Best Practices for Segregation of Duties in AR

When it comes to managing money in a business, especially in areas like accounts receivable, you can’t afford to cut corners. One simple mistake or act of fraud can cost a company big time. That’s why having proper checks in place is essential. One of the key controls to prevent both fraud and mistakes is something called “Segregation of Duties” (SOD). This isn’t just some fancy accounting jargon; it’s a straightforward concept that can save a lot of headaches down the line.

What is Segregation of Duties?

Segregation of duties is about separating tasks within a process so no one person has complete control. This is critical because if one person has too much power, they can manipulate things—whether it’s skimming money off the top, hiding mistakes, or even committing outright fraud.

In accounts receivable (AR), SOD means making sure that no single person is responsible for every step of the money-handling process. You divide responsibilities like creating invoices, receiving payments, recording transactions, and reconciling the accounts, so that everything has a second set of eyes on it. This not only helps prevent fraud but also catches errors before they become bigger problems.

Why It’s Crucial in Accounts Receivable

AR is where the money comes in. If the process isn’t airtight, the company’s finances are at risk. Without proper segregation, things can go wrong in multiple ways. Here are the biggest risks:

Fraud: Let’s assume that one person handles both tasks, i.e., generating invoices and collecting payments. However, they have the ability to create fictitious invoices, collect payments, and pocket the money without anyone noticing. They have the ability to independently apply discounts or write-offs without authorization. That leads to numerous frauds.

Errors: When anyone worries about the fraud, they still can make mistakes. If only one person is involved, it is unlikely that anyone will double-check for errors. Payments to the wrong customer or incorrectly recorded invoices are examples of these errors. Failure to properly check such things can lead to issues with financial statements, cash flow predictions, and other related areas.

No Accountability: There is no accountability if one person is in charge of the entire procedure. Since no other parties were engaged, it might be more difficult to determine the exact reason of a disagreement or problem. That’s detrimental to the company, and it becomes worse when auditors show up.

Key Roles to Separate in AR

So, how exactly do you implement SOD in accounts receivable? It boils down to separating these four key roles:

Invoice Creation vs. Payment Collection: The person generating invoices shouldn’t be the one collecting payments from customers. This reduces the risk of someone creating false invoices or hiding collected payments.

Payment Application vs. Recordkeeping: The person applying customer account payments should be different from the one recording transactions. This ensures the accuracy of the applied payments and the prompt detection of errors.

Bank Reconciliation: Whoever reconciles the bank statements (making sure the records match what’s in the bank) should be independent from the people handling the money or recording the transactions. This provides an extra layer of protection and accuracy.

Credit Approval vs. Payment Processing: The person deciding on credit terms or extending credit to customers shouldn’t be the same one who handles payment collection. This prevents employees from giving unauthorized credit extensions or manipulating customer accounts.

What Happens If You Don’t Do This?

Let’s be blunt—failing to properly segregate duties can lead to major problems:

Theft and Fraud: Fraud becomes extremely simple when there are no checks and balances in place. If one person regulates everything, they can cover their fraudulent activities easily. These activities can be misstating invoices or absconding with cash. Clearly, the likelihood of fraud increases if the SOD is absent.

Financial Misstatements: Even honest mistakes can cause serious problems. Misapplied payments or wrong entries can lead to inaccurate financial reports, making it harder for management to know the true financial health of the company.

Regulatory Trouble: Strong internal controls, such as SOD, are required by regulations in several sectors. Penalties, fines, and even worse outcomes might result from breaking these restrictions.

How to Implement SOD (Even If You’re a Small Business)

Let’s face it, not every business has the luxury of a large accounting department. So how do you implement segregation of duties if you’re short on staff?

Use Software: Accounting software can help split up roles within the system. You can set different permissions so certain users can only access specific parts of the process. For instance, one employee can generate invoices while another applies payments without needing to hire extra people.

Cross-Training: Train multiple people on different parts of the process, even if they don’t handle them daily. This ensures there’s a backup and no one has too much control. It also makes it easier to review each other’s work.

Dual Authorization: Require approval from two people for high-risk tasks. For example, issuing a credit memo or adjusting customer balances should require sign-off from two different employees.

Regular Audits and Reviews: Even if duties are segregated, things can still slip through the cracks. That’s why regular reviews are necessary. Either have a supervisor regularly review the AR process or bring in an external auditor periodically to ensure everything is in line.

Questions to Understand your ability

Que.1 Why is Segregation of Duties (SOD) a big deal in accounts receivable?

A) To make sure employees have more work

B) So no one person can mess with the whole process

C) To speed up how fast invoices get sent

D) So one person can do everything without interruptions

Que.2 What’s the worst thing that can happen if you don’t split up duties in AR?

A) Everyone works better as a team

B) Your financial statements stay accurate

C) You spot fraud more easily

D) It opens the door for theft or fraud

Que.3 Who should handle the bank reconciliation in a properly segregated AR process?

A) The person who makes the invoices

B) The one collecting the payments

C) Someone totally separate from those handling money or keeping records

D) The person applying the payments

Que.4 Which setup shows a good example of splitting duties in AR?

A) The same person makes invoices and takes payments

B) One person creates invoices, another applies payments

C) One person does recordkeeping and the bank reconciliation

D) The person applying payments also approves credit terms

Que.5 You’re a small business with a tiny team. How do you make SOD work?

A) Skip using any accounting software

B) Train people to handle different parts of the process

C) Let one person run the whole AR process

D) Only review your AR process once a year

Conclusion

Segregation of duties in accounts receivable isn’t just a good idea—it’s a must. Whether you’re running a large company or a small business, proper SOD reduces the risks of fraud, errors, and financial misstatements. It creates accountability and keeps your financial house in order. With the right systems in place, even smaller teams can manage to divide tasks and reduce risk without needing a huge staff. So, don’t wait until something goes wrong—implement SOD now and protect your business’s bottom line.