Chapter 4 - Transaction Cycles
If judged to be uncollectible, written authorization to write-off shoul be sent to accounts
receivable and general accounting
Chapter 4
Forms or o Form
Sales returns and allowances
1. Sales department
Reviews customer's request for returns and allowances
Grants sales returns and allowances and prepares credit memo whi is forwarded to customer,
accounts receivable (for recording), a inventory control (for returns)
2. Receiving department
Receives returned goods
Prepare receiving report
3. Inventory control
Compares goods received through the receiving department and credit memo
4. Accounting
Inventory: updates inventory records based on receiving report and prepare daily summaries to
be forwarded to general accounting
Accounts receivable: update records based on the credit mem received and prepares daily
summaries to be forwarded to genera accounting.
General: compares daily summaries from inventory and accounts receivable, then, updates
general ledgers.
PURCHASE TO PAY (P2P)
Business functions
Two major business functions are
Resources are acquired from vendors in exchange for obligations to paym
Accounts affected
Entity pays cash to vendors and employees
Accounts affected include the following:
Purchases (e.g. inventory and supplies)
Purchase returns, allowances and discount
Payables
Cash
Departments involved
Significant departments affecting the cycle are:
Expenditure
User (any department within the entity)
Purchasing or procurement
Receiving
Accounting (accounts or vouchers payable)
Accounting (inventory and general)
Disbursement
Treasury
Accounting (receivable and general)
Chapter 4 - Transaction Cycles
Forms or documents received, initiated and processed
Form
Description
Initiated by:
Distributed to:
Purchasing
Requisition slip (purchase requisition)
Contains the details of the user department's request
User department
Purchase order
Describes the goods to be acquired (quantity and description)
Purchasing department
Vendor
User
Receiving Accounts payable
Receiving report
goods description and condition) Describes the received (quantity,
Receiving department
Purchasing
Accounts payable
Shipping document
Describes the goods to be shipped and serves as contract between the vendor and carrier
Vendor (thru the carrier)
Receiving department
0 al
Vendors invoice
ts
Describes the goods sold, amount due and the terms of payment
Vendor
Accounts payable
Remittance advice
A document sent by the entity to the seller, informing the seller that their invoice has been paid.
Treasury
Vendor
for
Daily summaries
Summarizes transactions recorded during the day by the different department
Accounts payable (for purchases)
General accounting
Treasury (for payment)
Summary of Functions of Departments in P2P Process Cycle
A. User department
Prepares requisition slip to be forwarded to purchasing and accounts payable departments
B. Purchasing or procurement department
Primary objective: To meet the specific needs of the user department at the least possible cost
Activities
1. Receives approved requisition slip from the user department
2. Locates vendor and negotiates with terms
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Possible controls
Common controls adopted by different entities in this department include:
Purchasing department has an Chapter 4 - Transaction Cycles
3. Prepares purchase orders and distributes copies to vendor, user, receiving and accounts
payable
4. Monitors the status of the order
5. Updates customers as to the status of the order
exclusive function to communicate with the vendor
Entity maintains list of authorized vendors
Entity compares purchase price to market prices
Chapter
advice
4. Prepar be forw
C. Receiving department
Primary objective: To provide reasonable assurance that received goods are based on approved
purchase order
Activities
1. Files purchase orders until goods are received
2. Upon receipt, counts and checks the goods for appropriate quantity and condition
3. Reviews and compares purchase orders and shipping document from the carrier
4. Prepares receiving reports to be forwarded to purchasing and accounts payable accompanied
by purchase order from purchasing and shipping document from the carrier
Possible controls
Common controls adopted by different entities in this department include:
To ensure that the receiving department will count and check the goods received, the
purchasing department sends a blank purchase order
HUMAN
disburser
Human from its auditor is
a. P
te
si
b. F
D . Accounts or vouchers payable department
anim
Primary objective: To provide reasonable assurance that payments will only be made to
shipments received
Activities
1. Reviews and compares purchase order, receiving report and vendors invoice (i.e. 3-way
match)
2. Prepares voucher
3. Prepares voucher package (requisition slip, purchase order, receiving report, vendors invoice,
and voucher) and daily summary to be forwarded to the treasury and general accounting,
respectively
Possible controls
Common controls adopted by different entities in this department include:
Voucher should be supported by purchase order, receiving report and suppliers sales invoice or
any other supporting documents
Accounts payable department files voucher package by due date so as to pay liability on time
and take advantage of discounts, if any
Business functions
Accounts affected
Departme involved
E. Treasury department (Disbursement)
Activities
1. Reviews voucher package received
2. Prepares check and have it signed by authorized signatories
3. Forwards checks and remittance
Possible controls
Common controls adopted by different entities in this department include:
. The person last signing the check
Chapter 4 - Transaction Cycles
advice to vendors
4. Prepares daily summary which is to be forwarded to general accounting
cancels the voucher package by placing a mark such as "paid", "cancelled" or writing the check
number.
Entity may adopt any of the following in relation to issuance of checks
-Check over a certain amount should have an identified payee
No checks shall be issued without an identified payee
Checks should be signed by at least two authorized persons
yt
HUMAN RESOURCES AND PAYROLL CYCLE
g k g se
Human resource and payroll cycle are part of the expenditure and disbursement cycle. This
cycle covers the entity's acquisition of services from its employees or personnel. The following
are main reasons why the auditor is concerned with this cycle.
a. Payroll include different categories of employee benefits (short-term; post-employment,
other long-term and retirement) that could significantly affect major elements of financial
statements; and
b. For most entities, significant amount of resources is incurred
Business functions
Two major business functions are
Services are received from employees in exchange for obligations to pay
vill
by ent
Accounts affected
Entity pays cash to employees
Accounts affected include, but not limited to the following:
Salaries and wages expense and payable
Premiums expense and payable
Withholding taxes payable
Inventories (for inventoriable salaries and wages)
Cash
Departments involved
by port any
Significant departments affecting the cycle are:
Expenditure
User (any department within the entity)
Human resources (HR) or personnel
Payroll
Accounting (inventory and general)
Disbursement and distribution
Treasury
Accounting (general)
Chapter 4 - Transaction Cycles
Forms or documents received, initiated and processed
Form
HR records (Personnel records or 201 file)
Description
Initiated by:
HR department
Distributed to
It contains all information related to entity's employees from time they are hired up to their
eventual termination. It documents all actions taken by the employees or management on
behalf of an employee. Commonly, it also documents salary rates, deductions, and other payroll
related information
Payroll (limited payroll related information only)
Chapter 4-
Summary Cycle
A. User d Primam repres
1. Monitors records
Daily time record (DTR)
Payroll register
Labor cost summary
Describes the number of hours worked by an employee during a particular day covered by a pay
period
Shows all related payroll information (gross pay, all deductions, and net pay) for each pay period
Shows payroll information which is capitalizable or can be attributed to a particular job or
customer order
User department
Payroll
Payroll
Payroll
*Note: Hov devices. computeri systems, tracked th
B. HR d Prim: rende
Treasury
General accounting
Inventory accounting
1. Initiate records
2. Forwar to payr wage r and pa
Employee earnings record
Daily summaries
Shows the cumulative, year-to-date summary of earnings and deductions of every employee
Summarizes transactions recorded during the day by the different department
Payroll
Accounts payable
3. Detern (lump-termin
4. Immed depart to a emplo calcula
Payroll (for liability recognition)
Inventory (for inventoriable labor costs)
Treasury (for payment)
General accounting
Chapter 4 - Transaction Cycles
Summary of Functions of Departments in Human Resource and Payroll Cycle
A. User department
Primary objective: To ensure that time records prepared by employees represent actual hours
worked during a pay period
Activities
1. Monitors and approves daily time records
*Note: However, due to introduction of computerized human resources systems, time records
are commonly tracked through biometrics and access devices.
Possible controls
Common controls adopted by different entities in this department include:
Appropriate review activities shall be made to ensure the validity of daily time records prepared
by employees
In case of computerized systems, approval of any exceptions shall be made by the user
department head
B. HR department
Primary objective: To ensure employees included in the payroll are
rendering services to the entity
Activities
1. Initiates, updates and maintains HR records
2. Forwards payroll related information to payroll department (e.g. salary and wage rates,
bonuses, overtime pays, and payroll deductions)
3. Determines terms of settlement (lump-sum or installment) in case of termination of
employee/s
4. Immediately notify payroll department of terminated employee to avoid inclusions of these
employees in the subsequent payroll calculations
Possible controls
controls adopted by Common different entities in this department include:
Access, including initiating changes, to HR records shall be limited only to the HR department
Information not relevant to payroll calculation shall not be shared to other departments
C. Payroll department
Primary objective: To provide reasonable assurance that the payroll calculation in every pay
period is valid
Activities
1. Receives and reviews relevant payroll related information from HR and user departments
2. Considers any update on employees' pay rates and deductions
3. Prepares payroll register
Possible controls
Common controls adopted by different entities in this department include:
Appropriate level of management (preferably a member who is not involved in payroll
preparation)
Chapter 4 - Transaction Cycles
4. Updates cumulative earnings records employee
companies with inventoriable labor case of servicing and manufacturing accounting
capitalizable payroll in 5. Identifies and submits to inventory costs
accuracy and reasonableness reviews the payroll register for
. To assure adequacy of segregation of duties, payroll department Treasury, and some should be
segregated form HR, departments. user
bdPTArC
D. Treasury department - disbursement
Primary objective: To provide reasonable assurance that all payroll disbursement is based on
actual services rendered by employees
Activities
1. Reviews payroll register received
2. Prepares check and have it signed by authorized signatories*
3. Distributes checks to employees
4. Prepares daily summary which is to be forwarded to general accounting
*Note: Most companies disburse payroll through bank fund transfers from company's payroll
fund to individual employees payroll account. In this case, the treasury department should be
the one authorizing the bank transfer.
Possible controls
Common controls adopted by include: different entities in this department
Separate bank account should be maintained exclusively for payroll disbursements
On a surprise basis, an employee independent from payroll and user departments may
distribute paychecks. The purpose of this is to identify whether or not fictitious employees exist
Unclaimed payroll checks shall be re-deposited to the bank
E. Accounting department
Primary objective: To provide reasonable assurance that items related to payroll are
appropriately classified and recorded in correct accounting period at appropriate amounts
Inventory: Records inventoriable labor costs to appropriate jobs or customers account and
forward a daily summary to general accounting.
General: Reviews daily summaries and documents received from payroll, treasury and inventory
departments. It records the recognition of payroll related expenses and liabilities in the general
Morya journal.
PRODUCTION OR CONVERSION CYCLE
Production or conversion cycle covers the production of entity's product for sale. It is where
materials, labor and overhead are converted into finished goods.
The primary objective of this cycle is the proper valuation of inventories Such objective
encompasses the proper allocation of costs to each run made
60
FI
Fi tra Co lo or
Chapter 4 - Transaction Cycles
by the production department. In order to attain this, the production department uses inputs
from the expenditure and disbursement cycle and provides resources and information to
revenue and receipt cycle.
nt R, er
The details of the processes used in this cycle have been discussed in Cost Accounting course.
The focus of this discussion note will be purely on controls over custody of resources involved,
authorization of activities, and recording of transactions. As for the substantive test, you may
refer to Chapter 11.
oll
Summary of control-related duties and responsibilities
by ent
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be
ated rect
sor neral
from the meral
ct for ished
Cories. made
Recording
Duties and responsibilities
Custody
Person/s assigned to perform the function
Physical custody of materials and labor documents is normally held by department. the
production
Since most of the assets here are highly susceptible misappropriation, physical controls
implemented. to adequate must be
ath
Authorization
The production department is authorized to make normal production runs.
However, in case of special runs (to meet a special order), authorization must come from the
board of directors or its authorized representative.
are Transactions are recorded by the cost accounting. Daily summaries then prepared and
forwarded to general accounting for recording and posting in the general journal and ledger,
respectively.
Procedures performed by auditor
count observes and Auditor physical reconciles the result of such count to entity's records.
If held by other parties, send auditor may confirmation requests to the custodian (e.g.
consignees, agents, or branches)
Auditor reviews production orders and documents supporting production related runs made by
the department to determine whether it bears the necessary authorization.
Auditor reviews the normally competency of the individuals making journal entries.
reconciliation of the general ledger
FINANCE AND INVESTMENT CYCLE
Finance and investment cycle generally involves three major categories of transactions:
investments, long-term debts, and shareholders' equity. It covers complicated processes such as
accounting for investments, mergers, long-term liabilities, and equity transactions.
Chapter 4 - Transaction Cycles
This cycle normally involves few but significant amounts of resources. Thus, auditor commonly
employs substantive testing to gather sufficient substantive test procedures, control-related
duties and responsibilities is appropriate evidence. However, it must be noted that prior to
designing of one of the major consideration of the auditor.
With this, similar with the production or conversion cycle, the focus of this and recording of the
different transactions covered by this cycle. As for the discussion note will be on the different
controls over custody, authorization, substantive tests, you may refer to Chapters 14, 25 and 31.
Summary of control-related duties and responsibilities
Finance cycle
Duties and responsibilities
Custody
Person/s assigned to perform the function
Unissued equity and debt certificates must be kept by appropriate internal official (e.g.
Corporate Secretary) or independent external custodian.
Procedures performed by auditor
Auditor inquires directly to assigned custodians.
If held internally, auditor observes the accounting of unissued certificates
Authorization
As previously mentioned, transactions covered in this cycle involve large amounts of cash or
other resources. With this, transactions shall be approved by the board of directors.
Auditor reviews minutes of the board of directors' meetings.
In
Recording
Transactions are recorded in the general journal by personnel in the general accounting.
Auditor reviews the
normally
competency of the individuals making journal entries.
reconciliation of the subsidiary general ledgers and
I1
Important notes:
1. In case of settlement of equity or debt securities previously issued, the certificate is cancelled
thru perforation (e.g. the certificate is shredded). The purpose of this is to avoid duplicate
payments. The supporting records and documents are then kept as audit trail of the
transactions.
2. In case of debt instruments, the general accounting shall appropriately monitor any accruing
interests from the liabilities.
Chapter 4 - Transaction Cycles
Investment cycle
Duties and responsibilities
Custody
Person/s assigned to perform the function
Generally, investment certificates are kept as follows:
Negotiable certificates brokerage account
Titles to real estate - may be kept in a safe with the entity or bank safe deposit box
Procedures
performed by auditor
inquires Auditor directly to assigned custodians thru sending confirmation of requests.
If held internally, the auditor observes the accounting certificates held. for
Authorization
As previously mentioned, transactions covered in this cycle involve large amounts of cash or
other resources. With this, transactions shall be approved by the board of directors or by an
investment committee of the BOD.
reviews minutes of the board of directors meetings. Auditor
Recording
Transactions are recorded in the general journal by personnel in the general accounting.
normally Auditor reviews the
competency of the individuals making journal entries.
most companies Moreover, monitor transactions in the investment cycle through a subsidiary
ledger/s maintained by the treasury department.
periodic reconciliation subsidiary general ledgers of and
Important notes:
1. Regardless of the manner of safekeeping, access to these certificates is given to at least two
high-ranking officers (e.g. President, Treasurer, CEO, COO, CFO, or Chairman of the board). This
control is sometimes called dual control or joint custody.
2. The auditor normally requests for the conduct of securities count in the financial institutions
holding the client's certificates.