What is The Fraud Triangle Theory?

Fraud triangle theory shows how pressure, opportunity, and rationalization can lead to fraud in the workplace. This article covers ways businesses can reduce fraud risk with internal controls, ethical culture, realistic goals, and staff support.

By Douglas Wade, Attorney

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Table of Contents

1. Introduction

2. What is the theory of the fraud triangle?

3. The fraud triangle theory’s three sides

4. Take elements out of the fraud risk triangle to safeguard your business

Introduction

All businesses are known to be vulnerable to fraud. Occupational fraud is the intentional theft or misuse of an employer’s funds or assets by an employee working alone or in concert with others. It is sometimes referred to as internal fraud.

Organizations are better able to identify potential flaws and strategies for addressing them when they have a better understanding of the psychology and conditions surrounding internal fraud. The fraud triangle is useful in this situation! Continue reading this article for additional explanations.

What is the theory of the fraud triangle?

Dr. Donald Cressey first put forth the “fraud triangle” theory in a 1953 paper titled Other People’s Money. It was a study on the social psychology of internal fraud. While incarcerated, 133 convicted fraudsters were interviewed by criminologist Cressey. He discovered that the vast majority hadn’t been in settings that were primarily criminal. According to his research, three conditions have to be met for white-collar criminal activity to occur. These days, a lot of people use this model.

Opportunity, pressure, & rationalization were the three elements that Cressey recognized. The initial fraud triangle theory is still applicable today, despite the theory’s updates and developments over time.

The fraud triangle theory’s three sides

1. Incentives and pressure

Personal issues or external factors may provide pressure or an incentive to conduct fraud. Workers who are addicted to drugs, alcohol, gambling, or other substances may require money that they simply do not have.

Debts or large tax bills are examples of fraud triangle pressure that can encourage asset theft or misuse. Some individuals obsess about perceived wealth and prestige. They might perceive an opportunity to trick others into believing they are wealthier than they actually are.

People could worry that when they don’t reach company goals. They might lose their jobs or miss out on promotions. Pressure to fabricate accounts or sales may result from this. The Wells Fargo corruption incident was attributed to the pressure to meet goals (unattainable). Employees may be vulnerable to external bribery or corruption.

An employee’s performance is frequently evaluated based on specific financial metrics, like sales. This type of compensation has the drawback of pressuring an employee to reach predetermined standards. They might believe that committing fraud is their only way to receive the bonus.

The hypothesis states that for someone to commit fraud, they must think that speaking to other people wouldn’t assist or that their issues cannot be resolved lawfully.

2. Opportunity

When someone is willing to conduct fraud, they must believe they may accomplish so without being discovered. This is probably because they think they can take advantage of a position of respect or because they don’t think internal controls will find any irregularities. Fraud can be facilitated by inadequate accounting policies, inadequate supervision, and poorly recorded procedures.

The culture of the company is especially important. “All Fraud Triangle components are substantially influenced by the business environment in their firms,” according to the publication The Fraud Triangle revisited (2016, Schuchter and Levi). Workers are less likely to believe that they should if the business’s values and culture do not support ethics, integrity, and honesty.

3. Rationalization

The method people employ to psychologically defend their dishonest behavior is called rationalization. It entails coming up with defenses and explanations to make their dishonest actions appear necessary or acceptable to them.

Before committing fraud, a person will justify their conduct by claiming that they were “just borrowing” and planned to repay the money they had stolen. Employees who believe they have been mistreated by upper management and are entitled to more are an example of the fraud triangle rationalization. They can be worried about the consequences of failing to meet goals. This includes losing their job.

They essentially use rationalization to defend their actions and motivations.

Take elements out of the fraud risk triangle to safeguard your business

The dangers of fraud are greatly reduced if one or more of the fraud triangle’s components are absent. To make it as hard as possible for deception to occur, it makes sense for companies to keep an eye on each of these factors.

1. Lessen stress and get to know your staff

To lower the danger of accounting fraud, make sure the organization’s goals are reasonable and attainable. To find prior fraudulent activity, new hires should be checked. A person might feel distressed if they believe a firm is treating them poorly. Employees won’t believe that solving their own problems is the sole option if they feel comfortable discussing personal & financial concerns.

2. Use software and internal controls to limit opportunities

Strong procedures are necessary for organizations to stop individuals with financial access from behaving in a unilateral manner. It is necessary to implement or strengthen internal control mechanisms. Duties should be divided so that, for example, errors in bookkeeping or reporting can be immediately highlighted by checks and balances.

Occupational fraud can be prevented, tracked, and identified with the use of appropriate software. These technologies automatically examine payment files and look for unusual activity. They will boost security, especially for procure-to-pay mechanisms, and enhance the quality and security of third-party data.

3. Limit the chances of rationalization

The culture of the company must encourage transparency & moral conduct. A well-defined fraud detection strategy has to be implemented. Every employee should feel empowered to report fraud. They ought to receive frequent training. They must be trained on how to spot and avoid it.

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What is The Fraud Triangle Theory?

Introduction

What is the theory of the fraud triangle?

The fraud triangle theory’s three sides

Take elements out of the fraud risk triangle to safeguard your business

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