Creative accounting or aggressive accounting is a method used to manipulate financial figures. It does not violate the letter of the law or accounting standards but it is very much against their spirit. Moreover, creative accounting certainly does not provide the true and fair view of an enterprise that accounts are meant to project. Creative accounting tricks are generally applied in the following areas: By adopting these tricks, it is possible to inflate or deflate profit figures depending on the nature of the enterprise's need. That is to say, if operating efficiency needs to be boosted, then profits are inflated. Likewise, if secret reserves need to be created, then profits are deflated. Sometimes, enterprises may also reduce reported profits in good years to smoothen the results. Assets and liabilities may also be manipulated to remain within limits (e.g., debt covenants) or to hide problems. For example, working capital efficiency can be managed by valuing stock at market value rather than cost price (not recording the deviation), knowing full well that stock should be valued at the lower of the two. The reporting of deviation (if done) is undertaken most often in the notes to take shelter under the loose ends of law (freedom of interpretation). An important observation relating to creative accounting is that these techniques alter the figures in the financial statements but make themselves evident elsewhere (most often in the notes to the accounts). Unless the information user thoroughly examines the financial statements along with the notes to the accounts and other additional details, it is not possible to detect the hidden information. Accounting standards are meant to block specific ways of manipulating figures through creative accounting. However, when accounting standards change, the techniques that will or won't work also change. The above situation quickly gives rise to a paradox: namely, whenever well-intentioned changes in accounting standards are introduced, this opens up new opportunities for creative accounting. One of the best examples of this is the fair value concept. It should be noted that every rule has an exception or contains a loophole that is used by knowledgeable accountants to their advantage through creative accounting. Window dressing and creative accounting are often used as synonyms, but the meaning of these terms is not the same. In the context of accounting, window dressing is a broader term than creative accounting that can be applied to other areas. In the US, window dressing is often used to describe the manipulation of investment portfolio performance numbers. Additionally, compared to creative accounting, window dressing is more likely to involve illegal and fraudulent practices. Evidently, there is a subtle yet significant difference between creative accounting and window dressing. It may not be incorrect to conclude that creative accounting is often a means to an end where window dressing is an end in itself. An accounts manager who engages in creative accounting can defend their actions in the following way: While all of these changes are justifiable within the provisions of the law, the justification runs counter to the spirit of the law. Source: NGFL Wales Business Studies A Level Resources Spec. Issue 2nd Sep. 2008What Is Creative Accounting?
Areas of Creative Accounting
Explanation
Effect of Changes in Accounting Standards
Creative Accounting and Window Dressing
Justification With the Provisions of Law
Conclusion
Creative Accounting FAQs
Creative accounting is an umbrella term that describes the act of deliberately modifying the figures in the Financial Statements but making them evident elsewhere (most often in the notes to the accounts). Unless information users thoroughly examine the Financial Statements along with the notes to the accounts and other additional details, it is not possible to detect hidden information.
Creative accounting is neither an illegal nor a criminal activity, but it does conflict with the spirit of the law. As accounting standards change over time, so too do creative accounting techniques. This includes recording transactions and events in ways that seem most advantageous to certain stakeholders.
There are many creative accounting techniques, including but not limited to: the use of overly optimistic revenue recognition policies; recording expenses when they were incurred rather than when they are paid for; changing the way in which an asset is labeled on the balance sheet; over-optimistic valuations of investments and other financial assets; and altering the way in which assets are depreciated.
While creative accounting refers to deliberate modifications of figures, window dressing is a broader term that covers many techniques used to make financial figures look as attractive as possible (for example, hiding major liabilities or making unfavorable figures "disappear" by leaving them off the Financial Statements).
Creative accounting is not in itself an illegal or criminal activity, but it does conflict with the spirit of the law. As accounting standards change over time, so too do creative accounting techniques. This includes recording transactions and events in ways that seem most advantageous to certain stakeholders.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
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