Segregation of Duties: The Key to Proper Controls and Minimizing FraudWhitney Irish
Post By Alyssa Sproat
Segregation of duties (SOD) is an essential part of the effectiveness of internal controls for any business. This integral separation ensures that key processes are performed by more than one person to prevent fraud or financial misstatement. While technology continues to become more sophisticated, the time is now to implement controls that segregate key functions within processes such as cash disbursements, investments, payroll, and many other areas.
The first step to implementing effective SOD is to truly understand the business processes that occur on a daily basis. While it sounds easy in theory, high-level management may not know all the details, which is where the importance of SOD lies. When considering if your processes are properly segregated, the key parts to consider are custody, authorization, and recordkeeping. The basic questions you should be asking yourself while evaluating your processes are as follows:
- Who receives and/or maintains possession of the asset?
- Who has authorization to approve transactions?
- Who records the transactions to the general ledger?
Hopefully after you have answered these questions, you can confidently say that a different employee performs each function. If not, how can you can change the process to improve the SOD and overall effectiveness of internal controls? Let’s look at an example to better understand.
For cash disbursements, Accountant #1 receives the invoice from the vendor. From there, the accountant reviews the invoice and submits it for approval. The Controller reviews and approves the invoice by signing off (authorization). Accountant #2 maintains the check stock in a locked cabinet (custody). The approved invoice is routed to Accountant #2, where the check is printed. Accountant #2 has the check signed by the designated signers. The check is mailed by Accountant #1. The Controller records the expense to the general ledger (recordkeeping).
In the above example, the essential functions within the cash disbursements are separated among employees. If Accountant #2 maintained the check stock and approved the invoice, fraud could occur. If Accountant #2 maintained the check stock and recorded transactions to the general ledger, the accountant would have access to steal checks and omit them from the ledger. While you hope your employees would never do this, controls in place to minimize the opportunities of fraud are essential. If you are unsure of how to implement segregation of duties or how you can improve, a discussion with your Accounting department and/or CPA can help you segregate the essential controls and improve internal controls.