Question

What are the elements of the fraud triangle?

How can an internal control system limit reduce the risk of the elements within the fraud triangle?

If you were to identify the two most important internal control activities, what would they be?

Answer 1

The elements of fraud triangle are opportunity, motivation, and rationalization. The elements can be explained as follows:

1. Opportunity: The employees of a company are given an opportunity when the employees have access to the assets and information that can enable the employee to both commit and conceal the fraud. It is impossible to expect the employee to work without giving access to information and assets and this situation leads to inherent opportunity for an employee to commit the fraud.
2. Motivation: This is a complex element of all which can be either financial or nonfinancial. The pressure felt by an employee is the trigger that makes the employee commit the fraud. For example, the manager may inflate the items of financial statements under pressure to provide better results than earlier.
3. Rationalization: This is rather a psychological factor wherein the employee rationalizes committing fraud as correct owing to a variety of reasons say, for example, underpayment of compensation. Usually, the susceptibility of a person to this element depends upon the ethical values of the employee. A dishonest person can rationalize his acts of committing fraud while an honest person cannot do so.

By adopting strong internal controls and processes, any company may reduce the risk of the impact of the fraud triangle on the employee of the company. The internal control elements can reduce the chances of opportunity to the employees in particular. Proper placement of internal controls will expose the existing flaws to the management at earlier point of time thereby enabling the company and its management to be proactive in identifying such vulnerabilities and fix them as soon as possible.

The two most important internal control activities for preventing and controlling the fraud triangle are as follows:

1. Implementation and encouragement of whistleblowing: Whistle blowing is a medium through which source (whether internal or external) can confidentially report the happening of a fraud which comes to their knowledge;
2. Proper segregation of duties: The segregation of duties should be in such a way that no single person should be given access to both the custody of assets as well as authorization to record transactions pertaining to such asset in books of accounts. This will prevent an employee from both committing and concealing a fraud in isolation to others thereby killing their opportunity.