Segregation of duties in accounting: examples and best practices

segregation of duties in accounting

Last modified on June 21st, 2024

In 2023, a scrap metal business lost nearly $2 million after an employee embezzled the money. The criminal was able to pay invoices to a fake customer account and the money went into her bank account. Segregation of duties (SOD) in accounting could have prevented the fraudster from stealing from her employer in the first place.

Segregation of duties in accounting is a useful internal control, however, it should be complemented with fraud prevention software like Trustpair that guarantees zero fraud thanks to automated account validation. Request a demo to learn more!

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What is segregation of duties in accounting?

Generally, segregation of duties means getting more than one person to complete tasks so that it isn’t just left to one individual.

It is not role-focused and instead about differentiating between steps of the process.

Here is an inventory of the processes that should be separated:

  • Custody or control of assets – money or cash
  • Authorizing transactions or use of assets – payments
  • Recordkeeping of transactions or assets – e.g general ledger

In accounting, segregation of duties involves splitting the steps and tasks in the accounting department between different employees.

For example, segregation of duties can prevent individuals from having the responsibilities to both receive or be in control of money and also to approve transactions.

In accounting, different processes like payroll, and accounts payable should be split between several employees.

 

Why is segregation of duties important in accounting?

There are several reasons why the segregation of duties is so important:

Prevents employees gaining leverage over others

If employees can only access one section of processes and not to both personal or financial information and transaction authorization for example, the chance of them blackmailing an employee into sending them money is much more limited.

Limits chances of employees committing fraud

If processes such as being in custody of the payment, approving the payment, and paying the supplier are all separated out, the chance of an employee committing invoice fraud and internal fraud is much less likely. They could collude but this is also unlikely.

The fraud is limited because the employee couldn’t then have custody of their payment for the supplier, and when they are paying it they could alter the bank account information so the money is paid to an account controlled by them.

Reduce errors

As other employees are involved in different processes, there should be an increased chance that an error is spotted and can be rectified.

 

Separation of duties in accounting: examples and best practices

Employee embezzlement example

When a scrap metal business in Aberdeen was a victim of employee embezzlement, the fraudster was able to pay invoices into a false customer account under the name of G. Anderson who shared the same account details as the fraudster.

During her time at the company, the fraudster Coleen Muirhead dealt with invoices for a portion of their clients.

Following a drop in capital in the business, her fraudulent activity came to light when a review of the company finances was conducted.

G. Anderson was a sizable customer, but senior figures in the business were unaware of who this was. The records showed that the account details aligned with Muirhead’s and the connection was made that she was funneling money into her account.

In the future, it would be beneficial for the business to operate segregation of duties in the accounting procedure if they don’t already.

For example, for the portion of clients that Muirhead had dealings with, the stage of the process which involves receiving invoices, paying invoices and recording transactions could have been shared out across different employees. This should increase the likelihood of either these crimes being spotted or act as a deterrent to committing them in the first place.

Therefore, Muirhead wouldn’t have been able to receive and pay the invoice without any other employee overseeing the process.

Fake invoice scheme example

Another example of where segregation of duties is important is following an alleged fake invoice scheme where an employer was defrauded out of $44 million.

A former procurement manager at the business was able to create fraudulent invoices and process them for payment to an account controlled by himself.

If the task of processing invoices was segregated across a few employees, this should have limited the chance of fraud.

Best practices

Education about segregation of duties

It is important to chat with your employees about why you are segregating duties and why it is so important so that they can understand the operations. Also, by having it explained, your workers won’t feel like you lack trust in them. That way, you get full buy-in from your workers.

Apply the 4 eyes principle

The 4 eyes principle follows on from the segregation of duties idea and suggests that no employee should be able to commit fraud and hide it themselves too.

So, an activity completed by a worker such as paying an invoice should be reviewed by another competent employee.

The 4 eyes principle and segregation of duties are similar ideas. The former principle requires a little more information.

There must be a contingency plan that dictates employees actions if fraud is attempted. Also, the principle must include an approval chain of command and payment limits should be managed too.

Employees can be given different permissions to put this into practice.

 

Protect your business further with fraud prevention software

Segregation of duties is very helpful, but it does not 100% eliminate the chances of fraud.

However, fraud prevention software does that.

Our latest data found that companies believe the most beneficial measures to fight fraud are better education surrounding fraud (43%), better education around cyber-risks, and increasing automation for prevention (38%).

Automation platforms like Trustpair completely remove the chance of fraud thanks to constant account validation to ensure that you Know Your Supplier.

Therefore, you can rest assured that due diligence has been undertaken so you know exactly who you are working with. It not only limits the risk of fraud but also ensures your compliance with regulations.

Check out all the latest trends in B2B payment fraud by downloading our 2024 fraud study.

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Recap

Segregation of duties is one of the best internal controls that management teams can use to limit the chance of fraud, errors, and employee blackmail. While it can help decrease the risk of fraud, to ensure complete fraud protection your organization should explore fraud prevention software such as Trustpair. The platform’s automated account validation helps to prevent fraud.

FAQ

In accounting, you can separate duties by splitting up parts of the process and allocating them to different employees. For example, one worker may be in control of assets, another can authorize transactions, and another can keep a record of these transactions.

In accounts payable, an example of segregation of duties is that employees that are responsible for handling finances such as checks, cash, and cards not being able to give the go-ahead for purchases.

Manage the risks related to corporate treasury.

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