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Kevin Gan Wai Ming CEA120032

Ahmad Faiz Bin Ahmad Faisal CEA12005
Ahmad Norbasyir Bin Zulkifli CEA12006
Nur Fatin Syafiqah Bt Mohd Latif CEA120072
Nuur Syukrika Bt Rodzi CEA120084

Dr. Norhayah Binti Zulkifli

Puan Suhaily Binti Shahimi
Date of submission:
18th December 2014

Table of contents
















1.0 Abstract
Creative accounting has been one of the most debated issue in the profession of accounting in
this decade. It is legal but unethical. Yet, it is still being adopted everywhere. The aim of this paper is
to study the mutual relationships between creative accounting, ethics as well as it effects to professional
development. In total, there will be six sections in this paper. The first section is where the creative
accounting will be defined. Secondly, the study of techniques of creative accounting. Thirdly, the
discussion of ethical perspective of creative accounting. The question whether creative accounting is
acceptable from the view of ethical perspective will be answered in this section. Fourthly, a study of
how the creative accounting will affect the professional development. Fifthly, the comparisons of the
pros and cons of creative accounting as a whole. Lastly, a summarization of creative accounting, ethics
and professional development to be drawn based on the discussion of this paper.

2.0 Introduction
By referring to the journal of Creative Accounting: Nature, Incidence and Ethical Issues,
creative accounting Involves the repetitive selection of accounting measurement or reporting rules in
a particular pattern, the effect of which is to report a stream of income with a smaller variation from
trend than would otherwise have appeared. (Copeland, 1968)
Besides, creative accounting can be defined as a practice of accounting, laws and regulations,
known as generally accepted accounting principles (GAAP) (Stice & Stice, 2006, p. 13). Although,
the GAAP is being followed by the persons-in-charge of the preparation of accounts, they are making
good use out of the loopholes of the accounting principles and standards to falsely portray a better
image for the company itself, especially when appealing with the investors. The creative accounting
issue has also been highlighted in the movie The Procedures in 1968. Noted that the practice of
creative accounting is legal however is unethical.
Definitions of creative accounting can be varied as follow:
Is any action on the part of management which affects reported income and which provides
no true economic advantage to the organization and may in fact, in the long-term, be
detrimental. (Merchant and Rockness, 1994)
Involves the repetitive selection of accounting measurement or reporting rules in a particular
pattern, the effect of which is to report a stream of income with a smaller variation from trend
than would otherwise have appeared. (Copeland, 1968)

This paper should give a better understanding to the readers about creative accounting roles in
the industry, the pros and cons of creative accounting, as well as the perspective of creative accounting
from the ethical and professional development view. We may as well see, how creative the accountants
and managers in manipulating the concept to serve its purposes.

3.0 The Techniques of Creative Accounting

There are many ways creative accounting can manipulate the financial statement. Some of creative
accounting practices are outlined below.
3.1 Off-Balance Sheet Finance
Off-balance sheet financing (OBSF) is a form of financing in which huge capital expenses are
kept off of a companys balance-sheet through different classification ways. This is an effective
technique because auditors would face a hard time to detect it. Companies always use OBSF to keep
their debt to equity and leverage ratio low. By using OBSF, companies are able to show better debt
ratios. Therefore, the companies can loan more money but at the same time still maintain a good debt
ratio required by lenders and put on a good face for investors (Mathews and Perera, 1996). However,
OBSF has a weakness in which it will bring a long term problem of repaying the loan back to the
lender in future. Another example of OBSF is operating leases. The lessee only report the required
rental expense for the use of asset and the asset itself is kept on the lessors balance sheet.
3.2 Extraordinary Items
Extraordinary item is an accounting entry that will reflect materially-large cost or materiallylarge revenue that is not likely to occur and which does not derive from firms normal line of business.
Due to the broad definitions of extraordinary item, many companies considerably have the discretion
in classifying item as extraordinary. The company may wrongly use of extraordinary item category
to reduce some companys tax income (Naser, 1993). Besides, the company can easily manipulate
their return on equity (ROI) and return on asset (ROA) to get a better net profit after tax. Some firms
use it to make their financial look better or worse than they actually are. The manager tries to
manipulate the financial performance by using extraordinary item regarding of their interests.

3.3 Income Recognition

Income recognition is one of the famous creative accounting methods. Companies might make
improper revenue recognition. They might accelerate or postpone income recognition in regards of
their companys interest. Accelerating or postponing income recognition is a good tool for the
companies whose earnings are spread over more than two accounting period. An example of improper
revenue recognition is where the company might manipulate revenue figure by posting sales before
they are made or prior to payment such as include recording item shipments as sales. As a result, they
might overstate the companys asset by recognizing the sales revenue.
3.4 New Management and the Big Bath
According to Amat and Blake (1999) Big Bath accounting is a technique where a new
manager takes over responsibility and there is an intention to make provisions to ensure that any losses
appear as the responsibility of the previous manager. Big Bath is a term to show a different between
former negative period and a new positive period. They will incur as many expenses in the present
period, with the result increase in profit in the next financial period. Big Bath is one of the creative
accounting methods because it uses accounting choices for bad motive rather than to show financial
3.6 Acquisitions
The rule of acquisition is the companies have to attribute fair values to the asset and liabilities
they acquired. The acquisition price is designated as in-process research. The managers have
tendency to overstate the restructuring charges over actual charge, sometimes this is called as cookies
jar. By including provision for future losses, future profit could be protected. It is an arrangement
which make the balance sheet weak while flattering future earnings. As investors pay more intention
to earnings, the declining in balance sheet is being overseen.

3.0 Ethical Perspective of Creative Accounting

Ethics is about how people ought to act to be moral (Buchholz and Rosenthal 2005, p.314)
by setting a standards of good or bad, or right or wrong (Schermerhorn 2002, p. 146) or permissible
in ones conduct (Buchanan 1998). Meanwhile, business ethics focuses on how we use and should use
traditional ethical views to evaluate how institutions orchestrate human behavior (Dienhart 2000).
People make decision differently in business than at home. The factors that affect the ethical decision
making process in business are wider such as the ethical issue intensity, individual factors and
organizational factors.
Ethics is made up of few elements which are law and professional code of conduct. Some
people believed that if an action is legal then it is right although it is unethical. Rule-based approach
provides an accountant or individuals to operate near to the limit without breaking the rules. On the
other hand, Generally Accepted Accounting Principles (GAAP) leave plenty of wiggle room for
those inclined to dupe unsophisticated investors while remaining within the letter of the law (Kahn
2000). For instance, in the case of computing depreciation, accountants have several methods from
which they may choose such as straight line and declining balance.
According to the survey done by Australia Leung and Cooper (1995) the top three ethical
problems in an organization were conflict of interest, client proposals to manipulate accounts and client
proposals for tax evasion. Agency theory argued for company directors to take care of the interests of
the shareholders. Meanwhile, stakeholder theory argued for wider scope of relationship between the
company not only with the shareholders but also with the societies. Being an ethical organization does
help in sustaining the growth and long run of the organization.
There are three theories of ethics which can used to describe the ethical decisions made in creative
accounting which are teleological theory, deontological theory and ethical relativism theory.

3.1 Teleological theory

The term teleological is a Greek word referring to goal. This teleological theory is a
consequentialist approach also known as utilitarianism which based the moral judgment on the
outcomes of a certain action. The moral judgment in these theories is thus based on the intended
outcomes (Ruland 1984), the aims or the goals of a certain action. This theory looks at the ends rather
than the means. Utilitarianism theory holds a principle where the greatest amount of benefits are for
the greatest amount of people. Hence, cost-benefit analysis in accounting is considered similar to
utilitarianism but in a smaller scope.
In the context of creative accounting, a creative accountant would definitely consider the
reactions of financial statement users before adopting the creative accounting techniques such as
income smoothing and introduction of extraordinary items. The pressure from the management and
clients to manipulate the accounts would affect the ethical decisions of accountants. The consequences
of not following order would definitely cost them to lose their job. Ethical egoism is one of the extreme
form of teleological ethics. An egoist will choose decision that will which benefits himself or herself
to the greatest extent. In the other words, an egoist is known as selfish. Accountants might see the
abuse of accounting rules as falling within their domain and therefore demanding their ethical
judgment, while the manipulation of transactions falls within the domain of management and so is not
subject to the same ethical code (Merchant and Rockness 1994).
3.2 Deontological theory
This theory is based on the Greek word for duty, where a duty for a situation is being deduced
by looking at the desirability of principles. Deontological is a non-consequentialist theory. The
decision made is not based on the desirability of the consequences but based the moral judgment on
the underlying principles of the decision-makers motivation. It is not because we like the
consequences they produce so the action is right or wrong but because the underlying principles are
morally right.

People are likely to be in ethical dilemma if they apply the deontological theory compared to
teleological which has clear cut answer to an issue by weighing the advantages to the disadvantages.
For instance, an accountant can just listen to the order of his or her manager to manipulate the income
statement since by doing so, he or she would not lose job as from the perspective of utilitarianism.
However, if the accountant is an ethical person who holds strongly to the five fundamental principles
of professional accountants that conducting a fraud is totally wrong as it will blinded the users of
income statement from the true disclosure, then he or she would definitely encounters an ethical
dilemma. Possibly, the accountants will not follow the order of their superior.
3.3 Ethical relativism theory
Ethical relativism is the view that there are no universal moral rules. What is morally good in
one context may be morally bad in another. There is no rational way of determining whether an action
is morally right or wrong because different societies have different ethical beliefs unless by asking the
people of this or that society believe it is morally right or wrong. In other words, relativists argued that
there are no ethical standards that are absolutely true and that apply or should be applied to the
companies and people of the societies.
Relativism believes that something is morally right for the people or companies in one
particular society if it accords with their moral standards and vice versa. For instance, the people of
certain Arab societies hold that business bribery is morally acceptable, although the Americans believe
it is immoral. The ethical relativist will conclude that, although it is wrong for an American
multinational to bribe in America, it is not wrong for Arabs or their companies to bribe in their own
society. One of the factors that affect ethical decision making is the organizational factor. If the culture
in the organization allows for creative accounting to be practiced then there would have no issues of
unethical conduct arises as the organization culture believed it is morally right to do so.

4.0 Creative Accounting and Professional Development

Professional development in the scope of accounting is define as a process of improving and
increasing capabilities of an accountant through the learning and training opportunities in the
workplace, influenced by the spirit to learn and work with competent. Professional development also
helps to build and maintain morale of the employees, and is thought to attract higher quality employee
to an organization. The purpose of the professional development on scope of accounting is to provide
a broad range of programs and services designed to sustain and enhance the skills of members and
financial professionals.
It is important for us to uphold the principles and values of the social group that we are in.
Reputation takes times to be built while to save back a tarnished reputation takes double or maybe
triple the initial times. Same goes to the professional accountants as well, accounting being categorized
as a professional profession implied that community see the accounting as a trustable and integrity
profession. If professional accountants involved in frauds or negative activities, surely it will affect the
professional development of accountants. The publics will not trust the profession anymore. Therefore,
it is important to have standards or guidelines in every professional body to regulate the behaviors of
its members for them to act align with the rest.
There are five fundamental principles of code of ethics for professional accountants which are
integrity, objectivity, professional competence and due care; and professional behaviors. Breach of
code of ethic may be cause by lack of independence, conflict of interest, insider trading and fraud.
Although, there is guidelines code from IFAC, some practitioners are still willing to sacrifice for their
own interest and purposes (FEE, 2009). Lack of independence among accounting practitioners is a
main cause to many corporate scandals around the world.
The principle of integrity explained about the obligation of all professional accountants to be
honest and straightforward in their business relationships. It also emphasizes on truthfulness and fair

dealing with all transaction occurred in the company. All transactions must be approved with the right
procedure and had been authorized by the right person on its. Breach of it will resulting in heavy
punishments. For instance, Tyco executives were sentenced up to 25 years in prison after stealing by
manipulating the figures in financial statement of the company. In the case of professional accountants,
they should not make the misleading statement and materially false the report or communication of
information. An accountant also must expertise on the preparation of financial statement to prevent the
information furnished recklessly. The information provided should be clear and not contained in any
confusion that may be convicted. Creative accounting also should be avoided because it can challenges
the integrity of the professional accountants.
Objectivity discussed about an obligation of all professional accountants not to sacrifice their
professional and business judgment because of own interest and the undue influence of others. For
example, objectivity of Arthur Anderson who was the external auditor of Enron was impaired.
Anderson helped Enron cheated on its financial statements with overstated Enron profits 20 per cent
of it's earning for the 4 years, to prevent the loss of his important clients. Relationships that unduly
influence the professional judgment of the professional accountant should be avoided. In addition,
objectivity principles also can be explained further with the auditing aspects. Internal auditor is an
employee in a company and depends on management for salary and remuneration. So, he or she might
be biased in favor of management. For example, internal auditor does not report to the audit committee
when he or she discovered fraud because management threatened them to keep silent. Internal auditor
who afraid to lose their job in the company or being offers a high bonus may just follow the
management favor.
Professional competence and due care describes the obligations of professional accountants on
maintaining professional knowledge and skills at the level required. This is to ensure that employers
or clients receive competent professional service in their organization. While providing professional
services, an accountant should act diligently and technically with the applicable technic and

professional standards based on their expertise and regulations to show due care. Apart from that,
maintenance and attainment of professional competence are also important. Competence can be
clarified in many definitions such as a performance at workplace, applied what you already learned
and a focus on output rather than input (Brown & McCartney, 1994). Ethical competence also
distinguish between simply having skills and expertise, and having a true sense of professionalism,
(Parn, 2007).
Lastly, the principle of professional behaviour explained about the obligation of professional
accountants to comply with regulations and relevant laws, and also avoid any behaviour that may bring
discredit to the profession. This also includes give all relevant information to third party, which as the
result gives negative effects the reputation of the accounting profession. Professional accountants
should be truthful and honest. They should show good manners in accordance with those holding
positions as a professional accountant. As an example, an accountant cannot make exaggerated claims
for the services. All the claims, should under consideration from the business and the accountant
qualifications. Also, an accountant cannot critics and makes comparisons to the work of others.


5.0 Arguments for and against creative accounting

There are pros and cons from the introduction of creative accounting into a company. It is
called as creative because the owners of the company are using their imagination to provide a clever
idea or creative attitude that does not based on accountants or tax laws in preparing financial
statement. It is also known as a process whereby accountants use their accounting knowledge to
manipulate the figures reported in the accounts of a business (Amat, Blake, & Dowds, 1999).
Significantly, it does not break any laws. However, it must be stressed out that creative accounting is
not always bad (Mathews and Perera, 1996).
5.1 Arguments for creative accounting
a) Maintain or increase the share price
A positive share price growth implies a good image of a particular company. A stable and
higher share price are one of the objectives in every company because it will helps the company to
raise new capital from the issuance of new shares and in takeover attempts. In order to meet this
objective, the financial statement would have to look profitable. If not, the management can adopt
creative accounting by manipulating financial data such as decreasing the apparent levels of debt to
lower risk and increase the appearance of profit . This include recording the expenses as investments
and loans as profit. Consequently, debt level will decreases and showing the appearance of a good
profit trend. Whereby, a good profit will raise demands for shares and the higher demand of shares
that subsequently will increase the share price.
b) To gain a greater amount of loan
Every borrower will only lend their money to company that has high probability to payback
their money. Generally, the company must own a good debt ratio and good appearance profit.
Companies will also need loan to expand their businesses and in financing the day-to-day operations.
Usually, a new organization (not the new established company) will need a lot of money to start or

improve their business. Therefore, by using one mode of creative accounting, Off-Balance Sheet
Finance (OBSF), the company may gain a greater amount of loan from borrower. This is because of
the true financial position of the company in relations to its debt is distorted as it does not disclose
certain information in report. With that, companies are able to appear with appropriate debt ratio that
required by borrower in order to borrow more money (Mathews and Perera, 1996). As a result, not
everything that looks like profit is really a profit after the implementation of creative accounting.
c) To meet the internal expectations of company
A manager is responsible for managing company towards achieving the objectives and
company's expectations that has been made. Internal expectations can be categorized into various parts.
For instance, a forecast to get higher target on sales, profit and share price. These forecast will give
pressure to company that has poor performance and at the end, would push the manager to implement
the creative accounting. Creative accounting is legal for the manager to adopt however it is unethical
as there will be a gap between the actual performance of the firm and analysts expectations.
Managers have to make sure the accounts came out as expected in order to secure their job. An
example of creative accounting techniques that likely to be use was timing of a sales transaction. To
illustrate, if a company own a building that worth RM150,000 at historic costs, which is the book value
amount on the financial statements, and that building now has a current market value of RM800,000,
manager can freely choose whether to sell it now or not. Certainly, if company performance has
reached the forecast performance of the company, the best accounting option for company is not sell
the investment now. According to Hooper (1999), because of the discretionary nature of accounting,
it will always involve choices.


d) To meet the external expectations of company

Besides, manager also responsible for managing company towards achieving the company
external expectations according to agency and stakeholder theory. For instance, the external parties are
shareholders, employees, customers, suppliers and societies. Shareholders expect for their wealth
maximization. Customers expect a long term survival of the company for their interest. While for
suppliers, they want assurance of payment and long term relationship with the company. Therefore,
whenever the company is not performing, the manager will instruct their accountants to use creative
accounting techniques in order to meet the stakeholders expectations.
Moreover, a company has the option of deciding on an accounting method "that gives their
preferred image" (Amat and Blakee et. al, 1999). This fact really helps manager bring the company
toward achieving their goals. However, because of scare from losing their job the staffs may easily be
placed in difficult ethical situation. As according to Kahn (2000, p. 91), staff have been fired for
questioning inappropriate accounting practices.
5.2 Arguments against creative accounting
Not all managers agree with the implementation of creative accounting techniques in their
company. Some of them may think that it is not ethical. Whereby, it happens because of insufficient
personal skill, irresponsibility and unwillingness to involve in detailed analysis (Breton and Taffler,
a) Blindfold the investors
Basically, investors invest in a company because of the growth prospect and the positive
financial performance of the company. However, noted that the company is not providing a true and
fair view of its performance. Adoption of creative accounting lead to manipulation of financial
statement. Apparently, the company is not gaining profit although the financial statement showed
profit. Hence, investors are being fooled by the false representation from the management of company.

The practices of creative accounting make the information from financial statements become
unreliable and none useful anymore for investors to use it for the purpose of decision making.
In the real world situation, investors will find a company that clearly void the implementation
of creative accounting practices to invest. Nonetheless, it illustrates that its fruitless to invest
elsewhere in the world as the practice of creative accounting seems to be happening everywhere. Also,
Kraus (1999: p. 1) said, Dont believe any figures you get as there are unseen risk. This is the followup of the worldwide spread of this creative accounting practice in companies.
b) Effect the integrity of the profession
Fraud in reporting usually occurs among those above management level. According to Jones
(2011, p. 21), the concept of creative accounting has developed over time under the pressure of users,
such as managers, accountant, auditors, regulators, shareholders, and others. This situation will bring
a negative perception about the professions. Till some accounting practices that are legal to use
becomes suspicious by outsiders. Financial statement has to be transparent from any erroneous
activities. When creative accounting is used to create fraud, it will dampen the reputation of
professional accountants that prepared it. Consequently, it will creates a bad perception towards the
accounting profession. As a professional accountant, there is a duty to act professionally in order to
uphold the image of the profession. Reputation takes years to build while a tarnished reputation will
take double effort of building the initial reputation.
c) Effect the long run of business
The practices of creative accounting do give a benefit to business. However, it also effect the
long run of business. Norgard (1987) argued that many companies use creative accounting methods to
maintain their profits or minimize their losses. On top of that, an accountant did some changes to their
debit and credit entries which is no longer showing a true and fair view representations.


At first, auditor may fail to detect it. Somehow, when the same things always happen to the
company, this unethical practice will be detected and the company may be banned by many
stakeholders. Here David Brown, a Canadian corporate regulator make a comparison between
companies that applies creative accounting to athletes on steroids. Athletes that took steroids not
allowed to involve race and banned from competing again in a period. Then he said, a similar
punishment should be applies to company that practiced creative accounting to misrepresent their
d) Vibrant demand for creative compliant.
Can creative accounting ever be stopped? It is a big question. However, the answer is probably
not. Creative accounting practices has become a part of business nature because it is the best way and
easy way to set up a desired value and to attract stakeholders. Good ethical not be considered when
profit maximization is main priority of companys objective.
Moreover, Griffiths also mentioned that there is nothing to eliminate creative accounting when
the imposition of standards seems more sophisticated forms of financial manipulation. Due to that, it
is not impossible that vibrant demand for creative compliance will happen. In the end, there will be a
creative accounting arms race. So, all stakeholders must be aware in making any decision. Lastly,
deeply said by Austin Mitchell, manipulative accounting could be a name for creative accounting since
it has more in common with the massage parlour than the creativity of the literary salon.


In conclusion, one may think accounting is a clear-cut issue, but creative accounting sure is not.
However, creative accounting is not genuine illegal, but on the other hand, it is not widely promoted.
Managers and accountants may employ creative accounting or do it by themselves for the best interest
of the firm. Although they must follow generally accepted accounting principles (GAAP) while
completing financial statements, still, there is loopholes in the framework that allowed for
manipulations of certain items in financial statements.
It is impossible to impose similar standards in this world because of several reasons such as the
status of the country, the size of the businesses and the nature of the business operations. Hence, many
techniques were introduced and practiced by the accountants for the earning management. Next,
creative accounting is deemed as legal as long as it does not lead to fraud but from the ethics
perspective it is an unethical act. There are many ethical theories to support the arguments for and
against the implementation of creative accounting. No fines or punishments could be enforced on
someone as long as it is still legally right. Noted that, an action is deemed ethical or not is based on
the ethical theory that he held.
A bad sprout in a family will destroy the image or reputation of the family members as a
generalization. Same goes to the profession of accountants as well. Professional accountants accused
of misleading the users of financial statement and being convicted with frauds will leave a bad
impression to the community regarding the profession. Working in a professional field required the
practitioners to obey the standards and regulations that have been set. As for the case of professional
accountants, it is stated in one of the fundamental principles which is personal behavior where an
accountant has to comply with relevant laws and regulations and should avoid any action that discredits
the profession.


Should creative accounting practice be totally restricted? This is a point to be pondered on.
There are pros and cons of creative accounting. However, it is hard to come to a consensus whether it
is completely bad because different parties have different point of view. For instances, from the
perspective of the company, they may think that creative accounting is necessary to drive their
performance and might as well make it as a culture of the organization. On the other hand, from the
perspective of the stakeholders, the investors to be precise, they are strongly against creative
accounting as it denied them a truth picture of the companys performance. Hence, the practice of
creative accounting is debatable and further research and study have to be done.



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