The Fraud Triangle & Business Ethics: Parts & Application

Instructor: Deborah Schell

Deborah teaches college Accounting and has a master's degree in Educational Technology and is holds certifications as a CIA, CISA, CFSA, and CPA, CA.

Individuals commit fraud for a number of different reasons. In this lesson, you will learn about the different kinds of fraud, and the factors that explain why individuals commit it.

What Is Fraud?

Let's meet Tracey who is studying for her university ethics exam. During a lecture, her professor discussed the fraud triangle. She thought she understood the concept but in reviewing the material for the exam, now she's not quite so sure. Let's see if we can help Tracey with this problem.

Fraud is the act of intentionally deceiving someone for personal gain. It is not an accidental error, but a deliberate misrepresentation of the truth. There are a number of different types of fraud including:

  • Internal fraud
  • External fraud
  • Fraud against individuals

Internal fraud or 'occupational fraud' takes place when an employee of a company, at any level, carries out a fraud against his/her employer. Let's say Edward has responsibility for depositing cash as well as updating the accounting system. To commit fraud, he might pocket cash and create a journal entry to conceal the fact that he has stolen the money.

An external fraud is one committed by an individual or a company outside of the organization. An example of an external fraud would be a customer who attempts to return an item that they hadn't purchased from that store, or one that they had stolen, for a full refund.

Fraud against individuals includes frauds that third parties commit to steal money from individuals. Examples of this type of fraud include identity theft where an individual assumes your identity and uses your personal information for his/her financial gain.

Let's learn more about what motivates individuals and companies to commit a fraud.

What Is the Fraud Triangle?

fraud triangle

The fraud triangle represents a framework to describe the reasons that someone could commit an internal (occupational) fraud. The framework consists of:

  • Pressure
  • Opportunity
  • Rationalization

Let's explore each of these factors in more detail.

Pressure

Pressure represents the reason that an individual commits fraud. In many instances, an individual has some sort of financial problem that will lead him/her to commit internal fraud. For example, an employee could have a gambling problem that has caused her to accumulate a great deal of debt. She may feel as if the only solution is to commit fraud to get the money she needs to solve the problem.

Other examples of pressures include a desire to keep up with one's friends in terms of houses or cars, the desire for a larger bonus or investor pressure to meet company financial targets.

Opportunity

An employee must identify an opportunity or method to commit the fraud. The employee will want to identify a method that she/he feels is safe, in other words, the risk of being caught is low. Sometimes employees are presented with opportunities to commit fraud if they have been with the company for a long period of time or are in a position of trust.

For example, let's assume Betty has worked for her employer for 15 years. Given that she is a long-time employee, she has a large amount of responsibility as well as some incompatible functions. Her employer trusts her because she has been a valued employee for such a long time. But Betty has also been around long enough to know where the gaps in the control environment are, and how to get around them; providing her with the opportunity to commit a fraud if she is under pressure.

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