Charles Mulford

1. Creative Accounting: To what extent it is ethical??? Charles Mulford

2. Group members: • NURUSHALWA BT ABDUL AZIZ 132561 • NORSHAHFINI BT SIRAT 132714 • NURUL ZHAFARINA BT MD. SAID 132027 • NUUR ZAFIRAH BT ABD HALIM 132045 • KHAIRUNNABIHAH BT AHMAD 132718

3. INTRODUCTION Creative accounting is referred to as income smoothing, earnings management, earnings smoothing, financial engineering and cosmetic accounting.

4. Theory of Creative Accounting • consider creative accountant ‘an assembly of techniques, options and freedom room left by accounting regulation • as an assembly of procedures in order to change the profit, by increasing or decreasing, or to misrepresent the financial statements, or both of them

5. However, the creative accounting is badly treated, as a negative creation, designed to prepare the financial statements

6. 6 technique of Creative Accounting • flexibility in regulation • lack of regulation • for management that assumed some targets for the future • timing of some transactions • use of artificial transactions • reclassification and presentation of financials

7. THE FACTORS INFLUENCING CREATIVE ACCOUNTING Encouragement by the law Greek law (and especially the tax law and the law concerning the economic development of the country) offers many opportunities for practicing creative accounting E.g: law 2238/1994 annual depreciation charges, as well as provisions for doubtful debts Poor management performance Anecdotal evidence suggests that for several reasons (i.e. access to bank loans, good public image etc.) firms try to avoid reporting losses or decreasing profit by manipulating the accounts.

8. Perceived high income taxes, and rare inspection of books The income tax rate is perceived unfairly high and it has led many firms to denote a lot of efforts in attempting to pay the least taxes by exploiting the law or by violating it. Weak corporate governance structure strong corporate governance may have an important restraining influence regarding practice of creative accounting “the evidence suggests that given an incentive to manipulate, a weak governance structure is more likely to lead to the firm actively engaging in earnings management”. –Dechow’s and Skinner’s (2000)

9. Weak accounting profession accountant was not legally responsible for the financial statements vulnerable to management pressure not appreciated the significance of accounting information so that to hire individuals of high caliber accounting profession is relatively weak, not well paid and not well educated Limited extent of external auditing External auditing that may prevent creative accounting practices is compulsory only for those Greek companies which meet specific criteria stated by the codified business

10. DETECTING CREATIVE ACCOUNTING watch for attention-directing emphasis by directors and management carefully read the notes to accounts investigates any unusual item and another one is forgets about looking for any audit qualifications.

11. investors should be able to answer two questions when reading a statement - how the company makes money and how they are accounting for it • 5. role of whistleblowing

12. Advantages of Creative Accounting As general: boost reported profits/minimize reported losses; manipulate key ratios used in the market analysis; conceal financial risk; circumvent borrowing restrictions; escape shareholder control; enhance management performance and performance-related management payment; and gain access to finance that would otherwise be impossible to raise This study: innovative accounting techniques

13. Cont’d….. • Innovations are sometimes disruptive to the existing market structure • accounting scandals clearly illustrate the difficulty of managing the consequences of innovation for the public interest. • auditors are more likely to require adjustment if transactions are not structured, while this becomes much less likely with structured transactions • auditors are not likely to require their clients to adjust aggressive accounting that has been specifically structured to meet precise standards

14. Disadvantages of Creative Accounting • fraud, outright theft and misrepresentation • accountants are taking the accounting rules as they stand are in breach of the principle of substance over form • For example a company leases an asset, it used to be the case that the asset would not appear on the Balance Sheet; and neither would the finance that helped supply it.

15. Cont’d….. • There are 4 methods of creative accounting • Sometimes the accounting rules allow a company to choose between different accounting methods 2) Certain entries in the accounts involve an unavoidable degree of estimation, judgment, and prediction 3) Artificial transactions can be entered into both to manipulate balance sheet amounts and to move profits between accounting periods 4) Genuine transactions can also be timed so as to give the desired impression in the accounts

16. Related Issues of Creative accounting • Income smoothing • Ethics problem in creative accounting • Accounting manipulation

17. Income smoothing • companies generally prefers to report a steady trend of growth in profit rather than to show volatile profits with a series of dramatic rises and falls • variant on income smoothing is to manipulate profit to tie in to forecasts • company directors may keep an income-boosting accounting policy change in hand to distract attention from unwelcome news

18. Cont’d….. • help maintain or boost the share price both by reducing the apparent levels of borrowing • the directors engage in 'insider dealing' in their company's shares

19. Issue in CA-ethics problem • One serious problem in CA is ethics problem. • It frequently is perpetrated at levels of management above which internal control systems are designed to be effective. • In Australia, Leung and Cooper (1995) found in a survey of 1500 accountants the three ethical problems cited most frequently were as shown in Table 1.

20. Three most frequently cited ethical problems Table 1 Sources: Leung and Cooper (1995)

21. Issue in CA-accounting manipulation • Called by several terms such as earnings management, income smoothing, creative accounting practices or aggressive accounting. • Can prevents the allocation of resources in the most efficient areas in the economy. • Defined as when the managers of an organization intentionally misstate their financial information.

22. Cont… • Two surveys in the USA both highlight a difference in accountants attitudes to creative accounting whether it arises from abuse of accounting rules or from the manipulation of transactions. • Fischer and Rosenzweig (1995) found that accounting and MBA students were more critical than accounting practitioners of manipulated transactions, whereas accounting practitioners were more critical than students of abuse of accounting rules.

23. HOW TO PREVENT CREATIVE ACCOUNTING???

24. Mulford (2002) says accountants and managers should divide the duties of an internal control checklist and an independent audit committee should always have someone with a strong accounting background and audit experience who deals directly with outside auditors. Charles Mulford

25. 1.The firm should improved logical conceptual framework 2. A firm should focus on cash flow rather than income numbers 3. Put more than one person in charge of the accounting 4. There should have enquiring sceptical financial analysts, reporters, and investors 5. A firm should have an independent and qualified auditor to go over the statements after they have been tallied up by employees 6. A firm should allocate professional compensation for executives

26. CONCLUSION • Creative accounting is not exactly illegal, but on the other hand, it is not exactly widely promoted • If accountants want to use creative accounting, they will. • They should maintain integrity and objectivity calls for avoiding both actual and apparent conflicts of interest. This notion is termed independence. Being independent in fact and in appearance means that one not only is unbiased, impartial, and objective but also is perceived to be that way by others.