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Implementing Compensating Controls to Improve Segregation of Duties

April 22, 2019
By: Jennifer Frank

Segregation of duties is one of the most important initiatives a small business or government can implement to safeguard an organization’s assets and prevent theft and misuse (fraud). In an ideal world, a single person would not be responsible for more than one of the following accounting functions:

  1. Authorization
  2. Record Keeping
  3. Reconciliation
  4. Custody of assets

Unfortunately, most small businesses and governments do not have the luxury of completely separating the above accounting functions amongst different personnel. So what options are there if you do not have enough personnel to properly segregate duties? You can create compensating controls.

Let’s use an extreme scenario as the following example. A Town has only one person in the accounting department that is responsible for all four of the above functions. The Town does not have the funds or staffing to transfer any of these duties to anyone else.

To mitigate the risk that fraud will occur and go undetected, the Town needs to figure out some compensating controls. One good resource that is often underutilized is the governing council or board. Members of the council have a fiduciary duty to protect the assets of the citizens they serve. So why not get them more involved?

Here are some ideas for compensating controls that could be put in place in this situation:

  1. Bank reconciliations and bank statements (ideally with copies of cancelled checks) can be emailed to the council members each month to be reviewed. Any questions are asked, answered, and approval of the reconciliation is attached.
  2. Two to three council members can be the authorized signers on the bank accounts and dual signatures are required on checks over a certain amount. Signers should review backup for each transaction before signing the check.
  3. Work with the bank to give online read-only access to those council members that are not authorized signers on the bank accounts and have them periodically review the bank account activity.
  4. Work with the bank to set it up so that a council member is required to authorize any wire transfers entered into the system by accounting staff.
  5. Have bank statements mailed directly to a council member who opens and reviews the statement prior to it being given to accounting.
  6. Have a council member pick up the mail and open it prior to the mail being given to accounting.
  7. Council members can do surprise audits. Randomly select two weeks or months out of the year and request all back up for cash disbursements and receipts. Review for accuracy and proper documentation. For example, agree daily cash receipts to the deposit slip and bank statement. Verify all disbursements have an invoice and are approved purchases. Review payroll checks and agree to time cards, look for any anomalies. The key factor here is that these are surprise audits. Let staff know that they will occur but not when. One of the best deterrents to fraud that you can have is the perception of detection.
  8. Council members can review monthly budget-to-actual reports and question any variances.
  9. If the accounting person has a Town credit card, council members should ensure all expenses have receipts attached and appear to be legitimate town expenses before approving payment.
  10. Council members can approve any write-off of accounts receivable.

These activities could also be achieved by utilizing other department heads for some of the review activities. One of the key takeaways, in this situation, is that someone independent of the accounting function is reviewing and approving the activity and that the review is documented.

While implementing these compensating controls will not eliminate the segregation of duties issue, they will assist in mitigating the risk that fraud will go undetected.

 

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