Creative Accounting

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 certainty not providing the true and fair view of a company that accounts are supposed to. A typical aim of creative accounting will be to increase profit figures. Typical creative accounting tricks include off balance sheet financing, over optimistic revenue recognition and the use of exaggerated non- recurring items.

The technique of Creative accounting has changed over time. As accounting standards change, the techniques that will work will also change. Many changes in accounting standards are meant to block particular ways of manipulating accounts, which means that intent on creative accounting need to find new ways of doing things. At the same time, other well mentioned changes in accounting standards open up new opportunities for creative accounting.

According to critic David Ehrenstein, the term Creative Accounting was first used in 1968 in the film The Producers by Mel Brooks. Many creative accounting techniques change the main numbers show in the financial statements, but make themselves evident elsewhere, most often in the notes to the accounts. The term creative accounting as generally understood refers to systematic misrepresentation of the true income and assets of corporations and other organizations. Creative accounting is at the root of a number of accounting scandals.

The term “Window Dressing”

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

Earnings Management

Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of a company of influence contractual outcomes that depend on reported accounting numbers. Earnings management involves the artificial increase of revenues, profits or earnings per share figures through aggressive accounting tactics. Aggressive earnings management is a form of fraud and differs from reporting error. The main forms of earnings management are unsuitable revenue recognition, inappropriate accruals and estimates of liabilities, excessive provisions and generous reserve accounting and intentional minor breaches of financial reporting requirements that aggregate to a material breach.

Questions:

• What is Creative Accounting?
• What is Earnings Management?