Accuracy and reliability within accounting processes are vital to a company’s success. Ensuring the efficiency of these systems begins with the structure of internal controls. Internal controls refer to procedures bestowed by management that ensure compliance, maximize organizational efficiency, and control risk. The following preventive and detective control activities can help your organization avoid objectionable reporting outcomes.

Segregation of Duties

Segregation of duties (SOD) is the segmentation and assignment of a transaction to various people within an organization. SOD prohibits an individual from solely initiating, overseeing, and documenting a transaction. It is an essential and proactive approach to avoiding or correcting incidents of accidental and intentional error.

Authorization. Within small businesses it is not uncommon for individuals to take on numerous roles and responsibilities. When this happens, delegation of authorization capabilities can be generalized. Multiple people may share the ability to authorize an extensive span of actions. In order to avoid inefficiencies, it is imperative to implement a precise chain of people who are capable of authorizing particular stages of a transaction.

Defining each individual’s authoritative capacity assures that accounting tasks are filtered through various people prior to completion. Authorization procedures prevent one individual from having the ability to approve, initiate, review and record a transaction in entirety. Having different people responsible for certain stages serves as a method for checks and balances. In addition, defining a concrete authorization structure ensures that duties are only completed by those with expertise in that area.

Documentation & Reconciliation. The validity of a financial transaction is rooted in the documentation of the processes that led to its completion. Proper documentation tracks a transaction’s origination, development, and employee input. Expenditures, revenues, and inventory tracking are just some of the events and activities that must be recorded. Documentation is used as evidence to support a transaction and is the basis of financial reporting.

Reconciliation is the internal process companies engage in to identify reporting errors. The passage of the Sarbanes-Oxley Act effectively reinforced the responsibility for businesses to identify “material misstatements.” In the reconciling process, posted financial activity is compared to its documentation in order to pinpoint and correct discrepancies. Regardless of the size of a company, it is imperative to engage in periodic reconciliation. This may include a review of bank statements, purchase orders, and employees listed on payroll. Companies should pay close attention to trends and variations in financial statements.

Related Parties. Segregation of duties also includes the risk analysis of related parties in the accounting process. A related party is defined as any two or more individuals who are closely linked, either through familial bonds or personal relationships, that are aligned in the same management structure. This relationship between employees can be particularly precarious do to the risk of material misstatements. For this reason, it is best practice to utilize procedures for the management of personal relationships that influence reporting.

Companies should attempt to identify any relationship that could exert undue influence on another and realign those individuals, or at least monitor the transactions that have been carried out by them. These controls can preemptively identify undue influence, nepotism, and conflicts of interest that may occur within parental-child, sibling-sibling, other familial associations, and personal relationships between employees. For example, undue influence exerted within a parent and child stems from their established relationship outside of the workplace. If the responsibilities of a single transaction are delegated between the two, their familial relationship could confound the validity of the statement and its associated documentation. 

In order to prevent this from happening, it is critical that management implement effective internal controls that allow the systematic evaluation of these relationships and their impacts on financial reporting. The creation and continuous revision of a listing of relationships and affected transactions is a detective approach to addressing the matter. By making this list, management is able to better address authorization responsibilities and ensure that familial and personal ties do not interfere with accuracy.

Structured internal controls are fundamental to establishing accuracy and reliability within a company’s financial statements. If you need help implementing internal controls in your business, please feel free to reach out to us through the link below.

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