The Fraud Triangle
The Fraud Triangle
The fraud triangle was developed in the 1950s. It has been used for many years to help auditors with assessing fraud risk during an audit. However, with corporations changing so much since the 1950s, is the fraud triangle still relevent, or should more elements be included? This paper will explain what the fraud triangle is, why some experts no longer believe the elements are enough, and what elements these experts believe should be added to help auditors assess fraud risk in the modern corporation.
Have you ever heard of someone committing a fraud within their company and found yourself wondering what would lead someone to commit fraud? The fraud triangle gives some insight to possible answers to this question. This paper explains the three factors that increase the likelihood of fraud being committed, known as the fraud triangle, and also discusses the new components that experts believe should be incorporated into the assessment of the risk of fraud.
The Fraud Risk Triangle
The fraud triangle was developed in the 1950s by Dr. Donald Cressey (Marks 2009). Dr. Cressey was “..a criminologist whose research focused on fraudsters” (Pavlo 2011). When Dr. Cressey developed the fraud triangle, he identified three elements that would explain why a person would commit a fraud (Boise State n.d). The three elements, which are implied to have an interrelationship between them, are opportunity, pressure/incentive, and rationalization/attitude (Turner, Mock and Srivastava 2003).
Opportunity covers the ability of a fraud to be committed. Opportunity for a fraud to be committed can be created by several things. Some of these include “...weak internal controls, poor management oversight, and/or thorough use of ones position and authority” (Boise State n.d). Since opportunity is the element of the fraud triangle that companies have the most ability to control, it is very important for companies to implement good internal controls, process and procedures to detect and deter a fraud from being committed (Boise State n.d) .
Pressure is another element of the fraud triangle. It covers what can lead a person to commit fraud. There are several things that pressure includes. Some of these are financial problems, medical bills, and some sort of addiction. Often times, the fraudster does not believe he or she can talk about their problem and believe they need to solve their problem secretly (Boise State n.d).
The last element of the fraud triangle is rationalization. “Rationalization involves a person reconciling his/her behavior (stealing) with the commonly accepted notions of decency and trust” (Boise State n.d). Some rationalizations that people have is that they believe they deserve the money for working hard, they believe that the company owes them something because they are not satisfied with their job, or they intend to repay the money they stole (Boise State n.d).
The fraud triangle is so useful in the fraud risk assessment during an audit that it is now included in SAS 99. However, there are some concerns with the fraud triangle, which SAS 99 has addressed as follows: “'Although the risk of material misstatement due to fraud may be greatest when all three fraud conditions [e.g., attitude, opportunity, and incentives] are observed or evident, the auditor cannot assume that the inability to observe one or two of these conditions means there is no risk of material misstatement due to fraud'” (Wilks and Zimbelman 2002).
With corporations being so much different today than they were in the 1950s some experts do not believe that the fraud triangle has enough elements and believe that more need to be added. This belief is due to the fact that fraudsters today have more access to the assets within an organization than fraudsters did over 60 years ago, which increases the likelihood of missappropriation of assets (Marks 2009). Also, due to corporations now being more matix oranizations, “...individuals with greater autonomy have the authority to effect changes across the organization” (Marks 2009) which increases the likelihood of intentional misstatements of the financial statements. One of the new views is called the fraud diamond which adds the element of capability (Wolfe and Hermanson 2004). The other new view is called the crowe fraud pentagon which adds two elements, arrogance and competence (Marks 2009).
The fraud diamond has four elements that some experts believe should be considered during the assessment of fraud risk. It still includes pressure/incentive, opportunity, and rationalization/attitude but also adds the element of capability (Wolfe and Hermanson 2004). The element of capability refers to “...personal traits and abilities that play a major role in whether fraud may actually occur even with the presence of the other three elements” (Wolfe and Hermanson 2004). Though these four elements do overlap, capability should be considered separately when assessing fraud risk (Wolfe and Hermanson 2004). The example Wolfe and Hermanson give to illustrate capabilities is as follows: Consider a company where the internal controls allow the possibility that revenues could be recorded prematurely by altering sales contract dates in the sales system. An opportunity for fraud exists, if the right person is in place to understand and exploit it. This opportunity for fraud becomes a much more serious problem if the company's CEO... has the technical skills to understand that the control weakness exists, can coerce the CFO and sales manager to
manipulate the sales contract dates, and can consistently lie to analysts and board members about the company's growth. In the absence of such a CEO, the fraud possibility would never become reality... Thus, the CEO's capabilities are a major factor in determining whether this control weakness will ultimately lead to fraud (2004).
The second alternative to the fraud triangle is the crowe fraud pentagon. This view still has the three elements of the fraud triangle but also includes arrogance and competence. The element of arrogance addresses an individual’s attitude. If an individual believes he or she is superior or has some form of entitlement, this would be covered by the element of arrogance. Also, one who does not believe they need to follow company policies and procedures would also be covered under arrogance. Competence address more of ones abilities. If one is able to control situations to their advantage and/or is able to override internal controls, they are considered competent (Marks 2009).
Experts that believe the crowe fraud pentagon is more useful in the workplace today believe this because “Competence and arrogance play a major role in determining whether an employee today has what it takes to perpetrate a fraud” (Marks 2009). Marks also states that, “Adept individuals with widespread access to corporate information, a mindset of entitlement, and the confidence to pull it off compound the risk of fraud. Moreover, placing these individuals in a culturally lax environment with a poor tone at the top and weak internal controls is a recipe for disaster” (2009).
In closing, the elements of the fraud triangle are very helpful in assessing fraud risk. However, with corporations being very different than they were in the 1950s, and with employees having more access to assets within the organization and being more independent-minded (Marks 2009), some experts believe that the fraud triangle no longer contains enough elements to help with the assessment of fraud risk. These experts believe that either the fraud diamond, which includes the element of capability, would be more effective. Yet others believe that the Crowe’s fraud pentagon, which includes the elements of arrogance and competence, would be most effective. However, as it stands right now, SAS 99 incorporates the fraud triangle into it, not the fraud diamond or the Crowe’s fraud pentagon.
High risk case
Jane Smith is 40 years old. She is a teller at Wells Fargo. She is married with 3 kids, one of which is in college and another one is getting ready to start college. Jane's husband, Paul, owned his own successful business. However, with the economy crash, he ended going out of business. Now, Paul has no income because he has not been able to find a job. With not having Paul's income, the family is having a hard time making ends meet.
Jane recently was informed that they are two months away from losing there house. After receiving this news, Jane gets very upset. She has been at Wells Fargo for over 10 years and is only making $13 an hour. She has applied to promotions but has always been turned down for them. She starts to think that Wells Fargo owes her money because of all the hard work and long hours she has put in while working for them. Jane, in charge of the vault at Wells Fargo, knows that the video cameras in the vault have not been working for a few weeks. With the pressure of possibly losing her families house, the opportunity of not having working video cameras, and the rationalization that Wells Fargo owes her money, Jane decides to steal $10,000 to keep from losing her house and to catch up on some of their bills.
This case has a high risk of fraud because it includes the elements pressure, opportunity, and rationalization. Jane's pressure is that her husband lost his business, they maybe losing their house, and they have to pay for their kids college. The opportunity Jane has is that the video cameras in the vault are not working. The rationalization that Jane has is that she is only making $13 and has been passed up on promotions and she believes that Wells Fargo owes her. Though most of these things Wells Fargo cannot control, they can control the opportunity that Jane has. The video cameras should not have been down for so long and when the video cameras are down, they should then require a second person to be in the vault with the teller in charge of the vault.
Low risk case
Joe Smith is an accountant doing the accounting for a construction company. Joe has been an alcoholic for several years. He spends about $75 a day on alcohol. Over the past year Joe has developed a gambling problem as well. He owes over $30,000 to bookies. Due to his alcohol addiction and gambling problem, Joe has not made any house payments in several months and now is on the verge of losing his house. Joe's wife was diagnosed with a rare life threatening condition 11 months ago which requires very aggressive treatment. The company that Joe works for does not offer insurance. His wife was the one who carried the insurance through her work. However, she had to leave her job after she got sick and therefore has lost her health insurance so all medical expenses are having to be paid out of pocket. Due to everything going on in Joe's life, he started stealing money from the company 10 months ago. So far he has stolen over $20,000, all of which has gone to pay his wifes medical bills.
This is an example of low fraud risk because it only contains the element of pressure. The pressures are the fact that Joe is an alcoholic, he has a gambling problem, and is on the verge of losing his house. Joes wifes' medical condition also would fall under the element of pressure as would the fact that Joe's wife lost her job and they lost their health insurance and now have to pay her medical bills out of pocket.