Forensic audit: common red flags in financial records

A red flag is not proof of fraud. It is a pattern that calls for explanation. A forensic review gathers evidence until each red flag is either explained or confirmed.

Accounting red flags

• Large or unusual manual journal entries, especially near period end or posted by senior staff.
• Round-figure entries and entries just below approval limits.
• Suspense and clearing accounts with growing, unreconciled balances.
• Frequent changes in accounting policies or estimates that improve results.

Purchases and expenses

• Vendors with no GSTIN, a residential address or a bank account matching an employee.
• Sudden growth in purchases from one vendor without a business reason.
• Invoices with consecutive numbers from a supplier who should have many customers.
• Payments made before goods are received.

Sales and receivables

• Sales booked just before year-end and reversed after.
• Receivables ageing worsening while sales grow.
• Credit notes issued shortly after period end.
• Customers whose details match related parties.

Banking and funds

• Fund transfers to related parties described as advances for purchases.
• Round-tripping: money leaving and returning through intermediaries.
• Loans used for purposes other than those sanctioned.
• Cash withdrawals out of line with the nature of the business.

What the forensic review does

1. Preserves evidence: copies ledgers, bank statements and system logs before analysis.
2. Analyses data: matches masters, runs exception tests and traces fund flows.
3. Examines documents: checks originals, approvals and third-party confirmations.
4. Interviews: speaks with relevant staff after the documentary work is done.
5. Reports: sets out facts, evidence and findings without drawing legal conclusions.

For bank-referred assignments, the scope and report format follow the bank’s terms of reference and RBI’s framework on frauds.