The Fraud Triangle

What is fraud?

Fraud is any intentional act to deceptively

or unfairly take another's property or money.

The fraud triangle highlights how pressure,

rationalization,

and opportunity combine to heighten fraud risk.

When these three components converge,

fraud will likely occur.

Removing one or more of these components can deter fraud.

We often attribute fraudulent activity to individuals who are simply dishonest.

However,

over long careers,

everyone will face incentives or pressures to do things they would normally not do.

With the right conditions,

even historically honest people will make poor decisions.

Pressures may be created by family illness and related medical bills,

excessive debt,

addiction to drugs or gambling,

or simply a lavish lifestyle.

Don't fall into the trap of thinking that simply hiring honest people is enough.

It isn't.

While employees may face pressures to act poorly,

if they rationalize why it's acceptable to act upon them,

the pressures are enhanced.

Some individuals may initially intend to pay back stolen money,

while others may believe the amount is insignificant,

and no one will notice.

Some may believe they've been treated unfairly,

and they deserve what they're able to steal.

Individuals may feel wronged if they're passed over for a promotion

or feel underpaid when compared to a coworker.

Opportunity exists when an individual has the ability

to take cash or other assets without detection.

To minimize opportunity,

an entity should ensure internal controls are properly designed,

implemented,

and enforced.

Imagine you're at a high school football game.

If the gate attendant collects cash as people enter the game,

there's nothing that will prevent the attendant from stealing the cash.

However,

most high schools have a ticket office that sells pre-numbered tickets which

are given to the gate attendant who admits people into the game.

The control is completed when the number of tickets sold is multiplied by

the cost of admission to determine how much money should be received.

This amount is then compared to actual receipts,

and significant differences are investigated.

Opportunity is the only fraud triangle component entirely within management's

control and must be present for fraud to occur.

Imagine a justice court clerk is responsible

for receiving court fine payments from defendants

and has done so for many years without any known problems.

The judge periodically orders fine adjustments,

and the clerk is made responsible for

entering these adjustments into the accounting system.

In addition to already receiving the payments,

the clerk now has opportunity to zero

out the defendant's account in the accounting system

and steal cash without detection.

After a few years of employment,

the clerk has a child become ill and begins to incur high medical expenses.

These expenses make it impossible for the

family to meet its basic financial obligations,

which adds pressure to the situation.

The clerk eventually decides to borrow the money and rationalizes the decision

with an intention to pay the money back in the future.

As a result of opportunity,

pressure,

and rationalization,

the clerk made the poor decision to steal.

Remember,

management can limit opportunity,

the most important fraud triangle component.

Too often people we least suspect commit fraud.

Your entity may have honest people,

but to effectively protect employees from a momentary lapse of judgment,

sufficient oversight is a must.

Remember,

just the safety equipment is necessary to keep construction workers safe,

an entity must design,

implement,

and enforce internal controls to keep honest employees safe.

For more information,

see our fraud risk assessment implementation guide

and separation of duties digital short.