Most people with kids would totally understand that statement. Yes kids embellish stories ALOT!
I have heard that statement made at our daycare alot. Kids will say things totally out of context or retell a story thru the eyes of a child. Things are said that said reasonable to them that makes no sense to anyone else.
It is a common, and meant to be funny, expression that you only believe part of what a child says. An example of this my husband was using the electric screwdriver and (without the tip) used it on my son's arm, just to make it tickle. It scratched his skin--nothing major, my son was not bothered by it one bit. The next day at daycare my son told his teacher "my dad screwed me to the bone last night and made me bleed". Yes this required an explanation--but kids just say things wrong.
As a parent you will know when your kids embellish and when they are truly questionable. I promise you the quote was intended to be funny--and with kids that are 5 and almost 3-- I can only hope people do believe only 1/3 of what my kids say!!
-wendi