ACTA UNIVERSITATIS AGRICULTURAE ET SILVICULTURAE MENDELIANAE BRUNENSIS Volume 63 194 Number 5, 2015 http://dx.doi.org/10.11118/actaun201563051779 BIG BATH AS A DETERMINANT OF CREATIVE ACCOUNTING IN SMALL AND MICRO ENTERPRISES Lenka Zemánková1 1 Faculty of Business and Management, Brno University of Technology, Antonínská 548/1, 601 90 Brno, Czech Republic Abstract ZEMÁNKOVÁ LENKA. 2015. Big Bath as a Determinant of Creative Accounting in Small and Micro Enterprises. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 63(5): 1779–1785. Creative accounting is a 21st century phenomenon and in the context of the economic crisis and defi cit budget it has been receiving increasing attention, in particular in the area of prevention and detection of accounting manipulation. The focus of the research on small and micro-enterprises stems from little attention paid to these enterprises and the undeniable importance of small and micro-enterprises for the economy. Primary research is based on the examination of a phenomenological paradigm, i.e. it focuses on understanding human behaviour on the basis of a reference framework for research participants. The main research method used in research is a comparative case study, which is one of few methods that allow research of this sensitive topic. Research will focus on the existence of a big bath in the company’s ratio of profi t and turnover as a determinant of a change in the company’s approach to creative accounting. Keywords: creative accounting, fraudulent accounting, earnings management, bath in accounting INTRODUCTION Theoretical Background Creative accounting is o en associated with The concept of creative accounting can be the 21st century’s economy and for several years understood, in accordance with the defi nitions by it has been discussed in the media virtually every Naser in 1993, Krupová in 2001, O’Regan in 2004 day. Following the trend set by the media, creative and Tumpach in 2008, as a misuse of accounting accounting has become increasingly more o en methods and use of accounting manipulations at the subject of research studies and scientifi c the enterprise level in order to infl uence the fi nancial publications. statements so that they provide their users with A er media exposure of a series of accounting distorted information about the enterprise. scandals, the concept of creative accounting has In accordance with the defi nitions of the term gained a new dimension, which caused the focus of in more recent publications, creative accounting research in particular on large enterprises and the includes operations within the limits of law as well public administration. operations outside the law, i.e. fraudulent ones. In the context of the economic crisis and defi cit The reason for not excluding fraudulent operations budget, the issue of creative accounting is, in is also the diffi culty pro prove the intention to particular in terms of prevention and detection manipulate with accounting data. A number of accounting manipulation, an issue in focus. of research studies therefore concentrate on Small and micro-enterprises cannot remain under- accounting frauds as one of the worst activities in researched due to their undeniable importance to the area of creative accounting. the economy. Raising awareness of the issue of creative Eff ects of Creative Accounting accounting and the improvement of accounting The eff ects of creative accounting, as reported manipulation detection is one of the ways to fi ght in the published literature, can be divided into against creative accounting. in principle positive ones and negative ones. 1779 1780 Lenka Zemánková The positive eff ects of creative accounting include than the decline caused by the terrorist attacks in enhanced ability of external users of fi nancial September 2001. statements to predict the future of the company The eff ects of creative accounting can therefore (Roden and Sadan, 1980), or increased information be considered to be much greater than an ordinary value of the reported profi ts and the perception of person compiling the fi nancial statements realizes, the enterprise as less risky in the case of the use of and creative accounting must be understood purely creative accounting (Wang and Williams, 1994), as a negative phenomenon with adverse eff ects or increased sustainability and predictability of on the enterprise itself as well as on the society as revenue (Subramanyam, 1996). A positive eff ect can a whole. also be considered reduced cost of borrowed capital and improvement of conditions for obtaining Detection of Creative Accounting additional capital (Amat et al., 2000). Enterprises Understanding of creative accounting in may also see the confusion of competitors by false the negative sense raises the question of prevention data as a positive eff ect. Examples of authors who and fi ght against creative accounting. The search believe that the infl uence of creative accounting on and the use of tools to detect creative accounting is the market is insignifi cant include Imhoff (1977) or one of the ways that can help increase the perceived Healy and Wahlen (1999). risk of manipulating accounting data and can aid However, positive and neutral approaches of prevention and fi ght against the phenomenon authors to creative accounting are, consequently, of creative accounting. Detection of accounting subjected to arguments of authors who perceive manipulations is a very complex process, which is creative accounting as a negative phenomenon. As in the centre of attention of a number of research Stolowy and Breton (2004) argue, if market players studies. knew that the numbers are manipulated, there One of the determinants of creative accounting would be no reason for their manipulation. can be considered big bath accounting. In Healy’s Manipulation with accounting data, however, view (1985), big bath accounting represents has a more signifi cant consequence beyond a particular drop in accounting data which precedes providing manipulated information for company manipulation. Healy therefore understands the big shareholders and owners. Even assuming that bath as the cause of creative accounting, followed we acknowledge the benefi ts specifi cally for by creative accounting techniques with the aim to them, creative accounting provides manipulated eliminate great decreases in fi nancial indicators. information for the whole society. These results then Conversely, Blake et al. (1995) consider big bath aff ect the statistics of the entire country and hence accounting to be a result of creative accounting. GDP and other indicators. On a deeper thought, They start from the position that enterprises may statistics data then aff ect the allocation of resources. seek to report the maximum loss in one year to In an economy where allocation of resources is be able to report an improvement in fi nancial aff ected by interventions such as manipulations indicators in the following years. with accounting data of business units, the general The most commonly used indicators in economic target in the form of effi cient allocation the detection of creative accounting are of resources may be threatened. A specifi c part of the company’s profi t and income. In the USA, creative accounting which can already be classifi ed the term earnings management has been commonly as economic criminal activities has paramount used. Earnings management is understood as social and economic impact on the internal stability application of decision-making in the matter of of the State. Besides other aspects, it aff ects the basic fi nancial reporting and structuring of transactions revenue components of the State; if these are with the aim to provide misleading fi nancial threatened, the long-term functioning of the state reports to some stakeholders so as to infl uence mechanism is challenged. For example, fi nancial the performance of the enterprise or future analyst Smith (1992) believes that the greatest part transactions that depend on the reported results of the economic growth of the United Kingdom in (Healy and Wahlen, 1999). Earnings management the 1980s can be attributed to creative accounting is therefore based on information asymmetry, rather than actual economic growth. which occurs between the privileged management As far as negative eff ect is concerned, creative and more distant stakeholders (Schipper, 1989). accounting may have adverse, or even liquidating, Contemporary literature describes two basic consequences for enterprises that use it (Smith, objectives of earnings management. One of them 1992). Indirect damages relate to destabilization is an attempt to report the best results possible (e.g. of trust on the fi nancial markets, a decline in Bonner et al., 1998; Healy and Wahlen, 1999; Lynch the volumes of trading, and a reduction in et al., 2011). Another focus of earnings management the volume of investment by the enterprises described in the literature is, on the contrary, (Tumpach, 2008). Albrecht’s (2006) conclusions reporting of the lowest possible profi t in an attempt state that a er the manipulation with accounting to reduce the amount of the payments derived from data of Enron was published, the decline in trading the profi t (Tumpach, 2008; Ravisankar et al., 2011). caused by a loss of investors’ trust was even higher The managers of small and micro enterprises have diff erent approach than managers of big companies. Big Bath as a Determinant of Creative Accounting in Small and Micro Enterprises 1781 Accounting is closely connected to the taxes research due to their fear of the consequences of payment. In that system small and micro-enterprises the research on the continuation of the enterprise’s try to modify their taxes payments downwards. activity. Phenomenological paradigm seems to be In their research focused on creative accounting, more convenient also due to its main characteristics, other authors also concentrate on profi t; these as listed by Collis (2003). It involves production consider indicators based on profi t to be the most of rather qualitative data (although partly also suitable ones for fraud detection (e.g.