Fraud and the Fraud Triangle: Study with Video Lessons, Practice Problems & Examples

Fraud in the workplace involves dishonest acts by employees for personal gain at the company's expense. The fraud triangle outlines three essential elements: opportunity, incentive, and rationalization. Companies can control opportunities through internal controls, which safeguard assets and ensure compliance with laws. Incentives often stem from financial pressures, while rationalization allows employees to justify their actions. Understanding these concepts is crucial for maintaining ethical standards and preventing fraud within an organization.

Fraud and the Fraud Triangle

Alright, now let's discuss the concept of fraud when employees try and steal from the company. So we're going to talk about fraud and this is any dishonest act by an employee, a dishonest act for their personal benefit, right? So they're doing something for their own good and it's going to be at the cost of the employer. In this case, the company is usually what we're focused on in accounting, we're focused on the company and now there's an employee trying to steal from the company. So fraud comes in many forms, right? You could just steal money from the cash register, steal inventory from the warehouse, or you could get a little more intricate. You could be creating fake invoices that can be paid by the company and it makes it look legit, but since nobody's really paying attention, they're fake invoices, right, that could happen as well. So when we talk about fraud, we talk about the idea of the fraud triangle, okay? The fraud triangle basically tells us the three things that are necessary for fraud to occur. The first thing is opportunity. The opportunity to commit fraud. Okay? If an opportunity presents itself, will the employee take advantage of it? Okay? The next thing is incentive. They have to have some incentive to commit fraud, right? They're not just going to do it for no reason; there's going to have to be some reason why they commit fraud. And lastly is rationalization. They have to rationalize to themselves that this is okay, right? Because they're going to commit some kind of bad thing. They're going to steal, they're going to do something bad and they have to rationalize it to themselves that it's okay that they're doing that. Okay? So the next thing we want to learn is how to find the area of the fraud triangle, right? If you guys remember area equals half base times I'm just kidding. You don't have to do any geometry about fraud geometry here. Triangle, okay? I'm just trying to pull a fast one there. Alright. So let's talk a little bit more about these three things, opportunity, incentive, and rationalization, alright? So first, let's talk about incentive and rationalization. Alright? So first, let's talk about opportunity. So remember that there the opportunity has to present itself for the employee to commit fraud. So this is the most important element of the fraud triangle and this is the element that the company can control. They can try and limit the opportunities for an employee to commit fraud, right? So an example of an incentive easy to just take some money out, right? Next is the incentive, right? That incentive which is usually some sort of financial pressure that the employee feels, right? This is the reason that they want to commit fraud. So an example would be the employee is behind on bills, right? They're frustrated, they need extra money, they might commit fraud because they need that money or the employee just wants to live a lavish life, right? They just want money because they love money and they want to have a boat, they want to have a big house, so they will steal to get to that level, Okay? So they have that incentive and they have that opportunity. Finally, they need to rationalize it, right? They need to have a personality to rationalize this type of behavior. So the employee must feel okay with the dishonest behavior. So what's going to make them feel okay? Well, that could be some kind of situation where they're like well, my employer doesn't pay me enough anyways, right? So it's okay if I steal a little bit from the company. Anything to rationalize in their head that it's okay. Oh, you know my mom is sick and the company doesn't understand that, but I'm doing it for a good reason, right? I'm trying to help my sick mother, I need to steal from the company. Whatever it is, they're going to rationalize something to commit that fraud, right? So there it is, those are the three key elements of fraud and what can the company do, right? Like I said, they can try and minimize those opportunities to commit fraud, right? And how they do that is they use what's called internal controls, okay? Internal controls are systems in place in the company that are going to help safeguard their assets which means not allow employees to just walk out with cash or walk out with inventory, but it's also going to make the financial information more reliable because we're going to have these checks in place as we do transactions, as things happen, there's going to be certain policies and procedures that must be followed. Okay? And lastly, of course, it's going to ensure compliance with law. Alright? It's going to make sure that the company isn't doing anything unlawful. Okay? Internal controls, these are just systems inside the company that help minimize fraud, alright? Let's go ahead and move on to the next video.

Here’s what students ask on this topic:

What is the fraud triangle and its components?

The fraud triangle is a model that explains the factors that lead to fraudulent behavior in the workplace. It consists of three components: opportunity, incentive, and rationalization. Opportunity refers to the circumstances that allow fraud to occur, such as weak internal controls. Incentive is the motivation behind committing fraud, often driven by financial pressures or personal gain. Rationalization is the process by which the fraudster justifies their dishonest actions, convincing themselves that their behavior is acceptable. Understanding these components helps organizations implement measures to prevent fraud.

How can companies minimize opportunities for fraud?

Companies can minimize opportunities for fraud by implementing strong internal controls. These controls include segregation of duties, regular audits, access controls, and thorough documentation of transactions. Segregation of duties ensures that no single employee has control over all aspects of a financial transaction, reducing the risk of fraud. Regular audits help detect and deter fraudulent activities. Access controls limit who can access sensitive information and assets. Thorough documentation ensures transparency and accountability in financial transactions. By strengthening these internal controls, companies can significantly reduce the opportunities for fraud.

What are some common incentives that lead employees to commit fraud?

Common incentives that lead employees to commit fraud include financial pressures, such as being behind on bills or facing significant debt. Other incentives may include the desire for a lavish lifestyle, such as wanting to buy expensive items or live beyond their means. Additionally, personal issues like medical expenses or family emergencies can create financial stress, prompting employees to commit fraud. Understanding these incentives helps organizations identify potential risks and provide support to employees, reducing the likelihood of fraudulent behavior.

How do employees rationalize committing fraud?

Employees rationalize committing fraud by convincing themselves that their actions are justified. Common rationalizations include believing that they are underpaid and deserve more compensation, thinking that the company can afford the loss, or feeling that their actions are a temporary solution to a personal problem. Some may also rationalize fraud by comparing their actions to perceived unethical behavior by others in the company. By understanding these rationalizations, organizations can address underlying issues and promote a culture of integrity and ethical behavior.

What role do internal controls play in preventing fraud?

Internal controls play a crucial role in preventing fraud by establishing procedures and policies that safeguard a company's assets and ensure accurate financial reporting. These controls include segregation of duties, regular audits, access controls, and thorough documentation. Segregation of duties prevents any single employee from having control over all aspects of a transaction, reducing the risk of fraud. Regular audits help detect and deter fraudulent activities. Access controls limit who can access sensitive information and assets, while thorough documentation ensures transparency and accountability. By implementing strong internal controls, companies can significantly reduce the risk of fraud.