What is Segregation of Duties?

The segregation of duties is the assignment of various steps in a process to different people. The intent behind doing so is to eliminate instances in which someone could engage in theft or other fraudulent activities by having an excessive amount of control over a process. In essence, the physical custody of an asset, the record keeping for it, and the authorization to acquire or dispose of the asset should be split among different people.

The segregation of duties is an essential element of a control system. Auditors will look for duty segregation as part of their analysis of an entity's system of internal controls, and will downgrade their judgment of the system if there are any segregation failures. When there are segregation failures, the auditors will assume that there is an expanded risk of fraud, and adjust their procedures accordingly. This change in procedures usually involves in increase in the amount of audit work, which is passed through to the client in the form of higher audit fees.

Disadvantages of Segregation of Duties

While the segregation of duties is usually recommended in order to improve the robustness of your system of controls, there are also some disadvantages to this approach. These issues are as follows:

Not enough people. The segregation of duties is more difficult to accomplish in a smaller organization, where there are too few people to effectively shift tasks to different people.
Reduced efficiency. The segregation of duties shifts tasks among too many people, which makes the process flow less efficient. This can result in significantly slower processing speeds, which is a particular concern when processes impact customer service.

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Examples of Segregation of Duties

Here are several examples of how the segregation of duties concept is used within a business:

Accounts Payable: Invoice processing vs. payment authorization. An employee who enters vendor invoices into the accounting system should not be the same person who authorizes or processes payments. This separation ensures that someone cannot create a fake invoice and approve it for payment themselves. A second person verifying and authorizing payments helps detect unusual transactions and prevent fraud. This is a critical control in reducing the risk of fictitious vendor schemes.
Payroll: Employee setup vs. payroll disbursement. The person responsible for adding new employees or updating payroll records should not also be responsible for distributing or authorizing payroll payments. Without this separation, someone could create a fake employee (a "ghost employee") and direct payments to their own account. When roles are divided, it becomes harder for a single person to manipulate the system without detection. Audit logs and reconciliations by an independent reviewer further reduce the fraud risk.
Cash Handling: Receiving payments vs. recording transactions. Employees who receive cash or checks from customers should not be the same ones responsible for recording the transactions in the accounting system. If one person controls both functions, they could pocket some of the funds and adjust the books to cover it up. Separating these duties increases transparency and allows for cross-verification. Regular reconciliation by a third party further deters misappropriation.
Inventory: Ordering stock vs. receiving and counting. The person who places purchase orders for inventory should not be the one receiving or counting the goods upon delivery. This separation helps prevent fraudulent over-ordering or ordering from fake suppliers. If one person manages both, they might falsify records to hide theft or create fake receipts. Segregation ensures that goods received match what was ordered and paid for, providing a control against inventory fraud.
General Ledger: Journal entry creation vs. approval. The ability to create journal entries should be distinct from the authority to approve them. If one individual controls both, they could post fraudulent entries to hide theft or manipulate financial results. A separate reviewer ensures all entries are valid, supported by documentation, and align with financial policies. This is especially important for detecting fraud in financial reporting.