Segregation of Duties, also known as Separation of Duties, is the concept of requiring more than one person to complete a task. The purpose of this requirement is to help prevent fraud and mistakes, and the practice is a key internal control for any business. In effect, setting up a separation of duties creates a system of checks and balances to ensure that errors from simple mistakes to outright fraud are not made.
The key principle of separation of duties requires that no one individual can be assigned job functions in more than one of three categories of responsibilities. These three categories include asset management, bookkeeping or transaction recording, and review of transactions and balances.
- Team members who manage physical assets are not able to enter bills or invoices, so as to prevent them from incorrectly disposing of assets.
- Team members who manage accounts receivable are not able to work on accounts payable, in order to prevent them from creating fraudulent bills.
- Employees who manage accounts payable are not able to work on accounts receivable to prevent them from creating fraudulent invoices.
- Team members who enter transactions are not able to enter reconciliations to prevent concealment of any fraudulent transactions.
- Those team members who manage Accounts Payable and Accounts Receivable are not able to enter new customers or new vendors in order to prevent the creation of bogus accounts.
All of these controls help to ensure that entries remain in balance, reconciliations are completed, and fraud is prevented.
Another key principle is a second check, or second set of eyes. This practice is put in place in situations where certain transactions require approval from a peer or a supervisor, i.e., a return transaction where a refund is processed for a customer. This second check concept can be applied to many differing types of transactions, including a dual signature requirement on a check.
Most large companies that can afford it buy large ERP systems that are able to create roles and responsibilities within the system. However, these systems are cost prohibitive for small and medium sized businesses. When duties cannot be separated, compensating controls should be in place.
Compensating controls are internal controls that are intended to reduce the risk of an existing or potential control weakness. If a single person can carry out and conceal errors and/or irregularities in the course of performing his or her day-to-day activities, that employee has been assigned duties that are incompatible with creating an adequate segregation of duties. This situation provides an opportunity for unlawful activity to occur. There are several control mechanisms that can help enforce the segregation of duties:
- Audit Trail
- Exception Reports
- Transaction Logs
- Supervisory Reviews
- Independent Review
Setting up these controls can be costly. As most small and medium business know, creating a separation of duties requires adding additional staff that the business may be unable to afford. In these situations, the business owners should look to 3rdparty bookkeeping providers to help implement and maintain a system of segregation of duties. The 3rdparty services are fractional in nature and are typically less costly than hiring a full-time staff member, but these services offer the expertise to deploy the necessary controls.
The segregation of duties is a very important practice for small and medium businesses. These are the companies who will suffer the most from any fraudulent activities occurring on their company accounts, as they are the ones who can least afford to incur the losses.
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