Sometimes red flags may be as subtle as or as obvious as certain events in a novel or movie that may be overlooked by one or more of the main characters. This is sometimes the essence of red flags when certain vignettes that "something is wrong with this picture" are overlooked by executive management or supervisors. Accordingly, an essential aspect of internal controls is to train appropriate staff to increase their awareness of and to be monitoring for various red flags that are relevant to various control areas. In the financial management domain, it’s reasonable to state that most individuals would readily concur that activities that generate cash receipts are inherently important to monitor more closely.
Red flags associated with cash and accounts receivable include:
- Unexplained variances in cash deposit patterns following staff turnover or when substitutes cover for staff on-leave
- Unexpected patterns in cash deposits during cash-generating activities
- Absence of or low amounts of cash deposits relative to deposits of checks during cash-generating activities
- Prenumbered event tickets are not being used or are used in haphazard number sequence
- Cash count practices for various cash-generating activities do not require that at least two individuals be present
- Cash receipts that are retained for a long period of time in an employee’s office, in the trunk of their car, or in their personal residence, instead of being deposited daily
- Cash receipts are deposited after disbursements for various cash transactions, instead of being deposited intact
- Checks are deposited at the bank less cash
- Returned merchandise refunds, rebates or vendor overpayment refunds that do not agree with deposits
- Unauthorized bank accounts
- Bank accounts lacking oversight independent of the office staff that write transactions on the accounts
- Complaints received about erroneous non-payment notices
- Unexplained variances between bank deposits and postings in cash receipt logs
- Use of petty cash for check cashing purposes
- Insufficiently documented cash transactions
- Unexplainable or undocumented write-offs of accounts
- Bank accounts are not reconciled timely
- General ledger accounts cannot be reconciled
- Unusual bank account reconciliation patterns, including higher than expected month-over-month deposit-in-transit levels
- Unexpected patterns for cash deposits over the fiscal year
- Post-event revenue and expense reports are not generated and delivered to appropriate staff
Any indications or observed red flags should be promptly evaluated and consideration be made for prompt follow-up or investigation. In most instances, red flags are signs that relevant manuals for practices, procedures, processes and key controls should be reviewed and modified, as needed, and staff should receive additional relevant training to improve their skills and expertise. Red flags should be covered during after-action reviews to evaluate strengths and opportunities for improvement. Invariably most red flags are more recognizable as 20/20 hindsight.
It’s important to note that red flags do not stand on their own as an indication that fraud has occurred. When should a school official refer a matter to law enforcement? In all instances, this should be done only after consultation with the district's attorney-on-retainer, which was covered in a prior article titled Internal Control Tip of Week - When Do You Refer a Matter.