Question

Which of the following is not a potential “red flag” pointing to questionable accounting quality?

1. Unexplained transactions that boost profit.
2. Poor internal governance mechanisms.
3. Volatility in the difference between reported profits and cash-flows.
4. All of the above are potential red flags.

Answer 1

Option D is correct

A potential "red flag" pointing to questionable accounting quality occurs in below situations:

• Unexplained transactions that boost profit. To add to this, unexplained transactions that lead to losses is also a red flag.
• Poor internal governance mechanisms can lead to poor performance of the firm.
• Volatility in the difference between reported profits and cash-flows. The difference between reported profits and cash flows should be relatively stable.