Authorization is really about responsibility, and internal control comes down to each person taking responsibility for his or her decisions and actions, and their effects and consequences for the business.
The authorization phase of the accounts payable process doesn’t start when a disbursement is made, but rather when a commitment is made, with a vendor, contractor, or any other party. Commitments should be made based on pre-established criteria, originating from the budget, and before that, from the business plan and strategy.
In a large company there may be formalized delegations of authority procedures to determine who can approve what level of commitments or disbursements, and there may be powers of attorney granting certain individuals the formal authority to approve purchase orders, enter into contracts, or otherwise commit the company to an obligation with a vendor or contractor.
In a sole proprietorship, the owner probably makes virtually all the decisions regarding commitments and disbursements. In a small business, this authority may be concentrated in just one person or shared among a small group of people. The procedure for authorizing commitments may be formalized and documented, or it may be informal and based on mutual understanding and trust. Nevertheless, whether there is a formal written procedure or not, there needs to be a clear understanding as to who can approve what. This is necessary not only for properly managing the business, but also for maintaining good relationships, both inside the business and with outside suppliers, vendors, contractors, and others.
In a partnership there needs to be clear agreement about whether one partner can make a decision to commit the partnership, whether the partners need to mutually agree on all or certain commitment decisions, or whether a combination of both is to be used, for example with one partner authorized to make commitments up to a certain value, and amounts over that limit requiring authorization by all partners. It may be advisable to put this agreement in writing, and possibly include it in the partnership by-laws. Or powers of attorney could be drawn up, identifying each partner’s level of authority.
The authorization phase may involve more than one step, or approval level. A certain expenditure may be proposed internally by one person or department, and then evaluated and approved by another person or at another level, before agreeing with the outside vendor or contractor, and making a commitment.