What is the Fraud Triangle?
Ever wondered how someone ends up committing fraud? Well, it isn't a random decision. There's a theory called the Fraud Triangle that breaks down why someone chooses to act fraudulently. Let's explore this concept in simple terms and how it can help you on an audit. This model outlines the three factors that must be present for fraud to occur: pressure, opportunity, and rationalization.
What is the Fraud Triangle?
The Fraud Triangle is a model that helps explain why someone chooses to commit fraud. Picture a triangle, with each point representing a crucial factor: pressure, opportunity, and rationalization. At least two of the three factors have to be present for fraud to occur but commonly all three are.
1. Pressure
First up is 'pressure.' Imagine a friend who desperately needs money to pay for something – maybe they lost their job, or they can’t afford their next car payment. This desperate need for money is what we call 'pressure'. It's the push that can drive someone to consider doing something they normally wouldn't – like committing fraud.
2. Opportunity
The second point of the triangle is 'opportunity'. Let's say the same friend spots an unattended wallet. They realize they could take some money without anyone knowing. That's the 'opportunity.' It's the chance someone has to commit fraud without getting caught.
3. Rationalization
The final point is 'rationalization'. This is where the friend convinces themselves that it's okay to take the money. They might think, "I'll pay it back when I have the cash," or "The person who lost this wallet won't miss a little money." This rationalization is their way of justifying the fraudulent act, making it seem acceptable in their mind.
The Fraud Triangle helps us understand how fraud happens. When someone experiences pressure, spots an opportunity, and can rationalize the act, they may choose to commit fraud. Understanding this can help prevent it. It's not about making excuses for fraudsters but being aware of the circumstances that lead to fraud.
Thinking about audit procedures…
Under Yellow Book standards for both performance audits and financial audits, we are required to perform some fraud detection procedures. We’ll focus on the Yellow Book standards for performance audits.
YB 8.71 Auditors should assess the risk of fraud occurring that is significant within the context of the audit objectives. Audit team members should discuss among the team fraud risks, including factors such as individuals’ incentives or pressures to commit fraud, the opportunity for fraud to occur, and rationalizations or attitudes that could increase the risk of fraud. Auditors should gather and assess information to identify the risk of fraud that is significant within the scope of the audit objectives or that could affect the findings and conclusions.
8.72 Assessing the risk of fraud is an ongoing process throughout the audit. When information comes to the auditors’ attention indicating that fraud, significant within the context of the audit objectives, may have occurred, auditors should extend the audit steps and procedures, as necessary, to (1) determine whether fraud has likely occurred and (2) if so, determine its effect on the audit findings.
Significant within the context of the audit objectives, auditors should:
Gather information
Assess the risk
Design procedures
Sounds simple, right?
A great way to ensure that you perform the required fraud detection procedures is to utilize a fraud risk assessment checklist. The checklist serves as a handy sidekick that helps you identify fraud with a list of standard questions that you should consider when performing an audit under Yellow Book performance audit standards. The questions should be based on the principles of the COSO framework and the Green Book, which I talked about last week!
The checklist should be more than a list of questions - it’s a tool to lead your discussion among audit team members when considering the risk of fraud in the context of your audit objectives.
Would you like to learn more about fraud detection and earn CPE credit at the same time? Check out our two upcoming courses. Each course will discuss fraud and each participant will receive a copy of a fraud risk assessment checklist with over 30 questions to consider during your next performance audit.