The financial statements of an organisation explain what the organisation has done during the last 12 months so when financial statement fraud occurs, the financial statements do not tell the true or actual picture.
Both the Profit and Loss Statement and the Balance Sheet can be manipulated.
The Profit and Loss Statement can be misstated in the following ways:
By overstating revenue, the profit is improved or loss is reduced.
By understating expenses, the same effect as overstating revenue is achieved.
However, the opposite may also be possible in a nonprofit. For example, if an organisation is required to expend all of a grant and has not done so, increasing expenses would enable the grant to be acquitted as required by the grant provider.
The Balance Sheet can be misstated in the following ways:
Generally an organisation will want to overstate assets to show the organisation in a better position than it is actually in (for example to ensure the bank is happy with lending criteria). However, again the opposite may occur in a nonprofit organisation as the organisation may want to be seen to have fewer assets to ensure the continued receipt of grants.
It is normal in financial statement fraud that liabilities are understated.
Ultimately someone in the organisation has to undertake the falsified transactions and the accounts are then approved with or without knowledge of the fraud. However, if the accounts are then used, significant problems could arise, from fraud charges against an employee, management or a member of the board, reputation risk or loss of funding.