Creative accountant presents real transactions in an imaginative manner. He breaks no laws, he only bends them! No wealth is created in real terms. In most cases, what is highlighted as current year’s performance was either achieved last year, or it is what would actually materialize or accrue to the business next year or, worse, what might not happen in the foreseeable future?
The statement of accounting policies contains the clue to most of the creations of the creative accountant. An analyst having a good knowledge of the Accounting Standards and relevant legal frame-work can easily read between the lines of a ‘window dressed’ financial statement. Windows dressing is the technique by which financial statements are made to reveal a better picture than what they really are.
Inflating sales are recording bogus sales in the last few days and showing the same as sale returns in the next accounting year. This was resorted to by a company, a joint venture with American collaboration, to present an impressive picture just before going for the public issue. The fraud was detected later and the company had to refund the entire share capital. There should be some parity between growth rates of sales and earnings. If it is not seen, thorough analysis is needed.
All inter-divisional sales should be excluded to evaluate the performance. Sales to associate, parent or subsidiary should also be examined critically. Inflating sales compare the top-line growth rate of the enterprise with that of the industry.
Some companies manufacturing capital equipment and selling on hire-purchase basis might book the entire amount as sales for the year even though actual revenue receipt is spread over several years.
Expenditure or Asset?
All major capital expenditures need to be analyzed to find out whether they really refer to acquisition of assets having utility over a period of time or it is just an effort to capitalize on revenue expenditure. It is a common practice to classify a current liability as a deferred liability. Some creative accountant goes a step further – they show a liability as income.
Advance payment or even short term deposits received are sometimes shown as revenue. Deferred sales tax liability is not segregated and shown separately as a deferred liability or a current liability and the amount is shown as part of the NW. Carefully examine all sources of ‘income’ and the composition of all liabilities
Sale & Lease Back of Assets:
To boost sagging fortunes, some companies resort to the sale and lease back of existing assets. Simply put, an existing machine is ‘sold’ to an associate/ a friendly obliging finance company at the prevailing market price and profit is booked, and simultaneously, the same machine is taken back on lease.
By delaying the declaration of commercial production, the company does not reckon the working results for the delayed period as a part of the Profit & Loss account. Net deficit, if any, is capitalized. Profit is also diminished by under-valuation of stock. The actual impact is seen in the form of a reduction in the Current Assets and the amount is siphoned-off. On other occasions, stock may be over-valued or even obsolete stock is included in the inventory to inflate the advance value of the stock.
Revaluation of Fixed Assets:
Yet another way of manipulating profits is by changing the method of depreciation or, alternatively, not showing consistency in the application of the prescribed minimum rates. Capitalized Expenditure is not charged to Profit & Loss account and is, amortized directly against reserves (this is done because profits are inadequate; there are no tax implications because tax purpose accounting is done separately)Some companies create reserves and expand the balance sheet size by way of revaluation of fixed assets.
Care should be taken to treat the revaluation reserve as a fictitious reserve and the ratios should be worked out on the basis of true net worth (i.e. consistent with the accounting treatment of fixed assets in the immediately preceding year). As per the directives of the Company Law Board, revaluation reserve is not available for distribution by way of dividends.
Wealth is ‘inflated’ by not making adequate/needed provisions for contingent or disputed liabilities or for diminution in the value of investments on the ground that such liabilities will not materialize or the diminution is a transient phase.