What is Fraud Triangle Theory?

Table of Contents

3. What does the pressure or incentive part of the fraud triangle mean?

4. What does the opportunity part of the fraud triangle mean?

5. What does the rationalization part of the fraud triangle mean?

What does the fraud triangle mean?

The Fraud Triangle is a theory that helps us understand the reasons behind activities within an organization. It consists of three factors that when combined increase the likelihood of fraud. These factors are:

Opportunity – This factor refers to the circumstances or situations that allow someone to commit fraud without getting caught. Opportunities for fraud can arise from weaknesses in controls, lack of supervision or security gaps within the organization. When employees believe they can get away with fraud it creates an opportunity for them to engage in behavior.
Incentive or Pressure – Incentive or pressure refers to the motivation or financial need that drives someone to commit fraud. This could be due to financial struggles, a desire for personal gain or external pressures like overwhelming debt, addiction issues or other financial obligations. When individuals face financial or personal pressures they may be more likely to resort to fraudulent acts as a way to alleviate those pressures.
Rationalization – Rationalization is the process individuals use to justify their fraudulent actions internally. It involves creating excuses and justifications that make their dishonest behavior seem acceptable or necessary in their own minds.

In summary the Fraud Triangle highlights how opportunity, incentive/pressure and rationalization together contribute towards an environment for fraudulent activities, within an organization. Many individuals tend to justify engaging in activities by convincing themselves that it’s only temporary assuring they will repay the ill gotten gains or believing they deserve the money or benefits acquired through dishonest means. If your business is a victim of fraud or falsely accused of fraud, please contact our California civil litigation attorney for a free consultation.

According to the theory of the Fraud Triangle fraud is more likely to occur when these three conditions coincide. Organizations can reduce the risk of fraud by implementing internal controls fostering ethical behavior and addressing the underlying factors contributing to each of these conditions. Moreover establishing a workplace culture that values honesty and integrity can serve as a deterrent, for fraudsters.

What makes an act fraud?

Fraud happens when someone acts deceptively for personal gain. That is to say, it is when an employee or company uses deceit to collect money illegally. It should be noted that the unlawful action causes harm to the victimized parties.

Let’s say an employee takes cash from their employer’s cash register. This qualifies as fraud since the employee takes their employer’s money for their own benefit. The company suffers harm because it is losing money.

What does the pressure or incentive part of the fraud triangle mean?

The incentive part of the fraud triangle can also be referred to as pressure. This section of the triangle deals with the way an employee committing fraud thinks. The following are some examples of incentives that might tempt an employee to act unethically:

Performance-based bonuses

Often, an employee’s performance is graded according to certain financial measurements such as sales. The problem with this kind of bonus is that it puts pressure on an employee to meet certain benchmarks. To get the bonus, they may feel their only option is to commit fraud.

The need to meet expectations

When analysts or investors make predictions concerning a company’s performance, it can create pressure to falsify numbers.

Personal motivations

It could simply be that an individual wants to make more money to fund their lifestyle, pay off bills, or even support an addiction such as gambling.

What does the opportunity part of the fraud triangle mean?

In the fraud triangle, opportunity means the conditions that encourage fraud to happen. This element is the only one that a company has control of. Below are examples of company conditions that make fraud more likely:

Poor internal procedures

The purpose of internal procedures is to keep financial information and accounting honest and protected. Opportunities for fraud arise when there is not enough oversight, poor recording procedures, and overlapping duties.

Lack of executive commitment

It is up to the board and management to show integrity and act ethically. They set the tone for the rest of the company. If they do not take a stand against fraudulent activity, then the company is at greater risk of harm.

Poor accounting

Accounting refers to the way financial statements are recorded. If a company does not have adequate policies related to accounting, it is easy for employees to change numbers.

What does the rationalization part of the fraud triangle mean?

This part of the fraud triangle refers to how a person justifies the act of fraud. Often, people will use the following justifications:

Feeling wronged

It could be that an employee feels that they were treated poorly by an employer or manager. They may consider fraud to be a form of vengeance.

Everyone else is doing it

If a company’s executives are not setting a good example, employees may feel justified in committing acts of fraud.

No other choice

It could be that an employee thinks they are at risk of losing everything unless they take money from the company.

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