Definition: Segregation of duties is an internal control procedure implemented to reduce the risk of errors and fraud. To sum up, it is a practice that aims to avoid negligence and misconducts.
What Does Segregation of Duties Mean?
The practice of segregating duties is an important part of setting a robust internal control system. The process of segregation starts by identifying weak points in the company processes, these weak points are normally those that may have some room for negligence or intentional misconduct that will translate into a money loss without anyone noticing. By separating critical duties, the company can protect his assets against wrong doings.
This is particularly important in the financial department and on inventory procedures; in the case of the financial department, the person authorizing payments must be different from the person preparing them and recording them in the company books. By separating these duties, the degree of convolution that must take place for a fraud to be committed is much more complex and this reduces the motivation to engage in such fraudulent activities.
Let’s try to illustrate this concept with an example,
No More Cables LLC is a company that manufactures wireless devices for homes. The company is currently reviewing its internal control processes and it started by reviewing some tasks at the financial department. The company identified some weak spots, processes where fraud might be committed without the company noticing. One of these processes is the raw material inventory process. in each of these processes. According to our previous definition, how could they reduce the risk of fraud in this process?
As we previously stated, segregation of duties is a practice that reduces the risk of fraud or negligence in a given process. If the company wants to strength this process it has to break the process into pieces, an example of that might be: first inventory count, second inventory count and final physical inventory approval, by having different stages the company can assign each of them to different people.
In this case, the process should be done by 3 different people, one person doing the 1st count, another one doing the 2nd one and the last person approving the final count. By doing this, the duties are being segregated effectively and, in consequence, the risk of committing fraud is being reduced.