Simple Ways to Create Segregation of Duties (and avoid a management letter comment)

March 26, 2012

There are four categories of potential management letter comments: material weakness, significant deficiency, control deficiency, and “other comment”.  We want to go through some of the common scenarios that occur in each category and go through some suggestions for preventing them. We’ll start with the most common management letter comment we give: the lack of segregation of duties. Depending on severity, this is usually a control weakness. Incompatible tasks include: bank reconciliation and AP approval, cash receipts and authorization to adjust AR,   purchasing and inventory receipts, among others. They key factors to keep separate are:

  • Custody of assets (cash, inventory, fixed assets)
  • Authorization over transactions affecting those assets (approval for payroll, AP, purchasing)
  • Recording transactions (General Ledger and subledger entry)

Of course it’s easier for one person to do it. It’s streamlined and efficient. It’s also extremely dangerous for both the organization and the sole person all fingers will point to if something goes wrong. It doesn’t have to be that complicated or time consuming to add some solid layers of separation.

Below are some suggestions on how to avoid a lack of segregation issue.  I’ve divided the suggestions up based on the size of the accounting department.

One person accounting department:

  • Have someone outside the department receive and review the bank statements before they are given to the accountant. Remove the opportunity for someone to remove altered checks or cover suspicious activity.
  • Have the President/CEO review the supporting documents and then sign the checks after they are prepared. Approval should be noted in ink on the supporting document. This doesn’t have to be complicated. Put initials and a date. This removes the possibility of an invoice presented for payment multiple times and removes the likelihood of blindly signing a check that shouldn’t be there.
  • If the above two aren’t possible consider bringing in a contract bookkeeper to prepare checks and bank reconciliations.
  • Have someone outside the accounting department receive the cash/contributions/payments and create a log before forwarding it to the accountant to be recorded and deposited. The log should be reconciled to the books and reviewed with the bank reconciliation.
  • Someone that does not prepare the bank reconciliation should review and approve the reconciliation. Review and approval should be documented with ink initials and a date on the reconciliation. This should be retained on file.
  • Have someone review journal entries and approve them. Support for journal entries and their approval should be retained on file.

Two person accounting department:

  • Have one person approve the invoices while the other person prepares the checks. This removes the opportunity to have erroneous payments go out the door.
  • Someone outside the accounting department without access to the accounting system should sign the checks. No one should sign checks to themselves.
  • Have one person prepare the deposits while the other one records and makes the deposit. This helps prevent AR lapping schemes.
  • Have one person prepare the journal entries while the other person approves them.

Three people or more accounting department:

  • Have one person process payables, make deposits, and prepare the bank reconciliations.
  • Have one person with limited access to the accounting software sign checks.
  • Have the third person record deposits, prepare the checks, and review the bank reconciliation.
  • Have at least one person with the ability to review journal entries.
  • With the addition of each additional staff member over three the work can be even further spread out and you can have backups for each position.

These are just generic suggestions, if you feel you have a unique setup and need help deciding how to split up the responsibilities please feel free to contact us.  Part of our job is to help you help yourself. Stay tuned for more in this series.

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