Creative Accounting Sample Essay

Creative Accounting

Financial statements are the primary documents that are used by internal and external stakeholders to gain an in-depth understanding of the general financial performance of a company. The financial data extracted from these documents constitute crucial information that influences the decisions of these stakeholders concerning company management and performances. Therefore, the accuracy and reliability of these documents is a crucial factor to considers in order to make appropriate business decisions. This fact became a point of focus and importance following the collapse of well-established companies like HealthSouth, Enron, and WorldCom in 2001. Its significance is further intensified following the recent financial crises that have resulted in the collapse of many financial institutions around the globe.

To generate transparent, reliable, and timely financial statements, accountants should follow the guiding principles and standards as stipulated in the GAAP and IAS. Despite the existence of strong accounting standards (GAAP and IAS), it sometimes becomes impossible for accountants to create genuine financial statements without manipulating particular aspects of the business. These manipulative behaviors are primarily executed by the accounts who want to influence the decisions of users of these financial statements in favor of their corporations. The complex and unpredictable nature of the continuously changing business landscape makes it impossible to seal all the potential financial loopholes in advance when setting accounting and financial standards. However, Jones (2010) argues that even if the current accounting standards and regulations cannot prevent the financial scheming conducts in advance, they can curb it afterward. The purpose of this paper is to critically evaluate Companies’ use of Creative Accounting in Financial Reporting and examine its effects.

History and definition of creative accounting

Even though the practice of creative accounting has received many publications over the last few decades, there has always been an aspiration to manipulate business figures to create a favorable impression among business leaders. According to BALACIU and Alina (2010), the desire to make business figures more alluring to the public, stakeholders, and investors dated back more than 500 years ago. Luca Paciolo was an Italian mathematician, and early contributors to the field of accounting had developed the tradition of creative accounting in his book De Arithmetica (Balaciu & Alina, 2010) notes that. His records demonstrated that the Venetian trade men during that era had a practice of recording transactions between themselves by double-entry bookkeeping with inked quill-pens in primary and supplementary books. In case of any noticeable inconsistencies in these records, the ink column was periodically brushed over in the books to make the records more illegible. Citing from this example, it is evident that the manipulative behavior of figures in the business landscape is not a new phenomenon and date back five centuries ago.

Fast forward, the concept of account manipulation was brought into the light following the early researches of Copeland (1968). In his research, he defined the act as the ability of bookkeepers to skillfully manipulate their net profiting by either decreasing or increasing net profits or sales of their companies at will. However, Mulford and Comiskey (2005) demonstrated that account manipulation is a broad concept that also includes alterations in balance sheet transactions. Subsequently, the concept of account manipulation was coined into a business term “creative accounting” by a financial and economic journalist in the United King known as Griffiths. Numerous terms have since been coined to define the concept of account manipulation, including earning management in the US, innovative accounting, cosmetic accounting, financial engineering, income smoothing, or window dressing (Amat & Gowthorpe, 2004).

Similarly, several definitions have been coined over the years to describe the concept of creative accounting comprehensively. According to Griffith, creative accounting is the ability of business management teams to manipulate the accounting figures to achieve the desired outcome in their financial statement. In scholastic sagacity, Pijper (2016) defines creative accounting as the ability of accountants to creatively manipulate figures reported in the accounting books without a break the set accounting standards (GAAP and IAS). Jones (2010) explained it creative exploitation of ambiguities or gaps in accounting rules by accountants in order to depict their preferred picture of financial performance.

Motivations for Creative Accounting

There are several motivations behind the application of creative accounting practices in the commerce landscape. One of the primary incentives for using these techniques is the projected increase in stock prices. Every corporation goes into business intending to increase its value. According to Carmen and Moroi (2019), the ability of a corporation to produce a sustainable and possibly growing stream of earning creates an illusion that the company is performing exceptionally and is likely to have a positive impact on the stock prices. One possible explanation for this phenomenon is that profitable business attracts investors who willingly pay a higher value for stocks because of the corporate earning power and increasing cash flow. The cash flow must either be provided currently or expected to increase soon. Therefore, by applying creative accounting techniques, companies may effortlessly communicate to potential investors that their firms are on a growth trajectory of having higher profit margins, thus attracting higher stock prices (Carmen & Moroi, 2019).

Another motivation behind the use of creative accounting in companies is to attract higher credits and lower interest rates. Creative accounting helps in improving specific key performance ratios used by creditors to determine the viability of businesses to obtain credit. Cernusca et al. (2016) argue that inflating company assets and understating company liabilities on the balance sheet is one way of improving the crucial performance ratios analyzed by creditors. Also, to attract proper credits, companies can use creative accounting to conceal their unstable profits that portray as being susceptible to hostile takeover or stock fluctuations (Pijper, 2016). Creditors perceive companies with unstable net returns as less well managed and generally riskier in comparison to companies with stable returns. Furthermore, in certain instances, companies use creative accounting not to appear to be exceptionally profitable but to manage earnings down. However, the usefulness of this account manipulation will pivot on the acknowledgment or recognition of the reduced profit level as being valid by the key players (Pijper, 2016). For instance, during the Gulf War, oil companies applied income decreasing policies to evade the political consequences of a higher profit stemming from increased retail prices.

Techniques of Creative Accounting

There are several methods of creative accounting that companies have used to lure investors and creditors into investing in their businesses. Below are some of the significant creative accounting techniques:

Income Smoothing

According to Copeland (1968), income soothing is the ability of expert accountants to even out a company’s variations in net returns from one period to the next. This form of creative accounting is practiced by most companies in recognition of investors’ willingness to pay more for stocks from companies with steady and predictable cash flow as opposed to stocks from corporations with unsteady and unpredictable income. Investors’ term the volatile cash flow patterns of the later company as a higher risk investment and tend not to invest. Kliestikova, Kovacova, and Kliestik (2018) argue that the practice of income smoothing is not illegal as long as the preparers’ follows generally accepted accounting principles (GAAP). Bhasin (2016) note that expert accountants can use their accounting expertise to manipulate figures reported in accounting books without breaking accounting standards (GAAP and IAS) to ensure the legality of income smoothing.

One of the primary examples of income smoothing techniques is deferring revenue during a successful fiscal year in case the next business year is expected to be unfruitful. Also, the company can delay recognizing its sales during a challenging financial year in anticipation of a better return in the future (Bhasin, 2016). Additionally, a company may engage in deferring the recording of present time operating costs like payment of suppliers and rental fee, to subsequent period to make the current period earning look better. It is, therefore, sensible why companies engage in some level of creative accounting techniques. However, implementing the income smoothing process requires a consideration of what the Internal Revenue Service IRS permits and total deception.

Overvaluing Assets

During the construction of a balance sheet, accountants put much focus on assets valuation. Like liabilities, assets can be categorized as either current or long-term. Some of the everyday items found in the asset category include intellectual intangibles, inventories, account receivable, and cash and equivalents.

Manipulating inventory

According to Ali, Butt, and Bin (2011), inventory represents an organization’s manufactured goods that are yet to be sold to the final consumers. The value of inventory is usually priced at a wholesale price but sold to the consumers with a markup. If the inventory is sold, its wholesale value is recognized as the cost of goods sold, and the total value is recorded as revenue in the income statement (Ali, Butt & Bin, 2011). Therefore, increasing any inventory value subsequently leads to an understatement of cost of goods sold, and consequently attracts higher cash flow, assuming the sales volume remain constant. With an illusion of higher net income, companies can easily attract investors and creditors.

A typical example of this practice was carried out by Laribee Wire Manufacturing Co. The company under financial difficulties in the late 1980s decided to record an imaginary inventory and carried other inventory at bloated values to create a favorable impression among six different banks. Laribee Wire Manufacturing Co. reported having received more than $3 million in profit, while in the real sense, it had made a massive loss of $6.5 million (Ali, Butt & Bin, 2011). Wire Manufacturing Co. got away with this tactic and managed to receive a loan of $130 million by using its inventory as collateral.

Provision for Doubtful Accounts

Account receivables are considered as current assets in the balance sheet. Therefore, corporations that employ accrual accounting can record the anticipated revenue in their account receivables immediately sales are made. Thus, during the process of recording anticipated sales on account receivable, accountants often have the opportunity to manipulate figures in the balance sheet. That is, when they want to create a favorable impression to investors, they can increase the company profits by acknowledging that there will be a deficient level of non-payment for goods and services already sold.

Undervaluing Liabilities

Another crucial technique that accountants use to practice creative accounting in the business landscape is to undervalue corporation liabilities on the balance sheet. Understating any form of company expenses is crucial in boosting the bottom line profit. The following are some of the techniques used in this category:

Masking Contingent Liabilities

According to Balaciu and Alina (2010), contingent liabilities are liabilities that a corporation can accrue and are contingent upon the outcome of an unpredictable future event. These liabilities are reported at the footnote on the financial statements if the contingency is possibly to occur, and the sum of liability can sensibly be estimated. Kliestikova, Kovacova and Kliestik (2018 ) note that a company contingent liability can be an anticipating law suit from a competing firm for violation patent right, pension obligation, or warranty obligation. Accountants can innovatively account for these liabilities either downplaying their materiality or underestimating them. Underestimating contingent liabilities subsequently increases the company’s net income and shareholder’s equity. Bhasin (2016) notes that underestimation or downplaying contingent liabilities by corporation accountants is a violation of the GAAP and IFRS standards and regulation that requires firms to accurately record their contingent liabilities with full disclosure, prudence, and materiality.

Other Creative Accounting Techniques

“Big Bath” Accounting

According to Cernusca et al. (2016) big bath is an accounting practice where a company’s management team knowingly manipulate its income statements to make its poor net returns look much more worst than it really is, so that future net returns look better. This practice is often implemented in a bad financial year that is characterized by significantly reduced sales and increased liability, and performance artificially inflated in the following year. There are several techniques that company CEO can use to carry out bid bath: delaying the realization of revenue, taking write-offs, or prepaying expenses (Cernusca et al., 2016).

Using Cookie Jar Reserves

According to Pijper (2016) cooking jar reserves are saving from companies previous quarters that are used by companies to inflate or maintain net income in the subsequent quarters. Like smoothing income, the intent of using cookie jar reserves in reporting net profit is to create an impression among investor that the company is on a steady growth trajectory thus attracting higher stock prices. Using cookie jar reserve to normalize financial statements is considered unethical and illegal because it potentially mislead investors into believing that the company is doing great while it is recording loses in almost every quarter. As Mulford and Comiskey (2005) states this technique includes making unrealistic estimation of the more common liabilities like warranty cost, loan losses, or sales returns. The recorded accruals are then stashed in cookie jars during good times and retrieved during tough economic times.

Abuse of Materiality Concept

According to Mulford and Comiskey (2005) material concept is accounting principle that allows trivial matters to be disregarded from financial statement while all material items to be disclosed. Therefore, abuse of materiality concept involves an intentional documentation of errors in revenues, expenses, equity, within the defined percentage limit. Companies engaging in this practice often defend their actions by arguing that the effect on net on the net income is too insignificant to influence investors’ decisions (Amat & Gowthorpe, 2004).

Getting Creative with the Income Statement

It consist of the practice of recording a dissimilar level of earning power by using the layout of the income statement instead of using the normal format in which transactions are recorded. For instance, corporations may label a recurring expenditure as nonrecurring or record nonrecurring revenue as a recurring revenue “other revenue” (Amat & Gowthorpe (2004).

Problems with Cash-flow Reporting

Cash-flow reporting presents company executives with other loopholes to use in communicating higher earning power to indicate a sustainable and consistent cash flow. A corporation’s ability to earn more profits from sales of its products and services is much greater when it has steady cash flow. Therefore, a company can classify financing inflow as operating item, or operating expenditure as a financing or investing item. Jones (2010) argues that even though the following process may not potentially alter the total change in cash, it still increases cash flow from operations.

Other Important Issue to Address

If creative accounting is believed to be stemming from the presence of loopholes in the accounting standards (GAAP and IAS) maybe one of the principle roles belongs the setters in decreasing the possible negative effect of account manipulation. Milesi-Ferretti (2004) notes that the primary strengths of the currently practiced accounting standards (GAAP and IAS) is their ability to clear define and explain relevant accounting items which can help in preventing the abuse of accounting principles that are fundamental to creative accounting. Milesi-Ferretti (2004) further acknowledges that the IAS are constantly being reviewed to keep up with the emerging trends of creative accounting and views creative accounting as the primary drivers to the formation and expansion of IAS.

Even though this point of view is correct, it would be more important for standard setters’ to intensify the careful definition and clear clarification qualities of the standard. It is impractical to completely seal all the loopholes being exploited by accounts to practice creative accounting. However, it would be practical to reduce at least the negative impact of creative accounting by strictly implementing the accounting standards, decreasing managers’ flexibility in deciding among different accounting methods, and giving more importance to ethical considerations of accounting practice.

Recommendations

The concept of creative accounting has attracted mixed reaction from practitioners and academicians. Some scholars and practitioners’ view creative accounting as an unethical and unlawful act while another equal proportion argue that the practice is ethical and legal because it only exploits the flexibility of accountings standards. Whichever way we decided to view this practice, it is important to acknowledge that it plays a pivotal role in massive accounting scandals that have recently hit the global business landscape. Furthermore, the practice of engaging in creative accounting stems from different factors other than accounting standard loopholes and motivation of firms to appeal to outside investors.

Milesi-Ferretti (2004) asserts that the practice of creative accounting results from the insufficiency in the legal framework for banking and accounting, difficulties in enforcing the legal and ethical rules due to slow functioning of the judicial systems, and inadequacies in the independence of governmental regulation and supervision bodies. The following are some of recommendations that should be implemented to curb the growing incidences of creative accounting.

GAAP standards should be subjected to IAS and SAS standards to ensure the provision of comprehensive and effective rules and regulations of accounting practice within the business landscape to foretell the practice of creative accounting within organizations.
Operators of accounts and those performing accounting duties should strictly embrace and adhere to global financial reporting standards like the international financial reporting standards (IFRS).
There should be greater emphasis on enforcement of code of corporate governance and ethics. Regulatory bodies should effectively enforce changes in accounting regulations and ethical standard government code to prevent corporations from using deceptive reporting practices of creative accounting.
External auditors should honestly carry their duty in identifying and reporting dishonest entries in the financial statements.
Regulatory bodies should come up with rules and regulations that minimize the use of judgement prediction and estimations in the treatment of specific entries like extra ordinary item in financial reporting.

Conclusion

Creative according have recently hit the air waves following numerous accounting scandals around the globe. This paper comprehensively explored some of the critical creative accounting techniques, including Income Smoothing, Manipulating inventory, “Big Bath” Accounting, and Abuse of Materiality Concept. Generally, creative accounting has created formidable challenges in the accounting practice especially when carried to extreme negativity. Extreme creative accounting practices have often cast aspersion on the credibility of accounting standards and principles. As a result, there has been a rise in the need for close scrutiny of the potential abuses of accounting standards among corporations. Therefore, the effect of creative accounting on stakeholders as a whole should not be ignored and given much consideration than it is currently getting.

References

Ali Shah, S. Z., Butt, S. A., & Bin Tariq, D. (2011). Use or abuse of creative accounting techniques. International Journal of Trade, Economics and Finance, 2(6).

Amat, O., & Gowthorpe, C. (2004). Creative accounting: nature, incidence and ethical issues.

BALACIU Diana, Alina Beattrice Vladu (2010), “Creative Accounting – Players And Their Gains and Loses”, Annals of Faculty of Economics, Vol.: 1, issue: 2, pp. 813-819

Bhasin, M. L. (2016). Survey of Creative Accounting Practices: An Empirical Study. Wulfenia Journal KLAGENFURT, 23(1), 143-162.

Carmen, V. Ã., & Moroi, C. (2019). The Determining Factors of Creative Accounting. Ovidius University Annals, Economic Sciences Series, 19(2), 927-933.

Cernusca, L., David, D., Nicolaescu, C., & Gomoi, B. C. (2016). Empirical study on the creative accounting phenomenon. Studia Universitatis “Vasile Goldis” Arad–Economics Series, 26(2), 63-87.

COPELAND, Ronald M. (1968), “Income Smoothing”, Journal of Accounting Research, Vol. 6, pp. 101-116

Jones, M. J. (2010). Creative accounting, fraud and international accounting scandals. John Wiley & Sons.

Kliestikova, J., Kovacova, M., & Kliestik, T. (2018, April). Hiding the bankruptcy through creative accounting. In Proceedings of International Academic Conferences (No. 7508682). International Institute of Social and Economic Sciences.

Milesi-Ferretti, G. M. (2004). Good, bad or ugly? On the effects of fiscal rules with creative accounting. Journal of Public Economics, 88(1-2), 377-394.

Mulford, C. W., & Comiskey, E. E. (2005). The financial numbers game: detecting creative accounting practices. John Wiley & Sons.

Pijper, T. (2016). Creative accounting: The effectiveness of financial reporting in the UK. Springer.

Get professional assignment help cheaply

Are you busy and do not have time to handle your assignment? Are you scared that your paper will not make the grade? Do you have responsibilities that may hinder you from turning in your assignment on time? Are you tired and can barely handle your assignment? Are your grades inconsistent?

Whichever your reason may is, it is valid! You can get professional academic help from our service at affordable rates. We have a team of professional academic writers who can handle all your assignments.

Our essay writers are graduates with diplomas, bachelor, masters, Ph.D., and doctorate degrees in various subjects. The minimum requirement to be an essay writer with our essay writing service is to have a college diploma. When assigning your order, we match the paper subject with the area of specialization of the writer.

Why choose our academic writing service?

Plagiarism free papers
Timely delivery
Any deadline
Skilled, Experienced Native English Writers
Subject-relevant academic writer
Adherence to paper instructions
Ability to tackle bulk assignments
Reasonable prices
24/7 Customer Support
Get superb grades consistently

Get Professional Assignment Help Cheaply

Whichever your reason is, it is valid! You can get professional academic help from our service at affordable rates. We have a team of professional academic writers who can handle all your assignments.

Why Choose Our Academic Writing Service?

Plagiarism free papers
Timely delivery
Any deadline
Skilled, Experienced Native English Writers
Subject-relevant academic writer
Adherence to paper instructions
Ability to tackle bulk assignments
Reasonable prices
24/7 Customer Support
Get superb grades consistently

Online Academic Help With Different Subjects

Literature

Students barely have time to read. We got you! Have your literature essay or book review written without having the hassle of reading the book. You can get your literature paper custom-written for you by our literature specialists.

Finance

Do you struggle with finance? No need to torture yourself if finance is not your cup of tea. You can order your finance paper from our academic writing service and get 100% original work from competent finance experts.

Computer science

Computer science is a tough subject. Fortunately, our computer science experts are up to the match. No need to stress and have sleepless nights. Our academic writers will tackle all your computer science assignments and deliver them on time. Let us handle all your python, java, ruby, JavaScript, php , C+ assignments!

Psychology

While psychology may be an interesting subject, you may lack sufficient time to handle your assignments. Don’t despair; by using our academic writing service, you can be assured of perfect grades. Moreover, your grades will be consistent.

Engineering

Engineering is quite a demanding subject. Students face a lot of pressure and barely have enough time to do what they love to do. Our academic writing service got you covered! Our engineering specialists follow the paper instructions and ensure timely delivery of the paper.

Nursing

In the nursing course, you may have difficulties with literature reviews, annotated bibliographies, critical essays, and other assignments. Our nursing assignment writers will offer you professional nursing paper help at low prices.

Sociology

Truth be told, sociology papers can be quite exhausting. Our academic writing service relieves you of fatigue, pressure, and stress. You can relax and have peace of mind as our academic writers handle your sociology assignment.

Business

We take pride in having some of the best business writers in the industry. Our business writers have a lot of experience in the field. They are reliable, and you can be assured of a high-grade paper. They are able to handle business papers of any subject, length, deadline, and difficulty!

Statistics

We boast of having some of the most experienced statistics experts in the industry. Our statistics experts have diverse skills, expertise, and knowledge to handle any kind of assignment. They have access to all kinds of software to get your assignment done.

Law

Writing a law essay may prove to be an insurmountable obstacle, especially when you need to know the peculiarities of the legislative framework. Take advantage of our top-notch law specialists and get superb grades and 100% satisfaction.

What discipline/subjects do you deal in?

We have highlighted some of the most popular subjects we handle above. Those are just a tip of the iceberg. We deal in all academic disciplines since our writers are as diverse. They have been drawn from across all disciplines, and orders are assigned to those writers believed to be the best in the field. In a nutshell, there is no task we cannot handle; all you need to do is place your order with us. As long as your instructions are clear, just trust we shall deliver irrespective of the discipline.

Are your writers competent enough to handle my paper?

Our essay writers are graduates with bachelor's, masters, Ph.D., and doctorate degrees in various subjects. The minimum requirement to be an essay writer with our essay writing service is to have a college degree. All our academic writers have a minimum of two years of academic writing. We have a stringent recruitment process to ensure that we get only the most competent essay writers in the industry. We also ensure that the writers are handsomely compensated for their value. The majority of our writers are native English speakers. As such, the fluency of language and grammar is impeccable.

What if I don’t like the paper?

There is a very low likelihood that you won’t like the paper.

Reasons being:

When assigning your order, we match the paper’s discipline with the writer’s field/specialization. Since all our writers are graduates, we match the paper’s subject with the field the writer studied. For instance, if it’s a nursing paper, only a nursing graduate and writer will handle it. Furthermore, all our writers have academic writing experience and top-notch research skills.
We have a quality assurance that reviews the paper before it gets to you. As such, we ensure that you get a paper that meets the required standard and will most definitely make the grade.

In the event that you don’t like your paper:

The writer will revise the paper up to your pleasing. You have unlimited revisions. You simply need to highlight what specifically you don’t like about the paper, and the writer will make the amendments. The paper will be revised until you are satisfied. Revisions are free of charge
We will have a different writer write the paper from scratch.
Last resort, if the above does not work, we will refund your money.

Will the professor find out I didn’t write the paper myself?

Not at all. All papers are written from scratch. There is no way your tutor or instructor will realize that you did not write the paper yourself. In fact, we recommend using our assignment help services for consistent results.

What if the paper is plagiarized?

We check all papers for plagiarism before we submit them. We use powerful plagiarism checking software such as SafeAssign, LopesWrite, and Turnitin. We also upload the plagiarism report so that you can review it. We understand that plagiarism is academic suicide. We would not take the risk of submitting plagiarized work and jeopardize your academic journey. Furthermore, we do not sell or use prewritten papers, and each paper is written from scratch.

When will I get my paper?

You determine when you get the paper by setting the deadline when placing the order. All papers are delivered within the deadline. We are well aware that we operate in a time-sensitive industry. As such, we have laid out strategies to ensure that the client receives the paper on time and they never miss the deadline. We understand that papers that are submitted late have some points deducted. We do not want you to miss any points due to late submission. We work on beating deadlines by huge margins in order to ensure that you have ample time to review the paper before you submit it.

Will anyone find out that I used your services?

We have a privacy and confidentiality policy that guides our work. We NEVER share any customer information with third parties. Noone will ever know that you used our assignment help services. It’s only between you and us. We are bound by our policies to protect the customer’s identity and information. All your information, such as your names, phone number, email, order information, and so on, are protected. We have robust security systems that ensure that your data is protected. Hacking our systems is close to impossible, and it has never happened.

How our Assignment Help Service Works

1. Place an order

You fill all the paper instructions in the order form. Make sure you include all the helpful materials so that our academic writers can deliver the perfect paper. It will also help to eliminate unnecessary revisions.

2. Pay for the order

Proceed to pay for the paper so that it can be assigned to one of our expert academic writers. The paper subject is matched with the writer’s area of specialization.

3. Track the progress

You communicate with the writer and know about the progress of the paper. The client can ask the writer for drafts of the paper. The client can upload extra material and include additional instructions from the lecturer. Receive a paper.

4. Download the paper

The paper is sent to your email and uploaded to your personal account. You also get a plagiarism report attached to your paper.

PLACE THIS ORDER OR A SIMILAR ORDER WITH US TODAY AND GET A PERFECT SCORE!!!