What is the Acquisition and Payment Cycle?
The Acquisition and Payment Cycle (also referred to as the PPP Cycle for Purchases, Payables, and Payments) is mainly comprised of two classes of transactions. The first class is the acquisition class. The typical journal entry for this class of transactions is a debit to inventory or an expense and a credit to accounts payable. The classification assertion is highly important in this scenario because there are many possible debits that can fulfill the journal entry.
The second class of transactions in the acquisition and payment cycle is the cash disbursements class. The typical journal entry for this class is simply a debit to accounts payable and a credit to cash. All in all, this cycle is mainly about incurring payables and paying off those payables with cash.
Typical Business Functions and Important Documents
Although many companies follow different internal processes and use more electronic-based methods, the following flowchart is a typical business process in the acquisition and payment cycle.
The process generally starts with a purchase requisition that an employee of the company generates. The purchase requisition is a document that describes the product needed and the quantity required. The document is then sent to the purchasing department that generates a purchase order. The purchase order lists the product to purchase, the quantity to order, and the price the company is willing to pay.
Typically, companies are only permitted to buy from an approved vendor’s list. Once the ordered goods have been received by the next department, the company issues a receiving report. The report should reconcile with the purchase order and is sent to the accounts payable team in the accounting department. Here, the employee reconciles the received goods with the vendor invoice and the journal entry to accounts payable is recorded. Finally, the payment is processed in treasury and the cash is actually paid out.
General Methodology for Auditing Cycles
When auditing cycles for different companies, the typical approach is to:
- Understand the entity and its environment
- For each cycle, identify internal controls that exist
- Assess control risk and the risk of material misstatement
- Evaluate the cost-benefit analysis of testing controls and following a combined audit approach vs a purely substantive audit approach
Important Internal Controls For Acquisitions and Disbursements
Remember that for classes of transactions, there are five applicable assertions: cut-off, classification, completeness, occurrence, and accuracy.
An internal control pertaining to the occurrence assertion is that each purchase is accompanied by the necessary supporting documents such as the purchase requisition, purchase order, receiving report, and vendor’s invoice. Without such documents, a purchase cannot “occur” and hence should not have been recorded. Other controls include the approvals of purchase orders by higher level staff, the cancellation/defacing of documents once a transaction has been recorded/accounted for, and approving any changes to the vendor’s list.
In terms of the completeness assertion, purchase orders and receiving reports are typically pre-numbered and accounted for. If a number has been recorded twice or there is a missing number from the list, it will be easy to figure out the problem.
Finally, in terms of the classification assertion, some controls include adequate approval from a supervisor for journal entries, an adequate list/chart of accounts with descriptions of each, and comparing balances with budgeted amounts. In terms of the cash disbursements, important controls are mainly segregation of duties and frequent bank reconciliations.
The Auditor’s Role
Substantive analytical procedures, as we learned before, are typically trend and ratio analysis against industry data, prior year data, and expected results. Substantive analytical procedures are usually sufficient and appropriate as audit evidence because the amounts are not significant and very often involve relatively trivial balances such as general and administrative expenses. However, for more judgmental and more complex accounting issues with regards to legal expenses, repairs, and maintenance expense, and lease expense, for example, auditors will want to obtain more assurance and perform tests of details of balances.
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