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A PROJECT REPORT ON “ CAMOUFLAGE ACCOUNTING – MAPPING CREATIVE ACCOUNTING INTO ACCOUNTING FRAUDS” BY KISHORE AGARWAL B.COM. (FINANCE) DEPARTMENT ROLL NO. 456

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Page 1: Camouflage Accounting

A

PROJECT REPORT

ON

“ CAMOUFLAGE ACCOUNTING – MAPPING CREATIVE ACCOUNTING INTO

ACCOUNTING FRAUDS”

BY

KISHORE AGARWAL

B.COM. (FINANCE) DEPARTMENT

ROLL NO. 456

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ACKNOWLEDGEMENTSA

CKNOWLEDG

CERTIFI take this opportunity to express my deep sense of gratitude to all those who have

contributed significantly by sharing their knowledge and experience in the completion of this

project work. I am greatly obliged to, for providing me with the right kind of opportunity and

facilities to complete this venture.

I am highly thankful to Dr. P.P. Ghosh – my internal faculty guide under whose

able guidance this project work was carried out. I thank him for his continuous support and

mentoring during the tenure of the project. I also thank my college authorities and specially

my Vice Principal Fr. Dominic Savio for giving me the opportunity to work on this

project and for there constant support and encouragement. I would also like to thank my dear

friend Vinay Sharma for his cooperation, advice and encouragement during the long and

arduous task of carrying out the project and preparing this report.

I also extend my acknowledgement to my beloved Parents and all my Friends for

their continuous encouragement at every moment. Last but not the least; I thank each and

every individual who has rendered his/her assistance in the successful completion of this

project.

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Introduction

Creative accounting is also known as earning management and referring to accounting

practices that follows the letter of rules of standard accounting practices but certainly deviate

from the spirit of those rules. Creative accounting practices are different from fraudulent

practices and thus are not illegal but immoral in terms of misguiding investors. The practices,

which are followed in manipulating the books, are duly authorized by accounting system and

thus can not be considered as violation of any rule or regulations. It is characterized by

excessive compliance and the use of novel ways of characterizing income, assets, or

liabilities and the intent to influence readers towards the interpretations of desired results.

Earning Management or Creative accounting is result of judgments which is used by

managers in financial reporting and in maintaining books to manipulate reports for either

misleading investors or stakeholders or to influence economy to give positive response

towards financial performance of the company. The usual practice followed under earning

management is to increase or decrease earnings artificially through choices available in

accounting system.

Creative accounting is root cause of number of accounting scandals and many proposals for

accounting reform are focusing on removing such practices. Financial statement is the result

of the financial accounting process that accumulates, analyzes records, classifies,

summarizes, verifies, reports, and interprets the financial data of a business firm, which

reflect the financial position, performance and change in financial position of an enterprise

(Elliott, 2005).

However, in recent years, creative accounting is becoming increasing popular running

through companies, which lead to considerable allegation about the practice of creative

accounting. Companies are able to manipulate the financial statements through various types

of creative accounting techniques. It attracts more and more attention in the whole financial

market and its presence distorts the true and fair view of the financial position of companies,

and may cause serious corporate failure.

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What is Creative Accounting?

Creative Accounting is by definition “creative” and therefore it could be described as “art” or

having artistic qualities. It is therefore loose in form and comes in different variants

The commentators and analysts‟ argument is that accountants start with a predetermined

profit figure and they try to find sales and costs that can achieve this predetermined profit.

Basically what they will be refering to is a technique that is called creative accounting.

The above point has been put more colourfully by some observers who argue that the

preparation of the financial statements such as the profit and loss account starts from the

required earnings per share (EPS) figure and accountants then work backwards to produce

that predetermined EPS.

Creative accounting gives financial statements an appearance that does not fully reflect the

true and fair view of the business‟ financial performance, financial position, and financial

adaptability. In other words creative accounting deliberately misleads the users of financial

information from annual accounting reports.

Most publicly listed companies are accused by commentators and financial analysts of

practising creative accounting, but none of these companies admit that they use it. However,

creative accounting was practised at companies that were involved in financial collapses such

as Enron, WorldCom, and Parmalaat.

The fact that these companies used creative accounting only became known because these

companies had become insolvent or bankrupt and proceedings were going through the legal

system. It can be argued that creative accounting is normally exposed if something in a

company has gone wrong such as if the business is facing bankruptcy.

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Why is Creative Accounting Done?

If such high profile companies engaged in creative accounting then the question that should

be asked is why do companies or accountants use creative accounting? Some of the reasons

why creative accounting is used are as follows:

Creative accounting is used to overstate profits so that a business can appear to be more

profitable than it actually is. Businesses can inflate profits by deliberately excluding expenses

or understating expenses, overstating their revenues, or treating certain expenses as assets.To

preserve or to create an impression to the users of accounting information or the outside

world that they are a solvent business with a remote probability of financial distress.To

achieve market expectations or budgetary targets. Usually failure to meet market expectations

or budgetary targets is usually followed by a decline or collapse of the share price of the

reporting entity. Companies then use creative accounting to avoid market anger being meted

out to them.Some managers use creative accounting to ensure they meet targets that will

allow them to receive performance bonuses. Managers may use window dressing such as to

report more sales than they actually achieved or they can capitalise expenses to increase or

meet profit and efficiency targets. Managers can also use creative accounting to conceal

under-performing operations from users of accounting information.Businesses also use

creative accounting to mislead their bank managers and lenders so that they are able obtain

loans. Enron used creative accounting to mislead the markets about the company‟s poor

financial state and proximity to bankruptcy to maintain the value of the share price and to

maintain its relationship with financial stakeholders such as lenders, bankers, capital

providers, and counter parties. Businesses involved in raising equity can also use creative

accounting to underpin the share issue by inflating the financial performance.

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9 Signs of Potential Creative Accounting Practices

Here are nine things investors should watch for as possible warnings of accounting

gimmickry:

1. Overly Aggressive Performance Targets: The company ups the ante by continually

setting revenue and earnings growth targets that are far ahead of its competitors'.

2. Overly Aggressive Management: The company's corporate leaders are known to be hard-

driving types who have a flair for self-promotion.

3. Big Upward Change in Accounts Receivable: This could be a sign a company is trying

to pad revenue; look for more explanation.

4. Big Downward Change in Reserve Account: It could be the product of overly optimistic

assumptions about things like collection of unpaid debts.

5. Big Upward Change in Inventory Account: A favorite accounting gimmick is to

overvalue inventory or create nonexistent inventory.

6. Changes in Accounting Policies: Companies should provide detailed explanations for any

changes in accounting treatments.

7. Frequent One-Time Charges: These could be a sign the company is trying to disguise

some recurring charges as nonrecurring items.

8. Frequent Related-Party Transactions: These could be a sign of potential conflicts of

interest if they involve loans or other transactions with corporate officers.

9. Premature Revenue Recognition: Booking sales before goods are actually sold, or by

immediately booking all the proceeds of a long-term contract.

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WINDOW DRESSING

Window dressing is presenting company accounts in a manner which enhances the financial

position of the company. It is a form of creative accounting involving the manipulation of

figures to flatter the financial position of the business.

It is also defined as: „A form of accounting, which while complying with all the regulations,

nevertheless, gives a biased impression of the company‟s performance.‟

Though it is not illegal, it is considered by many financial pundits as unethical.

Reasons for Window Dressing:

Enhance Liquidity position of the Co. – hiding a deteriorating liquidity position,

and

Showcase stable Profitability of a company – massaging profit figures with

methods such as income smoothing or profit smoothing

Reduce Liability for Taxation

Ward-off takeover bids

Encourage Investors

Re-assure Lenders of Finance

To influence share price

Hide poor management decisions

Satisfy the demand of major investors concerning the desired level of return

Achieve the sales or profit target, thereby ensuring that management bonuses

are paid

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Methods used for Window Dressing :

It redistributes income statement credits and charges among

different time periods. The prime objective is to moderate income variability over the

years by shifting income from good years to bad years. An example is reducing

a Discretionary Cost (e.g., advertising expense, research and development expense) in the

current year to improve current period earnings. In the next year, the discretionary cost

will be increased.

– E.g. Computer

software with

useful life of 3 years. As revenue expenditure it is treated as negative item on P&L

account. As capitalizing expenditure, it is treated as an asset in balance sheet, with yearly

depreciation in the P&L.

- Increasing expected life of asset reduces

depreciation provision in P&L account, hence, increasing net profits. Also, net book value in

balance

sheet will be higher for a longer period, thereby, increasing firm‟s asset value.

- Change in method of stock valuation policy

(LIFO,

FIFO or AVCO) can lead to increase in value of closing stock, boosting up the profits.

For example, in a rising price scenario, usage of FIFO method helps in increasing closing

stock inventory valuation, thereby reducing the COGS, and hence inflating the earnings.

Similarly, in a falling price scenario, LIFO valuation method for inventory is more

favourable.

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– This involves selling fixed assets to a third party and then

paying

a sum of money per year to lease it back. Thus, the business retains the use of the asset

but no longer owns it.

-Balance Sheet Financing – Conversion of capital lease to operating lease so

that the

asset no longer features in the assets or liabilities of the balance sheet which

automatically improves ratios such as Total Asset Turnover Ratio (TATO), Return on

Assets, Equity Multiplier, etc. The costs saved are the interest expense on debt availed to

finance the capital lease and depreciation. Also, the debt-raising capacity of the company

increases as the liabilities component tones down. Naturally, earnings are inflated under

this method.

In the later years of use of asset, the company may revert back to capital lease financing

since the with net block having reduced considerably, the deprecation by WDV method

will also be very less, thereby providing an opportunity to inflate earnings. Also, it

provides the addition benefit of saving on tax.

- If intangible assets like goodwill are not depreciated

the

firm can maintain value of its assets giving a misleading view.

– Sales show up in the P&L account when the order is

received

and not at the point of transfer of ownership rights as mentioned in the notes to accounts

of the Co. under the heading of „Revenue Realisation‟.Encouraging customers to place

orders earlier than planned increases the sales revenue figure in P&L account. This brings

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sales forward from next year to this year.

- Extraordinary items are revenues or costs that occur, but not as

a

result of normal business activity. These events are unusual and unlikely to be repeated

They should be highlighted in accounts, and inserted after the calculation of Profit before

Interest and Taxation. To include these in normal revenues will again exaggerate business

profits.

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Examples of window dressing in Indian Companies :

1. Tata Motors transferred 24% stake in Tata Automotive Components (TACO), a company

with revenue of $675 in FY07, to Tata Capital, a group company, and booked a profit of

Rs 110 crore in Q1 FY09. Management declined to disclose the valuation methodology.

Tata Motors also changed its methodology for calculating provisions for doubtful

receivables, which resulted in higher reported Ebitda to the extent of Rs 50.7 crore (10%

of Ebitda).

2. TCS, the software major, increased its depreciation policy on computers from two years

to four years. As a result, Q1 FY09 PBT was higher by an estimated Rs 50 crore (4% of

net profit in 1QFY09). TCS followed cash-flow hedge accounting and till FY08, it used

to recognise hedging gains on effective hedges in its revenue line, thus boosting the

reported revenue growth and Ebit margin. In FY08, TCS had Rs 421crore from hedging

gains, of which, Rs 137 crore was included in the revenue line. However, from Q1 FY09,

TCS is expected to report all forex losses/gains below the Ebit line in other income. Thus,

the losses it had on its hedge position will no longer be booked in the operating line.

3. Jet Airways, changed its depreciation policy from WDV to SLM, and thereby wrote back

Rs 920 crore into its P&L, which helped the company to report profits during the quarter.

It also helped Jet to report a higher net worth, which will help in keeping reported gearing

low..

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4. Dr Reddy’s adjusted mark to market losses (Q1 FY08) on outstanding $250 million of

hedges in the balance sheet, while P&L reflects forex gains realised.

5. Reliance Communications adjusted short-term quarterly fluctuations in foreign

exchange rates related to liabilities and borrowings to the carrying cost of fixed assets.

The company adjusted Rs 109 crore of realised and Rs 955 crore of unrealised forex

losses in the above manner. In addition, the company has not recognised Rs 399 crore of

translation losses on FCCBs, since the FCCBs can potentially get converted, although the

FCCBs are out of money. Adjusted for all the above, the company would have virtually

no profits in Q1 FY09.

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EXAMPLES OF CREATIVE ACCOUNTING

EXAMPLE 1

Off- balance sheet financing

- balance sheet financing does not reveal certain financial information. It is effective

because off- balance sheet financing is not likely to be detected by independent users of

company accounts. It is not a new practice but it has grown rapidly in recent years.

• This could be done via a partial subsidiary which the company controls. For example

assets could be sold to this subsidiary. This produces a profit in the balance sheet, but

nothing has changed. It is simple a shuffling of debt/credit between companies

producing no overall increase in health or profitability.

• In using this method, companies are able to show better debt ratio, borrow more money

and still maintain the appropriate debt ratio required by lenders and put on a good ‟face‟

for investors. However, as off- balance sheet financing is a short term solution to a long

term problem, inevitability the loan still has to be repaid and the company still has to

obtain enough fund to pay off the „hidden‟ loan ( in the subsidiary ) to the ultimate lender,

which in most cases, is outside the group.

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EXAMPLE 2

Revenue Recognition

particularly for companies whose earnings are „lumpy” spreading over two or more

accounting periods. For example, leasing firms may front load rental payments by

charging installation fees or claiming up-front part of the eventual residual value of the

asset leased.

recognizing a sale prior to the completion of that sale, before the product is delivered to

the customer or at a time when the customer still has the option to terminate the deal

resulting is a lower revenue being observed.

EXAMPLE 3

Smoothing Expenses

inventory, paid directly from reserves or more

blatantly under-provided. Capitalisation of interest can be justified by deciding that the

cost of borrowing money is part of the overall cost of an asset. Though interest is

normally taken from profits, many companies argue that the interest charge is a cost of

capital. Consequently, the interest charges which are not included in the statement of

financial performance, resurfaces as an increase to the fix assets in the statement of

financial position.

expensing adjustments which may involve a capitalization option are:-

– the latter element may be capitalized

that work-in-progress and finished goods include a proportion of

overheads and developmental cost.

acquisition which involve restructuring and rationalisation.

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EXAMPLE 4

Improper accounting

mproper accounting for expenses as long –term investments making the company looks

more profitable. The executives may take ordinary operating expenses, such as wages

paid to workers for maintaining telecom systems, and treat them as capital expense

accounts. This allows the firm to spread their expenses out over several years rather

than accounting for them all at once.

-term investments

are spread out and subtracted from earnings over the life of the asset whereas operating

expenses are deducted from earnings immediately. In doing this the company artificially

lowered their expenses and may increase their profits. Therefore the value of the firm is

also artificially inflated.

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WHAT ARE THE MOTIVES TO DO CREATIVE ACCOUNTING?

The motivation to use Creative Accounting

Various research studies have examined the issue of managerial motivation to use creative

accounting. The following have been identified as significant factors:

1. Tax avoidance

especially when taxable income is measured through accounting numbers. If

income can be understated or expenses overstated, then it may be possible to

avoid tax.

2. Increasing shareholders confidence

period. Ideally, this would show a steady upward trajectory without nasty

surprise for these shareholders, and so would help to avoid volatility in share

price, and would make it easier to raise further capital via share issues.

3. To meet internal targets.

management with respect to sales, profitability and share prices.

4. Meet external expectations.

and customers want long term survival of the company for their interests.

Suppliers want assurance about the payment and long term relationships with

the company. Company also wants to meat analyst‟s forecasts and dividend

payout pattern.

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5. Provide income smoothing.

keep the share prices stable. Advocates of this approach favor it on account of

measure against the 'short-termism' of evaluating an investment on the basis of

the immediate yields. It also avoids raising expectations too high to be met by

the management.

6. Personal gain

uses are linked to profitability, there is a clear motivation

for manager to ensure that profit hit the necessary threshold to trigger a bonus

payment.

7. Following the pack

ve

accounting practices, they may feel obliged to do the same.

Besides, various opinions about the motivation to use creative accounting for example from

Healy and Whalen [1999] summarize the major motivations to manage earnings

which include

Public offerings, Regulation, Executive compensation, and financial liabilities. Schipper

[1989]

provides a conceptual framework for analyzing earnings management from an informational

perspective.

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Beneish [2001] added insider trading in this list of motives. Managers aware of

misstatement of profits can benefit by trading the securities. Stolowy and Breton

[2000] suggest three broad objectives for earnings management: minimization of

political costs; minimization of the cost of

capital and maximization of managers‟ wealth. Deangelo [1988] refers to earnings

management

in buyout cases.

Teoh, Welch and Wong [1998] find that firms manage earnings prior to seasoned

equity offers and IPO‟s.Burgstahler and Eames [1998] conclude that firms manage

earnings to meet financial analysts‟ forecasts.

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The Pros and Cons of IFRS

India was supposed to implement International Financial Reporting Standards, or IFRS, by

April 2011. It has deferred this indefinitely, and insisted on many modifications to the

standards - accounting boffins call them 'carve-outs' - as they relate to areas such as

agriculture, real estate, financial instruments and goodwill. It makes sense to adapt IFRS to

the realities of a particular country, but a large number of carveouts defeats the purpose of

global standards.

An example of necessary tweaking is China's decision to modify the IFRS on 'related party

transactions' to reflect state ownership of many companies on the mainland. The 'related

party' clause will not necessarily apply to Chinese companies. But in India's case, the

European Commission, an executive body of the European Union, has warned that the

country risks "creating a country-specific version of the IFRS that differs from those used

worldwide".

Among those who defend India's right to choose its own accounting standards is N.

Venkatram, Partner at Deloitte Haskins & Sells, a global consulting firm. "Every government

has a responsibility towards its own economy," he says. He cites the example of India's

conservative standards for banking, saying they ensured the sector was rock-steady when the

global downturn traumatised the industry worldwide.

Dolphy D'Souza, Partner, Ernst & Young India, has a different view. "The initial

modification may be a starting point, but ultimately, the market reality will bind India to

adopt IFRS in totality," he says. Many accountants and analysts agree that the main concern

that global standards seek to address is clarity in accounting, so that companies do not take

investors for a ride. Where there is scope for differing interpretations, they say, the standards

tend to be principle-based. IFRS may not be able to put a definitive end to accounting

jugglery and auditors' qualifications. However, D'Souza says: "Given that many countries

have already adopted IFRS, ambiguity and the scope for multiple interpretations are

substantially reduced."

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GLOBAL IMPLICATIONS OF CREATIVE ACCOUNTING

In an age when Indian corporations run global companies, accounting practices should be

conservative rather than aggressive when there is an element of uncertainty. Bharti Airtel,

Infosys and Wipro are among the few Indian companies which voluntarily follow global

financial reporting standards.

"Nothing stops Indian companies from adopting IFRS on their consolidated accounts," says

D'Souza of E&Y. The Securities and Exchange Board of India, or SEBI, allows listed

companies with subsidiaries to publish consolidated financial results in accordance with

IFRS. But apart from information technology companies, few others do so. "IFRS is more

relevant to companies which have international operations, or who wish to raise capital

overseas," says Venkatram of Deloitte. There is no dearth of such companies in India.

A bad accounting policy can devastate a company, as the cases of Enron, WorldCom, Tyco

International and AIG have shown. Regulators are becoming more proactive. For example,

SEBI quietly did investors a favour last month by making it mandatory for listed companies

to announce fourth quarter results along with audited annual results. Some companies had

been conveniently filing only annual results, and not fourth quarter results - an unhealthy

practice that makes it harder for investors to gauge quarter-to-quarter performance.

Accounting standards are like signs on a long highway - the driver has to make the right

judgment.

Venkatram argues for maturity in disclosure standards. "We need better enforcement," he

says. Independent directors, market regulators and other stakeholders - especially domestic

and foreign institutional investors - need to be vigilant and challenge promoters if they stray

from the road. Satyam Computers became India's first information technology company to

adopt IFRS, way back in 2008. History has shown that it was not enough

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Case Satyam Accounting Scandal

The Satyam Computer Services scandal was publicly announced on 7 January 2009 when

Chairman Ramalinga Raju confessed that Satyam s accounts had been falsified

Details

On 7 January 2009 company Chairman Ramalinga Raju resigned after notifying board

members and the Securities and Exchange Board of India SEBI that Satyam s accounts had

been falsified 1 2 3 Raju confessed that Satyam s balance sheet of 30 September 2008

contained inflated figures for cash and bank balances of 5 040 crore US 1 09 billion as

against 5 361 crore US 1 16 billion crore reflected in the books an accrued interest of 376

crore US 81 59 million which was non existent an understated liability of 1 230 crore US 266

91 million on account of funds was arranged by himself an overstated debtors position of 490

crore US 106 33 million as against 2 651 crore US 575 27 million in the books

Aftermaths

On 11 January 2009 the government nominated noted banker Deepak Parekh former

NASSCOM chief Kiran Karnik and former SEBI member C Achuthan to Satyam s board

Merrill Lynch now a part of Bank of America and State Farm Insurance terminated its

engagement with the company Satyam s shares fell to 11 50 rupees on 10 January 2009 their

lowest level since March 1998 compared to a high of 544 rupees in 2008 Chartered

accountants regulator ICAI issued show cause notice to Satyam s auditor

PricewaterhouseCoopers PwC on the accounts fudging The Crime Investigation Department

CID team picked up Vadlamani Srinivas Satyam s then CFO for questioning

On 22 January 2009 CID told in court that the actual number of employees is only 40 000 and

not 53 000 as reported earlier and that Mr Raju had been allegedly withdrawing INR 20 crore

rupees every month for paying these 13 000 non existent employees

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Root Cause

Prof Sapovadia in his study shows that in spite of there being a strong corporate governance

framework and strong legislation in India top management sometimes violates governance

norms either to favour family members or because of jealousy among siblings He finds that

there is a lack of regulatory supervision and inefficiency in prosecuting violators He

investigates in detail the recent governance failure at India s 4th largest IT firm Satyam

Computers Services Limited and considers possible reasons underlying such large failures of

oversight

PricewaterhouseCoopers Reply

On 14 January 2009 Price Waterhouse the Indian division of PricewaterhouseCoopers

announced that its reliance on potentially false information provided by the management of

Satyam may have rendered its audit reports inaccurate and unreliable 19

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Advantages of Creative Accounting

Several advantages can be obtained by creative accounting, but with increased liabilities and

risk. According to Mulford (2002), some identified advantages of creative accounting are as

follows:

a. Higher reported earnings, and the higher assets, lower liabilities, and higher shareholders‟

equity amounts that accompany higher earnings, can convey an impression of improved

credit

quality and a higher debt rating to a lender or bond investor.

As a result, the use of creative accounting practices to improve reported financial measures

may lead to lower corporate borrowing costs. Steps taken to boost revenue will increase

earnings, current assets, and shareholders‟ equity and, in some instances, reduce liabilities

temporarily. Some companies also give bonus payouts to certain key officers if net income

exceeds a specific goal, whereas no bonus will be paid if net income falls below that amount.

Clearly, executives are motivated by the thought of bonus payouts, thus creative accounting

is

sometimes used to allow management to enjoy a bonus payout (Mulford, 2002). Another

example of creative accounting is the reporting of „less revenue‟ for companies such as, Oil

owners or Microsoft that carry the weight of what legal authorities consider a monopoly. By

reporting less revenue, it can create the appearance that the company is not doing so well in

hopes that it will temporarily take some of the eyes off of the company‟s financials by legal

entities. Many other advantages can be had through the use of creative accounting as well.

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Disadvantages of Creative Accounting

As stated earlier, there are many benefits to be obtained through creative accounting, but

these

practices can lead to risks and liabilities (Mulford, 2002). Some identified disadvantages of

creative accounting are as follows:

a. Unforeseen errors in accounting calculations,

b. alteration of company image to customers and investors, and

c. adverse impact on creditors and employees – the employees typically face legal judgment

by lawsuits, the loss of money via no bonuses or lawsuits, and

d. the risk of being let go from their employer, as well as a critical gap in their resume to

explain to potential new employers.

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CONSEQUENCES OF CREATIVE ACCOUNTING TO THE

COMPANY

1. Enron: accounting/off balance sheet contrivances. Chief financial officer indicted. The

company bankrupt with billions of equity value lost.

2. Tyco: chief executive officer charged with tax evasion, waste of corporate assets.

Massive charge of $6 billion to earnings after disposal of CIT unit.

3. WorldCom: $3.8 billion fraud. Loans to chief executive officer and became bankruptcy.

4. Adelphia Communications: off balance sheet loans to senior officers.

5. Xerox: accounting overstates profits by $1.4 billion.

6. Global Crossing: filed for bankruptcy after fiddling accounts.

7. Qwest Communications: chief executive officer resigned. Profits restated assets cut by

50%, or $34 billion. The share price down.

8. Health South: $1.4 billion fraud. Make false entries created in income statements and

balance sheets. $110 billion merger of AOL and TimeWarner cemented with inflated

accounting of AOL revenues. Within 18 months, company value declined 75%, and

massive write-downs of asset values were taken – AOL‟s 2002 earnings were written

down by $98.7 billion (a figure only slightly smaller than the European Union‟s budget for

2003); civil litigation ensued for damages to investors.

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9. Bristol-Myers: restates $2.5 billion in sales and $900 million in profits after inflating

distributor‟s stock levels. They settles antitrust lawsuits for a cost of $670 million.

10.Vivendi-Universal in France: failure of strategy, loss to shareholders, and class action

suits filed alleging misrepresentation of company‟s financial realities.

11.HIH insurance group in Australia: failed with debts of $3.1 billion after consistently

understating claims liabilities. The chief executive officer, among other things, spent A$

340,000 on gold watches in 1 year. The criminal and civil charges pending against

several directors.

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CONCLUSION

To sum up the discussion on creative accounting practices, it is an unfortunate situation that

we cannot completely restrict or stop the misuse or abuse of creative accounting practices.

The improper use of such creative accounting practices had fooled both auditors and

regulators in the past and it continues to do the same. The complex and diverse nature of the

business transactions and the latitude available in the accounting standards and policies make

it difficult to handle the issue of creative 101 accounting. It is not that creative accounting

solutions are always wrong. It is the intent and the magnitude of the disclosure which

determines its true nature and justification.

In the current economic climate, there is tremendous pressure--and personal incentive

for managers--to report sales growth and meet investors' revenue expectations. As a result,

more companies have issued misleading financial reports, according to the SEC, especially

involving game playing around earnings. But it's shareholders who suffer from aggressive

accounting strategies; they don't get a true sense of the financial health of the company, and

when problems come to light, the shares they're holding can plummet in value. How can

investors and their representatives on corporate boards spot trouble before it blows up in their

faces? According to the authors, they should keep their eyes peeled for common abuses in six

areas: revenue measurement and recognition, provisions and reserves for uncertain future

costs, asset valuation, derivatives, related party transactions, and information used for

benchmarking performance. This article examines the hazards of each accounting minefield,

using examples like Metallgesellschaft, Xerox, MicroStrategy, and Lernout & Hauspie. It

also provides a set of questions to ask to determine where a company's accounting practices

might be overly aggressive. These questions are the first line of defense against creative

accounting. The authors argue that members of corporate boards need to be financially

literate