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Financial Accounting

Learn the toughest concepts covered in your Financial Accounting class with step-by-step video tutorials and practice problems.

6. Internal Controls and Reporting Cash

Fraud and the Fraud Triangle

Let's learn some fraud geometry!


Fraud and the Fraud Triangle

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Alright now let's discuss the concept of fraud when employees try and steal from the company. So we're gonna talk about fraud and this is any dishonest act by an employee, a dishonest act for their personal benefit, right? So they're doing something for their own good and it's gonna be at the cost of the employer in this case, the company usually what we're focused on in accounting, right? We're focused on the company and now there's an employee trying to steal from the company. So fraud comes in many forms, right? You could just steal money from the cash register, steal inventory from the warehouse, or you could get a little more intricate, You could be creating fake invoices that can be paid by the company and it makes it look legit. But since nobody's really paying attention, they're fake invoices, right? That could happen as well. So we when we talk about fraud, we talk about the idea of the fraud triangle, Okay, The fraud triangle basically tells us the three things that are necessary for fraud to occur. The first thing is opportunity, the opportunity to commit fraud. Okay, If an opportunity presents itself, well, will the employee take advantage of it? Okay, The next thing is incentive, they have to have some incentive to commit fraud, right? They're not just gonna do it for no reason, There's gonna have to be some reason why they commit fraud. And lastly, is the rationalization, they have to rationalize to themselves that this is okay, right? Because they're gonna commit some kind of bad thing, they're gonna steal, they're gonna do something bad and they have to rationalize it to themselves that it's okay that they're doing that. Okay, so the next thing we want to learn is how to find the area of the fraud triangle. Right? If you guys remember area equals half base times. I'm just kidding. You don't have to do any geometry about fraud geometry here. There's no such thing as the area of the fraud triangle. Okay. I'm just trying to pull a fast one there. Alright, so let's talk a little bit more about these three things opportunity, incentive and rationalization, right? So first let's talk about opportunity. So remember that they're the opportunity has to present itself for the employee to commit fraud. So this is the most important element of the fraud triangle. And this is the element that the company can control. They can try and limit the opportunities for an employee to commit fraud. Right? So an example of an opportunity is that cash registers are not counted at the end of the day, right? So if the cash registers are not counted, well then it's easy to just take some money out right next is the incentive, right? That incentive which is usually some sort of financial pressure that the employee feels right there, this is the reason that they want to commit fraud. So an example would be the employees behind on bills, right? They they're frustrated, They need extra money. They might commit fraud because they need that money or the employee just wants to live a lavish life, right? They just want money because they love money and they want to have a boat. They want to have a big house. So they, they will steal uh, to get to that level. Okay? So they have that incentive and they have that opportunity. Finally, they need to rationalize it, right? They need to have a personality to rationalize this type of behavior. So the employee must feel okay with the dishonest behavior. So what's gonna make, make them feel okay? Well that could be some kind of situation where they're like, well, my employer doesn't pay me enough anyways, right? So it's okay if I steal a little bit from the company, anything to rationalize in their head that it's okay. Oh, you know, my mom is sick and the company doesn't understand that, but I'm doing it for a good reason, right? I'm trying to help my sick mother. I need to steal from the company whatever it is, they're going to rationalize something to commit that fraud. Right? So there it is, those are the three key elements of a fraud. Um, and what can the company do? Right? Like I said, they can try and minimize those opportunities, opportunities to commit fraud, right? And how they do that is they use what's called internal controls. Okay? Internal controls is systems in place in the company that are gonna help safeguard their assets, which means not allow employees to just walk out with cash or walk out with inventory. But it's also gonna make the financial information more reliable because we're gonna have these checks in place as we do transactions as things happen, there's gonna be certain policies and procedures that must be followed. Okay? And lastly, of course, it's going to ensure compliance with laws. Alright? It's gonna make sure that the company isn't doing anything unlawful. Okay? So internal controls, this is just systems inside the company that help minimize fraud. Alright, Let's go ahead and move on to the next video.