7.11 Earnings management or creative accounting Flashcards
What has historically been the main cause of historic accounting scandals?
Fraud
What are the two sub-types of fraud?
- fraudulent financial reporting (aka intentional misstatement)
- misappropriation of assets (theft)
Is it the responsibility of the auditor or the legal system to determine whether fraud has occurred?
The legal system, however auditors should remain vigilant.
What is an “error” in accounting?
An unintentional misstatement in the financial statements
Is an “error” in the financial statement considered to be fraud?
No, unless intentional.
What are some common accounting irregularities considered to be fraud?
- manipulation, falsification or alteration of records of documents
- misinterpretation in, or omission from the financial statements of events, transactions or other significant information.
- misapplication of accounting principles relation to amount, classification etc.
What are some examples of misappropriation of assets (theft)?
- stealing tangible/intangible assets
- embezzling receipts
- making payments for the purchase of non-existent goods.
What is creative accounting?
The deliberate manipulation of figures for a desired result.
What is “off-balance sheet” financing?
A form of (creative) financing where large capital expenditures and the associated liability (such as operating leases) are kept off the balance sheet.
What is “cut off liability”?
Creative accounting where a company delays invoicing in order to move revenue to the following year.
Why does revaluation of non-current assets allow creative accounting?
The non-current assets can be revalued in a favorable manner.
What is window dressing (creative accounting)?
Transactions are passed through the books at year end to make the accounts more favourable. E.g. repaying a loan at year end and then immediately taking out another.
How can creative accounting be achieved through accounting policy changes?
The change can be done to make the figures more favourable. This is usually a last resort as companies are limited in how often they change policy.
What is meant by “manipulation of accruals, prepayments and contingencies” in creative accounting?
A company may only disclose the possibility of a liability, even though its eventual costs may be substantial.
What regulatory changes have been made to prevent creative accounting?
1 IAS 27 ensures consolidation of subsidiary and parent accounts, preventing exclusion of highly-geared subsidiaries.
2 IFRS 16 ensures proper disclosure of leased assets, making it difficult to keep liabilities off the balance sheet
3 IAS 37 ensures proper accounting and disclosure of provisions, contingent liabilities and contingent assets.
