Creative accounting

What is creative accounting?

Creative accounting is an act of using accounting choices, estimates and timing to manipulate reported results and financial position without telling users the full, honest economic story.

Common ways it is done:

1. Revenue recognition tricks

• Recognising revenue earlier than appropriate (e.g. before goods/services are really delivered).
• Using aggressive assumptions for long-term contracts so current year profit looks high.

2. Expense manipulation

• Capitalising costs that should be expensed (e.g. treating ordinary repairs as “assets”) to boost current profit.
• Deferring expenses to future periods (“parking” them under prepayments or intangible assets).
• Understating provisions (e.g. warranty, doubtful debts) so current expenses look lower.

3. Changing estimates and policies

• Extending useful lives of assets → lower depreciation now, higher profit.
• Changing inventory valuation method to improve gross profit.
• Adjusting bad debt percentages to “manage” profit.

4. Off–balance sheet and classification games

• Keeping liabilities off the balance sheet (e.g. certain leases, special purpose entities).
• Classifying liabilities as non-current instead of current to improve liquidity ratios.
• Reclassifying items in the cash flow statement to make “operating cash flow” look stronger.

5. “Big bath” behaviour

Taking huge write-offs in one bad year so future years look very good (cleaning the slate).

All of these may technically comply with standards if disclosed, but they distort the picture that users see.