Segregation of Duties: Definition & Examples

Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

Segregation of duties is an important part of protecting company assets such as money, inventory, and employee information. In this lesson, we'll define segregation of duties, explain how it works as an internal control, and provide examples.

Defining Segregation of Duties

In government, it is often called 'checks and balances.' If you are working on a big project, you might want a 'second set of eyes.' Whatever it's called, and in whatever context it is used, the idea that having more than one person involved in an important decision or complex process is helpful for several reasons. In managerial accounting and risk management, this concept is known as 'segregation of duties.'

Segregation of duties is the practice of having related duties or work tasks segregated so that different people are involved in key steps. To understand why this is important, think back on the 'checks and balances' and 'second set of eyes' cited in the last paragraph. If the same person is involved in receiving a payment, entering it into the accounts receivable system, and preparing the bank deposit, what happens if they accidently transpose two numbers, resulting in a payment for $5,800 being recorded as a payment of $8,500. The chances of catching that mistake is much higher if two or more people are involved than if one person does it all.

Examples of Segregation of Duties

In managerial accounting, there are two common examples used to explain segregation of duties. The first is the process of receiving payments, making the bank deposit, and reconciling the bank balance. Why is it important to segregate these activities? Good question.

Consider the two primary reasons segregation of duties are important. First, like we said earlier, as a second set of eyes to check for errors. The second, and unfortunately this is necessary in most companies, is to make it more difficult for people to steal or misuse company assets or fund. If we had one person receive payments, make the deposit, and reconcile the bank balance, who would know if that person was diverting funds to their own bank account?

For example, if that person received a check from a customer for a $500 order, but the check was $300 higher than the bill, could the employer steal the extra $300? Very easily. They could open an account at the same bank, prepare the deposit for the business and record $500 of the $800 on that deposit. Then, they could put their own deposit slip for $300 in the same batch. The checks would total the same as the two deposit slips, and the bank reconciliation would look okay to, and if it didn't, it wouldn't matter, since they would know what happened and could just say it looked fine.

The same could happen if a customer owed $10,000 and paid the $10,000. This time, the customer would have to steal from the vendor by only applying $9,700 of the payment. The customer's account would still say they owed $300, but since the same person is doing all the collecting, they would have the best idea of what customers may not pay close attention.

With segregated duties, if a customer overpaid by $300, the person that received the checks wouldn't even know, since someone else would be processing the payment. That person couldn't steal it, because they aren't preparing the bank deposit…that's someone else. So, in this example, the segregation of duties protects the assets of the organization by making it difficult for someone to have too much access to customer payments

Instead of protecting cash, let's use another example - inventory. Companies need to order raw materials, manufacturer them, and produce inventory. If one person is involved in the paperwork for all those steps, do they have an opportunity to steal or to make a mistake? Yes, they do.

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