1. Week 2: FAFI
Why People Commit Fraud
Dr Arika Artiningsih M.Acc., M.Com., M.Res., CFE
2. 3
• Research shows that anyone can commit fraud.
• Fraud perpetrators usually can’t be distinguished from other people
on the basis of demographic or psychological characteristics.
• Most employees, customers, vendors, and business associates and
partners fit the profile of fraud perpetrators and are capable of
committing fraud.
• It is impossible to predict in advance which employees, vendors,
clients, customers, and others will become dishonest.
Who Commits Fraud
3. 5
Three elements of the fraud
triangle
• Perceived pressure
• Perceived opportunity
• Some way to rationalize the
fraud as acceptable
The Fire and fraud Triangles
Fraud Triangle
Fire Triangle
5. 7
• Financial Pressures
• Vice Pressures
• Work-Related Pressures
• Other Pressures
The Elements of Pressure
6. 8
Financial Pressures
Individual Perpetrators
• Common real or perceived financial pressures
associated with fraud that benefits
perpetrators directly
• Greed
• Living beyond one’s means
• Inability to pay bills or personal debt
• Poor credit
• Personal financial losses
• Unexpected financial needs
Organizations
• When management fraud occurs
• Companies overstate assets on the
balance sheet and net income on the
income statement
• Some causes of pressure
• A poor cash position
• Receivables that aren’t collectible
• A loss of customers, obsolete inventory
• A declining market
• Restrictive loan covenants that are
being violated
7. 9
Vice and work-related Pressures
Work Related
• Some people commit fraud to
get even with their employer or
others.
• Motivating factors
• Getting little recognition for job
performance
• Having a feeling of job
dissatisfaction
• Fearing losing one’s job
• Being overlooked for a promotion
• Feeling underpaid
Vice
• Closely related to financial
pressures are motivations
created by vices
• Examples
• Gambling
• Drugs
• Alcohol
• Expensive extramarital
relationships
8. 10
• Family pressures
• Challenge to beat the system
• Envy
• Desire for success
Other Pressures
9. 11
• A perceived opportunity to commit fraud, conceal it, or avoid being
punished is the second element of the fraud triangle.
• At least six major factors increase perceived or real opportunities for
individuals to commit fraud within an organization.
1. Lack of internal controls that prevent and/or detect fraudulent behavior
2. Inability to judge quality of performance
3. Failure to discipline fraud perpetrators
4. Lack of access to information or asymmetrical information
5. Ignorance, apathy, or incapacity
6. Lack of an audit trail
The Elements of Opportunity
10. 12
• The control environment
• Management’s role and example
• Management communication
• Clear organizational structure
• Effective internal audit department
• Information and communication
• Control activities (procedures)
• Segregation of duties, or dual custody
• System of authorizations
• Independent checks
• Physical safeguards
• Documents and records
Internal Controls That Prevent and/or Detect
Fraudulent Behavior (1)
11. 13
Three components work together to eliminate or reduce the
opportunity for employees and others to commit fraud
• Control environment
Establishes an atmosphere in which proper behavior is modeled and labeled,
honest employees are hired, and all employees understand their job
responsibilities
• Accounting system
Provides records that make it difficult for perpetrators to gain access to assets,
to conceal frauds, and to convert stolen assets without being discovered
• Many variations of the five control activities or procedures
Prevent and detect fraudulent behavior
The Controls That Prevent or Detect Fraud
12. 14
• SAPID is an acronym to help you remember the five types of control activities
• Separation of duties
• Authorizations
• Physical controls
• Independent checks
• Documents and records.
• Two parts of the acronym
• First three activities (SAP) are the control activities that prevent fraud from occurring
but are often the most expensive to implement.
• Last two activities (ID) don’t prevent fraud but are instead detective controls that help
catch or detect fraud before it gets too large.
Five Types of Control Activities (SAPID)
14. 16
Judging quality of performance
• Situations where it is easy—fence example
• Situations where it is difficult—hiring lawyer, a doctor, a dentist, an
accountant, an engineer, or an auto mechanic
Often difficult to know whether you are paying an excessive amount or receiving inferior
service or products
Easy for service provider to overcharge, perform work not needed, provide inferior
service, or charge for work not performed
Inability to Judge the Quality of Performance (2)
16. 18
• Many frauds are allowed to be perpetrated because victims don’t
have access to information possessed by the perpetrators.
• These are cases of asymmetrical information: that is, one party has
information about products or situations and the other party does
not.
This is especially prevalent in many of the large management frauds that have
been perpetrated against stockholders, investors, and debt holders.
Certain employee frauds are also allowed to be perpetrated because only
offenders have access to information.
Lack of Access to Information or Asymmetrical
Information (4)
17. 19
• Older people, individuals with language difficulty, and other
“vulnerable” people are often fraud victims because perpetrators
know that such individuals may not have the capacity or the
knowledge to detect their illegal acts.
• Various consumer frauds such as prime bank fraud, pyramid scams,
Internet fraud, phone scams, chain letters, modeling agencies,
telemarketing fraud, and Nigerian scams are all crimes of persuasion
that try to get victims to unknowingly invest money.
Ignorance, Apathy, or Incapacity (5)
19. 21
• Organizations go to great lengths to create documents that will
provide an audit trail so that transactions can be reconstructed and
understood.
• Many frauds, however, involve cash payments or manipulation of
records that cannot be followed.
• Smart fraud perpetrators understand that their frauds must be concealed.
• They also know that such concealment must usually involve manipulation of
financial records.
• When faced with a decision about which financial record to manipulate,
perpetrators almost always manipulate the income statement because they
understand that the audit trail will quickly be erased.
Lack of an Audit Trail (6)
20. 22
• Most fraud perpetrators are first-time offenders who would not commit
other crimes.
• In some way, they must rationalize away the dishonesty of their acts.
• Common rationalizations used by fraud perpetrators include the following:
The organization owes me.
I am only borrowing the money and will pay it back.
Nobody will get hurt.
I deserve more.
It’s for a good purpose.
We’ll fix the books as soon as we get over this financial difficulty.
Something has to be sacrificed—my integrity or my reputation.
The Element of Rationalization
21. 23
• The majority of frauds—especially financial statement frauds—are
collusive, meaning that the act involves more than one perpetrator.
• In some cases one person, after he or she has become involved in
fraud as a result of the fraud triangle, influences another individual to
participate in the fraud.
• Power is used in different ways to recruit people to participate in
fraud.
Fraud Recruitment
23. 25
• Reward power
The ability of a fraud perpetrator to convince a potential victim that he or she will receive a certain
benefit through participation in the fraud scheme
• Coercive power
The ability of the fraud perpetrator to make an individual perceive punishment if he or she does not
participate in the fraud
• Perceived expert power
The ability of the fraud perpetrator to influence another person because of expertise or knowledge
• Legitimate power
The ability of the fraud perpetrator to convince a potential perpetrator that he or she truly has power
over him or her
• Referent power
The ability of the perpetrator to relate to the potential co-conspirator
Power
