Fraudulent Financial Reporting: Do Red Flags Really Help?

Abstract

Purpose– Aims to determine whether red flags can be helpful for external auditors in detecting fraudulent financial reporting. The research explores whether external auditors demographic factors affect external auditors’ perception about the ability of red flags to detect fraudulent financial reporting in Egypt.

Design/methodology/approach– Data was collected using a questionnaire that was pretested by a pilot study. A questionnaire was then distributed to a sample of 100 external auditors working in different audit firms in Egypt and having different years of experience. The sample of external auditors was randomly selected.

Findings – According to external auditors’ opinion, red flags are helpful in detecting fraud. Our research didn’t support the effect of external auditors’ experience and type of audit office on auditors’ perception about red flags ability to detect fraudulent financial reporting.

Research Limitations– two external auditors from the big 4 international audit firms filled in the questionnaire, thus our results can’t be generalized to all audit firms in Egypt. There can also be other red flags in the literature that aren’t mentioned in the research study.

Originality/value- Our research included a list of specific red flags for fraudulent financial reporting that were highly accepted by the sample of external auditors in our study. These specific red flags can be used in conjunction with SAS 99 red flags to enhance external auditors’ ability in detecting fraudulent financial reporting. The research also ranked all red flags for fraudulent financial reporting according to their relative importance based on external auditor opinion which can help auditors to focus their efforts more on high quality red flags during brainstorming sessions which will in turn facilitate fraud detection. Future research should be more directed toward listing other red flags for fraudulent financial reporting in the literature and should test them using other methods like experiments or interviews. The list of red flags presented in our research can for a good base for future research.

Keywords: fraud, fraud detection, fraudulent financial reporting, red flags, auditing standards

JEL Classification: APS