Segregation of duties is key to reducing fraud. But smaller entities may not be able to do so. Today, I tell you how overcome this problem, regardless of the entity’s size. Show
 The Environment of FraudDarkness is the environment of wrongdoing. Why? No one will see us. Or so we think. Fraud occurs in darkness. In J.R.R. Tolkien’s Hobbit stories, Sméagol, a young man murders another to possess a golden ring, beautiful in appearance but destructive in nature. The possession of the ring and Sméagol’s hiding of self and his precious (the ring) transforms him into a hideous creature–Gollum. I know of no better or graphic portrayal of how that which is alluring in the beginning, is destructive in the end. Fraud opportunities have those same properties: they are alluring and harmful. And, yes, darkness is the environment where fraud happens. What’s the solution? Transparency. It protects businesses, governments, and nonprofits. But while we desire open and understandable processes, our businesses often have just a few employees that perform the accounting duties. And, many times, no one else understands how the system works. It is desirable to divide accounting duties among various employees, so no one person controls the whole process. This division of responsibility creates transparency. How? By providing multiple eyes to see what’s going on. But this segregation of duties is not always possible. Lacking Segregation of DutiesSome people says here are three key duties that must always be separated under a good system of internal controls: (1) custody of assets, (2) record keeping or bookkeeping, and (3) authorization. I add a fourth: reconciliation. The normal recommendation for lack of segregation of duties is to separate these four accounting duties to different personnel. But many organizations are unable to do so, usually due to a limited number of employees. Some small organizations believe they can’t overcome this
problem. But is this true? I don’t think so. Here’s two easy steps to create greater transparency and safety when the separation of accounting duties is not possible. 1. Bank Account TransparencyFirst, consider this simple control: Provide all bank statements to someone other than the bookkeeper. Allow this second person to receive the bank statements before the bookkeeper. While no silver bullet, it has power. Persons who might receive the bank statements first (before the bookkeeper) include the following:
What is the receiver of the bank statements to do? Merely open the bank statements and review the contents for appropriateness (mainly cleared checks). In many small entities, accounting processes are a mystery to board members or owners. Why? Only one person (the bookkeeper) understands the disbursement process, the recording of journal entries, billing and collections, and payroll. Relying on a trusted bookkeeper is not a good thing. So how can you shine the light? Allow a second person to see the bank statements. Fraud decreases when the bookkeeper knows someone is watching. Suppose the bookkeeper desires to write a check to himself but realizes that a board member will see the cleared check. Is this a deterrent? You bet. Don’t want to send the bank statements to a second person? Request that the bank provide read-only online access to the second person. And let the bookkeeper know. Even the appearance of transparency creates (at least some) safety. Suppose the second person reviewer opens the bank statements (before providing them to the bookkeeper) and does nothing else. The perception of a review enhances safety. I am not recommending that the review not be performed. But if the bookkeeper even thinks someone is watching, fraud will lessen. When you audit cash, see if these types of controls are in place. Now, let’s look at the second step to overcome a lack of segregation of duties. Surprise audits. 2. Surprise AuditsAnother way to create small-entity transparency is to perform surprise audits. These reviews are not opinion audits (such as those issued by CPAs). They involve random inspections of various areas such as viewing all checks clearing the May bank statement. Such a review can be contracted out to a CPA. Or they can be performed by someone in the company. For example, a board member. Additionally, adopt a written policy stating that the surprise inspections will occur once or twice a year. The policy could be as simple as: Twice a
year a board member (or designee other than the bookkeeper) will inspect the accounting system and related documents. The scope and details of the inspection will be at the judgment of the board member (or designee). An inspection report will be provided to the board. Why word the policy this way? You want to make the system general enough that the bookkeeper has no idea what will be examined but distinct enough that a regular review occurs. Surprise Audit IdeasHere are some surprise audit ideas:
The reviewer may not perform all of the procedures and can perform just one. What is done is not as important as the fact that something is done. In other words, the primary purpose of the surprise audit is to make the bookkeeper think twice about whether he or she can steal and not get caught. I will say it again. Having multiple people involved reduces the threat of fraud. Segregation of Duties SummaryIn summary, the beauty of these two procedures (bank account transparency and surprise audits) is they are straightforward and cheap to implement. Even so, they are powerful. So shine the light. What other procedures do you recommend? For more information about preventing fraud, check out my book: The Little Book of Local Government Fraud Prevention. Learn from my CPA Hall Talk newsletter!Get my free accounting and auditing digest with the latest content. Why is it important to have separation of duties?Separation of duties is critical to effective internal control because it reduces the risk of both erroneous and inappropriate actions. All units should attempt to separate functional responsibilities to ensure that errors, intentional or unintentional, cannot be made without being discovered by another person.
Why is it important to have segregation of duties especially in transactions involving money?Segregation of duties serves two key purposes: It ensures that there is oversight and review to catch errors. It helps to prevent fraud or theft because it requires two people to collude in order to hide a transaction.
Does segregation of duties apply when dealing with cash?Cash segregation of duties is most common in larger corporations, but small businesses also can benefit from minimal segregation of duties or having a manager thoroughly oversee and review the cash duties. Proper segregation of duties in a cash business requires authorization, custody, recording and reconciliation.
Why should the responsibility for maintaining the accounting records be separated from the responsibility for operations?The responsibility for maintaining the accounting records should be separated from the responsibility for operations so that the accounting records can serve as an independent check on operations.
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