Detecting Circular Cash Flow

Fraudsters have been creating increasingly complex and sophisticated schemes designed to rely on potential weaknesses in the execution of audit procedures surrounding key assertions such as existence. A financial statement auditor can use his or her professional judgment while carrying out audit procedures to detect such a scheme. Given the difficult economic times of the past year, special care should be given to consider fraud while performing audit engagements. One fraud scheme that has been encountered with increasing frequency involves the inflation of accounts receivable and sales through the creation of a circular flow of cash through a company to give the appearance of increasing revenue and existence of accounts receivable. This article addresses this fraud technique when used to materially overstate assets and inflate borrowing capacity under an asset-based revolving line of credit. This article also points out red flags that may help uncover such a scheme.