Signs of financial statement fraud
What financial statement fraud looks like in a small company, the warning signs an audit team should watch for, and what to do when they add up.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
Financial statement fraud in a small company rarely looks like the corporate scandals in textbooks. It looks like a year-end sale to a friendly customer that is reversed in February, an accrual that quietly vanishes, or a stock sheet "recounted" after the auditors went home. The amounts are modest. The effect on a loan application, a tender submission or the sale of the business can be decisive.
Audit teams see these signs more often than they recognise them, because each one on its own has an innocent explanation. This article sets out what the fraud looks like, the signs worth noticing, and what to do when several appear together.
Falsified records, omissions and misapplied standards
ACCA groups the frauds a forensic accountant may investigate into three categories: corruption, asset misappropriation and financial statement fraud. It describes financial statement fraud, also called fraudulent financial reporting, as fraud causing a material misstatement in the financial statements, which can include deliberate falsification of accounting records, omission of transactions, balances or disclosures, or misapplication of financial reporting standards. ACCA's technical article on forensic accounting explains those categories and how investigations of them are approached.
In small-company terms, the three forms look like this:
- Falsified records: invented sales invoices, altered count sheets, backdated delivery notes, doctored bank statements.
- Omissions: supplier invoices kept in a drawer until after year end, a loan from a related party left off the books, a lawsuit nobody mentions.
- Misapplied standards: revenue recognised on signing rather than on delivery, costs capitalised that should be expensed, a provision released with no change in the facts.
Asset misappropriation is a different fraud, theft rather than misreporting, but it often needs a reporting fraud to hide it, so the two can turn up together.
Profit without cash
Investopedia warns that a company recognising credit sales as revenue earns a profit on the income statement without yet having the cash, and that if this happens too often it can run out of cash despite being profitable. In honest hands that is a working-capital problem. As a fraud sign, it is the classic shape of fictitious or premature revenue: profit grows, receivables grow faster, and cash from operations stays flat or falls.
Look for:
- receivables collection periods lengthening year on year;
- large balances with a few customers, especially new or related ones;
- credit notes issued soon after year end against sales made just before it;
- a revenue spike in the final month with no operational reason.
Pressure from lenders and financial distress
ACCA lists indicators that an entity may not be a going concern, among them adverse key financial ratios, signs that the bank is withdrawing support, negative operating cash flows and major debt repayments the entity cannot meet. ACCA frames those indicators around ISA 570; for periods within its scope, check them against ISA 570 (Revised 2024).
Each indicator is also a motive. A covenant test due at year end, a tender that requires a minimum net asset value, a buyer conducting due diligence, a family dispute over dividends: all create a reason for someone to want the statements to read better than the business performed. Note the pressure in the risk assessment even when nothing yet looks wrong.
Unusual journals and analytics as early signs
The IAASB states that ISA 240 (Revised) emphasises a fraud lens in the auditor's risk assessment and in the responses to identified risks. Often the first signs show in analytics before they show in documents:
- margins improving while competitors' fall;
- ratios that are suspiciously steady from year to year;
- revenue that does not move with volumes, headcount or capacity;
- year-end journals to revenue, inventory or provisions;
- entries posted by senior people who do not normally post.
In Achekam, the team loads the client's whole-population journal extract into Journal Entry Testing and maps its columns; Achekam then flags manual, weekend, after-hours and post-close postings, and the team decides which to select and test. The final analytical review is the other natural place to catch figures that do not make sense together.
Automated review findings are prompts, not proof
Where the firm also prepares the statements on Achekam, staff can run an automated review of a draft that lists findings for a person to accept, resolve or dismiss. It is advice only and does not block signing. A separate Validation & Math Engine runs fixed, non-AI checks such as double entry and note ties.
Neither is a fraud detector. A clean automated review says the draft hangs together internally; it says nothing about whether the entries beneath it are genuine. Treat a finding as a question worth asking, and treat the absence of findings as no evidence at all about fraud.
What to do when the signs add up
One sign is a question. Several together are a pattern, and the response should escalate:
- Take it to the engagement partner promptly, with the signs listed and the explanations received so far.
- Reassess the fraud risk for the affected areas and the statements as a whole.
- Extend procedures where the signs point: confirmations sent directly, documents obtained from third parties, cut-off tested more widely.
- Reconsider how much weight to put on management's explanations and written representations.
- Think about who may be involved before deciding whom to tell, and consider whether forensic specialists are needed.
- Communicate with those charged with governance as the circumstances require, and record every step.
Revenue is where most of these patterns surface first; see responding to revenue fraud risk. The habit that matters most is to look at the signs together. Fraud rarely announces itself in one document, but it often leaves the same fingerprints across several.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
