During the verification process cops visit the applicant's home and they verify information provided from neighbor's as well. They don't ask about everything though but, if they find something odd they will question. Generally they just want to check whether the applicant is really a resident and Indian national.
It will lead to cancellation of the application and police may charge the applicant for providing false information.
FAQ Q2: Why is Police Verification required for issuance of passport?
A: Passport is a very valuable document. Thus, in order to ensure that it does not go in wrong hands, police verification is required for issuance of passport.
Source: https://portal1.passportindia.gov.in/AppOnlineProject/online/faqPoliceVerification
In addition to this applicant will also need to go to police station for interview and submitting the documents.