What Is Creative Accounting?

Creative accounting follows accounting practices according to laws and regulations but capitalizes on loopholes in 澳洲幸运5开奖号码历史查询:accounting standards to falsely portray a better financial image of a company. Creative accounting techniques vary and evolve as regulations change to close the loopholes that allow them.

Analyzing Financial Statements

Public accounting statements 澳洲幸运5开奖号码历史查询:allow investors to compare the financial health of competing companies. However, when firms indulge in creative accounting, they often distort the value ofꦬ the information that their financials provide.

If a 澳洲幸运5开奖号码历史查询:gray area in accounting is found, it may b𓂃e exploited and mislead investors. Some management teams risk a company's reputation by condoning creative accounting to meet short-term expectations or year-end financial targets.

Investors should be skeptical. Reading 澳洲幸运5开奖号码历史查询:financial statements closely, rather than just focusing on what management highlights, can go a long way to detecting suspicious activity. The company 澳洲幸运5开奖号码历史查询:footnotes, auditors' reliability, and unusuꦇal financial t💜rends may prove a good starting point.

Types of Creative Accounting

Creative accounting tricks vary and consistently evolve as regulations to police them change. Here are some examples 澳洲幸运5开奖号码历史查询:of common techniques:

• Overestimating revenues: 澳洲幸运5开奖号码历史查询:Public companies may prematurely recognize revenue. 澳洲幸运5开奖号码历史查询:Revenue recognition is an accounting method that recognizes sales before a product or service is delivered.
• Lowering 澳洲幸运5开奖号码历史查询:depreciation charges: Companies often spread out the cost of assets, rather than expensing them once. Companies may extend the 澳洲幸运5开奖号码历史查询:useful life estimate of the asset or increase its assumed 澳洲幸运5开奖号码历史查询:salvage value.
• Delaying expenses: Deferring recording of current period expenses, such as payments to suppliers and rent, to a subsequent period makes current period earnings look better.
• Masking 澳洲幸运5开奖号码历史查询:contingent liabilities: Failure to record potential liabilities that are likely to occur—and underestimating how much they are likely to cost—can boost 澳洲幸运5开奖号码历史查询:net income or 澳洲幸运5开奖号码历史查询:shareholders' equity.
• Undervaluing pension liabilities: 澳洲幸运5开奖号码历史查询:Pension obligations can be manipulated since the liability occurs in the future and estimates need to account for them. 
• Inventory manipulation: Inventory represents the value of goods that were manufactured but not yet sold. Overstating inventory leads to a lower 澳洲幸运5开奖号码历史查询:cost of goods sold, and an artificially higher net income.

Examples of Creative Accounting

In the 1990s, the energy, commodities, and services company Enron Corp. engaged in 澳洲幸运5开奖号码历史查询:unethical accounting practices. It hid debt, understated losses and manipulated various financial figures to create an illusion of profitability, before filing for bankruptcy in 2001. Twenty-two executives pled guilty or were convicted, and many 澳洲幸运5开奖号码历史查询:went to prison.

The 澳洲幸运5开奖号码历史查询:WorldCom scandal is another example of creative accounting leading to fraud. To hide its falling profitability, the company inflated net income and 澳洲幸运5开奖号码历史查询:cash flow by recording expenses as investments. By capitalizing expenses, it exaggerated profits by around $3 billion in 2001 and $797 million in Q1 2002, reporting a profit of $1.4 billion instead of a net loss. Among others, the 澳洲幸运5开奖号码历史查询:former CEO and CFO were sent to prison.

The Bottom Line

Creative accounting takes advantage of loopholes to falsely portray a company’s financial health as ☂better than it is. While creative accounting is legal, it can lead to accounting fraud.