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ANALYSIS
ASSIGNMENT I
Submitted By:
Saket Jhanwar
09BS0002013
Creative Accounting has been defined as any action on part of the management
which affects the reported income and which provides no true economic advantage
to the organization and may, infact, in the long term detrimental. It involves
manipulation of figures to flatter the financial position of the business. Discuss the
concept with specific reference to the motives and practices followed at
Enron
Satyam
Creative accounting, also called aggressive accounting, is the manipulation of financial
numbers, usually within the letter of the law and accounting standards, but very much
against their spirit and certainly not providing the “true and fair” view of a company that
accounts are supposed to.
A typical aim of creative accounting will be to inflate profit figures. Some companies may
also reduce reported profits in good years to smooth results. Assets and liabilities may
also be manipulated, either to remain within limits such as debt covenants, or to hide
problems.
Typical creative accounting tricks include off balance sheet financing, over-
optimistic revenue recognition and the use of exaggerated non-recurring items.
"Creative accounting" is at the root of a number of accounting scandals
ENRON SCANDLE
3. Mark-to-market accounting requires that once a long-term contract was signed, income
was estimated as the present value of net future cash flows. Often, the viability of these
contracts and their related costs were difficult to judge. Due to the large discrepancies of
attempting to match profits and cash, investors were typically given false or misleading
reports. While using the method, income from projects could be recorded, this increased
financial earnings. However, in future years, the profits could not be included, so new and
additional income had to be included from more projects to develop additional growth to
appease investors. For one contract, in July 2000, Enron and Blockbuster Video signed a
20-year agreement to introduce on-demand entertainment to various U.S. cities by year-
end. After several pilot projects, Enron recognized estimated profits of more than $110
million from the deal, even though analysts questioned the technical viability and market
demand of the service. When the network failed to work, Blockbuster pulled out of the
contract. Enron continued to recognize future profits, even though the deal resulted in a
loss.
inflated figures for cash and bank balances of Rs 5,040 crore (US$ 1.07
billion) as against Rs 5,361 crore (US$ 1.14 billion) crore reflected in the books.
an accrued interest of Rs. 376 crore (US$ 80.09 million) which was non-existent.
an understated liability of Rs. 1,230 crore (US$ 261.99 million) on account of
funds was arranged by himself.
an overstated debtors' position of Rs. 490 crore (US$ 104.37 million) (as
against Rs. 2,651 crore (US$ 564.66 million) in the books).
Raju claimed in the same letter that neither he nor the managing director had benefited
financially from the inflated revenues. He claimed that none of the board members had
any knowledge of the situation in which the company was placed.The gap in the balance
sheet has arisen purely on account of inflated profits over a period of last several years
(limited only to Satyam standalone, books of subsidiaries reflecting true performance).
What started as a marginal gap between actual operating profit and the one reflected in
the books of accounts continued to grow over the years. It has attained unmanageable
proportions as the size of the company operations grew significantly (annualized revenue
run rate of Rs 11,276 crore in the September quarter, 2008 and official reserves of Rs
8.392 crore). The differential in the real profits and the one reflected in the books was
further accentuated by the fact that the company had to carry additional resources and
assets to justify higher level of operations – thereby significantly increasing the costs.
Based on the above cases it is observed that the most common creative accounting
practices include improper revenue recognition and misreporting expenses .Hence, to
prevent creative accounting, accountants and managers should divide the duties of an
internal control checklist. Furthermore, an independent audit committee should always
have someone with a strong accounting background and audit experience who deals
directly with outside auditors. Focus on cash flow rather than income numbers.