Financial Statement Fraud: Everything You Need to Know as a Business Owner

As a property manager in today’s constantly evolving digital environment, cutting down the number of cases of rental fraud you encounter should, without question, be a top priority. This will help shield your property and safeguard your rental company overall.

Modified bank statements and pay stubs are more common than ever, leaving property managers anxious about how to tackle this issue. Consider this statistic: From 2016 to 2018, 97% of property management companies said they experienced fraud in some capacity, with 80% seeing it up to 20 times, according to a Forrester study featured in a TransUnion article. In addition, the report noted that prospective tenants submit approximately 59% of rental applications online versus in-person.

Over the last decade, this digitization of the overall rental application process has launched new avenues for fraud. Fortunately, there are ways to arm yourself against rental application and financial statement fraud to minimize the risk. Avoiding these issues starts with learning how to recognize fraud, the warning signs to look for, and the tools and strategies available to ensure you and your business are safe. 

What is Financial Statement Fraud?

Financial statement fraud is the intentional falsification of financial statements, whether via embellishment or inadvertence, to reflect a more favorable impression of a company or individual’s overall financial position, cash flow, and performance.

In many corporate cases, senior management commits financial statement fraud and is often a means to an end. For example, motives may be for keeping a business afloat or for personal gains. Regardless of the reason, document fraud almost always leads to significant issues. In the business world, it can result in enormous reputational damage, severe regulator sanctions (i.e., the U.S. Securities and Exchange Commission (SEC), and even worse, arrests.

Regarding individual fraud, potential tenants often create fake pay stubs, hoping to impress a prospective landlord when vying for a rental unit. Numerous websites can churn out fake pay stubs in a matter of minutes. These pay stubs look legitimate and are nearly indistinguishable from a real pay stub. Fraudsters can input any data they want to “qualify” for a rental, opening your property to financial and reputational risk.

Types of Financial Statement Fraud

 Financial statement fraud comes in many forms, including overstated revenue or assets or understated liabilities and expenses. It also appears in the form of bribery, kickbacks, and payroll fraud. Generally, most cases involve intentionally misrepresenting accounting so that financial data or other valuation methods make a business or individual seem more profitable. Fraudsters strategically finesse revenue, expenses, liabilities, and assets to give the illusion of an entity in a more positive light.

Here are some examples:

• Falsely inflating revenue. When someone claims money as received before goods or services are delivered. This can be done by recording future expected sales or uncertain sales prematurely. If revenue is overstated, it produces a false depiction of fiscal health.
• Fabricated revenue and sales. Claiming the sale of goods or services that never took place, like double-counting sales, depicting fake customers or overstating or altering legitimate customer invoices. Criminals that conduct this type of fraud may reverse the false sales at the end of the reporting period to help cover up the scam.
• Playing with time. This trick involves understating revenue in one accounting period by developing a reserve that can be claimed in less robust periods. This can also include posting sales before they are made or before payment, reinvoicing past-due accounts and prebilling future sales.
• Inadequate disclosures. Disclosed financial statement information must be accurate and clear to not mislead recipients. When this type of fraud is committed, factors like significant events, related-party transactions, contingent liabilities, and accounting changes are often omitted from financial statements.
• Altering expenses. When a company doesn’t fully record its expenses, exaggerating net income and understating costs, it creates a false impression of the net income earned.
• Misappropriations. Altering a financial statement to mask theft or embezzlement via double entry bookkeeping or including fake expenses is a serious felony – it is often conducted by an individual hoping to enrich themselves versus other kinds of fraud intended to inflate a company’s valuation.

Financial Statement Fraud Warning Signs

There are numerous kinds of lease application and financial statement fraud. Here are some red flags to watch for when screening prospective renters:

•  Incomplete information: Potential tenants who give you incomplete income or credit information or whose credit history doesn’t match their pay stubs could be scammers. To avoid headaches, ensure all applicants complete every section of your rental application. Also, always cross-check the income verification they submit with their credit report.
• Credit reports don’t match. If a candidate insists on giving you a hard copy printed version of their credit report – or asks you not to run one – it’s a warning sign. If you run a credit check that doesn’t correspond with the information or printed report, move on to the next option on your list of renters.
•  A rushed process. It’s always a sign of a potential fraudster when they offer to pay extra – or pay in advance – to rush or skip through the steps of their approval. Scammers don’t want you to review carefully or check references as they realize you will likely uncover evidence of falsified information.

 How to Prevent Financial Statement Fraud

Based on the current rental housing environment, financial statement fraud likely won’t slow down anytime soon. Consider these tips and tactics to prevent it from happening to you:

• Always ask for multiple forms of ID, like a passport and driver’s license
• Confirm employment and income information via direct contact with employers
• Look into criminal history by conducting a comprehensive background check
• Check previous rental references to confirm a prospective tenant’s rental history and character references
• Utilize digital tenant screening platforms to quickly and easily detect any inconsistencies or red flags within applicant information.

The Bottom Line

Unfortunately, financial statement fraud can create financial losses – and big headaches – for landlords and property managers. However, educating yourself on the red flags and warning signs and taking proactive steps to reduce this type of issue can help you ultimately identify ideal renters – and safeguard you and your company against scammers.