What’s the fraud triangle?

An organization is vulnerable to fraud when these three conditions occur together: Pressure Opportunity Rationalization Together, they form what’s known as the fraud triangle, and help explain why people within an organization commit fraud. For example, an employee can succumb to the pressures of money problems — such as student loans, medical bills, or gambling debt — when they see a temporary opportunity to commit fraud. Then, they’ll find a way to rationalize and justify the fraudulent behavior.

What are the potential consequences of committing fraud?

Fraud impacts and risk may vary depending on the number of employees. Here’s a breakdown of specific risks and their impact for organizations of varying sizes. Small organizations: Fewer than 100 employees Fraud transactions are often small sums of money that result in large losses over time. For a small organization, the impact can be devastating. The average median loss was $117,000 per incident according to the ACFE. If the fraud incident continued for over five years, the average loss grew to $2.2 million. If it continued for 10 years or more, the number could be as high as $5.4 million, according to a 2017 Hiscox study. Inadequate controls Smaller transactions make theft harder to detect and the origin more difficult to pinpoint. Small organizations — or small branches of larger organizations — also tend to have fewer anti-fraud controls in place. The lack of these controls can lead to process loopholes and structure gaps, which allow employees an opportunity to exploit an organization. Approximately 29% of fraud incidents are caused by lack of internal controls and 23% are committed by an owner or executive, according to the same 2022 ACFE report. Trust issue In addition to financial loss, a lack of trust may develop between an organization and its employees or between the employees and the management team. The staff might be asked to pull double duty and assist in the investigation at a time when caution should be exercised. They may also be asked to allocate resources to cover key operational priorities, such as ongoing monitoring, taking funds away from their teams and tasks, and drawing further attention to the incident. Large organizations of more than 100 employees Although large organizations may have more resources to invest in their anti-fraud programs, their median loss is still $138,000 per incident, according to the 2022 ACFE report. They also face greater exposures to risk, such as: More employees who are willing to rationalize a fraud scheme Increased opportunities for fraud to occur because processes are more complex Greater volumes of financial transactions to tempt and pressure employees Larger organizations may feel safer because the average financial loss of each incident is lower, but more incidents of fraud could happen at a faster rate than smaller organizations.

What are the barriers to fraud prevention?

It can be easy to fall behind on risk reduction measures because fraud can originate from multiple sources, such as: Internal staff Customers Vendors Service providers Technology also continues to evolve, introducing new vulnerabilities and related fraud considerations. For example, blockchain and decentralized finance (DeFi) have simultaneously strengthened security and controls while also establishing new environments for fraud of various types to thrive, including Ponzi schemes, digital asset scams, and rug pulls. If adopting such technologies, whether internally or through a third-party service provider, it is important for entities to consider the impact to internal controls and fraud risk. When an organization is tackling a fraud prevention plan, they tend to face three key challenges: Identification of emerging fraud risks and how to address them Lack of internal resources and expertise Shortage of manpower to tackle a manual review of transactions Although these factors can lead to a higher risk of fraud occurring at an organization, they often go ignored until an incident has occurred.

How can your organization prevent fraud?

Risk management is a continuous process. Once a fraud incident is identified, an organization must assess and respond to the occurrence. Then, it should continue to carefully monitor its risks because inaction presents the perfect opportunity for future incidents to occur. Fraud risk assessment Performing an independent assessment of an organization’s internal controls provides an objective view of procedures and potential vulnerabilities. It’s an effective method of laying a strong foundation for anti-fraud objectives while controlling costs at the same time.

Article

Take a solutions-based approach to fraud prevention

Oct. 28, 2019 · Updated Aug. 30, 2022 · Authored by Colin Wallace

Occupational fraud can sometimes equal millions of dollars in revenue loss. But the bottom line isn’t the only thing that suffers.

Small amounts, taken over the course of several years can equal substantial loss. It also has the potential to break trust with management, employees, customers, and clients — sometimes a more devastating consequence.

Ultimately, fraud is detectable, but prevention requires diligence. Given the high cost of occupational fraud loss, taking precautions, and implementing risk reduction measures should be necessary steps for any organization, no matter its size.

How much does theft and fraud cost?

According to the Association of certified fraud examiners (ACFE) in 2022, 5% of revenue is lost each year to employee and executive fraud.

What are common risk factors and fraud techniques for organizations?

There are a number of possible risk factors that might make an organization more vulnerable to various fraud techniques. Here are some examples of both:

Risk factors

Weak Internal control. This includes a lack of timeliness for cash deposits, failing to monitor overdraft funds, lack of appropriate segregation of duties, and a gap in the reconciliation of departmental expenditures. The ACFE also found that internal control weaknesses were responsible for nearly half of all frauds in the United States in 2022.
Smaller organizations. In a small organization, the median loss per incident is $150,000. In comparison, organizations with more than 100 people suffer fraud losses of $104,000 on average, per the ACFE.
Specific industries. The manufacturing, energy, and public administration sectors are industries at higher risk for corruption schemes.

Colin Wallace

Principal

Take a solutions-based approach to fraud prevention

How much does theft and fraud cost?

What are common risk factors and fraud techniques for organizations?

Risk factors

Colin Wallace

Fraud techniques

What’s the fraud triangle?

What are the potential consequences of committing fraud?

Small organizations: Fewer than 100 employees

Inadequate controls

Trust issue

Large organizations of more than 100 employees

What are the barriers to fraud prevention?

Fear of future outcomes

How can your organization prevent fraud?

Fraud risk assessment

Confidential reporting hotline

Anti-fraud management technologies

Third-party protections

Have questions? Baker Tilly can help.