Creative Accounting Meaning
Creative accounting is a method, which is used to make or interpret accounting policies falsely with the objective of misusing the accounting techniques and standards, which are being set by the accounting bodies. The purpose of doing this type of practice is to make profits by not reporting the exact figures. It is an exploitation of loopholes in our accounting system as well as audit system after the accounts are finalized.
There are many ways of doing it. The most popular ones are to manipulate the profit figures to get rid of excessive taxation in futures, many a time the books of accounts through which these tax figures are found out are generally not correct the manipulation is done from the very primary level. The main adjustments regarding the accounts which the management wants to manipulate are done by adjusting the figures related to employee benefits or incentives. Some companies practice creative accounting to pretend that the financial condition of their company is sound and people can invest in our companies.
Methods of Creative Accounting
#1 – Wrong Estimation of Inventory in Stores
The management of some of the companies do this type of practice to overstate the inventories’ valuation just to show that their cost of goods sold is understood thus tries to show the increased profits that their company is going to earn in this year.
#2 – Failures to Make Proper Contingent Liabilities
This is a very technical method of creative accounting. the contingent liabilities are not shown properly in the notes to accounts thus it will give the impression that the company is not having any liability and thus is free from that.
#3 – Booking Less Expense
The company sometimes to show a lower expenses figure does the payment to their clients either by cash or by an outdated cheque this will help the management to book the lower expenses per year and their books of accounts will depict the fewer expenses figure which may attract some investors.
#4 – Willfully Attempting to Manipulate Depreciation Figures and Methods
This technique is used by many companies to make a good impression on their investors. The depreciation calculation method is sometimes changed by simply giving a disclaimer. The life span of the assets is increased by no estimation. the management makes an attempt to set an arbitrary life span usually more than expected and thus can have a less deprecation calculated on the above and corresponding to that increases the salvage value of the assets of the company. Although depreciation is cashless the calculation of the same makes a great impact on the finances of the company.
#5 – Lowering Personal Liabilities of the Company
A company does not usually tend to show their personal liability so it is also a great technique of creative accounting.
#6 – Manipulating Revenues and Sales Figures
This is a very basic thing most of the companies are doing, sometimes they lower the sales revenue in their books to get rid of taxes and sometimes they increase the sales figure with some arbitrary transaction to show the revenue of the company to encourage their investors.
Examples of Creative Accounting
- The company raises invoices before the end of the accounting year to inflate its sales figures and but the actual transaction occurs on the post date. This is an example where the company attempts to show the boosted up revenue figures.
- The company sometimes gives loans to their known person to willfully hide the transactions made during the year.
- The company increases the useful life of an asset arbitrary to get rid of the higher depreciation charged.
- The company can show a smooth and good growing graph of the company. The management adopts this technique to show steady profits and good revenue to attract their investors.
- Creative accounting helps the company to set required parameters for them which is practically impossible.
- The company that makes losses can be benefited from this type of creative accounting the investors can be hopeful by seeing the future gains in the companies’ budgeted accounts and many times company can cope with the given situation.
- The company by adopting this method can somewhere conceal the financial risk which they may tend to suffer.
- Although creative accounting is an ethical practice sometimes it may be treated as illegal. When the values of the books of accounts are unethically or illogically misrepresented then it can call for some qualifications.
- The company will always be at a high risk of losing its investors because in case the investors get to understand the manipulations it will not be good for the company. The investor’s interest might get hampered.
- The biggest disadvantage is that if the manipulation is done by an expert then it is fine but if not so the financial literate director or CEO decides to make a change then it will be a problem, therefore, this may add to their cost of hiring a financial expert.
- In the long run, if this is disclosed that the company does a creative accounting practice then the expectation from the company by their clients will also be at a risk thus the company may lose its business.
Creative accounting is an accounting practice that helps the company to deviate the profits, revenues for the year by following rules and regulations. It is a skill, which is used by experts to manipulate the accounts of the company. The loopholes in the system are best used by the experts and the method should be ethical otherwise it can be a serious problem for the company’s management.
The most important thing here is that investors should be very careful while choosing companies for investment. They should be knowing the financial arrangements which are possibly done by understanding the notes to the accounts any suspicious item should be asked by the management and if the management is unable to answer the query the investor should not invest their money in these bogus companies.
This has been a guide to what is creative accounting and its meaning. Here we discuss the top 6 methods of creative accounting along with examples, advantages, and disadvantages. You can learn more from the following articles –