The various posts on the concept of fraud triangle have been combined into this page. Why? When many posts are up on a topic, they appear in reverse chronological order. So when an idea develops over many posts, you read them backwards on the blog. So, I will pull the fraud triangle posts together here in chronological order. Should be easier to read. Will only make a few minor editing changes. Here goes:
This will be the first in a series of on what accountants call the fraud triangle.
Just a few comments before we begin. These posts will be written in a more casual style that you would usually see from an accountant. They will definitely be more casual than you have seen in my published resources, which you can find here. When this series of posts is nearly finished, I will start compiling them into a ‘page’ on this blog so you can read them in sequence, instead of the reverse order from when they were written.
What is the fraud triangle?
Think back to your Boy Scout or Girl Scout days. Do you recalled the fire triangle? That is the description of what is necessary for fire to exist and continue. You need to have fuel, oxygen, and heat to have fire. To put out a fire (or more to the value of this analogy, to prevent a fire) you need to remove one of those three sides to the triangle. You could stop the fire by removing the fuel or removing the oxygen. You could also remove the heat to prevent or stop a fire. Do you know why a heavy stream of water sent into a burning room works so well to extinguish the fire? When the water hits the flames some portion of it boils into steam. When water turns to steam it expands tremendously. The steam crowds out the oxygen. It also absorbs a tremendous amount of heat. A good stream of water into an inflamed room shuts down the fire really fast.
That is a powerful analogy for fraud. There are three sides of a fraud triangle, all of which need to be present for fraud to take place. You can tremendously improve your odds of preventing a fraud by removing some of the sides of the triangle, which consists of:
*opportunity– the ability to do something wrong
*motivation–an incentive (or pressure) to carry it out
*rationalization –the self-deception to believe it is actually okay.
We will discuss these in more detail
Opportunity is the first side of the fraud triangle we will discuss. This is when there is a situation that would allow a person to do something wrong. These are the weaknesses and procedures to correct them that we usually talk about. Places where someone could get their hands on money and get it out the door. For example, having the bookkeeper sign checks. Not reconciling the bank accounts on a timely basis, or perhaps not reconciling them at all. Not having anyone look at the credit memorandums that are issued. Not paying attention to the accounts receivable that have been written off. Leaving the Sunday offering in a place where one person could get into the offering by themselves without anyone knowing they had accessed the offering. With new bill paying services offered by many banks, having the bookkeeper initiate electronic bill payments is another opportunity. All of these are examples of how money could go missing.
Other opportunities? Not keeping track of how many computers you have. Never checking to see if all your computers and A/V equipment is still around. Not getting competitive bids for supplies or equipment. Buying janitorial supplies exclusively from that “great deal” your custodian found. Pulling cash out of the collections from a special event to pay for costs of the special event. These, along with a long list of other situations are opportunities to commit fraud.
We could characterize all of these illustrations as weaknesses in the internal control procedures. These are the kinds of things you will usually hear CPAs discussing. We will discuss later how ministries can minimize opportunities or at least put boundaries around the opportunities.
Having the door wide open is one way to describe the concept of opportunity to commit fraud – there is nothing stopping you from getting your hands on the money and getting it out of the organization.
How does a person realize there is opportunity to do something wrong? One way is for a person to realize logically that some control or procedure that should be in place is not. This would happen with someone who has some understanding of internal controls, perhaps from formal training. More likely the knowledge would come from practical experience at a previous job where some controls were present back then but aren’t working in the new job.
The more dangerous path to knowledge is from experience. A person makes a mistake and it is never noticed. At some point the person would intentionally do something small that could be explained away as “a mistake” if detected. If that is missed by the controls, then a bigger amount is tried. If that is missed, then the barn door is not only wide open, but the walls are gone too.
Examples? A bookkeeper transposes an expense reimbursement (paying someone $910 instead of $190) and no one ever notices or comments. Bookkeeper falls behind on the bank reconciliations by six months and nobody comments. An employee reports some mileage or phone costs twice and it is not corrected. A manager requests a large payment to a new vendor without any supporting documentation and the vendor gets paid. Repeat the behavior a few times with transactions that are actually legitimate to make sure the systems is missing the boat all the time and you can cut loose.
In the typical fraud pattern the amounts are very small at first, most likely accidents. Then the amounts grow. In time, as the amounts are never noticed, the fraudster will get bolder with ever-increasing amounts.
Motivation is typically described as the pressure or incentive to commit fraud. When great pressure is brought to bear, people will do things you would have never thought possible. We used to illustrate this with someone who has a drinking problem or a gambling problem. Those illustrations of pressure don’t paint a good enough picture because you can’t drink enough (and still function) to create pressure to steal enough money to cause a severe problem. Let’s expand the picture. Long before someone with a drug problem deteriorates to the point of non-functioning, they can appear to function normally on the outside but have a need for so much money that the only way they could possibly feed their addiction is to steal from the ministry. I don’t know anything about the going price for illicit drugs, but I am aware enough to know that a serious problem would quickly be larger than anyone’s income in the non-profit world.
Let’s expand the motivation picture even further. Consider medical costs. Think about the way coverages have dropped and the marvels of modern technology have increased (along with the skyrocketing costs of all those astounding drugs and phenomenal machines). Today it is possible for a person to have $50,000 or $100,000 of uncovered costs from a serious illness. If a loved one is severely ill or suffers from a chronic disease, the uncovered costs could be astronomical. If someone has worked in ministry for a long time (at the wages typically paid in the NPO sector), where in the world will a person get the cash to continue caring for their loved one? From their savings? Not likely. From their house equity? Not anymore. Without any turmoil in the work environment, a person could find themselves with severe pressure to get money any way they can. Those silly little gaps in your accounting procedures quickly become a solution to all the problems.
Consider also the current housing crisis. A huge jump in monthly payments because of an adjustable rate mortgage could devastate a family’s finances. The pressure of being behind several months on a large loan could be more financial distress than a person has ever felt before. The fear of losing everything you have built up in a lifetime of work could be an overwhelming pressure.
It is very sad to read about the tragedies that take place. Immediately after posting the previous discussion of the motivation side of the fraud triangle, went to a blog I frequent. Have now added it to the blogroll on the right. Here is the article . It clearly illustrates the motivation factor.
A few quotes from the article:
“A judge has ordered a former church bookkeeper to pay $179,670 in restitution and write an apology to members of a Colorado Springs congregation after she pleaded guilty to stealing church funds.”
Church officials told police that the bookkeeper “…had submitted a letter Nov. 25 admitting to the theft. In the letter, she stated that she used the money to pay medical bills for her daughter, who had suffered a skiing accident in Summit County in January 2009. I have no excuse but to say I was desperate. We were overwhelmed with lawyer and court bills,” the letter stated. ‘I kept this all to myself and tried to pay some of it off. I did not tell my husband because I was so ashamed. I really thought that I could get it paid back.’ “
You can also see the ‘I will pay it back’ rationalization. Will discuss that factor later.
If you are so inclined, pray for the congregation, the woman, and her family.
Amongst the many dangers is that some motivations would be hidden from view in the workplace. Some of them, such as drinking or narcotics, would eventually show side effects in the workplace. Those factors could create visibility that would raise questions which in turn could in turn possibly result in discovery of the fraud. If that is the motivation, the plan could self-destruct fairly quickly.
Other motivations, such as health costs from serious illness of a loved one, uncontrollable gambling, or imminent house foreclosure could easily be completely invisible to coworkers and supervisors. Frauds driven by those motivations could last a long time.
Accountants used to think that motivations came from outside the workplace. Family illness, drugs, booze, gambling, and foreclosures don’t arise from the job. That is not the case anymore. Some NPOs have imposed across-the-board pay cuts with no change in hours. Many churches are on four day workweeks, which is a 20% cut in pay. Few people can absorb that without a lot of pain. Anxiety over whether there will be layoffs in the future can create a lot of fear. Even though changes like those may be absolutely necessary to keep a ministry alive, they can increase the risks of creating motivation for fraud. Those risks may not change the action plan, but leaders need to be aware there may be collateral harm caused by layoffs, pay cuts, and benefit reductions.
The final component needed to complete the fraud triangle is rationalization. This is the ability to persuade yourself that something you otherwise know is wrong is really OK. A lot of mental gymnastics are obviously needed to do so, but that is the point. If a person goes through those gymnastics, than what was wrong before is now acceptable. How can that happen?
One easy way for this to happen is the “borrowing” approach. I have a serious problem so I will just borrow this money until next payday. Then I’ll pay it back. Then on the next payday, the problem has not gone away, so the thought is: I’ll borrow a little bit more and pay it back for sure next month. All internal restraint has been removed.
Another approach is the entitlement mentality. I’ve worked so hard for this organization that I deserve a raise. That’s all this is – just a raise. Or, I am making a big sacrifice working at this salary because I could get another job at a much higher rate so I deserve a big raise. Even after this small raise I am still a bargain.
The atmosphere created by senior management can lend itself to rationalization: I know what the top bosses get away with, so the company will never miss this little amount.
The scary part here is rationalization takes place in the mind and cannot be seen. The entire shift in mind set could take place invisibly. It is possible this shift could manifest itself in comments or a change in attitude but not likely. The rationalization most likely will never be visible.
When a person is rationalizing a situation to convince themselves that it is really okay to do something wrong, they are telling themselves “rational lies”. Okay, it’s an old joke. But “rational lies” tells the story in one phrase.
A theological description of rationalization can be found in Jeremiah 17:9, which says “The heart is deceitful above all things and beyond cure. Who can understand it?” (NIV) Our human ability to deceive ourselves is beyond comprehension. As I talk with people or observed things going on in our culture, I step back and simply observe how people think. In those situations I can frequently see self-deception at work. Sometimes it is so painfully obvious. The destructive power is incredible.
I think of what C.S. Lewis said in his forward to The Screwtape Letters. When asked where he found the diabolically twisted thinking that appears in the book, he said he needed to look no further than his own heart. Self-deception is the same way. It is very unsettling on those rare occasions when I see self-deception working in my own mind. If you work at it, you might even find places where self-deception has been working in you.
Oh yes, the human heart is deceitful above all things. That remarkable ability we have to deceive ourselves is beyond understanding.
When it comes to the fraud triangle, I think that Christians are especially capable of recognizing and comprehending the risk because of the assistance provided by Scripture.
As you can see from the previous posts, all three sides of the fraud triangle work together. A person has to have an opportunity to do something wrong combined with some sort of serious pressure along with a mindset to say that something that previously would have been wrong is now actually reasonable.
Lacking one side would stop the fraud. If there is a wide open opportunity along with unbearable pressure but a realization that it would be horribly wrong to do something with likely jail sentence to follow, then there is no problem. If there is terrible pressure combined with a mindset that it would be okay to take something, but no opportunity to do so (or the internal control procedures would quickly identify the problem), then again no problem. Likewise if there is opportunity and rationalization but no motivation. So all three sides need to be present for a fraud to take off.
Another factor that comes into play is that just like most things in life, there is a continuum of behavior when it comes to committing fraud. Some people are wired so they would never steal. Some people would in a flash. Most people are in between. The word picture used to describe this (assuming opportunity, motivation, and rationalization) is that if you had a pile of $100 bills on a table, 10% of people would not take anything if they worked in a room next to that table, by themselves, for eight hours a day. Perhaps 10% of people would take a few bills from the table if you were on the other side of the table watching them but turned around for ten seconds. You don’t need to do anything about the first 10% and you can’t do anything about the last 10%. That leaves 80% in the middle. Unfortunately, it is incredibly difficult to tell where anyone person is in that word picture. The danger is the overwhelming pressures that can arise today could move someone from one group to another.
Watched a few minutes of a TV movie. The main character was busy lying to police as she framed a co-worker for hacking the bank’s computer system to hide her taking unidentified valuables out of safe deposit boxes and transferring who-knows-how-much money between accounts so she could get her hands on it.
Why was she doing all this? Her daughter was being held by a kidnapper demanding tons of money she didn’t have. Since she worked at a bank, she got busy getting the money any way she could.
The authors of this movie get the motivation part of the fraud triangle. When the pressure is great enough, people will do anything they can to get money. Your daughter being held for ransom is a biggie.
In the movie, she was able to easily log onto the computer system using someone else’s account and get into safe deposit boxes without anyone knowing. And of course, we all know that in the made-for-TV world, the cops have never solved any crime by themselves—they always need the assistance of the victims to get the bad guys. I think the writers of this show don’t get internal controls (the opportunity side of the fraud triangle) and they skipped the rationalization side, but they nailed the motivation side.
Having discussed the fraud triangle, you may wonder if there is anything you can do in your organization to stop the three sides of the fraud triangle from coming together and igniting into a disaster. Well, you can not absolutely prevent fraud. However, you can work to minimize the risk on each side of the triangle and as a result greatly reduce the danger of fraud. Some of the things you can do as an organization are discussed here, here, and here.
Previous posts here and here discussed the opportunity to carry out a fraud. Opportunity means the door is open for a person to do something wrong. What can a ministry or church to manage or reduce the opportunity to commit fraud?
Opportunity can be drastically reduced by setting up proper internal controls. Good procedures can create major obstacles to wrongdoing. Separating responsibilities makes it very difficult for one person to get to the money and get it out and hide having done so.
Time is tight and we are all busy. I know that. Use your limited time to split out responsibilities that just do not go together. Don’t let your bookkeeper sign checks. Look at the bank recs. Have appropriate program managers approve disbursements for their area. Hit all the basics.
Pay attention when your CPA says you missed something big. If your CPA works with lots of other NPOs, he or she gets to see lots of different settings. Take advantage of that knowledge.
NPOs have lots of ways to control the risk of the opportunities to commit fraud. I think this area is the biggest opportunity for ministries to break up the fraud triangle.
Many of the motivations to do wrong cannot be controlled by an organization. The personal problems of an individual are often private, and a church can’t do anything to reduce an employee’s pressures if it doesn’t know about them. Chemical addiction issues are probably invisible until they get completely out-of-control. A gambling addiction could stay hidden for years. Catastrophic medical issues could be invisible, especially if they affect a member of the family and not the employee.
Other motivations can be managed by an organization. How?
Since a lousy work environment can generate negative motivation, an organization could strive to create a healthy environment. If there is the will, an organization can improve its environment. I didn’t say it was easy, but it can be done.
Layoffs and pay cuts create fertile ground for all sorts of dysfunctional behavior, including motivation to do something wrong. Good communication and treating people fairly won’t change the bad news or alter what you have to do to keep the organization alive. However, good communication can minimize the chance that difficult times will feed a motivation to rip off the ministry.
NPOs may not be able to do anything about the personal motivations that arise. However, you can do something. Providing a fair wage, creating a healthy work environment, and fostering good communication are not only biblically sound ways to treat people, they can greatly reduce the motivation side of the fraud triangle.
A longer discussion of the fraud triangle is found here.
When you dig into the rationalization process, you realize that churches and ministries are in a wonderful position to counter this part of the fraud triangle.
The rationalization process involves convincing oneself that what would otherwise be wrong is actually acceptable and perhaps even the right thing to do. Your staff would never think they could take some cash from a co-workers purse because they want it or take money out of the offering plate because they feel like getting a raise. Only by the process of major-league rationalizing can the following attitudes be acceptable:
- It’s okay to take this valuable thing home because I’m not getting paid what I’m worth. I could get a big raise tomorrow by getting another job anywhere else.
- I’m making a big sacrifice by working at this ministry so this extra amount on my expense report is a small bonus which doesn’t even offset my sacrifice.
- The big bosses are getting away with so much that this little thing is nothing’ compared to what they’re doing
- This ministry is so big; they’ll never miss this money.
- I’m in a financial crisis but can easily pay this loan back later.
How to challenge those mindsets? Perhaps by confronting the faulty thinking with truth-telling. Hearing often that right-is-right and wrong-is-wrong would make it far more difficult for a person to rationalize into fraud. In our secular, multicultural environment this can be a challenge. Speaking such truth is natural in the religious community. There are dozens of ideas that would be powerful counters to rationalization. Righteousness, holiness, and living above reproach are three things that quickly come to mind. You can think of many others.
When to discuss these ideas with your staff? Wow, the opportunities are endless. Those topics are the obvious focus of many sermons in a church. Many ministries have weekly chapel. Most ministries have a short devotion as a part of staff meetings. Management teams often discuss books as part of their meetings or planning times. Any of those situations would be opportunities to emphasize your core values or biblical truth in general and by doing so subtly undercut any rationalizations that are developing. Reminding your staff of your mission and the passion you bring to bear on the cause can counter the entitlement attitude.
None of those discussions need to be negative or scolding. By holding up the biblical standard, a positive message and encouragement are presented. The counter-rationalization message does not actually have to be explicitly stated – it is implied and in the background.
One of the questions that auditors ask is how the organization is communicating from top management to the staff that the staff is expected to do things right and ethically. When I ask that question in a church, the business administrator ponders a while, trying to remember when those issues were explicitly discussed in staff meetings. While looking for the proper ‘audit’ answer, the person will hesitatingly ask, “Does it count when the pastor discusses those ideas from the pulpit?” BINGO! Telling the congregation (along with all the staff who happen to be sitting in the pews!) that they should live Godly lives that are above reproach and do so in every area of their life is exactly the kind of thing auditors are looking for. Taking that approach into staff meetings every once in a while is a very powerful antidote to the rationalization mindset.
I have discussed this fraud at a local church here and here. The very short version of the story is a bookkeeper accepted a plea bargain to one felony charge of theft. The plea agreement reportedly calls for 9 months in jail and $25,000 restitution.
Fraud has the potential to wreak havoc on a ministry. If you haven’t thought about the collateral damage from a fraud incident, ponder with me some of the ways that this has turned into a tragedy.
The bookkeeper – He is going to jail. No matter how well deserved that may be, it is still a tragedy. He is now a felon. His future employment prospects are bleak. He is reportedly age 48. He will have a difficult time providing for his family for the two decades until he hits retirement age. How will he feed his family? He has tarnished his own name, his family name, all people of faith, and the cause of Christ. His actions will probably bring ridicule on other people who convert from a different faith to Christianity. There are multiple tragedies here.
His family – They obviously have been devastated. Again, I know nothing of the case other than what is on the internet, but his wife almost certainly knew nothing of what was going on and his children were certainly unaware. Picture if you can the conversation when the husband had to tell his wife what he had done, the tears streaming from her face when he said he got caught and the police will be here soon. I cannot imagine the devastation the kids felt when daddy told them that he was in trouble. Now imagine their horror to know that daddy admitted everything in court (they don’t understand stuff like nolo contendere, and that an admission now prevents the very high risk of many long years in jail, and a no contest plea can’t be used against him in a civil trial). Then imagine the cruel things that could be said on the school playground in the future.
The shock to his family that I have described here is what I wish all fraudsters could see in their future – maybe it might change their calculations in the fraud triangle. Here’s what I’d like to say — forget about all the other consequences that are headed your way — how will you tell your little girl that her hero is going to jail?
Now think about the implications for the church.
Members of the congregation – The people sitting in the pew have been hurt deeply. There is probably a wide range of emotions, all of them harshly negative. It was their hard-earned money they sacrificially gave to the church that was stolen. Will they think twice before sacrificially giving again? Without having talked to anyone at the church, I can guess that their anger (which is perfectly justified) is venting at the bookkeeper, the church leadership, and even the pastor.
Church leadership and the Pastor – They are most likely bearing the brunt of the anger and have to take all the public attention. They have to keep the ministry moving even as they themselves are feeling betrayed. They have poured tremendous effort into dealing with the fraud situation that could have otherwise been focused on helping people, starting new programs, and generally improving the world for Christ. Instead, they have been terribly sidetracked. I am sad for the ministry impact that could have been.
I do not wish to imply through my comments on internal controls the slightest suggestion that any of this is the fault of the leadership. Please understand this: the responsibility for the fraud rests squarely on the shoulder of the fraudster. I do not know what method was used for the fraud. That it totaled the alleged amount over several years suggests to me that it was a subtle, clever scheme. Whether internal controls could have prevented it, I do not know. Let me be very clear: regardless of whether the internal controls were loosey-goosey or rock solid, the leadership and pastor are victims of the fraud.
The ministry of this particular church – Even though the size of the involved church is in the megachurch range, losing an alleged $750,000 over several years is a big drain. Imagine the extra pressure on budgeting and staffing created by that missing money. Picture the number of staff that either were let go or could not be hired because of missing around $250k or so per year in the budget. Then imagine the lost impact on the community and the mission of the church from that lost staffing.
All of this makes me very sad. It breaks my heart to see the impact on the individual, the family, the church leadership, the church members, and the kingdom of God. At the moment, I see nothing good from this situation. I see tragedy all around.
Please pray. For everyone affected. Then double-check the internal controls at your church. Please.
Final comment: One other thing – this page is copyright (c) 2010 James Ulvog.