A set of accounting practices that are meant to show compliance with principles and rules (such as those prescribed by accounting standards), but only within the letter of these principles and rules, and at the expense of their spirit (the so-called substance versus form). This is done by manipulating accounting figures and information provided in the financial statements of an entity. Creative accounting exploits the flexibility of such principles and rules to the effect of preparing financial statements that divert from the intended treatment and presentation set out in these standards. An example of creative accounting practices is a management’s attempts to increase the amount of reported profits in order to give grounds for payment of dividends (or payment of higher dividends) to shareholders.
The main tools of creative accounting include window dressing and off-balance-sheet reporting. In general, window dressing involves all deceptive intervention to manipulate balances within a specific financial period/ year and beyond or record specific events or transactions that occur after the close of a current year’s accounts in a bid to make matters seem better at the ending date of a financial period.
Off-balance-sheet reporting involves the removal of liabilities from the statement of financial position (SFP), especially in cases where an entity finds itself at risk of having too much debt on its balance sheet and as a result breaching its loan covenants towards lenders.
Overall, methods of creative accounting might be countless, and new methods appear over time as the realm of accounting practices widens and gets more complicated and diverse.
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