Creative

Accounting &
Intellectual Capital

LECTURE WEEK TEN

Literature Reviews of
Creative Accounting in
Scopus.
CREATIVE ACCOUNTING – DEFINITION
Bhasin (2016) describes creative
accounting as an accounting practice that
may (or may not) adhere to accounting
principles and standards, but deviates from
what those principles and standards intend
to achieve, in order to present the desired
business image.
Creative accounting is the process of
transforming accounting information from
what it actually is to what the company
wants it to be, using the benefits (or
loopholes) in the existing rules or by
ignoring part of the rules.
Creative accounting can also be described as a
series of actions initiated by the company’s
management that affect the reported business
result, which, however, do not bring true economic
benefits to the company, but can instead result in
great damages in the long term
(Merchant, Rockness, 1994). Shah (1998), in turn,
defined creative accounting as a process in which
managers utilise the so-called loopholes and
ambiguities in accounting standards to
demonstrate financial success in a biased manner.
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CREATIVE ACCOUNTING

Since creative accounting often does not violate legal

rules, the question is whether it is good or bad.
This depends on the basic purpose for which it is used
and the manner in which it is applied. Bhasin (2016)
describes it in a very picturesque way: creative
accounting is like a double-edged sword – management
can either use it in a positive sense, or it can abuse it.
Thus, the idea to present the business in a better light
can ultimately result in a total loss of company image.

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 THE CREATIVE ACCOUNTING ACTIVITES
Doing so may result in overestimation
of the value of assets, high inventory
levels, reduction in expenditures,
changes in depreciation methods,
showing provisions as assets, etc.
(Shahid, Ali, 2016).
The techniques of creative accounting
follow the changes of accounting
standards, which are modified with
the aim of reducing accounting
manipulation.
The changes in accounting
standards often result in opening
up of new opportunities for
accounting manipulations.
Although companies apply
accounting standards, at the same
time they use “loopholes” to
enhance the key indicators (Karim
et al., 2016).
Creative accounting can have a positive
impact on a company’s business in the
short term, but in the long run it may
result in decreased stock prices,
insolvency, and even bankruptcy.
It is the root of numerous accounting
scandals, as well as many accounting
reforms, which is why doubts in the
transparency and honesty of financial
reporting arise.
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METHOD OF CREATIVE ACCOUNTING

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EXPLAINATION

• #1 – Wrong Estimation of Inventory in Stores

• The management of some of the companies do this type of practice to overstate
the inventories’ valuation. They do this to just show that their cost of goods sold
is understood thus tries to show the increased profits that their company is going
to earn this year.
• #2 – Failures to Make Proper Contingent Liabilities
• It is a very technical method of creative accounting. The contingent liabilities are
not shown properly in the notes to accounts; thus, it will give the impression that
the company is not having any liability and thus is free from that.
• #3 – Booking Less Expense
• The company sometimes, to show lower expenses, make client payment either by
cash or by an outdated cheque. It helps the management to book the lower
expenses per year, and their books of accounts will depict the fewer expenses
figure, which may attract some investors. 7
CONTINUE

• #4 – Willfully Attempting to Manipulate Depreciation Figures and Methods

• This technique is used by many companies to make a good impression on their
investors. The depreciation calculation method is sometimes changed by simply
giving a disclaimer. No estimation increases the life span of the assets. The
management attempts to set an arbitrary life span, usually more than expected. It
thus can have a less deprecation calculated on the above and corresponding to
that increases the salvage value of the assets of the company. Although
depreciation is cashless, the calculation of the same makes a great impact on the
finances of the company.
• #5 – Lowering Personal Liabilities of the Company
• A company does not usually tend to show their liability, so it is also a great
technique of creative accounting.

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• #6 – Manipulating Revenues and Sales Figures
• It is a very basic thing most of the companies are doing. Sometimes they lower the sales revenue in their
books to get rid of taxes, and sometimes they increase the sales figure with some arbitrary transaction to
show the revenue of the company to encourage their investors.

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Examples of Creative Accounting

• The company raises invoices before the end of the accounting year to inflate its sales
figures and but the actual transaction occurs on the post date. It is an example where the
company attempts to show the boosted up revenue figures.
• The company sometimes gives loans to their known person to willfully hide the
transactions made during the year.
• The company increases the useful life of an asset arbitrary to get rid of the higher
depreciation charged.

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Advantages

• The company can show a smooth and good growing graph of the company. The management adopts this
technique to show steady profits and good revenue to attract their investors.
• Creative accounting helps the company to set the required parameters for them, which is practically
impossible.
• The company that makes losses can be benefited from this type of creative accounting. Investors can be
hopeful by seeing the future gains in the companies’ budgeted accounts, and many times the company can
cope with the given situation.
• The company, by adopting this method, can somewhere conceal the financial risk which they may tend to
suffer.

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Disadvantages

• Although creative accounting is an ethical practice sometimes it may be treated as illegal. When the values
of the books of accounts are unethically or illogically misrepresented, then it can call for some qualifications.
• The company will always be at a high risk of losing its investors because in case the investors get to
understand the manipulations, it will not be good for the company. The investor’s interest might get
hampered.
• The biggest disadvantage is that if an expert does the manipulation, then it is fine, but if not so the financial
literate director or CEO decides to make a change, then it will be a problem. Therefore, this may add to the
cost of hiring a financial expert.
• In the long run, if this is disclosed that the company does a creative accounting practice, then the
expectation from the company by their clients will also be at risk; thus, the company may lose its business.

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 Discussion on Creative Accounting – LR AND CASES

• The influence of creative accounting on the credibility of accounting reports

• Creative accounting - motives, techniques and possibilities prevention
• A brief review of creative accounting literature and consequences in practice
• Creative accounting and financial performance of public listed companies in Malaysia
• Creative Accounting : An Empirical Study from Professional Prospective
• The Ethic of Creative Accounting

https://d.docs.live.net/ca17e2d7abf1d204/Desktop/ACT3129/CREATIVE%20ACCT%20SCANDAL.pdf

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Search the Literature Reviews of
Intellectual Capital in Scopus.
WHAT IS INTELLECTUAL CAPITAL ?

• Intellectual Capital is the knowledge of organization’s human resource that can be

used for money-making or other useful purpose or any other information or
knowledge that provide the organization with a competitive advantage.

• In other words it is an asset of the company as it is the informational resources

which company can use at its disposal for making profits, attracting customers,
creating a new product, enhancing existing product or improve business.

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 COMPONENT OF INTELLECTUAL CAPITAL

#1 – Human Capital
• Human capital includes employees, their knowledge and experience, the organization’s relationship with employees,
employee training and appraisal, employee satisfaction, employee review about the organization, etc. all contribute to
the capital of the organization.
• Example – Leadership and managerial skills, key employees and their knowledge, professional competencies, work
ethics, and work culture, employee training, etc.
#2 – Relational Capital
• Relational capital includes the organization’s relationship with employees, its investors, its customers, its supplier’s,
etc. review of all investors, customers, suppliers, employees all matters. Feedback of all also matters and ways of
improving and developing etc. contribute to relational capital.
• Example – Customer satisfaction, relationship with employees, customers and stakeholders, contracts with service
providers, reputation in the community, investor feedback rating, etc.

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COMPONENT OF INTELLECTUAL CAPITAL

#3 – Structural Capital
• It is organization processes, databases, policies, culture, vision, mission and value statement, etc. contribute to the
capital of the organization. If the organization’s work culture is good, and it provides quality products and its
reputation in the market, its competitive advantage, etc. are real intellectual capital for the organization.
• Example – Vision, Mission, Structures, goals of the organization, its work culture, its approach towards
employees training and providing knowledge, its tools, programs ways of working, and best practices.
• For a company like Infosys its employees working with them, work culture, client relationships, investor
relationships, key employees, training process, its reputation in the industry, its work culture, vision, mission and
values, databases, the experience of employees and management, etc. are the intellectual capital.
• Similarly, SONY is known for its quality products, so the main intellectual asset for Sony is its quality services
and reputation in the market.

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 Measurement

• Measurement of intellectual capital is difficult in financial terms; hence it cannot be recognized in the
accounts only goodwill, know-how, copyrights, patents, etc. to be recognized in the accounts if they are
measurable.
• Non-financial capital and very important for the organization, and it’s the real wealth of the organization.
• Measurement in financial terms is difficult, in non-financial terms and real wealth, it is of much value. If
the organization has satisfied employees, investors, and customers, then it is the real wealth of the
organization and an indicator that its intellectual capital is high.

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 Intellectual capital discussion based on MFRS 138 and LR

• Refer to https://d.docs.live.net/ca17e2d7abf1d204/Desktop/ACT3129/LR%20IC.pdf
• Refer to https://d.docs.live.net/ca17e2d7abf1d204/Desktop/ACT3129/BV2018_MFRS%20138.pdf

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END OF CLASS

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