Question

The “Fraud Triangle” models the interplay between the three conditions that lead to fraud: (a) incentives/ pressures; (b) opportunities and (c) attitudes/ rationalisations. Use Appendix 1 of ASA 240 to classify the following examples of risk factors relating to misstatements arising from fraudulent financial reporting as an example of either: incentives/ pressures; opportunities or attitudes/ rationalisations.

Note: In answering this question please write the letter that denotes the statement followed by either incentive/ pressure; opportunity/; or attitude/ rationalisation

A. Management failing to remedy known significant deficiencies in internal control on a timely basis.

B. Significant portions of management compensation (for example, bonuses, share options, and earn-out arrangements) being contingent upon achieving aggressive targets for share price, operating results, financial position, or cash flow

C. Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult “substance over form” questions.

D. Overly complex organisational structure involving unusual legal entities or managerial lines of authority.

E. Low morale among senior management.

Answer 1

The fraud triangle is used to explain the motivation behind a fraud.In other words, fraud is a deceitful activity used to gain an advantage or generate an illegal profit. In addition, the illegal act benefits the perpetrator and harms other parties involved.

Opportunity refers to circumstances that allow fraud to occur. In the fraud triangle, it is the only component that a company exercises complete control over.

Incentive, alternatively called pressure, refers to an employee’s mindset towards committing fraud.

Rationalization refers to an individual’s justification for committing fraud.

Management failing to remedy known significant deficiencies in internal control on a timely basis is an example of :

(b) opportunities for fraud.

Significant portions of management compensation (for example, bonuses, share options, and earn-out arrangements) being contingent upon achieving aggressive targets for share price, operating results, financial position, or cash flowis an example of :

(a) incentives for committing fraud.

Significant, unusual, or highly complex transactions, especially those close to period end that pose difficult “substance over form” questions is an example of :

(b) opportunities for fraud.

Overly complex organisational structure involving unusual legal entities or managerial lines of authority is an example of :

(b) opportunities for fraud.

Low morale among senior management is an example of :

(c) attitudes/ rationalisations.