Segregation of Duties
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
One person holding too much control over a transaction isn't just a fraud risk — it also means nobody's positioned to catch an honest mistake. Segregation of duties is the fix, and it comes down to three functions that need to stay in different hands.
What is the custody function?
Custody is physical access. If a check comes in, custody is whoever actually holds that check and has the ability to deposit it.
What is the recording function?
Recording is who enters information into the accounting system — who makes the actual journal entries. The person with recording access should never also have custody.
Combine recording and custody, and fraud gets easy to hide. An employee with both could falsely record that a customer never paid, write off the receivable, and quietly deposit the actual check into a personal account — committing the fraud and covering it up with the same set of hands.
What is the authorization function?
Authorization is who can approve a transaction — for example, who signs off when a customer requests a return.
Combine authorization and custody instead, and a different fraud opens up: approve a return that never happened, let the company cut a refund check to a fictitious customer, then deposit that check personally.
How do the three functions fit together?
| Function | Controls | Risk if combined with custody |
|---|---|---|
| Custody | Physical access to assets | — |
| Recording | Entering transactions into the accounting system | Falsify records to hide a stolen asset |
| Authorization | Approving transactions | Approve a fictitious transaction to generate a payout, then take it |
Keeping these three functions in separate hands is what makes it hard for any one person to both create a loss and hide it.
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 90 on AUD. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.