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ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
Volume 5 Issue 4 (2014)
www.elkjournals.com ………………………………………………………………………………………………………………………….
1
CRITICAL ANALYSIS OF THE CREATIVE ACCOUNTING
Dr. K. Kanaka Raju
Assistant Professor , Department of Management
Studies,
Andhra University Campus, Tadepalligudem,
Andhra Pradesh, India
Email: dr.kanakaraju2011@gmail.com
ABSTRACT
Keywords: Creative accounting, Analysis, Accounting Practices
Introduction
With the help of accounting knowledge,
the actual figures manipulated to gain the
personal profits. This process of
manipulation of accounts is called as the
creative accounting. It is possible through
the effects of increase or decrease of
expenses, increase or decrease of the
income, increase or decrease of assets,
crease or decrease of owners‟ funds,
increase or decrease of debts,
reclassification of assets or liabilities. These
are the reasons for mismatch between true
and fair view.
Definition of Creative Accounting:
Kamal Naser: Creative accounting is the
transformation of financial accounting
figures from what they actually are to what
preparers desire by taking advantage of the
existing rules and/origins some or all of
them. (1993:2)
Reasons for Creative Accounting:
The following reasons were prevailing in the
process of creative accounting.
1) Smoothing of Income: Companies avoid
presenting volatile profits with a series
of highs and lows and prefer reporting a
The paper attempts to critically analyse creative accounting. For the same, 150 respondents were interviewed to
gather the information through a structured questionnaire. The secondary data was also collected with the help of
the existing literature and review. The data analysis included estimation of mean, percentage, standard deviation,
and t-test, which were applied to derive the results. This research study seeks to explain the reasons and
practices of the creative accounting and perceptions of the respondents on various issues of the creative
accounting.
ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
Volume 5 Issue 4 (2014)
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steady growth. This is achieved by
making unreasonably high provisions for
liabilities and against values of assets in
profitable years so as to report higher
profits in not so profitable years by
reducing these provisions. Supporters of
this approach argue that it is a measure
against the 'short-termism' of evaluating
an investment on the basis of the yields
achieved in the immediately succeeding
years
2) Manipulating profits and attaching them
to forecasts is a variant on income
smoothing. Fox (1997) argues on how
accounting policies are designed at
Microsoft to match reported earnings to
forecasted profits. Microsoft defers a
large part of its profits from the sale of
software to cover cost of upgrading and
customer service costs that may arise in
future years. This highly conservative
and perfectly respectable accounting
policy suggests that future earnings are
easily predictable.
3) Directors of companies might keep an
income-boosting accounting policy
change ready, in order to divert attention
from distasteful news. Collingwood
(1991) describes how a change in
accounting method heightened K-Mart's
quarterly profit figures by some $160
million, in spite of the company slipping
to number two slots from being the
largest retailer in the USA thereby
diverting the attention from the event.
4) Creative accounting may help in
maintaining or boosting the share price
both by reducing the apparent levels of
borrowing, thereby making the company
appear less susceptible risk, and by
setting a profit trend example. This may
help the company to raise capital from
issue of new share issues, offer their
shares in takeover bids, and combat
takeover by other companies.
5) If the directors involve in 'insider
trading' in their company's shares they
may utilize creative accounting to
postpone the release of information to
the market, thereby enhancing their
probability of benefitting from inside
knowledge .It should be noted that,
ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
Volume 5 Issue 4 (2014)
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analysts will not be misguided by
superficial accounting charges in an
efficient market. Indeed, income
boosting accounting changes may be
perceived as an indicator of weakness by
the alert analysts. Dharan and Lev
(1993) present a study that indicates
poor performance of shares in the years
immediately succeeding income
inflating changes in accounting. Another
set of justifications for creative
accounting, which applies to all
companies, arises because companies are
subject to various types of constraints,
contractual rights and obligations based
on the reported accounting figures.
Review of Literature:
From the viewpoint of a business journalist,
Griffiths (1986), argues: "Every company in
the country is fidgeting with its profits.
Every set of furnished accounts is based on
books which have been gently cooked or
completely roasted. The figures which are
disclosed twice a year to the investing public
have all been tampered with in order to
protect the culpable. It is the biggest con
trick since the Trojan horse ... In fact this
deception, commonly called creative
accounting is completely legitimate and in
good taste. (p1)
From the viewpoint of an accountant,
Jameson (1988), observes: "The accounting
process consists of dealing with numerous
matters of judgement and of resolving
clashes between competing methodologies
of presentation of the results of financial
events and transactions .This resilience
presents scope for manipulation, deceit and
misrepresentation. These activities practiced
by the less scrupulous elements of the
accounting profession – have come to be
known as 'creative accounting'
As an investment analyst, Smith (1992)
agues: "We experienced that much of the
visible growth in profiles which had
occurred in the 1980's was the outcome of
accounting stratagem of hand rather than
genuine economic growth, and we set out to
unmask the main tools and techniques
ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
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involved, and to provide live examples of
companies making use of those techniques".
From an academic‟s point of view, Naser
(1993) suggests a definition: "Creative
accounting is the art of metamorphosing
financial accounting figures from what they
really are to what developers desire by
exploiting the existing rules and/or ignoring
some or all of them"
Some common arguments run through
popular works: Creative accounting involves
„fiddling‟ and „figures which have been
changed‟ (Griffiths) to achieve
„misrepresentation‟ (Jameson) by „sleight of
hand‟ (Smith) to transform figures from
„what they actually are‟ (Naser).
Categorically in Naser, and tacitly in the
other three versions, is suggested that
creative accounting deviates from and masks
some underlying truth in financial figures.
Creative accounting is evidenced
extensively in the UK. Naser believes that
because of the freedom of choice it allows
the accounting systems in Anglo-Saxon
countries as especially prone to such
manipulation. He argues, “The freedom of
choice provided by Anglo-Saxon accounting
system could be abused ...”
Similarly in context of the accounting
problem in UK, Waller (1990) suggests
moving to a more prescriptive, legal
continental tradition. Finally all four authors
perceive creative accounting as a
disreputable practice, using terms such as
„fiddling‟, and deceit ‟and„ taking
advantage.
Objectives of the Study
After review of the existing literature the
following objectives have been adopted for
carrying of this study:
1) To examine the reasons and practices of
creative accounting.
2) To review the impact of legalized
accounting frame work on financial
results and condition.
3) To interpret and analyze the perceptions
of respondents on various issues of
creative accounting.
ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
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4) To offer a suitable suggestions to
overcome the existing complexities in
accounting procedure and practices to
reflect the true and fair view of
financial statements.
Methodology of the Study
The data has been collected through
structured questionnaire from the 150
respondents, and informal conversations
with them. The secondary data obtained
from the existing literature and review.
Techniques
The SPSS 16.0 version was used to interpret
and analyze the data. The percentage,
frequency and t-test applied to analyze the
data.
Hypothesis: The following hypotheses were
adopted to test the results for come to the
valid reasons.
Hypothesis 1:
Null Hypothesis (Ho): There was no client
proposal to manipulate accounts for tax
evasion.
Alternative hypothesis (Ha): There was
client proposal to manipulate accounts for
tax evasion.
Hypothesis 2:
Null Hypothesis (Ho): New structure of
financial regulation is not the causes of
directions are more ethical.
Alternative Hypothesis (Ha): New
structure of financial regulation is the causes
of directors are more ethical.
Creative Accounting techniques and
practices:
The availability of making choices in
recommended policies and treatments in
International accounting rules makes way
for creative accounting. Such freedom of
choice generates significant uncertainty
regarding the consistency and comparability
of information. In the following, we will try
to highlight some creative accounting
ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
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techniques and their effect on the
performance of the entity:
Inventory related Creative Accounting
Practice: The purchase costs of inventories
(Transportation costs) will be included in
the purchase cost or not, in this regard that
an entity acquires goods in the following
situations: Purchase cost of goods Rs.
10,800, Transport costs Rs. 600, Revenues
from the sale of goods Rs. 27,000 .
Table 1: Inclusion and Exclusion of Transport Costs for Manipulation of Accounts.
Elements Transport Costs Included
in the Cost of Goods
Acquisition
Transport Costs Excluded
from the Cost of Goods
Acquisition
Revenues from the Sale of
Goods
27,000 27,000
Cost of Goods Sold 10,800 10,200
- Purchase Cost 10,000 10,000
- Transport Expenses 6,00 -----------
- Handling Expenses 200 200
Accounting Result 16,200 16,800
The above table 1 reveals that the
accounting result was decreased where
transport expenses considered in cost of
goods sold, i.e. 16,200 (Instead of 16,800).
Hence, it is possible to manipulate the
accounting results and conditions under the
purview of the existing accounting rules and
procedure. Hence, it is recommended to
strengthen the existing procedure of rules
and regulations with compliance of the
International Financial Reporting Standards
to project the true and fair view of the
financial results.
Table 2: Capitalization and Non Capitalization of Interest Regarding Creative Accounting.
ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT
ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014
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Elements Interest is capitalized Interest is not capitalized
Turnover 67,000 67,000
Variation of Stocks 12,000 11,000
Expenses with Raw materials 25,000 25,000
Salary and Social Expenses 13,000 13,000
Other Operating Expenses 9,000 9,000
Operating Result 32000 31000
Expenses Regarding the
Interest
-------------- 1500
Accounting Result 32,000 29,500
The table 2 reveals that capitalization and
non-capitalization of Interest regarding
manipulation of accounts. If the interest is
not included the accounting results declined
from the Rs. 32000 to Rs. 29,500. It means
there is possibility of projecting the
undervalued financial results rather than
original values.
To exemplify it is supposed that
the entity has an industrial building acquired
at a consideration of Rs. 7,000,000, where
the depreciated value is Rs. 4,000,000. The
depreciation method used is linear and the
remaining life is 10 years.
Table 3: Capitalization and Non-Capitalization of Renovation Expenses for Manipulation
Accounts
Elements
N
-------------------------------
Renovation expenses
N+1
Renovation Expenses
Itis It is not It is It is not
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capitalized Capitalized capitalized capitalized
Turnover 15,000,000 15,000,000 15,000,000 15,000,000
Renovation Expenses ---------- 1,700,000 ---------- ----------------
Depreciation Expenses
1,900,000 1,000,000 1,900,000 1,000,000
Expenses with raw
materials
3,000,000 3,000,000 3,000,000 3,000,000
Salary and Social Expenses
1,300,000 1,300,000 1,300,000 1,300,000
Other Operating Expenses
700,000 700,000 700,000 700,000
Accounting Result 81,00,000 74,00,000 81,00,000 90,00,000
The table 3 witnessed that comparison of
renovation expenses for N period to N plus
one period in the context of capitalization
and non-capitalization of renovation
expenses .The results were due to
capitalization and non-capitalization. For N
period the capitalized value were higher than
non-capitalized value, but in N plus one
period the capitalized value were lesser than
non-capitalized value due to depreciation.
At the beginning of N, the entity‟s
management decides to re-examine the
immobilization, the fair value being Rs.
8,000,000. The equity situation before the
reevaluation was as follows: social capital
Rs. 120,000,000, revaluation reserves Rs.
9,000,000. As reported by the statement of
changes in equity, the entity‟s performance
before and after revaluation is:
Table 4: Effect of Revaluation Reserve on
Financial Condition
Elements Before the
Revaluation
After the
Revaluation
Social 1,20,000,000 1,20,000,000
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Capital
Revaluation
Reserve
9,000,000 13,000,000
Total
Equity
1,29,000,000 1,33,000,000
The table 4 reveals that the value of equity
increased after its revaluation, by
400,000,000 because of revaluation value
was manipulated. The depreciation expense
increases as an effect of revaluation of
depreciable assets. The annual depreciation
before revaluation is Rs. 400,000, and after
revaluation is Rs. 800,000 (8,000,000 x
10%).Thus, after revaluation, the outcome is
reduced by 400,000 mu (we maintain the
data in the example on the previous page):
Table 5: Effect of Depreciation Expenses
on Financial Results
Elements Before the
Reevaluatio
n
After the
Reevaluatio
n
Turnover 1,20,000 1,20,000
Depreciatio
n Expenses
400,000 800,000
Expenses
with Raw
materials
3,000,000 3,000,000
Salary and
Social
Expenses
1,300,000 1,300,000
Other
Operating
Expenses
900,000 900,000
Accounting
Results
4,400,000 4,000,000
The above table reveals that how the value
of depreciation is effect on financial results
of the firm. The above table reflects that
before manipulation of depreciation
financial results were higher than after
revaluation. Hence, to counteract the
decrease of the result, entities prefer to
reassess depreciable assets.
Perceptions of the Respondents:
Table 6: Distribution of Respondents
by their Age
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Age Frequency Percent
V 20-30 years 48 32.00
30-40 years 37 24.60
40-50 years 37 24.60
50-60years 28 18.66
Total 150 100.00
The table above suggests that, the majority
of the respondents (32 percent) represented
from the 20-30 years age group, followed by
30-40 years, 40-50 years etc. Hence, it can
be inferred that the bulk of the respondents
were selected from the 20-30 years.
Table 7: Distribution of Respondents by
their Gender
Gender Frequency Percent
Male 101 67.33
Female 49 32.666
Total 150 100.00
The above table reveals that, the majority of
the respondents (67.33 percent) represented
from the male category and remaining
respondents represented from the female
category. Hence, the majority of the
respondents belonged to the male category.
Table 8:Distribution of Respondents by
their Income
Income Frequency Percent
Below 10000 10 6.66
10000-20000 10 6.66
20000-30000 37 24.66
30000-50000 37 24.66
Above 50000 56 37.33
Total 150 100.00
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The above table makes it clear that, the
majority of the respondents (37, 33) earns
above 50,000, and 24.66 percent of the
respondents earns in between the 20,000-
30,000. Hence, it can be concluded that the
majority of the respondents earns above
50,000.
The majority of the respondents possess the
post-graduation qualification, followed by
the Ph.D. degree and intermediate. Hence, it
is evident that the majority of the
respondents represented from the post-
graduation qualification.
The table above table suggests that, the
majority of the respondents (81.3 percent)
opined that, the creative accounting was a
significant problem in India, and rest of the
respondents opined that it was not a
significant problem. Hence, it can be
inferred that the majority of respondents
opined that creative accounting was a
significant problem, because of there were
so many fraudulent activities in the financial
accounting.
Table 9: Distribution of Respondents by
their Education Qualifications
Educational
Qualifications Frequency Percent
Intermediate 7 4.66
Degree 7 4.66
PG 94 62.66
PHD 42 28.00
Total 150 100.00
Tale 10: Respondents opinion on
Problem of Creative Accounting in
India
Frequency Percent
Yes 122 81.3
No 28 18.7
Total 150 100.0
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The above table reveals that the 37.33
percent of the respondents opined that there
was no change in aspects of creative
accounting in India. 18.7 percent of them
opined that much reduced and 15.3 percent
of them opined that much and some reduced.
Hence, it can be concluded that the majority
of them opined that there was no change in
practices and manipulations of creative
accounting.
Hypothesis 1:
Null Hypothesis (Ho): There was no client
proposal to manipulate accounts for tax
evasion.
Alternative hypothesis (Ha): There was
client proposal to manipulate accounts for
tax evasion.
Table 12: Hypothetical Testing Group Statistics
Table 11: Opinion on creative accounting becoming more or less common in India
Frequency Percent
Much Reduced 23 15.3
Some Reduced 23 15.3
Unchanged 56 37.3
Much Reduced From Past
but Now 28 18.7
Slight Revival 20 13.3
Total 150 100.0
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Client
Proposal for
tax evasion N Mean
Std.
Deviation
Std. Error
Mean
Client Proposal
to Manipulate
Accounts
Strongly
Agree 130 1.5769 .49596 .04350
Agree 20 1.6500 .48936 .10942
Analysis
The above table makes it clear that the null
hypothesis was accepted, where (t =-0.614,
df =148, p=0.000) and concluded that there
was no client proposal to manipulate
accounts for tax evasion, but within the
organizations itself manipulate the accounts.
Hypothesis 2:
Null Hypothesis (Ho): New structure of
financial regulation is not the cause of
directions is more ethical.
Alternative Hypothesis (Ha): New
structure of financial regulation is the cause
of directors is more ethical.
Levene's Test for Equality of Variances
F Sig. t df
Sig. (2-
tailed)
Client Proposal to
Manipulate Accounts
Equal variances
assumed 2.431 .121 -.614 148 .540
Equal variances
not assumed
-.621 25.386 .540
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Table 13: Hypothetical Testing Group
Statistics
Levene's Test for Equality of Variances
F Sig. t df
Sig. (2-
tailed)
New Structure of
Financial Regulation
Equal variances
assumed 1.703 .195 -.658 104 .512
Equal variances
not assumed
-.660 91.299 .511
The table above suggests that the null
hypothesis was accepted, where ( t=-0.658,
df = 104, p=0.512) .Hence, it can be inferred
that the new structure of financial regulation
was not the cause of directors are more
ethical.
Findings of the Study
Directors are
more Ethical N Mean
Std.
Deviation Std. Error Mean
New Structure of
Financial Regulation
Strongly Agree 63 1.5397 .50243 .06330
Agree 43 1.6047 .49471 .07544
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On the existing literature and review, the
following were attempted to extract on the
creative accounting.
1. The study found that creative
accounting was a significant problem
in India, because of there was
number of fraudulent activities in the
existing accounting procedures and
regulations.
2. The study observed that 37.3 percent
of the respondents opined that there
was no change in aspects of creative
accounting in India and it implied
that there was no change in practices
and manipulation of creative
accounting.
3. The study concluded that there was
no client proposal to manipulate
accounts for tax evasion, but the
organization made itself utilized the
creative accounting practices and
methods.
4. The study also found that, the new
structure of financial regulation was
not the cause of directors were more
ethical.
Suggestions:
1. To overcome the disadvantage of
reducing result, entities may use the
surplus value imputation from
revaluation on revaluation reserves.
2. It is recommended to strengthen the
existing procedure of rules and
regulations with compliance of the
International Financial Reporting
Standards to project financial results
truly and fairly.
3. To overcome the decrease of the result,
entities prefer to reassess depreciable
assets to reflect the true and fair view of
financial results and condition.
4. The study observed that manipulation of
accounts within a legal frame work was
widely spread and cause of significant
losses. Hence, it should be custard the
manipulation of accounts through
creative accounting, for this purpose,
there should be a well-organized legal
frame work to eradicate the creative
accounting practices and manipulations.
5. There should be an awareness
programme amongst the chartered
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accountants and create a social
responsibility amongst them.
6. The study observed that due to the
available chances of provisions of
existing accounting procedure is the
cause of creative accounting. Hence,
there should be ratifying those
provisions to see a true and fair view of
accounts to come out the exact financial
results and condition.
7. There should be an external audit
committee parell with the internal audit
committee based on the periodicity of
small internal rather than year end. All
the professional bodies should come into
a single unanimous opinion to have a
synergetic effect on eradication of
creative accounting practices and
manipulations.
Conclusion
Creative accounting adversely effect on
Indian economy loss of investors‟
confidence in promotion of capital
formation and other illegible and invisible
defects were occurred. The study found that
the creative accounting was a significant
problem in India and implied that there was
no change in aspects of creative accounting
in India. Hence, there is on immense need of
curtail the manipulation of accounts through
the creative accounting for this purpose,
there should be design a constructive
organized frame work and also facilitate the
awareness programme amongst the
chartered accountants. The available
chances of provisions of existing accounting
procedure are the cause of creative
accounting. Hence there should be ratifying
those provisions to see a true and fair view
of accounts to come out with the exact
financial results and condition.
References:
[1] Dima Florin-Constant in, creative
Accounting through the Policies and
Accounting Options.
[2] Griffiths I (1986), “Creative
Accounting”, London: Sidgwick &
Jackson.
[3] Jameson M (1988), Practical Guide to
Creative Accounting, London: Kogan
Page.
[4] N. Feleagă, L. Malciu, “Accounting
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Policies and Options”, Economic
Publishing House, Bucharest, 2002
[5] Naser K (1993), Creative financial
accounting: its nature and use, Hemel
Hempstead: Prentice Hall.
[6] Oriol Amat, and John Blake, Jack
Dowds Economics working paper the
Ethics of creative Accounting,
December 199, pp: 02.
[7] Smith T (1992), “Accounting for
growth”, London: Century Business.
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