Creative accounting Prepared by Olga Zaharchuk OBP-21
What is creative accounting? Creative accounting, also called aggressive accounting, is the manipulation of financial numbers, usually within the letter of the law and accounting standards, but very much against their spirit and certainly not providing the “true and fair” view of a company that accounts are supposed to.
A typical aim of creative accounting will be to inflate profit figures. Some companies may also reduce reported profits in good years to smooth results. Assets and liabilities may also be manipulated, either to remain within limits such as debt covenants, or to hide problems. Typical creative accounting tricks include off balance sheet financing, overoptimistic revenue recognition and the use of exaggerated non-recurring items.
The term “window dressing” has similar meaning when applied to accounts, but is a broader term that can be applied to other areas. In the US it is often used to describe the manipulation of investment portfolio performance numbers. In the context of accounts, “window dressing” is more likely than “creative accounting” to imply illegal or fraudulent practices, but it need to do so.
The techniques of creative accounting change over time. As accounting standards change, the techniques that will work change. Many changes in accounting standards are meant to block particular ways of manipulating accounts, which means those intent on creative accounting need to find new ways of doing things. At the same time, other, well intentioned, changes in accounting standards open up new opportunities for creative accounting (the use of fair value is a good example of this).
Reasons why a business would make use of creative accounting. There are many reasons why a business would make use of creative accounting. One of the more common is to increase the desire for the stock issued by the business. In some countries, this can be accomplished by releasing reports that indicate the officers are receiving bonuses due to increased sales volume, even though that volume did not result in any real increase in profits. At the same time, the business releases additional shares of stock. This sends the message to investors that the company is on the move, and will entice some to execute orders to purchase shares before they are snapped up by other investors. The end result is that the demand for the stock drives up the value of the shares, and benefits the business financially.
In recent years, a number of nations have taken steps to minimize the incidence of creativeaccounting by implementing regulations that make it more difficult for businesses to cook the books and present a financial position that is does not tell the entire story. The hope is that by doing so, investors will be able to obtain all the data required to make an informed decision about their investment options, and prevent the economy from being adversely affected by misleading financial accounting practices at major corporations. Since there a number of ways to engage in creative accounting, chances are it will take a number of years to craft regulations that will make those unorthodox accounting processes explicitly illegal.
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