Acquisition and Payment Cycle

The PPP Cycle for Purchases, Payables, and Payments, or the Acquisition and Payment Cycle, primarily consists of two groups of transactions: the acquisition class and the cash disbursements. 

For the acquisition class, the typical journal entry is a debit to inventory or a cost and a credit to accounts payable. The classification assertion is crucial given that numerous alternative debits could complete the journal entry.

On the other hand, cash disbursements are the second class of purchase and payment cycle transactions. The journal entry for this class is only a debit to accounts payable and a cash credit. Overall, this cycle focuses on accrued payables and clearing them with cash.

Even though many businesses have unique internal procedures and employ electronic-based techniques, a purchase request created by a firm employee often initiates the procedure. 

For example, a document that specifies the items and the quantity needed is a buy request. The purchasing division receives the document and creates a purchase order. 

Employees often have access to a list of approved vendors only. The business issues a receiving report once the subsequent department has received the ordered goods. 

The report is delivered to the accounting department's accounts payable team, which should agree with the purchase order. 

Here, the employee compares the vendor's invoice to the products received before recording the journal entry for accounts payable. The money is then really disbursed when the Treasury processes the payment.

General Methodology for Auditing Cycles

The accounting procedure auditors use to analyze a corporation's financial statements and supporting documents is an audit cycle. 

An audit cycle refers to the procedures an auditor follows to confirm the accuracy of the company's financial data. Depending on the audit cycle, different tasks may need to be completed at different times. 

For instance, inventory counts may be due in October, while account receivables determinations may be due in November. When auditing cycles for various businesses, the usual method is to:

1. Identification Phase 

The identification phase is the first step, during which the company meets with auditors to determine which accounting areas require further study.

2. Audit Methodology Phase

During this stage, the auditors determine the methodology and approach for gathering and analyzing the data. 

3. Compare and Contrast Accounting Samples

The audit fieldwork stage involves the examination and comparison of accounting samples. Auditors select a representative sample of transactions or documents related to the audited cycle. 

4. Conclusions

In the management review meeting, the fourth stage, the auditors present their conclusions to the company's management team. 

They communicate the findings, including any discrepancies or areas of concern identified during the audit, and provide an opportunity to clarify the audit results.

5. Audit Report

The audit report is prepared and delivered to management in the final phase. This report comprehensively overviews the audit process, findings, and recommendations. 

It highlights any inconsistencies or deficiencies discovered in the company's financial accounts, aiming to enhance transparency and accountability.

Important Internal Controls For Acquisitions and Disbursements

Several internal controls can be implemented to ensure the effectiveness and accuracy of the acquisition and payment cycles. Here are some key controls for each of the five appropriate assertions:

1. Occurrence Assertion

The events and transactions that have been noted or revealed have taken place and are relevant to the entity.

Each purchase is supported by the required supporting papers, such as the buy request, purchase order, receiving the report, and vendor's invoice, according to internal controls relating to the occurrence assertion.

2. Completeness Assertion

All transactions and events that needed to be reported have been reported, and the financial statements now contain all necessary associated disclosures.

3. Classification Assertion

 The appropriate accounts have been used to record transactions and events.

4. Cut-off Assertion

Events and transactions have been documented during the appropriate accounting period.

5. Accuracy Assertion

Amounts and other information pertaining to the transactions and events have been properly recorded, and the relevant disclosures have been measured and explained.

Other controls include:

• Having higher-level employees approve purchase orders.
• Canceling paperwork after a transaction has been documented or accounted for.
• Approving any modifications to the vendor list.

Purchase orders and receiving reports are often pre-numbered and accounted for regarding the completeness assertion. Therefore, it will be simple to identify the issue if a number has been registered twice or is absent from the list.

The Auditor's Role

An auditor plays a crucial role in ensuring a company's financial records' accuracy, compliance, and integrity. Here are the key responsibilities and functions of an auditor:

1. Verification of Compliance
A realistic way to comply with compliance obligations is to incorporate compliance into internal processes. Compliance regulations must be adhered to as closely as feasible. Verifications of compliance come in several forms. 

You may be able to meet the requirements set in their specific industries with the aid of these verifications. 

2. Evaluation of Internal Controls
With a thorough grasp of controls, an auditor may see risks related to the client's internal controls and, as a result, may plan and implement the necessary countermeasures.

3. Examination of Financial Records

Through different documented transactions, financial statements depict a company's funding, investing, and operating operations. The financial statements were created domestically, so it is possible they were prepared fraudulently.

4. Questioning and Inquiry

A simple inquiry testing technique uses interview-style questions with the point of contact for some controls. It is considered a weaker kind of evidence since the accuracy and sincerity of the interviewee determine the quality of the information obtained through inquiry.

5. Risk Assessment and Recommendations 
A risk assessment is a methodical procedure carried out by a qualified individual that entails locating, evaluating, and controlling any risks or dangers present in a circumstance or location. 

This decision-making tool tries to identify which actions should be taken to mitigate or control such risks and to indicate which should be prioritized based on their likelihood and potential effects on the company.

How to Audit the Acquisition and Payment Cycle

The purchase and payment cycle of a business is prone to error. Companies can exaggerate the worth of the inventory they buy, which gives the impression that assets are larger than they actually are. 

Management may overlook or undervalue accounts payable, which exaggerates financial strength. Management and auditors keep a tight eye on internal controls and important acquisition accounts to avoid this situation.

1. Assess Risks
Depending on the environment, a firm may face distinct dangers at different stages of the acquisition cycle. Companies that sell low-margin items in a highly competitive market are incentivized to manipulate their margins through inventory and COGS valuation. 

Without excellent accounting department staff with operational knowledge, businesses might not adequately track purchase and cash disbursement paperwork. 

Depending on the intrinsic strengths and weaknesses of the organization, auditors will pay closer attention to personalized risk factors and identify areas where there may be a higher risk of misstatement or manipulation.

2. Ensure Controls are in Place
The likelihood of fraud or errors in the company's purchasing system decreases with greater internal controls in place. 

The best businesses mandate that their purchasing representatives only work with recognized vendors and conduct frequent vendor reviews. As a result, there is a lower possibility of fraud and kickbacks. 

3. Evaluate Inventory and COGS

Auditors want to ensure inventory isn't exaggerated because it's a big asset. Auditors will see the physical inventory count to check that the numbers add up and conduct their sample count. 

To ensure that transactions were recorded appropriately, they will verify inventory purchase transactions close to a financial cutoff period. 

4. Look at Accounts Payable and Related Expenses 

Auditors will look for unrecorded accounts payable because it accounts for a sizable portion of the money the company owes to third parties. 

The main ledger, which decides the financial statements, frequently takes transactions from a subsidiary accounts payable ledger to verify that they are also recorded. They might contact important suppliers and vendors to see if they concur with the amount the business claims to owe them. 

5. Analyze Vendor Relationships

You probably can't run your entire business in-house, whether a Fortune 100 firm or a mom-and-pop shop. 

The vendors step in at this point. Vendors may offer services (coaching, photography, social media creation) or items (fresh fruit, hardware, car fleets) which can be essential to your company's success.

How to Simplify the Acquisition and Payment Cycle

How businesses function, exchange commodities for cash, and pay for services has changed as the world becomes increasingly digital.

Many business processes are still needlessly complex—and in some cases, redundant — even though they have been reduced in almost every department over the years. It is a lengthy procedure that involves many people, departments, and outside organizations.

To simplify the acquisition and payment cycle, businesses can adopt certain strategies and leverage digital advancements. Here are some:

1. Embrace Technology
The rise of artificial intelligence (AI), the Internet of Things (IoT), and other digital advancements have altered how organizations conduct contracts, purchase orders, invoices, and more. 

This also impacts the entire procurement and payment cycle; a corporation must determine what it needs to purchase.

2. Organizational Change and Culture
Companies will probably need to make organizational and cultural modifications when switching to an automated strategy. 

While some businesses may be happy with how they now conduct business, others will find a method to streamline their acquisition and payment procedures by implementing or embracing new technologies. 

3. Establish a Single Point of Contact 
Streamlining your procurement department is crucial in improving your sales and procurement procedures. A single point of contact (SPOC), a central procurement contact, can help.

4. Automate the Invoice Matching Process 

Paying your provider is the next step after acquiring goods or services. However, many businesses still use manual invoice matching procedures, which might hinder development needlessly.

5. Change the Way You Manage Contracts
Businesses frequently strike a balance between having too little and too much paperwork while maintaining important contracts. 

As a result, there are sometimes several redundant tasks to complete. Such tasks include filling out the same paperwork multiple times in different locations. 

Using AI, you can design contracts that adjust to each unique business environment, saving time on repetitive activities. Another method for streamlining the contract administration procedure is to use managed service providers (MSPs). 

Reviewed and edited by Parul Gupta | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• Accounts Payable
• Accounts Payable Turnover Ratio
• Accounts Receivable
• Accounts Receivable Turnover Ratio
• Audit Sampling