Creative accounting Flashcards
what is creative accounting
production of the financial statement which gives a biased impression of the financial performance and position of the reporting entity
includes earnings management
why does creative accounting occur
agency theory problem
consequences in creative accounting
lack of trust and confidence in financial reporting
- poor quality decision making by users
- inefficiencies in stock markets and less liquidity
- national economic effect
Increase the cost of capital for companies
- greater returns demanded from investors and lenders
how is creative accounting possible
- override requirement for statement to show true-and-fair view
- lack of ethical standards- dishonesty
- IFRS are principle based- not rigid rules
(flexibility and subjectivity) - professional judgement needs to be applied
methods of creative accounting
- accruals accounting
- choice of accounting policies and methods and change to these
- use of estimates
e. g. depreciation, allowances, inventory - income smoothing techniques
- management of actual activities
- presentation methods
how are inventories used for creative accounting
- manipulation cut-off procedures
- fictitious transfers
- excluding consignment inventory
- including obsolete inventory
under/overvaluation of inventories
why should there be a standard for provisions?
manipulation of profit
- creation of provision reduces profits
- if provisions not required, reversing them inflate profits
define agency theory problem
managers judged and rewarded on the basis of company performance:
- profit-related bonuses
- share options
- covering up mistakes or poor business decisions
leads to profit smoothing
is there any prevention to creative accounting?
- changes in regulation concerning auditor independence
- corporate governance mechanisms
- increasing emphasis on ethics
- inventory valuation
- provisions
- revenue recognition
what are provisions made for?
future operating losses
reoreganisation costs
environmental liabilities
