But financial pressure and rationalization closely involve individuals’ ethical framework and organizational culture, and those are much more difficult to influence overtly and directly. Each of these rationalizations serves to reconstruct the fraudster’s identity from a wrongdoer to a righteous actor, a defender of personal values, or a victim of circumstance. The complexity of these justifications highlights the intricate psychological mechanisms at play and underscores the challenges in both preventing and addressing fraudulent behavior. Understanding these rationalizations is crucial for developing more effective deterrents and for helping individuals resist the temptation to rationalize fraudulent actions. Fraudulent behavior often begins not with a grand scheme or a clear intent to deceive, but with small, seemingly insignificant steps that gradually lead down a perilous path.
- They perceive GAAS audits as not sufficiently focused on detecting fraud, as the primary institutional inhibitor of fraud detection.
- The Schneider Downs Our Thoughts On blog exists to create a dialogue on issues that are important to organizations and individuals.
- The complexity of these justifications highlights the intricate psychological mechanisms at play and underscores the challenges in both preventing and addressing fraudulent behavior.
- It highlights the need for a nuanced approach to ethics, one that considers the cultural context in which decisions are made.
- Whenever the fraud incident occurs, the need to look at the situation from the fraudster’s perspective is important.
Opportunity: The Gateway to Fraud
If you have any questions on preventing fraud in your organization, or suspect fraud may have already occurred at your organization, please contact an Anders advisor below. The Fraud Triangle helps companies understand how and why fraud is committed so they can take proactive measures to address the causes of fraud before it occurs and better detect fraud if and when it does occur. Learn accounting fundamentals and how to read financial statements with CFI’s free online accounting classes. Forensic accounting is the investigation of fraud or financial manipulation by performing extremely detailed research and analysis of financial information.
For instance, an employee with mounting debts might manipulate financial statements to secure a bonus or promotion. Similarly, a company facing intense market competition may inflate earnings to meet investor expectations, violating accounting standards like GAAP or IFRS. Once aware of typical rationalizations, CPAs must address them, and theExhibitprovides many potential responses. Research shows that individuals who behave unethically usually experience guilt and discomfortbeforecommitting the deviant act, and that they try to reduce this guilt and discomfort through rationalization. By understanding the common techniques for rationalization, organizations can design antifraud programs to make rationalization harder and, as a result, make it more challenging for potential fraud-sters to commit fraud.
SVA’s Biz Tips are quick reads on timely information sent to you as soon as they are published. The second leg of the fraud triangle is the opportunity, also called perceived opportunity. Dr. Cressey found in his research that all three components of the fraud triangle must be present for an ordinary person to commit fraud. Various people obey the laws and regulations of the country because they believe that compliance with laws and regulations is their main responsibility. These types of people are afraid of being exposed if they are found in any illegal activity or non-compliance with any law or regulation.
The Sarbanes-Oxley Act mandates whistleblower protections, encouraging employees to report unethical practices without fear of retaliation, thereby disrupting the rationalization process. Creating feelings of ownership in the organization through stock options or rationalizing fraud similar compensation can also backfire, as past frauds prove that this encourages the very behavior companies seek to prevent. Accordingly, a strong corporate board, an internal audit function, and external audit monitoring are critical for mitigating this principal-agent problem. Gaining an understanding of the Fraud Triangle can help management, accountants and counsel develop proper internal controls to help combat fraud in the workplace. In order to create effective antifraud programs that counter this tendency, it is important to recognize typical rationalizations that potential fraudsters are likely to invoke.
- The week-long campaign encourages business leaders and employees to proactively take steps to minimize the impact of fraud by promoting anti-fraud awareness and education.
- An additional issue that is needed for fraud to continue over a period of time is the ability of the perpetrator to rationalize the situation as being acceptable.
- It involves understanding the various ways people rationalize their actions and implementing strategies that can counter these justifications.
- Schneider Downs is a Top 60 independent Certified Public Accounting (CPA) firm providing accounting, tax, audit and consulting services to public and private companies, not-for-profit organizations and global companies.
Opportunity enables individuals to exploit weaknesses in an organization’s systems or controls. A lack of robust internal controls is a key contributor, allowing potential fraudsters to bypass checks and balances. For example, if an organization does not segregate duties properly, an employee may be able to initiate, authorize, and record transactions independently, creating conditions ripe for fraud. Effective internal control systems, as emphasized by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), are essential to mitigating these risks. Similarly, framing a fraudulent act as being “below the materiality threshold” is another dangerous rationalization unique to the accounting context.
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It is easy to invoke this technique while manipulating financial statements, because shareholders are so far removed from the immediate fraud perpetrators. Patrick Kuhse, who stole millions of dollars from the state of Oklahoma through fraudulent commissions in the early 1990s, rationalized that no one would be hurt much since Oklahoma has millions of taxpayers. In the above-mentioned case of Autonomy Corporation, Hussain’s lawyer argued the case should have been dismissed because Autonomy was a U.K. Corporation, purchased by a Dutch subsidiary of Hewlett Packard—which made it challenging to identify the fraud victims and related jurisdiction. Because of my early fraud research in business, many have asked me if I was the person who first developed this triangle. In this article, I’ll present a brief history of how the Fraud Triangle came to be.
Surprisingly, none of the examples of potential fraud rationalizations in COSO’s Integrated Framework include anything related to the first two items above. Of the three examples COSO provides, two center on fraud consequences, and the third relates to denial of the victim. These examples are helpful, but incomplete; unless CPAs learn to think like crooks, they will continue to handcuff their fraud-fighting efforts. It may not be possible to address all pressures on employees, especially if the pressure is from external sources. Yet, appropriate employment policies, such as employee assistance programs and appropriate levels of time off may help.
Perhaps auditors, using enhanced interview skills, can learn to detect the rationalizations that are psychological red flags for underhanded behaviour. According to a recent report by PricewaterhouseCoopers, one in three organizations is a victim of fraud within a one-year period. Another study by the Association of Certified Fraud Examiners indicates that organizations lose about five percent of annual revenues to fraud.
Rationalization: Justifying the Means: The Psychology Behind Fraud Rationalization
First, consider that the incentive structures and external economic realities that feed this rationalization are common across employees. Recognize that all employees are likely to fear job loss and retaliation, and to feel a responsibility for their colleagues’ well being. “Pressure” refers to the motivation of the employee – that is, what is driving him or her to commit fraud. These pressures may be unrelated to work, and are rather personal in nature, such as overwhelming debt, addiction, divorce, or other family issues. However, there may also be work-related pressures, such as high demands by supervisors regarding meeting financial targets or performance-related bonuses.
Fraud deterrence is based on the premise that fraud is not a random occurrence; fraud occurs where the conditions are right for it to occur. Cultural influence on ethical boundaries is a complex interplay of societal values, norms, and practices. It shapes the way individuals perceive and rationalize their actions, including those that fall into the gray area of ethics. Understanding this cultural dimension is crucial for comprehensively addressing the psychology behind fraud rationalization. It highlights the need for a nuanced approach to ethics, one that considers the cultural context in which decisions are made. Rationalization allows individuals to justify unethical behavior by reframing their actions as acceptable under the circumstances.
Understanding the Fraud Triangle: The Motivation, Opportunity, and Rationalization Behind Fraudulent Acts
Some may view their actions as a temporary loan they intend to pay back, while others might feel entitled to the funds due to perceived injustices, such as being underpaid. There are those who rationalize their behavior by believing that the victim, often a faceless corporation, can afford the loss or that it’s a victimless crime. However, from the viewpoint of the victim, be it an individual, a business, or society at large, the consequences of fraud are real and tangible, ranging from financial loss to emotional distress.
The key takeaway is management, with advice from corporate counsel and accountants, has the power to identify and mitigate fraud risks. Next, to address the rationalization aspect, it is important for companies to create a corporate culture that truly values employees, sets proper ethical codes of conduct, and insists on accountability. In the aftermath of fraudulent behavior, individuals often engage in a psychological process to justify their actions, a phenomenon known as post-fraud rationalization.
Rationalization is a psychological defense mechanism wherein individuals justify choices that may be in conflict with their moral principles or societal norms. In the context of fraud, rationalization often serves as the bridge over the ethical gap that separates dishonest actions from an individual’s self-image as a good person. Breaking this cycle of rationalization is crucial for both preventing and addressing fraudulent behavior. It involves understanding the various ways people rationalize their actions and implementing strategies that can counter these justifications.
Cognitive dissonance occurs when a person holds contradictory beliefs, ideas, or values, and is typically experienced as psychological stress when they participate in an action that goes against one or more of them. To learn how people rationalize unethical behaviour, Pamela runs experiments with students in networked computer labs. She plays with the three sides of the fraud triangle—incentive, opportunity, and rationalization—to see how people rationalize behaviour when they have opportunity and motive to act unethically. Students perform a task that leads to earned income, then are given the opportunity to report their hours worked—even lie—in order to be paid more. Current auditing standards provide little guidance on identifying, understanding, and mitigating fraudsters’ rationalizations. In addition, denial of the victim is a popular rationalization when the victim is not known or physically distant.
Performance measurements for rewarding senior executives and others should be expanded to include accomplishment of more ethics-based matter. Rationalization is known to be the wild card of the Fraud Triangle because it factors in emotional challenges, as well as the ability to manipulate others while operating in a false reality. Understanding why people commit fraud can help in preventing fraud at your organization.
