Management, internal and external auditors are responsible for detecting material misstatements due to error and fraud.  Errors are unintentional mistakes, misjudgments, or omissions of amounts or disclosures.  In contrast, fraudA knowing or reckless misrepresentation or concealment of a material fact to induce detrimental reliance by another person. is an intentional act by one or more parties involving the use of deception that results in a misstatement in financial statements.

Although management and auditors cannot be expected to detect all instances of fraud, they must be able to recognize the conditions that are generally present when fraud occurs (referred to as the fraud triangle).  These are:

• Incentive (motivation/pressure):  the reason (eg, personal gain) the fraud was committed (Choice A)
• Opportunity:  the conditions (eg, weak controls) that allowed the fraud to occur (Choice C)
• Rationalization:  the perpetrator's justification for committing fraud (Choice D)

CollusionA secret or illegal agreement between two or more people designed to cheat or deceive others is a secret or illegal agreement between two or more people designed to cheat or deceive others.  For example, the inventory clerk in the accounting department and the warehouse manager work together to steal inventory and cover up the theft.  Collusion is a tactic used in executing fraud, not one of the conditions included in the fraud triangle.

Things to remember
Management and auditors must be able to recognize the conditions that are generally present when fraud occurs (referred to as the fraud triangle).  These include incentive (motivation/pressure), opportunity, and rationalization.