Expenditure Cycle: Cycle Controls

What is Expenditure Cycle?

Businesses need resources in order to conduct their business–to produce and sell a product or to provide a service. The expenditure cycle is concerned with the acquisition of fixed assets, raw materials, or manufactured components and the use of employee labour to yield a finished product.

As was the case in the revenue cycle, this effort can be viewed as having both a physical phase and a financial phase.

Expenditure Cycle

The expenditure cycle consists of the following phases:

  1. Apportionment of Appropriations and Release of Funds to Spending Units
  2. Commitment
  3. Acquisition and verification (or certification)
  4. Payment

Apportionment of Appropriations and Release of Funds to Spending Units

Funds may be released through notification of cash limits, issue of warrants, funds transfers to imprest accounts, and other mechanisms. In some countries, the release of funds includes two steps:

  • Apportionment by the central budget office, which consists of defining which part of the appropriation the line ministries and spending units can use.
  • Allotment by the line ministries and main spending units, which consists of allocating apportioned appropriations to subordinate spending units.


The commitment stage is the point where a future obligation to pay is incurred. A commitment consists of placing an order or awarding a contract for specified goods or services to be delivered. It entails an obligation to pay when the third party has complied with the provisions of the contract.

However, as discussed below, the precise definition of a “commitment”, in the budgetary sense, varies from one budget system to another and depends on the economic category of the expenditure.

Acquisition and verification (or certification)

At this stage, goods are delivered and/or services are rendered and their conformity with the contract or order is verified. Assets and liabilities of the government are increased and recorded in the books if the country has an accrual accounting system.

Expenditures at the verification stage are also called accrued expenditures (e.g. in the US) or actual expenditures (e.g. in some FSU countries). Expenditure at the verification stage entails liability, and arrears are the difference between expenditures at the verification stage and payments.


At this stage, payments are made through various instruments such as cheques, cash disbursed, electronic transfers, debt instruments, barter agreements, deduction from taxes and cash vouchers. The practice of making payments through barter agreements, deduction from taxes and cash vouchers is questionable.

Payments through deduction from taxes are frequent in some FSU countries but have negative consequences on both tax collection and competition among suppliers. Barter agreements impede competition among suppliers.

Cash vouchers should generally be seen as an administrative stage in the expenditure cycle, rather than as a payment mechanism, especially when they are not paid immediately. Payments through cheques are, in most countries, recorded when cheques are issued.

Comparisons with bank statements should be systematic. When the float of unpaid cheques is significant, payments must also be reported on the basis of cheques paid.

Expenditure Cycle Controls

Control ActivityPurchases Processing SystemCash Disbursements System
Transactions AuthorizationInventory control.AP authorizes payment.
Segregation of DutiesInventory control is separate from purchasing and inventory custody. AP subsidiary ledger separate from the general ledger.Separate AP subsidiary ledger, cash disbursements, and general ledger functions.
SupervisionReceiving area.
Accounting recordsAP subsidiary ledger, general ledger, purchases requisition file, purchase order file, receiving report file.Voucher payable file, AP subsidiary ledger, cash disbursements journal, general ledger cash accounts.
AccessSecurity of physical assets. Limit access to the accounting records above.Proper security over cash. Limit access to the accounting records above.
Independent verificationAP reconciles source documents before liability is recorded. General ledger reconciles the overall accuracy of the process.Final review by cash disbursements. Overall reconciliation by the general ledger. Periodic bank reconciliation by the controller
Expenditure Cycle Controls

These are control points in the expenditure cycle explained briefly:

  1. Transaction Authorization
  2. Segregation of Duties
  3. Supervision
  4. Accounting Records
  5. Access Controls
  6. Independent Verification

Transaction Authorization

Purchases Subsystem: The inventory control function continually monitors inventory levels. As inventory levels drop to their predetermined reorder points, inventory control formally authorizes replenishment with a purchase requisition.

Cash Disbursements Subsystem: The AP function authorizes cash disbursements via the cash disbursement voucher. To provide effective control over the flow of cash from the firm, the cash disbursements function should not write checks without this explicit authorization.

A cash disbursements journal (check register) containing the voucher number authorizing each check provides an audit trail for verifying the authenticity of each check written.

Segregation of Duties

Segregation of Inventory Control from the Warehouse: Within the purchases subsystem, the primary physical asset is inventory. Inventory control keeps detailed records of the asset, while the warehouse has custody. At any point, an auditor should be able to reconcile inventory records to the physical inventory.

Segregation of General Ledger and Accounts Payable from Cash Disbursements: The asset subject to exposure in the cash disbursements subsystem is cash. The records controlling this asset are the AP subsidiary ledger and the cash account in the general ledger.

An individual with the combined responsibilities of writing checks, posting to the cash account, and maintaining AP could perpetrate fraud against the firm. For instance, an individual with such access could withdraw cash and then adjust the cash account accordingly to hide the transaction.

Also, he or she could establish fraudulent AP (to an associate in a nonexistent vendor company) and then write checks to discharge the phoney obligations. By segregating these functions, we greatly reduce this type of exposure.


In the expenditure cycle, the area that most benefits from supervision are the receiving department. Large quantities of valuable assets flow through this area on their way to the warehouse. Close supervision here reduces the chances of two types of exposure: (1) failure to properly inspect the assets and (2) the theft of assets.

Accounting Records

The control objective of accounting records is to maintain an audit trail adequate for tracing a transaction from its source document to the financial statements. The expenditure cycle employs the following accounting records: AP subsidiary ledger, voucher register, check register, and general ledger.

The auditor’s concern in the expenditure cycle is that obligations may be materially understated on financial statements because of unrecorded transactions. This is a normal occurrence at year-end closing simply because some supplier invoices do not arrive in time to record the liabilities.

This also happens, however, as an attempt to intentionally misstate financial information. Hence, in addition to the routine accounting records, expenditure cycle systems must be designed to provide supporting information, such as the purchase requisition file, the PO file, and the receiving report file.

By reviewing these peripheral files, auditors may obtain evidence of inventory purchases that have not been recorded as liabilities.

Access Controls

Direct Access: In the expenditure cycle, a firm must control access to physical assets such as cash and inventory. These control concerns are essentially the same as in the revenue cycle. Direct access controls include locks, alarms, and restricted access to areas that contain inventories and cash.

Indirect Access: A firm must limit access to documents that control its physical assets. For example, an individual with access to purchase requisitions, purchase orders, and receiving reports has the ingredients to construct a fraudulent purchase transaction. With the proper supporting documents, a fraudulent transaction can be made to look legitimate to the system and could be paid.

Independent Verification

Independent Verification by Accounts Payable: The AP function plays a vital role in the verification of the work others in this system have done. Copies of key source documents flow into this department for review and comparison.

Each document contains unique facts about the purchase transaction, which the AP clerk must reconcile before the firm recognizes an obligation. These include:

  1. The PO, which shows that the purchasing agent ordered only the needed inventories from a valid vendor.3 This document should reconcile with the purchase requisition.

  2. The receiving report, which is evidence of the physical receipt of the goods, their condition, and the quantities received. The reconciliation of this document with the PO signifies that the organization has a legitimate obligation.

  3. The supplier’s invoice, which provides the financial information needed to record the obligation as an account payable. The AP clerk verifies that the prices on the invoice are reasonable compared with the expected prices on the PO.

Independent Verification by the General Ledger Department: The general ledger function provides an important independent verification in the system. It receives journal vouchers and summary reports from inventory control, AP, and cash disbursements.

From these sources, the general ledger function verifies that the total obligations recorded equal the total inventories received and that the total reductions in AP equal the total disbursements of cash.

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