The BESC Journal of Commerce and Management (Print ISSN: 2395-4639, Volume 3, July 2017) Included in the UGC Journal List: Journal No. 44452 Online issue URL: http://bjcm.bescollege.net/v3n1 Online article URL: http://bjcm.bescollege.net/v3/n1/v3n101.pdf

Creative Accounting – a Creation for Destruction: with Reference to Some Global Instances

Dr. Anish Kumar Dan Assistant Professor in Commerce, Bangabasi College. Email: [email protected]

Abstract Lawmakers of accounting profession got disrupted by some sensational news recently. Bankruptcy of , a Fortune 500 company and some high profile companies viz. Xerox, World Com, Satyam have created ripple in the corporate world since the reason behind this is not always the recessionary phase of global economy. More interestingly, these have happened in USA and , considered to be the Mecca of professional and transparent accounting. At one end introduction of Corporate Governance, mandatory application of stringent Accounting Standards associated with growing regulatory role of Security Exchange authorities and at the other end the events of accounting frauds, auditor-company collusion and window dressing of accounts under camouflaged wording of audit report have put the accounting profession on the cross road of Creative versus Credible Accounting. Idea of ‘Creative Accounting’ developed from accounting practice that is technically correct but deviates from how accounting policies were intended to be used. In general, creative accounting capitalizes on loopholes in generally accepted accounting principles in order to disguise financial performance, such as by keeping debt off a . The sorts of accounting irregularities that are often seen as creative accounting may be technically permitted but in general are frowned upon and often indicate fraud. Purpose of this paper is to move towards a practice of authentic accounting practice, where the primary purpose is to follow generally accepted accounting principles (GAAP), to prepare financial statements to be used by various external and internal stakeholders. Potential external stakeholders include investors, financial analysts, employee groups, lenders, suppliers and even government agencies. For the purpose of analysis, ten corporate scams of recent days are selected over the world. Chronologically arranged, those are: Waste Management Scandal (1998), (2001), WorldCom Scandal (2002), Tyco Scandal (2002), HealthSouth Scandal (2003), Freddie Mac Scandal (2003), American International Group Scandal (2005), Lehman Brothers Scandal (2008), Scandal (2008) and (2009). In the concluding part we can state that, if the creative accounting starts with the loopholes in the accounting standards maybe one of the biggest roles belong to the standard setters in decreasing the possible negative effects of creative accounting. One of the main strengths of accounting standards is careful definitions and clear explanations of relevant accounting items which can prevent the abuse of accounting definitions that is fundamental to creative accounting. International Accounting Standards are continuously improving as new techniques of creative accounting are emerging, so we find creative accounting as a drive to the creation and improved International Accounting Standards. It would be unrealistic to think that it is possible to eliminate creative accounting or earnings management practices at all. However it would be possible to minimize at least the negative effects of them by adopting the accounting standards, giving more importance to ethical considerations and decreasing the flexibility of the managers in deciding among different accounting methods. Keywords: Creative Accounting, generally accepted accounting principles, stakeholders

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I. Introduction Accounting profession has yielded some sensational news recently. Bankruptcy of Enron, a Fortune 500 company and some high profile companies viz. Xerox, World Com, Satyam have created ripple in the corporate world since the reason behind this is not always the recessionary phase of global economy. More interestingly, these have happened in USA and India, considered to be the Mecca of professional and transparent accounting. At one end introduction of Corporate Governance, mandatory application of stringent Accounting Standards associated with growing regulatory role of Security Exchange authorities (e.g. SEBI, SEC) and at the other end the events of accounting frauds, auditor-company collusion and window dressing of accounts under camouflaged wording of audit report have put the accounting profession on the cross road of Creative versus Credible Accounting. Creative accounting refers to any accounting practice that is technically correct but deviates from how accounting policies were intended to be used. In general, creative accounting capitalizes on loopholes in generally accepted accounting principles in order to disguise financial performance, such as by keeping debt off a balance sheet. The sorts of accounting irregularities that are often seen as creative accounting may be technically permitted but in general are frowned upon and often indicate fraud. Creative accounting is also referred to by the phrase ‘cooking the books’, implying that these practices require falsification and omission in the presentation of company financial records. While unfortunately common and occasionally harmless, professional accountants are cautioned against resorting to these sorts of practices.

II. Literature Review Some literatures in the related area are reviewed and the observations are summarized here. Griffith (1986) observed, “Every Company in the country is fiddling its profits. Every set of published accounts is based on books that have been gently cooked or completely roasted. The figures, which are fed twice a year to the investing public, have all been changed in order to protect the guilty. It is the biggest con trick since the …In fact this deception is all in perfectly good taste. It is totally legitimate. It is creative accounting.” According to Michael Jameson (1988), “The accounting process consists of dealing with many matters of judgment 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 - practiced by the less scrupulous elements of the accounting profession – have come to be known as ‘creative accounting’.” Newton L.H. (1988) opined that except for a small clutch of academic shark-defenders, everyone seems to know that hostile takeovers are wrong, destructive of people and industries, and damaging to the long-term competitiveness of corporate America. But analysis of the takeover process, absent insider trading, fails to identify any injury that is not replicated elsewhere in the business system. Current suggestions for remedying the situation seem inadequate, ill-fitted to the problem, or hostile to the entire capitalist system. Insider trading is illegal, and is widely believed to be unethical. It has received widespread attention in the media and has become, for some, the very symbol of ethical decay in business. For a practice that has come to epitomize unethical business behavior, however, insider trading has received unexpectedly little ethical analysis. The article of Moore (1990) critically examines the principal ethical arguments against insider trading: the claim that the practice is unfair, the claim that it involves a misappropriation

3 Creative Accounting – a Creation for Destruction: with Reference to Some Global Instances

of information and the claim that it troubles ordinary investors and the market as a whole. The author concluded that each of these arguments has some serious insufficiencies; no one of them by itself provides a sufficient reason for outlawing insider trading. This does not mean, however, that there are no reasons for prohibiting the practice. Moore argued that the real reason for outlawing insider trading is that it weakens the fiduciary relationship that lies at the heart of American business. Timely and reliable accounting information is essential. Not only firms themselves but the markets they serve, and particularly the investment community, depend on it. Accounting data and their interpretation must be above suspicion, said Riahi-Belkaoui (1992), and to be sure of that, corporations and other users of accounting information must be certain that accountants subscribe to and practice morality set to high standards. What these standards are, and how they are deficient, distorted, and sometimes even fallacious, are the themes explored here. In doing so, the author identifies as the five aspects of accounting morality: fairness, ethics, honesty, social responsibility, and truth. The discussion begins with fairness as a concept of justice. Then the author moved to ethics in accounting, and a review of such ethical perspectives as the utilitarian, the deontological, and the notion of fittingness. He also takes up the subject of ethical codes, and asked how the accounting profession can be disciplined. The study also focused on the honesty in the accounting environment and to discussions of the nature and framework of fraud, including what he calls outcome situations arising from corporate fraud and explored the relationship between accounting and social responsibility, and pointed out that there is a need for an effective paradigm to define and help implement a socially responsible accounting. Finally, he comes to grasps with the problem of truth in accounting, the notion of truth, then the impossibilities as well as the possibilities of attaining it. Morality in Accounting will be of special value to the producers and users of accounting. Smith (1992) reported, “We felt that much of the apparent growth in profits which had occurred in the 1980s was the result of accounting sleight of hand rather than genuine economic growth, and we set out to expose the main techniques involved, and to give live examples of companies using those techniques.” Naser (1993) offers his view as “Creative accounting is the transformation of financial accounting figures from what they actually are to what preparers desire by taking advantage of the existing rules and/or ignoring some or all of them.” According to Basu (1996), who clearly pointed out the framework of Off Balance Sheet financing as a tool towards Creative Accounting, these activities are used when an entity wants to keep its leverage ratios as low as possible, possibly to avoid breaching a loan contract that prevents a high degree of leverage. Also, by presenting a low debt level to financiers, borrowers can obtain a lower interest rate on their debt. The use of off balance sheet financing is not encouraged, since it makes for obscure financial statements that do not reflect an entity's true form. Investors may be surprised at a later date when the situations change or there are modifications to the accounting standards, resulting in the unexpected appearance of large amounts of debt on an organization’s balance sheet. Amatet al (1999) claimed that their paper explores the nature and incidence of creative accounting practices within the context of ethical considerations. It explores several definitions of creative accounting and the potential and the range of reasons for a company's directors to engage in creative accounting. Later the paper considers the various ways in which creative accounting can be undertaken and summarizes some empirical research on the nature and incidence of creative accounting. The ethical dimension of creative accounting is discussed, drawing evidence from several empirical studies. Their paper concluded with the analysis of possible solutions for the creative accounting problem.

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Jagati (2003) in his article of ICAI suggested that clear and credible accounting is making a variance, in the wake of Enron's collapse amid disclosures of hidden debts and overstated profit. Investors dumped stocks of companies believed guilty of ambiguous accounting or understating liabilities in their financial reports, and their reactions already are forcing changes in corporate reporting and in the accounting profession. Now companies will have to end or severely limit their use of off-balance-sheet partnerships that hold debt or assets away from their reports to shareholders and the Securities and Exchange Commission. Enron had used such partnerships extensively to make its financial situation look better than it actually was. Moreover, accounting firms will get new regulations from time to time, and they will have to separate auditing of company books from other services to clients, such as management and information technology consulting. Jones (2010) studied that “Business scandals are always with us from the South Sea Bubble to Enron and Parmalat. As accounting forms a central element of any business success or failure, the role of accounting is crucial in understanding business scandals … aims to explore the role of accounting, particularly creative accounting and fraud, in business scandals. The background and context of creative accounting and fraud is explored. Then the work looks at a series of international and draws some themes and implications from the country studies.” From the above literature survey, it can be concluded that creative accounting is practiced in different formats though its objective remains the same. Fortunately, in India we have not experienced much scams, in comparison to the global scenario, both in numbers and in values. Few books and articles have appeared in different conferences and journals, which primarily discuss existing conceptual aspects in brief and, in a few cases only, some practices. A systematic research work towards intention of these accounting frauds is needed to point out the importance of ethical aspects of accounting beside implementation of accounting standards and doctrines.

III. Objective and Methodology In section I, we have seen that, ‘creative accounting’ is a euphemism referring to accounting practices that may follow the letter of the rules of standard accounting practices, but deviate from the spirit of those rules. They are characterized by excessive complication and the use of novel ways of characterizing income, assets, or liabilities and the intent to influence readers towards the interpretations desired by the authors. The terms "innovative" or "aggressive" are also sometimes used. Objective of this paper is to move towards a practice of authentic accounting practice, where the primary purpose is to follow generally accepted accounting principles (GAAP), to prepare financial statements to be used by various external and internal stakeholders. Potential external stakeholders include investors, financial analysts, employee groups, lenders, suppliers and even government agencies. The Sarbanes-Oxley Act, 2002focused upon the viability of principle-based accounting over rules-based accounting. The proposed shift was in response to the problematic complexity in the GAAP and the increasing likelihood of inaccuracies due to the consistently expanding detail of the rules-based method under which accountants were working. For the purpose of analysis, ten corporate scams of recent days are selected over the world. Chronologically arranged, those are: Waste Management Scandal (1998), Enron Scandal (2001), WorldCom Scandal (2002), Tyco Scandal (2002), HealthSouth Scandal (2003), Freddie Mac Scandal (2003), American International Group Scandal (2005), Lehman Brothers Scandal (2008), Bernie Madoff Scandal (2008) and Satyam Scandal (2009). The nature of fraud along with intention is studied. For each case, the company and its base, the fact of fraud, the officials involved in the scam, the modus operandi,

5 Creative Accounting – a Creation for Destruction: with Reference to Some Global Instances

detection of fraud and the aftermath are listed to find out the similarities and dissimilarities between these incidents.

IV. Analysis and Findings As mentioned in section III, the ten incidents are studied and the main issues are discussed hereunder. The intention of the fraud is tried to be linked with the mode of organizing the fraud. In the following part, these are discussed in details. Moreover a summary table of these frauds is given under Annexure I.  Waste Management Inc Waste Management Inc is a company in North America that provides waste and environmental services. This company was founded by Larry Beck in 1894. The company’s operations also involved managing air and gas, environmental and groundwater protection as well as environmental engineering. By 1971, the company became more public after the 133 acquisitions and the $82M in revenue that were made and soon became the largest waste hauler in the country. This Company offered environmental services to almost 20 million customers in America, Canada as well as Puerto Rico. Waste Management soon took the position of becoming North America’s largest residential recycler. It was able to handle and manage more than 8.5 million tons of materials. These materials included plastic, metal, glass, electronics and paper at 128 different facilities. Waste Management Inc did unfortunately go through a massive financial fraud between the years of 1992-1997 that was committed by the senior officers.  Enron The Enron scandal, revealed in October 2001, eventually led to the bankruptcy of the Enron Corporation, an American energy company based in Houston, Texas, and the de facto dissolution of , which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron was cited as the biggest audit failure. Enron was formed in 1985 by after merging Houston Natural Gas and Inter North. Several years later, when was hired, he developed a staff of executives that – by the use of accounting loopholes, special purpose entities, and poor financial reporting – were able to hide billions of dollars in debt from failed deals and projects. Chief Financial Officer Andrew Fastow and other executives not only misled Enron’s board of directors and audit committee on high-risk accounting practices, but also pressured Andersen to ignore the issues.Enron shareholders filed a $40 billion lawsuit after the company’s stock price, which achieved a high of US$90.75 per share in mid-2000, plummeted to less than $1 by the end of November 2001. The U.S. Securities and Exchange Commission (SEC) began an investigation, and rival Houston competitor Dynegy offered to purchase the company at a very low price. The deal failed, and on December 2, 2001, Enron filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. Enron’s $63.4 billion in assets made it the largest corporate bankruptcy in U.S. history until WorldCom’s bankruptcy the next year.  WorldCom WorldCom has revealed a further $3.3bn in accounting errors, doubling the size of the accounting scandal at America’s second largest long distance phone company to more than $7bn.The company said an internal audit had discovered that $3.3bn in profits was improperly recorded on its books from 1999 to the first quarter of 2002. That is on top of the $3.8bn in expenses the company said it had improperly reported as capital investments. WorldCom now says it must issue revised financial statements for 2000 and 1999 as well. The revision will reduce 2000 profits by more than $3.2bn, but this may not be the end

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of accounting horrors as the company warned it may find more problems. WorldCom said most of the $3.3bn irregularity involved the manipulation of reserves. Companies set aside reserves to cover estimated losses such as uncollected payments from customers and judgments in lawsuits and other expected costs.It is a perfectly legitimate practice, like setting aside funds for a rainy day. But reserves can be abused to create the accounting equivalent of a slush fund. If a company wanted to massage profits to meet Wall Street expectations it can transfer the necessary sums from the reserve. The suspicion is that WorldCom deliberately inflated its reserves to be able to dip into them to boost profits in order to meet profit projections.  Tyco International Ltd., a corporation that makes a diversity of products, from healthcare supplies to alarm systems, has recently accused three former high-level executives of fraud. The three accused managers, have been indicted for fraud and theft by the Securities and Exchange Commission (SEC) as well as their former employer. They have all pleaded innocent. Tyco’s financial accounting first came under review in January 2002 after a tip suggested that a less-than-legal transaction might be taking place. The SEC and Tyco International have indicted the former executives on charges of civil fraud and theft. They are accused of giving themselves interest-free or low interest loans for personal purchases of property, jewelry, and other frivolities. According to the SEC, these loans were never approved or repaid. It is alleged that these bonuses acted as de facto loan forgiveness for employees who had borrowed company money or were used to buy the silence of those who suspected the former CEO and CFO of fraud. According to Tyco, the individuals who received loan forgiveness were not aware that they were participating in anything illegal; they were told the program had the board’s approval.  HealthSouth Corporation HealthSouth Corporation, based in Birmingham, Alabama, is the United States’ largest owner and operator of inpatient rehabilitative hospitals. Operating in 33 states across the country and in Puerto Rico, HealthSouth serves patients through its network of inpatient rehabilitation hospitals, outpatient rehabilitation satellite clinics, and home health and hospice agencies. HealthSouth was involved in a corporate accounting scandal in which its founder, chairman, and chief executive officer, Richard M. Scrushy, was accused of directing company employees to falsely report grossly exaggerated company earnings in order to meet stockholder expectations. By mid- to late 2006, HealthSouth, which never had to file for Chapter 11 Bankruptcy Protection, Spartenburg Courts South Carolina completed its recovery and relisted its stock on the New York Stock Exchange under the symbol HLS. The company currently operates one division: inpatient rehabilitation. The company formerly operated an outpatient rehabilitation, surgery center and diagnostics division. The company also previously owned and operated several acute care hospitals that specialized in orthopedics, but sold all of those hospitals by 2006. The former outpatient division also operated an occupational medicine division until 2001, when it was sold. HealthSouth also sold its Long-term acute care facilities in May 2011. The long-term hospitals contributed around $200 million in revenue.  Freddie Mac Originally known as the Federal Home Loan Mortgage Corporation, Freddie Mac was chartered by Congress in 1970 as a private company with a public mission to stabilize the nation’s mortgage markets and widen opportunities for home ownership and affordable rental housing. Freddie Mac (and its sister institution Fannie Mae) was set up based on the idea that neither government nor private banking interests could address the nation’s housing finance needs. In December 2003 Freddie Mac, the federally chartered mortgage financing giant, agreed to pay a civil penalty of $125 million and implement measures to correct its accounting and governance problems as part of a consent order with

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a federal regulator. The company faced a criminal investigation by the Justice Department and a civil inquiry by the Securities and Exchange Commission. When the company’s problems imploded earlier in the year, the McLean, Virginia-based firm declared that its accounting errors were different from those plaguing corporate America these days. Rather than inflating its earnings, the company had understated its profits. But when the company restated its financial statements last November, it disclosed that its cumulative earnings for the years 2000-2002 were higher than what it had reported originally, and it had inflated its earnings for 2001 by nearly $1 billion.  American International Group On March, Maurice Hank Greenberg resigned his position as CEO of American International Group (AIG) amidst allegations of fraud and accounting manipulations at the world’s largest insurer. In an attempt to contain an escalating scandal, the company fired two more top executives, including the chief financial officer, Howard Smith.AIG is the 10thlargest corporation in the United States. Greenberg, who remains the chairman of the board of directors, has long been considered the titan of the insurance industry. The evidence of fraud, including recent revelations as well as information that has come to light over the past year, suggests that AIG arranged deals to manipulate financial figures, both its own and those of other companies. It is yet another indication of the vast extent of the fraud perpetrated by the highest levels of the American corporate and financial elite.  Lehman Brothers Lehman Brothers had humble origins, tracing its roots back to a small general store that was founded by German immigrant Henry Lehman in Montgomery, Alabama in 1844. In 1850, Henry Lehman and his brothers, Emanuel and Mayer, founded Lehman Brothers. While the firm prospered over the following decades as the U.S. economy grew into an international powerhouse, Lehman had to contend with plenty of challenges over the years. Lehman survived them all – the railroad bankruptcies of the 1800s, the Great Depression of the 1930s, two world wars, a capital shortage when it was spun off by American Express Co. (AXP) in 1994, and the Long Term Capital Management collapse and Russian debt default of 1998. However, despite its ability to survive past disasters, the collapse of the U.S. housing market ultimately brought Lehman Brothers to its knees, as its headlong rush into the subprime mortgage market proved to be a disastrous step. In February 2007, the stock reached a record $86.18, giving Lehman a market capitalization of close to $60 billion. However, by the first quarter of 2007, cracks in the U.S. housing market were already becoming apparent as defaults on subprime mortgages rose to a seven-year high. On March 14, 2007, a day after the stock had its biggest one-day drop in five years on concerns that rising defaults would affect Lehman’s profitability; the firm reported record revenues and profit for its fiscal first quarter. As the credit crisis erupted in August 2007 with the failure of two hedge funds, Lehman’s stock fell sharply. During that month, the company eliminated 2,500 mortgage-related jobs. Lehman Brothers filed for Chapter 11 bankruptcy protection on September 15, 2008. The filing remains the largest bankruptcy filing in U.S. history, with Lehman holding over $600 billion in assets.  Madoff investment The Madoff investment scandal was a major case of stock and securities fraud discovered in late 2008. In December of that year, Bernard Madoff, the former NASDAQ Chairman and founder of the Wall Street firm Bernard L. Madoff Investment Securities LLC, admitted that the wealth management arm of his business was an elaborate . Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960, and was its Chairman until his arrest. Investigators have determined others were involved in the scheme. The U.S. Securities and Exchange Commission (SEC) has also come under fire for not investigating Madoff more thoroughly; questions about his firm had been raised as

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early as 1999. Madoff’s business, in the process of liquidation, was one of the top market makers on Wall Street and in 2008, the sixth-largest.  Satyam Computer Services Satyam’s case has been widely regarded as the debacle of the Indian Financial System.The case of Satyam is often referred to as “I’s Enron”. As mentioned earlier, Enron was a US based company which was inflicted with a similar accounting fraud. It was aI7,136 crore (nearly $1.5 billion) fraud and it is seen as I’s Most Colossal Financial Fraud. The fraud shows how disastrously investors can lose money by simply misstating the figures in the Balance Sheet. Ironically, Satyam means “truth” in Sanskrit! According to Mr. Raju’s statement, about 94% of the cash on the company’s books, was made up – and analysts say it was the manipulation of the cash flow which could have been one reason why the deceit was undetected. Many analysts also say that the chase for huge profits, and the desire to keep up with the break-neck speed of I’s $50bn outsourcing industry’s growth rates that may have been behind Mr. Raju’s motivation in fudging the accounts at his firm. In 2008, a series of cyber-intrusions at the World Bank raised concerns about the security of international financial data held at the institution. The Bank’s chief vendor for cyber-security, Satyam Computer Services Ltd. of I, came under scrutiny as the IT system the company had designed appeared vulnerable. The facts that emerged about the scandal subsequently included a massive accounting fraud, an ineffective World Bank response to the emergency and persistent questions about the integrity of the Bank and its actions. Satyam, a billion- dollar IT outsourcing corporation collapsed under the weight of the fraud in January 2009. Form the above cases we find that though the companies are from different industries and different economical conditions, yet the basic nature of fraud remains the same. Commonly we think that is only the greed, but some other driving forces enter into the way. A “Fraud Triangle” can be presented with ‘Pressure’, ‘Rationalisation’ and ‘Opportunity’ as the three apexes. Once those elements fall into place, the idea of fraud becomes more of a possibility. These apexes are discussed hereunder:  Pressure to Commit Fraud Bad situations lead to bad decisions. Employees in stressful situations can see fraud as an easy way to eliminate their problems. Pressure can also be caused by people other than the company higher authorities. Spouse, relative, or friend might push a person down the fraudulent path. Even another employee looking to commit fraud may pressure another if that coworker would be needed to complete the crime. Pressure can force a variety of human responses, and sometimes that can lead to internal fraud.  Rationalization that Fraud is Legitimate Rationalization can come in form of justification. An employee who has not getting promotion of good salary during last few years may feel the company owes him or her, so the person commits fraud to try and get the money he feels is long overdue. Fraud does not have to result in the theft of big amounts. An employee may justify that by stealing small amounts. In truth, it is always bad, but the person committing fraud may have himself convinced otherwise.  Moment of Opportunity for Fraud This is the biggest factor in The Fraud Triangle. Even if a person is under pressure to commit fraud or has rationalized the idea to the point of no return, it is impossible to commit fraud without having an opportunity to do so. Once the reasons are identified the following section IV will try to find out how such frauds through creative accounting can be detected and prevented.

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V. Summary and Conclusions Accounting is the language of business. Accounting is the recording of financial transactions plus storing, sorting, retrieving, summarizing, and presenting the information in various reports and analyses. Accounting is instrumental within organizations as a means of determining financial stability. Accountants are responsible for determining an organization’s overall wealth, profitability, and liquidity. Without accounting, organizations would have no basis or foundation upon which daily and long-term decisions could be made. Accounting is also a profession consisting of individuals having the formal education to carry out these tasks. One part of accounting focuses on presenting the information in the form of general purpose financial statements such as income statement and balance sheet to stakeholders, the people outside of the company. Another part of accounting involves compliance with government regulations pertaining to income tax reporting. Accounting is both an essential practice and a vital profession in the economically developed world of today. The term ‘creative accounting’ is defined as a process whereby accountants use their knowledge of accounting rules to manipulate the figures reported in the accounts of a business. Creative accounting means using the flexibility within accounting to manage the measurement and presentation of the accounts so that they serve the interests of preparers. With increasing hard economic times, companies may be motivated to practice creative accounting for diverse reasons. Players in the accounting profession may not fully understand the operations of creative accounting because different companies practice creative accounting for different reasons. The practice of recognizing revenue in a way that makes a company look better than it is while still conforming to the GAAP. Creative accounting seeks to inflate stock prices, for example, by selling assets at the end of a year to create a profit that offsets a loss. It is argued that creative accounting hides a company’s true financial state, but, unlike aggressive accounting, creative accounting is generally legal. Aggressive and questionable accounting techniques are used in order to produce a desired result, generally high earnings per share. Creative accounting may include selling assets with a low cost basis, shipping unusually large quantities of product near the end of the year, and failure to write down inventories that have declined in value. Creative accounting the use of discretion in the application of accounting concepts so as to report profit and asset figures which are flattering to the company. By subtle use of different depreciation methods for fixed assets, or different stock valuation methods, or techniques like off-balance sheet financing, a company’s senior managers can ‘window-dress’ the profits for any trading period to impress shareholders. Such interpretations are legal, if somewhat dubious. Although the professional accounting bodies have issued Statements of Standard Accounting Practice and Financial Reporting Standards to try to curtail the scope for arbitrariness in the application of accounting concepts when measuring business income, considerable latitude still exists in the interpretation of accounting data and the reporting of accounting results. Practice of creative accounting is getting enhanced by two factors: motives and environmental opportunities. Motives may be personal or market driven. Personal motives are exclusively for selfish needs like manipulation in calculations for more commission and bonus. Embezzlement of cash and accordingly manipulation of accounts are also coming under this category. Market motives are viewed from company viewpoint. To show a better picture of the company, increase the share price or to procure a bank loan, such fraudulent practices are followed. The other way to increase the potential of fraudulent attempts is through environmental opportunities. The accounting practices and the organizational rules may be so relaxed that anyone can organize such a crime without any fear of getting caught. Poor quality of administrative as well as regulatory supervision is responsible here.

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Next we will raise the issue of reduction and ultimate elimination of creative accounting. It is beyond any question that if the environment opportunities are withdrawn and the rules are made truly strict then that will reduce the strength of creative accounting. Under this approach, regular audit of accounting practices are needed. One’s job may be checked by some other from inside the organization or outside. Proper system should be introduced to educate investors about the financial terms and its probable impact on financial position through providing booklet of methods adopted by the security exchange regulators for various items in different situations and expected changes in special circumstances. Close examination is needed of some unusual transactions which are changed under special circumstances and reasons behind it are to be stated. Transactions with related parties should also be examined thoroughly. These findings are also given in a pictorial presentation under Annexure II. While concluding we can state that, if the creative accounting starts with the loopholes in the accounting standards maybe one of the biggest roles belong to the standard setters in decreasing the possible negative effects of creative accounting. One of the main strengths of accounting standards is careful definitions and clear explanations of relevant accounting items which can prevent the abuse of accounting definitions that is fundamental to creative accounting. International Accounting Standards are continuously improving as new techniques of creative accounting are emerging, so we find creative accounting as a drive to the creation and improved International Accounting Standards. It would be unrealistic to think that it is possible to eliminate creative accounting or earnings management practices at all. However it would be possible to minimize at least the negative effects of them by adopting the accounting standards, giving more importance to ethical considerations and decreasing the flexibility of the managers in deciding among different accounting methods.

Bibliography

Amat, O et. al. (1999). “The ethics of creative accounting”, Journal of economic literature classification. www.econ.upf.es. Basu, A K. (1996). Off balance sheet financing. Business Studies. Volume XIX. Number 182 Griffiths, I. (1986). Creative Accounting, London: Macmillan Jagati, O P. (2003). Creative vs. Credible Accounting, The Chartered Accountant, ICAI, March Jameson, M. (1988). A Practical Guide to Creative Accounting, Kogan, NY Jones, Michael J. (2010). Creative Accounting, Fraud and International Accounting Scandals, Wiley, UK Moore, Jennifer (1990). “What is really unethical about insider trading?”, Journal of , vol. 9. Naser, Kamal H. M. (1993). Creative Financial Accounting: Its Nature and Use, Prentice Hall, USA Newton, Lisa H. (1988). Charting shark – infested waters: Ethical dimension of the hostile takeover. Journal of Business Ethics, vol. 7. Riahi – Belkaoui, Ahmed (1992). Morality in Accounting. Quorum Books. UK Smith, J. (1992). Contemporary Issues in Accounting Regulation, Springer, Germany www.aig.com www.cbi.nic.in www.ecommercetimes.com www.fraudconferencenews.com www.investopedia.com www.panmore.com www.quora.com www.theguardian.com

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Annexure I: Summary of the Frauds Discussed

Scam (Year) Company Details The Architects Modus Operandi Bubble Burst Penalties Waste Houston-based Founder/CEO/Cha Reported $1.7bn fake earnings. Falsely New CEO and Settled a shareholder class- Management publicly traded irman Dean L. increased depreciation time length for management action suit for $457 mn. SEC Scandal (1998) waste management Buntrock, other property, plant and equipment team went fined ArthurAndersen $7 mn company top executives; through the Arthur Andersen books Company (auditors) Enron Scandal Houston-based CEO Jeff Skilling Shareholders lost $74bn, thousands of Turned in by Lay died before serving time; (2001) commodities, energy and former CEO employees and investors lost their internal Skilling got 24 years in prison. and service Ken Lay retirement accounts, and many whistleblower Company filed for corporation employees lost jobs. Kept huge debts off Sherron Watkins; bankruptcy. Arthur Andersen balance sheets high stock prices found guilty of fudging. fueled external suspicions WorldCom Telecommunications CEO Bernie Inflated assets by as much as $11 bn, WorldCom's CFO was fired, controller Scandal (2002) company; now MCI, Ebbers 30,000 lost jobs and $180 bnlosses for internal auditing resigned, company filed for Inc investors. Under-reported line costs by department bankruptcy.Ebbers capitalizing rather than expensing and uncovered $3.8 sentenced to 25 years for inflated revenues with fake accounting bn of fraud fraud, conspiracy and filing entries false documents with regulators

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Tyco Scandal New Jersey-based CEO Dennis CEO and CFO stole $150 mn and inflated SEC and Kozlowski and Swartz were (2002) blue-chip Swiss Kozlowski and company income by $500 mn. Siphoned Manhattan D.A. sentenced to 8-25 years in security systems former CFO Mark money through unapproved loans and investigations prison. A class-action lawsuit Swartz fraudulent stock sales. Money was uncovered forced Tyco to pay $2.92 bn smuggled out of company disguised as questionable to investors executive bonuses or benefits accounting practices, including large loans made to Kozlowski that were then forgiven HealthSouth Largest publicly CEO Richard Earnings numbers were allegedly inflated Sold $75 mn in Scrushy was acquitted of all Scandal (2003) traded health care Scrushy $1.4 bn to meet stockholder expectation. stock a day before 36 counts of accounting company in the U.S Allegedly told underlings to make up the company fraud, but convicted of numbers and transactions from 1996- posted a huge bribing the governor of 2003. loss, triggering Alabama, leading to a 7-year SEC suspicions prison sentence Freddie Mac Federally backed President/COO $5 bn in earnings were misstated. SEC investigation $125 mn in fines and the Scandal (2003) mortgage-financing David Glenn, Intentionally misstated and understated firing of Glenn, Clarke and giant Chairman/CEO earnings on the books Brendsel Leland Brendsel, ex-CFO Vaughn Clarke, former senior VPs Robert Dean and NazirDossani American Multinational CEO Hank Massive accounting fraud to the tune of SEC regulator Settled with the SEC for $10 International insurance Greenberg $3.9 bn was alleged, along with bid- investigations, mn in 2003 and $1.64 bn in Group (AIG) corporation rigging and stock price manipulation. possibly tipped 2006, with a Louisiana Scandal (2005) Allegedly booked loans as revenue, off by a pension fund for $115 mn, steered clients to insurers with whom whistleblower and with three Ohio pension AIG had payoff agreements, and told funds for $725 mn. traders to inflate AIG stock price Greenberg was fired, but has faced no criminal charges

13 Creative Accounting – a Creation for Destruction: with Reference to Some Global Instances

Lehman Global financial Lehman Hid over $50 bn in loans disguised as Went bankrupt Forced into the largest Brothers services firm executives and sales. Allegedly sold toxic assets to bankruptcy in U.S. history. Scandal (2008) the company's Cayman Island banks with the SEC didn't prosecute due to auditors, Ernst & understanding that they would be lack of evidence Young bought back eventually. Created the impression Lehman had $50 bn more cash and $50 bn less in toxic assets than it really did Bernie Madoff Bernard L. Madoff Bernie Madoff, Tricked investors out of $64.8 bn through Madoff told his 150 years in prison for Scandal (2008) Investment his accountant, the largest Ponzi scheme in sons about his Madoff and $170 bn Securities LLC was a David Friehling, history.Investors were paid returns out scheme and they restitution. Prison time for Wall Street and Frank of their own money or that of other reported him to Friehling and DiPascalli investment firm DiPascalli investors rather than from profits. the SEC. He was founded by Madoff arrested the next day. Satyam Scandal Indian IT services Founder/Chairma Falsely boosted revenue by $1.5 bn. Admitted the Raju and his brother charged (2009) and back-office n RamalingaRaju Falsified revenues, margins and cash fraud in a letter to with breach of trust, accounting firm balances to the tune of 50 bnINR. the company's conspiracy, cheating and board of directors falsification of records. Released after the Central Bureau of Investigation failed to file charges on time

14 The BESC Journal of Commerce and Management, Volume 3, July 2017

Annexure II: Potential for Creative Accounting

Potential for Creative Accounting and Fraud

Enhanced by Reduced by

Environmental Motives Environmental Enforcement opportunities constraints and ethics

- Lax rules & - Appropriate regulations reward & incentive structures - Harsh - Poor - Personal supervision - Better penalties regulations and - Market - Inappropriate code of reward & governance - Code of incentive - Enhanced ethics structures supervision