Fraud Triangle: The Causes of Financial Statements Fraud in a Company

By Rizka Maria Merdeka   |  

Fraud triangle is a term related to fraud/manipulation that is known mainly in the business domain. Commonly, the term fraud triangle is used to describe three conditions that cause fraud in financial statements in the business field or company.

There are many risks that must be faced and anticipated in doing business, one of which is fraud. Other risks can come from external factors such as constraints on suppliers, natural disasters, pandemics, as well as internal factors such as financial statements fraud and embezzlement. The fraud triangle is also a theory which discusses fraud that occurs in a business. The fraud triangle theory was introduced in the 1950s by Donald R. Cressey, in which he explained the reasons or factors causing fraud in the company.

What are the factors that cause fraud in the company? A more complete explanation regarding the fraud triangle, the causative factors, and examples will be discussed in this article. Check out the following article to get more information about the fraud triangle!

What is the fraud triangle?

The fraud triangle is a term used to explain three conditions/elements/encouragements that cause someone attempting to commit fraud in order to gain a group or personal benefit by using illegal actions. This usually happens a lot in business, especially in a corporate domain, one of which is the manipulation/fraud of financial statements.

Fraud itself is a type of violation that is often found especially in financial matters. Business practitioners really avoid and make a lot of prevention against the risk of fraud, because the impact is very detrimental and even makes the related business undergoing bankruptcy. Moreover, the fraud triangle is a violation committed intentionally accompanied by an attempt to cover up the committed fraud.

In the business sphere, anyone has the potential to commit fraud, especially in a large company environment with a large number of employees. From these problems, Donald R. Cressey then developed the fraud triangle theory to reveal the factors that cause financial-related fraud in the company. The term fraud triangle itself arises because Cressey states that there are three conditions that cause fraud in business, namely pressure, opportunity, and rationalization. These three conditions or incentives then become things that influence someone to commit fraud.

Factors causing the fraud triangle

According to Cressey in the fraud triangle theory, there are three factors that cause the occurrence of financial fraud in a company. As previously mentioned, these factors or conditions are pressure, opportunity, and rationalization. The following is an explanation regarding the three conditions or factors that cause fraud.

1. Pressure

The first factor is the existence of pressure. The pressure experienced by fraudsters encourages and motivates them to commit illegal acts that harm the company’s finances. The impact of the experienced life pressures makes the fraudsters unable to think clearly about the actions, consequences, and effects that may affect themselves and others if they do so. Usually when in a difficult situation, a person cannot think logically so that makes him act irrationally. If that person is an employee in a company, there is a possibility for a person to commit fraud such as theft, forgery, accepting bribes, and so on. Here are some examples of pressures that can provoke someone to commit fraud.

  1. Paying children’s education costs
  2. Paying hospital fees
  3. Paying debt, home mortgage, and car debts
  4. Getting laid off
  5. Fulfilling a consumptive lifestyle
  6. Paying credit card debt
  7. Undergoing an economic crisis, especially the cost increase of basic commodities
  8. Drug and alcohol addiction
  9. Getting a salary that does not match the workload
  10. In gambling debt, and so on.

2. Opportunity

The next factor is the existence of opportunity or particular moments that allows someone to commit fraud. Specifically, when someone is faced with a condition where fraud can be committed, even though previously there was no intention from the fraudster to do so. Opportunities can be a chance for fraudsters if there are the following things.

  1. The applied SOPs in the company are not implemented with high discipline.
  2. There are employees who have multiple job desks.
  3. The lack of employee performance supervision, especially from company management.
  4. The use of the company’s systems/technology whose security is not updated regularly.
  5. The lack of disciplinary action for policies violations or regulations, even for minor violations.

To avoid the emergence of opportunities for anyone who does or does not intend to commit fraud, companies need to enforce better policies and regulations. Besides, the company has to control the performance of its employees closely and regularly, especially for divisions related to the company’s finances such as HR, purchasing, marketing, cashier, finance, and sales. Each company director must also be able to read the financial statements carefully in order to always be up to date with the company’s financial condition, so that they can take the right strategic policies.

3. Rationalization

The third factor is rationalization. This action is self-defense by the fraudsters because they think they are innocent by justifying their reasons for committing the fraud. Fraudsters feel that the reason for committing fraud is understandable and acceptable because of the situation they are in. It is common for fraudsters to blame the company for their actions because they feel they are the victims of the existing situation, or commonly known as playing victims. The following are the examples of reasons for justification or rationalization.

  1. Seeing the wages given are not adequate compared to their hard work and the benefits obtained by the company.
  2. Disappointed because they did not get a promotion.
  3. Thinking that the company will not lose or undergo bankruptcy just because of the fraud they did.
  4. Feeling that the company is being unfair to them.
  5. Thinks that committing fraud is the only way to free them from financial problems they face.
  6. Feeling that it is their right because they also contribute to the progress of the company.

Example of a fraud triangle in a company

The cases of fraud triangle often occur in large companies and even lower-middle companies. No one expected that one of his employees had the potential to commit illegal acts such as fraud for his personal benefit. Here are some examples of fraud triangle cases that often occur.

  1. Embezzlement of company funds by employees for personal gain to support their luxurious lifestyle.
  2. Stealing company’s products and selling them illegally because they need money for their children’s school fees.
  3. Falsification or manipulation of financial statement data because the company’s money is used by them to fulfill personal needs.
  4. Mark-up the purchasing cost of raw materials or products in order to obtain material benefits for themselves.
  5. Manipulating product stock data and using the company’s products without official permission from the authorized parties.
Tags : CompanyFraud, Financial, FraudTriangle

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