Question

How would we determine whether a company has used “creative accounting” in their financial statements?

Answer 1

Creative accounting capitalizes on loopholes in the financial accounting to give a false portray of better image of an organisation. The primary three pillars of the financial accounting are income statement, cash flow, and balance sheet. The manipulation or any creative accounting in any of these accounts would be definitely reflected in the other account. Accounts receivable has a main role in detecting the manipulation in income. The creative accounting can be detected if the reserves for doubtful debts are inadequate with the comparison of the accounts receivable to revenue and net income. An overvalued inventory can be detected by determining whether the inventory is increasing faster compared to the sales; and if there is a decline in the inventory turnover or whether the inventory is increasing faster compared to total assets.

The most widely techniques used in creative accounting are:

-- Changes in depreciation methods and accounting policies;

-- Income and expense items manipulation;

-- Manipulation of off-balance sheet financing items;

-- Changes in the money value;

-- Revenue overestimation by recording fictitious revenues from sales;

-- Receivables write-offs manipulation;

-- Accruals manipulation