Red Flag & Anomaly Detection Flashcards

A company's inventory turnover ratio has declined significantly over three years while the industry average remained stable. This anomaly may indicate:

Answer: Inventory obsolescence, theft, or fictitious inventory

A declining inventory turnover relative to industry peers may signal overstated inventory balances, obsolete stock, or theft being hidden in the records.

Which of the following is a red flag specific to financial statement fraud involving revenue recognition?

Answer: Increasing days sales outstanding (DSO) with high revenue growth

Rising DSO alongside revenue growth suggests customers are not paying, indicating potential fictitious revenue or premature revenue recognition.

An employee who handles petty cash fund reconciliation also has custody of the petty cash box. This is a red flag for which control deficiency?

Answer: Lack of segregation of duties between custody and recordkeeping

Combining custody of assets with recordkeeping responsibility violates segregation of duties and creates a clear opportunity for misappropriation.

A company's SG&A expenses remain perfectly flat as a percentage of revenue over five years despite significant business changes. This pattern is suspicious because:

Answer: Real expenses rarely stay perfectly proportional; this may indicate manipulation

Suspiciously stable ratios that defy natural variation may indicate that expenses are being manipulated to meet analyst expectations.

During an investigation of a nonprofit organization, an auditor finds large cash disbursements to a board member's consulting firm with no written contract. This is a red flag for:

Answer: Self-dealing and conflicts of interest

Payments to insiders' related businesses without proper contracts or competitive bidding indicate self-dealing and potential misuse of nonprofit funds.

Which of the following best describes the 'broken window' theory as applied to fraud prevention?

Answer: Small ethical violations left unaddressed signal tolerance for fraud and invite larger offenses

The broken window theory suggests that tolerating minor misconduct signals that controls are weak, creating an environment where larger frauds are more likely to occur.

An auditor using continuous monitoring detects that a user account belonging to a terminated employee was used to access the financial system two weeks after termination. This is a red flag for:

Answer: Unauthorized access and potential fraud by a former employee or insider

Active use of a terminated employee's credentials indicates either that access was not properly revoked or that credentials were shared, both serious fraud red flags.