When I make a flag cake, I cover it in a buttercream or cream cheese frosting. This is just icing sugar, butter or equal parts butter and cream cheese and a dash of vanilla. I make a sheet cake and slather it generously in the frosting. Then, depending on what looks best at the market, I make the red stripes out of raspberries or strawberries and the blue part is made out of putting blueberries fairly close together, but allowing enough white to show through to simulate the "stars."
But really, there are no hard and fast rules for a flag cake. Some people take the frosting and colour it, and then pipe it on the cake for the stars and stripes. Just have fun with it!