An Analysis of the Fraud Triangle

The concept of a “Fraud Triangle” is introduced to the professional literature in SAS No. 99, Consideration of Fraud in a Financial Statement Audit. The Fraud Triangle consists of three conditions generally present when fraud occurs: Incentive/Pressure, Opportunity, and Attitude/ Rationalizations. Input from forensic experts, academics and others consistently show that evaluation of information about fraud is enhanced when auditors evaluate in the context of these three conditions. To examine the impact of the fraud triangle on the audit process, this paper develops an evidential network that has two major sub-networks: one to capture risk and evidential relationships for a conventional financial statement audit and the other to capture the risk and evidential relationships for fraud risk assessment. These networks use the Belief Functions approach to express the uncertainties involved in the evidence in a financial statement audit. The results of the analyses support the concept of the fraud triangle in that the three components and the relationships between those components are shown to have a substantial impact on audit risk. AN ANALYSIS OF THE FRAUD TRIANGLE INTRODUCTION The main objectives of this research are to present a baseline model of audit risk that incorporates the risk of fraud; to determine reasonable combinations of audit evidence for this model that will result in an assessment of audit risk of approximately 0.05 or less; and most importantly, to enhance this model to incorporate the requirements of a recent Exposure Draft (AICPA 2002) intended to modify SAS No. 82. The characteristics of this enhanced model then are formally evaluated. These models are based on prior research into evidential audit networks (Srivastava and Shafer 1992), into audit planning (Mock et al.1998) and into fraud risk assessment (Turner et al.2002). To achieve these objectives, this paper develops an evidential network that has two major sub-networks: one to capture risk and evidential relationships for a conventional financial statement audit and the other to capture the risk and evidential relationships for fraud risk assessment. Given that prior research (Turner et al. 2002) has investigated the basic features of this type of framework, this paper investigates more complex relationships between the main factors that seem to affect fraud and audit risk. Specifically, the following research questions are investigated in this paper: RQ1: What is the effect on Audit Risk of an interaction between Incentives and Management Integrity? RQ2: What is the effect on Audit Risk of interactions between Incentives and Management Integrity and Opportunities and Management Integrity? RQ3: What is the effect on Audit Risk of Modified Audit Procedures?