Rationalizing Fraud

To identify incentives that are conducive to fraud, researchers look at the relationship between structural incentives, such as executive compensation structures, and incentives to engage in fraud. The key takeaway is management, with advice from corporate counsel and accountants, has the power to identify and mitigate fraud risks. While there is no action that can completely eliminate fraud, implementing policies that address the three arms of the Fraud Triangle will not only help to reduce the risk of fraud, but will also aid in detecting fraud if it does occur. Next, to address the rationalization aspect, it is important for companies to create a corporate culture that truly values employees, sets proper ethical codes of conduct, and insists on accountability. For example, companies can promote work/life balance, conduct performance reviews, adopt an ethics code, create a hotline for reporting abuses by employees, provide rewards for whistleblowers and thoroughly investigate and respond to complaints.

Why do auditors not find fraud?

Insufficient or Inadequate training; • Lack knowledge of fraud schemes; and • Undue trust in management. They perceive GAAS audits as not sufficiently focused on detecting fraud, as the primary institutional inhibitor of fraud detection. Auditors are not effectively trained to detect or recognize fraud.

Outsourcing of functions and processes will likely decrease the sense of employee ownership over these processes and related controls. COSO recognizes the unique risks created when organizational activities are outsourced to a service provider and explicitly discusses potential responses to such risks throughout the framework. For example, under Principle 1, COSO mentions the importance of communicating ethical values to OSPs, but also stresses that management should be aware that it still bears the ultimate responsibility for delegated processes and outcomes. COSO also points out under Principle 3 the importance of the board of directors to consider OSPs when establishing authority structures and reviewing potential conflicts of interest. These and other measures discussed in COSO with respect to OSPs should reduce the risk of invoking responsibility-driven rationalizations. Fraud deterrence is based on the premise that fraud is not a random occurrence; fraud occurs where the conditions are right for it to occur.

Don’t Take This Fraud For Granted

Similarly, framing a fraudulent act as being “below the materiality threshold” is another dangerous rationalization unique to the accounting context. Surprisingly, none of the examples of potential fraud rationalizations in COSO’s Integrated Framework include anything related to the first two items above. Of the three examples COSO provides, two center on fraud consequences, and the third relates to denial of the victim. These examples are helpful, but incomplete; unless CPAs learn to think like crooks, they will continue to handcuff their fraud-fighting efforts. It may not be possible to address all pressures on employees, especially if the pressure is from external sources. Yet, appropriate employment policies, such as employee assistance programs and appropriate levels of time off may help.

fraud triangle

Because of my early fraud research in business, many have asked me if I was the person who first developed this triangle. In this article, I’ll present a brief history of how the Fraud Triangle came to be. If you have any questions on preventing fraud in your organization, or suspect fraud may have already occurred at your organization, please contact an Anders advisor below. The Fraud Triangle helps companies understand how and why fraud is committed so they can take proactive measures to address the causes of fraud before it occurs and better detect fraud if and when it does occur. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. Forensic accounting is the investigation of fraud or financial manipulation by performing extremely detailed research and analysis of financial information.

Transforming Corporate Cultures By Placing Cfes In Top Echelons

Current auditing standards provide little guidance on identifying, understanding, and mitigating fraudsters’ rationalizations. In addition, denial of the victim is a popular rationalization when the victim is not known or physically distant. It is easy to invoke this technique while manipulating financial statements, because shareholders are so far removed from the immediate fraud perpetrators. Patrick Kuhse, who stole millions of dollars from the state of Oklahoma through fraudulent commissions in the early 1990s, rationalized that no one would be hurt much since Oklahoma has millions of taxpayers. In the above-mentioned case of Autonomy Corporation, Hussain’s lawyer argued the case should have been dismissed because Autonomy was a U.K. Corporation, purchased by a Dutch subsidiary of Hewlett Packard—which made it challenging to identify the fraud victims and related jurisdiction.

  • Although this article focuses on the direct relationship between the fraudster and the company, it is important to remember that organizations do not exist in a social vacuum.
  • The Fraud Triangle is universally accepted in almost every setting in which fraud is described or analyzed.
  • Employees may have an easy time rationalizing fraud, for example, when they perceive that executives condone fraud or believe that fraud is widespread across an industry.
  • A person may be liable for significant liabilities, such as the cost of supporting sick relatives, college loans, car loans, and so forth.
  • Fraud deterrence has gained public recognition and spotlight since the 2002 inception of the Sarbanes-Oxley Act.
  • All of these elements are typically present, so effectively addressing any one of them will help minimize the fraud risk.

Weak internal controls such as poor separation of duties, lack of supervision, and poor documentation of processes give rise to opportunities for fraud. When the preceding pressures are present, a person must also see an opportunity to commit fraud. For example, a maintenance worker may realize that there are no controls over checking out and returning tools; this is an opportunity for theft. Generally, the opportunity for fraud increases when a business has poor internal controls. While understanding potential rationalizations is important, it is just a first step in designing effective antifraud programs.

Why Don’t Auditors Find Fraud?

Creating feelings of ownership in the organization through stock options or similar compensation can also backfire, as past frauds prove that this encourages the very behavior companies seek to prevent. Accordingly, a strong corporate board, an internal audit function, and external audit monitoring are critical for mitigating this principal-agent problem. Despite these figures from the Association of Certified Fraud Examiners’ 2018 Global Study On Occupational Fraud And Abuse, many companies fail to incorporate comprehensive policies and procedures to prevent, detect and mitigate fraud. Gaining an understanding of the Fraud Triangle can help management, accountants and counsel develop proper internal controls to help combat fraud in the workplace. In order to create effective antifraud programs that counter this tendency, it is important to recognize typical rationalizations that potential fraudsters are likely to invoke. According to the ACFE’s 2020 Report to the Nations, 35% of reported fraud cases arise in organizations that lack internal controls.

An individual may be spiteful towards their manager or employer and believe that committing fraud is a way of getting payback. Personal incentives may include wanting to earn more money, the need to pay personal bills, a gambling addiction, etc. Refers to upper management and the board of directors’ commitment to being ethical, showing integrity, and being honest – a poor tone at the top results in a company that is more susceptible to fraud. This article’s use of external links may not follow Wikipedia’s policies or guidelines. You may improve this article, discuss the issue on the talk page, or create a new article, as appropriate. The examples and perspective in this article deal primarily with the United States and do not represent a worldwide view of the subject. If you are on a personal connection, like at home, you can run an anti-virus scan on your device to make sure it is not infected with malware.


The “opportunity” element of the fraud triangle refers to the circumstances that allow fraud to occur. This is the only component of the fraud triangle over which the company exercises significant, or in some circumstances complete, control.

fraud triangle

First, consider that the incentive structures and external economic realities that feed this rationalization are common across employees. Recognize that all employees are likely to fear job loss and retaliation, and to feel a responsibility for their colleagues’ well being. Second, remember that some of the most prominent frauds of the past involved collusion, and many fraud instigators seem to be intuitively aware that appealing to the bigger mission is an effective method of convincing others to participate. “Pressure” refers to the motivation of the employee – that is, what is driving him or her to commit fraud. These pressures may be unrelated to work, and are rather personal in nature, such as overwhelming debt, addiction, divorce, or other family issues. However, there may also be work-related pressures, such as high demands by supervisors regarding meeting financial targets or performance-related bonuses.

About The Acfe

Even if the company operates exclusively in the United States, culture outside an entity matters as much as culture inside. While many organizations focus their attention on developing an appropriate code of conduct, this is only one measure needed for an effective control environment. Management’s actual behavior and its reactions to deviations from the code of conduct send a much stronger message to employees than the content of the code itself. Recall that Enron produced a 64-page code of ethics, signed by every employee, as well as a training video on integrity. That code was no more than a piece of paper; management’s behavior—greed, corruption, and extreme hubris—created a toxic tone at the top and a culture tailor-made for fraud.

fraud triangle

Poor accounting policies may provide an opportunity for employees to manipulate numbers. Pressure sometimes involves personal situations that create a demand for more money; such situations might include vices like drug use or gambling or merely life events like a spouse losing a job. At other times, pressure arises from problems on the job; unrealistic performance targets may provide the motive to perpetrate fraud. For example, Sullivan defended the capitalization of line expenses to the WorldCom board with the matching principle. Executives should be mindful about such doublespeak, and board members should follow up with probing questions if they spot it in senior management’s presentations. This rationalization technique—and the next—is more intuitive and more familiar to CPAs.

Once aware of typical rationalizations, CPAs must address them, and theExhibitprovides many potential responses. Research shows that individuals who behave unethically usually experience guilt and discomfortbeforecommitting the deviant act, and that they try to reduce this guilt and discomfort through rationalization. By understanding the common techniques for rationalization, organizations can design antifraud programs to make rationalization harder and, as a result, make it more challenging for potential fraud-sters to commit fraud.

  • “Monitoring activities deal with ongoing or periodic assessment of the quality of internal control performance by management to determine that controls are operating as intended and that they are modified as appropriate for changes in conditions” .
  • “Rationalization” is the final factor and it is how the perpetrator justifies his or her fraud.
  • Lax control over assets or reporting can generate feelings that a company is “asking for it” or doesn’t care what employees do.
  • Focusing on the bigger mission may be the most difficult rationalization to root out.
  • Fraud deterrence is based on the premise that fraud is not a random occurrence; fraud occurs where the conditions are right for it to occur.
  • While understanding potential rationalizations is important, it is just a first step in designing effective antifraud programs.

A person may be liable for significant liabilities, such as the cost of supporting sick relatives, college loans, car loans, and so forth. However, there may only be a perceived level of pressure, such as earning comparatively less than one’s friends. This latter situation can trigger expectations for a better lifestyle, perhaps involving a sports car, foreign travel, or a larger house.

The Fraud Triangle

The fraud triangle is a model showing the conditions that increase the likelihood of fraud being committed. The three components of the fraud triangle are perceived pressure, opportunity, and rationalization.

fraud triangle

An additional issue that is needed for fraud to continue over a period of time is the ability of the perpetrator to rationalize the situation as being acceptable. For example, a person stealing from a company’s petty cash box might rationalize it as merely borrowing, with the intent of paying back the funds at a later date.

Control Activities

Not surprisingly, fraud becomes pervasive when those institutions establish dysfunctional incentives and loosen oversight (Ramamoorti et al. 2013). When opportunities to commit fraud exist alongside motivation, the fraud triangle suggests that a third, necessary component for fraud is the ability for employees to justify fraud.

  • Even if the company operates exclusively in the United States, culture outside an entity matters as much as culture inside.
  • Because of my early fraud research in business, many have asked me if I was the person who first developed this triangle.
  • In order to preserve their self-respect, fraudsters will justify their behavior by using a neutralization or disengagement technique.
  • However, it is important to understand that even in organizations with a robust control environment, fraud is possible if employees circumvent controls.
  • Current auditing standards provide little guidance on identifying, understanding, and mitigating fraudsters’ rationalizations.
  • For example, focusing on the victim can be easily invoked in conditions of weak internal controls.

Finally, when rationalizing with a focus on the victim, the perpetrator shifts the blame to the victim and claims unjust treatment as an excuse, presenting his own actions as rightful retaliation or fair punishment. The goal of this article is to help gain better insight into the minds of fraudsters in order to fight fraud more effectively. When faced with fraud-related threats, accountants often put too much faith in generic and dispassionate policies and controls, forgetting the psychological complexity that makes people the weakest link in the internal control chain. Accordingly, careful attention must be paid to rationalizations that make fraud possible. As the research of Sutherland and Cressey pointed out, even individual acts of fraud are rarely the direct result of inherent personal traits, but rather are highly influenced by conditional environmental factors. The fraud triangle is therefore an important conceptual tool for highlighting environments that are conducive to fraud.

Multi-award-winning investigative journalist Dan McCrum overcame many roadblocks while investigating the Wirecard fraud scandal for the Financial Times. One of the creators of the venerable Fraud Triangle describes its history, rationale and uses for preventing, deterring, detecting and investigating fraud .