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Fraud Triangle

Reference entry · last updated 20261007

The fraud triangle is a model of why people commit occupational fraud. It names three conditions: an incentive or pressure, a perceived opportunity, and a rationalization of the act.[1][3] The model grew out of Donald Cressey's research on embezzlers and is embedded in auditing standards.[2][3]

First principles and definitions

For audit purposes, fraud is an intentional act that results in a material misstatement in audited financial statements. Intent separates fraud from error.[1]

PCAOB auditing standard AS 2401 states that three conditions generally are present when fraud occurs:[1]

1. Incentive or pressure. Management or other employees have a reason to commit fraud.
2. Opportunity. Circumstances allow the fraud, for example absent or ineffective controls, or management's ability to override controls.
3. Rationalization. Those involved can justify the act to themselves. Some people hold values that permit a dishonest act. Otherwise honest people can also commit fraud under sufficient pressure.

The same standard notes that greater incentive or pressure makes rationalization more likely.[1] It applies the conditions to two types of misstatement: fraudulent financial reporting and misappropriation of assets.[1]

Opportunity is the condition an organization controls most directly. AS 2401 states that when management and overseers set the proper tone and establish controls, the opportunities to commit fraud can be reduced significantly.[1]

Origins in embezzlement research

The model is usually traced to criminologist Donald R. Cressey. He was a doctoral student of Edwin Sutherland, who coined the term "white-collar criminal".[3] Cressey's question was why some people in positions of financial trust violate that trust while others in similar positions do not.[3]

Between 1949 and 1951, Cressey interviewed 133 male prisoners at Joliet, Chino, and Terre Haute. Each had accepted a position of trust in good faith and later violated it. He used analytic induction: he revised his hypothesis whenever a case contradicted it.[3] He published the results in Other People's Money (1953).[4]

His final hypothesis described a sequence of three conditions:[3]

• The person sees a "financial problem which is non-shareable", one they feel unable to disclose to others.
• The person knows the problem can be solved in secret by violating the position of trust.
• The person has a verbalization that reconciles being a trusted person with using the entrusted funds.

The ACFE summarizes the three components as unshareable financial need, perceived opportunity, and rationalization.[2] Later formulations widened the first condition from a non-shareable problem to incentive or pressure in general, as seen in AS 2401.[1][3]

Origin of the name

Cressey did not use the term "fraud triangle" in his writings, and his study concerned embezzlement rather than fraud in general.[3] Two accounts of the name exist:[3]

• An ACFE representative told researchers that the association's founder, Joseph Wells, first drew the three factors as a triangle in a 1985 video featuring Cressey.
• W. Steve Albrecht has said he coined the label after a seminar attendee compared the factors to the fire triangle. Albrecht used the term in a 1991 article.

Current ACFE material describes the fraud triangle as developed by Cressey.[2]

Use in auditing standards

The three conditions entered US auditing standards in 2002 through SAS No. 99, Consideration of Fraud in a Financial Statement Audit. ISA 240 carries a parallel formulation internationally. These standards do not use the phrase "fraud triangle", but they are understood to refer to it.[3]

For public-company audits, the appendix to PCAOB AS 2401 lists example fraud risk factors in three groups: incentives/pressures, opportunities, and attitudes/rationalizations. It gives separate lists for fraudulent financial reporting and for misappropriation of assets, and it states that the examples are not exhaustive.[1]

Illustrative mapping

Illustrative example, not a reported case: a bookkeeper with a hidden gambling debt also reconciles the bank account they record. The bookkeeper plans to repay the money before anyone notices.

The table is an author-created illustration of how the three conditions are commonly applied. The control responses are examples, not requirements from a cited standard.

Extensions: the fraud diamond

The most widely discussed extension is the fraud diamond proposed by David T. Wolfe and Dana R. Hermanson in 2004. It adds a fourth element, capability: the personal traits and position that let a person carry out and conceal a fraud.[3][5] Their list of capabilities covers the person's position or function, intelligence and skill, a strong ego, the ability to coerce others, the ability to lie convincingly, and the ability to handle stress.[3]

Albrecht has also argued that the triangle applies to any kind of "compromise", not only fraud.[3]

Criticisms and limits

• Little predictive power. Analytic induction explains cases already identified. Cressey himself wrote that the theory had few practical applications for prevention or detection.[3]
• No control group. Cressey did not interview trusted people who had not violated trust, to see whether they also showed the three conditions. His subjects also had to recall their past states of mind.[3]
• Scope. The sample was embezzlers who accepted trust in good faith. Applying the model to fraud in general, including planned frauds, extends it beyond the population studied. One critic proposed renaming it the "embezzlement triangle".[3]
• Are all three conditions required? Cressey held that the absence of any one condition precludes violation. Albrecht's later work found that the forces interact, so a strong enough motive might suffice without the others. Interview research by Schuchter and Levi found that all three were not always present.[3]
• Individual focus. The model describes one offender. Reviews of major corporate frauds, such as Enron and WorldCom, note that collusion is central to many complex frauds.[3]

See also

• Trust
• Phishing

References

1. Public Company Accounting Oversight Board, AS 2401: Consideration of Fraud in a Financial Statement Audit, paragraphs .04 to .07 and Appendix A.1 to A.2.
2. Association of Certified Fraud Examiners, Fraud 101: What Is Fraud?, section "Why Do People Commit Fraud?".
3. Leandra Lederman, The Fraud Triangle and Tax Evasion, Indiana University Maurer School of Law Research Paper No. 398, working paper, 2019 (SSRN abstract 3339558). Secondary source for Cressey's method and hypothesis, the naming accounts, SAS No. 99, the fraud diamond, and the criticisms, with citations to the primary works.
4. Donald R. Cressey, Other People's Money: A Study in the Social Psychology of Embezzlement, 1953. Print source; details on this page are as reported in [3].
5. David T. Wolfe and Dana R. Hermanson, "The Fraud Diamond: Considering the Four Elements of Fraud," The CPA Journal 74 (December 2004): 38. Not retrieved in full; details on this page are as reported in [3].