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By Nitin Malhotra 09PT2-72 09PT2Sameer Rawal 09PT2-84 09PT2Sanjeev Kumar 09PT2-89 09PT2Saurabh Gulati 09PT2-90 09PT2Sumit Kumar Sharma 09PT2-99 09PT2-
Overview
Introduction Definitions Managerial Motivation Creative Accounting Methods of creative Accounting Research Evidence Accounting Scandals Impact of Creative Accounting and Fraud Controlling Creative Accounting and Fraud Comprehensive checklist of warning signs
Creative Accounting
Creative Accounting
Two Quotes How do you explain to an intelligent public that it is possible for two companies in the same industry to follow entirely different accounting principles and both get a true and fair audit report? M. Lafferty Every company in the country is fiddling its profits . I. Griffiths
Definitions
1. Fair Presentation
Using the flexibility within accounting to give a true and fair picture of the accounts so that they serve the interests of users.
Definitions
2. Creative Accounting
Using the flexibility within accounting to manage the measurement and presentation of the accounts so that they serve the interests of preparers.
Definitions
3. Impression Management
Using the flexibility of the accounts (especially narrative and graphs) to convey a more favourable view than is warranted of a company s results serving the interests of preparers.
Definitions
4. Fraud
Stepping outside the Regulatory Framework deliberately to give a false picture of the accounts.
Definitions
No exibi ity exibi ity to give a true and fair view exibi ity to give a creative view exibi ity to give a fraudu ent view
Working within regu atory framework to serve preparers interests Outside regu atory framework
Managerial Motivation
Managers may wish to:
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Managerial Motivation
Which company would you invest in: A or B?
Company A Year 1 1m Year 2 2m Year 3 4m Year 4 8m
4m
(1)m
15m
(3)m
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Creative Accounting
More profit?
Less profit?
Fewer assets?
Fewer liabilities?
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Changing accounting policies, particularly depreciation, asset valuations Overstating costs, particularly in regulated industries
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Capital o it
to k
11.5
os
os 11.5
eet A os os
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Company wants to acquire new premises Merchant bank sets up a special purpose company to acquire clients properties. Loans secured on properties Ownership spread over clients Company leases properties Rents pay loan interest End of initial lease, clients can i, buy leased properties; or ii, sell properties and repay
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Client Immediate access If property appreciates will gain @ Effective ownership without having to borrow No need for loan on financial statements
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Real Life
High S res in Health Che k unting te hniques in Phillips and Drew s C mpanies using the m st reative a Health Che k Comp y Britis Aerosp e M xwe Burton Group Dixons Cab e and Wire ess Blue Circle TI Group Bookers Asda Granada Next Sears LEP Laporte British Airways Tiphook Ultramar
Se tor E gineering Media Stores Stores Te ep one networks Building materials Engineering Food manufacturing Food retailer Leisure Stores Stores Business services Chemicals Transport Transport Oils
Freq e 7 7 7 6 6 5 5 5 5 5 5 5 5 5 5 5 5
Source: M.J. Jones (1992), Accounting for Growth: Surviving the Accounting Jungle, Management Accounting, Fe ruary, . 22
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Research Evidence
R a n in rea iv e a cc n in r K O ra c ice s a n ie s % 7 se d E r v isi n s n ra d in r i s E ra rd in a r c s s e n si n nds a i a isa i n a ch a r e O a a n ce sh e e d e e re cia i n rre n c is a ch Bra n d n a e s s E a rn
hi i s and re
7 7 7
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Accounting Scandals
Perennial
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Fraud
Individuals use businesses as own private bank account to plunder at will. Fictitious transactions. Transactions which break accounting rules.
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Accounting Scandals
Adecco Adelaid Steamship Adelphia Communications Ahold Albert Fisher Alstom AOL/Time Warner Argyll Foods Ashtead Associated British Ports Atlantic Computers Barchris Construction Barlow Clowes BCCI Bond Corporation Holdings Brent Walker Brentford Nylons Britannia Securities British & Commonwealth British Aerospace British Airways Authority British Printing BTR Burton Group Cendant Cisco City Equitable Fire Insurance City of Glasgow Banking Coloroll Computer Associates Conseco Consolidated Cotton Duck Continental Vending Corporate Services Group Court Line Courtaulds Cray Electronics Dynergy Eastern Counties Railway El paso Enron Equity Funding European Commission Four Seasons Nursing GEC/AEI Global Crossing Collins Holdings Grand Metropolitan Green Department Store Green Tree Financial Halliburton HealthSouth HIH Home Stake Production IBM ImClone Systems Insull Utility Investment Int l Signals and Control Interpublic Inyerstate Hosiery Mills Investors Overseas Services reditanstalt reuger & Toll Ladbroke Group
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Accounting Scandals
Leasco Lemont & Hauspit Levitt Group Lockheed London & county Securities London Capital Group Lonrho Lucent Maxwell Communications Mc esson &Robbin Micro Focus Microstrategy Minsec National Student Marketing Nortel Nvidia Oxford Health Plans Parmalet Penn Central Pergamon Press Polly Pekc Poseidon Quaity Software Products Queens Moat Houses Qwest Rank hovis McDougall Reid Murray Rite Aid Rolls Razor Rolls-Royces RollsRoyal British Bank Royal mail Steamship Rush & Tomkins Saatchi & Saatchi Skandia Spring Ram Storehouse Sunbeam Swedish Match Texas Gulf Sulphur Tiphook Trafalfar House Tyco International US Realty & Construction Vehicle & General Versailles Waste Management WorldCom WPP Xerox Yale Express Yale Transport
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Accounting Scandals
1. Maxwell Communications
i, ii, iii,
Worldwide global communications Net debts 1.5bn vs net assets 1bn Dubious methods Pledge assets and then sell Plunder pension funds Share support 7 out of 10 in creative accounting blob index
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Accounting Scandals
2. Enron collapses, 7th biggest US company.
uses special purpose vehicles to keep debts off balance sheet Treats loans as sales Swops assets and treats them as sales Creative accounting and fraud Auditors position uneasy
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Accounting Scandals
3. Other US Scandals
i, Worldcom
Capitalises revenue expenditures
ii, Xerox
Premature recognition of leasing
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Tweedie I find it frightening some people are just lifting the numbers and using them as sancrosant ... some of them would be better off driving buses - it would be safer for a lot of us
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Griffiths Rather than eliminate creative accounting the imposition of standards appears to have created more and more sophisticated forms of financial manipulation Ongoing innovations. Merchant banks develop creative compliance schemes. Succession regulatory activity since 1990s regulators strive to curb creative accounting. Vibrant demand for creative compliance . A creative accounting arms race.
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Either new business is slowing or company released some reserves to inflate revenue Pricing pressure results in lower gross margins Company may have failed to transfer the entire cost of the product from inventory Unstable gross margin could indicate accounting irregularities
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Thank You