Separation of duties is an internal control that reduces error and fraud by assigning responsibility to various individuals for company transactions and procedures. Ideally, the following tasks should be separated (though additional controls may be implemented depending on the industry and a cost/benefit analysis). Examples of the separation of duties in a retail company are included below for illustrative purposes:
- Custody of Assets/Access to Assets
- An independent employee prepares checks, checks are signed by an approved check signer, and checks over a certain dollar amount require an additional authorized signature.
- Authorization of transactions
- All transactions are approved by both the requesting department or authorized employee (through a purchase requisition) and the purchasing department or authorized employee (through a purchase order).
- Performed by a bookkeeper.
- Independent Reconciliation
- Bank account reconciled by an independent employee. Reconciliation of control account (e.g., general ledger) and a subsidiary account (detail supporting general ledger).
From our experience conducting forensic investigations for smaller organizations, a lack of separation of duties often creates an environment conducive to fraud. For example, a company bookkeeper could commit fraud if the bookkeeper is responsible for recording transactions, depositing cash and checks to the bank, and reconciling bank accounts. Also, these employees may not be required to obtain authorization from another independent employee for the recording of transactions. Thus, there is no other employee supervising the bookkeeper and making sure transactions have been properly authorized, documented, recorded, and reviewed. A simple review of an employee’s job duties and responsibilities can make evident the lack of separation of duties.
With Covid-19 devastating the global economy, small businesses are aggressively cutting costs to survive the pandemic. Companies that are financially struggling may lay off employees and have other employees take on additional responsibilities. Employees, many of whom are now working remotely, and struggling to cope with the stress from Covid-19, may experience more financial and personal pressure. Many employees are working more hours for the same pay and may rationalize misappropriating assets such as cash or inventory from an organization. Due to the increase in pressure, it is crucial for organizations to separate duties in a cost-effective manner to mitigate their fraud risk.
Small businesses with few employees can separate duties amongst available staff to ensure some benefits. The businesses may need to rotate job duties amongst employees to ensure fairness in the delegation of duties. At a minimum, two employees should be involved in each company transaction.
Though the separation of duties does not guarantee that a fraud or error will be detected or avoided in all instances, such as when two or more employees collude to misappropriate assets from an organization, it does increase the credibility of accurate financial reporting and reduces the likelihood of fraud.
This article was written by Juan Martinez, CPA, ABV, CFF, CFE Procor Solutions + Consulting Vice President. Connect with Mr. Martinez on LinkedIn here>