CFA Red Flag & Anomaly Detection 3 — Questions and Answers
Question 1: Which ratio anomaly most directly signals potential revenue fraud when revenue is increasing but cash flow from operations is declining?
- Current ratio deterioration
- Earnings quality ratio divergence (Correct answer)
- Inventory turnover decline
- Days payable outstanding increase
Correct answer: Earnings quality ratio divergence
A divergence between reported earnings and operating cash flow (earnings quality ratio) is a key indicator of potential revenue manipulation.
Question 2: During a procurement review, an auditor finds multiple vendors with sequential invoice numbers and similar amounts. This pattern suggests:
- Efficient vendor billing practices
- Shell company or fictitious vendor scheme (Correct answer)
- Volume discount pricing
- Automated invoicing systems
Correct answer: Shell company or fictitious vendor scheme
Sequential invoice numbers and similar amounts from multiple vendors indicate a shell company scheme where invoices are fabricated.
Question 3: An employee's lifestyle appears significantly beyond their known salary, including expensive cars and vacations. Under the fraud triangle, this relates to which element?
- Opportunity
- Rationalization
- Pressure or incentive (Correct answer)
- Capability
Correct answer: Pressure or incentive
Living beyond one's means is a behavioral red flag associated with financial pressure or incentive, one of the three fraud triangle elements.
Question 4: A whistleblower hotline report alleges that a manager approves her own expense reports. Which control weakness does this highlight?
- Lack of physical security controls
- Absence of segregation of duties (Correct answer)
- Inadequate hiring background checks
- Poor IT access controls
Correct answer: Absence of segregation of duties
Allowing a manager to approve her own expense reports violates segregation of duties, a fundamental internal control.
Question 5: In a payroll fraud investigation, ghost employees are most likely to be identified by comparing:
- Payroll records to tax filings
- HR records to payroll records for matching employees (Correct answer)
- Bank statements to general ledger entries
- Timesheets to production output
Correct answer: HR records to payroll records for matching employees
Ghost employees appear on payroll but not in HR records; comparing the two lists reveals names that exist only in payroll.
Question 6: Which of the following is the strongest red flag of a Ponzi scheme during due diligence?
- High investment minimums
- Consistent above-market returns with no losing periods (Correct answer)
- Lack of a marketing team
- Use of a third-party custodian
Correct answer: Consistent above-market returns with no losing periods
Consistently above-market returns with no losing periods are a hallmark red flag of Ponzi schemes, as legitimate investments experience volatility.
Question 7: An auditor reviews credit card statements and finds numerous charges at the same restaurant, each just under $25, submitted by the same employee on different days. This pattern suggests:
- Legitimate business meal expenses
- Expense report fraud through splitting charges (Correct answer)
- Fictitious vendor payments
- Skimming of cash receipts
Correct answer: Expense report fraud through splitting charges
Repeatedly splitting charges to stay below a reimbursement threshold is a red flag for expense reimbursement fraud.
CFA Red Flag & Anomaly Detection 3
Which ratio anomaly most directly signals potential revenue fraud when revenue is increasing but cash flow from operations is declining?