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  Creative Accounting Methods

Introduction to Creative accounting methods

The ways by which unscrupulous directors can compute the financial statements are many and varied. Though, they generally include adopting novel or unorthodox practices for reporting main elements of the financial statements like revenue, expenses, assets and liabilities. They might also include the use of complicated or ambiguous transactions in an effort to hide the underlying economic reality. The computation carried out might be designed either to twist the rules or to break them.

Below we refer some of the more significant ways in which rules may be bent or broken.

Misstating revenue

Some creative accounting methods are intended to overstate the revenue for a period.

These methods frequently include the early recognition of sales revenue or the reporting

of sales transactions which have no real substance.

Massaging expenses

A number of creative accounting methods highlight on the manipulation of expenses. Those expenses that depend on estimates of directors of the future or their choice of accounting policy are specifically vulnerable to manipulation.

Through changing estimates about the future (for instance, the helpful life or residual value of an asset), or through changing accounting policies (for instance, switching from FIFO to AVCO), it may be feasible to derive an expense figure, and subsequently a profit figure, which suits the directors.

The wrong 'capitalisation' of expenses might also be employed as a means of manipulation. This includes treating expenses like if they were amounts acquired to incur or develop non-current assets, than amounts consumed throughout the period. The net influence of this is that the expenses will be not fairly understated and profit will, so be unfairly boosted. Businesses which build their own assets are frequently best placed to undertake this form of malpractice.

Misstating assets

There are several ways in which assets might be misstated. These involve:

  • using asset values which are higher than their fair market values;
  • capitalising costs which should have been written off as expenses, as explained before;
  • recording assets which are not owned or which do not present.

Inadequate disclosure

Directors might misrepresent or try to conceal specific information. This might relate to commitments made, main changes in accounting policies or estimates, important events and so on. The information might also relate to financial transactions among the directors and the business.

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Figure: the main methods of creative accounting

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