Financial statements are the reflections of every company. Information on the financials will be communicated to the interested parties who then make various decisions based on such data. The information presented should be accurate and reliable. However, businesses are increasingly resorting to beautify the financial statements in order to make their images more appealing and attract many investors as possible. This is a good reason why the concept of creative accounting is derived. There can be distortion of financial information which casts doubts on the accuracy and reliability.
Creative accounting can be referred as the accounting practice that may or may not follow the accounting standards and principles but deviates from what the standards and principles intend to achieve, in order to present the desired company image. In other words, it is the process of transforming the accounting information from what it actually is to what the company prefers it to be by exploiting the loopholes and benefits in the existing rules or ignoring part of them.
The use of creativity in financial reporting is often quite challenging to detect and may result in overestimation of the values of assets, high inventory levels, massive cut in expenditures and even changes in depreciation methods.
Creative accounting can have a positive impact on the business in short-term, but in the long run, the company may suffer from damaged reputation, decreasing stock price, insolvency or bankruptcy. It is the essence of numerous accounting scandals which raises questions in the transparency and honesty of financial reporting. Therefore, forensic accounting is greatly sought and emphasised in recent years.
In most cases, the management is answerable for any manipulation of financial reporting. The main motives for application of creative accounting are:
- obtaining personal gains;
- enticing investors;
- increasing or maintaining the capital level;
- delaying for debt settlements;
- beating analysts’ forecasts about the future company performance.
Since creative accounting has been used in a bad light, resulting in various scandals with dire consequences, it is vital to establish efficient techniques to minimise financial manipulation. Some of the techniques include:
- adapting the accounting standards in terms of limited use of estimates and applying accounting methods with consistency;
- recognising and asserting on the function of internal and external audit in identifying and reporting improper estimates and preventing accounting manipulations;
- changing of auditors from one accounting period to another;
- hiring independent directors and members of audit committee;
- establishing effective corporate governance controls;
- making employees aware of the code of ethics and developing a whistleblowing policy.
Financial statements serve as a medium to communicate the business to the relevant stakeholders. The main objective of financial reporting is to provide a fair and unbiased picture of the business, considering the fundamentals of accounting assumptions and standards. However, these often require and allow varied estimates, which lead to accounting manipulation.
In order to portray the business in a positive angle, companies tend to utilise various methods of creative accounting. The base for manipulative procedures lies in accounting estimates that are permitted within the standards. Since creative accounting is often implemented with malicious intent, it is necessary to set up control measures that can minimise the practice in order to prevent distorted financial reporting.
All in all, the use of creative accounting cannot be completely removed but it can be greatly reduced by adopting the abovementioned methods.
About BlackStorm Consulting
BlackStorm Consulting (http://blackstormco.asia/) is a boutique growth consultancy firm that specialises in corporate strategy, profit management and investment management. We mainly serve clients in four sectors: FinTech, Gaming, Technology, Media and Telecommunications (TMT), and manufacturing.
Our clients and connections are internationally present and range from small and medium sized businesses, MNCs, to government agencies.