The Fraud Triangle
The Fraud Triangle
The fraud triangle are conditions for fraud arising from fraudulent financial reporting and misappropriation of assets. These conditions are:
The fraud triangle is depicted by the following image:
Management or other employees will have incentives or circumstances of pressure to commit fraud. If the decision is made by management to report fraudulent financial statements, the most common reason for this will be threat by economic, industry or entity operating conditions to the financial stability and profitability of ...view middle of the document...
The misstatements of financial statements occur when the opportunity to do so is present. In industries where significant judgments and estimates are involved, the financial statements of these companies are subject to manipulation. Companies with diverse inventories in many locations can reevaluate their inventories subjectively, with the risk being greater if the inventory is obsolete. A high turnover of accounting personnel, internal audit or IT staff creates the opportunity for misstatements. Ineffective audit committee members or board of directors, who do not conduct proper oversight of the financial statements, create an opening for management to fraudulently report the company’s earnings.
The opportunity to steal exists in all companies, but the integrity of the staff determines if theft will occur. Once there is an accessibility to cash, inventory or valuable assets, employees will take advantage of the opportunity. If an organization lacks proper internal controls and duties are not properly segregated, the opportunity to misappropriate assets greatly increases (Fox School of Business 2009).
The attitude of top management towards financial reporting sets the tone of the organization. If no ethical values exist within an organization, management and employees may be in an environment that causes them to rationalize committing a dishonest act. If top management displays a disregard for the financial reporting process, constantly issue overly optimistic forecasts, or become obsessed with meeting industry expectations, fraudulent reporting is likely. Management may cheat customers by setting overly high prices for goods or engaging in high pressure sale tactics, which in turn encourage employees to behave in the same manner and cheat of time cards and expense reports. Disregarding the need to monitor the risk of misappropriating assets or overriding existing internal controls by failing to correct internal deficiencies is a huge risk factor (Fox School of Business 2009).
All three characteristics of the fraud triangle must be present for fraud to occur. Management or employees must have the incentive or pressure to commit fraud, see the opportunity present itself and be able...