Creative accounting

Question 1

Creative Accounting

Answer 1

• process of using flexibility of rules to make financial statements somewhat different from what was intended by the rule.
• consists of rule bending and loophole seeking
• includes process by which transactions are structured so as to produce the required accounting out come

Question 2

Creative accounting case study examples

Answer 2

• eron
• worldcom
• tesco
• patisserie Valarie
• carillon

Question 3

Aim of Regulators

Answer 3

financial statements a are true and fair view of accounts
- in theory users support this aim

Question 4

aim of preparers

Answer 4

• wish to manage their accounts in their own interest
• Some existing shareholders may support these strategies

Question 5

Purpose of Creative accounting

Answer 5

• boost a weak statement of financial position
• increase or decrease reported profits
• increase or decrease reported EPS

Question 6

Profit smoothing

Answer 6

• the stock market prefers. a steady progression in earnings to erratic earnings pattern

Question 7

window dressing

Answer 7

• method of carrying out transactions to distort the position shown by the financial statements
• generally to improve the position shown

Question 8

examples of window dressing

Answer 8

• chasing receivables more quickly at the end of the year to improve bank balance
• changing depreciation estimate (eg. increasing expected useful economic life). this results in increased profits as there’s smaller charges
• existing loan may be repaid immediately before the year end and then taken out again in the next financial year

Question 9

creative accounting in income statement: areas to consider

Answer 9

• income recognition
• deferring costs
• provisions against future expenses
• depreciation policy
• year-end inventory valuation and gross profit

Question 10

income statement/ revenue recognition- long term contracts

Answer 10

• links to IFRS 15
• standard ensures revenue is recognised at the correct time when it spans various periods
• still room for some manipulation when contracts are longer than 1 year

Question 11

Deferring costs - IAS16 - PPE

Answer 11

capitalising expenses which should be included in expenses

Question 12

Deferring costs - IAS38 - R&D costs

Answer 12

• capitalised and amortised with reference to sales of product if it satisfies all the criteria. company could argue that there’s uncertainty regarding fulfilling some criteria

Question 13

Deferring costs - IAS2 - Inventories

Answer 13

• method of absorption of production overheads in inventory. to push costs to next period

Question 14

Provisions against future expense - IAS37

Answer 14

• Bad debts and doubtful debt provision
• smoothing profits by creating/ increasing bad debts/ provisions when profits are high and reducing them when profits are low to avoid fluctuations

Question 15

Depreciation policy

Answer 15

• annual depreciation charge Varys depending on economic life, residual value, basis of valuation and method used.
• impairment of non-current assets - may be reserved when conditions causing impairment cease to exist

Question 16

year end inventory valuation and gross profit

Answer 16

• Including slow-moving / obsolete inventory at cost instead of making write-off’s to state them at NRV, or making unnecessary write-off’s.
• Artificial sales of inventory i.e. window dressing by selling goods before the year end and buying it back after the year end.
• Manipulating year-end cut-off procedures e.g. goods included in inventory but purchase invoices have not yet been recorded.

Question 17

Trade receivables (SOFP)

Answer 17

provision for doubtful debts and increases / decreases in this provision; factoring of amounts receivable to improve the liquidity position; delaying of sales invoices

Question 18

Cash (SOFP)

Answer 18

delaying payments, sale and leaseback of property to release substantial amounts of cash to pay off liabilities

Question 19

Liabilities (SOFP)

Answer 19

estimates of accruals, manipulation of subjective provision and contingencies guidance

Question 20

prevention to reduce creative accounting

Answer 20

• Improved financial standards
• Education and awareness for future accountants
• Ethical codes and guidance
• National & international rules/regulations (money laundering, whistle-blowing, anti-bribery)
• FRC

Question 21

Detection & penalties to reduce creative accounting

Answer 21

• Sanctions and penalties are imposed by professional bodies
• Financial Reporting council annual enforcement review
• Auditor fines
• UK’s Accounting and Actuarial Disciplinary Board: regulatory authority which investigates and deals with complaints relating to inappropriate behaviour by accountants.