Business owners and accounting professionals need to be aware of the importance of financial reporting and transaction systems integrity. Financial statement audits are designed to assure that the financial statements are fairly presented per Generally Accepted Accounting Principles (GAAP). However, if an organization’s financial reporting and transaction systems are not properly segregated, it could result in the misstatement of financial information.
The segregation of duties is a management concept that involves identifying individual tasks within certain business operations and assigning those tasks to different people. In other words, the segregation of duties requires more than one person’s involvement to complete a financial transaction or manipulate accounting records.
For example, when preparing the journal entries during the monthly close process, it would be difficult for an individual employee to enter 100 journal transactions by himself/herself without manipulating the asset, liability, revenue, and expense account balances. By limiting access to sensitive data entry fields within automated systems (e.g., accounts payable), segregating duties is an effective control method for implementing internal controls over financial reporting (ICFR). A strong internal control system will ensure that account balances are not misstated and that transactions are recorded per GAAP.
Segregation of duties has many benefits that can help businesses increase their overall efficiency.
Protection Against Fraud
One primary example is that segregation of duties in accounting helps protect companies against fraud and employee theft through collusion, which occurs when two or more people work together for illicit gains.
For instance, if the accounts payable department manager colludes with suppliers to defraud the company by paying inflated invoices for supplies, an inappropriate accounting entry would occur because the books do not match the supplier’s records.
Someone performing a Segregation of Duties (SoD) audit should detect this discrepancy immediately because different employees are required to sign off on these transactions.
Limiting Access to Assets
Another way SoD protects businesses is by ensuring limited access to assets only to authorized individuals only at authorized times. To illustrate, suppose a bookkeeper is responsible for updating the general ledger with transactions received from the accounts payable department.
If she has access to both functions, her ability to manipulate accounting records increases. Therefore, it may be safer to separate these two functions into two different jobs – one that only updates accounting records and another that only enters data into the general ledger.
Multiple Levels of Approval
Providing multiple layers of approval can also help companies avoid careless or costly mistakes. For instance, if an employee submits an invoice for goods received but has not yet been paid by Accounts Payable, this entry will cause an inappropriate debit to cash because it’s still in transit (goods on their way out).
By requiring more than one person to approve important transactions before they are posted/implemented, the risk of costly errors decreases.
Enhanced Data Security
Finally, segregation of duties can enhance data security by limiting access to sensitive information. For instance, it might be better if only one person has permission to access customer credit card numbers or employee social security numbers because controlling who has authorized access helps protect against unauthorized disclosure.
Final Thoughts
Segregation of duties is an important element in protecting business assets. By limiting the number of individuals with access to important information and functions, companies can increase profits by minimizing fraud and maximizing their assets.