Creative accounting Flashcards
Creative Accounting
- 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
Creative accounting case study examples
- eron
- worldcom
- tesco
- patisserie Valarie
- carillon
Aim of Regulators
financial statements a are true and fair view of accounts
- in theory users support this aim
aim of preparers
- wish to manage their accounts in their own interest
- Some existing shareholders may support these strategies
Purpose of Creative accounting
- boost a weak statement of financial position
- increase or decrease reported profits
- increase or decrease reported EPS
Profit smoothing
- the stock market prefers. a steady progression in earnings to erratic earnings pattern
window dressing
- method of carrying out transactions to distort the position shown by the financial statements
- generally to improve the position shown
examples of window dressing
- 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
creative accounting in income statement: areas to consider
- income recognition
- deferring costs
- provisions against future expenses
- depreciation policy
- year-end inventory valuation and gross profit
income statement/ revenue recognition- long term contracts
- 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
Deferring costs - IAS16 - PPE
capitalising expenses which should be included in expenses
Deferring costs - IAS38 - R&D costs
- 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
Deferring costs - IAS2 - Inventories
- method of absorption of production overheads in inventory. to push costs to next period
Provisions against future expense - IAS37
- 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
Depreciation policy
- 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
year end inventory valuation and gross profit
- 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.
Trade receivables (SOFP)
provision for doubtful debts and increases / decreases in this provision; factoring of amounts receivable to improve the liquidity position; delaying of sales invoices
Cash (SOFP)
delaying payments, sale and leaseback of property to release substantial amounts of cash to pay off liabilities
Liabilities (SOFP)
estimates of accruals, manipulation of subjective provision and contingencies guidance
prevention to reduce creative accounting
- Improved financial standards
- Education and awareness for future accountants
- Ethical codes and guidance
- National & international rules/regulations (money laundering, whistle-blowing, anti-bribery)
- FRC
Detection & penalties to reduce creative accounting
- 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.
