Sep 11, 2014

Possible Advantages of Creative Accounting

Creative accounting simply means income or earnings smoothing. It may be referred to as cosmetic accounting whereby accountants tend to manage their corporations earnings. United States use the term earnings management while Europe call it creative accounting.

Creative accounting does involve some manipulation in financial statements, especially the balance sheet. The benefits and drawbacks vary with different scenarios. For instance, if a country follows very conservative accounting systems it would have a pronounced impact of creative accounting because of the accumulation of high level of provisions. Some companies have specifically designed such accounting policies within the context of general accounting rules, and these custom accounting policies are then used to match reported income with the forecasted profit in a year. Benefit lies in the situations where these companies sell their services and/ or products, and a big pie of profit is deferred to near-term fiscal accounting periods.

Strategic Insights into Creative Accounting

Similarly when a company expects a bad loss, it tends to capitalize on the actual big loss by reporting an increased loss. This tendency of maximizing the reported annual loss is done to make the performance of company in future years more lucrative and progressive. The accountants call this concept as big bath. A creative accountant can utilize the concept of income smoothing to hold and enhance his/ her companys share price. S/he will show to the outer world as the apparent level of borrowing is declining and the firm is observing less exposure to risk as well as increasing trend in profits. This will support the firm in multiple strategic dimensions such as to issue new shares for raising the capital, to offer its own shares in buyout bids, and to resist acquisition and takeover by other corporate entities.

In conditions of insider dealing. the company directors create delay in releasing information for the market so that they can improve their chance to gain from insider knowledge.

Motivations behind Creative Accounting

Financial analysts have some key motivating factors behind the application of creative accounting. The analysts are of the view that earnings management may prove beneficial for the valuation of company securities and the reduction of risk. Creative accounting comes into play when the accountants have high expectations for a large number of capital market transactions, and/ or when they foresee a gap between an enterprises actual performance and their own anticipations.

Money-spinning attractions

The elements of creative accounting practices do exist in the corporate world today. It is an ever increasing wish of the companies to present a steady trend of progress in profit instead of reporting volatile profits with dramatic upswings and downswings. So, the creative accountants undertake this phenomenon in good intentions to promote their companies.