SEA - Practical Application of Science Volume II, Issue 3 (5) /2014

Laura – Maria POPESCU Ileana NIȘULESCU, The Bucharest University of Econimic Studies, Romania

CREATIVE Empirical study VERSUS FRAUD

Keywords Creative accounting Fraud Users Accounting Information

JEL Classification M40, M41, M42

Abstract

This article sets out to present the difference between the means of executing creative accountingand that of executing fraud, the way in which they are perceived in the business environment, as well as the implications that they have in companies’ activities. The article’s structure consists in an analysis of the terms „creative accounting” and „fraud”, presenting ideas and definitions that a series of economists have attributed to these terms, the differences between the two concepts, the risks that they imply and the opinion of the business environment regarding the two phenomena. The hypotheses that the article is based on constituted the starting point for a study conducted on the employees of companies operating on Romanian territory. The conclusions confirmed most of the study’s hypotheses and the fact that the two terms are often mistaken for one another and, in the opinion of the majority of respondents, constitute reasons for concern with regard to the financial statements submitted by a company.

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Introduction are manipulated and, taking advantage of the The article approaches the main flexibility, one chooses the measurement and differences between fraudulent financial reporting disclosure practices that allow them to transform and creative accounting, accounting areas that the summary documents from what they should be enable creative accounting and fraudulent financial into what the managers would like them to be” . reporting, conducive factors, types of behaviour Feleagă and Malciu (2002) define creative that may indicate potential fraud, as well as the accounting as:,,the process through which opinions of people in the business environment accounting professionals use their knowledge in with regard to the two phenomena. Accounting order to manipulate the figures included in the scandals, creative accounting and fraud date back yearly accounts” . to the period when accounting was discovered, the Despite the fact that the term „creative fifth century. Whether it’s less developed countries accounting” is used frequently, there are many or pioneers of global economics, these problems contradictions regarding its definition. One of the occur all over the world. The topicality and largely accepted definitions is:„Creative accounting generalisation of this problem represent the main represents using accounting flexibility in order to reason for approaching this research topic. The present and measure the financial statements so that article’s structure consists in analysing the terms of they prioritise those that draft them over the users”. „creative accounting” and „fraud”, presenting ideas (Black’s Law Dictionary, 7th edition, 1999, UK).A and definitions that a series of economists have more ample definition is formulated by attributed to these terms, the differences between economistsMulfordandComiskey: „Creative the two concepts, the risks that they imply and the accounting is any intentional act of distorting the opinion of the business environment with regard to accounting figures and aggressively choosing and the two phenomena. Creative accounting has been applying accounting principles, both within the defined as ”the art of forging or window dressing a limits of accepted accounting principles and ”, ”the art of calculating benefits” outside them, as well as fraudulent financial ( N a s e r , 1993), ”the art of presenting a balance reporting”(Mulford and Comiskey, 2002, USA). sheet”, ”the art of creating provisions” being the The American definition of creative process through which accounting professionals accounting generally includes the term of „fraud”, use their knowledge in order to manipulate the thus rendering it illegal, while in the UK creative accounting numbers, taking advantage of the accounting is not seen as an illegal action, but a use possibility of interpreting legislation and the of accounting flexibility and excludes fraud. The existence of numerous options for solving different ideal scenario is that in which the flexibility accounting issues. allowed in accounting is used to the extent to which it can provide users with an accurate image of the The current state of knowledge financial statements, so that they can make correct It’s often extremely difficult to economic decisions, such as the decision to buy, differentiate between creative accounting and sell or keep shares. However, the flexibility of accounting fraud. The necessity of creating a accounting rules opens the door for managers to favourable image of economic entities in an ever use creative accounting. From a certain point of more unstable and competitive economic view, this is not a bad thing, as it does not break environment led to the appearance of creative any rule, the problem being that they are straying accounting, a concept that is also known from the basic purpose of accounting – that of as“cooking the books” or “doctoring financial providing users with an accurate image of the statements”. accounting data. In professional literature we find this Many authors have approached the issue concept explained by several authors, of which a of creative accounting as a synonym of “doctoring few definitions are presented in the following lines. financial statements”. More recently, creative Most professional papers present the negative accounting has been associated with accounting significance of creative accounting and its use for fraud and the lifting of accounts as a method that the purpose of misleading the external users of the “stands in the waiting room of fraud” (Ristea – summary documents. Griffiths states that“any Accounting, instrument – class notes). company window dresses its benefits. The The first record of fraud features two published summary documents are drafted based Greek merchants, XenothemisandHegestratos, on registers that have been“cooked” in a delicate or condemned 360 BCfor acts of deception (Singleton not so delicate manner. The numbers presented to and Singleton, 2010). Later, the discovery of the investors have been entirely manipulated in order New World and the mirage of the opportunities to protect the guilty parties (the managers).” offered by the American continent at that time According to Naeser, creative accounting allowed for usury fraud in the railroad field, with is ,,the process through which, given the existence the most notorious examples being the cases of a loophole in the rules, the accounting numbers ofSouth SeaBubble (1717-1720) andMeyer versus

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Sfeton(1817). A century later, the famous frauds in confirm the presented hypotheses, with the results the period of the Great Depression(1929-1933): being processed using the SPSS program. Thus, the Charles Ponzi andU.S. Postal Service (1920), survey contains a category of questions with the Samuel Insull(1920-1929), Kreuger& Toll (1929), purpose of identifying the status of the interviewed Securities Exchange Act (1934)occured. Much person within the company, a category that tests later, at the start of the twenty-first century, the their knowledge with regard to creative accounting complexity of embezzlement and inadequate and fraud, a category of questions meant to detect financial reporting schemes in the cases of their attitude with regard to these practices and (2001), WorldCom (2002), ArthurAndersen(2002), another one referring to presenting accounting SociétéGénérale(2008), (2010) or information in relation with its users. The research Olympus Corporation (2011) highlighted the role is conducted on a representative test group, with of the financial auditor in the prevention and the subjects being selected from various fields of detection of financial fraud. The experience of activity in order for the research to be more these acts revived the interest for learning more trustworthy. about the mechanisms of fraud, the determining factors and the schemes through which fraud can Research results be executed. The necessity of this knowledge that, Delimiting the concept of creative according to Francis Bacon, represents power in accounting from that of fraud is important. itself,led to the study of financial fraud and According toDicționarulexplicativromân,the word determined positive developments in legislation, by ,,fraud” is defined as an act of ‚,deceit, an act of ill- adopting laws, standards and protocols that would will perpetrated by a person, usually in order to support the auditor in preventing and detecting its make a material profit from someone else’s rights; presence at company level. theft”. Even though creative accounting is based on Accounting specialists are subjected to the the objectivity in the professional reasoning of the pressure of finding solutions to favour and improve person drafting the accounting information, which the image of entities and adapt to the new is realised by applying the best policies and requirements that appeared along with the accounting options, creative accounting is mostly globalisation of businesses and of markets where perceived in a negative way, as a negative creation competitiveness is permanently on the rise. meant to draft financial statements that correspond to managers’ desires with regard to the company’s Research methodology financial position and performance. This way, With regard to the proposed research financial statements are not what they are supposed methodology that was based on bibliographical to be according to legislation, but what documentation, the objective was the systemic management wants them to be. Thus,due to the fact observation of the phenomenon, followed by the that the creative accounting technique involves analysis of the data, along with their summary and procedures of,,doctoring” financial statements validation. The thesis combines quantitative and without breaking the law, it’s not considered an act qualitative research, using specific methods, of fraud. document and content analysis. In order to attain Practitioner Jameson states that "The the proposed objectives, a series of bibliographical accounting process involves operating with sources, such as professional literature, accounting, different opinions and solving conflicts between tax and legal regulations, studies and articles them in order to present the results generated by published at a national and international level by transactions.This kind of flexibility facilitates different bodies operating in this field were used, manipulation, deceit and misrepresentation. These while the instrument of the quantitative research activities, practiced by some of the more was the survey. unprincipled members of the profession, are The purpose of the research was to starting to be known as creative accounting. identify the opinion of persons directly involved in Creative accounting does not break the law and managing the accounting activities of different accounting rules. It respects their wording, but not companies with regard to the two issues being their spirit.One could say that the appearance of studied. In this regard, one can highlight the creative accounting was also influenced by the similarities and differences between the perceptions flexibility of international accounting of entrepreneurs, managers and accounting regulations.Creative accounting is mostly perceived professionals as to the two practices, how they in a negative light (negative creation), meant to perceive the limits of accounting, the way in which lead to the drafting of financial statements that they influence the company’s activity and their correspond to the managers’ wishes with regard to attitude with regard to their use in the relation with the company’s financial position and performance. the organisation and consumers. The research This way, financial statements are not what they consists in applying a survey composed of 14 are supposed to be (legal discourse), but what questions to a number of 54 test subjects in order to someone wants them to be (interested discourse).

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The fact that creative accounting is simultaneously alicious activity perpetrated at the of perceived as an instrument for realising accounting clients or investors, be it of civil or criminal nature, interests, as well as doctoring financial statements, at the expense of the company or for its benefit, is the result of the accounting policies adopted by a inside or outside of the company, by managers or company in order to produce and communicate non-managers. From the category of frauds information. perpetrated by managers, fraud The Accounting Rules according to produces the most losses at company level and has European Directives, approved by the Ordinance of the purpose of misrepresenting the financial truth in the Public Finances Ministry no. 1.752/2005 and, order to obtain certain advantages or hide certain later, bythe Ordinance of the Public Finances losses or negative performances. The main Ministry no. 3.055/2009, allow one to deviate from schemes, the objective of which is financial the accounting rules if they don’t lead to an statement fraud are caused by inadequate financial accurate image of the , debts, financial reporting and make use of recognizing income in position, profit or loss of the entity. Such advance, overvaluing assets, undervaluing deviations from the rules force the entity to use and debt and, in the case of fraud, additional information (“additional information an important role is played by embezzlement. must be submitted”), as well as to specify in the Even though creative accounting and explanatory notes the deviations from the rules, the fraud mostly occur when the company is reasons for the deviations and the effect that they experiencing financial difficulties, they are not had on the entity’s assets, debts, financial position, considered synonymous, creative accounting profit or loss. This flexibility in the regulation of involves,,doctoring accounting information,a accounting also takes into the fact that process that is not considered illegal,but certainly accounting truth is not a “reflected”one, but rather does not comply with ethics standards.As for the a “constructed” one. perception in the business environment with regard On one side, this construction is based on to the two research subjects, the opinions are a series of rules and regulations with regard to the mixed. Based on the research conducted on classification, acknowledgement, evaluation and companies in our country, most people who processing of the elements in the financial answered the study’s questions are weary of the statements and, on the other side, on professional subject, considering that any deviation from reasoning in selecting the best options. The represents a way of deceiving the development of creative accounting, especially the user of the accounting information. The following perverted part favoured by loopholes in accounting table presents the main differences between the two rules, has direct repercussions, such as the loss of concepts, based on the basic principles, the accounting information credibility, especially from methods of execution and the impact that they have investors and financiers. Fraud is an intentional and on the information and the persons involved. Tabel 1 others also perceive it as omitting or hiding With regard to the methods of executing information from its users. creative accounting and fraud there is a series of One of the main research hypotheses very important specific elements presented in the refers to the way in which creative accounting is following table. They highlight the fundamental perceived by persons in the business environment. differences between the two concepts, the more or This is also confirmed by presenting respondents’ less negative character of each one and the risks choices when asked to identify methods of that they involve for the company. When manipulation. This poses the problem of deceiving respondents were asked to look at a list and select the user through financial statements based on techniques associated with fraud or creative creative accounting. Most respondents considered accounting, one could observe a series of mistakes that manipulation had the role of attracting in their identification, which supports the idea of financing sources, over 65%, and almost 40 % the lack of an exact delimitation between the two believe that it doesn’t have a negative effect on the phenomena. companies involved. From the analysis of the Tabel 2 answers, one can observe that creative accounting Based on research conducted on persons in the activities are not perceived as deceptive, but rather, business environment, a series of opinions as a means of “selling” the company’s image by regarding the two concepts have been concluded. highlighting the positive aspects. Thus, most respondents had the tendency to When asked to provide a description of mistake the two concepts for one another, stating the terms of creative accounting and fraud from that they represented methods of deceiving the their own perspective, most respondents were users of the financial statements and attributing tempted to only use words such as deception, negative connotations to both creative accounting doctoring, illegal actions, which shows the negative and fraud. While some respondents only associate light that creative accounting is viewed in, as a fraud with stealing from the company’s assets, result of the thin line between it and fraud.

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Whether based on their motivation, means attributing negative connotations to both creative of execution or purpose, the two activities represent accounting and fraud. completely different actions on the company and, The hypothesis according to which the most times, even the persons involved. From the users of financial statements could be deceived by point of view of similarities, one can highlight: the submitting documents that were altered in order to intention of hiding information from third parties, present a more favourable image of the company is the critical period in which they are executed, the partially confirmed, since a very large number of impact that they have on users and the hidden respondents believed that creative accounting was character of their execution. legal and meant to benefit the company in certain situations. Conclusions Even though there are clear differences Even though creative accounting is based between creative accounting and fraud, both on objectivity in the professional reasoning of the phenomena occur when the company is person producing the accounting information, experiencing financial difficulties. In the context of which is realised by applying the best accounting the economic crisis, the temptation to make use of policies and options, creative accounting is usually the two becomes almost inherent. perceived in a negative light, as a negative creation with regard to the company’s financial position and Bibliography performance. This way, financial statements are [1] Black’s Law Dictionary, 7th edition, 1999, UK not what they are supposed to be according to the Dilip, K. S. (2006), ‘Creative Accounting in regulations, but what the manager wants them to Bangladesh and Global be. [2] Feleagă N, Malciu L., Based on the research conducted on Politicişiopţiunicontabile, EdituraEconomică, persons in the business environment, a series of 2002; opinions with regard to the two concepts were [3] Naser, C. (1993). Creative financial concluded. Thus, most respondents had the accounting: its nature and use,Pretince Hall, tendency to mistake the two activities for one citat de Feleagã N., Malciu L., another, stating that they represented ways of Politicișiopțiunicontabile, Fair Accounting deceiving the users of the financial statements and versus Bad Accounting, EdituraEconomicã, București, 2002;

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Table 1.The main differences between creative accounting and fraud Creative accounting Fraud Exploits the imprecise and incomplete character of negative and illegal accounting rules If there is more than one way to solve a certain Involves forging or altering accounting records and problem, the will choose the one that leads supporting documents based on which financial to the result desired by management. statements are drafted Alters the economic reality without breaching accounting The erroneous interpretation or intentional omission of regulations events, transactions or other significant information in financial statements. When used in good faith, represents a necessary The intentional wrong application of accounting instrument for the construction and presentation of an policies associated with the evaluation, accurate image. acknowledgement, presentation or description of information Represents a series of techniques for manipulating Fraudulent financial reporting can be committed as a financial statements, doctoring companies’ images in result of the pressures that the management is order to make them more attractive to investors or subjected to, from inside or outside the company, to potential investors attain a predicted profit target. The techniques and practices provided by creative Involves actions such as misrepresentations occurring accounting result in doctoring reality to the limit of as a result of fraudulent financial reporting and credibility, with the purpose of serving certain misrepresentations occurring as a result of asset interests embezzlement.

Source: created by the author

Table 2.Execution methods Creative accounting Fraud Selecting (or altering) evaluation methods; selecting Forging accounting records or supporting documents (or altering) the methods of presenting the summary based on which the financial statements are drafted documents (payment, evaluation); Voluntarily publishing optional summary documents The inadequate application of accounting policies (e.g.financing table); (overvaluing the current sales amounts);

Establishing information published in the management Recording transactions that did not take report place(recording fictional transactions); Establishing the volume and degree of aggregation of Destroying or omitting records or documents referring the information published in the summary documents, to transaction results especially in the annex Selecting (or changing) the auditor; observing Asset misappropriation (theft or abuse of assets (partially or entirely) the international accounting belonging to the entity, such as hiding sales, regulations or the acknowledged international fraudulent invoicing, fraudulent payments. accounting regulations Establishing the date for the communication of the financial information Abandoning certain accounting principles Source: created by the author

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