Summary by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida
The purpose of this paper is to report on a study that involved an extensive review of the fraud related literature to identify the factors that indicate a high probability of fraud. The authors provide an interesting and useful list referred to as "The Red Flags of Possible Fraudulent Activity" (p. 53). They separate the red flags into three main categories including: Opportunity red flags, Personal Characteristic red flags and Situational Pressure red flags. An abbreviated list appears below.
Types of Red Flags of Possible Fraudulent Activity:
Opportunity Red Flags: Employees Against the Company
Familiarity with operations and in a position of trust.
Close association with suppliers and other key people.
The firm that does not inform employees about rules or of the action taken to combat fraud.
Rapid turnover of key employees.
No mandatory vacations, or periodic rotations etc.
Inadequate personnel screening policies when hiring employees to fill positions of trust.
Absence of explicit and uniform personnel policies.
No maintenance of accurate personnel records of dishonest actions and disciplinary actions.
Executive disclosures and examinations not required.
Dishonest or overly dominant management.
Operating on a crisis mode.
No attention to details.
Unrealistic productivity measurements.
Poor compensation practices.
Lack of internal security.
Inadequate training programs.
Opportunity Red Flags: Individuals on Behalf of the Company
Complex business structure.
Ineffective internal audit staff.
Highly computerized company.
In atypical or "hot" industries.
Uses several audit firms or changes auditors frequently.
Reluctant to provide auditors with needed data.
Uses several legal firms or changes firms often.
Uses an unusually large number of banks.
Continuous regulatory problems.
Large year-end or unusual transactions.
Inadequate internal control.
Unusually liberal accounting practices.
Poor accounting records.
Inadequate accounting staff.
Inadequate disclosure of unusual accounting practices.
Personal Characteristic Red Flags
Rationalization of contradictory behavior.
Lack of strong code of personal ethics.
A "wheeler dealer" personality.
Lack of stability.
A strong desire to beat the system.
A criminal or questionable background.
A poor credit rating and financial status.
Situational Pressure Red Flags: Employees Against the Company
High personal debts or financial losses.
Inadequate income for lifestyle.
Extensive stock market or other speculation.
Undue family, company or community expectations.
Perceived inequities in the organization.
Resentment of superiors and frustration with job.
Peer group pressures.
Undue desire for self enrichment and personal gain.
Situational Pressure Red Flags: Management on Behalf of the Company
Unfavorable economic conditions within the industry.
Insufficient working capital or high debt.
Dependence on one or two products, customers or transactions.
Extreme rapid expansion through new business or product lines.
Reduced ability to acquire credit, or restrictive loan agreements.
Cost and expenses rising faster than revenues.
Difficulty collecting receivables.
Progressive deterioration in quality of earnings.
Significant tax adjustments.
Urgent need for favorable earnings to support high price of stock or to meet earnings forecast.
Need to gloss over a temporary bad situation to maintain management prestige.
Significant litigation, especially between stockholders and management.
Significant reduction in sales backlogs.
Possibility of license being revoked.
Suspension or delisting from a stock exchange.
Pressure to merge.
Sizable inventory increase without comparable increase in sales.
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