journal vendor company) and then write checks to discharge the phony
• Receiving Report • General Ledger obligations.
File Cash Accounts
Access • Security of physical • Proper security 3. Supervision
assets. over cash. Receiving department is the area that most benefits from
• Limit access to the • Limit access to the
accounting records accounting
supervision.
above. records above.
Independent • AP reconciles • Final review by Exposures
verification source documents cash a. failure to properly inspect the assets
before liability is disbursements. b. the theft of assets.
recorded. • Overall
• General ledger reconciliation by
reconciles overall general ledger. a. INSPECTION OF ASSETS.
accuracy of • Periodic bank - When goods arrive from the supplier, receiving clerks must inspect
process. reconciliation by items for proper quantities and condition (damage, spoilage, and so
controller. on).
- To obtain quantities information, which is needed for the receiving
1. Transaction Authorization report, the receiving personnel are forced to physically count and
PURCHASES SUBSYSTEM. inspect the goods.
Inventory control function
- continually monitors inventory levels. Benefits
- drop to their predetermined reorder points formally authorizes - Inspecting and counting the items received protect the firm from
replenishment with a purchase requisition. incomplete orders and damaged goods.
- Supervision is critical at this point to ensure that the clerks properly
Formalizing the authorization carry out these important duties.
- promotes efficient inventory management
- ensures the legitimacy of purchases transactions. Packing Slip
- with quantity information
Unauthorized purchasing can result in: - circumvent the inspection process often accompanies incoming
1. excessive inventory levels for some items, goods.
2. others go out of stock - A supervisor should take custody of the packing slip while receiving
3. tie up the organization’s cash reserves clerks count and inspect the goods.
4. stock-outs cause lost sales and manufacturing delays.
b. THEFT OF ASSETS.
CASH DISBURSEMENTS SUBSYSTEM. - incoming inventories are exposed to theft until they are securely
AP function placed in the warehouse.
- authorizes cash disbursements via the cash disbursement voucher.

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- Improper inspection procedures coupled with inadequate - verifies that the total obligations recorded equal the total
supervision can create a situation that is conducive to the theft of inventories received and that the total reductions in AP equal the
inventories in transit. total disbursements of cash.

4. Accounting Records Physical Systems.

- maintain an audit trail adequate for tracing a transaction from its MANUAL SYSTEM
source document to the financial statements. a. Inventory Control
1. When inventories drop to a predetermined reorder point, the clerk
Accounting Records of Expenditure Cycle prepares a purchase requisition.
a. AP subsidiary ledger
b. voucher register 2. One copy of the requisition is sent to the purchasing department
c. check register
d. general ledger 3. One copy is placed in the open purchase requisition file.

- obligations may be materially understated on financial statements Note that to provide proper authorization control, the inventory
because of unrecorded transactions. control department is segregated from the purchasing department,
i. because some supplier invoices do not arrive in time to record the which executes the transaction.
liabilities.
ii. as an attempt to intentionally misstate financial information. b. Purchasing Department
4. The purchasing department receives the purchase requisitions,
- designed to provide supporting information, such as the purchase sorts them by vendor, and prepares a multipart PO for each vendor.
requisition file, the PO file, and the receiving report file.
- By reviewing these peripheral files, auditors may obtain evidence of 5. Two copies of the PO are sent to the vendor.
inventory purchases that have not been recorded as liabilities.
6. One copy of the PO is sent to inventory control, where the clerk
5. Access Controls files it with the open purchase requisition.
DIRECT ACCESS.
- must control access to physical assets such as cash 7. One copy of the PO is sent to AP for filing in the AP pending file.
and inventory.
Direct access controls include locks, alarms, and restricted access to 8. One copy (the blind copy) is sent to the receiving department,
areas that contain inventories and cash. where it is filed until the inventories arrive.

INDIRECT ACCESS 9. The clerk files the last copy along with the purchase requisition in
- must limit access to documents that control its physical assets. the open PO file.

For example, an individual with access to purchase requisitions, c. Receiving

purchase orders, and receiving reports has the ingredients to 10. Goods arriving from the vendor are reconciled with the blind copy
construct a fraudulent purchase transaction. of the PO.

6. Independent Verification 11. Upon completion of the physical count and inspection, the
INDEPENDENT VERIFICATION BY ACCOUNTS PAYABLE. receiving clerk prepares a multipart receiving report stating the
AP Function quantity and condition of the inventories.
- plays a vital role in the verification of the work others in this system
have done 12. One copy of the receiving report accompanies the physical
- copies of key source documents flow into this department for review inventories to the storeroom.
and comparison.
13. Another copy is sent to the purchasing department, where the
1. The PO, which shows that the purchasing agent ordered only the purchasing clerk reconciles it with the open PO.
needed inventories from a valid vendor. This document should
reconcile with the purchase requisition. 14.. The clerk closes the open PO by filing the purchase requisition,
the PO, and the receiving report in the closed PO file.
2. The receiving report, which is evidence of the physical receipt of the
goods, their condition, and the quantities received. The reconciliation 15. A third copy of the receiving report is sent to inventory control
of this document with the PO signifies that the organization has a where (assuming a standard cost system) the inventory subsidiary
legitimate obligation. ledger is updated.

3. The supplier’s invoice, which provides the financial information 16. A fourth copy of the receiving report is sent to the AP department,
needed to record the obligation as an account payable. The AP clerk where it is filed in the AP pending file.
verifies that the prices on the invoice are reasonable compared with
the expected prices on the PO. 17. The final copy of the receiving report is filed in the receiving
department.
INDEPENDENT VERIFICATION BY THE GENERAL LEDGER
DEPARTMENT d. AP Department
- receives journal vouchers and summary reports from inventory 18. When the invoice arrives, the AP clerk reconciles the financial
control, AP, and cash disbursements information with the documents in the pending file

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19. records the transaction in the purchases journal and posts it to Automation
the supplier’s account in the AP subsidiary ledger (voucher register). - involves using technology to improve the efficiency and
effectiveness of a task
20. After recording the liability, the AP clerk transfers the source
documents (PO, receiving report, and invoice) to the open vouchers Objective of Reengineering
payable (APOK) file. - to eliminate nonvalue–added tasks
- involves replacing traditional procedures with innovative
e. General Ledger Department procedures that are often very different from those previously in
21. The general ledger department receives a journal voucher from place.
the AP department and an account summary from inventory control.
AUTOMATING PURCHASES PROCEDURES USING BATCH
22. The general ledger clerk reconciles these and posts to the PROCESSING TECHNOLOGY
inventory and AP control accounts. a. Data Processing Department: Step 1
1. When inventories are reduced by sales to customers or usage in
THE CASH DISBURSEMENTS SYSTEMS production, the system determines if the affected items in the
a. AP Department inventory subsidiary file have fallen to their reorder points.
1. Each day, the AP clerk reviews the open vouchers payable (AP) file
for items due 2. If so, a record is created in the open purchase requisition file.
- Each record in the requisition file defines a separate inventory item
2. sends the vouchers and supporting documents to the cash to be replenished.
disbursements department. - The record contains the inventory item number, a description of the
item, the quantity to be ordered, the standard unit price, and the
b. Cash Disbursements Department vendor number of the primary supplier.
3. The cash disbursements clerk receives the voucher packets and
reviews the documents for completeness and clerical accuracy. 4. The information needed to create the requisition record is selected
from the inventory subsidiary record, which is then flagged ‘‘On
4. For each disbursement, the clerk prepares a three-part check and Order’’ to prevent the item from being ordered again before the
records the check number, dollar amount, voucher number, and current order arrives.
other pertinent data in the check register.
5. At the end of the day, the system sorts the open purchase
5. The check, along with the supporting documents, goes to the cash requisition file by vendor number and consolidates multiple items
disbursements department manager, or treasurer, for his or her from the same vendor onto a single requisition.
signature.
6. Next, vendor mailing information is retrieved from the valid vendor
6. The negotiable portion of the check is mailed to the supplier. file to produce hard copy purchase requisition documents, which go
to the purchasing department.
7. The clerk returns the voucher packet and check copy to the AP
department and files one copy of the check. b. Purchasing Department
7. Upon receipt of the purchase requisition, the purchasing
8. Finally, the summarizes clerk the entries made to the check register department prepares a multipart PO.
and sends a journal voucher to the general ledger department.
8. Copies are sent to the vendor, AP, receiving, data processing, and
c. AP Department the purchasing department’s file.
9. Upon receipt of the voucher packet, the AP clerk removes the
liability by recording the check number in the voucher register and 9. A computer program identifies inventory requirements and
filing the voucher packet in the closed voucher file. prepares traditional purchase requisitions, but the purchasing agent
reviews the requisitions before placing the order.
10. Finally, the clerk sends an AP summary to the general ledger - Some firms do this to reduce the risk of placing unnecessary orders
department. with vendors because of a computer error.
- create a bottleneck and delays the ordering process
d. General Ledger Department - sufficient computer controls are in place to prevent or detect
11. Based on the journal voucher from cash disbursements and the purchasing errors, then more efficient ordering procedures can be
account summary from AP, the general ledger clerk posts to the implemented.
general ledger control accounts and files the documents.
Alternative for Authorizing and Ordering
Concluding Remarks 1. This system automatically prepares the PO documents and sends
1. Manual generate a great deal of paper documentation. them to the purchasing department for review and signing.
2. For purposes of internal control, functions are located in physically - The purchasing agent then mails the approved POs to the vendors
separate departments. Add cost. and distributes copies to other internal users.
Computer based - computer programs perform these clerical tasks,
which is much cheaper and far less prone to error. 2. Distributing the POs directly to the vendors and internal users,
thus bypassing the purchasing department completely.
COMPUTER-BASED PURCHASES AND CASH DISBURSEMENTS - system produces a transaction list of items ordered for the
APPLICATIONS purchasing agent’s review.
Technology continuum
- automation at the low end and reengineering at the high end. 3. Represents a reengineering technology called electronic data
interchange.

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- produces no physical POs. 3. The check number is recorded in the voucher register to close the
- computer systems of both the buying and selling companies are voucher and transfer the items to the closed AP file.
connected via a dedicated telecommunications link.
4. The checks, along with a transaction listing, are sent to the cash
The buyer and seller are parties to a trading partner arrangement in disbursements department.
which the entire ordering process is automated and unimpeded by
human intervention. 5. Finally, batch totals of closed AP and cash disbursements are
prepared for the general ledger update procedure.
In each of the three alternatives, the tasks of authorizing and ordering
are integrated within the computer system. 6. At the end of the day, batch totals of open (unpaid) and closed
- Because physical purchase requisitions have no purpose in such a (paid) AP, inventory increases, and cash disbursements are posted to
system, they are not produced. the AP control, inventory control, and cash accounts in the general
- Digital requisition records, however, would still exist to provide an ledger.
audit trail. - The totals of closed AP and cash disbursements should balance.

b. Data Processing Department: Step 2 b. Cash Disbursements Department

10. A copy of the PO is sent to data processing and used to create a 7. The cash disbursements clerk reconciles the checks with the
record in the open PO file. transaction listing and submits the negotiable portion of the checks
to management for signing.
11. The associated requisitions are then transferred from the open
purchase requisition file to the closed purchase requisition file. 8. The checks are then mailed to the suppliers.

c. Receiving Department 9. One copy of each check is sent to AP, and the other copy is filed in
12. When the goods arrive from vendors, the receiving clerk prepares cash disbursements, along with the transaction listing.
a receiving report and sends copies to the stores (with the goods),
purchasing, AP, and data processing. c. Accounts Payable Department
10. Upon receipt of the check copies, the AP clerk matches them with
d. Data Processing Department: Step 3 open vouchers and transfers these now closed items to the closed
13. The data processing department creates the receiving report file voucher file.
from data provided by the receiving report documents.
REENGINEERING THE PURCHASES/CASH DISBURSEMENTS SYSTEM
14. Then a batch program updates the inventory subsidiary file from - simply replicates many of the procedures in a manual system
the receiving report file. - AP task of reconciling supporting documents with supplier invoices
is labor-intensive and costly.
15. The program removes the ‘‘On Order’’ flag from the updated
inventory records and calculates batch totals of inventory receipts, Change the business environment.
which will later be used in the general ledger update procedure. - initiated trading partner agreements with suppliers in which they
agreed in advance to terms of trade such as price, quantities to be
16. Finally, the associated records in the open PO file are transferred shipped, discounts, and lead times.
to the closed PO file. - With these sources of discrepancy eliminated, Ford reengineered
the work flow to take advantage of the new environment.
d. Accounts Payable
17. When the AP clerk receives the supplier’s invoice, he or she Data Processing
reconciles it with the supporting documents that were previously The following tasks are performed automatically.
placed in the AP pending file. 1. The inventory file is searched for items that have fallen to their
reorder points.
18. The clerk then prepares a voucher, files it in the open voucher 2. A record is entered in the purchase requisition file for each item to
file, and sends a copy of the voucher to data processing. be replenished.
3. Requisitions are consolidated according to vendor number.
e. Data Processing Department: Step 4 4. Vendor mailing information is retrieved from the valid vendor file.
19. The voucher file is created from the voucher documents. 5. Purchase orders are prepared and added to the open PO file.
6. A transaction listing of POs is sent to the purchasing department
20. A batch program validates the voucher records against the valid for review.
vendor file and adds them to the voucher register (open AP
subsidiary file). Receiving Department
- When the goods arrive, the receiving clerk accesses the open PO file
21. Finally, batch totals are prepared for subsequent posting to the in real time by entering the PO number taken from the packing slip.
AP control account in the general ledger.
- The receiving screen, then prompts the clerk to enter the quantities
CASH DISBURSEMENTS PROCEDURES received for each item on the PO.
a. Data Processing Department
1. Each day, the system scans the DUE DATE field of the voucher Data Processing
register for items due. The following tasks are performed automatically by the system.
1. Quantities of items received are matched against the open PO
2. Checks are printed for these items, and each check is recorded in record, and a Y value is placed in a logical field to indicate the receipt
the check register (cash disbursements journal). of inventories.
2. A record is added to the receiving report file.

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3. The inventory subsidiary records are updated to reflect the receipt Below The Threshold: signed automatically
of the inventory items. Above The Threshold: signed by an authorized manager or the
4. The general ledger inventory control account is updated. treasurer.
5. The record is removed from the open PO file and added to the
open AP file, and a due date for payment is established. 3. Time Lag
- lag may negatively affect the sales process.
Each day, the DUE DATE fields of the AP records are scanned for items - When salesclerks do not know the current status of inventory, sales
due to be paid. may be lost.
The following procedures are performed for the selected items.
1. Checks are automatically printed, signed, and distributed to the 4. Purchasing Bottleneck
mail room for mailing to vendors. - purchasing department is directly involved in all purchase decisions.
- EDI vendors receive payment by electronic funds transfer (EFT). - creates additional work, which extends the time lag in the ordering
2. The payments are recorded in the check register file. process.
3. Items paid are transferred from the open AP file to the closed AP
file. Automated Routine Purchases
4. The general ledger AP and cash accounts are updated. - freeing purchasing agents from routine work such as preparing POs
5. Reports detailing these transactions are transmitted via terminal and mailing them to the vendors.
to the AP and cash disbursements departments for management - Attention can then be focused on problem areas (such as special
review and filing. items or those in short supply), and the purchasing staff can be
reduced.
Trading Partner Agreement
- financial information about purchases is known in advance 5. Excessive Paper Documents
- the vendor’s invoice provides no critical information that cannot be - Paper documents add costs because they must be purchased,
derived from the receiving report. stored, prepared, handled by internal mail carriers, and converted by
- able to eliminate the task of reconciling vendor invoices with the data processing personnel.
supporting documents for the majority of purchase transactions. - Organizations with high volumes of transactions benefit
considerably from reducing or eliminating paper documents in their
CONTROL IMPLICATIONS systems.
The Automated System
1. Improved Inventory Control The Reengineered System
2. Better Cash Management - addresses many of the operational weaknesses associated with the
3. Time Lag automated system.
4. Purchasing Bottleneck
5. Excessive Paper Documents Improvements
1. uses real-time procedures and direct access files to shorten the lag
1. Improved Inventory Control. time in record keeping
- Inventory requirements are detected as they arise and are processed
automatically. 2. it eliminates routine clerical procedures by distributing terminals to
- risks of accumulating excessive inventory or of running out of stock user areas
are reduced.
3. achieves a significant reduction in paper documents by using digital
Control: Authorization communications between departments and by digitally storing
Program errors or flawed inventory models records.
a. suddenly inundated with inventories
b. desperately short of stock Control Implications
1. Segregation of Duties
Monitoring automated decisions 2. Accounting Records and Access Controls
- extremely important.
- well-controlled system should provide management with adequate 1. Segregation of Duties
summary reports about inventory purchases, inventory turnover, - removes the physical separation between authorization and
spoilage, and slow-moving items. transaction processing
- computer programs authorize and process POs as well as authorize
2. Better Cash Management and issue checks to vendors
- scanning the voucher file daily for items due, thus avoiding early
payments and missed due dates. To compensate:
- by writing checks automatically, the firm reduces labor cost, saves - provides management with detailed transaction listings and
processing time, and promotes accuracy. summary reports.
- describe the automated actions taken by the system and allow
Control: Unauthorized Payments management to spot errors and any unusual events that warrant
- all additions to the voucher file should be validated by comparing investigation.
the vendor number on the voucher against the valid vendor file.
- If the vendor number is not on file, the record should be diverted to 2. Accounting Records and Access Controls
an error file for management review. - maintain accounting records on digital storage media, with little or
no hard-copy backup.
Control: Automate Check Signing - requires organization management to implement adequate control
- which is more efficient when check volume is high security measures to protect accounting records from unauthorized
- set a materiality threshold for check writing. access and destruction.

7
 Chapter 6: The Expenditure Cycle Part II:
Payroll Processing and Fixed Asset Procedures 4. At the end of the week, the supervisor reviews, signs, and sends
the timecards to the payroll department.
The Conceptual Payroll System
Payroll processing c. Update WIP Account
- special-case purchases system in which the organization purchases 5. After cost accounting allocates labor costs to the WIP accounts, the
labor rather than raw materials or finished goods for resale. charges are summarized in a labor distribution summary and
forwarded to the general ledger function.
Reason for Specialized Procedures
1. A firm can design general purchasing and disbursement procedures d. Prepare Payroll
that apply to all vendors and inventory items. Payroll procedures, 6. The payroll department receives pay rate and withholding data
however, differ greatly among classes of employees. from the personnel department and hours worked data from the
- Payroll processing requires special accounting procedures for production department.
employee deductions and withholdings for taxes that do not apply to
trade accounts. 7. A clerk in payroll then performs the following tasks.
a. Prepares the payroll register showing gross pay, deductions,
2. General expenditure activities constitute a relatively steady stream overtime pay, and net pay.
of purchasing and disbursing transactions. Business organizations b. Enters the this information into the employee payroll records
thus design purchasing systems to deal with their normal level of c. Prepares employee paychecks.
activity. Payroll activities, on the other hand, are discrete events in d. Sends the paychecks to the distribute paycheck function.
which disbursements to employees occur weekly, biweekly, or e. Files the time cards, personnel action form, and copy of the payroll
monthly. register (not shown).
- The task of periodically preparing large numbers of payroll checks in
addition to the normal trade account checks can overload the general e. Distribute Paycheck
purchasing and cash disbursements system. 8. Use a paymaster to distribute the paychecks to employees. This
individual is independent of the payroll process—not involved in
3. Writing checks to employees requires special controls. payroll authorization or preparation tasks.
- Combining payroll and trade transactions can encourage payroll
fraud. 9. If a valid employee does not claim a paycheck, the paymaster
returns the check to payroll. The reason the check went unclaimed
Payroll Process can then be investigated.
1. Personnel Department
2. Production Department f. Prepare Accounts Payable
3. Update WIP Account 10. The accounts payable (AP) clerk reviews the payroll register for
4. Prepare Payroll correctness and prepares copies of a cash disbursement voucher for
5. Distribute Paycheck the amount of the payroll.
6. Prepare AP
7. Prepare Cash Disbursement 11. The clerk records the voucher in the voucher register and submits
8. Update General Ledger the voucher packet (voucher and payroll register) to cash
disbursements.
a. Personnel Department
1. The personnel department prepares and submits personnel action 12. A copy of the disbursement voucher is sent to the general ledger
forms to the prepare payroll function. function.

Personnel Action Forms g. Prepare Cash Disbursement

- documents identify employees authorized to receive a paycheck and 13. Upon receipt of the voucher packet, the cash disbursement’s
are used to reflect changes in hourly pay rates, payroll deductions, function prepares a single check for the entire amount of the payroll
and job classification. and deposits it in the payroll imprest account.

b. Production Department 14. The employee paychecks are drawn on this account, which is used
2. Production employees prepare two types of time records: job only for payroll.
tickets and timecards. - Funds must be transferred from the general cash account to this
imprest account before the paychecks can be cashed.
Job tickets
- capture the time that individual workers spend on each production 15. The clerk sends a copy of the check along with the disbursement
job. voucher and the payroll register to the AP department, where they
- Cost accounting uses these documents to allocate direct labor are filed (not shown).
charges to work-in-process (WIP) accounts.
16. Finally, a journal voucher is prepared and sent to the general
Timecards ledger function.
- capture the time the employee is at work
- sent to the prepare payroll function for calculating the amount of Update General Ledger
the employee’s paycheck. 17. The general ledger function receives the labor distribution
summary from cost accounting, the disbursement voucher from AP,
3. Each day at the beginning of the shift, employees place their time and the journal voucher from cash disbursements.
cards in a special clock that records the time.
- formal record of daily attendance.

8
18. The debits and credits from these entries must equal. If they do b. Paymaster. The use of an independent paymaster to distribute
not, there is an error in the calculation of either labor distribution checks (rather than the normal supervisor) helps verify the existence
charges or payroll. of the employees. The supervisor may be party to a payroll fraud by
pretending to distribute paychecks to nonexistent employees.
19. When the equality has been verified, the clerk files the voucher
and labor distribution summary. c. Accounts payable. The AP clerk verifies the accuracy of the payroll
register before creating a disbursement voucher that transfers funds
PAYROLL CONTROLS to the imprest account.
1. Transaction Authorization
Personnel Action Form d. General ledger. The general ledger department provides
- helps payroll keep the employee records current verification of the overall process by reconciling the labor distribution
- describes additions, deletions, and other changes to the employee summary and the payroll disbursement voucher.
file
- acts as an important authorization control to ensure that only the THE PHYSICAL PAYROLL SYSTEM
timecards of current and valid employees are processed. MANUAL PAYROLL SYSTEM
Key Tasks
2. Segregation of Duties 1. Payroll authorization and hours worked enter the payroll
The time-keeping function and the personnel function should be department from two different sources: personnel and production.
separated.
2. The payroll department reconciles this information, calculates the
Personnel function payroll, and distributes paychecks to the employees.
- provides payroll with pay rate information for authorized hourly
employees 3. Cost accounting receives information regarding the time spent on
- offer a range of valid pay rates based on experience, job each job from production. This is used for posting to WIP account.
classification, seniority, and merit.
- If the production (time-keeping) department provided this 4. AP receives payroll summary information from the payroll
information, an employee might submit a higher rate and perpetrate department and authorizes the cash disbursements department to
a fraud. deposit a single check, in the amount of the total payroll, in a bank
imprest account on which the payroll is drawn.
Payroll function
- has both asset custody (employee paychecks) and record-keeping 5. The general ledger department reconciles summary information
responsibility (employee payroll records). from cost accounting and AP. Control accounts are updated to reflect
these transactions.
Accounts Payable
- reviews the work done by payroll (payroll register) and approves Computer-Based Payroll Systems
payment. AUTOMATING THE PAYROLL SYSTEM USING BATCH PROCESSING
- Because payroll systems run periodically (weekly or monthly), they
Cash disbursements are well suited to batch processing.
- writes the check to cover the total payroll.
- None of the employee paychecks is a negotiable instrument until the 1. The data processing department receives hard copy of the
payroll check is deposited into the imprest account. personnel action forms, job tickets, and time cards, which it converts
to digital files.
3. Supervision
- Sometimes employees will clock in for another worker who is late or 2. Batch computer programs perform the check writing, detailed
absent. record keeping, and general ledger functions.
- Supervisors should observe the time-keeping process and reconcile
the timecards with actual attendance. Control Implications
- promotes accounting accuracy and reduces check-writing errors.
4. Accounting Records - does not significantly enhance operational efficiency; however, for
a. Timecards, job tickets, and disbursement vouchers. many types of organizations, this level of technology is adequate.
b. Journal information, which comes from the labor distribution
summary and the payroll register. REENGINEERING THE PAYROLL SYSTEM
c. Subsidiary ledger accounts, which contain the employee records - payroll processing is often integrated within the human resource
and various expense accounts. management (HRM) system.
d. The general ledger accounts: payroll control, cash, and the payroll
clearing (imprest) account. HRM system
- captures and processes a wide range of personnel- related data,
5. Access Controls including employee benefits, labor resource planning, employee
Assets: labor and cash. relations, employee skills, and personnel actions (pay rates,
- misappropriated through improper access to accounting records. deductions, and so on), as well as payroll.
- misrepresent the number of hours worked on the time cards and - need to provide real-time access to personnel files for purposes of
thus embezzle cash. direct inquiries and recording changes in employee status as they
occur.
6. Independent Verification
a. Verification of time. Before sending time cards to payroll, the Reengineering vs Simple Automated System:
supervisor must verify their accuracy and sign them. 1. the various departments transmit transactions to data processing
via terminals

9
2. direct access files are used for data storage 1. acquisition
3. many processes are now performed in real time. 2. maintenance
3. disposal
a. Personnel
1. The personnel department makes changes to the employee file in Specific Objectives
real time via terminals. 1. Process the acquisition of fixed assets as needed and in accordance
- These changes include additions of new employees, deletions of with formal management approval and procedures.
terminated employees, changes in dependents, changes in
withholding, and changes in job status (pay rate). 2. Maintain adequate accounting records of asset acquisition, cost,
description, and physical location in the organization.
b. Cost Accounting
2. The cost accounting department enters job cost data (real time or 3. Maintain accurate depreciation records for depreciable assets in
daily) to create the labor usage file. accordance with acceptable methods.

c. Time-Keeping 4. Provide management with information to help plan for future fixed
3. Upon receipt of the approved time cards from the supervisor at the asset investments.
end of the week, the time-keeping department creates the current
attendance file. 5. Properly record the retirement and disposal of fixed assets.

d. Data Processing Differences between Expenditure Cycle and Fixed Asset System
At the end of the work period, the following tasks are performed in a 1. Routine vs Non-Routine
batch process: Expenditure cycle processes: routine acquisitions of raw material and
1. Labor costs are distributed to various WIP, overhead, and expense finished goods inventories.
accounts. . In contrast, organizations often automate the authorization
procedures for routine acquisitions of inventories.
2. An online labor distribution summary file is created. Copies of the
file are sent to the cost accounting and general ledger departments. Fixed asset system processes: nonroutine transactions for a wider
group of users in the organization.
3. An online payroll register is created from the attendance file and - fixed asset transactions are unique, they require specific
the employee file. Copies of the files are sent to the AP and cash management approval and explicit authorization procedures
disbursements departments.
2. Expense vs Capitalize
4. The employee records file is updated. Inventory acquisitions: expense of the current period

5. Payroll checks are prepared and signed. They are sent to the Fixed asset acquisitions: capitalize fixed assets that yield benefits for
treasurer for review and reconciliation with the payroll register. The multiple periods.
paychecks are then distributed to the employees. - productive extends beyond one year
- acquisition cost is apportioned over its lifetime and depreciated in
6. The disbursement voucher file is updated and a check is prepared accordance with accounting conventions and statutory requirements.
for the funds transfer to the payroll imprest account. The check and a
hard copy of the disbursement voucher are sent to cash Fixed Asset Accounting Systems
disbursements. - include cost allocation and matching procedures that are not part of
a. One copy of the voucher is sent to the general ledger department, routine expenditure systems.
b. and the final copy is sent to AP.
THE LOGIC OF A FIXED ASSET SYSTEM
7. At the end of processing, the system retrieves the labor distribution a. Asset Acquisition
summary file and the disbursements voucher file and updates the 1. Asset acquisition usually begins with the departmental manager
general ledger file. (user) recognizing the need to obtain a new asset or replace an
existing one.
Control Implications
Operational benefits 2. Authorization and approval procedures over the transaction will
1. reductions in paper depend on the asset’s value.
2. clerical labor
3. lag time between event occurrence and recording Below Limit:
- Department managers typically have authority to approve purchases
Computer-based systems below a certain materiality limit.
- must produce adequate records for independent verification
- controls must be implemented to protect against unauthorized Above Limit:
access to data files and computer programs - Capital expenditures above the limit will require approval from the
higher management levels.
THE CONCEPTUAL FIXED ASSET SYSTEM - This may involve a formal cost-benefit analysis and the formal
Fixed assets solicitation of bids from suppliers.
- property, plant, and equipment used in the operation of a business
- relatively permanent items that often collectively represent the 3. Once the request is approved and a supplier is selected, the fixed
largest financial investment by the organization. asset acquisition task is similar to the expenditure cycle procedures

Fixed Asset System Processes Transactions Difference between Expenditure Cycle and Fixed Asset

10
i. Receiving department delivers the asset into the custody of the 2. Like any other transaction, the disposal of an asset requires proper
user/manager rather than a central store or warehouse. approval.

ii. The fixed asset department, not inventory control, performs the 3. The disposal options open to the firm are to sell, scrap, donate, or
record-keeping function. retire the asset in place.

b. Asset Maintenance 4. A disposal report describing the final disposition of the asset is sent
- involves adjusting the fixed asset subsidiary account balances as the to the fixed asset accounting department to authorize its removal
assets (excluding land) depreciate over time or with usage. from the ledger.

Common Depreciation Methods The Physical Fixed Asset System

1. straight line COMPUTER-BASED FIXED ASSET SYSTEM
2. sum-of the- years’ digits Acquisition Procedures
3. double-declining balance 1. The process begins when the fixed asset accounting clerk receives
4. units of production. a receiving report and a cash disbursement voucher.
- provide evidence that the firm has physically received the asset and
- The method of depreciation and the period used should reflect, as show its cost.
closely as possible, the asset’s actual decline in utility to the firm.
2. From the computer terminal, a clerk creates a record of the asset
Accounting conventions and Internal Revenue Service rules in the fixed asset subsidiary ledger.
- sometimes specify the depreciation method to be used. - Notice that in addition to the historic cost information, the record
contains data specifying the asset’s useful life, its salvage (residual)
Used To Manufacture Products value, the depreciation method to be used, and the asset’s location in
- charged to manufacturing overhead and then allocated to WIP. the organization.

Not Used In Manufacturing 3. The fixed asset system automatically updates the fixed asset control
- treated as expenses in the current period. account in the general ledger and prepares journal vouchers for the
general ledger department as evidence of the entry.
Depreciation calculations are transactions that the fixed asset system
must be designed to anticipate internally when no external event 4. The system also produces reports for accounting management.
(source document) triggers the action. Fixed asset status report
- showing the cost, the accumulated depreciation (if any), and residual
An important record used to initiate this task is the depreciation value for each of the firm’s fixed assets.
schedule. A separate depreciation schedule will be prepared by the
system for each fixed asset in the fixed asset subsidiary ledger. 5. Based on the depreciation parameters contained in the fixed asset
records, the system prepares a depreciation schedule for each asset
Depreciation Schedule when its acquisition is originally recorded.
- shows when and how much depreciation to record
- shows when to stop taking depreciation on fully depreciated assets. 6. The schedule is stored on computer disk to permit future
– Management report: useful for planning asset retirement and depreciation calculations.
replacement
Asset Maintenance
Asset maintenance also involves adjusting asset accounts to reflect 7. The fixed asset system uses the depreciation schedules to record
the cost of physical improvements that increase the asset’s value or end-of-period depreciation transactions automatically.
extend its useful life.
. Specific tasks
Finally, the fixed asset system must promote accountability by a. calculating the current period’s depreciation
keeping track of the physical location of each asset.
- distributed throughout the organization and are subject to risk from b. updating the accumulated depreciation and book value fields in the
theft and misappropriation. subsidiary records

When one department transfers custody of an asset to another c. posting the total amount of depreciation to the affected general
department, information about the transfer should be recorded in the ledger accounts (depreciation expense and accumulated
fixed asset subsidiary ledger. depreciation)

Each subsidiary record should indicate the current location of the d. recording the depreciation transaction by adding a record to the
asset. The ability to locate and verify the physical existence of fixed journal voucher file.
assets is an important component of the audit trail.
7. Finally, a fixed asset depreciation report is sent to the fixed asset
c. Asset Disposal department for review.
When an asset has reached the end of its useful life or when
management decides to dispose of it, the asset must be removed 8. Department managers must report any changes in the custody or
from the fixed asset subsidiary ledger. status of assets to the fixed asset department.

1. It begins when the responsible manager issues a request to dispose 9. From a computer terminal a clerk records such changes in the fixed
of the asset. asset subsidiary ledger.

11
Disposal Procedures Chapter 7 – The Conversion Cycle
10. The disposal report formally authorizes the fixed asset Conversion Cycle
department to remove from the ledger an asset disposed of by the - transforms (converts) input resources, such as raw materials, labor,
user department. and overhead, into finished products or services for sale

11. When the clerk deletes the record from the fixed asset subsidiary Traditional Batch Production Model
ledger, the system automatically 1. plan and control production
a. posts an adjusting entry to the fixed asset control account in the 2. perform production operations
general ledger 3. maintain inventory control
4. perform cost accounting
b. records any loss or gain associated with the disposal
Goal of Lean Manufacturing
c. prepares a journal voucher - to improve efficiency and effectiveness in
1. product design
12. A fixed asset status report containing details of the deletion is sent 2. supplier interaction
to the fixed asset department for review. 3. factory operations
4. employee management
CONTROLLING THE FIXED ASSET SYSTEM 5. customer relations.
Areas Of Principal Difference
1. Authorization Controls - achieving manufacturing flexibility, which involves the physical
Fixed asset acquisitions organization of production facilities and the employment of
- formal and explicitly authorized automated technologies, including
- initiated by a written request from the user or department. 1. Computer Numerical Controlled (CNC) Machines
2. Computer Integrated Manufacturing (CIM)
High-Value items 3. Automated Storage And Retrieval Systems (AS/RS)
- independent approval process that evaluates the merits of the 4. Robotics
request on a cost-benefit basis. 5. Computer-Aided Design (CAD)
6. Computer-Aided Manufacturing (CAM)
2. Supervision Controls
- are widely distributed throughout the organization Alternative Accounting Models
- more susceptible to theft and misappropriation than inventories 1. Activity-Based Costing (ABC)
that are secured in a warehouse. 2. Value Stream Accounting

Management Supervision Materials Requirements Planning (MRP) Systems

- physical security of fixed assets - used to determine how much raw materials are required to fulfill
- ensure that fixed assets are being used in accordance with the production orders.
organization’s policies and business practices.
Manufacturing Resources Planning (MRP II)
Microcomputers purchased for employees - evolved from MRP to integrate additional functionality into the
- should be secured in their proper location manufacturing process, including sales, marketing, and accounting.
- not be removed from the premises without explicit approval.
Enterprise Resource Planning (ERP) Systems
Company vehicles - take MRP II a step further by integrating all aspects of the business
- secured in the organization’s motor pool at the end of the shift into a set of core applications that use a common database.
- not be taken home for personal use unless authorized by the
appropriate supervisor. The Traditional Manufacturing Environment
The conversion cycle consists of both physical and information
3. Independent Verification Controls activities related to manufacturing products
Periodically, the internal auditor should review the asset acquisition for sale.
and approval procedures to determine the reasonableness of factors
used in the analysis. 1. Revenue – customer orders
- These include the useful life of the asset, the original financial cost, 2. Market System – sales forecasts
the proposed cost savings as a result of acquiring the asset, the - inputs are used to set a production target and prepare a production
discount rate used, and the capital budgeting method used in the plan, which drives production activities.
analysis.
3. Expenditure Cycle - Purchase requisitions for the raw materials
- The internal auditor should verify the location, condition, and fair needed to meet production objectives are sent to the purchases
value of the organization’s fixed assets against the fixed asset records procedures (expenditure cycle), which prepares purchase orders for
in the subsidiary ledger. vendors.

- In addition, the automatic depreciation charges calculated by the 4. Expenditure Cycle - Labor used in production is transmitted to the
fixed asset system should be reviewed and verified for accuracy and payroll system (expenditure cycle) for payroll processing.
completeness.
5. GL/FRS - Manufacturing costs associated with intermediate work-
- System errors that miscalculate depreciation can result in the in-process and finished goods (FG) are sent to the general ledger (GL)
material misstatement of operating expenses, reported earnings, and and financial reporting
asset values. system.

12
Production Methods 4. Work Order or Production Order
1. Continuous processing - draws from BOMs and route sheets to specify the materials and
2. Make-to-order processing production (machining, assembly, and so on) for each batch.
3. Batch processing - These, together with move tickets, initiate the manufacturing
process in the production departments.
1. Continuous processing
- creates a homogeneous product through a continuous series of 5. Move Ticket
standard procedures. - records work done in each work center and authorizes the
- firms attempt to maintain finished-goods inventory at levels needed movement of the job or batch from one work center to the next
to meet expected
sales demand. 6. Materials Requisition
- The sales forecast in conjunction with information on current - authorizes the storekeeper to release materials (and subassemblies)
inventory levels triggers this process. to individuals or work centers in the production process.
- usually specifies only standard quantities.
2. Make-to-order processing
- involves the fabrication of discrete products in accordance with Materials needed in excess of standard amounts
customer specifications. - require separate requisitions that may be identified explicitly as
- This process is initiated by sales orders rather than depleted excess materials requisitions.
inventory levels. - allows for closer control over the production process by
highlighting excess material usage.
3. Batch processing
- produces discrete groups (batches) of product. Less than the standard amount of material is used in
- Each item in the batch is similar and requires the same raw materials production.
and operations. - work centers return the unused materials to the storeroom
- To justify the cost of setting up and retooling for each batch run, the accompanied by a materials return ticket.
number of items in the batch tends to be large
Batch Production Activities
Batch Processing System - provides a physical view of the batch processing system
- provides a conceptual overview of the batch processing system
Goals
4 Basic Processes 1. organization functions involved
1. plan and control production 2. tasks performed in each function
2. perform production operations 3. documents that trigger or result from each task
3. maintain inventory control
4. perform cost accounting Batch Production Activities
1, Production Planning and Control
depicts the primary information flows (documents) that integrate a. Materials and Operations Requirements
these activities and link them to other cycles and systems. b. Production Scheduling
2. Work Center and Storekeeping
Documents in the Batch Processing System 3. Inventory Control
1. Production Schedule 4. Cost Accounting
2. Bill of Materials
3. Route Sheet 1, Production Planning and Control
4. Work or Production Order a. specifying materials and operations requirements
5. Move Ticket b. production scheduling
6. Materials Requisitions
A. Materials and Operations Requirements.
1. Production Schedule RM Requirement
- is the formal plan and authorization to begin production - difference between what is needed and what is available in the RM
a. describes the specific products to be made, inventory.
b. quantities to be produced in each batch - information comes from analysis of inventory on hand, the sales
c. manufacturing timetable for starting and completing production. forecast, engineering specifications (if any), and the BOM.

2. Bill of materials (BOM) Product

- specifies the types and quantities of the raw material (RM) and - creation of purchase requisitions for additional RMs
subassemblies used in producing a single unit of finished product. - procedures for preparing purchase orders and acquiring inventories
The RM requirements for an entire batch are determined by are the same as those described in Chapter 5.
multiplying the BOM by the number of items in the batch.
Operations Requirements
3. Route Sheet - involve the assembly and/or manufacturing activities that will be
- shows the production path that a particular batch of product follows applied to the product
during manufacturing. - determined by assessing route sheet specifications
- similar conceptually to a BOM.
- BOM specifies material requirements B. Production Scheduling
- Route sheet specifies the sequence of operations (machining or Master Schedule for a production run
assembly) and the standard time allocated to each task. - coordinates the production of many different batches

13
 2. The lead time—the time between placing an order for inventory
1. time constraints and its arrival—is known and constant.
2. batch size
3. specifications derived from BOMs and route sheet 3. All inventories in the order arrive at the same time.

- produces work orders, move tickets, and materials requisitions for 4. The total cost per year of placing orders is a variable that decreases
each batch in the production run. as the quantities ordered increase.
- A copy of each work order is sent to cost accounting to set up a new Ordering costs include the cost of preparing documentation,
work-in-process (WIP) account for the batch. contacting vendors, processing inventory receipts, maintaining
- The work orders, move tickets, and materials requisitions enter the vendor accounts, and writing checks.
production process and flow through the various work centers in
accordance with the route sheet. 5. The total cost per year of holding inventories (carrying costs) is a
variable that increases as the quantities ordered increase. These costs
2. Work Centers and Storekeeping. include the opportunity cost of invested funds, storage costs,
a. The actual production operations begin when workers obtain raw property taxes, and insurance.
materials from storekeeping in exchange for materials requisitions.
6. There are no quantity discounts. Therefore, the total purchase price
b, These materials, as well as the machining and the labor required to of inventory for the year is constant.
manufacture the product, are applied in compliance with the work
order. Objective
- to reduce total inventory costs
c. When the task is complete at a particular work center, the - As the quantity ordered increases, the number of ordering
supervisor or other authorized person signs the move ticket, which events decreases, causing the total annual cost of ordering to
authorizes the batch to proceed to the next work center. decrease.
- As the quantity ordered increases, however, average inventory on
d. To evidence that a stage of production has been completed, a copy hand increases, causing the total annual inventory carrying cost to
of the move ticket is sent back to production planning and control to increase.
update the open work order file. - We minimize total inventory costs by minimizing the total carrying
cost and total ordering costs.
e. Upon receipt of the last move ticket, the open work order file is
closed. The finished product along with a copy of the work order is Reorder point (ROP)
sent to the finished goods (FG) (if any), warehouse. ROP = I x d
where: I = lead time
f. Also, a copy of the work order is sent to inventory control to update d = daily demand (total demand/number of working days)
the FG inventory records.
Safety stock
Recording labor time costs - must be added to the reorder point to avoid unanticipated stockout
- work center supervisors who, at the end of each workweek, send events.
employee time cards and job tickets to the payroll and cost
accounting departments, respectively. Stock-outs
- result in either lost sales or back-orders
3. Inventory Control.
a. Provides production planning and control with status reports on Back-order
finished goods and raw materials inventory. - a customer order that cannot be filled because of a stock-out and
will remain unfilled until the supplier receives replenishment stock.
b. is continually involved in updating the raw material inventory
records from materials requisitions, excess materials requisitions, and Other Models
materials return tickets. 1. Back-Order Quantity Model
2. Production Order Quantity Model
c. receipt of the work order from the last work center, inventory
control records the completed production by updating the finished Controls in the Traditional Environment
goods inventory records. Six General Classes of Internal Control Activities
1. Transaction Authorization
Objective 2. Segregation of Duties
- to minimize total inventory cost while ensuring that adequate 3. Supervision
inventories exist to meet current demand. 4. Access Control
5. Accounting Records
1. When should inventory be purchased? 6. Independent Verification
2. How much inventory should be purchased?
Control Class Control Points in the System
Economic Order Quantity (EOQ) Model 1. Transaction Work Orders
- based on simplifying assumptions that may not reflect the economic Authorization Move Tickets
reality. Materials Requisitions
2. Segregation of 1. Inventory control separate from RM and
1. Demand for the product is constant and known with certainty. Duties FG inventory custody
2. Cost accounting separate from work
centers

14
 3. GL separate from other accounting 1. Firms often limit access to sensitive areas, such as storerooms,
functions production work centers, and FG warehouses.
3. Supervision Supervisors oversee usage of RM and
timekeeping - Control methods used include identification badges, security guards,
4. Access Control Limit physical access to FG, RM stocks, and observation devices, and various electronic sensors and alarms.
production processes
Use formal procedures and documents to 2. use of standard costs
release materials into production.
- By specifying the quantities of material and labor authorized for each
5. Accounting Work orders, cost sheets, move tickets, job
product, the firm limits unauthorized access to those resources.
Records tickets, materials requisitions, WIP records,
- To obtain excess quantities requires special authorization and formal
FG inventory file
documentation.
6. Independent Cost accounting function reconciles all cost
Verification of production
GL reconciles overall system B. Indirect Access To Assets.
Assets, such as cash and inventories, can be manipulated through
I. Transaction Authorization access to the source documents that control them.
1. Production planning and control authorize the production activity
via a formal work order. Critical documents
Work Order 1. materials requisitions
- reflects production requirements, which are the difference between 2. excess materials requisitions
the expected demand for products (based on the sales forecast) and 3. employee timecards
the FG inventory on hand. - supports an audit trail is the use of prenumbered documents

2. Move tickets signed by the supervisor in each work center V. Accounting Records
- authorize activities for each batch and for the movement of products - to establish an audit trail for each transaction.
through the various work centers. Use of:
1. work orders
3. Materials requisitions and excess materials requisitions 2. cost sheets
- authorize the storekeeper to release materials to the work centers. 3. move tickets
4. job tickets
II. Segregation of Duties 5. materials requisitions
i. Separate the tasks of transaction authorization and transaction 6. WIP file
processing 7. FG inventory file.

- Production planning and control department is organizationally Prenumbering source documents and referencing these in the WIP
segregated from the work centers. records,
- can trace every item of FG inventory back through the production
ii. Segregate record keeping from asset custody. process to its source
1. Inventory control maintains accounting records for RM and FG
inventories. 1. detecting errors in production and record keeping
- kept separate from the materials storeroom and from the FG 2. locating batches lost in production
warehouse functions, which have custody of these assets. 3. performing periodic audits

2. Cost accounting function accounts for WIP and should be separate VI. Independent Verification
from the work centers in the production process. 1. Cost accounting reconciles the materials and labor usage taken
from materials requisitions and job tickets with the prescribed
3. To maintain the independence of the GL function as a verification standards.
step, the GL department must be separate from departments keeping - identify departures from prescribed standards, which are formally
subsidiary accounts. reported as variances.
- Therefore, the GL department is organizationally segregated from
inventory control and cost accounting. Calculated variances are an important source of data for the
management reporting system.
III. Supervision
1. The supervisors in the work centers oversee the usage of RM in the 2. The GL department also fulfills an important verification function
production process. by checking the total movement of products from WIP to FG.
- helps to ensure that all materials released from stores are used in - done by reconciling journal vouchers from cost accounting and
production and that waste is minimized. summaries of the inventory subsidiary ledger from inventory control.
- Employee timecards and job tickets must also be checked for
accuracy. 3. Finally, internal and external auditors periodically verify the RM
and FG inventories on hand through a physical count.
2. Supervisors also observe and review timekeeping activities. - compare actual quantities against the inventory records and make
- promotes accurate employee timecards and job tickets. adjustments to the records when necessary.

IV. Access Control World-Class Companies and Lean Manufacturing

A. Direct Access to Assets a. continuous innovation
- nature of the physical product and the production process b. continuous improvement.

What is a World-Class Company?

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1. must maintain strategic agility and be able to turn on a dime. - 7. Established Supplier Relations
Top management must be intimately aware of customer needs and 8. Team Attitude
not become rigid and resistant to paradigm change.
1. Pull Processing
2. motivate and treat employees like appreciating assets. - involves pulling products from the consumer end (demand), rather
- To activate the talents of everyone, decisions are pushed to the than pushing them from the production end (supply)
lowest level in the organization. The result is a flat and responsive
organizational structure. - inventories arrive in small quantities from vendors several times per
day, just in time to go
3. profitably meets the needs of its customers into production.
- Its goal is not simply to satisfy customers, but to positively delight - pulled into production as capacity downstream becomes available
them. - avoids the creation of batches of semifinished inventories at
- With competitors aggressively seeking new ways to increase market bottlenecks.
share, must continue to delight its customers.
2. Perfect Quality
4. The philosophy of customer satisfaction permeates the world- - Success of the pull processing model requires zero defects in RM,
class firm. WIP, and FG inventory.
All of its activities, from the acquisition of raw materials to selling the - Poor quality is very expensive to a firm.
finished product, form a chain of customers. - cost of scrap, reworking, scheduling delays, and extra inventories to
compensate for defective parts, warranty claims, and field service.
- Each activity is dedicated to serving its customer, which is the next -. Quality has ceased to be a trade-off against price. Consumers
activity in the process. The final paying customer is the last in the demand quality and seek the lowest-priced quality product.
chain.
3. Waste Minimization
5. Finally, manufacturing firms that achieve world-class status do so - All activities that do not add value and maximize the use of scarce
by following a philosophy of lean manufacturing. resources must be eliminated.
- Waste involves financial, human, inventory, and fixed assets.
a. doing more with less
b. eliminating waste a. Overproduction of products
c. reducing production cycle time. - includes making more than needed and/or producing earlier than
needed.
Examines
1. techniques b. Transportation of products farther than is minimally necessary.
2. technologies
3. accounting procedures c. Bottlenecks of products waiting to move to the next production
4. information systems that enable it step.

Principles Of Lean Manufacturing d. Idle workers waiting for work to do as production bottlenecks clear.
Lean manufacturing
- evolved from the Toyota Production System (TPS), which is based on e. Inefficient motion of workers who must walk more than necessary
the just-intime (JIT) production model. in the completion of their assigned tasks.

Traditional manufacturing, f. Islands of technology created by stand-alone processes that are not
1. high inventory levels linked to upstream or downstream processes.
2. large production lot sizes
3. process inefficiencies e. Production defects that require unnecessary effort to inspect
4. waste. and/or correct.

Goal of Lean Production g. Safety hazards that cause injuries and lost work hours and
- improved efficiency and effectiveness in every area associated expenses.
1. product design
2. supplier interaction 4. Inventory Reduction
3. factory operations Common Problems
4. employee management 1. Inventories cost money.
5. customer relations. - an investment in materials, labor, and overhead that cannot be
realized until sold. Inventories also contain hidden costs.
- involves getting the right products to the right place, at the right - must be transported throughout the factory
time, in the right quantity - must be handled, stored, and counted
- minimizing waste and remaining flexible - lose value through obsolescence

Principles 2. Inventories camouflage production problems.

1. Pull Processing - Bottlenecks and capacity imbalances in the manufacturing process
2. Perfect Quality cause WIP inventory to build up at the choke points.
3. Waste Minimization - build up when customer orders and production are out of sync.
4. Inventory Reduction
5. Production Flexibility 3. Willingness to maintain inventories can precipitate overproduction.
6. Production Flexibility

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- Because of setup cost constraints, firms tend to overproduce - The WIP follows a circuitous route through the different operations
inventories in large batches to absorb the allocated costs and create across the factory floor
the image of improved efficiency.
- true cost of this dysfunctional activity is hidden in the excess b. Islands of Technology
inventories. - describes an environment in which modern automation exists in the
form of islands that stand alone within the traditional setting.
5. Production Flexibility - The islands employ computer numerical controlled (CNC) machines
- Long machine setup procedures cause delays in production and that can perform multiple operations with little human involvement.
encourage overproduction. - CNC machines contain computer programs for all the parts that are
- Lean companies strive to reduce setup time to a minimum, which manufactured by the machine.
allows them to produce a greater diversity of products quickly, - humans still set up the machines but little setup time (and cost) is
without sacrificing efficiency at lower volumes of production. needed to change from one operation to another.

6. Established Supplier Relations c. Computer-Integrated Manufacturing

- Late deliveries, defective raw materials, or incorrect orders will shut - completely automated environment with the objective of eliminating
down production immediately because this production model allows non–value-added activities.
no inventory reserves to draw upon. - makes use of group technology cells composed of various types of
CNC machines to produce an entire part from start to finish in one
7. Team Attitude location.
- Each employee must be vigilant of problems that threaten the - employs automated storage and retrieval systems and robotics.
continuous flow operation of the production line.
- requires a constant state of quality control along with the authority Flexible manufacturing
to take immediate action. 1. faster development of high-quality products
2. shorter production cycles
Techniques and Technologies That Promote Lean Manufacturing 3. reduced production costs
1. Physical Reorganization of the Production Facilities 4. faster delivery times
2. Automation of the Manufacturing Process
3. Automated Storage and Retrieval Systems (AS/RS) 3. Automated Storage and Retrieval Systems (AS/RS)
4. Robotics - increased productivity and profitability by replacing traditional
5. Computer-Aided Design (CAD) forklifts and their human operators with automated storage and
6. Computer-Aided Manufacturing (CAM) retrieval systems (AS/RS).
- computer-controlled conveyor systems that carry raw materials from
stores to the shop floor and finished products to the warehouse.
1. Physical Reorganization of the Production Facilities
Traditional manufacturing facilities Operational Advantages
- tend to evolve in piecemeal fashion over years into snakelike 1. reduced errors
sequences of activities. 2. improved inventory control
- Products move back and forth across shop floors, and upstairs and 3. lower storage costs
downstairs through different departments.
- add handling costs, conversion time, and even inventories to the 4. Robotics
manufacturing process - programmed to perform specific actions over and over with a high
- usually organized along functional lines, this structure tends to degree of precision and are widely used in factories to perform jobs
create parochialism among employees, promoting an us-versus-them such as welding and riveting.
mentality, which is contrary to a team attitude. - useful in hazardous environments or for performing dangerous and
monotonous tasks that are prone to causing accidents
Flexible production system
- organized into a smooth-flowing stream of activities 5. Computer-Aided Design (CAD)
- Computer-controlled machines, robots, and manual tasks that a. to design better products faster
comprise the stream are grouped together physically into factory b, increase engineers’ productivity
units called cells. c, improve accuracy by automating repetitive design tasks
- arrangement shortens the physical distances between the activities d. allow firms to be more responsive to market demands.
- reduces setup and processing time, handling costs, and inventories e. greatly shortens the time frame between initial and final design.
f. allows firms to adjust their production quickly to changes in market
flowing through the facility.
demand
g. allows them to respond to customer requests for unique products.
2. Automation of the Manufacturing Process
- By replacing labor with automation, a firm can reduce waste, - interface to the external communication network to allow a
improve efficiency, increase quality, and improve flexibility. manufacturer to share its product design specifications with its
- The deployment of automation, however, varies considerably vendors and customers.
among manufacturing firms. - allows the manufacturer to receive product design specifications
electronically from its customers and suppliers for its review.
a. Traditional Manufacturing
- consists of a range of different types of machines, each controlled Advanced CAD systems
by a single operator - can design both product and process simultaneously
- require a great deal of setup time, the cost of setup must be - management can evaluate the technical feasibility of the product
and determine its ‘‘manufacturability.’’
absorbed by large production runs.
- The machines and their operators are organized into functional
6. Computer-Aided Manufacturing (CAM)
departments
- use of computers to assist the manufacturing process.
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- focuses on the shop floor and the control of the physical 1. Shows what matters to its customers (such as quality and service).
manufacturing process 2. Identifies profitable products.
3. Identifies profitable customers.
a. The output of the CAD system is fed to the CAM system. 4. Identifies opportunities for improvement in operations and
b. The CAD design is thus converted by CAM into a sequence of products.
processes such as drilling, turning, or milling by CNC machines. 5. Encourages the adoption of value-added activities and processes
c. The CAM system monitors and controls the production process and within the organization and identifies those that do not add value.
routing of products through the cell. 6. Efficiently supports multiple users with both financial and
nonfinancial information.
Benefits
1. improved process productivity What’s Wrong with Traditional Accounting Information?
2. improved cost and time estimates - emphasize financial performance rather than manufacturing
3. improved process monitoring performance.
4. improved process quality - do not support the objectives of lean manufacturing firms.
5. decreased setup times
6. reduced labor costs Deficiencies
1. Inaccurate Cost Allocations
Value Stream Mapping 2. Promote Nonlean Behavior
Essential activities - add value 3. Time Lag
Nonessential activities do not add value, and should be eliminated. 4. Financial Orientation

Value Stream 1. Inaccurate Cost Allocations

- all the steps in the process that are essential to producing a product. - Assumption: All overheads need to be allocated to the product and
- steps for which the customer is willing to pay. that these overheads directly relate to the amount of labor required
to make the product.
Value stream map (VSM)
- to graphically represent their business processes to identify aspects Traditional: direct labor is a much larger component of total
of it that are wasteful and should be removed manufacturing costs than in the CIM environment.
- identifies all of the actions required to complete processing on a Automated: Overhead a far more significant element of cost
product (batch or single item), along with key information about each
action item. - leads to product cost distortions in a lean environment, causing
some products to appear to cost more and others to appear to cost
VSM of a production process less than they actually do.
- from the point at which an order is received to the point of shipping
the product to the customer - Poor decisions regarding pricing, valuation, and profitability may
- itemizes the amount of overtime, staffing, work shifts, process result.
uptime, and task error rate
- shows the total time required for each processing step and the time 2. Promote Nonlean Behavior
required between steps Primary Performance Measurements Used in Standard Costing a.
- identifies the types of time spent between steps such as the personal efficiency of production workers
outbound batching time, transit time, and inbound queue time. b. effective utilization of manufacturing facilities
- reveals that considerable production time is wasted between c. degree of overhead absorbed by production
processing steps.
Some commercial VSM tools produce both: - conceals waste within the overhead allocations and is difficult to
1. current-state map detect
2. future-state map - inclined to produce large batches of products and build inventory.
- depicting a leaner process with most of the waste removed This built-in motivation is in conflict with lean manufacturing.
- action steps can be identified to eliminate the non–value-added
activities within the process. 3. Time Lag
Standard: historic in nature.
Future-state VSM - can be applied after the fact to correct errors
- basis of a lean implementation plan.
Lean: need immediate information about abnormal deviations.
VSM works best in highly focused, high-volume processes - must know in real time about a machine breakdown or a robot out
- real benefit is derived from reducing repetitive processes by even of control.
small amounts of time.
4. Financial Orientation
Less effective at eliminating waste in low-volume processes - use dollars as a standard unit of measure for comparing disparate
- in which the employees are frequently switched between multiple items being evaluated.
tasks. - Decisions are not necessarily well served by financial information
produced through standard cost techniques.
Accounting in a Lean Manufacturing Environment - may distort the problem and promote bad decisions
Traditional information produced under conventional accounting
techniques ACTIVITY-BASED COSTING (ABC)
- does not adequately support the needs of lean companies. - method of allocating costs to products and services to facilitate
better planning and control.
Requirements of Lean Manufacturing Environment

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- assigning cost to activities based on their use of resources and - simplified (lean) accounting approach works because RM and WIP
assigning cost to cost objects based on their use of activities. inventories on hand are low, representing perhaps only one or two
days of stock.
Activities
- describe the work performed in a firm Labor costs of employees
- included whether they design, make, or simply transport the product
Cost objects from cell to cell.
- reasons for performing activities. - not allocated to individual products in the traditional way (time
- include products, services, vendors, and customers. F spent on a particular task).
- the sum of the wages and direct benefits paid to all individuals
Traditional accounting: products cause costs. working in the value stream is charged to the stream.
ABC: activities cause costs, and products (and other cost objects) - Support labor are also included.
create a demand for activities.
Only Allocated Cost In The Value Stream
Steps in Implementing ABC - charge per square foot for the value stream production facility.
1. Determine the cost of the activity. - include the cost of rent and building maintenance.
2. The activity cost is then assigned to the relevant cost object by - to promote efficiency by encouraging value stream team members
means of an activity driver. to minimize the space used to operate the value stream.
- measures the activity consumption by the cost object
General Overhead Costs Incurred Outside The Value Stream
Advantages of ABC - which cannot be controlled by the value stream team, are not
- allows managers to assign costs to activities and products more attached to the product family
accurately than standard costing permits. - no attempt is made to fully absorb facilities costs.
1. More accurate costing of products/services, customers, and - corporate overhead costs must be accounted for but they are not
distribution channels. allocated to value streams.
2. Identifying the most and least profitable products and customers.
3. Accurately tracking costs of activities and processes. Information Systems That Support Lean Manufacturing
4. Equipping managers with cost intelligence to drive continuous MRP systems
improvements. - limited in focus and geared toward determining how much raw
5. Facilitating better marketing mix. materials are required to fulfill production orders
6. Identifying waste and non–value-added activities.
Manufacturing resources planning (MRP II)
Disadvantages of ABC - evolved from MRP to integrate additional functionality into the
1. too time-consuming and complicated for practical applications over manufacturing process, including sales, marketing, and accounting.
a sustained period.
2. The task of identifying activity costs and cost drivers can be a Enterprise resource planning (ERP) systems
significant undertaking that is not completed once and then - takes MRP II a step further by integrating all business functions into
forgotten. a core set of applications that use a common database.
3. Unless significant resources are committed to maintaining the
accuracy of activity costs and the appropriateness of drivers, cost 1. Materials Requirement Planning (MRP)
assignments become inaccurate. - automated production planning and control system used to support
4. Rather than promoting continuous improvement, ABC creates inventory management.
complex bureaucracies within organizations that conflict with the
lean manufacturing philosophies of process simplification and waste
elimination.

VALUE STREAM ACCOUNTING

- captures costs by value stream rather than by department or activity
-cut across functional and departmental lines to include costs related
to marketing, selling expenses, product design, engineering, materials
purchasing, distribution, and more

Defining the Product Family

-share common processes from the point of placing the order to
shipping the finished goods to the customer.

Value stream accounting

- includes all the costs associated with the product family
- makes no distinction between direct costs and indirect costs.

Raw material costs

- calculated based on how much material has been purchased for the
value stream, rather than tracking the input of the raw material to
specific products.

Total value stream material cost

- sum of everything purchased for the period

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Operational Objectives Benefits
a. Ensure that adequate raw materials are available to the production a. Improved customer service
process. b. Reduced inventory investment
b. Maintain the lowest possible level of inventory on hand. c. Increased productivity
c. Produce production and purchasing schedules and other d. Improved cash flow
information needed to control production. e. Assistance in achieving long-term strategic goals
f. Help in managing change (for example, new product development
- calculation method geared toward determining: or specialized product development for customers or by vendors)
a. how much of which raw materials are required g. Flexibility in the production process
b. when they should be ordered to fill a production order.
3. Enterprise Resource Planning (ERP) Systems
By comparing FG inventory on hand with the needed levels (based on - MRP II has evolved into large suites of software
the sales forecast), MRP calculates the total production requirements - integrates departments and functions across a company into one
and the individual batch lot sizes needed. system of integrated applications that is connected to a single
common database.
BOM - enables various departments to share information and
- exploded to produce a list of raw materials needed for production, communicate with each other.
which is compared to the raw materials on hand. - composed of function-specific modules that reflect industry best
- difference is the amount that will be ordered from vendors. practices
- designed to interact with the other modules, these commercial
Primary Outputs from the MRP system packages support the information needs of the entire organization,
- RM purchase requisitions that are sent to the purchases system. not just the manufacturing functions.

System Output - can calculate resource requirements, schedule production, manage

- may include production schedules, management reports, and day- changes to product configurations, allow for future planned changes
to-day production documents such as work orders and move tickets. in products, and monitor shop floor production
- provides order entry, cash receipts, procurement, and cash
2. Manufacturing Resource Planning (MRP II) disbursement functions along with full financial and managerial
- extension of MRP that has evolved beyond the confines of inventory reporting capability.
management.
- both a system and a philosophy for coordinating a wide range of Lean Manufacturing Company
manufacturing activities. - ERP system that is capable of external communications with its
- integrates product manufacturing, product engineering, sales order customers and suppliers through electronic data interchange (EDI).
processing, customer billing, human resources, and related
accounting functions. EDI communications link (via Internet or direct connection)
- allow the firm to electronically
1. receive sales orders and cash receipts from customer
2. send invoices to customers
3. send purchase orders to vendors
4. receive invoices from vendors and pay them
5. send and receive shipping documents.

Similarities are most noticeable when comparing top-end MRP II

systems with low-end ERP packages.
- Primary Distinction: ERP has evolved beyond the manufacturing
marketplace to become the system of choice among
nonmanufacturing firms as well.
- enabled software vendors to sell MRP II packages to
nonmanufacturing companies.

The market for ERP systems

- limited by high cost and complexity to only the largest companies
and was dominated by a few software vendors
a. produces a BOM for the product - tremendously with the entry of many small vendors targeting small
b. fit the production of the product into the master production and mid-sized customers with less expensive and more easily
schedule implemented ERP systems
c. produces a rough-cut capacity plan based on machine and labor
availability
d. design a final capacity plan for the factory
e. manages the RM and FG inventories
f. produces a materials requirements plan that will schedule the
delivery of the raw materials on a JIT basis

The ordering of raw material must be coordinated with the

manufacturing process to avoid waste (early arrival) while ensuring
that stock-out situations do not disrupt the production processes.
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