Motivation Behind Creative Accounting Accounting Essay

Creative accounting is a practice that potentially being undertaken as a result from some specific care more on their own interest and indirectly causes issues come up in ethical aspect of creative accounting. From information point of view, agency theory gives a clear picture on creative accounting circumstance. Whereby professionals misuse their privileged position in manipulating financial reporting in their own interest which providing superior information content to shareholder. Insufficient personal skill or unwillingness to carry out detailed examination making individual shareholders don't have the clear take on the result of accounting manipulation give a high likelihood in the incidence of creative accounting.

Definition of creative accounting

In the USA, the preferred term of creative accounting is "earnings management", yet, in Europe the most well-liked term is "creative accounting". Generally, creative accounting is accounting practice that falls outside the legislation and give gain to certain people. It can be described as a practice with a definite aim to interrupt the financial reporting process which affects reported income to make it searched normal and no true economic benefits to relevant parties like shareholders. Concisely, creative accounting is the change of financial accounting numbers from what they actually are from what users' desire by taking advantage of the accounting guidelines which is permitted by accounting standard.

Motivation for creative accounting

There are several motivations have been discovered in revitalizing the behaviour of creative accounting in the organization. These are proven by various studies being done in the past.

Firstly, the significant motivator for creative accounting is to report a decrease in business income to lower the duty paid. Second, to enable the business's performance show up better in future, company will increase the reported damage to make bad reduction in that season. That is called 'big bathtub' accounting with the objective in smoothing the income. Thirdly, to provide positive view on targets, securities valuation and decrease on risk for experts in expected capital market transactions and maintain firm's performance in analyst's expectation.

Other motivations are to manipulate profit in order to complement the reported income to benefit forecasts and also to distract attention from negative information by enhancing company's profit body though change in accounting guidelines. Managers' motivations in managing getting aim to report a stable progress in revenue not only to reduce the understanding of variability toward organisation's profits, but also are with regards to income measurement. To make company faces less risk and gain more advantage in aspect of raising fund, takeover bids as well as prevent takeover by other company.

Creative accounting is required to maintain or promote the show price and build a good profit growth. To gain reap the benefits of inside knowledge, director of the company employ creative accounting to postpone the release of information to the marketplace. Last but not least, many types of contractual right, responsibility and constraints predicated on the amount reported in the accounts also encourage company to use creative accounting.

Techniques of creative accounting

Creative accounting is positively applied in six areas. The first area is regulatory flexibility, whereby changes in accounting insurance plan are allowed by accounting rules. For example, IAS permit holding non-current asset can be retrieved at either revalued amount or depreciated historical cost in property valuation. Second, dearth of rules where some accounting treatment may not be fully governed as there may be few obligatory requirements.

The third area is management has large scope of estimation in discretionary areas, such as assumption in bad debts provision. Fourthly, some deals can be timed as to show the required appearance in accounts. For example, the administrator is free to choose the timing to sell the investment merely to increase earning in the accounts. Fifthly, to manipulate balance sheet volumes by using unnatural transaction.

Last but not least, by reclassification and presentation of financial volumes through balance sheet manipulation in order to soft financial ratios and also predicated on cognitive research point in financial numbers' display.

Existence of creative accounting

Theoretically, professionals' desire in creative accounting is appropriate. However, there may be various empirical studies have figured certain of companies apply a specific techniques of creative accounting to some extent, for example, applied in non-discretionary component of the bad debts provision. Other proof is classificatory smoothing utilizing the amazing items, such as pensions cost, dividends from unconsolidated subsidiaries, remarkable charges and credits and research and development costs in manipulating the physique of income in financial assertions as it was proven by several research workers.

Merchant found that managers acknowledge manipulative behaviours in accounting information and Black color argued non-current property sales are exploited by director as creative accounting tools through timing of its trades since relevant accounting expectations are permissive. Creative accounting behaviour is just a little still persisting although restrictions are tightened.

Amat reported out of 35 large outlined companies especially in Spanish determined that creative accounting behaviour was overt and considered legal. Furthermore, there are 3 possible signals of creative accounting: (1) auditor statement skills, (2) special authorizations from regulatory businesses, and (3) changes in accounting procedures.

In Spanish circumstance, the course of creative accounting was linked to general economic conditions and this somehow affected reported earning and altered earning against Spanish posted companies. However, there are a few unique top features of Spanish accounting environment draw out special attention like the audit report certification are standard, and creative accounting may be arose from the collusion of the regulatory government bodies.

Creative accounting behaviours can be determined with thoughtful research of financial record or detected by reasonably well- informed consumer of financial record. But, how clearness the users of declaration observe creative accounting is doubtful. Such as Spanish, analysts fail to report the existence of creative accounting. Anyway, value of information content in financial record can be involved even though financial assertions give satisfactory information enable users to adjust for creative accounting as certain investors count on reported earning statistics in income declaration.

Ethical perspective of creative accounting

There are some honest issues regarding the exercise of creative accounting. Revsine mentioned that loopholes in accounting expectations provide manager some spots in the sense of manipulate the timing in income reporting. In his view, accounting is an instrument to supervise contracts between professionals and financial organizations, identify probability of accounting manipulation and how properly it shown in rates and contracting decisions. Ethics of bias in choosing accounting policy which implied in creative accounting can be seen through accounting regulators and management level.

There are 2 views of accounting (deontological and teleological) which seen differently by Revsine and Ruland. From Ruland's point of view, deontological view is the moral applied to real action and teleological view is activities should be judged based on the consequence of such action. Whereas from Revsine perspective, teleological view of accounting is utilized in private sector which enable manager to make use of 'loose' standard to attain what they need and deontological view is about strict standard in avoiding accounting manipulation in public areas sector. In addition, Ruland has also differentiated positive responsibility and negative responsibility. From accounting perspective, positive responsibility identifies present an account free from bias. Meanwhile, negative responsibility refers to professionals would be responsible for activities done by others, which they fail to avoid. Compared to "duty to act", Ruland has pressured on "duty to refrain", which means all the inherent bias in creative accounting. Its importance can be investigated 3 issues, that happen to be relentlessness, certainty of end result and responsibility.

Professional accountant respect creative accountings are ethically doubted. Conner stated that managers tend to misapply accounting ideas to provide better appearance in financial statement to investors. Conflict of interest, client requests to alter account as well as for tax evasion will be the most frequent moral issues. Accountants' attitudes toward creative accounting be based upon whether it is arisen from misuse of accounting rule and manipulation of transactions. Merchant and Rockness discovered that accountants more critic in misuse of accounting guidelines as accountants duty is on rule-based and it comes within their know-how. Failure to act ethically may harm the reputation as an accountant unless she or he reports the abuse to the appropriate party. Slotting is no appropriate accounting treatment in company methods.

There are some action can be taken by accounting regulators in order to restrain creative accounting:

Decrease allowable accounting method or fix method used in various condition so that scope for choosing accounting method can be narrow downed. Companies also needs to be constant in using method chosen by them.

Some rules should be founded to reduce the misuse of judgement. For example, International Accounting Criteria presently have almost removed the "extraordinary item" from functioning profit. Also, companies should be regular in making use of accounting insurance policy to restrain the abuse of judgement.

Implementation of "Compound over form" can decrease artificial transaction and this can make connected transfer become one as complete.

To restrict the utilization of timing of genuine deal, item in profile should be regularly revaluated. The increase or decrease in value should be explained in the account each year the revaluation occurs. International Accounting Benchmarks also will value item at good value somewhat than historical cost.

Besides alteration in accounting legislation, ethical requirements and governance codes must be properly executed to avoid people from doing creative accounting.

Comparison with other author on the article presented

From the analysis done by Dilip and Eno in 'Creative Accounting in Bangladesh And Global Perspectives' discovered that the cause of creative accounting is the issues appealing among different interest organizations. For example, taking care of shareholders want to pay less taxes and dividends. Investor-shareholders are interested to get more dividends and capital benefits. Country's tax regulators wish to collect more and more taxes. Employees are interested to get better salary and higher earnings share.

Dilip and Eno also reported that creative accounting may arise under 3 different financial market conditions:

Depending on the financial market evaluation of the business's future prospects, company keep changes its shares to attract shareholders to donate to such shares either at par or at reduced.

Aim to show an appealing picture of its financial conditions when the company whose shares are already outlined in a stock market.

Based on inflated income through overvaluation of possessions, undervaluation of liabilities and change in systems of stock valuation that promote the image of company very quickly, company having its shares listed in the stock exchange may declare and pay high dividends.

Both of them examines creative accounting in Bangladesh scenario, they discovered lots of the company prospectuses posted in Bangladesh derive from creative accounting. A specialist opinion study also done by them and effect showed that though it is not clear for the length of time, creative accounting has been evidently practice in Bangladesh. Creative accounting not only being applied in Bangladesh but it seems to be widespread globally in developed countries such as UK, USA as well as Australia. And the case of Enron is the most broadly known case of creative accounting in USA.

Dilip and Eno also advised that the code of professional ethics should be totally overemphasized. Accounting education is necessary as well as the sensible of trainer to instill moral worth of integrity, honesty and sincerity into student's persona as it is advisable to modern society, the business enterprise world and the accounting career.

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