Creative Accounting - Why it's so not creative anymore

To be creative implies creating something that is unique, something new, something original. Well, creative accounting fails in all those respects unfortunately.

So what is creative accounting exactly? Why is it not such a nice thing? Why does it pop up everytime we discuss financial standards and corporate governance?

Creative accounting, to be put simply is earnings management. Earnings management, is a fancy way of saying 'fudging the numbers'.
Creative accounting has its root in baking terminology. Say you baked a cake, and the cake came out all broken, twisted, crumbly and ugly. Yuck. So in order to fix it, you slather on some icing, pop out some fondant hearts and put a little cherry rose on top. Fixed! It looks presentable, its creative baking at its best! But when you cut the cake, it falls apart like the crumbly heap that it is. (In the interests of full and fair disclosure, I am a big fan of baking).

Creative accounting is the icing that goes on top of ugly cakes. It masks the realities of a financially distressed company and it misrepresents the information that is being shown to stakeholders. Creative accounting is like the make-up that goes on to hide the blemishes, the paint that is used to cover the cracks, the silicone implants that create the illusion of curves and... well I could go on but you get the point.

Creative accounting is usually done by manipulating the figures in the accounts. This can mean an overstatement of sales or an understatement of expenses. More often than not, creative accounting is used to avoid or reduce the amount of tax payable. Companies can come up with creative expense accounts, thus lowering their profits and lowering the amount of tax they have to pay. A common way of bumping up the expenses is to hire a close family member for a 'consulting' job, bill the company for 'consulting expenses' and manipulate the cost for the 'consulting' expense. That is creative accounting at its most basic level. And almost everyone does it.

So when a lot of businesses do it, it stops being creative and it starts being downright sneaky. This means that the government is being cheated out of several hundreds and thousands of revenue! (Now now, don't get started on Government misappropriation of funds, this isn't the blog for it!). Of course at that level, its hard to police and quite frankly, paying a close family member for a consulting job isn't illegal (though it may be ethically questionable). What can get you landed in jail is if you fail to meet the financial reporting requirements when preparing the accounts for a publicly-listed company.

Offshore accounts, special investment vehicles, overseas joint ventures, these are some of the ways bigger (badder) companies 'manage' their earnings (by manage I mean massage, by massage I mean messing up the numbers!). By shifting their losses or profits to these external ventures, companies are able to creatively cook up the numbers and present a financial situation which is appealing to their stakeholders.

Unfortunately, creative accounting has its limits, and like the crumbly cake which is held together by icing, it tends to fall apart when you take a few good cuts out of the company, i mean cake, or company. Gah. Baking metaphors.

So remember: Creative accounting, just like cake icing,  isn't creative (yes, icing is a cheating way of covering up baking inadequacies!), it may look good, but its bad for you!