The Fraud Triangle

Demystifying Valuation, Economic Damages + Forensic Accounting

In order for fraud to occur, there normally needs to be three conditions present: a pressure, an opportunity and a rationalization. This is known as the fraud triangle.

The first side of the fraud triangle is pressure. Pressure can take many forms, and the pressures that motivate employee fraud differ from those that motivate management fraud. Pressures on employees most often include financial, emotional and lifestyle.

  • Financial pressures may be high personal debt/expenses, heavy financial losses, tax avoidance and “inadequate” salary/income.
  • Emotional pressures include job dissatisfaction, coercion by management, fear of losing one’s job and the need for power or control.
  • Lifestyle pressures include addictions such as gambling, drugs, or alcohol; and family/peer pressure. It is important to note that lifestyle pressures do not necessarily exist in the person committing the fraud but may be found in a spouse, romantic partner, or other family member.

Some red flags that may be found in employees experiencing pressure are living beyond one’s means, recent acquisition of high dollar assets such as a sports car or boat, refusal to share job duties, reluctance to take time off, expression of bitterness over a missed promotion or pay raise, radical changes in behavior and/or appearance, sudden decline in performance, and sudden attendance issues. Organizational pressures on management, which often inspire financial statement fraud, include management characteristics, industry conditions and financial pressure.

The second side of the fraud triangle is rationalization. Rationalization provides the justification for committing fraud, and can take three forms, a justification, an attitude or a lack of personal integrity. Joseph Heath, a philosophy professor at the University of Toronto (U of T), and the former director of the U of T Centre for Ethics, suggests that there are seven rationalizations for unethical actions (*):

  • Denial of responsibility
  • Denial of injury
  • Denial of the victim
  • Condemnation of the condemners
  • Appeal to higher loyalties
  • Everyone else is doing it
  • Entitlement

The final side of the fraud triangle is opportunity. Opportunity is the condition or situation that allows an individual to commit fraud, conceal fraud, and convert the theft or misrepresentation to personal gain. This side of the fraud triangle is the easiest for organizations to address through the design, implementation and enforcement of internal controls. Some examples of controls include segregation of duties, authorization procedures, proper supervision, safeguarding of assets, clear lines of authority, adequate documentation and independent checks on performance.

In discussing the fraud triangle, and the motivations for fraud, it is also important to keep Maslow’s Hierarchy of Needs in mind, as this may provide additional insight into fraudster motivations and potential vulnerabilities. For example, an individual may be motivated by the need for money to maintain their family (a physiological need), and by job security (a safety need). An individual may also be susceptible to management coercion because they want to be seen as a worthy employee (a love, affinity need/an esteem/respect need). Individuals who commit fraud may be subject to the influence of needs along all levels of Maslow’s Hierarchy.

By Shyla A. Ingram, MSA

(*) Brooks, L.J., & Dunn, P. (2010). Business & professional ethics for directors, executives & accountants (6th ed.). Mason, OH: South-Western