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Creative Accounting – Misrepresentation of Facts

28 June 2010 - News - Editor

It's a common misconception that accountants lack creativity. The numerous accounting scandals over past decades have revealed that at least some accountants can be extremely creative with the finances they control. Such creativity can include the misdirecting or misusing of funds, understating expenses, overstating revenues, understating liabilities and overstating corporate asset values, thereby misrepresenting the financial state of a company. To be fair, large scale creative accounting (also referred to as innovative accounting or aggressive accounting) is seldom, if ever, the brain-child of the accountant in charge, but is carried out with the support of key executives in a company, and may even rely on the cooperation of officials in other corporations or affiliated companies. Creative accounting generally skirts along the edges of the rules of acceptable accounting practices, using very complicated ways of presenting assets and liabilities, and income and expenditure, with the view to enriching certain individuals in some way. Creative accounting can also be used to manipulate the value of a publicly traded company’s shares for financial gain.

Oversight agencies, such as the Security and Exchange Commission (SEC) in the USA, may be called upon to investigate whether creative accounting amounts to fraud. Sometimes, creative accounting can work in a company's favor without actually breaking the law, although possibly still being considered as unethical.

By means of information asymmetry – where one party in a business transaction has better information than the other – top executives are able to present a reduced price of the company's stock with relative ease. This reduced share price would make the company attractive for a takeover bid, with the takeover executives gaining from the reduced share price, while the former executives are likely to be guilty of nothing more than being conservative in accounting and earnings estimates. The fact that the former executives may be awarded lucrative settlement packages, simply speaks of generosity by the new owners. At other times, creative accounting can result in huge losses for investors.

Recognizing the need to protect investors, the Sarbanes-Oxley Act was enacted as a US Federal Law in July 2002, following financial scandals of corporate public companies such as Adelphia, Enron, Tyco International, WorldCom and Peregrine Systems. President Obama has been reported as saying regarding the current Wall Street reform proposals, that the US is poised to pass the toughest financial reform since the aftermath of the Great Depression, and going into the future Wall Street would be held accountable to the people.

 


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