The cash disbursements cycle steps - approval, preparation, authorization - can leave your company vulnerable to fraud and theft if basic controls are not in place. Two of the most important controls are segregation of duties and check signing/EFT approval procedures.  Controls over these two steps in the cash disbursement cycle minimize the risk of fraud.  The steps are simple and, for the most part, easy to implement. 

What is segregation of duties?

The American Institute of Certified Public Accountants (AICPA) says that the principle of  segregation of duties is based on shared responsibilities of a key process that disperses the critical functions of that process to more than one person or department.  The AICPA considers segregation of duties to be a basic building block of sustainable risk management and internal controls for a business.  A more basic definition of segregation of duties is that it is an internal control procedure that requires related duties and tasks to be separated among several employees to reduce the chance of errors and fraud.  Commonly segregation of duties is called checks and balances.

Separating the procedures in the disbursement cycle

To maintain separate duties in the disbursement cycle, the areas of approval, recording, and custody (disbursement) must be identified and assigned to different employees.  No financial payment should be handled by one person from beginning to end.

Approval:

First, a payment must be authorized.  This authorization is noted on a purchase order (in most cases).  This approval indicates that it is okay to pay the associated invoice.  Approval is most likely from a department head outside of the accounting department. 

Recording:

Disbursements are prepared within the accounting department in one of two forms, electronic payment or check.  This preparation is done through the company’s accounting system. 

Custody/Disbursement:

Once prepared by an employee of the accounting department, disbursements are authorized, which is evidenced by a signed check or approved electronic funds transaction.  

Separating out the approval, processing and disbursement steps ensures that one employee does not have the ability to make a disbursement out of a company account without someone else’s eyes on it.

Maximizing cash controls as part of the disbursement cycle:

Restrictions over the final step of the cycle, custody, are key in minimizing fraud.  This person is in charge of releasing custody of the company’s funds through a final signature on a check or a final approval of an electronic transaction.  Check signers/EFT approvers must not have the ability to do the following: add vendors to the accounting system, prepare invoices for payment, prepare bank reconciliations or maintain the accounts payable ledger.  Those authorizing payments should not have access to the accounting system to approve transactions or preparing payments.  Dual authorizations are another way to ensure improper payments are not made.  Many companies set a minimum dollar threshold for dual signatures.  Depending on the size of the company, adding a second signature requirement for disbursements is a simple way to increase controls.  A higher level member of the company, such as a Treasurer or CFO, can fill the second signature role.

Reviewing two key disbursement internal controls, segregation of duties and cash custody controls, is a simple way to confirm the risk of fraud is being mitigated.