elk asia pacific journal of finance and risk ......from the viewpoint of a business journalist,...

ELK ASIA PACIFIC JOURNAL OF FINANCE AND RISK MANAGEMENT

ISSN 0976-7185 (Print) ISSN 2349-2325 (Online); DOI: 10.16962/EAPJFRM/issn.2349-2325/2014

Volume 5 Issue 4 (2014)

www.elkjournals.com ………………………………………………………………………………………………………………………….

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CRITICAL ANALYSIS OF THE CREATIVE ACCOUNTING

Dr. K. Kanaka Raju

Assistant Professor , Department of Management

Studies,

Andhra University Campus, Tadepalligudem,

Andhra Pradesh, India

Email: [email protected]

ABSTRACT

Keywords: Creative accounting, Analysis, Accounting Practices

Introduction

With the help of accounting knowledge,

the actual figures manipulated to gain the

personal profits. This process of

manipulation of accounts is called as the

creative accounting. It is possible through

the effects of increase or decrease of

expenses, increase or decrease of the

income, increase or decrease of assets,

crease or decrease of owners‟ funds,

increase or decrease of debts,

reclassification of assets or liabilities. These

are the reasons for mismatch between true

and fair view.

Definition of Creative Accounting:

Kamal Naser: 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/origins some or all of

them. (1993:2)

Reasons for Creative Accounting:

The following reasons were prevailing in the

process of creative accounting.

1) Smoothing of Income: Companies avoid

presenting volatile profits with a series

of highs and lows and prefer reporting a

The paper attempts to critically analyse creative accounting. For the same, 150 respondents were interviewed to

gather the information through a structured questionnaire. The secondary data was also collected with the help of

the existing literature and review. The data analysis included estimation of mean, percentage, standard deviation,

and t-test, which were applied to derive the results. This research study seeks to explain the reasons and

practices of the creative accounting and perceptions of the respondents on various issues of the creative

accounting.





2

steady growth. This is achieved by

making unreasonably high provisions for

liabilities and against values of assets in

profitable years so as to report higher

profits in not so profitable years by

reducing these provisions. Supporters of

this approach argue that it is a measure

against the 'short-termism' of evaluating

an investment on the basis of the yields

achieved in the immediately succeeding

years

2) Manipulating profits and attaching them

to forecasts is a variant on income

smoothing. Fox (1997) argues on how

accounting policies are designed at

Microsoft to match reported earnings to

forecasted profits. Microsoft defers a

large part of its profits from the sale of

software to cover cost of upgrading and

customer service costs that may arise in

future years. This highly conservative

and perfectly respectable accounting

policy suggests that future earnings are

easily predictable.

3) Directors of companies might keep an

income-boosting accounting policy

change ready, in order to divert attention

from distasteful news. Collingwood

(1991) describes how a change in

accounting method heightened K-Mart's

quarterly profit figures by some $160

million, in spite of the company slipping

to number two slots from being the

largest retailer in the USA thereby

diverting the attention from the event.

4) Creative accounting may help in

maintaining or boosting the share price

both by reducing the apparent levels of

borrowing, thereby making the company

appear less susceptible risk, and by

setting a profit trend example. This may

help the company to raise capital from

issue of new share issues, offer their

shares in takeover bids, and combat

takeover by other companies.

5) If the directors involve in 'insider

trading' in their company's shares they

may utilize creative accounting to

postpone the release of information to

the market, thereby enhancing their

probability of benefitting from inside

knowledge .It should be noted that,





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analysts will not be misguided by

superficial accounting charges in an

efficient market. Indeed, income

boosting accounting changes may be

perceived as an indicator of weakness by

the alert analysts. Dharan and Lev

(1993) present a study that indicates

poor performance of shares in the years

immediately succeeding income

inflating changes in accounting. Another

set of justifications for creative

accounting, which applies to all

companies, arises because companies are

subject to various types of constraints,

contractual rights and obligations based

on the reported accounting figures.

Review of Literature:

From the viewpoint of a business journalist,

Griffiths (1986), argues: "Every company in

the country is fidgeting with its profits.

Every set of furnished accounts is based on

books which have been gently cooked or

completely roasted. The figures which are

disclosed twice a year to the investing public

have all been tampered with in order to

protect the culpable. It is the biggest con

trick since the Trojan horse ... In fact this

deception, commonly called creative

accounting is completely legitimate and in

good taste. (p1)

From the viewpoint of an accountant,

Jameson (1988), observes: "The accounting

process consists of dealing with numerous

matters of judgement and of resolving

clashes between competing methodologies

of presentation of the results of financial

events and transactions .This resilience

presents scope for manipulation, deceit and

misrepresentation. These activities practiced

by the less scrupulous elements of the

accounting profession – have come to be

known as 'creative accounting'

As an investment analyst, Smith (1992)

agues: "We experienced that much of the

visible growth in profiles which had

occurred in the 1980's was the outcome of

accounting stratagem of hand rather than

genuine economic growth, and we set out to

unmask the main tools and techniques





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involved, and to provide live examples of

companies making use of those techniques".

From an academic‟s point of view, Naser

(1993) suggests a definition: "Creative

accounting is the art of metamorphosing

financial accounting figures from what they

really are to what developers desire by

exploiting the existing rules and/or ignoring

some or all of them"

Some common arguments run through

popular works: Creative accounting involves

„fiddling‟ and „figures which have been

changed‟ (Griffiths) to achieve

„misrepresentation‟ (Jameson) by „sleight of

hand‟ (Smith) to transform figures from

„what they actually are‟ (Naser).

Categorically in Naser, and tacitly in the

other three versions, is suggested that

creative accounting deviates from and masks

some underlying truth in financial figures.

Creative accounting is evidenced

extensively in the UK. Naser believes that

because of the freedom of choice it allows

the accounting systems in Anglo-Saxon

countries as especially prone to such

manipulation. He argues, “The freedom of

choice provided by Anglo-Saxon accounting

system could be abused ...”

Similarly in context of the accounting

problem in UK, Waller (1990) suggests

moving to a more prescriptive, legal

continental tradition. Finally all four authors

perceive creative accounting as a

disreputable practice, using terms such as

„fiddling‟, and deceit ‟and„ taking

advantage.

Objectives of the Study

After review of the existing literature the

following objectives have been adopted for

carrying of this study:

1) To examine the reasons and practices of

creative accounting.

2) To review the impact of legalized

accounting frame work on financial

results and condition.

3) To interpret and analyze the perceptions

of respondents on various issues of






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4) To offer a suitable suggestions to

overcome the existing complexities in

accounting procedure and practices to

reflect the true and fair view of

financial statements.

Methodology of the Study

The data has been collected through

structured questionnaire from the 150

respondents, and informal conversations

with them. The secondary data obtained

from the existing literature and review.

Techniques

The SPSS 16.0 version was used to interpret

and analyze the data. The percentage,

frequency and t-test applied to analyze the

data.

Hypothesis: The following hypotheses were

adopted to test the results for come to the

valid reasons.

Hypothesis 1:

Null Hypothesis (Ho): There was no client

proposal to manipulate accounts for tax

evasion.

Alternative hypothesis (Ha): There was

client proposal to manipulate accounts for

tax evasion.

Hypothesis 2:

Null Hypothesis (Ho): New structure of

financial regulation is not the causes of

directions are more ethical.

Alternative Hypothesis (Ha): New

structure of financial regulation is the causes

of directors are more ethical.

Creative Accounting techniques and

practices:

The availability of making choices in

recommended policies and treatments in

International accounting rules makes way

for creative accounting. Such freedom of

choice generates significant uncertainty

regarding the consistency and comparability

of information. In the following, we will try

to highlight some creative accounting





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techniques and their effect on the

performance of the entity:

Inventory related Creative Accounting

Practice: The purchase costs of inventories

(Transportation costs) will be included in

the purchase cost or not, in this regard that

an entity acquires goods in the following

situations: Purchase cost of goods Rs.

10,800, Transport costs Rs. 600, Revenues

from the sale of goods Rs. 27,000 .

Table 1: Inclusion and Exclusion of Transport Costs for Manipulation of Accounts.

Elements Transport Costs Included

in the Cost of Goods

Acquisition

Transport Costs Excluded

from the Cost of Goods

Acquisition

Revenues from the Sale of

Goods

27,000 27,000

Cost of Goods Sold 10,800 10,200

- Purchase Cost 10,000 10,000

- Transport Expenses 6,00 -----------

- Handling Expenses 200 200

Accounting Result 16,200 16,800

The above table 1 reveals that the

accounting result was decreased where

transport expenses considered in cost of

goods sold, i.e. 16,200 (Instead of 16,800).

Hence, it is possible to manipulate the

accounting results and conditions under the

purview of the existing accounting rules and

procedure. Hence, it is recommended to

strengthen the existing procedure of rules

and regulations with compliance of the

International Financial Reporting Standards

to project the true and fair view of the

financial results.

Table 2: Capitalization and Non Capitalization of Interest Regarding Creative Accounting.





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Elements Interest is capitalized Interest is not capitalized

Turnover 67,000 67,000

Variation of Stocks 12,000 11,000

Expenses with Raw materials 25,000 25,000

Salary and Social Expenses 13,000 13,000

Other Operating Expenses 9,000 9,000

Operating Result 32000 31000

Expenses Regarding the

Interest

-------------- 1500

Accounting Result 32,000 29,500

The table 2 reveals that capitalization and

non-capitalization of Interest regarding

manipulation of accounts. If the interest is

not included the accounting results declined

from the Rs. 32000 to Rs. 29,500. It means

there is possibility of projecting the

undervalued financial results rather than

original values.

To exemplify it is supposed that

the entity has an industrial building acquired

at a consideration of Rs. 7,000,000, where

the depreciated value is Rs. 4,000,000. The

depreciation method used is linear and the

remaining life is 10 years.

Table 3: Capitalization and Non-Capitalization of Renovation Expenses for Manipulation

Accounts

Elements

N

-------------------------------

Renovation expenses

N+1

Renovation Expenses

Itis It is not It is It is not





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capitalized Capitalized capitalized capitalized

Turnover 15,000,000 15,000,000 15,000,000 15,000,000

Renovation Expenses ---------- 1,700,000 ---------- ----------------

Depreciation Expenses

1,900,000 1,000,000 1,900,000 1,000,000

Expenses with raw

materials

3,000,000 3,000,000 3,000,000 3,000,000

Salary and Social Expenses

1,300,000 1,300,000 1,300,000 1,300,000

Other Operating Expenses

700,000 700,000 700,000 700,000

Accounting Result 81,00,000 74,00,000 81,00,000 90,00,000

The table 3 witnessed that comparison of

renovation expenses for N period to N plus

one period in the context of capitalization

and non-capitalization of renovation

expenses .The results were due to

capitalization and non-capitalization. For N

period the capitalized value were higher than

non-capitalized value, but in N plus one

period the capitalized value were lesser than

non-capitalized value due to depreciation.

At the beginning of N, the entity‟s

management decides to re-examine the

immobilization, the fair value being Rs.

8,000,000. The equity situation before the

reevaluation was as follows: social capital

Rs. 120,000,000, revaluation reserves Rs.

9,000,000. As reported by the statement of

changes in equity, the entity‟s performance

before and after revaluation is:

Table 4: Effect of Revaluation Reserve on

Financial Condition

Elements Before the

Revaluation

After the

Revaluation

Social 1,20,000,000 1,20,000,000





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Capital

Revaluation

Reserve

9,000,000 13,000,000

Total

Equity

1,29,000,000 1,33,000,000

The table 4 reveals that the value of equity

increased after its revaluation, by

400,000,000 because of revaluation value

was manipulated. The depreciation expense

increases as an effect of revaluation of

depreciable assets. The annual depreciation

before revaluation is Rs. 400,000, and after

revaluation is Rs. 800,000 (8,000,000 x

10%).Thus, after revaluation, the outcome is

reduced by 400,000 mu (we maintain the

data in the example on the previous page):

Table 5: Effect of Depreciation Expenses

on Financial Results

Elements Before the

Reevaluatio

n

After the

Reevaluatio

n

Turnover 1,20,000 1,20,000

Depreciatio

n Expenses

400,000 800,000

Expenses

with Raw

materials

3,000,000 3,000,000

Salary and

Social

Expenses

1,300,000 1,300,000

Other

Operating

Expenses

900,000 900,000

Accounting

Results

4,400,000 4,000,000

The above table reveals that how the value

of depreciation is effect on financial results

of the firm. The above table reflects that

before manipulation of depreciation

financial results were higher than after

revaluation. Hence, to counteract the

decrease of the result, entities prefer to

reassess depreciable assets.

Perceptions of the Respondents:

Table 6: Distribution of Respondents

by their Age





10

Age Frequency Percent

V 20-30 years 48 32.00

30-40 years 37 24.60

40-50 years 37 24.60

50-60years 28 18.66

Total 150 100.00

The table above suggests that, the majority

of the respondents (32 percent) represented

from the 20-30 years age group, followed by

30-40 years, 40-50 years etc. Hence, it can

be inferred that the bulk of the respondents

were selected from the 20-30 years.

Table 7: Distribution of Respondents by

their Gender

Gender Frequency Percent

Male 101 67.33

Female 49 32.666

Total 150 100.00

The above table reveals that, the majority of

the respondents (67.33 percent) represented

from the male category and remaining

respondents represented from the female

category. Hence, the majority of the

respondents belonged to the male category.

Table 8:Distribution of Respondents by

their Income

Income Frequency Percent

Below 10000 10 6.66

10000-20000 10 6.66

20000-30000 37 24.66

30000-50000 37 24.66

Above 50000 56 37.33

Total 150 100.00





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The above table makes it clear that, the

majority of the respondents (37, 33) earns

above 50,000, and 24.66 percent of the

respondents earns in between the 20,000-

30,000. Hence, it can be concluded that the

majority of the respondents earns above

50,000.

The majority of the respondents possess the

post-graduation qualification, followed by

the Ph.D. degree and intermediate. Hence, it

is evident that the majority of the

respondents represented from the post-

graduation qualification.

The table above table suggests that, the

majority of the respondents (81.3 percent)

opined that, the creative accounting was a

significant problem in India, and rest of the

respondents opined that it was not a

significant problem. Hence, it can be

inferred that the majority of respondents

opined that creative accounting was a

significant problem, because of there were

so many fraudulent activities in the financial

accounting.

Table 9: Distribution of Respondents by

their Education Qualifications

Educational

Qualifications Frequency Percent

Intermediate 7 4.66

Degree 7 4.66

PG 94 62.66

PHD 42 28.00

Total 150 100.00

Tale 10: Respondents opinion on

Problem of Creative Accounting in

India

Frequency Percent

Yes 122 81.3

No 28 18.7

Total 150 100.0





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The above table reveals that the 37.33

percent of the respondents opined that there

was no change in aspects of creative

accounting in India. 18.7 percent of them

opined that much reduced and 15.3 percent

of them opined that much and some reduced.

Hence, it can be concluded that the majority

of them opined that there was no change in

practices and manipulations of creative

accounting.

Hypothesis 1:

Null Hypothesis (Ho): There was no client

proposal to manipulate accounts for tax

evasion.

Alternative hypothesis (Ha): There was

client proposal to manipulate accounts for

tax evasion.

Table 12: Hypothetical Testing Group Statistics

Table 11: Opinion on creative accounting becoming more or less common in India

Frequency Percent

Much Reduced 23 15.3

Some Reduced 23 15.3

Unchanged 56 37.3

Much Reduced From Past

but Now 28 18.7

Slight Revival 20 13.3

Total 150 100.0





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Client

Proposal for

tax evasion N Mean

Std.

Deviation

Std. Error

Mean

Client Proposal

to Manipulate

Accounts

Strongly

Agree 130 1.5769 .49596 .04350

Agree 20 1.6500 .48936 .10942

Analysis

The above table makes it clear that the null

hypothesis was accepted, where (t =-0.614,

df =148, p=0.000) and concluded that there

was no client proposal to manipulate

accounts for tax evasion, but within the

organizations itself manipulate the accounts.

Hypothesis 2:

Null Hypothesis (Ho): New structure of

financial regulation is not the cause of

directions is more ethical.

Alternative Hypothesis (Ha): New

structure of financial regulation is the cause

of directors is more ethical.

Levene's Test for Equality of Variances

F Sig. t df

Sig. (2-

tailed)

Client Proposal to

Manipulate Accounts

Equal variances

assumed 2.431 .121 -.614 148 .540

Equal variances

not assumed

-.621 25.386 .540





14

Table 13: Hypothetical Testing Group

Statistics

Levene's Test for Equality of Variances

F Sig. t df

Sig. (2-

tailed)

New Structure of

Financial Regulation

Equal variances

assumed 1.703 .195 -.658 104 .512

Equal variances

not assumed

-.660 91.299 .511

The table above suggests that the null

hypothesis was accepted, where ( t=-0.658,

df = 104, p=0.512) .Hence, it can be inferred

that the new structure of financial regulation

was not the cause of directors are more

ethical.

Findings of the Study

Directors are

more Ethical N Mean

Std.

Deviation Std. Error Mean

New Structure of

Financial Regulation

Strongly Agree 63 1.5397 .50243 .06330

Agree 43 1.6047 .49471 .07544





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On the existing literature and review, the

following were attempted to extract on the


1. The study found that creative

accounting was a significant problem

in India, because of there was

number of fraudulent activities in the

existing accounting procedures and

regulations.

2. The study observed that 37.3 percent

of the respondents opined that there

was no change in aspects of creative

accounting in India and it implied

that there was no change in practices

and manipulation of creative

accounting.

3. The study concluded that there was

no client proposal to manipulate

accounts for tax evasion, but the

organization made itself utilized the

creative accounting practices and

methods.

4. The study also found that, the new

structure of financial regulation was

not the cause of directors were more

ethical.

Suggestions:

1. To overcome the disadvantage of

reducing result, entities may use the

surplus value imputation from

revaluation on revaluation reserves.

2. It is recommended to strengthen the

existing procedure of rules and

regulations with compliance of the

International Financial Reporting

Standards to project financial results

truly and fairly.

3. To overcome the decrease of the result,

entities prefer to reassess depreciable

assets to reflect the true and fair view of

financial results and condition.

4. The study observed that manipulation of

accounts within a legal frame work was

widely spread and cause of significant

losses. Hence, it should be custard the

manipulation of accounts through

creative accounting, for this purpose,

there should be a well-organized legal

frame work to eradicate the creative

accounting practices and manipulations.

5. There should be an awareness

programme amongst the chartered





16

accountants and create a social

responsibility amongst them.

6. The study observed that due to the

available chances of provisions of

existing accounting procedure is the

cause of creative accounting. Hence,

there should be ratifying those

provisions to see a true and fair view of

accounts to come out the exact financial

results and condition.

7. There should be an external audit

committee parell with the internal audit

committee based on the periodicity of

small internal rather than year end. All

the professional bodies should come into

a single unanimous opinion to have a

synergetic effect on eradication of

creative accounting practices and

manipulations.

Conclusion

Creative accounting adversely effect on

Indian economy loss of investors‟

confidence in promotion of capital

formation and other illegible and invisible

defects were occurred. The study found that

the creative accounting was a significant

problem in India and implied that there was

no change in aspects of creative accounting

in India. Hence, there is on immense need of

curtail the manipulation of accounts through

the creative accounting for this purpose,

there should be design a constructive

organized frame work and also facilitate the

awareness programme amongst the

chartered accountants. The available

chances of provisions of existing accounting

procedure are the cause of creative

accounting. Hence there should be ratifying

those provisions to see a true and fair view

of accounts to come out with the exact

financial results and condition.

References:

[1] Dima Florin-Constant in, creative

Accounting through the Policies and

Accounting Options.

[2] Griffiths I (1986), “Creative

Accounting”, London: Sidgwick &

Jackson.

[3] Jameson M (1988), Practical Guide to

Creative Accounting, London: Kogan

Page.

[4] N. Feleagă, L. Malciu, “Accounting





17

Policies and Options”, Economic

Publishing House, Bucharest, 2002

[5] Naser K (1993), Creative financial

accounting: its nature and use, Hemel

Hempstead: Prentice Hall.

[6] Oriol Amat, and John Blake, Jack

Dowds Economics working paper the

Ethics of creative Accounting,

December 199, pp: 02.

[7] Smith T (1992), “Accounting for

growth”, London: Century Business.

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