Creative Accounting and Ethics

Topics: Ethics, Business ethics, Business Pages: 8 (3021 words) Published: July 3, 2013
Title: Creative Accounting & Ethics: Arguments For and Against Creative Accounting Introduction
The accounting process consists of dealing with many matters which includes judgment and resolving conflicts between challenging approaches to the presentation of the results of financial transactions. This flexibility provides opportunities for manipulation, deceit and misrepresentation and is widely known as creative accounting (Harris n.d.). Creative accounting can be defined as a process which involves the accountants to exercise their knowledge of accounting rules to manipulate the figures reported in the accounts of a business. Other terms used may include income smoothing, earnings management, earning smoothing, financial engineering and cosmetic accounting (Boškin 2005). The ways that companies usually manipulate their accounts include recording revenues too soon, recording bogus revenues, boosting income with one time gains, shifting expenses and income forward and backward, failure to disclose liabilities and changing estimates such as bad debts, litigation costs, capital asset lives, and pension assumptions (Schilit, cited in Davin n.d.). While opinions on the acceptability of accounting manipulation vary, it is often perceived as reprehensible (Gowthorpe & Amat 2004). Hence, knowing when to do the right thing is both a question of ethics and professional responsibility. Motivations for Creative Accounting

An important factor in accounting regulation is the sheer scale of the economic impact of accounting rules. The choice of an accounting rule may have a very significant impact on, for example, reported profits. The level of profitability of a commercial entity potentially affects distributions to owners, wage and salary negotiations, levels of pensions funding, ability to borrow or to raise further risk capital, taxes paid and so on. Regulators may attempt to take the economic consequences of their actions into account, but they are likely to be confounded in many ways. The problem is that when the stakes are high, there are considerable incentives for financial statement preparers to confound the work of the regulators (Gowthorpe & Amat 2004). Management’s participation in earnings management may call into question the integrity of management. Many stakeholders and shareholders in the organization carefully scrutinize the ethics behind management’s actions. The principal-agent relationship is fiduciary, which is a relationship based on trust. The managers (agent) have the authority to act on behalf of and instead of the owners (principal), using a degree of their own discretion. Any perceived violation of this trust can breed skepticism and mistrust (Belski & Brozovsky 2002). Tax is indeed the most significant element in almost all companies. In countries with strict conservative accounting systems the process of enhancing the income can be particularly pronounced because of the high level of accumulated provisions. Not only that, another reason for manipulating the accounting data can be linked to the cost of external borrowing. Banks only grant loans to enterprises after the entities establish their credit rating first and secure the risk level on the basis of the borrower’s credit standing. Thus, the price of loan relies on the risk assessed. The higher level of risk an entity has, the higher the interest rate will be charged. Arguments for Creative Accounting

Sometimes, the accounting rules allow a company to choose between different accounting methods. Management wishing to show earnings at certain level or following a certain pattern seek loopholes in financial reporting standards that allow them to adjust the numbers as far as is practicable to achieve their desired aim or to satisfy projections by financial analysts. Genuine transactions can also be timed so as to give the desired impression in the accounts. In this sense, income smoothing does not violate the accounting regulations, but enhances...

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