Auditing the Expenditure Cycle - Chapter 10 PDF

CHAPTER 10 Auditing the Expenditure Cycle L E A R NI NG O B J E CT I V E S After studying this chapter, you should: Understand the primary tasks associated with the expenditure cyc...

CHAPTER 10 Auditing the Expenditure Cycle L E A R NI NG O B J E CT I V E S After studying this chapter, you should: Understand the primary tasks associated with the expenditure cycle under different levels of technology. Understand audit objectives related to the expenditure cycle. Be familiar with expenditure cycle control issues related to alternative technologies. Recognize the relationship between expenditure cycle audit objectives, controls, and tests of controls. Understand the nature of substantive tests in achieving expenditure cycle audit objectives. Be familiar with common features and functions of ACL that are used to perform substantive tests. T his chapter examines audit procedures associated with the expenditure cycle. This chapter is divided into three main sections. It begins with a review of computer technologies used in both legacy and modern systems. The focus is on the way that key operational tasks are performed under different technological environments. The second section discusses the expenditure cycle audit objectives, controls, and tests of controls that an auditor would normally perform to gather the evidence needed to limit the scope, timing, and extent of substantive tests. The last section describes substantive tests in relation to expen- diture cycle audit objectives that can be performed using ACL software. EXPENDITURE CYCLE ACTIVITIES AND TECHNOLOGIES This chapter assumes that the reader is familiar with the general procedures that consti- tute the expenditure cycle and with the key accounting records and documents employed in expenditure cycle transaction processing. Those who need to review this body of material should turn to the appendix at this point, where it is presented in detail. This section examines alternative information technologies used to support expendi- ture cycle activities. The first of these is a purchases and cash disbursements system that 469 Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 470 Chapter 10: Auditing the Expenditure Cycle employs batch processing and uses sequential files for storing accounting data. This type of system is an example of an early legacy system. This approach characterizes the era of data ownership in which files were designed exclusively for the use of a single user. Data sharing is virtually impossible in this setting and results in a great deal of data redun- dancy and data obsolescence. Second, we review the operational features of a modern system that employs real-time processing and uses direct access files or databases. The final example depicts a modern payroll system that uses real-time processing and data- base technology. You should recognize that space limitations prohibit a review of all possible config- urations of processing technologies, techniques, and file structures. The objective, in- stead, is to present examples of fundamentally different approaches that are typically found in practice and examine their control and audit implications. Purchases and Cash Disbursement Procedures Using Batch Processing Technology Many of the manual functions in the batch system presented in Figure 10.1 are the same as those found in manual purchase systems. The principal difference is that the routine accounting tasks are automated. The following section describes the sequence of events as they occur in this system. Data Processing Department: Step 1 The purchasing process begins in the data processing department, where the inventory control function is performed. The revenue cycle (in retailing firms) or the conversion cycle (in manufacturing firms) actually initiates this activity. When inventories are reduced by sales to customers or usage in production, the system determines if the affected items in the inventory subsidiary file have fallen to their reorder points.1 If so, a record is created in the open requisition file. Each record in the open requisition file defines a separate inventory item to be replenished. The record contains the inventory item num- ber, a description of the item, the quantity to be ordered, the standard unit price, and the vendor number of the primary supplier. The information needed to create the requisition record is selected from the inventory subsidiary record. The inventory subsidiary record is then flagged “On Order” to prevent the item from being ordered again before it arrives. At the end of the day, the system sorts the open requisition file by vendor number and consolidates multiple items from the same vendor in to a single requisition. Next, vendor mailing information is retrieved from the valid vendor file to produce purchase requisition documents. Copies of these documents go to manual procedures in the pur- chasing and accounts payable (AP) departments. Purchasing Department. Upon receipt of the purchase requisition, the purchasing department prepares a five-part purchase order. Copies go to the vendors, accounts pay- able, receiving, data processing, and the purchasing department’s own file. The system in Figure 10.1 employs manual procedures to control the ordering process. A computer program identifies inventory requirements and prepares traditional purchase requisitions, thus allowing the purchasing agent to verify the purchase transaction before placing the order. Some firms use this technique to reduce the risk of placing unnecessary 1 This may be batch or real time, depending on the revenue and conversion cycle systems that interface with the expenditure cycle. The raw materials and finished goods inventory files link these three transac- tion cycles together. The design of one system influences the others. For example, if sales processing (rev- enue cycle) reduces inventories in real time, the system will naturally identify inventory requirements in real time also. This is true even if the purchases system is batch oriented. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  FIGURE 10.1 Batch Purchases System Purchases Receiving Data Processing Purchases System Accounts Payable A Purchase Purchase D Receiving B Purchase Requisition Order Inventory Sales Procedures Report Requisition Sub File Update inventory and Step 3 identify items at their Vendor reorder points. This C Purchase Prepare Update Terminal Order PO Program program creates an open purchase requisition file. Packing PO Slip E Receiving PO Receiving Report Expenditure Cycle Activities and Technologies PO Report File Open Purchase PO Requisition File Inventory Purchase Prepare Order RR Sub-Ledger Vendor Update C Sort by Vendor Inventory Accounts Pay and prepare Pending File RR Open Purchase Vendor File Updated D Supplier Vendor RR Requisitions Inventory Invoice Receiving Step 1 Match Invoice with E Receiving Report PR AP Pending File A Report File Purchase and Prepare Cash Requisition Open Disbursement B PO File Voucher Close Out GL Batch Open PO Totals PR Purchase Voucher Closed PO Requisition Purchase PO File RR Purchase Order (Batch) Invoice Order Voucher Voucher Receiving Step 2 (Batch) Report Terminal Open Purchase Step 4 Terminal Requisition File Update Open Voucher File File Program Closed Voucher Requisition File File Vendor Open Record File PO File Voucher in Register Open GL Batch Voucher AP File Totals Register Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 471  472 FIGURE 10.1 Batch Purchases System (Continued) Data Processing Cash Disbursements System Accounts Payable Cash Disbursements Copy PR Check Copy A Voucher PO Copy Register RR Invoice Check Voucher Transaction Search Voucher File Listing for Items Due. Write GL Batch Open Checks, Record In Totals Voucher File Check Register Match Transaction Match Check with Listing Support Documents Transaction in Open Voucher File Listing A Copy Check Closed Copy Copy Copy Register AP File PR PO (Cash Disbursements Check RR Check Journal) Invoice Voucher Chapter 10: Auditing the Expenditure Cycle Check File End of Day Procedures: General Ledger Update Sign Checks Batch Totals Inventory General Ledger Closed Voucher File Check Update GL from Open AP Batch Totals Closed AP Vendor Updated Cash Disbursement Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  Expenditure Cycle Activities and Technologies 473 orders with vendors due to a computer error. However, such manual intervention cre- ates delays in the ordering process. If sufficient computer controls are in place to pre- vent or detect purchasing errors, then more efficient ordering procedures can be implemented. Before continuing with our example, we need to discuss alternative approaches for authorizing and ordering inventories. Figure 10.2 illustrates three different methods. In alternative one, the system advances the procedures shown in Figure 10.1 one-step further. This system prepares the purchase order documents and sends them to the purchasing department for review and signing. The purchasing agent then mails the approved purchase orders to the vendors and distributes copies to other internal users. The system shown in alternative two expedites the ordering process by distributing the purchase orders directly to the vendors and internal users, thus bypassing the pur- chasing department completely. This system produces a transaction list of items ordered for the purchasing agent’s review. Alternative three represents a reengineering system that uses electronic data inter- change (EDI). This method produces no physical documents (purchase orders or sales orders). Instead, the computer systems of both the buying and selling companies are connected via a special telecommunications link. The buyer and seller are parties in a trading partner arrangement in which the entire ordering process is automated and un- impeded by human intervention. In each of the three alternatives, the authorization and the ordering steps in the pro- cess are consolidated and performed by the computer system. Purchase requisition docu- ments serve no purpose in such systems and are not produced. However, requisition records may still exist on magnetic disk or tape to provide an audit trail. Data Processing Department: Step 2 Returning to Figure 10.1, the purchase order is used to create an open purchase order record and to transfer the corresponding record(s) in the open purchase requisition file to the closed purchase requisition file. Receiving Department When the goods arrive from vendors, the receiving clerk prepares a receiving report. Copies go to purchasing, accounts payable, and data processing. Data Processing Department: Step 3 The data processing department runs a batch job (Step 3) that updates the inventory subsidiary file from the receiving reports and removes the “On Order” flag from the in- ventory records. The system calculates batch totals of inventory receipts for the general ledger update procedure and then closes the corresponding records in the open purchase order file to the closed purchase order file. Accounts Payable. When the accounts payable clerk receives the supplier’s invoice, he or she reconciles it with the supporting documents that were previously placed in the accounts payable pending file. The clerk then prepares a voucher, files it in the open voucher file, and sends a copy of the voucher to data processing. Data Processing Department: Step 4 A batch program validates the voucher records against the valid vendor file, adds them to the voucher register (or open AP subsidiary file), and prepares batch totals for posting to the AP control account in the general ledger. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 474 Chapter 10: Auditing the Expenditure Cycle FIGURE 10.2 Alternative Inventory Ordering Procedures Purchases Data Processing Department Receiving Accounts Payable Purchase Requisition File Blind Copy Acct Pay Copy Prepare Blind Copy Acct Pay Copy File Copy Purchase Open Purchase Orders Vendor File Order File Purchase Order Blind Copy Acct Pay Copy File Copy Review and Purchase Distribute Order Blind Copy Acct Pay Copy File Copy Purchase Order Vendor ALTERNATIVE 1 Purchases Data Processing Department Receiving Accounts Payable Purchase Transaction Requisition File List Prepare Blind Copy Acct Pay Copy Purchase Review Open Purchase Orders Vendor File and Order File File Blind Copy Acct Pay Copy Purchase Order Transaction List Transaction List Vendor ALTERNATIVE 2 Data Processing Department Purchase Requisition File Prepare Purchase Open Purchase Orders Vendor File Order File Electronic Transfer of Purchase Order Direct to Vendor's Computer System Vendor ALTERNATIVE 3 Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  Expenditure Cycle Activities and Technologies 475 Cash Disbursement: Data Processing Department. Each day, the system scans the Due Date field of the voucher register for items due. Checks are printed for these items, and each check is recorded in the check register (cash disbursements journal). The check number is recorded in the voucher register to close the voucher and transfer the items to the closed AP file. The checks, along with a transaction listing, are sent to the cash disbur- sements department. Finally, batch totals of closed accounts payable and cash disburse- ments are prepared for the general ledger update procedure. At the end of the day, batch totals of open (unpaid) and closed (paid) accounts pay- able, inventory increases, and cash disbursements are posted to the accounts payable control, inventory control, and cash accounts in the general ledger. The totals of closed accounts payable and cash disbursements should balance. Cash Disbursement: Cash Disbursements Department The cash disbursements clerk reconciles the checks with the transaction listing and sub- mits the negotiable portion of the checks to management for signing. The checks are then mailed to the suppliers. One copy of each check goes to accounts payable, and the other copy is filed in cash disbursements along with the transaction listing. Cash Disbursement: Accounts Payable. Upon receipt of the check copies, the ac- counts payable clerk matches them with open vouchers and transfers these closed items to the closed voucher file. The expenditure cycle process concludes with this step. Reengineering the Purchases/Cash Disbursement System The automated system just described simply replicates many of the procedures in a man- ual system. In particular, the accounts payable task of reconciling supporting documents with supplier invoices is labor intensive and costly. The following example shows how reengineering this process can produce considerable savings. The Ford Motor Company employed more than 500 clerks in its North American accounts payable department. Analysis of the function showed that a large part of Ford’s accounts payable clerks’ time was devoted to reconciling discrepancies between supplier invoices, receiving reports, and purchase orders. The first step in solving the problem was to bring about fundamental changes in the business environment. Ford initiated trading partner agreements with suppliers in which they agreed in advance to terms of trade such as price, quantities to be shipped, discounts, and lead times. With these sources of discrepancy eliminated, Ford reengineered the workflow to take advantage of the new environment. The flowchart in Figure 10.3 depicts key features of a reengineered system. Data Processing The following tasks are performed automatically: 1. The inventory file is searched for items that have fallen to their reorder point. 2. A record is entered in the purchase requisition file for each item to be replenished. 3. Requisitions are then consolidated according to vendor number. 4. Vendor mailing information is retrieved from the valid vendor file. 5. Purchase orders are prepared and sent to the vendor. Alternatively, these may be transmitted using EDI technology. 6. A record of each transaction is added to the open purchase order file. 7. A transaction listing of purchase orders is sent to the purchasing department for review. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 476 Chapter 10: Auditing the Expenditure Cycle FIGURE 10.3 Reengineered Purchases/Cash Disbursement System Data Processing Receiving Accounts Payable Inventory Scan Inventory Goods and Prepare Arrive Valid Vendors Purchase Orders Inventory Packing Purchase File Purch. Req. Slip Orders File Vendor Update Inventory File and Flag Items Received Transaction Terminal/ Open PO in the Open PO File. Listing Printer File Update GL File. Purchasing Transfer the Closed PO to the Open AP File. Receiving Report File GL Receiving Control Report File GL Control Accts Open AP Closed AP File File Terminal/ Printer A Batch Program at Check the End of the Day Transaction Transaction Register Selects AP Due, Writes Listing Listing Checks, and Records These in Register. Vendor Checks Cash Disbursements File Receiving Department When the goods arrive, the receiving clerk accesses the open purchase order file in real time by entering the purchase order number taken from the packing slip. The receiving screen, illustrated in Figure 10.4, then prompts the clerk to enter the quantities received for each item on the purchase order. Data Processing The following tasks are performed automatically by the system: 1. Quantities of items received are matched against the open purchase order record, and a “Y” value is placed in a logical field to indicate the receipt of inventories. 2. A record is added to the receiving report file. 3. The inventory subsidiary records are updated to reflect the receipt of the inventory items. 4. The general ledger inventory control account is updated. 5. The record is removed from the open purchase order file and added to the open AP file, and a due date for payment is established. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  Expenditure Cycle Activities and Technologies 477 FIGURE 10.4 DATE: 12/15/04 PURCH. ORDER # 567 CLERK ID MD Receiving Screen ITEM # QTY RECVD QTY ORDER Discrepancy Displays after Qty Recvd has been entered 45-709 50 55 5 MANUAL ENTRY = Each day, the Due Date fields of the accounts payable records are checked for items due to be paid. The following procedures are performed for the selected items: 1. Checks are printed, signed, and distributed to the mailroom for mailing to vendors. EDI vendors receive payment electronically. 2. The payments are recorded in the check register file. 3. Items paid are transferred from the open accounts payable file to the closed AP file. 4. The general ledger accounts payable and cash accounts are updated. 5. Reports detailing these transactions are transmitted via terminal to the accounts payable and cash disbursements departments for management review and filing. Since the financial information about purchases is known in advance from the trading partner agreement, the vendor’s invoice provides no critical information that cannot be derived from the receiving report. By eliminating this source of potential dis- crepancy, Ford was able to eliminate the task of reconciling vendor invoices with the supporting documents for the majority of purchase transactions. As a result of its reengineering effort, the company was able to reduce its accounts payable staff from 500 to 125. Control Implications The technology control issues (i.e., those pertaining to the use of sequential files versus direct access files) are general in nature. The points made in the last chapter apply to the expenditure cycle also. Therefore, let’s examine only the issues specific to this cycle by focusing on the differences between an automated versus a reengineered system. The Automated System Improved Inventory Control. The greatest advantage of the automated (batch) system over its manual counterpart is its improved ability to manage inventory needs. Inventory requirements are detected as they arise and are processed automatically. As a result, the risks of accumulating excessive inventory or of running out of stock are reduced. However, with this advantage comes a control concern. Authorization rules governing purchase trans- actions are consolidated within a computer program. Program errors or flawed inventory models can cause firms to be suddenly inundated with inventories or desperately short of stock. Therefore, it is extremely important to monitor automated decisions. A well- controlled system will provide management with adequate summary reports on inventory purchases, inventory turnover, spoilage, and slow-moving items. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 478 Chapter 10: Auditing the Expenditure Cycle Better Cash Management. This type of system promotes effective cash management by scanning the voucher file daily for items due, thus avoiding early payments and missed due dates. In addition, by writing checks automatically, the firm reduces labor cost, saves processing time, and promotes accuracy. As a control against unauthorized payments, comparing the vendor number on the voucher with a valid vendor file validates all entries in the voucher file. If the vendor number is not on file, the record is presumed to be invalid and is diverted to an error file for management review. In this system, a manager in the cash disbursements department physically signs the checks, thus providing control over the disbursement of cash. However, many computer systems automate check signing with special printing equipment, which is more efficient when check volume is high, but relinquishes some control. To offset this exposure, firms often set a materiality threshold for check writing. Checks for amounts below the thresh- old are signed automatically, and an authorized manager or the treasurer signs those above the threshold. Less Time Lag. A lag exists between the arrival of goods in the receiving department and recording inventory receipts in the inventory file. Depending on the type of sales order system in place, this lag may affect sales negatively. Because of this time lag, sales clerks will not know the current status of inventory, and sales may be lost. Better Purchasing Time Management. In this hypothetical batch system, the pur- chasing department is directly involved with all purchase decisions. For many firms, this creates additional work that extends the time lag in the ordering process. A vast number of routine purchases could be automated. By freeing purchasing agents from routine work, such as preparing purchase orders and mailing them to the vendors, attention can be focused on problem orders (such as special items or those in short supply), and the purchasing staff can be reduced. Reduction of Paper Documents. The basic batch system is laden with paper docu- ments. All operations departments create documents, which are sent to data processing and which data processing must then convert to magnetic media. A number of costs are associated with paper documents, since the paper must be purchased and the documents filed, stored, handled by internal mail carriers, and converted by data processing personnel. Organizations with high volumes of transactions benefit considerably from reducing or eliminating paper documents in their systems. The Reengineered System This system addresses many of the operational weaknesses found in the basic batch system. Specifically, the improvements in this system are that (1) it uses real-time procedures and direct-access files to shorten the lag time in recordkeeping; (2) it eliminates routine man- ual procedures through automation; and (3) it achieves a significant reduction in paper documents by using electronic communications between departments and by storing records on direct-access media. These operational improvements, however, carry control implications. Segregation of Duties. This system removes the fundamental separation between authorization and transaction processing. Here, computer programs authorize and pro- cess purchase orders and authorize and issue checks to vendors. To compensate for this exposure, the system needs to provide management with detailed transaction listings and summary reports. These documents describe the automated actions taken by the system and allow management to spot errors and any unusual events that warrant investigation. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  Expenditure Cycle Activities and Technologies 479 Accounting Records and Access Controls. This system maintains accounting records exclusively on magnetic disks. To preserve the integrity of these records, the organization must implement controls that limit access to the disks. Unauthorized access to magnetic re- cords carries the same consequences as access to source documents, journals, and ledgers in a manual environment. Organizations can employ a number of physical and software tech- niques to provide adequate access control. However, keep in mind that some techniques are costly, and management must justify these costs against their expected benefits. Overview of Payroll Procedures Payroll processing is actually a special expenditure system. In theory, payroll checks could be processed through the regular accounts payable and cash disbursements system. However, as a practical matter, this approach would have a number of drawbacks: General expenditure procedures that apply to all vendors will not apply to employees. Payroll procedures differ greatly among classes of employees. For example, different procedures are used for hourly employees, salaried employees, piece workers, and commissioned employees. Also, payroll processing requires special accounting pro- cedures for employee deductions and withholdings for taxes. Cash disbursements for trade accounts do not require special processing. Therefore, general expenditure systems are not designed to deal with these complications. Writing checks to employees requires special controls. It is easier to conceal payroll fraud when payroll checks are combined with trade account checks. General expenditure procedures are designed to accommodate a relatively smooth flow of transactions. Business enterprises are constantly purchasing inventories and dis- bursing funds to vendors. Naturally, they design systems to deal adequately with their normal level of transaction activity. Payroll activities are discrete rather than continuous. Disbursements to employees occur weekly, biweekly, or monthly. To pe- riodically impose this processing burden on the general system may have an over- whelming peak-load effect. Because payroll systems run infrequently (weekly or monthly), they are often well suited to batch processing and sequential files. Figure 10.5 shows a flowchart for such a system. The data processing department receives the personnel action forms and time cards, which it converts to sequential files. Batch computer programs perform the detailed record-keeping, check-writing, and general ledger functions. Control Implications The strengths and weaknesses of this system are similar to those in the batch system for general expenditures discussed earlier. This system promotes accounting accuracy and reduces check-writing errors. Beyond this, it does not significantly enhance operational efficiency; however, for many types of organizations, this level of technology is adequate. Reengineering the Payroll System For moderate-sized and large organizations, payroll processing is often integrated within the human resource management (HRM) system. The HRM system captures and pro- cesses a wide range of personnel-related data, including employee benefits, labor resource planning, employee relations, employee skills, personnel actions (pay rates, deductions, and so on), as well as payroll. HRM systems must support real-time access to personnel files for purposes of direct inquires and recording changes in employee status as they occur. Figure 10.6 illustrates a payroll system as part of an HRM system. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  480 FIGURE 10.5 Batch Payroll System with Sequential Files Production Data Processing Cash Disbursements Job Job Pay A Tickets Tickets Checks Terminal Personnel Labor Action Hours Sign and Send to Paymaster for Job Cost Distribution Timecards Personnel Hours Update Employee Employee File Payroll File Personnel Pay Action Checks Pay A Checks WIP Update File WIP File Timecards Payroll Register Paymaster B Chapter 10: Auditing the Expenditure Cycle Prepare payroll register, funds transfer check, and journal voucher record. Funds Terminal Payroll Post to check register. Transfer Register Check Voucher Labor Dist File Summary Funds Compare Check with Personnel Labor Transfer Payroll Register. Action Hours Check Sign Check and Check Send to Bank. Register Update General Sort by Payroll Ledger B Employee Register Number Funds Payroll Transfer Voucher Register Check File Personnel Labor Hours General Action Ledger Sign and Send to Bank Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  FIGURE 10.6 Payroll System with Real-Time Elements Cost Personnel Accounting Timekeeping Data Processing Real-Time Processing Terminal Job Human Tickets Resource Labor Labor Management Usage File Usage File Expenditure Cycle Activities and Technologies Terminal Employee Attendance Post to WIP accounts File and Prepare Labor Cost Timecards File Dist Summary Accounting Files Labor Dist Summary Cost Acctg Batch Process Labor Dist Summary Terminal Payroll Processing Voucher Labor Dist File Summary Gen Ledger Payroll Accts Pay Register Payroll Register Cash Disb Payroll Master File Paycheck Update Voucher General Gen Ledger General Funds Ledger Ledger Transfer Check Payroll Register Voucher Voucher Voucher File Accts Pay Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. 481 482 Chapter 10: Auditing the Expenditure Cycle This system differs from the simple automated system described previously in the following ways: (1) operations departments transmit transactions to data processing via terminals, (2) direct access files are used for data storage, and (3) many processes are now performed in real time. We discuss the key operating features of this system as follows: Personnel. The personnel department makes changes to the employee file in real time via terminals. These changes include additions of new employees, deletions of terminated employees, changes in dependents, changes in withholding, and changes in job status (pay rate). Cost Accounting. The cost accounting department enters job cost data (real time or daily) to create the labor usage file. Timekeeping. Upon receipt of the approved timecards from the supervisor at the end of the week, the timekeeping department creates the current attendance file. Data Processing. At the end of the work period, the following tasks are performed in a batch process: 1. Labor costs are distributed to various work-in-process, overhead, and expense accounts. 2. An online labor distribution summary file is created. Copies of the file go to the cost accounting and general ledger departments. 3. An online payroll register is created from the attendance file and the employee file. Copies of the files go to the accounts payable and cash disbursements departments. 4. The employee records file is updated. 5. Payroll checks are prepared and signed. They are sent to the treasurer for review and reconciliation with the payroll register. The paychecks are then distributed to the employees.2 6. The disbursement voucher file is updated and a check is prepared for the funds transfer to the payroll imprest account.3 The check and a hard copy of the disburse- ment voucher go to cash disbursements. One copy of the voucher goes to the gen- eral ledger department, and the final copy goes to accounts payable. 7. At the end of processing, the system retrieves the labor distribution summary file and the disbursements voucher file and updates the general ledger file. EXPENDITURE CYCLE AUDIT OBJECTIVES, CONTROLS, AND TESTS OF CONTROLS Chapter 1 introduced the concept of audit objectives derived from general management assertions about financial statement presentation. The assertions are existence or occur- rence, completeness, accuracy, rights and obligations, valuation or allocation, and presen- tation and disclosure. Table 10.1 shows how these translate to specific expenditure cycle audit objectives. Achieving these audit objectives requires designing audit procedures to gather evidence that either corroborates or refutes management assertions. As we saw in the 2 For added internal control, many companies encourage their employees to have their checks directly de- posited in their bank accounts. 3 An imprest account is established at a specified, predetermined amount of the total payroll. When all paychecks clear, the account balance is 0. Copyright 2011 Cengage Learning, Inc. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part.  Expenditure Cycle Audit Objectives, Controls, and Tests of Controls 483 TABLE 10.1 Relationship Between Management Assertions and Expenditure Cycle Audit Objectives Management Assertions Expend