Creative Accounting Meaning Examples Top 6 Methods

Creative Accounting Meaning

There are many ways of doing it. The most popular ones are to manipulate the profit figures to eliminate excessive taxation in the future. Often, the books of accounts through which these tax figures are found are generally incorrect; the manipulation is done from the very primary level. The main adjustments regarding the accounts the management wants to manipulate are made by adjusting the figures related to employee benefits or incentives. Some companies practice creative accounting to pretend that the financial condition of their company is sound and people can invest in our companies.

Methods of Creative Accounting

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Creative Accounting (wallstreetmojo.com)

#1 – Wrong Estimation of Inventory in Stores

Some companies’ management does this type of practice to overstate the inventories’ valuation. They do this to show that their cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. read more is understood and thus tries to show the increased profits their company will earn this year.

#2 – Failures to Make Proper Contingent Liabilities

It is a very technical method of creative accounting. The contingent liabilitiesContingent LiabilitiesContingent Liabilities are the potential liabilities of the company that may arise at some future date as a result of a contingent event that is beyond the company’s control. read more are not shown properly in the notes to accounts; thus, it will give the impression that the company is not having any liability and thus is free from that.

#3 – Booking Less Expense

To show lower expenses, the company sometimes makes client payments by cash or an outdated cheque. It helps the management book the lower expenses per year, and their books of accounts will depict the fewer expenses figure, which may attract some investors.

#4 – Willfully Attempting to Manipulate Depreciation Figures and Methods

Many companies use this technique to make a good impression on their investors. The depreciation calculation method is sometimes changed by simply giving a disclaimer. No estimation increases the lifespan of the assets. The management attempts to set an arbitrary life span, usually more than expected. It thus can have a less depreciation calculated on the above and corresponding to that increases the salvage value of the assetsSalvage Value Of The AssetsSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company’s machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000.read more company’s assets. Although depreciation is cashless, the calculation of the same greatly impacts the company’s finances.

#5 – Lowering Personal Liabilities of the Company

A company does not usually tend to show its liability, so it is also a great creative accounting technique.

#6 – Manipulating Revenues and Sales Figures

It is a very basic thing most companies are doing. Sometimes they lower the sales revenueSales RevenueSales revenue refers to the income generated by any business entity by selling its goods or providing its services during the normal course of its operations. It is reported annually, quarterly or monthly as the case may be in the business entity’s income statement/profit & loss account.read more in their books to get rid of taxes, and sometimes they increase the sales figure with some arbitrary transaction to show the company’s revenue to encourage their investors.

Examples of Creative Accounting

The company raises invoices before the end of the accounting year to inflate its sales figures, but the actual transaction occurs on the post date. It is an example where the company attempts to show the boosted revenue figures.The company sometimes gives loans to their known person to willfully hide the transactions made during the year.The company arbitrarily increases an asset’s useful life to get rid of the higher depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year.
read more charged.

Advantages

Disadvantages

Although creative accounting is an ethical practiceAccounting Is An Ethical PracticeAccounting ethics refers to adhering to specific rules and guidelines established by governing bodies that every person involved in accounting should adhere to in order to prevent the misuse of financial information or their managerial position.read more, sometimes it may be treated as illegal. When the values of the books of accounts are unethically or illogically misrepresented, it can call for some qualifications.The company will always be at a high risk of losing its investors because in case the investors get to understand the manipulations, it will not be good for the company. The investor’s interest might get hampered.The biggest disadvantage is that if an expert does the manipulation, it is fine, but if not, so the literate financial director or CEO decides to make a change, it will be a problem. Therefore, this may add to the cost of hiring a financial expert.In the long run, if it is disclosed that the company does a creative accounting practiceAccounting PracticeAccounting practice is a set of procedures and controls used by an entity’s accounting department to keep track of accounting records and entries. Other reports are generated based on accounting records, such as financial statements, cash flow statements, fund flow statements, payroll, tax workings, payment and receipts statements, and so on, and they form the basis of the auditor’s reliance while auditing the financial statements.read more, then the expectation from the company by their clients will also be at risk; thus, the company may lose its business.

Conclusion

Creative accounting is an accountingAccountingAccounting is the process of processing and recording financial information on behalf of a business, and it serves as the foundation for all subsequent financial statements.read more practice that helps the company deviate from the profits and revenues for the year by following rules and regulations. It is a skill that experts use to manipulate the company accounts. The experts best handle the loopholes in the system, and the method should be ethical; otherwise, it can be a severe problem for the company’s management.

The most important thing here is that investors should be cautious while choosing investment companies. They should know the financial arrangements, which are possibly done by understanding the notes to the accounts. The management should ask about any suspicious item, and if the management cannot answer the query, the investor should not invest their money in these bogus companies.