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A Presentation on Creative Accounting

Creative Accounting Definitions

Even within the law, various practices can be carried

out by accountants which are often regarded as being unethical, the most common practice of this kind is known as Creative Accounting It is a phrase which is popularly associated with cooking the books in a way which is legal although morally dubious. The practice of creative accounting, however, is not necessarily unethical.

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Creative Accounting means: Using the flexibility

within accounting to manage the measurement and presentation of the accounts so that they serve the interests of preparers.

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Creative accounting
What do we want to create? More profit? More assets? More liabilities? Less profit?

Fewer assets? Fewer liabilities?

Creative accounting could involve

Inflating reported profits and EPS
Accounting for losses via balance sheet reserves and all

profits through P & L Reporting profits without generating equivalent cash Reporting lower borrowings

Creative accounting practices

Income smoothing move profit from one year to another
Changing accounting policies, particularly

depreciation, asset valuations Overstating costs, Making expenses into Assets capitalisation Off-balance sheet financing , e.g. leasing, Sale and buyback, special purpose vehicles

Methods of creative accounting

Valuation of Stock

The following example shows that how a company can increase its profit by valuation of its stock. Suppose the value of stock is Rs.100000, Capital is Rs.65000 and profit is Rs.35000.

Balance Sheet A Capital Profit Rs. 65000 _35000 100000 Stock Rs. 100000 ______ 100000

Now suppose, the company adopts different stock valuation policy, then: Balance Sheet B Capital 65000 Profit _55000 120000 Stock 120000 ____ 120000

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Depreciation:
Business Profit Rs.10,000 Fixed Assets Rs.100000 Depreciation straight line 10 years If company adopts 20 year asset life will this affect profit? Yes: Original policy New policy Rs. Rs. Profit before depreciation 10,000 10,000 Depreciation (10,000) (5,000) Profit after depreciation 5,000
Profit increases by Rs.5,000

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Off Balance-sheet scenario

If the Company wants to acquire new premises, Merchant bank sets up a special purpose company to acquire clients properties. Company leases properties Rents pay loan interest End of initial lease, clients can : i, buy leased properties; or ii, sell properties and repay

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Accounting Scandals
Enron
Uses special purpose vehicles to keep debts

off balance sheet Treats loans as sales Swaps assets and treats them as sales Creative accounting and fraud

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WorldCom Capitalizes revenue expenditures
Xerox Premature recognition of leasing Adelphi Communications the owners looted

company and used it as personal piggy bank Satyam Used the loopholes in the accounting standards, played with the financial statements for more than a decade.

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Controlling Creative Accounting

Can creative accounting and fraud ever be stopped?
Probably not Part of human nature Best we can do is set up a sound conceptual framework and

sound standards Promote good ethical conduct Be aware.

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