The nature, incidence and ethical issues of creative accounting

Understandably, there are a variety of ways in which a company can manage their earnings, and if accomplished successfully, the results can be highly profitable. Not all techniques are fraudulent, as effective earnings management is considered good for business and shareholders. Income smoothing is a specific example of permissible earnings management that involves controlling fluctuations in net income to make earnings less variable over a given period of time (Goel & Thakor, 2003). Smoothing is acceptable as long as it adheres to the restrictions of U.S. GAAP, which maintains that all revenues and expenses are accounted for in a defined fashion. There are a lot of incentives in figuring how to effectively smooth income, as substantial value can be created through the successful arrangement of financial transactions. Management is able to make more intelligent decisions with regards to the future of the firm if the earnings are able to match the forecasts. One instance this is seen is when management is faced with the decision to smooth total income or

Part of ABC’s Finance Director’s justification for manipulating the financial results is that: “a win-win situation for everyone”. This section will explore the impact of ABC’s creative accounting practice to the interest of different stakeholder groups. It will also identify the winners and losers if the finance director’s proposals are carried out.

In this article, Miller et al. concern about the understanding of the historical foundation of accounting practice by investigating how theories of costing and budgeting were constructed in the first thirty years of the 20th century. In addition, the authors suggest several radical factors of theoretical understanding of accounting in relation to the other social and organizational practices.

Firstly, it is crucial to acknowledge of the Positive Accounting Theory. According to Deegan & Samkin (n.d.), Positive Accounting Theory explains and predicts accounting practice and does not seek to determine particular actions. For instance, which accounting policies will be choosen by firms and how newly proposed accounting standard will be reacted to by firms (Deegan & Samkin n.d.). In the same report, the author claims the first aspect of Positive Accounting Theory, which is “Explanation” means providing reasons for observed practice. For example, positive accounting theory pursues to explain why historical cost accounting continues being used by firms and why convinced firms switch between a numbers of accounting techniques. The second factor, which is “Prediction” indicates that the theory predicts “unobserved phenomena” (Deegan & Samkin n.d.). The author clarifies that this phenomena is not necessarily a future phenomena, they

Financial accounting is a subjective area that strives to provide complete and accurate information for the end user. Before the class discussion, I felt accounting was more of a science than an art – if you tested items and they fell into a certain parameter, it was an accurate representation of the facts and figures under review. The class discussion and another person’s experience has caused me to rethink this perspective because when one considers the variables incorporated into financial accounting, it is not as simple and clear cut as some would like to think. Hines (1988, p. 252-253) states “having the full picture – a true, a fair view of something – depends on people deciding that they have the full picture. Sometimes, they later decide they did not have the

Earnings management is the use of accounting techniques, such as change in accounting policies and accounting estimates, with an objective to create an optimistic outlook (sometimes overly optimistic) of a company’s business activities and financial position. Although to some it may seem like it is earnings fraud, earnings management actually took benefit from the flexibility and the legitimateness (within the framework of Generally Accepted Accounting Principles (GAAP)) of accounting rules to manipulate revenue and expenses recognition.

prevent decrease in stock value, higher borrowing cost, evade corporate bankruptcy and non-financial motives are believed to be more powerful (p.286). Stallworth and Degregorio (2004) identified that most companies managed earnings for several reason, however the most common motivations is the pressure to meet the market and analyst expectations by prematurely or fictitiously recognizing revenue (p.55). Stallworth and Degregorio suggests that the internal auditor should be cautious of the indications to perform abusive earning management or motivation to commit fraud, such as personal benefits like prestige, extra compensation, bonuses, employee stock option and increased stock value as a reward when earning expectations are met or exceeded, while negative outcomes provide the same level of motivation like reputational damage or embarrassment, loss of employment, demotion or lowered compensation (p.56).

Accountants cannot predict every business structure, every new and innovative transaction. Therefore, they build up principles that allow for flexibility so that they can adapt to changing circumstances. However, people make use of that flexibility. They employ earnings management techniques to shade financial unpredictability. Thus, the real results of the decisions of the management are veiled.

Several studies have revealed a number of motivations for engaging in earnings management. Some of the reasons for this practice include managers’ remuneration packages (Healy, 1985), meeting company forecasts (Kasznik, 1999) or analyst forecasts. Yet, one other reason for earnings management is when firms plan to make an acquisition or merger that involves an exchange of shares for a target. This is done to soar the shares price of the acquirer in order to reduce the number of shares of the acquirer that will be exchanged for the target (Goodwin, 2009).

Jim will appear to making less money than it actually did and therefore have to report fewer taxes. In other words, Jim is seeking for a tax saving. It can be explain by using the contracting perspective where manager will choose accounting techniques that will maximizes his or her utility at the expenses and also maximize bonuses. Furthermore, by creating LIFO inventory layer adjustment it will give lower reported earnings. If the company can avoid the inventory increase for the year and instead having a reduction, they can take a credit adjustment to cost of sale and increase their profit. Under literature Scott (2000), this proposal fall under opportunistic earning management where the management report earnings opportunistically to maximize own profit. Related study are Burgstahler and Dichev (1997) conclude that managers engage in earning management to avoid reporting losses or earning decline. Research show that there is negative relationship between unexpected discretionary accruals and stock returns around the earnings announcement date. This result indicates that the market views discretionary accruals as opportunistic.

Earnings Management: Earnings management occurs when managers manipulate firms’ reported earnings through the biasing of accrual judgments and structuring of transactions or other means, eroding the usefulness of earnings information and misleading investors (Barua Cready, Fan and Thomas, 2010; Wilson, 2011; Healy and Wahlen, 1999).

This method 's use or value may not be apparent at first, but through its practice we see why this is the standard in regards to this area of financial reporting. Since the goal is to give the fairest representation of the financial position, at times adjustments such as these must be made.

Nowadays, as our economy is facing possible everyday crises, managers undergo an increasing pressure in order to keep their company 's earnings stable. Shareholders and analysts expect companies to meet forecasted goals and not to deviate from these. Especially, reliable companies are to report positive results and shall not present any 'surprises '. Managers therefore often turn to their accounting departments for help, whose job it then is to improve the bottom line by changing the information shown in financial

The management accounting is an effective and important provider for business information that helps the management to make decisions relating to business activities and investment decisions. Managerial accountants play a crucial role in advising managers about the financial implications of projects; and run some analysis such as cost benefit analysis, sensitivity analysis. At the same time managerial accounting streamline the management by explain the financial consequences of business decisions. It plays a crucial role in formulate business strategy to assist the higher management to build the strategic goals and strategic plan. Managerial accountants always monitor spending and financial control as well as conduct internal business audits. The management accounting is a control tool used for various internal business processes of the enterprise, consequently becoming essential in any manager’s daily processes and operations.

Basically, creative accounting does involve some manipulation in financial statements, especially in the balance sheet. It can be simply means income or earns something. Creative accounting will always be reflected in financial indicators and fundamentally the factor of company solvency, doesn’t matter what is the reason of it. This is because not everything that looks like profit is really a profit.