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How Companies Make Purchases

As an auditor you have to assess the purchasing procedures your client uses. An important part of the purchasing process is — no surprise! — paying for the purchase. Businesses and individuals alike have only two ways to pay for expenses:

  • Cash purchases: Cash changes hands at the same time that the goods or services do. If your boss sends you to the office supply store with a company check to buy an emergency supply of printer paper, you’re paying for the expense with cash.

  • Credit purchases: The company and its vendor agree that the payment for the goods and services will come after the fact. Most established businesses purchase their goods and supplies using this method. When your client does so, the client records these transactions in the purchases journal.

    Credit terms make the business world go round. Businesses that sell goods extend credit terms to customers to encourage them to spend more money. Those same businesses secure credit terms from their vendors so they have payment from their customers before they have to pay their vendors. (That’s the hope, anyway.)

In accounting, cash is a generic term for any payment method that’s assumed to be automatic. When you sign a check and give it to a vendor, part of your implicit understanding is that the funds are immediately available to clear the check. Anytime cash goes out of the business, the company records that amount in the cash payments journal (also known as the cash disbursements journal). This journal has several different columns. How the company labels each column depends on the type of accounting software it uses. As an auditor, you need to do some sampling and testing of the cash payments journal to verify that payments on the journal also reflect as clearing the bank statements and are for authorized company expenses.

The following terms may not exactly match what you’ll see on your audit clients’ cash payments journals, but based on my experience with different software programs, these terms are generic enough that you can connect the dots when looking at your clients’ reports:

  • Type: Refers to how the cash payment is made. The options include check, petty cash disbursement, or debit card transaction.

  • Number: Tracks the unique number of the payment method — if one exists. Good internal controls dictate that petty cash receipts have a number. Of course, any company check also has a number. Debit transactions usually don’t have a number.

  • Date: Records the date the cash payment occurs.

  • Name: Records whom the payment is made to — the pay-to entity on the check, petty cash receipt, or debit card entry.

  • Amount: Lists how much money is paid.

  • Account: Explains why the company made the expenditure and to which financial statement account it’s taken.

Anytime a business buys something using credit (on account), it records the transaction in its purchases journal. Typically this journal has columns for date, number, and amount. It also has the following columns:

  • Accounts payable or trade payables: Because the company is purchasing on account, the current liability account accounts payable or trade payables is always affected.

  • Terms: This column shows any discount terms the company may have with the vendor. For example, 2/10, n/30 means the company gets a 2-percent discount if it pays within 10 days; otherwise, the full amount is due in 30 days.

  • Supplier’s name: The company records the name of the vendor from which the purchase is made.

  • Account: This column shows to which financial statement account(s) the purchase is taken. Examples include inventory, purchases, freight-in, and sales tax.

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