Financial Statement Fraud

Managers typically act under pressure to meet targets, hold a share price or satisfy loan covenants. The usual methods inflate profit or assets, or hide debts: booking revenue early or for sales that never happened, delaying expenses, overstating inventory, understating liabilities, and keeping transactions off the books through side arrangements or special vehicles. Hidden transactions are particularly hard to find because they leave no trace in the ledger. Honest mistakes and aggressive but lawful accounting choices are different, since fraud requires intent. External auditors design tests with this risk in mind, and internal audit, audit committees and whistleblowers add further lines of detection. Once found, the accounts are restated, trust in management usually collapses, and the people responsible may face penalties or prosecution.

A listed manufacturer is close to breaching a loan covenant on profit. Senior managers instruct staff to invoice customers for goods still in the warehouse and to leave a large repair bill unrecorded. Profit appears healthy for two quarters. An auditor visiting the warehouse finds the stock sitting in place and the customers confirm they have not received it. The accounts are restated.