The Institute of Internal Auditors
RED FLAGS OF FRAUD
Situational pressures that contribute to 3. Suspension or delisting from a stock
management fraud exchange.
Opportunities that allow or encourage
Company financial pressures that can lead to management fraud
fraud are:
1. Heavy investments or losses. Relationships with outside parties that make
2. Insufficient working capital. fraud easier to commit are:
3. Unusually high debt. 1. Related-party transactions.
4. Reduced ability to acquire credit 2. Use of several different auditing firms
5. Profit squeeze. or the frequent changing of auditors.
6. Restrictive loan agreements. 3. Reluctance to give auditors needed data.
7. Progressive deterioration in quality of 4. Use of several different legal firms or
earnings. the frequent changing of legal counsels.
8. Urgent need for favorable earnings. 5. Use of a large number of banks.
9. Need to gloss over temporarily bad 6. Continuous problems with regulatory
situations. agencies.
10. Unmarketable collateral.
Organizational structures that make fraud easier
Company limitations that can lead to fraud are: to commit are:
1. Dependence upon only one or two 1. Complex business structures.
products. 2. Ineffective or nonexistent internal
2. Dependence upon only one or two auditing staff.
customers. 3. High level of computerization in a firm.
3. Excess capacity. 4. Inadequate internal controls.
4. Severe obsolescence. 5. Rapid turnover of key employees.
5. Extremely long cycle.
6. Existence of revocable or imperiled An economic environment that makes fraud
licenses. easier to commit is:
Business decisions that can lead to fraud are: 1. An atypical or "hot" industry.
1. Extremely rapid expansion.
2. Publishing of overly optimistic earnings Accounting practices that make fraud easier to
forecasts. commit are:
1. Large year-end or unusual transactions.
External economic conditions that can lead to 2. Unduly liberal accounting practices.
fraud are: 3. Poor accounting records.
1. Unfavorable economic conditions 4. Inadequate staffing in the accounting
within an industry. department.
2. Difficulty in collecting receivables. 5. Inadequate disclosure of questionable or
3. Unusually heavy competition. unusual accounting practices.
4. Significant reduction in sales backlog.
5. Pressure to merge.
6. Sizeable inventory increase without a
comparable sales increase.
Legal difficulties that can lead to fraud are:
1. Significant tax adjustments.
2. Significant litigation, especially
between stockholders and management.
2010 APIPA Conference
Contract & Procurement Fraud 1
July 21, 2010
The Institute of Internal Auditors
3. Resentment of superiors.
4. Frustration with the job.
5. Peer-group pressures within the
Personal characteristics that can lead to fraud company.
6. Personal/family expectations that
Personal and psychological characteristics that cannot be met.
suggest a high probability of fraud are: 7. Insatiable desire for self-enrichment or
1. Low moral character. personal gain.
2. Rationalization of contradictory
behavior. Opportunities that can lead to fraud
3. A lack of a strong code of ethics.
4. Wheeler-dealing. Personally-created opportunities that can make
5. A lack of stability (associated with fraud easier are:
promotional stagnation, career 1. Familiarity with operations (including
plateauing, aging, or domestic cover-up capabilities).
incompatibility). 2. Close association with suppliers and
6. A strong desire to beat the system. other key people.
Demographic characteristics that suggest a high Firm characteristics that make it easier for an
probability of fraud are: individual to commit fraud are:
1. Criminal or questionable background. 1. Failure to inform employees about rules
2. Poor credit rating or financial status. and disciplines of fraud perpetrators.
2. Rapid turnover of key employees.
Personal situational pressures that can lead to 3. Absence of mandatory vacations.
fraud 4. Absence of periodic rotations or
transfers of employees.
Personal financial factors that can lead to fraud 5. Inadequate personnel screening policies
are: for hiring new employees.
1. High personal debts. 6. Absence of explicit and uniform
2. Significant personal losses. personnel policies.
3. Inadequate income. 7. Failure to maintain accurate personnel
4. Living beyond one's means. records for disciplinary actions.
5. Illness. 8. Failure to require executive disclosures.
9. Dishonest or unethical management.
Personal habits that can lead to fraud are: 10. Dominant top management.
1. Extensive stock market or other types of 11. Constantly operating under crisis
speculation. conditions.
2. Extensive gambling. 12. Paying little attention to details.
3. Illicit sexual involvement. 13. Impersonal relationships or poor
4. Heavy use of alcohol or drugs. morale.
5. Routine borrowing. 14. Lack of internal security.
15. Too much trust is placed in key
Personal feelings that can lead to fraud are: employees.
1. Extreme community or social 16. Tenure on key jobs becomes too long.
expectations to succeed. 17. Books and records are sloppy.
2. Perception of being treated unfairly or
inadequately by organization.
Note: Red flags provided are examples, and not intended to represent an exhaustive list.
2010 APIPA Conference
Contract & Procurement Fraud 2
July 21, 2010
The Institute of Internal Auditors
2010 APIPA Conference
Contract & Procurement Fraud 3
July 21, 2010
