Creative accounting involves presenting income, expenses, assets or liability with the intent to influence readers towards the interpretations desired by the authors. It becomes the financial number game and is systematic misrepresentation of net income or net assets. This is achieved through the aggressive choice and application of accounting principles, fraudulent financial reporting , earning management or income smoothing.
The facts may be twisted or the freedom given in accounting standards may be misused. ultimately, the financial statement do not reflect a true and fair view that the author desires. this involves ‘creativity’ on part of the accountant and hence it is called ‘creative accounting’ .
The following are some of the method used in creative accounting
Income recognition and cut-off
Manipulation of cut-off is relatively straightforward. For instance, a company may delay invoicing in order to move revenue into the following year.
The optional nature of the revaluation of non-current assets leaves such practices open to manipulation. The choice of whether to revalue can have a significant impact on a company’s statement of financial position.
This is where transactions are passed through the books at the year end to make figures look better, but in fact they have not taken place and are often reversed after the year end. An example is where cheques are written to creditors, entered in the cash book, but not sent out until well after the year end.
Change of accounting policies
This tends to be a last resort because companies which change accounting policies know they will not be able to do so again for some time. The effect in the year of change can be substantial and prime candidates for such treatment are depreciation, inventory valuation, changes from current cost to historical cost (practiced frequently by privatized public utilities) and foreign currency losses.
Manipulation of accruals, prepayments and contingencies
These figures can often be very subjective, particularly contingencies. In the case of impending legal action, for example, a contingent liability is difficult to estimate, the case may be far off and the lawyers cannot
give any indication of likely success, or failure. In such cases companies will often only disclose the possibility of such a liability, even though the eventual costs may be substantial.