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A creative account is defined as a process whereby accountants use their knowledge of accounting rules to manipulate the figures reported in the accounts of a business. (Amat, Blake and Dowds, 1999)
Another definition of creative accounts is:
Use of unorthodox massage parlor techniques, which while following provision of generally accepted accounting principle (GAAP) (a desired negative or positive as the case may be) picture of a firm finances. For example, selling an asset (whose market value is high but book value is low) to create non operating profit that offsets operating loss. Unlike cooking the book, creative accounting is generally legal.
The practice of recognizing in a way that makes a company look better than it is while still conforming to the GAAP. Creative accounting seeks to inflate stock prices, for example selling assets at the end of the year to create a profit that offsets a loss. One could argue that creative accounting hides a company true financial state, but unlike aggressive accounting. It is also called financial engineering.
A main component of accounting is financial statement, where the purpose is to present a fair representation of the company's financial standing. Managers and accountants can employ creative accounting to significantly skew their financial statements. However this does not occur with all creative accounting cases.
In the United States, the financial Accounting Standards Board (FASB) set the accounting standards and rule that are knows as generally accepted accounting principle (GAAP). Although all managers and accountants must follow these principles when completing financial statements, there are perfectly legitimate techniques that can be employed when computing certain items. This is where the controversy of creative accounting surfaces. Just how creative can managers and accountants be before their actions are considered unethical?
It is extremely difficult to draw an ethical line on creative accounting when the generally accepted accounting principle often allow multiple accounting method that a company can choose from when calculating certain items. This is due to many types of business in the economy. With all of the different sizes and natures of transaction, it is extremely difficult for there to be just one accounting method for all companies to used, and therefore, multiple accounting method exits for companies to choose from . For example, in the case of computing depreciation, managers and accountants have several methods from which they may choose. Some of these are straight line, declining balance and double declining- balance depreciations. Not only can the managers and accountants select any of the multiple depreciation methods when computing depreciation cost, but they can also pick one method for depreciating one thing, such as building and another method for depreciating another thing. The depreciation example is just one of the many multiple accounting methods that a company can legally employ. Thus companies will most likely, if not probably, use the accounting method that will give them their most preferred image.
Accounting profession and organisation have been subjected to high scrutiny After major corporate scandals. Companies like Enron, Icelandic Banking, Lehman Brothers, Satyam, Arthur Anderson etc have used creative accounting techniques to fabricate their company accounts and balance sheet which indirectly resulted into bankruptcy. These corporate scandals gave birth to Sarbanes-Oxley Act in the USA. It was also stated that Use of International Financial Reporting Standards has somehow played the role in highlighting these scandals worldwide.
COMPANIES INVOLVED IN THESE ACCOUNTING PRACTICE
One of the major companies involved in the corporate scandals by fabricating the companies' accounts was Enron.
ENRON ACCOUNTING SCANDALS
HISTORY AND FACTUAL DETAILS
Enron traces its roots to the Northern Natural Gas Company, which was formed in 1932 in Omaha, Nebraska. It was reorganized in 1979 as the leading subsidiary of a holding company, InterNorth. In 1985, it bought the smaller Houston Natural Gas and changed its name to Enron in the process.
The merged company initially named itself "HNG/InterNorth Inc.", even though InterNorth was the nominal survivor. It built a large headquarters complex in Omaha. Lay the CEO, soon moved Enron's headquarters to Houston and began to thoroughly re-brand the business.
Enron was originally involved in transmitting and distributing electricity and gas throughout the United States. The company developed, built, and operated power plants and pipelines while dealing with rules of law and other infrastructures worldwide. Enron owned a large network of natural gas pipelines which stretched ocean to ocean and border to border including Northern Natural Gas, Florida Gas Transmission, Transwestern Pipeline Company and a partnership in Northern Border Pipeline from Canada. These were the cash cows that made all of the other Enron companies, ventures and investments possible. They were the only part of Enron that made significant profits. In 1998, Enron moved into the water sector, creating the Azurix Corporation, which it part-floated on the New York Stock Exchange in June 1999. Azurix failed to break into the water utility market, and one of its major concessions, in Buenos Aires, was a large-scale money-loser.
Enron grew wealthy, it claimed, via its pioneering, due largely to marketing and promoting power. Enron was named "America's Most Innovative Company" by Fortune magazine for six consecutive years, from 1996 to 2001. It was on the Fortune's "100 Best Companies to Work for in America" list in 2000, and had offices that were, in hindsight, stunning in their opulence. Enron was hailed by many, including labor and the workforce, as an overall great company, praised for its large long-term pensions, benefits for its workers and extremely effective management until its exposure in corporate fraud. The first analyst to publicly disclose Enron's financial flaws was Daniel Scotto who in August 2001 issued a report entitled "All Stressed up and no place to go" which encouraged investors to sell Enron stocks and bonds at any and all costs.
As was later discovered, many of Enron's recorded assets and profits were inflated, or even wholly fraudulent and nonexistent. Debts and losses were put into entities formed "offshore" that were not included in the firm's financial statements, and other sophisticated and arcane financial transactions between Enron and related companies were used to take unprofitable entities off the company's books.
Its most valuable asset and the largest source of honest income, the 1930s-era Northern Natural Gas, was eventually purchased back by a group of Omaha investors, who moved its headquarters back to Omaha, and is now a unit of Warren Buffett's Mid-American Energy Holdings Corp. NNG was put up as collateral for a $2.5 billion capital infusion by Dynegy Corporation when Dynegy was planning to buy Enron. When Dynegy looked closely at Enron's books, they backed out of the deal and fired their CEO, Chuck Watson. The new chairman and interim CEO, the late Daniel Dienstbier, had been president of NNG and an Enron executive at one time and an acquaintance of Warren Buffett. NNG continues to be profitable today.
The Enron scandal was a financial scandal involving Enron Corporation (former NYSE ticker symbol: ENE) and its accounting firm Arthur Andersen, that was revealed in late 2001. After a series of revelations involving irregular accounting procedures conducted throughout the 1990s, Enron was on the verge of bankruptcy by November 2001. A white knight rescue attempt by a similar, smaller energy company, Dynegy, was not viable. Enron filed for bankruptcy on December 2, 2001.
As the scandal was revealed, Enron shares dropped from over US$90.00 to less than 50Â¢. Enron's plunge occurred after revelations that much of its profits and revenue were the result of deals with special purpose entities (limited partnerships which it controlled). The result was that many of Enron's debts and the losses that it suffered were not reported in its financial statements.
In addition, the scandal caused the dissolution of Arthur Andersen, which at the time was one of the five largest accounting firms in the world.
Accounting scandal of 2001
After a series of revelations involving irregular accounting procedures bordering on fraud perpetrated throughout the 1990s involving Enron and its accounting firm Arthur Andersen, Enron stood on the verge of undergoing the largest bankruptcy in history by mid-November 2001 (the largest Chapter 11 Bankruptcy until that of Lehman Brothers on September 15 2008). A white knight rescue attempt by a similar, smaller energy company, Dynegy, was not viable.
As the scandal was revealed, Enron shares dropped from over US$90.00 to just pennies. Enron had been considered a blue chip stock, so this was an unprecedented and disastrous event in the financial world. Enron's plunge occurred after it was revealed that much of its profits and revenue were the result of deals with special purpose entities (limited partnerships which it controlled). The result was that many of Enron's debts and the losses that it suffered were not reported in its financial statements.
Enron filed for bankruptcy on December 2, 2001. In addition, the scandal caused the dissolution of Arthur Andersen, which at the time was one of the world's top accounting firms. The firm was found guilty of obstruction of justice in 2002 for destroying documents related to the Enron audit and was forced to stop auditing public companies. Although the conviction was thrown out in 2005 by the Supreme Court, the damage to the Andersen name has prevented it from returning as a viable business.
Polly Peck International (PPI)Â
Polly Peck was a small and barely profitableÂ United KingdomÂ textile companyÂ which expanded rapidly in the 1980's and became a constituent of theÂ FTSE 100 IndexÂ before it collapsed in 1991.
Early in 1980, Asil Nadir bought 58% of Polly peck shares for £270,000. He took over asÂ Chief Executive. On 8 July 1980 Polly Peck launched aÂ rights issueÂ to raise £1.5m of new capital for investments abroad.
In 1982 Nadir began the early ventures. These included Uni-Pac Packaging Industries Ltd, Voyager Kibris Ltd, and Sunzest Trading Ltd, three companies incorporated in theÂ Turkish Republic of Northern Cyprus.
In September 1982 Nadir acquired a major stake of 57% in a textile trader, Cornell, whose shares were consideredÂ penny shares.Â Cornell rose from 26p to over 100p as soon as Nadir's interest was confirmed. Nadir had Cornell sell a rights issue, raising £2.76 million. This capital, plus a further £6 million from Polly Peck, was used to set up the 'Niksar' mineral water bottling plant in Turkey. Â Niksar subsequently sold an estimated 100 million bottles of water to theÂ Middle East.
InÂ 1983, Nadir also began expanding PPI's textile business by purchasing a 76 percent stake in Santana Inc. in theÂ United States, and a majority stake in InterCity PLC in the UK. Nadir then extended PPI's textile operations into theÂ Far East, acquiring a majority stake in Impact Textile Group inÂ 1986, and by increasing PPI's existing stake in Shuihing Ltd. to 90 percent. InÂ 1987Â PPI acquired a majority interest in Palmon (UAE) Ltd., a manufacturer of casual shirts.
In AprilÂ 1984, PPI also diversified into theÂ electronicsÂ business by acquiring 82 percent ownership ofÂ Vestel Electronics, one of the largest publicly traded companies inÂ Turkey. Â PPI's success in the electronics business was substantially enhanced in early 1986 whenÂ AkaiÂ of Japan decided to join Ferguson, Salora, andÂ Gold StarÂ as licensors to Vestel. Subsequently, PPI also acquired house wares manufacturerÂ Russell Hobbs.
ByÂ 1989Â Polly Peck had become an international player by acquiring a 51% majority stake inÂ SansuiÂ (a Japanese electronics company on hard times).Â This was one of the first foreign acquisitions of a major Japanese company listed on the Tokyo Stock Exchange. Also in 1989, Polly Peck bought the formerÂ Del Monte fresh fruit division for $875 million fromÂ RJR Nabisco, which had previously acquired it.Â Polly Peck then gained the ultimate accolade of being admitted to the Financial Times 100 Share Index in 1989.
In less than ten years, under this growth-by-acquisition strategy, PPI's market capitalization went from only £300,000 to £1.7 billion at its peak.Â It became a holding company for a worldwide group of over 200 direct and indirect subsidiary companies.
With pre-tax profits of £161.4 million, net assets of £845 million and 17,227 employees, the Polly Peck group was one of Britain's top one hundred quoted companies. Polly Peck and its subsidiaries was the largest employer in Northern Cyprus (after the state) with 7,500 employees there.
In August 1990 Nadir came to the view that the Company was undervalued and then announced that he was taking it private.Â Almost as suddenly later that month he announced that he had changed his mind.
On 20 September 1990, theÂ Serious Fraud OfficeÂ (SFO) raided South Audley Management, the company that controlled the Nadir family interests.Â The raid triggered a run on Polly Peck shares with the price practically in free fall.
Trading in the company's shares was suspended on 20 September 1990. PPI's problems became apparent from the structure of the group's debts. The company had over £100 million in short-term revolving lines of credit. Even more debt consisted of long term loans for which Nadir had offered Polly Peck's shares asÂ collateral.
On 25 September 1990 the Company was placed inÂ administration.
Ultimately the company collapsed, and charges were brought against Asil Nadir for 70 charges of false accountingÂ and the theft, which he denied.
In 1991, Polly Peck Group transferred all of its Vestel Electronics shares to one of its subsidiaries, Collar Holding BV, which was based in the Netherlands. In the same year, following the collapse of the Polly Peck Group, PPI was placed in administration. In November 1994, Ahmet Nazif Zorlu acquired PPI from the administrator by buying the entire share capital of Collar Holding BV, which at the time held 82% of the Polly Peck's issued share capital.
Nadir left the UK just after his £3.5 million bail had lapsed, while the detectives who were watching him were off duty to save overtime pay on aÂ bank holiday. He remains a fugitive in Northern Cyprus, which has no diplomatic relations. Peter Diamond, the pilot who flew him out of Britain, was convicted of aiding a fugitive, but the conviction was quashed once it was determined that the bail had lapsed.
At the end of the controversy, the Serious Fraud Office and the British political establishment were both discredited. A government minister resigned, denouncing prosecuting authorities.Â A high court judge and aÂ QC were accused of a 'plot' to pervert the course of justice. TheÂ Attorney GeneralÂ had to apologies for misleading Parliament.
WORLDCOM ACCOUNTING SCANDAL
In 1998 the telecommunication industry began to drop and as a result the shares of WorldCom's were decreasing. The CEO of WorldCom Mr. Bernard Ebbers came under a tremendous pressure from banks to cover the margin cost of the company stock that was used to finance its different business operation (timber, yachting etc). The company also suffered a huge lost when it was forced to abandon its proposed merger with sprint in late 2000. During the year 2001, the CEO persuaded the other directors to provide him with corporate loan and guarantees worth $400 million. As he wanted to cover its margin calls. But this strategy of Ebbers failed and was ousted as CEO in April 2002.
From 1999 onwards continuing till May 2002, WorldCom (under the direction off Scott Sullivan (CFO), David Myers (Controller) and Buford Yates (Director of General Accounting) used shady accounting methods to cover its declining financial condition by falsely professing financial growth and profitability to increase the price of WorldCom's stock.
The fraud was accomplished in 2 main ways. Firstly, WorldCom's accounting department underreported line costs (interconnection expenses with other telecommunication companies) by capitalizing these costs on the balance sheet rather than properly expensing them. Secondly, the company inflated revenues with bogus accounting entries from corporate unallocated revenue accounts.
The discovery of this illegal activity was made by WorldCom's own internal audit department who uncovered approximately $3.8 billion of the said fraud in the year June 2002. The company's audit committee and board of directors were notified of the fraud and acted swiftly. Mr. Sullivan companies CFO was fired. David Myers the controller resigned and the Securities and Exchange Commission (SEC) launched an investigation. By the end of 2003, it was estimated that the company's total assets had been inflated by around $11 billion.
Parmalat Accounting Scandal,
Similarly like Enron Parmalat, the Italian food and dairy multinational filed for bankruptcy in December 2003. It was the biggest ever corporate failure in Europe. The scandal, also called ''Europe's Enron," broke out when Bank of America announced that a document reflecting nearly 4 billion euro's deposit in Parmalat Cayman Island subsidiary. Bonalt Financial Corporation to be counterfeit. Since the 199os, Parmalat entered into the financial markets in a grand way, expanding its presence into 30 countries from 6 by financing major acquisition with debt. It was discovered that Parmalat was using its assets to conceal its liabilities through a network of offshore and foreign companies, but the trouble was that these assets were merely imaginary. The fraud was so widespread that company profit history may almost entirely be fabricated, having claimed that its subsidiary Bonlat had sold sufficient milk powder to generate 55 gallons of milk per capita in the small island nation of Cuba in one particular year.
The scandal created quite a shockwave throughout Italy and around the world affecting a mass of victims. Parmalat's 36,000 employees in 30 countries lost their jobs, dairy farmers from as far as Brazil and Australia were not paid for the milk delivered; and 70,000 to 90,000 investors unexpectedly found their holdings of the company's stock and bonds practically worthless (Parmalat had a stock market value of 1.8 billion euro's before the scandal became public). Some major companies were also entangled by the scandal including accounting firms Grant Thornton and Deloitte and Touche and banks- Bank of America and Citicorp. Bank of America had aided Parmalat acquire $170 Million credit in Venezuela; while Citicorp found its uncollectible abruptly increase by $1.5 billion.
Included among the 11 convicted in connection with the scandal were Calisto Tanzi, Parmalat's founder and chief executive, who was sentenced for 10 yearss imprisonment for market rigging and accounting fraud in December 2008; and Fausto Tonna his chief financial officer was given 2 Â½ years sentence in 2005 for committing forgery and conceiving a web of offshore companies to hide the firm's true liabilities.
AIG Accounting Scandal
In 2005, Maurice "Hank" Greenberg was forced to resign from his position as CEO of American International Group amidst accusations of improper accounting practices. The Crisis has its origin from a transaction made in 2000 between AIG and General Re, a unit of Warren Buffett's Berkshire Hathaway at a time when AIG's reserves were considered too low according to investigations conducted by then New York Attorney General Eliot Spitzer and SEC.
General Re, a reinsurance company, is supposed to sell insurance plans to insurance companies that are trying to relieve themselves of some of the risk they have assumed from individuals and corporations. However, AIG and General Re exchanged roles in 2000 deal wherein General Re agreed to pay AIG a premium of $500 million. The transaction was not unlawful per se, but the policies General Re surrendered over to AIG involved insignificant or no risk at all. In addition, AIG was obligated to pay back over time the entire amount, which was in essence a loan. The internal probe initiated by AIG revealed that the $500 million was disguised on its books as premium revenues to boost reserves, and that may other accounting manipulations were also committed to strengthen financial performance. AIG subsequent recalculation of its financial statement resulted in the decrease of its shareholder equity by $2.7 billion, approx 3.3% reduction in company's net worth.
In 2006, a former AIG executive and 4 former General Re executives were found guilty for their participation in the deception. And in settlement of the civil suit filed by spitzer and the SEC. AIG paid a fine of $1.64 billion to resolve allegation that it resorted to fraudlent accounting to mislead regulators and investors. These scandals show the great degree of dishonesty capable of being perpetrated by the highest levels of the corporate and financial elite at the expense of public interest.