Auditor Corner: The Importance of Segregation of Duties (SOD)

Starting a new business can be overwhelming, especially when it comes to accounting and compliance best practices. One crucial practice that every business owner should implement is segregation of duties (SOD). SOD is a fundamental technique used to reduce risk in nearly all aspects of your business, and it should be used when delegating responsibilities to yourself and your employees. 

In this article, we will provide you with a three step guide for implementing SOD in your business.

Step 1: Understand the ARC principle

The ARC principle is an easy-to-remember acronym that stands for Authorization, Recording, and Custody. 

A – Authorization relates to the initiation of transactions.

R – Recording refers to documenting the proof of transactions and entering them into the accounting record

C – Custody is the physical control over assets or records

To implement the ARC principle, you must identify all the tasks and processes in your business that involve financial transactions. 

For example, when processing payroll, the authorization of a new employee and pay rate should be the function of the HR or personnel department. The accounting department should be responsible for processing the payroll hours and recording the necessary journal entries. The employees should have physical control over their paychecks, whether a paper check or direct deposit.

Step 2: Identify roles and responsibilities

Once you have identified the tasks and processes in your business that involve financial transactions, you need to identify the roles and responsibilities of each employee involved in the process. It’s essential to ensure that no employee has complete control over any one aspect of the financial transaction. For example, the employee responsible for authorizing a transaction should not also be responsible for recording or custody of the asset.

By dividing the tasks and responsibilities among different employees, you create a system of checks and balances that makes it difficult for any one employee to commit fraud or errors. It’s crucial to ensure that every employee understands their role and responsibility in the process and the importance of maintaining SOD policies.

Step 3: Monitor and review

Implementing SOD policies is not a one-time event. You must continuously monitor and review your policies to ensure they are working effectively. As your business grows, new tasks and processes will emerge that involve financial transactions, and it’s crucial to ensure that they are included in your SOD policies.

Regular monitoring and review of your SOD policies also help you identify any weaknesses in your system. You can use this information to make necessary changes to your policies and strengthen your internal controls.

In conclusion, implementing segregation of duties policies is crucial for reducing your business’s risk of fraud or errors. By understanding the ARC principle, identifying roles and responsibilities, and monitoring and reviewing your policies, you can create a system of checks and balances that protects your business’s financial integrity. 

Remember, it’s never too early or too late to implement SOD policies in your business. If you need assistance with implementing SOD policies or other accounting and compliance best practices, please reach out to Morem and Waller CPAs, or set up a meeting with us on our Calendly page.