Applying Segregation of Duties Beyond Standard Checks and Balances

Segregation of duties is a bedrock principal of internal accounting control systems and is visible in many elements of nonprofit organization accounting policies and procedures. Without segregation of duties, internal accounting control systems would not be safe or effective. Less often recognized is the powerful impact segregation of duties can have when applied to operational planning and resource management.

The AICPA defines segregation of duties as follows:

“Segregation of duties (SOD) is a basic building block of sustainable risk management and internal controls … The principle of SOD is based on shared responsibilities of a key process that disperses the critical functions of that process to more than one person or department. Without this separation in key processes, fraud and error risks are far less manageable.”

This principle is steadfast and effective. However, applying the separation principle to management decision-making, including operational planning and resource management, will make SOD even more beneficial to nonprofit organizations.

SOD is often considered through a “standard checks and balances” methodology, separating a process or function into component parts and making sure one individual or department does not have singular control.

Separating duties allows for compliance checking (such as proper approval, budget parameters, allowable cost, etc.) and error identification (such as calculation of amounts due on an invoice, duplicate payments, general ledger account selection, etc.).

Beyond compliance checking, there is an additional layer to SOD that is often overlooked: separation of thought and allowing for strategic questioning of a transaction or process. This use of the SOD principle provides valuable opportunities for strategic assessment, reconsideration, and possibly altering of outcomes.

To illustrate, visualize SOD as having two separate pause buttons: one for checks and balances and one for thought and questioning.

• The checks and balances button is there to make sure transactions are safe and error free.

• The second button for thought and questioning adds a layer of strategic quality control to make sure a function, process, or transaction is a good use of resources, aligns with the mission, and enhances sustainability.

These two pause buttons are very different in both purpose and perspective. The natural tension between the purpose of checks and balances and having a thought and questioning perspective is a useful example of the separation principle in and of itself.

Using accounts payable as an example, a safety and error checking process includes compliance (budget consideration, allowable expense, general ledger account coding, etc.) and safety (review for calculation errors, quantity received, purchase order discrepancies, etc.) procedures. While a second strategic assessment concentrates on cost effectiveness and usefulness to a program or activity.

An invoice for 500 boxes of chocolate to be distributed at a conference might check-out fine for order quantity, shipping, and correct product received, but a separate manager-level review might raise questions about the appropriateness of purpose, associated cost, and attendee perception of the giveaway.

Planning Tip – Due to their limited staff size, small nonprofit organizations struggle to implement segregation of duties (SOD). Small-staffed organizations can augment SOD by using independent third-party vendor services (bank, payroll, bill-payment, and other outsourced services) and having volunteer leadership take active roles (for example, the Board chair approving large transactions, the treasurer assisting with approval of bank reconciliation and monthly financial reports, and ethics committee review of new member applications). With proper thought and documentation, these SOD procedures can be just as effective as staff-driven efforts.

Overreliance on standard SOD checks and balances can give a false sense of security. Bigger picture questioning and strategic planning associated with mission, resource use, and sustainability must also be woven into day-to-day SOD procedures. Long-term sustainability and financial health will benefit.

VIDEO: Applying the Segregation of Duties Principle | 5-Minute Lessons 4 Nonprofits

Q&A #39 – How should a small-staffed nonprofit address audit findings on segregation of duties?