Research Paper

Topic : FRAUD SCALE

Presented by : CA A B

Membership No : 123456

Introduction

In law, fraud is deliberate deception to secure unfair or unlawful gain, or to deprive a victim of a legal
right. Fraud itself can be a civil wrong (i.e., a fraud victim may sue the fraud perpetrator to avoid the
fraud or recover monetary compensation), a criminal wrong (i.e., a fraud perpetrator may be prosecuted
and imprisoned by al authorities) or it may cause no loss of money, property or legal right but still be an
element of another civil or criminal wrong. The purpose of fraud may be monetary gain or other benefits,
such as obtaining a passport or travel document, driver's license or qualifying for a mortgage by way of
false statements.

In recent years, corporate financial accounting scandals no longer become unexpected news of the day.
Cases such as Enron, WorldCom, Global Crossing and Tyco are among the most prominent ones who had
suffered from the devastating impact of fraud. These costly scandals have increased global concerns about
fraud, wiping out billions of dollars of shareholder value, and led to the erosion of investors and public
confidence in the financial markets (see, Peterson and Buckhoff, 2004; Rezaee, Crumbley and Elmore,
2004 in Bierstaker, Brody and Pacini 2006). Many studies have discussed fraud-related issues, and the
general view is that fraud prevention should be the main focus. It is less expensive and more effective to
prevent fraud from happening than to detect it after the occurrence. Usually, by the time the fraud is
discovered, the money is unrecoverable or the chance to recover the full amount of the loss is very slim.
Furthermore, it is costly and time consuming to investigate frauds especially involving large-scale
multinational operations. However, if the focus is on fraud prevention all the monetary losses, time and
effort to reconstruct fraudulent transactions, track down the perpetrator, and reclaim missing funds can be
saved. Thanasak (2013:1) states that before making any efforts to reduce fraud and manage the risks
proactively, it is important for the business organizations to identify the factors leading to fraudulent
behaviour by understanding who are the fraudsters, when and why frauds are committed. Various theories
have attempted to explain the causes of fraud and the two most cited theories are the Fraud Triangle
Theory (FTT) of Cressey (1950) and Fraud Diamond Theory (FDT) of Wolfe and Hermanson (2004).
Both of them identify the elements that lead perpetrators to commit fraud. According to Dorminey,
Fleming, Kranacher, and Riley (2010), the origin of the FTT dates to the works of Edwin Sutherland
(1939) who coined the term white-collar crime, and Cressey was one of Sutherland's former students.
Cressey (1950) focused his research on the factors that lead individuals to engage in fraudulent and
unethical activity. His research later became known as the FTT. This theory consists of three elements
that are necessary for fraud to occur: (i) perceived pressure, (ii) opportunity, and (iii) rationalization.
David T. Wolfe and Dana R. Hermanson believed that the former FTT has to be enhancing to improve
both fraud prevention and detection by considering an additional element above the three, mentioned
elements of FTT. They considered four sided FDT thereby adding capability as the fourth element. Wolfe
and Hermanson (2004, p. 38) state that fraud cannot successfully conceal unless the fraudster has the
capability to have all personal traits and abilities even in the presence of the other three elements. In their
separate works, Wolfe and Hermanson (2004), Thanasak (2013), Norman and Faizal (2010), Florenz
(2012), Gbegi and Adebisi (2013) examined and discussed the FDT. Their main conclusion was that the
FDT is an extended or improved version of the FTT with an addition of “capability” added to the three
basic elements of fraud in the FTT. Therefore, this paper aims to explain further the convergent and
divergent between the FTT and FDT.

Fundamental Concept of Fraud

Fraud has grown rapidly over the last few years, and there is a growing trend for large organizations to
consider hiring professionals such as forensic accountants to reduce the pressure and potential of
occupational, financial frauds. ACFE (2010) and Sutherland (1943) occupational fraud is the process of
using one's occupation or responsibility to satisfy his personal interest by enriching himself through the
deliberate abuse of power. Abuse of power by the fraud perpetrators includes deliberate mismanagement,
and misrepresentation of organizational resources (fixed and current assets). Regardless of the type or
nature of the sectors, various category of financial crime and other types of occupational are taking place
such as swindles and employee trust violations (ACFE, 2010; Duffield and Grabosky, 2001; Levi, 2008;
Kiragu, Wanjau, Gekara, and Kanali, 2013). Merriam Webster's Dictionary of Law (1996) as quoted in
Manurung and Hadian (2013, p. 4), fraud can be defined as: “Any act, expression, omission, or
concealment calculated to deceive another to his or her disadvantage, specifically, a misrepresentation or
concealment with reference to some fact material to a transaction that is made with knowledge of its
falsity. And or in reckless disregard of its truth or falsity and worth the intent to deceive another and that
is reasonably relied on by the other who is injured thereby.” Ernst and Young (2009) defines fraud as an
act of deliberate action made by an entity, knowing that such action can result in a possession of unlawful
benefits. Adeneji (2004) and Institute of Chartered Accountants of Nigeria (ICAN) (2006), state that
fraud is an intentional act of individuals among management, employees or third parties who produce
errors in financial reporting in favour of their personal desires. Fraud can also be considered as any
deliberate misrepresentation, concealing and negligence of a truth to manipulating the financial statement
to at the expenses of the firm.

To prevent fraud, we must first understand why it occurs. Unfortunately, there is no definitive answer as
to why people commit fraud. Every human being is unique. Everyone’s chemical makeup is different, and
everyone has different personal experiences. Accordingly, people act differently in similar situations.
Although there is no clear answer as to why people commit fraud, research and experience have provided
some insight into the matter, and the following material describes the most common theories explaining
why people commit fraud.
Who Commits Fraud?

It helps to break down and understand the categories of fraudsters as a foundation for delving deeper into
their respective motivations. This discussion divides the perpetrators of fraud into the following
categories:
 Executive officers
 Managers
 Employees
 Contractors
 Customers or beneficiaries
 External perpetrators

Executive Officers

For the purposes of this course, the term executive officers refers to individuals who manage a agency or
departments of agencies; they can be elected or appointed. For example, in a typical city in the United
States, the mayor and city controller are executive offers. The mayor serves as the city’s executive officer,
and the city controller serves as the city’s chief financial officer (CFO).

According to the 2011 PwC Global Economic Crime Survey, senior executives within and state-owned
enterprises committed 24 percent of the reported frauds.

Executives might commit fraud for a number of reasons, such as to improve the appearance of their
entities. Typically, executives have the ultimate responsibility for the success or failure of their agency or
department, and they often serve as role models and authority figures. They face significant pressure to
ensure the organizational success, meet budgets and targets, and keep their jobs. Accordingly, they want
to see their agencies or departments succeed, and such desires might drive them to commit fraud to
conceal losses or poor performance. Some executives commit fraud because they consider it to be the
only way out of a bad situation.

Moreover, to become an executive, an individual generally must be ambitious and dedicated. Thus,
individuals in these roles are driven and often seek respect, social status, accomplishment, and even
power. Sometimes, however, the drive to obtain such benefits can overshadow a person’s ethics and cloud
his ability to make sound moral decisions.

Additionally, executives have authority over systems that they can exploit for fraudulent purposes. If an
executive who is responsible for ensuring that a organization meets its budgets and targets also has
authority over and the ability to influence lower-level staff, as well as access to the organization’s
information systems and records, the executive has the ability and motivation to commit fraud.

Executives in an organization might also use their influence over lower-level staff to perpetrate fraud.
Executives might pressure employees with threats of being fired, provide an environment that encourages
unethical practices, or offer financial incentives to employees to engage in fraud.
Managers

For purposes of this course, the term managers refers to employees who both supervise employees and
report to other employees within a organization. These individuals are expected to follow and lead at the
same time. Like executives, managers often face pressure to meet budgets and targets, which might
prompt them to unethical means to achieve their goals.

According to the 2011 PwC Global Economic Crime Survey, middle management within and
state-owned enterprises committed 24 percent of the reported frauds.

The types of frauds perpetrated by managers depend largely on which departments they work in. For
example, accounting managers might be able to perpetrate accounting-related frauds such as manipulating
journal entries or perpetrating shell company schemes. They also might have the ability to submit
falsified expense reports, falsify timesheets, or influence supplier or contract decisions in exchange for
bribes or kickbacks.

Employees

For purposes of this course, employees refer to individuals within an organization who do not have
management authority. There are various reasons why employees might commit fraud, but because
employees do not have the same access to financial records as management and executives, the types of
fraud and the magnitude of the losses that employees can cause is more limited. According to ACFE
research, occupational frauds are most often committed by individuals at the employee or managerial
level. There are likely many factors behind this: It might be a function of probability and organizational
structure—in general, there are more workers at those levels—or it might indicate that lower-level
employees and managers face greater risk factors, such as financial stress or job dissatisfaction, than
owners and executives.

Contractors

All entities rely on third-party contractors to deliver goods and services, and such entities can commit
fraud. Because entities are some of the largest buyers of goods and services, they engage in vast numbers
of contracts with third parties, which expose them to fraud risks. fraud related to contracting often
involves bribery or kickbacks, shell company schemes, bid rigging, market division schemes, bid
tailoring, and so on.

Beneficiaries

Beneficiaries—entities that receive benefits—can also commit fraud. Beneficiaries might use fraudulent
means to acquire benefits that they do not deserve. Often, opportunity and need motivate beneficiaries to
commit fraud.
External Perpetrators

External perpetrators are parties who commit fraud against an organization that does not employ them and
does not provide them with benefits. As with the other categories of perpetrators, external perpetrators
have a wide array of reasons for committing fraud. Many external perpetrators make a career out of
defrauding others, such as fraudsters who are part of organized crime rings. Others are motivated by the
same pressures as internal fraudsters.

The Fraud Triangle

The best and most widely accepted model for why people commit fraud is the fraud triangle. This is a
model developed by Dr. Donald Cressey, a criminologist whose research focused on embezzlers— people
he called “trust violators.” According to Cressey, there are three factors that must be present at the same
time for an ordinary person to commit fraud:
 Pressure
 Perceived opportunity
 Rationalization

a. Pressure (Non-Shareable Financial Problems)

The first leg of the fraud triangle represents pressure—what motivates the crime in the first place. The
individual has some financial problem that he is unable to solve through legitimate means, so he begins to
consider committing an illegal act as a way to solve his problem. The financial problem can be personal
(e.g., he’s too deep in personal debt) or professional (e.g., his job or business is in jeopardy).

Examples of pressures that commonly lead to fraud include:

b. Perceived Opportunity

The second leg of the fraud triangle is perceived opportunity, which is the method by which the crime can
be committed. The person must see some way he can abuse his position of trust to solve his financial
problem with a low perceived risk of getting caught.

According to the fraud triangle model, the presence of a non-shareable financial problem by itself will not
lead an employee to commit fraud. The non-shareable financial problem creates the motive for the crime
to be committed, but the employee must also perceive that he has an opportunity to commit it without
being caught. The perceived opportunity can arise from several sources, including:

 Poor internal controls

Thus, the person must see some way he can abuse his position of trust with a low perceived risk of being
caught. For example, if an employee has access to blank checks, he might see an opportunity to write a
company check payable to himself. But that check might be spotted during the reconciliation of the bank
statement and the employee would be caught. Under such facts, there is an opportunity to steal the funds,
but there is no opportunity to steal them without being caught. Conversely, suppose the same employee
also reconciles the company’s bank statement. Under these revised facts, the employee can write a check
to himself, destroy the fraudulent check when the bank statement arrives, and force the balance on the
reconciliation. Under such facts, the employee has a perceived opportunity to commit fraud .

c. Rationalization

The third leg of the fraud triangle is rationalization. Fraudsters must justify their crime to themselves in a
way that makes it an acceptable act, and this is known as rationalization. Rationalization must occur
before the crime takes place; it is not a means of justifying a fraud after the fact.
Fraudsters rationalize their misconduct in various ways. Here is a list of common excuses fraudsters give
to explain their corrupt conduct:
 Everyone else does it.
 We have always done it.
 It was the only way we could compete.
 We had no idea our agent was …
 We thought our anti-corruption programs were sufficient.
 We did not know the conduct would be considered a bribe.
 It was not a bribe; it was part of conducting business.
 Bribery is part of the culture in the country.

When Does the Fraud Triangle Not Apply?

The fraud triangle applies to most embezzlers and occupational fraudsters, but it does not apply to
predatory employees—individuals who take jobs with a premeditated intent of stealing from employers.

Also, while a rationalization is necessary for most people to begin committing fraud, perpetrators often
abandon rationalizations after the initial act. Most frauds are not one-time events. They usually start as
small thefts or misstatements and gradually increase in size and frequency. As the perpetrator repeats the
act, it becomes easier to justify until eventually no justification is needed at all.

The Fraud Diamond

Cressey’s fraud triangle demonstrates certain characteristics that increase the likelihood for fraud to
occur, but it does not provide perfect guidance. Although the fraud triangle helps explain the nature of
many occupational offenders, it does not explain the nature of all occupational offenders. Moreover,
Cressey’s study is nearly half a century old, and there has been considerable social change in the interim.
Now many anti-fraud professionals believe there is a new breed of occupational offender—one who
simply lacks a conscience sufficient to overcome temptation. Moreover, some experts believe that the
fraud triangle could be enhanced by considering a fourth element. In their article “The Fraud Diamond:
Considering the Four Elements of Fraud,” David Wolfe and Dana Hermanson incorporated the element of
capability—personal traits and abilities that play a major role in whether fraud will actually occur—into
Cressey’s model, transforming it from a triangle into a diamond. (See the figure below.)
According to Wolfe and Hermanson, many frauds would not have occurred without the right person with
the right ability to carry out the fraud. “Opportunity opens the doorway to fraud, and incentive and
rationalization can draw the person toward it. But the person must have the capability to recognize the
open doorway as an opportunity and to take advantage of it by walking through, not just once, but time
and time again. Accordingly, the critical question is, ‘Who could turn an opportunity for fraud into
reality?’

Wolfe and Hermanson state that there are observable traits for committing fraud, especially those that
involve large sums of money or last a long time:
 The person’s position or function might provide the ability to create or exploit an opportunity to
commit fraud.
 The person has the capacity to exploit control weaknesses.
 The person is confident that he will not be caught or believes that, if he is caught, he can talk his
way out of trouble.
 The person is persuasive and can coerce others to commit or conceal fraud.
 The person is a good liar.
 The person is good at dealing with the stress that comes from committing fraudulent acts.

Workplace Conditions

In 1983, Richard C. Hollinger and John P. Clark published Theft by Employees, a study based on
federally funded research involving surveys of nearly 10,000 U.S. workers. In their book, Hollinger and
Clark reached a different conclusion than Cressey. They concluded that employees steal primarily as a
result of workplace conditions and job dissatisfaction, and that the true costs of the problem are vastly
understated: “In sum, when we take into consideration the incalculable social costs … the grand total paid
for theft in the workplace is no doubt grossly underestimated by the available financial estimates.”

In short, Hollinger and Clark proposed that fraud prevention requires that management pay attention to
the following four aspects of workplace conditions:
 Having a clear understanding regarding theft behavior
 Continuously disseminating positive information reflecting the organization’s policies
 Enforcing sanctions
 Publicizing sanctions

Additionally Dr. Steve Albrecht and two of his colleagues, Keith R. Howe and Marshall B. Romney,
conducted research that identified ten environment factors that result in fraud:
 Placing too much trust in key employees
 Lack of proper procedures for authorization of transactions
 Inadequate disclosures of personal investments and incomes
 No separation of authorization of transactions from the custody of related assets
 Lack of independent checks on performance
 Inadequate attention to details
  No separation of custody of assets from the accounting for those assets
 No separation of duties among accounting functions
 Lack of clear lines of authority and responsibility
 Department that is not frequently reviewed by internal auditors

All of the factors on this list affect employees’ opportunities to commit fraud without being caught.

The Fraud Scale

To help predict the likelihood of a fraudulent act, Albrecht, Howe, and Romney created the Fraud Scale
to be a tool to help assess the likelihood of a fraudulent act through the evaluation of the relative forces of
pressure, opportunity, and personal integrity.

The Fraud Scale suggests that when pressure, opportunity, and integrity are considered at the same time,
one can determine whether a situation possesses a higher probability of fraud.

The fraud scale provides that when situational pressures and perceived opportunities are high and
personal integrity is low, occupational fraud is much more likely to occur than when the opposite is true.
Albrecht describes situational pressures as “the immediate problems individuals experience within their
environments, the most overwhelming of which are probably high personal debts or financial losses.

BIBLOGRAPHY
1. www.acfe.com
2. www.wikipedia.com
3. www: aaajournals.org
4. www.floridatechonline.com