Transcript
Creative Accounting, Fraud Creative Accounting, Fraud and Accounting Scandalsand Accounting Scandals
22
OverviewOverview IntroductionIntroductionDefinitionsDefinitionsManagerial MotivationManagerial MotivationMethods of Impression ManagementMethods of Impression ManagementCreative PresentationCreative PresentationResearch EvidenceResearch EvidenceAccounting ScandalsAccounting ScandalsImpact of Creative Accounting and FraudImpact of Creative Accounting and FraudControlling Creative Accounting and FraudControlling Creative Accounting and Fraud
33
Creative AccountingCreative Accounting
44
Two QuotesTwo Quotes
““How do you explain to an intelligent public How do you explain to an intelligent public that it is possible for two companies in the that it is possible for two companies in the same industry to follow entirely different same industry to follow entirely different accounting principles and both get a true accounting principles and both get a true and fair audit report?”and fair audit report?”
M. LaffertyM. Lafferty““Every company in the country is fiddling its Every company in the country is fiddling its
profits”.profits”.I. GriffithsI. Griffiths
55
DefinitionsDefinitions1.1. Fair PresentationFair Presentation
Using the flexibility within accounting to giveUsing the flexibility within accounting to give
a true and fair picture of the accounts soa true and fair picture of the accounts so
that they serve the interests of users.that they serve the interests of users.
66
DefinitionsDefinitions2. 2. Creative AccountingCreative Accounting
Using the flexibility within accounting to Using the flexibility within accounting to
manage the measurement and presentation manage the measurement and presentation
of the accounts so that they serve the of the accounts so that they serve the
interests of preparers.interests of preparers.
77
DefinitionsDefinitions3. 3. Impression ManagementImpression Management
Using the flexibility of the accounts Using the flexibility of the accounts
(especially narrative and graphs) to convey(especially narrative and graphs) to convey
a more favourable view than is warranted ofa more favourable view than is warranted of
a company’s results serving the interests ofa company’s results serving the interests of
preparers.preparers.
88
DefinitionsDefinitions4. 4. FraudFraud
Stepping outside the Regulatory FrameworkStepping outside the Regulatory Framework
deliberately to give a false picture of thedeliberately to give a false picture of the
accounts.accounts.
99
DefinitionsDefinitions No Flexibility to Flexibility to Flexibility to Flexibility give a “true give a creative give a fraudulent and fair” view view view Regulatory framework Working within Working within Working outside eliminates accounting regulatory framework regulatory framework regulatory choice to ensure users’ to serve preparers’ framework interests interests Within regulatory framework Outside regulatory framework
1010
Managerial MotivationManagerial Motivation
Managers may wish to:Managers may wish to:
Boost profits to benefit fromBoost profits to benefit fromi,i, Profit related payProfit related payii,ii, Shares and share optionsShares and share options
Manage gearingManage gearing
Profit-smoothProfit-smooth
1111
Managerial MotivationManagerial MotivationWhich company would you invest in: A or B?Which company would you invest in: A or B?
CompanyCompany Year 1Year 1 Year 2Year 2 Year 3Year 3 Year Year 44
AA £1m£1m £2m£2m £4m£4m £8m£8m
BB £4m£4m £(1)m£(1)m £15m£15m£(3)m£(3)m
1212
Methods of Creative Methods of Creative Accounting 1Accounting 1
Innumerable, but managers can, for example, Innumerable, but managers can, for example, manipulate income, expenses, assets and manipulate income, expenses, assets and
liabilitiesliabilities
1.1.Income RecognitionIncome Recognition2. Interest payable e.g., capitalisation2. Interest payable e.g., capitalisation3.3.StockStock4.4.DepreciationDepreciation5.5.Goodwill and IntangiblesGoodwill and Intangibles6.6.Off balance sheet financingOff balance sheet financing
1313
Methods of Creative Methods of Creative Accounting II StockAccounting II Stock
Only one asset, stock, worth say 10 Only one asset, stock, worth say 10
million Euros. If capital is 5 million Euros and this year’smillion Euros. If capital is 5 million Euros and this year’s
profit is 5 million Euros, then balance sheet A:profit is 5 million Euros, then balance sheet A:
Balance Sheet A
Euros m Euros m Capital 5 Stock 10 Profit 5 10 10 The company: (1) adopts a more generous stock valuation policy (increases stock by 5 million Euros), (2) does a particularly thorough stock-check (increases stock by 1.0 million Euros). We now have balance sheet B. Balance Sheet B
Euros m Euros m Capital 5.0 Stock 11.5 Profit 6.5 11.5 11.5
1414
Methods of Creative Methods of Creative Accounting III DepreciationAccounting III Depreciation
Business ProfitBusiness Profit 10,000 Euros10,000 EurosFixed AssetsFixed Assets 100,000 Euros100,000 EurosDepreciation straight line 10 yearsDepreciation straight line 10 yearsIf company adopts 20 year asset life will this affect If company adopts 20 year asset life will this affect profit?profit?Yes:Yes: Original policyOriginal policy New policy New policy EurosEuros Euros EurosProfit before depreciationProfit before depreciation 10,000 10,000 10,00010,000DepreciationDepreciation (10,000)(10,000) (5,000)(5,000)Profit after depreciation Profit after depreciation - - 5,0005,000
Profit increases by 5,000 EurosProfit increases by 5,000 Euros
1515
Methods of Creative Methods of Creative Accounting IVAccounting IV
Simple off balance sheet financing scenarioSimple off balance sheet financing scenario Company wants to acquire new premisesCompany wants to acquire new premises Merchant bank sets up a special purpose Merchant bank sets up a special purpose
company to acquire clients properties. Loans company to acquire clients properties. Loans secured on propertiessecured on properties
Ownership spread over clientsOwnership spread over clients Company leases propertiesCompany leases properties Rents pay loan interestRents pay loan interest End of initial lease, clients can End of initial lease, clients can i, buy leased properties; ori, buy leased properties; or ii, sell properties and repayii, sell properties and repay
1616
Methods of Creative Methods of Creative Accounting VAccounting VFinancing ScenarioFinancing Scenario
BankerBanker10 year secured loan10 year secured loanReceives rentalReceives rentalCapital GuaranteedCapital Guaranteed
ClientClientImmediate accessImmediate accessIf property appreciates will gainIf property appreciates will gain Effective ownership without having to borrowEffective ownership without having to borrow No need for loan on financial statementsNo need for loan on financial statements
1717
Methods of Impression Methods of Impression ManagementManagement
1. 1. Graphs may be usedGraphs may be used
1.1. SelectivitySelectivity
2.2. Deliberately to exaggerate trendsDeliberately to exaggerate trends
2. Accounting Narratives2. Accounting Narratives
1. Selectivity1. Selectivity
2. Spin and bias2. Spin and bias
3. Emphasise good news not bad news3. Emphasise good news not bad news
1818
Research EvidenceResearch EvidenceRevsine (1991) “Research evidence is Revsine (1991) “Research evidence is
consistent consistent with the notion that managers use latitude inwith the notion that managers use latitude inexisting financial reporting to benefit existing financial reporting to benefit
themselves”.themselves”.
In Regulated Industries Managers will lobby In Regulated Industries Managers will lobby for and choose accounting policies which for and choose accounting policies which reduce their regulatory visibility reduce their regulatory visibility
Earnings management linked to variables Earnings management linked to variables such as size, risk, managerial compensationsuch as size, risk, managerial compensation
County Natwest Woodmac (1992) find that: County Natwest Woodmac (1992) find that: 1.1. 29 out of 45 UK companies which failed 29 out of 45 UK companies which failed
reported a rise in EPSreported a rise in EPS2.2. 3 out of 45 were qualified3 out of 45 were qualified
1919
Real LifeReal LifeHigh Scores in Health Check
Companies using the most creative accounting techniques in Phillips and Drew’s ‘Health Check’
Company Sector Frequency British-Aerospace Engineering 7 Maxwell Media 7 Burton Group Stores 7 Dixons Stores 6 Cable and Wireless Telephone networks 6 Blue Circle Building materials 5 TI Group Engineering 5 Bookers Food manufacturing 5 Asda Food retailer 5 Granada Leisure 5 Next Stores 5 Sears Stores 5 LEP Business services 5 Laporte Chemicals 5 British Airways Transport 5 Tiphook Transport 5 Ultramar Oils 5
Source: M.J . Jones (1992), Accounting for Growth: Surviving the Accounting Jungle, Management Accounting, February, p. 22
2020
Research EvidenceResearch EvidenceRanking of Creative Accounting Practices used by 185
Major UK Companies TYPE
NO
%
RANKING
Provisions Non-trading profits Extraordinary costs Pension funds Capitalisation Low tax charge Off balance sheet debt Depreciation Currency mismatch Brand names Earn outs
105 63 54 52 50 24 23 17 16 14 9
57 34 29 28 27 13 12 9 9 8 5
1 2 3 4 5 6 7 8 9 10 11
Phillips and Drew (1992)
2121
Accounting ScandalsAccounting Scandals PerennialPerennial
South Sea Bubble to Enron and ParmalatSouth Sea Bubble to Enron and Parmalat
Mixture of fraud and creative accounting Mixture of fraud and creative accounting
2222
FraudFraud
Individuals use businesses as own private Individuals use businesses as own private bank account to plunder at will.bank account to plunder at will.
Fictitious transactions.Fictitious transactions.
Transactions which break accounting Transactions which break accounting rules.rules.
2323
Accounting ScandalsAccounting ScandalsAdeccoAdecco British PrintingBritish Printing European CommissionEuropean CommissionAdelaid SteamshipAdelaid Steamship BTRBTR Four Seasons NursingFour Seasons NursingAdelphiaAdelphia Burton GroupBurton Group GEC/AEIGEC/AEI CommunicationsCommunications CendantCendant Global CrossingGlobal CrossingAholdAhold CiscoCisco Collins HoldingsCollins HoldingsAlbert FisherAlbert Fisher City Equitable FireCity Equitable Fire Grand MetropolitanGrand MetropolitanAlstomAlstom Insurance Insurance Green Department Green Department
StoreStoreAOL/Time WarnerAOL/Time Warner City of Glasgow BankingCity of Glasgow Banking Green Tree FinancialGreen Tree FinancialArgyll FoodsArgyll Foods ColorollColoroll HalliburtonHalliburtonAshteadAshtead Computer AssociatesComputer Associates HealthSouthHealthSouthAssociated British PortsAssociated British Ports ConsecoConseco HIHHIHAtlantic ComputersAtlantic Computers Consolidated CottonConsolidated Cotton Home Stake ProductionHome Stake ProductionBarchris ConstructionBarchris Construction Duck Duck IBMIBMBarlow ClowesBarlow Clowes Continental VendingContinental Vending ImClone SystemsImClone SystemsBCCIBCCI Corporate Services GroupCorporate Services Group Insull Utility InvestmentInsull Utility InvestmentBond CorporationBond Corporation Court LineCourt Line Int’l Signals and Int’l Signals and
ControlControl HoldingsHoldings CourtauldsCourtaulds InterpublicInterpublicBrent WalkerBrent Walker Cray ElectronicsCray Electronics Inyerstate Hosiery MillsInyerstate Hosiery MillsBrentford NylonsBrentford Nylons DynergyDynergy Investors OverseasInvestors OverseasBritannia SecuritiesBritannia Securities Eastern Counties RailwayEastern Counties Railway Services ServicesBritish & CommonwealthBritish & Commonwealth El pasoEl paso KreditanstaltKreditanstaltBritish AerospaceBritish Aerospace EnronEnron Kreuger & TollKreuger & TollBritish Airways AuthorityBritish Airways Authority Equity FundingEquity Funding Ladbroke GroupLadbroke Group
2424
Accounting ScandalsAccounting ScandalsLeascoLeasco Pergamon PressPergamon Press TiphookTiphookLemont & HauspitLemont & Hauspit Polly PekcPolly Pekc Trafalfar HouseTrafalfar HouseLevitt GroupLevitt Group PoseidonPoseidon Tyco InternationalTyco InternationalLockheedLockheed Quaity Software ProductsQuaity Software Products US Realty & US Realty &
ConstructionConstructionLondon & countyLondon & county Queens Moat HousesQueens Moat Houses Vehicle & GeneralVehicle & General SecuritiesSecurities QwestQwest VersaillesVersaillesLondon Capital GroupLondon Capital Group Rank hovis McDougallRank hovis McDougall Waste ManagementWaste ManagementLonrhoLonrho Reid MurrayReid Murray WorldComWorldComLucentLucent Rite AidRite Aid WPPWPPMaxwell CommunicationsMaxwell Communications Rolls RazorRolls Razor XeroxXeroxMcKesson &RobbinMcKesson &Robbin Rolls-RoycesRolls-Royces Yale ExpressYale ExpressMicro FocusMicro Focus Royal British BankRoyal British Bank Yale TransportYale TransportMicrostrategyMicrostrategy Royal mail SteamshipRoyal mail SteamshipMinsecMinsec Rush & TomkinsRush & TomkinsNational StudentNational Student Saatchi & SaatchiSaatchi & Saatchi MarketingMarketing SkandiaSkandiaNortelNortel Spring RamSpring RamNvidiaNvidia StorehouseStorehouseOxford Health PlansOxford Health Plans SunbeamSunbeamParmaletParmalet Swedish MatchSwedish MatchPenn CentralPenn Central Texas Gulf SulphurTexas Gulf Sulphur
2525
Accounting ScandalsAccounting ScandalsCase Studies
1. Polly Peck (charismatic chairman: Asil Nadir)
One of fastest growing UK firms in 1990s 1990 interim results analysts predict a substantial
increase. 6 days later collapses Why? a, Banks and shareholders shut their eyes b, Fraud and deception c, Accounting policies flattering
i, Brands ii, £405 million stranded in Turkey iii, Delmonte sales overestimated iv, Growth in borrowing 1985 1989 Profit 64m 139m Interest In 0.5 77.4 Out (5.7) (55.6) Cash 30 250 Borrowings 66 1106
2626
Accounting ScandalsAccounting Scandalsv, Currency v, Currency
mismatchmismatch Borrows heavily in two strong currencies DM and Swiss Francs
Deposits in weak currency Turkey
Weak currencies depreciate against strong ones
causing capital losses Capital Losses (£44.7m) in 1988, and (£170.3m) in 1989 taken direct to Reserves Interest Receivable greater than interest payable therefore P & L Gains!!
2727
Accounting ScandalsAccounting Scandals
2.2. Maxwell CommunicationsMaxwell Communications
i,i, Worldwide global communicationsWorldwide global communications
ii,ii, Net debts 1.5bn vs net assets £1bnNet debts 1.5bn vs net assets £1bn
iii,iii, Dubious methodsDubious methods Pledge assets and then sellPledge assets and then sell Plunder pension fundsPlunder pension funds Share supportShare support 7 out of 10 in creative accounting ‘blob’ 7 out of 10 in creative accounting ‘blob’
indexindex
2828
Accounting ScandalsAccounting Scandals3.3. Enron collapses, 7 Enron collapses, 7thth biggest US biggest US
company.company.
-- uses special purpose vehicles to uses special purpose vehicles to keep keep debts off balance sheetdebts off balance sheet
-- Treats loans as salesTreats loans as sales
-- Swops assets and treats them as Swops assets and treats them as salessales
-- Creative accounting and fraudCreative accounting and fraud
-- Auditors’ position uneasyAuditors’ position uneasy
2929
Accounting ScandalsAccounting Scandals4.4. Other US Scandals Other US Scandalsi,i, WorldcomWorldcom
-- Capitalises revenue expendituresCapitalises revenue expenditures
ii,ii, XeroxXerox-- Premature recognition of leasingPremature recognition of leasing
iii, Adelphi Communicationsiii, Adelphi Communications-- Rigase’s “looted company” used it as aRigase’s “looted company” used it as a
““personal piggy bank”personal piggy bank”iv, Global Crossingiv, Global Crossing
-- Swaps of capacity treated as incomeSwaps of capacity treated as income
3030
Accounting ScandalsAccounting Scandals5. Parmalat5. Parmalat
Run by charismatic Calisto TanziRun by charismatic Calisto TanziCreates fictitious salesCreates fictitious sales
e.g., double counts salese.g., double counts sales
e.g., fictitious subsidiariese.g., fictitious subsidiaries Has dubious loans treated as equityHas dubious loans treated as equityFake Bank of America account worth 5 Fake Bank of America account worth 5
billion dollarsbillion dollars
3131
Impact of Creative Accounting Impact of Creative Accounting and Fraud Iand Fraud I
i, Erodes currency of accountingi, Erodes currency of accounting““Lawyers and merchant bankers .... [should Lawyers and merchant bankers .... [should
recognise] best long term interests lie in recognise] best long term interests lie in financially prudent practices rather than in financially prudent practices rather than in resort to technical devices that, while not in resort to technical devices that, while not in conflict with the letter of accounting standards, conflict with the letter of accounting standards, impair the effectiveness of the system”impair the effectiveness of the system”
Tweedie “I find it frightening some people are Tweedie “I find it frightening some people are just lifting the numbers and using them as just lifting the numbers and using them as sancrosant ... some of them would be better off sancrosant ... some of them would be better off driving buses - it would be safer for a lot of us”driving buses - it would be safer for a lot of us”
3232
Impact of Creative Accounting and Impact of Creative Accounting and Fraud IIFraud II
ii,ii,Regulatory war of the fittestRegulatory war of the fittestGriffiths “Rather than eliminate creative Griffiths “Rather than eliminate creative
accounting the imposition of standards appears accounting the imposition of standards appears to have created more and more sophisticated to have created more and more sophisticated forms of financial manipulation”forms of financial manipulation”
Ongoing innovations. Merchant banks develop Ongoing innovations. Merchant banks develop creative compliance schemes.creative compliance schemes.
Succession regulatory activity since 1990s Succession regulatory activity since 1990s regulators strive to curb creative accountingregulators strive to curb creative accounting
Vibrant demand for creative compliance . A Vibrant demand for creative compliance . A creative accounting arms race.creative accounting arms race.
3333
Controlling Creative Controlling Creative Accounting and Fraud IIIAccounting and Fraud III
Can creative accounting and fraud ever be Can creative accounting and fraud ever be stopped?stopped?
Probably notProbably notPart of human naturePart of human natureBest we can do is set up a sound Best we can do is set up a sound
conceptual framework and sound standardsconceptual framework and sound standardsPromote good ethical conductPromote good ethical conductBe aware.Be aware.
3434
Controlling Creative Controlling Creative Accounting and FraudAccounting and Fraud
““CREATIVE ACCOUNTING COULD BE CREATIVE ACCOUNTING COULD BE
BETTER CALLED MANIPULATIVEBETTER CALLED MANIPULATIVE
ACCOUNTING BECAUSE IT HAS MORE INACCOUNTING BECAUSE IT HAS MORE IN
COMMON WITH THE MASSAGE PARLOURCOMMON WITH THE MASSAGE PARLOUR
THAN THE CREATIVITY OF THE LITERARYTHAN THE CREATIVITY OF THE LITERARY
SALON”.SALON”.
AUSTIN MITCHELLAUSTIN MITCHELL
top related