Accounting fraud definition

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What is Accounting Fraud?

Accounting fraud is the intentional manipulation of financial statements or tax returns for personal or corporate gain. For example, a business might overstate its revenue, understate its expenses, overstate its assets, or understate its liabilities. Managers, accountants, or other employees may engage in accounting fraud. A person who engages in accounting fraud is subject to criminal prosecution.

Several situations involving accounting fraud are noted below:

  • Overstating revenue. A business keeps its books open for several days past month-end in order to record additional sales transactions in the prior month. Doing so overstates revenue in that month, though it will also understate revenues in the following month, which will have a significantly smaller number of days in which to generate revenue. Businesses that overstate their revenue are always taking revenue away from a future period in order to recognize it now, so the fraud tends to continue for multiple periods into the future.

  • Understating expenses. A business neglects to accrue expenses for services consumed within the month but not yet billed to the business. This is an understatement of expenses, and is most commonly pursued when management wants to report unusually strong results to investors or lenders. The downside of understating expenses is that it results in more taxable income, on which taxes must be paid in the near term.

  • Overstating assets. A business neglects to record depreciation expense. This overstates assets. Another way to overstate assets is to reduce the capitalization limit, which is the threshold dollar value above which a supplier billing is recorded as an asset. A cap limit reduction results in more expenditures being classified as assets, which reduces expenses.

  • Understating liabilities. A business withholds several supplier invoices at month-end, so that they are not recorded within the correct period. Doing so understates liabilities.

  • Overstating equity. A business misclassifies a loan as an investment in the entity. Doing so reduces the reported amount of debt and replaces it with equity. When combined, these two changes make the organization look far more liquid than is really the case.

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Omissions of Information

These manipulations usually involve deliberate alterations, but can also relate to the omission of information that would otherwise change the perceptions of a user of the presented information. For example, not disclosing that a company has recently been named as the defendant in a major lawsuit by a customer might be of considerable interest to the investment community.