FRAUD THEORY

April 08, 2017

FRAUD THEORY

Group Assignment

Members of Group:

1. Ghina Rizqy C1L014020
2. Larasati Nanda R. C1L014021
3. Yuni Sofia M. C1L014036

Fraud is one of the most negative factors of society; it had appeared in ancient times and has not disappeared to this day. In today’s environment, dominated by democratic, high-tech and information systems, not only the number of the executed frauds has increased, but also their volume; there have also emerged new types of fraud, fraud-committing, and evasion techniques that have been completely unknown before. Here are some of fraud theory which is developed until now:

Fraud Triangle

Cassey’s theory―fraud triangle, aiming at emphasizing the basic elements determining fraud:

Opportunity is the ability to commit fraud. The perpetrator believes that he/she can conceive and commit acts of fraud without being detected. It should be noticed that opportunities must be perceived as real by the perpetrator, meaning that opportunity is not implicitly real. The perpetrator’s conviction is based on identified weaknesses in the internal control, poor management oversight, inadequate external oversight and monitoring (performed by external auditors, supervision entities, and governmental units), the management failure to implement adequate fraud mitigation and monitor processes, lack of a formalized policy on conflicts of interest, lack of prosecution of perpetrators, weak ethical culture etc.

The pressure, the second element in the fraud triangle, has financial and non-financial nature. Pressure takes different forms as for example: high financial needs, need to report better results due to the pressure to meet (unrealistic sometimes) targets (especially in austere times), frustrations related to work environment, professional aspiration and the desire to reach it sooner, the competitive professional environment and sometimes just the person’s desire to prove he/she can defeat the system, the inadequate incentive systems etc. Professionals in fraud forensic concluded that pressure is generally non observable.

Rationalization is considered by many specialists to be a crucial component in most frauds. In many cases, persons that had proved in time ethical and professional integrity are the initiators of frauds or fraudulent financial reporting. As the fraudster profile shows, the most frequent cases involve senior management as for example CEOs and CFOs, individuals highly respected and recognized for their professionalism. Cressey noticed that a morally acceptable rationalization is necessary before the crime takes place. By rationalization the fraudster is preserving his self-image as a trustworthy person.
Fraud Diamond

An important contribution to the fraud research is provided by David T. Wolfe and Dana R. Hermanson, authors’ of the ―fraud diamond concept. The ―fraud diamond concept adds the fourth component to ―fraud triangle: the individual’s capability. They started from the premise that fraudulent financial statement involves large amounts, solid accounting knowledge and specific abilities. Wolfe and Hermanson have selected four observable characteristics that can be identified in case of frauds involving large amounts.

Using the four-element fraud diamond, a fraudster’s thought process might proceed as follows :

Incentive: I want to, or have a need to, commit fraud.

Opportunity: There is a weakness in the system that the right person could exploit. Fraud is possible.

Rationalization: I have convinced myself that this fraudulent behavior is worth the risks.

Capability: I have the necessary traits and abilities to be the right person to pull it off. I have recognized this particular fraud opportunity and can turn it into reality.

The fraud diamond highlights the fact that the capabilities to commit fraud are explicitly and separately considered in the assessment of fraud risk. As a result, the fraud diamond moves beyond viewing fraud opportunity largely in terms of environmental or situational factors. The capabilities are generated by the person’s position or function within the organization that may offer the ability to create or exploit an opportunity for fraud not available to others. The fraudster is trained person that understands and exploits internal control weaknesses and uses his position in his advantage.
Fraud Pentagon Theory

There are five elements of the Fraud Pentagon :

Arrogance
Arrogance or lack of conscience is an attitude of superiority and entitlement or greed on the part of a person who believes that internal controls simply do not personally apply.

Competence
Competence is an employee’s ability to override internal controls, develop a sophisticated concealment strategy, and to control the social situation to his or her advantage by selling it to others.

Opportunity
Weak controls provide the opportunity for a person to commit fraud.

Rationalization
There is a motive to commit and conceal a fraud

Pressure
Not an ex post facto means of justifying a theft or fraud that has already occurred.
Fraud Scale Theory

Dr. Steve Albrecht—The Fraud Scale

There are top 3 factors from personal characteristic list:

• Living beyond their means

• Overwhelming desire for gain

• High personal debt

Based on that, Dr. Steve Albrecht conclude that fraud most likely to occur when:

• Situational Pressure is High

• Personal Integrity is Low

• Perceived Opportunity is High
MICE Theory

Another model called “MICE” was suggested by Kranacher, in 2010. In this model they suggested that motivation of fraud perpetrators, which is one of the sides in the fraud triangle, may be more appropriately expanded and identified with the acronym: MICE that stands for:

Money,
Ideology,
Ideological motivators justify the means where they can steal money or participate in a fraud act to achieve some perceived greater good that is consistent with their beliefs
Coercion,
Coercion occurs when individuals may be unwillingly pulled into a fraud scheme, but those individuals can turn into whistleblowers.
and Ego.
Ego can also be a motive for fraud, where sometimes people don’t like to lose their reputation or position of power in front of their society or families.

This social pressure can be a motive to commit fraudulent act just to keep their ego. In addition, Dorminey, et al. (2010) argued that the model cannot solve the fraud problem alone because two sides of the fraud triangle, pressure and rationalization, cannot be easily observed.
GONE Theory
The GONE theory holds that Greed, Opportunity, Need and the Expectation of not being caught are what lay the groundwork for fraud. Greed and/or need provides the motive.
The fraud may be further driven by:

-          Financial problems, possible due to marriage breakdown or heavy debt load

-          Delusions of grandeur

-          An inflated ego

-          A craving for success

-          A compulsion, such as gambling or substance abuse problems.

More specific indicators of fraud include:

-          Reluctance to take vacations,

-          Living beyond one's means

-          Sudden mood swings or personality change

-          Inability to keep up with regular work responsibilities
These factors are frequently characterized as the typical 'red flags' that may indicate the potential for fraud. If in addition, your organization has lax or non-existent internal controls, fails to segregate duties and has a willingness to put its trust in the wrong hands, you have the explosive combination that spells opportunity.