Q. The example of creative compliance given by Shah (1996) shows the accounting regulation does not work. Discuss.
“Regulations, or rules, are the primary vehicles by which agencies implement laws and general agency objectives. They are specific standards or instructions concerning what can or cannot be done by individuals, businesses, and other organisations” (Dudley, 2005). In the context of accounting domain, ‘accounting standards’ provide the regulatory framework that define a set of rules or directives for entities to conform and adhere to by clearly setting out parameters that guide them in preparing financial documents. As defined by the Accounting Standards Board, “Accounting standards are authoritative statements of how particular types of transaction and other events should be reflected in financial statements and accordingly compliance with accounting standards will normally be necessary for financial statements to give a true and fair view.”
According to the Accounting Standards Board, the ‘accounting standards’ give form and shape to financial information provided by listed companies and other entities in achieving the fundamental objective of promoting the integrity, competence and transparency of the accountancy profession for the benefit of users, preparers, and auditors of financial data. Thus, the importance and relevance of accounting regulation cannot be over-emphasized.
Accounting standards have several advantages. It enables investors to assess the returns and risks associated with alternative investment plans. Standards provide rules of authority that accountants can appeal to while dealing with their clients. By doing so, accountants can firmly but politely refuse the client’s demand to accept reports that accountants believe to be incorrect or misleading, confident that some other accountant will not accept the risk of violating the standards, thereby getting the client’s business. The standards act as a safety net that gives power and confidence to the accountants. Users of financial information might find accounting reports, produced in accordance with established standards, to be more easily aggregated and used. All these factors have been important determinants of the establishment of accounting standards (Benston, 1982).
In my opinion, accounting standards provide a concrete and well-defined structure for entities to conform to and facilitate comparability, making financial statements more meaningful. I also think that, at some level, accounting standards do work and curtail the use of judgement and discretion by setting out specific rules for treatment of particular transactions, which go a long way in keeping fraudulent activities at bay. If it weren’t for accounting standards, accountants could exercise free will and complete freedom in preparing financial statements providing ample opportunities for scams.
However, the reality is that rule-based regulation has loopholes that can be exploited by complex strategic management accounting. These escape clauses provide enough room for exercising judgement and discretion, not to mention application of creative accounting techniques as a means of working around the rules, making accounting regulations less effective (Shah, 1996).
Creative accounting is the principal modus operandi used by accountants to manipulate accounting information. “The accounting process consists of dealing with many matters of judgement and of resolving conflicts between competing approaches to the presentation of the results of financial events and transactions... this flexibility provides opportunities for manipulation, deceit and misrepresentation. These activities - practised by the less scrupulous elements of the accounting profession - have come to be known as 'creative accounting'” (Jameson, 1988, cited by Amat et al., 1999).
The motivation of management of an organisation to manipulate accounts through creative accounting is umpteen....
References: Amat, O., Blake, J., & Dowds, J., 1999. The Ethics of Creative Accounting. Journal of Economic Literature Classification, [online]. Available at:
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AllBusiness.com, Inc (2007). AllBusiness[online]. Available at: http://www.allbusiness.com/glossaries/income-smoothing/4944051-1.html
Benston, J.G., 1982. An Analysis of the Role of Accounting Standards for Enhancing Corporate Governance and Social Responsibility. Journal of Accounting and Public Policy, [online]. 1, p. 5-17. Available at: http://www.sciencedirect.com.ezproxy.nottingham.ac.uk/science?_ob=ArticleURL&_udi=B6VBG-45P4HT3-3&_user=5939061&_coverDate=07%2F01%2F1982&_rdoc=1&_fmt=&_orig=search&_sort=d&view=c&_acct=C000009959&_version=1&_urlVersion=0&_userid=5939061&md5=4ee9338888b6250a673446760731ba6f [accessed 2nd Dec 2007]
Dudley, E. S., 2005. Mercatus Policy Series, p. 4. [online]. Mercatus Center at George Mason University. Available at: http://www.mercatus.org/Publications/pubID.2331/pub_detail.asp [accessed 3rd Dec 2007]
Shah, A. K., 1996. Creative Compliance in Financial Reporting, in: Accounting. Organizations and Society, 21(1), p. 23-39
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