As part of my Accounting Fraud Examination Concepts course at FAU, I wrote a paper about The Fraud Triangle and how it is used in fraud examination. Below is an excerpt from the paper. If you would like to read the entire paper, you can download it here.
Fraud examination is the investigative process of discovering how, when, where, and why a fraud happened, and who was involved. Using the Fraud Triangle as a guide, the fraud examiner or forensic accountant creates a hypothesis about the fraud that can be tested and refined as he/she gathers evidence and determines the facts of the case. The process of documenting the investigation and focusing on facts, not opinions, is critical since there may be criminal and/or civil lawsuits resulting from the findings.
Once a fraud has been exposed, determining the opportunity involved in the fraud is a good beginning point as this can help answer the how, when, and where questions, and lead the investigation to the who and why. Let us consider the example of discovering payments to an illegitimate vendor. Examining the accounts payable process would help identify the internal controls in place, or lack thereof. Who enters new vendors in the accounting system? Who approves them and how are they verified as a legitimate vendor? Who approves invoices? Is there a separation of duty between who enters the invoice and who makes the payments? The examiner might find a system rife with internal control weaknesses, where only one person handles all aspects of the accounts payable function and there are no invoice approvals. They could also find the appropriate internal controls are in place and the only way a fraud could happen is through collusion between co-conspirators. This part of the investigation identifies how the fraud was perpetrated and the players involved.
The next step is looking at the players and using the element of pressure to determine the motivation for fraud. Certainly, interviewing people is a part of this but the examiner needs to be aware the possibility for false statements is high since individuals will be trying to avoid implicating themselves. The examiner may need to look to outside sources and observations about lifestyles and social interactions to get to the heart of the pressure that existed driving the fraudulent behavior.
Rationalizations, although more for the benefit of the perpetrator’s psyche, can lend valuable clues as to why a fraud happened and can be revealing about the circumstances surrounding it. For example, if the rationalization was “everyone else was doing it”, this may lead to a discovery of additional frauds and an examination of the company’s workings and culture as a material weakness allowing fraud to occur. No part of the Fraud Triangle should be ignored, and all elements are important in a fraud examination.
Conclusion
Although the Fraud Triangle is more than 50 years old, it is still relevant and important to understand when combatting fraud or conducting a fraud investigation. Addition of the fourth element of capability to create a Fraud Diamond was important to enhance the opportunity construct. The focus in the corporate world is often placed on the ability to control the opportunity component of the triangle, with internal controls and organizational structure used to deter fraud. But organizations are put at a disadvantage if they do not consider the impact of pressure and rationalization. The psychology of the fraudster has a profound role and the interaction of all three elements together determine whether fraud occurs. Companies should address pressure, opportunity, and rationalization in their efforts to educate their workforce, promote awareness, and create the appropriate environment where fraud is less likely to happen. The Fraud Triangle is a good foundational theory to guide hypothesis creation and testing in fraud examination. However, enhancements to the triangle as well as alternate theories like the fraud scale and others that were not discussed in this paper have advanced the field and should not be ignored.