Can You Identify Fraud-Related Red Flags?

Fraud Red Flags

International Fraud Awareness Week is November 15 - 21, 2020, and with the Covid-19 pandemic still ranging, it's never been more important to be able to identify and report fraud. According to data from the Federal Trade Commission, Americans have filed more than 205,000 reports of fraud attributable to the novel coronavirus and lost more than $145 million to Covid-19-related fraud. In fact, the prevalence of fraud is likely much higher, because this number doesn't account for unreported instances of fraud.

All organizations face fraud risks. Fraud risks can be either internal or external. Internal fraud risks refer to risks that come from within the organization, such as employees who abuse their position in order to unjustly enrich themselves through acts such as the misappropriation of company resources or assets. External fraud risks come from outside the organization, and may involve customers, vendors, contractors, or other third parties who seek to acquire money illegally. Whether internal or external, fraud contributes to waste, depletes resources, and causes revenue losses. One of the best ways organizations can protect themselves from fraud is through training and heightened awareness. More specifically, this involves being able to identify red flags indicative of fraud. Recognizing red flags can help organizations detect fraud and minimize losses.

What are Fraud Red Flags?

Fraud red flags are indicators or warning signs that may signal the presence of fraud or fraud-related activity. Fraud-related red flags can be grouped into a number of categories. The most common categories of fraud-related red flags are behavioral, general, and accounting red flags. These are broad and generalized categories and red flags may overlap.

Behavioral Red Flags

Behavioral red flags are specific clues displayed by fraudsters. In fact, a large percentage of fraud is internal, and is committed by employees. Therefore, behavior red flags generally pertain to employee behaviors. They include the following:

  • Lifestyle changes or individuals who are living beyond their means

  • Financial difficulties and history of debt

  • Excessive gambling

  • Unusually close relationship with vendor/customer

  • Control issues and an unexplainable unwillingness to share duties

  • Irritability, suspiciousness, or defensiveness

The majority of fraud studies show that 85% of people who were caught committing fraud exhibited at least one behavioral red flag. Furthermore, individuals living beyond their means was the most common red flag identified.

Accounting Red Flags

Accounting red flags are those most likely to be identified by accounting and/or audit professionals. They include the following:

  • Excessive or unaccounted for cash transactions

  • Unreconciled bank account statements

  • Unusual amount of expense items, supplies, or employee reimbursements

  • Sudden activity in inactive accounts

  • Spikes in invoice volume

General Red Flags

General red flags are a broad category of fraud-related red flags that can apply to either internal or external fraud. General red flags include the following:

  • Missing or falsified documents

  • Unexplainable excess purchases

  • Use of business funds for personal reasons

  • Conflicting statements (especially in connection with fraud-related disclosures)

  • Suppression or manipulation of reporting mechanisms

  • Inventory shrinkage

  • Rise in complaints

The above lists represent just some of the possible categories of red flags, and are by no means exhaustive. Red flags may also differ by industry. The mere presence of a red flag is not conclusive evidence of fraud. The facts and circumstances of each case must be reviewed and examined in total. However, the presence of multiple red flags signals a greater likelihood of fraud. Learning how to identify and spot red flags is one of the most effective and cost efficient measures an organization can take to protect itself and prevent fraud from occurring.

International Fraud Week provides a great opportunity for organizations to train their personnel about their fraud policy and related procedures, including how to identify and report fraud.

For more information on International Fraud Week, as well as links to useful fraud-related resources, see here.

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