Last month, as I spent time studying for my CIMA Managerial Level P08 paper on Financial Analysis, I came across a topic which caught and has successfully retained my interest- CREATIVE ACCOUNTING.With the numerous high profile scandals (such as Enron, WorldCom,Satyam) associated with it, it didn't take much.Rest assured, I'm interested in reading up on it, not practising it
After all, it takes a criminal to catch another.
It revolves around the idea of entities playing with their accounting records in a way which is within the letter of the law but going against the spirit of law. In simpler terms, creative accounting refers to businesses using the loopholes in law to give a rosier picture of their financial standing.
To make the concept clearer, here is a list of a few methods adopted which accounts to creative accounting:
-Playing with the minds of the financial analysts by forecasting lower figures than expected so that when the results come, the company appears to have exceeded expectations
-Exclusion of liabilities/Off-balance sheet financing: this is where the liability is not shown in the books
-Altering the timing of the transaction:companies may delay/hurry the despatch of sales, plan the timing of sale/purchase of assets
-Use of alternative methods of accounting which certain standards allow, especially in cases of depreciation and provisions
-Playing with the leverage given to the management to make some classification decisions
-Recognition of revenue before/after it is rightfully earnt
The motivation behind the concept of creative accounting is listed as-
1. For personal gains of the managers(who get bonuses and other benefits in the light of good performance)
2.For indirect personal gains (where the entity's reputation of a good performer sticks onto the employee)
3.Tax Avoidance (need i say more?)
4.An attitude of following the pack- where managers feel everyone/major players in the industry are doing it and hence they must too.
5.Meeting convenants(conditions)set by banks and financial institutions
6.Increasing shareholder confidence.
While studying the above, I was able to accept all the reasons (which at least to me seemed to revolve around internal factors) except the last one, which I believe has a huge external factor,sparked off an internal debate in me.
If entities are white washing their accounts to show exemplary performance and hence raise shareholder confidence in the company, what about when everything comes to light? Like in Enron and Satyam? At the same time, in my opinion no shareholder would like it if they come to know that the company they have invested in isn't doing well and would most probably withdraw their funds. Every entity is dependant on its shareholder's funds. This directly threatens the future growth of said entity. If this is taken as reasoning than one would be compelled to agree that perhaps its the external pressure on the company which is leading it to adopt unethical methods like creative accounting. However, one can easily argue that in all righteousness the pressure must lead to performance. My argument is- especially in these times where even the top performing companies feel the pinch, how can any entity which knows that most of its shareholders may not be very acquainted with technical commerce,be confident that its funds will not be threatened? At the end of the day, the shareholders are primarily-i repeat-primarily concerned with the return they get in the form of dividends and if this is going to go down a mile, im guessing the smile soon going to become a frown.
So, are we, as society, as shareholders partly in blame for the unethical methods adopted by entities? Can the last reason stated be completely justified as a reason?c
