Creative accounting 2

Creative accounting, also called aggressive accounting, is the manipulation of financial numbers, usually within the letter of the law and accounting standards, but very much against their spirit and certainly not providing the true and fair view of a company that accounts are supposed to. A typical aim of creative accounting will be to inflate profit figures. Some companies may also reduce reported profits in good years to smooth results. Assets and liabilities may also be manipulated, either to remain within limits such as debt covenants, or to hide problems. Typical creative accounting tricks include off balance sheet financing, over-optimistic revenue recognition and the use of exaggerated non-recurring items. The term window dressing has similar meaning when applied to accounts, but is a broader term that can be applied to other areas. In the US it is often used to describe the manipulation of investment portfolio performance numbers. In the context of accounts, window dressing is more likely than creative accounting to imply illegal or fraudulent practices, but it need to do so. The techniques of creative accounting change over time. As accounting standards change, the techniques that will work change. Many changes in accounting standards are meant to block particular ways of manipulating accounts, which means those intent on creative accounting need to find new ways of doing things. At the same time, other, well intentioned, changes in accounting standards open up new opportunities for creative accounting (the use of fair value is a good example of this). Many (but not all) creative accounting techniques change the main numbers shown in the financial statements, but make themselves evident elsewhere, most often in the notes to the accounts. The market has been surprised before by bad news hidden in the notes, so a diligent approach can give you an edge. Related pages: Revenue recognition | Off balance sheet finance | Inpairment | IFRS | Disclosure Related categories: Accounts

Accounting standards
Accounting standards are rules according to which accounts have to be drawn up. They demand minimum levels of disclosure, lay down fundamental principles, define the meanings of terms and specify how numbers should be calculated. There are three main sources of accounting standards:

The IASB which issues IFRS, National standards bodies such as the ASB, the requirements of legislation,

the requirements of regulators of particular industries or types of organisation. For example, Ofwat has detailed reporting requirements for water companies.

The latter two are not strictly speaking imposing accounting standards in the sense of the first two, but have the same effect In the case of EU countries, both EU and national legislation sets standards. Conflicting requirements may mean that more than one set of accounts needs to be prepared, or that reconciliations need to be provided. For example, companies with both UK and US listings will need to reconcile accounts draw up under IFRS to US GAAP or vice-versa. IFRS are important because they are a unifying force. Even countries that have not adopted IFRS are attempting to converge national standards with IFRS. Prior to this there were quite large differences; particularly between countries that has very detailed, prescriptive rules, and those that had looser rules and relied on enforcement of underlying accounting principles. The position of national standards bodies now varies. In the EU listed companies are required to use IFRS, so the role of national bodies is limited to private companies and unincorporated entities. The ASB is also responsible for enforcement of standards, including IFRS, on British companies. It is also common for many aspects of accounting standards to vary with company size. The UK goes as far as to have a separate standard for smaller companies (and other entities).

What is Creative Accounting?

5 Mar 2010

In the accounting world, the general rule is that accounts should give a true and fair view. Under local and international law, a professionally qualified accountant has a responsibility to comply, a corporation has a legal responsibility to comply, auditors have a legal responsibility to give some sort of opinion on compliance; yet frequently this all goes out of the window. Occasionally accountants and businesses are motivated to produce accounts that do not show a true and fair view. Not only this, but auditors rely on sampling and somehow fail to spot there is a problem.

Creative accounting is the practice of producing financial accounts that suit a particular purpose but do not really show the true and fair view. Sometimes the accountant may wish to show favorable profits (e.g. to get a bonus) at other times losses (e.g. to pay less tax). Sometimes the accountant may wish to show a healthy balance sheet (e.g. to get a bank loan), at other times an unhealthy balance sheet (e.g. before a management buy-out to get a bargain). Creative accounting often fools auditors and regulators, e.g. Enron, WorldCom, and the recent Madoff case.