Fraud triangle

What Is the Fraud Triangle?

The fraud triangle is a foundational concept in forensic accounting that explains the three conditions generally present when an individual commits occupational fraud: perceived pressure, perceived opportunity, and rationalization. This model provides a framework for understanding the motivations behind fraudulent behavior, often employed in areas such as internal controls, auditing, and risk management. It posits that all three elements must exist for fraud to occur, acting as a valuable tool for organizations to identify and mitigate potential vulnerabilities to financial crime.

History and Origin

The conceptual framework of the fraud triangle originated from the work of criminologist Donald R. Cressey in the 1950s. Cressey, a student of Edwin Sutherland (who coined the term "white-collar crime"), conducted extensive research by interviewing convicted embezzlers. His findings were published in his 1953 book, Other People's Money: A Study in the Social Psychology of Embezzlement.¹³ In this seminal work, Cressey hypothesized that "trusted persons become trust violators when they perceive of themselves as having a financial problem which is non-shareable, are aware that this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the trusted funds or property."¹² While Cressey himself never explicitly used the term "fraud triangle," the three core elements he identified—pressure, opportunity, and rationalization—became the cornerstones of what is widely recognized today as the fraud triangle.

##¹¹ Key Takeaways

• The fraud triangle identifies three key elements that are typically present when occupational fraud occurs: perceived pressure, perceived opportunity, and rationalization.
• "Perceived pressure" refers to a non-shareable financial need or problem that motivates an individual to commit fraud.
• "Perceived opportunity" relates to the individual's belief that they can commit and conceal the fraudulent act without being detected.
• "Rationalization" is the process by which individuals justify their dishonest actions, allowing them to maintain a positive self-image despite their fraudulent behavior.
• The model serves as a valuable tool in fraud detection, risk assessment, and the design of more robust internal controls.

Interpreting the Fraud Triangle

The fraud triangle provides a qualitative lens through which to interpret and analyze potential fraud risks within an organization. It suggests that if any one of the three components is absent, the likelihood of fraud decreases significantly. For instance, strong internal controls can diminish the perceived opportunity, while fostering ethical standards and supporting employees through personal difficulties can reduce pressure and challenge rationalizations. Understanding these dynamics helps auditors and compliance officers assess vulnerabilities and implement preventative measures.

Hypothetical Example

Consider Sarah, an accounts payable clerk at a small manufacturing firm.

1. Pressure: Sarah is facing mounting medical bills for a family member's illness, creating a significant, non-shareable financial problem. She feels desperate and sees no other immediate solution.
2. Opportunity: Due to recent staff cuts, Sarah's workload has increased, and oversight of invoice processing has become lax. She notices a gap in the approval process for smaller vendor payments, allowing her to generate a fraudulent invoice for a fictitious vendor she controls. This perceived opportunity makes her believe she can commit the embezzlement without being caught.
3. Rationalization: Sarah tells herself that the company can afford it, that she'll pay it back once her family's situation improves, or that she is underpaid for her increased responsibilities anyway. This internal justification allows her to proceed with the fraudulent activity while maintaining her self-perception as an otherwise honest person.

In this scenario, the presence of all three elements of the fraud triangle significantly increases the likelihood of Sarah committing fraud.

Practical Applications

The fraud triangle is a widely utilized framework in various financial and organizational settings for fraud prevention and detection. Auditors often use it during financial statement audits to identify areas of higher fraud risk, examining processes for potential weaknesses that create opportunity, looking for signs of employee pressure, and understanding the company culture that might enable rationalization. For¹⁰ example, a common type of financial statement fraud involves improper revenue recognition, which often stems from pressure to meet aggressive financial targets. The⁹ Securities and Exchange Commission (SEC) actively pursues enforcement actions against companies and individuals involved in financial statement fraud, emphasizing the importance of robust internal controls to prevent such abuses. Hig⁷, ⁸h-profile cases, such as the Enron scandal, illustrate how a breakdown in corporate governance and internal controls can create the opportunity for massive financial misrepresentation and fraud. Bus⁶inesses leverage the fraud triangle to develop more effective anti-fraud programs, including whistleblower programs, employee monitoring, and enhancing oversight mechanisms.

Limitations and Criticisms

While widely accepted, the fraud triangle has faced certain limitations and criticisms. Some scholars argue that its three elements may not fully capture the complex motivations behind all types of fraud, particularly in cases where financial pressure is not evident, or when individuals commit fraud purely due to ego or a desire for power. Cri⁵tics suggest that the model might oversimplify human behavior and that additional factors, such as "capability" (the perpetrator's skills and position to execute and conceal the fraud), should be considered. This led to the development of alternative models like the "Fraud Diamond," which adds capability as a fourth element. Fur⁴thermore, the fraud triangle's focus on individual motivation can sometimes overshadow the institutional environment and organizational culture that might inadvertently foster or enable fraudulent behavior. Des³pite these criticisms, it remains an essential conceptual model for understanding and addressing the root causes of financial fraud.

Fraud Triangle vs. Fraud Diamond

The fraud triangle comprises three elements: perceived pressure (or motivation), perceived opportunity, and rationalization. It posits that all three must be present for an individual to commit fraud.

The fraud diamond extends the fraud triangle by adding a fourth element: capability. This fourth element acknowledges that even if pressure, opportunity, and rationalization exist, a person must also possess the necessary skills, knowledge, and position to carry out and conceal the fraud effectively. The fraud diamond suggests that the individual's specific capabilities, such as their intelligence, creativity, and ability to handle stress, play a crucial role in whether fraud actually occurs. While the fraud triangle focuses on the why and how of fraud, the fraud diamond further refines the who, emphasizing the unique traits that enable a person to become a successful fraudster.

FAQs

What are the three elements of the fraud triangle?

The three elements of the fraud triangle are perceived pressure (the motive), perceived opportunity (the means), and rationalization (the justification).

How does the fraud triangle help prevent fraud?

By understanding the elements of the fraud triangle, organizations can implement strategies to mitigate each component. For example, strong internal controls reduce opportunity, while employee support programs might alleviate financial pressures. Promoting a strong ethical culture can also reduce an individual's ability to rationalize dishonest acts.

Is the fraud triangle applicable only to financial fraud?

No, the principles of the fraud triangle can be applied to understand various types of dishonest behavior beyond just financial fraud, including academic dishonesty. How²ever, it is most widely used in the context of occupational and financial crime.

Who developed the fraud triangle concept?

The underlying concepts of the fraud triangle were developed by American criminologist Donald R. Cressey in his 1953 research on embezzlers.¹