The Fraud Triangle, Red Flags and Skepticism

Jill S. G. Palmeter, CPA, Partner (Feb, 2015)

Most anyone who has attended a fraud seminar or read articles about fraud has also heard of the Fraud Triangle of opportunity, rationalization and pressure.  When opportunity, such as weak internal controls, combines with pressure, such as personal financial problems or unrealistic performance demands, some individuals will rationalize fraud by convincing themselves that they are not being rewarded in a fair manner. These three conditions play an important role in triggering an organization’s susceptibility to fraud and can lead an otherwise honest employee to commit fraud.

Nonprofit organizations are usually operating on tight budgets with limited staff, most of whom have a trusting nature.  Even though fraud can be difficult to detect, especially if upper management is involved, there are some “red flags” that can serve as early indicators that there may be a problem.  If internal controls or the checks and balances in organizations are weak, fraud can be a big concern.  A sampling of questions to ask:

  • Are bank reconciliations being done in a timely manner?  Are they being reviewed in a timely manner by someone other than the person preparing them?  Do the balances match the accounting data?
  • Is there oversight of the person who has control over cash disbursements?  Are there approvals for all expenditures by the correct level of management?
  • A total accounts receivable balance might look “reasonable” when compared to prior years, but is it comprised of old or “stale” accounts receivable with little follow-up activity?  Do answers provided make sense or are they offered hesitantly?
  • Are accounts payable tested for approval?  Are voids and credit memos properly approved and monitored? 
  • Are journal entry postings changing or adjusting the record of accounting transactions reviewed and approved by responsible parties?
  • Have donors mentioned not receiving a written acknowledgement for their contributions?  Might some receipts have been misdirected?
  • Is an audit trail of transactions backed up daily or weekly and stored offsite?  Are they ever tested to ensure their integrity?
  • Are computer passwords periodically changed to reduce the risk of improper access?
  • Are there written whistleblower and conflict of interest policies?  Are employees at all levels encouraged to report improper practices without fear of improper retaliation?
  • Do any employees appear to living beyond their means?

Remember, if an employee experiences the pressure, opportunity and ability to rationalize his or her fraudulent behavior, then the applicable management of the organization needs to remember to be skeptical.  If these three conditions are present, ask probing questions, critically assess evidence and be attentive to inconsistencies.  There is also the potential for governance deficiencies---failure to set an ethical tone, a disengaged board, management override of controls, collusive behavior that goes unnoticed, or a lack of communication or sufficient knowledge on the part of those who have a role in financial reporting.

Fraud-resistant organizations usually have a tone at the top that encourages an ethical culture, demonstrates the presence of skepticism, and engages all participants in the financial reporting function so they can understand and effectively perform their roles.

At Dermody, Burke & Brown, we encourage every organization to be as educated as possible regarding their system of internal controls.  Accounting fraud and the different ways to combat it remain a challenging element of all organizations.  Contact your audit and certified fraud team at DB&B with any questions or concerns.


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The information reflected in this article was current at the time of publication. This information will not be modified or updated for any subsequent tax law changes, if any.