TERM PAPER
ON
CREATIVE ACCOUNTING
MBA APM-2 SECTION-01
ACCOUNTING AND FINANCE
DR. HARISH KUMAR SINGLA
SUBMITTED BY:
P2371006 :
JAY JADAV
P2371060 :
RINTU RANJAN OSTAD
P2371061 :
AVILASH AICH
P2371067 :
BEN CHACKO ABRAHAM
1
INDEX
1. ABSTRACT………….……………………………………………………03
2. INTRODUCTION….…………………………………………………….. 03
3. LITERATURE REVIEW ..………...………………………………………04
3.1. THEORITICAL FRAMEWORK.……….……………………………05
4. METHODOLOGY……………………………………………...…………06
5. RESULT AND DISCUSSION…………………………………………….07
6. CONCLUSION……………………………………………………………11
2
1. Abstract
This paper presents an empirical and critical investigation of the issue of creative accounting
in financial reporting. The study not only examines the ethical responsibility associated with
creative accounting, but also considers other factors that influence financial reporting, such as
the role of auditors, government regulations or international standards, the impact of
manipulative behaviours, and the impact of ethical values of individuals. Data was collected
through a structured questionnaire from the industrial sector. Descriptive and inferential
statistics were employed to generalize the results and draw conclusions.
The study concludes that companies involved in fraud or scandals are influenced by several
factors, including unethical behaviours, agency problems, and non-professional attitudes.
Creative accounting is neither illegal nor legal, but its excessive use can lead to scandals. While
creative accounting plays a significant role in financial reporting, it has been negatively
correlated, indicating that more managers involved in it may decrease the value of financial
information. Government regulation/international standards have a positive and significant role
if they are flexible in financial reporting. Auditor comments also play a positive and significant
role in financial reporting. Ethics play an important and positive role in financial reporting, as
greater ethical values lead to lesser manipulative behaviours. Therefore, manipulative
behaviours only serve to damage the image of any company.
2. Introduction
The emergence and development of the concept of creative accounting raises questions
regarding its origins and influences. This practice was born out of favourable circumstances
related to the economic growth of world states and the need for economic entities to establish
a positive reputation in a competitive and challenging environment. The first mention of
creative accounting practices can be traced back to Luca Paciolo, the founder of accounting,
who incorporated such practices in his renowned De Arithmetica, the first accounting manual,
over 500 years ago. The term "cover-up" originated from the practice of deliberately making
entries illegible by spilling ink on the books. In the current world economic crisis, creative
accounting is viewed as a field that can offer life-saving solutions or be blamed for negative
developments. The subjectivity of the viewer influences the interpretation of financial
statements, which are processed and understood based on the receiver's interests, experience,
state, and perception. The purpose of this article is to present the current state of knowledge in
the field of creative accounting, including the identification of the protagonists, conditions
favouring these practices, and objectives set. The paper reviews the main foreign and domestic
approaches to the concept of creative accounting and academic articles on the subject in the
last decade. The article concludes with suggestions for future research from the scientific
databases – “Emerald”, “Science Direct” and “ProQuest”
3
3. Literature Review
The topic of creative accounting has been extensively discussed in literature. The first person
to write about creative accounting in an Anglo-Saxon context was in the 1970s. Watts and
Zimmerman (1990) provide guidelines for positive creative accounting practices in their
literature on accounting practices. Similarly, Shah et al. (2011) conclude that creative
accounting can be used as a weapon in critical situations for a firm, and that it is not necessarily
bad if the firm shows flexibility in its accounting regulations. The ethical environment of a firm
also plays a role in how and why management uses creative accounting techniques. However,
some analysts highlight the negative consequences of creative accounting practices, citing
examples such as Enron and WorldCom. Gherai and Balaciu (2011) predict that enterprises
engaging in creative accounting practices put their stake at risk, as these practices only provide
short-term benefits and can lead to scandals. Therefore, close governance of financial reporting
is necessary, and management should identify the causes that provoke creative accounting
practices. Managers and auditors play important roles in any firm, with the former receiving
rewards based on the company's performance. The close supervision of auditors can reduce the
chances of applying creative accounting. Yadav (2013) finds that the involvement of outside
directors can also reduce the practices of creative accounting, as the involvement of
professionals in financial decision-making can build trust among stakeholders. Qualified
accountants can also help companies with the use of creative accounting techniques. Corporate
governance is considered the best way to reduce these practices, as it evaluates the performance
of the company and controls unethical practices. The relationship between corporate
governance and creative accounting is related to agency theory, as conflicts between managers
and owners may be the cause of creative accounting practices. Ethics also play a crucial role in
any enterprise, as following the right ethics can prevent crises. Afolabi and Oluseye (2013)
conducted research on manufacturing firms in Nigeria and concluded that financial reporting
has an effect on managerial and investment decision-making, and high transparency can help
avoid corporate fraud. Al Momani and Obeidat (2013) investigated the ethical capabilities of
auditors to detect creative accounting practices and found that their ethics can affect these
practices. Overall, the factors affecting creative accounting practices in an organization can be
portrayed holistically, as shown in Figure 1.
4
Factors that
limit
Beyond the
regulatory
boundaries
Creative
accounting
practices
Fraud/in crisis
or scandals
Unethical
behaviors
Agengy problem
Within this
regulatory
boundaries
Corporate
governance
Non
professional
attitude
Immorality
Lack of
knowledge
Injustice
Lack of
awarness
Success of
management
decisions
Professional
attitude
Increase the no.
of outside
shareholder
Micro
manipulation
Director from
outside
Macro
manipulation
Figure 1: Conceptual model of factors affecting creative accounting.
3.1 Theoretical framework
Based on review of literature theoretical framework is developed for testing purposes (Figure
2).
Awareness of
creative
accounting
Manipulative
behaviors
Auditor's
comment
Financial
repoting
Ethical values
Standards/
regulation
Figure 2: Theoretical frame work
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4. Methodology
Numerous scholars have conducted research on the topic at hand, utilizing various variables
and economic settings. The research design employed in these studies is predominantly
quantitative. Both primary and secondary data have been utilized, with structured
questionnaires serving as the primary data collection method and published sources serving as
the secondary data source. The questionnaire utilized in this study was adapted from Lin and
Yang's (2006) research and was administered to professionals in the industrial sector. The
sample size consisted of 120 professionals, although only 80 responses were obtained. Multiple
regression and correlation analyses were conducted to determine the relationship between
dependent and independent variables, while descriptive statistics were used to determine the
percentages and frequencies of respondents. The literature review facilitated the development
of the following hypotheses:
(1) Awareness of creative accounting techniques has a significant impact on financial reporting.
(2) Government regulations or standards have a positive impact on financial reporting
(3) Auditor's comments have a significant impact on financial reporting
(4) Ethical values have a positive impact on financial reporting
(5) Manipulative behaviour has a negative impact on financial reporting.
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5. RESULTS AND DISCUSSION
The present study employed descriptive statistics to determine the frequency and percentage of
responses to various questions. The results indicated that 62.6% of respondents expressed trust
in financial information, while 15.1% did not trust financial reporting information, and 22.5%
were unsure. Additionally, 77.6% of respondents agreed that financial reports are a key element
of any company, while 12.5% disagreed, and 10% remained neutral (Table 1).
Table 1: Trust on financial statements and key elements
Valid Cumulative
Frequency Percent percent
percent
Trust
Completely
untrustworthy
Untrustworthy
Neutral
Trustworthy
Completely
trustworthy
Key element
Strongly
disagree
Disagree
Neutral
Agree
Strongly agree
3
9
18
39
3.8
11.3
22.5
48.8
3.8
11.3
22.5
48.8
3.8
15
37.5
86.3
11
13.8
13.8
100
4
6
8
25
37
5
7.5
10
31.3
46.3
5
7.5
10
31.3
46.3
5
12.5
22.5
53.8
100
When asked about the purpose of using
creative accounting in financial reporting,
38.8% of respondents stated that companies
use creative accounting techniques due to
fierce competition, 11.3% said it was for the
benefit of manipulators, 32.5% cited the
basic need to chase investment, and 17.5%
mentioned the materialization of statementmaking art. Regarding the ease of using
creative accounting techniques for
manipulation, 31.3% of respondents were
neutral, 32.5% found it hard to use, and
36.3% found it easy to use in financial
reporting. Similarly, when asked about the
ease of detecting creative accounting
techniques in financial reporting, 37.5% of
respondents were neutral, 37.6% found it
hard to detect, and 25% found it easy to
detect in financial statements (Table 2).
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Furthermore, when respondents were asked
about the impact of creative accounting
techniques on financial reporting, 65% of
respondents stated that creative accounting
techniques have a significant impact on
financial reporting, 21.3% said it has a
moderately significant impact, 10% said it
has a slightly significant impact, and 3.8%
said it has no significant impact. Similarly,
when asked about whether the use of
creative accounting techniques is a good
treatment for financial reporting, 42.5% of
respondents were neutral, 22.5% disagreed,
and 35% agreed that the use of creative
accounting techniques is good for financial
reporting. When asked about how
companies may reduce the use of creative
accounting, 45% of respondents suggested
that companies may reduce the use of
creative accounting by strengthening their
internal
auditors,
10%
suggested
strengthening their external auditors, 28.8%
suggested improving their accounting
standards,
and
16.35%
suggested
increasing punishments (Table 3).
Regarding the parties that may suffer from
loss due to creative accounting techniques,
17.5% of respondents believed that
companies may suffer, 12.5% believed that
customers may suffer, 56.3% believed that
investors may suffer, and 13.8% believed
that society may suffer. When asked about
where manipulation is mostly done in
financial statements, 42.5% of respondents
believed that manipulation is mostly done
in off-balance-sheet financing through
creative accounting techniques, 18.8%
believed it is mostly done in depreciation
policies, 15% believed it is mostly done in
off-balance-sheet
financing
through
extraordinary items, and 23.8% believed it
is mostly done in off-balance-sheet
financing through the valuation of money.
When asked about the legality of creative
accounting
techniques,
35.1%
of
respondents considered it to be legal, 35%
considered it to be illegal, and 30% were
neutral about its legality (Table 4).
Furthermore, when asked about the
trustworthiness of auditors' comments,
65.1% of respondents expressed trust,
17.5% expressed mistrust, and 17.5% were
8
neutral. Similarly, when asked about the
importance of government regulations in
preventing creative accounting techniques,
37.5% of respondents stated that these
regulations play an important role in
preventing creative accounting practices,
18.8% stated that they do not play an
important role, and 43.8% stated that they
play a moderate role. When asked about the
usefulness of international standards in
preventing creative accounting techniques,
61.3% of respondents found them useful,
5.1% found them useless, and 33.8% were
unsure about their usefulness (Table 5).
Regarding the main manipulators of
creative accounting techniques in financial
reporting, 28.8% of respondents identified
accountants as the main manipulators,
43.8% identified managers, 17.5%
identified auditors, and 10% identified
CEOs. Similarly, when asked about the role
of ethics in preventing creative accounting
techniques, 47.6% of respondents agreed
that ethics may prevent creative accounting
techniques in financial reporting, 22.6%
disagreed, and 30% were unsure. When
asked about the role of ethical values in
demolishing the use of creative accounting
techniques in financial statements, 51.3%
agreed that ethical values can help demolish
creative accounting practices, 17.5%
disagreed, and 31.3% were unsure
(Table 6).
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The results of inferential statistics indicate a negative association between the manipulation of
behaviours and financial reporting. However, the relationship was found to be insignificant
based on F and t statistics, as presented in Table 7.
Regarding the relationship between creative accounting and financial reporting techniques, the
inferential statistics reveal that the overall model is significant, with P (0.025) <0.05. The
standardized coefficient beta (-0.251) indicates a negative interaction between the predictor
(independent variable) and the dependent variable, as shown in Table 8.
Similarly, for the relationship between auditors' comments and financial reporting techniques,
the inferential statistics demonstrate that the overall model is significant, with P (0.007) <0.05.
The standardized coefficient beta (0.299) suggests a positive influence of the predictor
(independent variable) on the dependent variable, as presented in Table 9.
Furthermore, the inferential statistics report a significant overall model for the relationship
between ethical values and financial reporting techniques, with P (0.005) <0.05. The
standardized coefficient beta (0.312) indicates a positive influence of the predictor
(independent variable) on the dependent variable, as shown in Table 10.
Finally, the inferential statistics reveal a significant overall model for the relationship between
government regulations/international standards and financial reporting techniques, with P
(0.048) <0.05. The standardized coefficient beta (0.222) suggests a positive influence of the
predictor (independent variable) on the dependent variable, as presented in Table 11.
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6. Conclusion
The elimination of creative accounting practices is not feasible, but their use can be reduced.
This paper presents a comprehensive analysis of the two sides of creative accounting practices.
The focus of this paper is on the negative aspects of creative accounting techniques employed
by companies. Fraudulent activities or scandals in companies can be attributed to several
factors, including unethical behaviour, agency problems, and non-professional attitudes.
Unethical behaviour is caused by a lack of moral values, which may be individual or
professional, and injustice, which may force individuals to engage in fraudulent activities.
Agency problems arise when managers do not receive their deserved rewards, leading them to
use creative accounting techniques for their own benefit. Non-professional attitudes may also
lead to the crossing of legal boundaries, which occurs when individuals lack knowledge and
awareness of creative accounting techniques. This paper also identifies other factors that limit
the use of creative accounting practices. Corporate governance can control the use of creative
accounting practices by acting as a watchdog. Increasing the number of outside directors in a
company increases its social responsibility, making it accountable to a larger number of people.
The presence of an external director may also reduce the use of creative accounting practices.
The results of this study reveal several outcomes. Creative accounting practices are neither
illegal nor legal, but their excessive use can lead to scandals. Strengthening internal auditors
can reduce the use of creative accounting practices. Finally, this paper explores the relationship
between creative accounting practices, government regulations/international standards, the role
of auditors, ethical values, and manipulative behaviours in financial reporting. Creative
accounting plays a significant role in financial reporting, but its excessive use can decrease the
value of financial information. Government regulations/international standards have a positive
and significant role in financial reporting if they are flexible. The comments of auditors also
play a positive and significant role in financial reporting. Ethical values play an important and
positive role in financial reporting, as they reduce manipulative behaviours. The role of ethics
in companies and financial reporting cannot be denied. Nowadays, a company's ethical values
are crucial in preventing scandals and frauds. Manipulative behaviours only serve to tarnish a
company's image.
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