Final answer:
1) Inability to generate cash flows from operations while reporting substantial earnings growth. Factors that heighten an auditor's concern about the risk of fraudulent financial reporting include inability to generate cash flows from operations while reporting substantial earnings growth and inability to borrow necessary capital without granting debt covenants.
Step-by-step explanation:
When it comes to the risk of fraudulent financial reporting, there are several factors that can raise an auditor's concern. One such factor is the inability to generate cash flows from operations while reporting substantial earnings growth. This can be a red flag because it suggests that the reported earnings may be fraudulent or manipulated to create a false appearance of financial strength. For example, if a company is reporting high profits but is unable to generate cash to support those profits, it may indicate that the reported earnings are not genuine.
On the other hand, factors such as management's lack of interest in increasing the entity's earnings trend or large amounts of liquid assets that are easily converted into cash are less likely to raise concerns about fraudulent financial reporting. These factors do not necessarily indicate fraudulent activity and may be attributed to other business decisions or strategies.
Lastly, the inability to borrow necessary capital without granting debt covenants can also be a potential red flag for fraudulent financial reporting. Debt covenants are conditions imposed by lenders that require the borrower to meet certain financial ratios or performance measures. If a company is unable to meet these covenants or is reluctant to agree to them, it may signal that the company is trying to hide its true financial position.