What is accounting fraud?

Accounting fraud is intentional manipulation of financial statements to create a facade of a company's financial health. It involves an employee, account or the organization itself and is misleading to investors and shareholders. A company can falsify its financial statements by overstating its revenue or assets, not recording expenses and under-recording liabilities.

For example, a company commits accounting fraud if it overstates its revenue. Suppose company ABC is actually operating at a loss and is not generating any revenues. On its financial statements, the company's profits would be inflated and its net worth would be overstated. If the company overstates its revenues, it would drive its share price up and falsely depict the its true financial health.

Another example of a company committing accounting fraud is when it overstates its assets and under-records its liabilities. For example, suppose a company overstates its current assets and understates its current liabilities. This falsifies a company's short-term liquidity. Suppose a company has current assets of $1 million, and its current liabilities are $5 million.

If the company overstates its current assets and understates its current liabilities, this will falsify the liquidity of the company. If the company states it has $5 million in current assets and $500,000 in current liabilities, potential investors will believe that the company has enough liquid assets to cover all of its liabilities.

A third example is if a company does not record its expenses. As a result, the company's net income is overstated and expenses are understated on its income statement. This type of accounting fraud creates a facade of how much net income a company is receiving while, in reality, it may be losing money.