What is a Fraud Triangle?

The 3 Elements

#1 – Pressure

The pressure is the motivation behind fraud committing, and that can be either personal financial pressure or pressure from superiors. Both the pressures give the motivation for committing fraud. If the pressure remains unsolved by rational & legal means, then individuals might go for irrational ways. Some common examples of personal financial pressure are non-shareable financial problems, revenue shortage, pressure from banks to pay loans, and lifestyle maintenance. And some examples of pressure from superiors are window dressingWindow DressingWindow dressing in accounting refers to the intentional manipulation of financial statements by company management in order to present a more favourable picture of the company to users of the financial statement before it is released to the public.read more of accounts, teeming and lading, inventory pilferage and selling, sharing secret information with competitors to earn money, etc. When a person cannot see the apparent path of achieving personal or work goals by honest means, they may adopt dishonest alternatives.

#2 – Opportunity

When pressure is present, the employee looks for an opportunity to commit fraud. For example, if there is no internal controlInternal ControlInternal control in accounting refers to the process by which a company implements various rules, policies, or procedures to ensure the accuracy of accounting and finance information, safeguard the various assets of the business, promote accountability in the business, and prevent the occurrence of frauds in the company.read more over the inventory room, then the employee finds the chance to pilferage it and sell it in the market. It can be done by abusing the position, for example, pressure by superior to subordinate to show accounts by window dressing.

#3 – Rationalization

It is the last stage in the fraud triangle. This stage requires fraudsters to justify fraud acceptably. Most fraud committers do not see themselves as criminals; instead, they explain the situation of committing fraud. Similarly, fraud by management gives reason for performance and pressure from shareholders for dividends and all.

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Challenges

  • Strong Internal Control – To Prevent organizations and management from committing fraud, there must be robust internal control and compliance with the law and high penalties for committing fraud to reduce it.Favorable Employee Policies – There must be favorable employee policies so that employees in need can get finance from the company instead of committing fraud.Strong Fraud Deterrence Policies – There must be strong fraud deterrence policies so that employees do not even think of committing fraud because of its substantial consequences.Ethical Training – There must be proper ethical training for all employees, which teaches them that ethics are most important in life. Doing fraud or cheating in any situation is unethical, which helps to change the mindset of fraudsters.

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Which is an Important Element?

The fraud triangle has three elements – Pressure, opportunity, and rationalization, and the most crucial factor is an opportunity. It is so because the opportunities available for committing the fraud motivate the fraudsters to commit the fraud. For example, suppose there are strong organizational controls, rigid policies, and proper and crystal-clear reporting policies. In that case, fraudsters might not get the opportunity to commit the fraud, so that no fraud can occur.

How Can the Fraud Triangle Help to Identify Fraud and Avoid it?

  • The motivation for committing fraud can vary from financial to non-financial. To prevent fraud, companies must implement strong internal controls. As an organization with strong internal control, experience lower frauds and quickly identify frauds.Strong Fraud deterrence policies also help prevent fraud as employees fear its consequences like losing their job and not getting a job anywhere.In audits, management auditManagement AuditManagement audit refers to an audit of management in which multiple tools examine the management’s performance and progress toward the process of best decision making. Instead of focusing on operational aspects, the emphasis here is on management’s “Quality of Decision-Making.“read more and operational audits are motivated so that management fraud can be detected.In the case of the statutory auditStatutory AuditOne of the most common types of audits is the statutory or financial audit. Its main purpose is to gather all relevant information so that the auditor may provide an accurate and unbiased assessment of the company’s financial position.read more, there is a clause where the auditor has to report whether fraud is committed by employees, management, or a third party.

Importance

The fraud triangle comprises three components: pressure, opportunity & rationalization. It helps in preventing the fraud if there are:

  • Zero Tolerance – Zero tolerance for errors and mistakes. Many employees pity themselves after committing the fraud, and organizations shouldn’t be kind and have zero tolerance for this.Surprise Visits and Audits – Top management must have a system of surprise checks and visits, and auditorsAuditorsAn auditor is a professional appointed by an enterprise for an independent analysis of their accounting records and financial statements. An auditor issues a report about the accuracy and reliability of financial statements based on the country’s local operating laws.read more should also do surprise audits to ensure that no frauds are committed by or on the company.Code of Ethics – Companies have a robust code of ethics to ensure that they send the right message to employees regarding fraud. And provide that code of ethics to be followed by one and all.

Conclusion

The fraud Triangle is the concept that explains the reason behind committing the fraud. The main elements are pressure, opportunity, and rationalization. In addition, there must be strong internal controls, zero tolerance, and a proper code of ethics to prevent fraud, which motivates employees to be ethical. To prevent and detect fraud, there must be surprise checks and audits, management audits are also encouraged, and there must be strong fraud deterrence policies so that no employee can think of committing fraud.

This article has been a guide to the Fraud Triangle. Here we discuss elements of the fraud triangle, how it can help identify theft and avoid it, and its importance. You may learn more about financing from the following articles –

  • Mortgage FraudTax FraudCompliance AuditAccounting PracticeInterim Audit