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Creative Accounting exists in the complex world of finance, but in a different way, to interpret and present financial data. Creative Accounting, on the other hand, violates the law by exploiting the loopholes or gray areas between standard accounting. It is not illegal but it can sometimes make company financial statements misleading by making a company performance look more favorable. Understanding of creative accounting techniques is important for business owners, finance managers, and professionals who are looking at accounting software in Saudi.
When you are in the accounting world, especially if you are looking for the Best accounting software in Saudi Arabia, it is important to differentiate between ethical accounting practices and those that might fall on the line of legality. The right software can ensure accuracy and enforcement to the financial rules, but creative accounting provides you with an insight into how numbers are reshaped to showcase a different financial reality. Continue reading to learn about the examples of creative accounting and why one needs to be skeptical about this practice.
Creative accounting is the use of accounting practices that, while technically correct, are used to modify financial statements so that a company looks to have a better financial image. These are methods which use the gaps or ambiguity in the accounting standards and regulations that misleads the investors and stakeholders. Creative accounting is always changing to adjust to the ever evolving laws of accounting to stay within the laws. While these practices are legal in some cases, they can damage the reputation of a company and in extreme cases, become the subject of legal consequences.
Main Takeaways:
In the business world, it is very important to be able to analyze the financial health of competitor firms. But when companies opt to slip when providing information, the information the financial statements offer can be manipulated. Creative accountants know how to find a loophole or make use of some flexible accounting method so that they can present numbers in the best possible way that companies can assure they present themselves. While these methods continue to adhere to the law and therefore are legal, they manipulate revenue recognition and activity timing so that they can distort the face of the financial realities, and in turn, also mislead investors and stakeholders.
The primary goal of creative accounting is to present a firm as being more successful and profitable than it actually is. And creative accountants can take advantage of gaps in accounting regulations or ambiguities to do the same thing, saying that they inflated profits or even hidden liabilities. This improves and attracts potential investors and stakeholders by making a company’s financial situation appear better. These techniques will afford you a boost of perceived consciousness that may be temporary, but can be very damaging in the long run if detected.
Creative accounting is extremely dangerous. If found out, it can very badly harm a company’s reputation and result in legal and financial consequences. Most of the time, it is a result of the pressure to meet short term financial expectations or year end forecasts. While companies may reach creative accounting to maintain high stock price to please investors, there will be a risk of getting exposed fraudulent method. In the end, being caught can damage a business’s finances and its leadership.
Premature revenue recognition is one of the common methods of creative accounting where companies record the sale of the product before the product is delivered or the service is rendered. The technique helps businesses report higher profits in the short term. Although this strategy can give a company the appearance of greater profitability, it rarely benefits from an investor point of view, and the gap between real performance and the reported earning is enormous.
Some of these companies to reduce their reported expenses, extend the useful life of assets or increase estimated salvage value, thus reducing depreciation cost. This reduces the expense of asset over a period of time allowing its impact on finances on any given year. In the short term it can help boost profits, but it may misrepresent the truly cost of utilizing assets.
Another method of creative accounting is to delay expenses to a future period. Companies can show higher profits for the current period by delaying costs such as rent, salaries or supplier payments. This technique temporarily inflates net income and makes a company look less financially sound than it really is if costs are continually pushed forward.
A creative accountant may not record current liabilities by ignoring future costs, e.g., costs of future lawsuits, pension obligations or other contingent liabilities. This allows companies to estimate or eliminate these liabilities and artificially increase net income and equity. The first is that this can give the impression that the company is more financially stable, but it can be a risk if the liabilities ever come to pass.
Basically, inflation of goods is a common method used by the businesses to inflate the value of the goods that have not been sale to reduce the cost of goods sold (COGS). The company inflates the inventory’s value to report lower costs and higher profits. While this may temporarily provide a company with a better financial performance, it can mislead the accuracy of a company’s profit margin and the real value of its assets.
Examples of Creative Accounting from the Real World
In the 1990s, high flying energy corporation Enron, covered debt and inflated profits with creative accounting. This process of manipulation included hiding liabilities, underplaying loss and changing financial numbers to make it appear as growth. However, these practices eventually led to its collapse, and several top executives were convicted for creative accounting gone too far.
It is hard to recognize creative accounting because there are so many practices that go unnoticed until the damage is done. But investing requires skepticism and cynical looking at financial statements beyond what’s put forward by management investors to detect potential red flags. It is possible to look over accounting methods for consistency and seek any discrepancy between reported earnings and actual performance, as a sign of manipulation.
Finally, creative accounting can give a company a temporary boost to its appearance, but at a great risk. The impact of such practices might seem clever, however, it is clearly wrong and even leverage loophole in the accounting regulations to boost up a business profitability in order to create more fake performance can mislead the investors and can harm the credibility of the organization. In fact, financial statements are not to be approached lightly by either business owners or investors, because when these are thought to involve creative accounting practices, it is important that they are approached with caution. Always, transparency and compliance with set accounting standards should be the priority.
Additionally, using accounting software in Saudi or any other tool without a good grasp of the financial data may result in missing some discrepancies. However, as the world changes, so do creative accounting techniques to fit with the changing regulation. Keeping a watchful eye is important. In case you are a business owner or an investor, anything that modifies financial reports should be scrutinised, as well as known developments in accounting method to avoid being hoodwinked by bogus financial practices.
