Creative Accounting Tactics

Creative Accountants | How It Works | Examples | Production Accounting
Creative Accounting | Creative Accounting Tactics | Earnings Management
Monkey Points

Although not technically wrong, many annual and quarterly reports and presentations dive heavily into theoretical scenarios where "one time charges" to earnings are excluded. What this means is for example, a lawsuit settlement amount would be taken out of the reported profit in one big chunk, even if it is paid out little by little over time (this practice is called reserving). Often, while explaining the quarterly results, a CEO might say "well if we didn't take this charge for the lawsuit, we would have made this much money". Very often, the hypothetical situations proposed get even more complicated. The main "creative" aspect to this is when a "one time" "exceptional" charge really is something that is very common to the business.

Banks are able to lend out most of the money they receive in deposit (they also can lend money they borrow from other banks). However, to protect against bad loans, banks must keep aside a supply of money called a "reserve". The bank, within general guidelines, gets to set the size of this reserve to what it feels is prudent compared to how risky its outstanding loans are. However, when the bank wants to make it look like it made more money this quarter than last, one way to do that is to take money from the reserve and call it profit with the excuse that the loans are safer now than before and that amount was no longer needed.

One of the main genres of "creative accounting" is known as slush fund accounting, whereby some earnings from this quarter are hidden away just in case the profit from next quarter is not enough for the management to make their bonuses. This happened most famously at freddie mac. As of 2004 there is a large investigation underway to see if retroactive insurance policies from insurers such as general re of berkshire hathaway were used for slush fund accounting. The question is if these insurance policies truly transferred some risk or were merely a slush fund.

Creative accounting is not limited to large firms with banks of accountants. Smaller companies often use creative accounting, but for tax saving purposes rather than meeting bonuses or Shareholder expectations. Salaries are sometimes included in profits to benefit from corporation tax rates being lower than personal tax rates and spouses are sometimes put on the books as employees, though they may never have worked for the company. As smaller companies are generally subject to less onerous rules - and many of them fall below the limit required for a full annual audit every year - much of the creative accounting in this sector does not get a lot of publicity.

 

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