CREATIVE ACCOUNTING

Meaning
Creative accounting is the technique which is
commonly used to conceal corporate fraud
within the boundary of accounting principles.
Creative accounting is referred to also as
income smoothing, earnings management,
earnings smoothing, financial engineering and
cosmetic accounting in USA.
Creative accounting in Europe
 Definition
Is the deliberate dampening of fluctuations
about some level of earnings considered to be
normal for the firm. (Barnea et al. 1976)
Is any action on the part of management
which affects reported income and which
provides no true economic advantage to the
organization and may in fact, in the long-term,
be detrimental. (Merchant and Rockness,
1994)
 Definition .. Contd

Creative accounting is the transformation of

financial accounting figures from what they
actually are to what preparers desire by taking
advantage of the existing rules and/or
ignoring some or all of them. (Kamal Naser)
 Objectives of creative accounting
To Keep the companys financial results within
agreed limits set by creditors;
To fulfill public listing requirements;
To help negotiations with regulators;
To pay less tax; and
To push the company towards insolvency.
Limitations of Creative Accounting
Difficulty for investors to distinguish between
the fair and unfair statements.
Do not always offer a detailed picture of the
financial positions and performance
It can impress the investors only over short-
time periods while the financial position goes
worse this becomes useless
Distrust of the investors conducted by the
collapse of companies
Techniques of Creative Accounting
Big bath charges: Conservative estimates
about inventory. Can be used at bad times
Creative Acquisition Accounting: Allocate a
large portion of an acquisition price as in
process. E.g. R & D
Cookie jar Reserve: Unrealistic assumptions
when calculating estimates for sales returns,
loan losses or warranty costs.
 Techniques . Cont.
Materiality: Intentionally records errors within
a defined percentage ceiling.
Revenue Recognition: Increase their earnings
by recognizing a sale prior to the completion
of that sale.
Round-Trip Techniques: Increase the volume
of transactions through buying and selling
products simultaneously between companies
working together