Reasons for Creative Accounting: Consideration of creative accounting have alert mainly on the impact on decision of investors in the stock market. Reasons for the directors of listed companies to seek to influence the accounts for following reasons: 1. Income smoothing: Companies generally prefer to report a steady trend of growth in Profit rather than to show volatile profits with a series of dramatic rises and falls.This is achieved by making unnecessarily high provisions for liabilities and against asset values in good years so that these provisions can be reduced, thereby improving reported profits, in bad years. 2. Company directors may keep an income-boosting accounting policy change in hand to distract attention from unwelcome news. 3.
Creative accounting may help maintain or boost the share price both by reducing the apparent levels of borrowing, so making the company appear subject to less risk, and by creating the appearance of a good profit trend.Accounting Ethics: Ethics in the business background is essential to success, however some stipulate to the more deceitful approach of accomplishing their goals at any moral or ethical cost. When developing an accounting curriculum, it is solution to connect both students and professionals with situations that require ethical responses. It is sometimes not enough to rely on the “if-then” symbol of “if you steal, you go to jail. ” Money is between the most tempting of desires, and those who work with it often possess such emotions.It is extremely difficult to draw an ethical line on creative accounting when the generally accepted accounting principles often allow multiple accounting methods that a company can choose from when calculating certain items. This is due to the many types of businesses in the economy.
With all of the different sizes and natures of transactions, it is extremely difficult for there to be just one accounting method for all companies to use, and therefore, multiple accounting methods exist for companies to choose from.For example, in the case of computing depreciation, managers and accountants have several methods from which they may choose. Some of these are straight-line, declining-balance, and double-declining-balance depreciation. Not only can the managers and accountants select any of the multiple depreciation methods when computing depreciation cost, but they can also pick one method for depreciating one thing, such as buildings, and another method for depreciating another thing, such as equipment.This depreciation example is just one of the many multiple accounting methods that a company can legally employ. Thus, companies will most likely, if not probably, use the accounting method that will give them their most preferred image. The ultimate argument: Proponents of creative accounting argue that all the examples given are done in an ethical capacity.
They claim that the FASB has set the generally accepted accounting principles to give managers and accountants various accounting methods from which they can select.When applying certain methods, the companies are going to choose the ones that make their financial statements better. This is the nature of business—to make the company succeed as well as possible. Creative accounting assists in this endeavor. On the other hand, opponents of creative accounting see it as “accounting manipulation”. The opponents believe that creative accounting is used when managers and accountants want to manipulate the financial statements to show a certain outcome.For instance, when managers want to portray better figures in certain accounts to stockholders, they will employ creative accounting techniques to get their desired results.
In these cases, management is most likely not achieving a company’s ultimate goal of increasing stock value. In the short run, the company’s stock value might rise due to the numbers shown by the creative accounting, but in the long run, the creative accounting hurts the ultimate goal of increasing stock value because the company cannot employ the creative accounting techniques forever.Since the company cannot continually deceive stockholders with the figures derived by creative accounting, the reality of the situation must eventually be divulged. When this occurs, this hurts the value of the stock not only at the time, but also in the long run if the company does not go out of business. The accounting scandals of Enron, WorldCom, Tyco, Adelphia, and the like illustrate when creative accounting unquestionably becomes unethical and illegal. In these cases, creative accounting was taken to the extreme.The generation of auditors, accountants, and managers present in these companies at the time of their collapses did not respond correctly or quickly enough when confronted with ethical dilemma.
In the case of Enron, management employed “aggressive accounting” where there was a total of almost $1 billion in accounting “errors” by the time the company collapsed. Opponents of creative accounting use this case as an example of why creative accounting should not be employed.