The Concept of Segregation of Duties and the CPA Exam
Segregation of duties is the process of separating critical duties among multiple employees to reduce the risk of theft. On the business environment and concepts (BEC) test part of the CPA exam, this process is a vital internal control that you should understand.
Although other controls — like written approvals and reconciling bank accounts — are important, how you allocate work to employees is critical. If duties aren’t carefully segregated, dishonest workers can override all your other internal controls.
Here are three responsibilities that should be assigned to different staff members:
Custody of assets: Employee A has access to assets, such as the company checkbook.
Authorization to move assets: Employee B has authority to sign checks, which allows cash to be moved (paid). Employee B also approves purchases of large dollar amount items.
Recordkeeping: Employee C is typically an accountant. Employee C reviews the records that document a transaction and then posts the activity into the accounting records. Employee C reconciles the checkbook. Employee B signs checks, and Employee A keeps the physical checkbook.
Here’s a segregation of duties scenario. Suppose that a restaurant manager, Rob, has the authority to authorize payment as well as the ability to sign checks. Rob decides to generate a disbursement voucher.
A voucher is a document that authorizes payment to an outside vendor. In this case, the voucher is for $1,000 for a payment to Northern Meat Supply. The restaurant buys meat, chicken, and fish from vendors. Using the voucher as documentation, Bob generates a check payable to Northern Meat Supply.
Sue, the restaurant’s accountant, reconciles the bank account. She notices payments each month to Northern Meat Supply. She doesn’t think of the payments as unusual, because the restaurant pays vendors for meat, chicken, and fish. Several months later, Rob leaves to work at another restaurant.
At year-end, the auditors perform procedures to audit accounts payable. As part of their procedures, an auditor agrees (compares) a sample of vendor payments to incoming shipments of product. The auditors find that no product was received from Northern Meat Supply. After further investigation, the company determines that Northern Meat was a fictitious payee.
The firm was simply a bank account that Rob controlled. Because Rob had two duties that should’ve been segregated (authority to purchase goods and to sign checks), he was able to steal assets from the company. This scenario is common on the BEC test. Segregation of duties is also on the auditing and attestation (AUD) test.