Creative Accounting

Topics: Balance sheet, Asset, Depreciation Pages: 23 (4917 words) Published: December 14, 2013
International Journal of Trade, Economics and Finance, Vol. 2, No. 6, December 2011

Use or Abuse of Creative Accounting Techniques
Syed Zulfiqar Ali Shah, Safdar Butt, and Yasir Bin Tariq
India who are always short of this product. It takes three
years for a cement plant to start production. By the time the new plants came into production in late nineties, the
country’s economic scenario had changed. The government
had no money for development, the economy was generally
in recession, and construction had virtually come to a halt. With tremendous overcapacity, the cement prices started
falling precariously. The companies got together and
slashed production. Plants started operating at an average of around 22% production capacity to ensure that prices do not
fall. The prices drop stopped but still it did not help much. Now cement is one industry where the largest slice of costs
is fixed and time related, rather than operations related. As much as 72% of annual costs of a new cement plant may
comprise of only two items namely depreciation and interest. Both of these are fixed and computed on the basis of time.
As a result, a low capacity utilization meant higher cost per ton of cement produced in any period, leading to huge
losses. One creative way found around this situation was to
convert the depreciation cost from a fixed time related cost to a variable charge. To achieve this end, the method of
computing annual depreciation by dividing the total plant
cost over the number of plant’s useful life was abandoned. Instead, the total cost of plant was divided over the total
cement production to be expected from the plant over its
entire life – thereby computing depreciation cost per ton of cement produced. This drastically curtailed the periodic
charge to the Income Statement and improved the
profitability figures. This had no implication for corporation taxes as depreciation is not a tax allowable expense virtually anywhere in the world. So using a creative accounting tool,
the companies were able to show profits, or minimize losses, during a difficult period when the capacity utilization was
low. This enabled them to keep the investors reasonably
comforted and the staff relaxed. The interesting thing is that when the demand rose and companies started operating at
higher capacity, they did not need to change their
accounting policy. Hence, without any deception, ill-will or dishonesty, the directors of cement plants were able to pull through a crisis.
Now lets have a view on some technical aspects of this
phenomenon.

Abstract—The study has been conducted to have a detailed
view on creative accounting. A very important question has
been tried to be answered in this study that why managers do creative accounting and how they become successful in
performing such practice in the presence of stringent rules and procedures. Another aspect of creative accounting has been
tried to be explored that whether this creative accounting
practice is good for the companies or it brings companies in crises situation. Discussion based model has been used on the basis of past references and experiences. Link of governance with creative accounting practices has also been tried to be explored in the study. At the end it is concluded that the

complex and diverse nature of the business transactions and
the latitude available in the accounting standards and policies make it difficult to handle the issue of creative accounting. It is not that creative accounting solutions are always wrong. It is the intent and the magnitude of the disclosure which

determines its true nature and justification.
Index Terms—Creative accounting, earnings management,
corporate governance.

I. INTRODUCTION
Subject of Creative Accounting is normally portrayed
maligned and negative act. As soon as these words
“Creative Accounting” are mentioned, the image that
emerges in one’s mind is that of manipulation, dishonesty
and...
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