CREATIVE ACCOUNTING AND CORPORATE

GOVERNANCE: - A LITERATURE REVIEW

SONIA MUDEL

M.Phil. Scholar,

Department of Commerce, Delhi School of Economics

University of Delhi

Delhi (India)

ABSTRACT

The concept of corporate governance and creative accounting has come into picture after the big
accounting scandals (Enron, WorldCom, Satyam computers etc.).Corporate governance
represents the manner in which a company is directed and controlled and this aspect is closely
related to creative accounting practices, ownership structure, board of director’s structure, they
all can encourage or discourage creative accounting practices. Corporate governance is a
current issue with great impact on creative accounting. This paper is based on how corporate
governance seen as possible solution to reduce creative accounting practices. Occurrence of
creative accounting is related to weakness of corporate governance. The paper is structured as
follow, at first some definitions of creative accounting and corporate governance after
introduction. After that motivators of creative accounting, consequence of creative accounting ,
techniques of creative accounting , solution to these techniques, theories of corporate

Electronic copy available at: http://ssrn.com/abstract=2708464

governance are bring into attention to identify the nature , existence and incidences. After that
relation between corporate governance and creative accounting is shown. The paper continues
with a review of some code of conduct of corporate governance like SOX Act, Cadbury
committee, Blue Ribbon committee, and concludes by suggesting some solutions and
recommendations for this problem of creative accounting.

Key words: Creative accounting, corporate governance, SOX, Code of conduct.

I. INTRODUCTION

The counterattack of financial statement fraud in recent times has attracted a considerable
attention from the business community, academicians, regulations and the accounting profession.
In the US alone, over 347 public companies were alleged to have reported and present fraudulent
statement between the period 1997 to 2008(Rajan and Nasib, 2008).

In India this topic has been the most talked about subject after the collapse of SATYAM in
January 2009.Currently, there is a strong trend of cross disciplinary research on this topic. This
topic came under the spotlight as a result of chain of events, more specific series of highly
publicized giant corporate failure which have created anxiety and lack of confidence in capital
market. Enron debacle in 2001, number of other scandals involving large companies such as
Tyco, Quest, Global crossing, the World.com, Xeroz, Parmalat etc. were happened just because
of creative accounting practices. These practices were perpetuated by management and staff in
participation with the auditors.

Corporate governance is a method against creative accounting. Corporate governance is the

system by which companies are directed and controlled while creative accounting is the
transformation of financial accounting figures from what they actually are to what prepares
desire by taking undue advantage of the existing rules or by ignoring some or all of them.

Electronic copy available at: http://ssrn.com/abstract=2708464

Creative accounting is the practice which is adopted with the framework of accounting system or
in other words taking undue advantages of loopholes of accounting system. It is an art of
manipulating the books in a manner that desired results can be drawn. Corporate governance is
the relationship among various participants in determining the direction and performance of
corporations. Creative accounting is examined under two positive and negative viewpoints. From
positive viewpoint, it may seem that creative accounting connotes invention of accounting
principles and techniques to recognize changes in accounting practice. From negative viewpoint
creative accounting means undesirable practices which assimilate unethical elements of for
attracting providers of the capital by presenting a misleading and deceptive state of a certain
firm‟s affairs. The general trend identified in the literature supports the negative viewpoint.
Aggressive accountings, cooking the books, massaging the numbers are few common terms used
for creative accounting. Since the scandals have deeply influenced both the national and world
economies the concept of creative accounting and corporate governance and the ways the
tackling this problem have come in agenda of business firm and government.

II. RELEVANCE OF THE TOPIC

The purpose of the topic is to provide literature review on creative accounting practices and
corporate governance. The topic is very relevant in today‟s time because of various giant
corporate failures in various countries due to creative accounting practices and how corporate
governance came as a solution to these practices by incorporating BOD structure, independent
audit committee, and by applying various code of conduct like Sarbanes Oxley Act. Thus the
paper brings attention as how corporate governance helps in detecting and controlling these
creative accounting practices.

III. OBJECTIVE

The objectives of this paper are:

 What is the relation between creative accounting and corporate governance

  To provide literature review on above two most debated topics
 How corporate governance seen as possible solution to reduce creative accounting
practice

IV. METHODOLOGY

This paper is based on the information obtained from various secondary sources primarily
the previous articles, journals, books available, various official websites were visited to
get the required information. This paper follows fundamental approach for providing
literature review on creative accounting and corporate governance.

V. LIMITATIONS

Since the aim of the study is to do a literature review, the sampling of the literature is crucial.
Other is we used only the secondary sources from various sites and books that were written in
English language this could result a limitation of the study.

As further research involved we intend to assess empirically the association of corporate

governance features and creative accounting in the Indian economic environment since no study
has been conducted so far in this respect in India.
CONCEPTUAL FRAMEWORK ON CREATIVE ACCOUNTING
AND CORPORATE GOVERNANCE

Definitions on creative accounting

Manipulating numbers to get a favorable impression has a long history. According to Balaciu
and Vladu (2010), ambition of making figures more appealing or the opposite, if the case is
as old as 500 years and Luca Paciolo had shaped the practices of creative accounting in his
book De Arithmetica. Venetian trade men at those times recorded the transactions between
themselves by double-entry book keeping with ink and quill-pen in main and subsidiary
books. If there arose any inconsistencies the inkwell was occasionally knocked over on these
books in order to make entries illegible. This example shows that manipulative behavior of
trade or business people is not a new phenomenon and goes back to centuries ago. There are
various definitions on creative accounting; these are some from different perspective point in
US:

Ian Griffiths, writing from the perspective of a business journalist, observes every company in
the country is fiddling its profits. Every set of published accounts is based on books which have
been gently cooked or completely roasted. The figures which are fed twice a year to the investing
public have all been changed in order to protect the guilty. It is the biggest con trick since the
Trojan horse. . . In fact this deception is all in perfectly good taste. It is totally legitimate. It is
creative accounting. (1986)

Michael Jameson, writing from the perspective of the accountant, argues:

The accounting process consists of dealing with many matters of judgment and of resolving
conflicts between competing approaches to the presentation of the results of financial events and
transactions... this flexibility provides opportunities for manipulation, deceit and
misrepresentation. These activities - practiced by the less scrupulous elements of the accounting
profession - have come to be known as 'creative accounting'. (1988)

Terry Smith reports on his experience as an investment analyst:

We felt that much of the apparent growth in profits which had occurred in the 1980s was the
result of accounting sleight of hand rather than genuine economic growth, and we set out to
expose the main techniques involved, and to give live examples of companies using those
techniques. (1992)

Kamal Naser presenting an academic view offers this definition:

Creative accounting is the transformation of financial accounting figures from what they actually
are to what preparer‟s desire by taking advantage of the existing rules and/or ignoring some or all
of them. (1993)
It is interesting to observe that Naser perceives the accounting system in Anglo-Saxon countries
as particularly prone to such manipulation because of the freedom of choice it permits.

“Purposeful intervention in the external financial reporting process with the intent of obtaining
some exclusive gain”.

“The process of manipulating accounting figures by taking advantage of the loopholes in

accounting rules and the choices of measurement and disclosure practices in them to transform
financial statements from what they should be, to what preparers would prefer to see reported”.

“The process by which transactions are structured so as to produce the required accounting
results rather than reporting transactions in a neutral and consistent way”.

Many terms can be used to describe the practices of changing the facts in accounting, e.g.
cooking the books, aggressive accounting, massaging the numbers, window dressing, earnings
management, etc.
Common Labels for Financial Numbers Game
Label Definition
Aggressive Accounting A forceful and intentional choice and application of
accounting principles done in an effort to achieve desired
results, typically higher current earnings, whether the
practices followed are in accordance with GAAP or not.
Earnings management The active manipulation of earnings toward a
predetermined target, which may be set by management, a
forecast made by analysts, or a amount that is consistent
with a smoother, more sustainable earnings stream.
A form of earnings management designed to remove
Income Smoothing peaks and valleys from a normal earnings series, including
steps to reduce and “store” profits during good years for
use during slower years.
Intentional misstatements or omissions of amounts or
disclosures in financial statements, done to deceive
Fraudulent financial financial statement users, that are
reporting determined to be fraudulent by an administrative, civil, or
criminal proceeding
Any and all steps used to play the financial numbers
game, including the aggressive choice and application of
Creative accounting accounting principles, fraudulent financial reporting, and
practices any steps taken toward earnings management or income
smoothing

Source: The Financial Number Game by Charles W. Mulford & Eugene E Comiskey, 2002 (John
Wiley & Sons)

All the above definitions imply a misuse of creative accounting techniques for the purpose of
deception or attaining dishonest ends.
Motivation for Creative Accounting
Healy and Whalen [1999] summarize the major motivations to manage earnings which include
Public offerings, Regulation, Executive compensation, and financial liabilities. Schipper [1989]
provides a conceptual framework for analyzing earnings management from an informational
perspective. Beneish [2001] added insider trading in this list of motives. Managers aware of
misstatement of profits can benefit by trading the securities. Stolowy and Breton [2000] suggest
three broad objectives for earnings management: minimization of political costs; minimization of
the cost of capital and maximization of managers‟ wealth. Deangelo [1988] refers to earnings
management in buyout cases. Teoh, Welch and Wong [1998] find that firms manage earnings
prior to seasoned equity offers and
IPO‟s. Burgstahler and Eames [1998] conclude that firms manage earnings to meet financial
analysts‟ forecasts. The managers are motivated for fixing financial statements for either
managing position or profits.

Following are important concerns for managers:

(a) To meet internal targets: The managers want to cook the books for meeting internal targets
set by higher management with respect to sales, profitability and share prices.
(b) Meet external expectations: Company has to face many expectations from its stakeholders.
The Employees and customers want long term survival of the company for their interests.
Suppliers want assurance about the payment and long term relationships with the company.
Company also wants to meat analyst‟s forecasts and dividend payout pattern.
(c) Provide income smoothing: Companies want to show steady income stream to impress the
investors and to keep the share prices stable. Advocates of this approach favor it on account of
measure against the 'short-termism' of evaluating an investment on the basis of the immediate
yields. It also avoids raising expectations too high to be met by the management.
(d) Window dressing for an IPO or a loan: The window dressing can be done before corporate
events like IPO, acquisition or before taking a loan. (Sweeney (1994) reports the tendency of
companies for violation of debt covenants is two or three times to make income increasing,
accounting policy changes than other companies).
(e) Taxation: The creative accounting may also be a result of desire for some tax benefit
especially when taxable income is measured through accounting numbers.
(f) Change in management: There is another important tendency of new managers to show
losses due to poor management of old management by some provisions Dahi (1996) found this
tendency in US bank managers.

Consequences of creative accounting

The practice of creative accounting has the power to manipulate accounting figures by taking
advantage of the loopholes in accounting rules and the choices of measurement and disclosure
practices in them to transform financial statements from what they should be, to what preparers
would prefer to see reported or distort the underlying financial performance of a firm, making
more difficult for an investor or financial analyst to assess the performance of the firm and to
compare between different companies. Performance comparison that involves choosing the
benchmark that portrays current financial performance in the best possible light. They were
explaining about the positive language used to report the financial information to stakeholders,
which make them difficult to understand the language used in reporting and they invest money in
bad investment. This type of manipulation is known in the literature also under the name of
“Positive Bias “. They also explained about “Polly Anna Principle” (concept introduced by
Hildebrandt & Synder, 1988) managers used to present financial performance of the firm in the
best light possible using only positive words.
Creative Accounting practices underlie most corporate frauds and accounting scandals. It may be
difficult or completely impossible for individual stakeholders to notice the effect of accounting
manipulations because of inefficient personal skill, indifference or unwillingness to engage in
detailed analysis. Even analyst‟s perception of Creative Accounting devices is somewhat
deficient (Breton & Taffler, 1995). They argued that even the sophisticated users can
misinterpret or even ignore such clear signals. Therefore, Dechow & Skinner (2000) argued that
even if financial statements provide sufficient information to permit users to adjust for Creative
Accounting, there would still be cause for concern over the value of the information content.
This is because of the possibility that certain investors rely completely in earnings numbers
reported in the face of the income statement and their ability to process more sophisticated
information is limited. Due to Creative Accounting, Schiff (1993:94) has warned the investors
who take a company‟s financial statements at face value can be „a recipe for disaster.

List of major scandals of the twenty-first century

Serial No. Company Year Auditor Descriptions
1 Enron 2001 Arthur Anderson Involved in
special purpose
entities
transactions

2 Global Crossing 2002 Arthur Anderson Overstated

revenue and
earnings above
Network
capacity swaps.

3 WorldCom 2002 Arthur Anderson Covering and

recording of
improper
expenses ,
Overstated cash
flows

4 Tyco 2002 Price Water Conglomerate

House with questionable
Coopers practices on
accounting for
actions and other
issues
 5 Adelphia 2002 Deloitte And Overstated
Touché earnings
6 Imdone 2002 KPMG Insider training
7 Health-South 2003 Ernst and Young Overstated
earnings and
assets
8 Fannie Mae 2004 KPMG $9 billion
restatement from
derivative
accounting
valuations and
extent payouts to
Ousted executive.

9 Krispy Krene 2005 Price Water Egregious

House Coopers accounting to
inflate earnings
10 Anglo Irish Bank 2008 Ernst & Young Hidden loan
controversy
11 Satyam 2009 Price Water Falsified
Computer House Coopers accounts
Services
12 Lehman Brothers 2010 Ernst & Young Failure to
disclose repo
rate

Source: Giroux, G. (2006), Wikipedia (2011)

Techniques of creating accounting
Opportunity for creative accounting practices arises due to: flexibility permitted by the Generally
Accepted Accounting Principle (GAAP), imprecise accounting measurement bases, lots of
estimations, judgments and predictions, provision for alternative accounting treatment or
measurement, artificial and related party transactions, insider dealings, pressure on managers to
achieve short-term results, meet budget or raise market share prices and the reclassification and
presentation of financial numbers. (Largay, 2002; Mulford & Comiskey, 2002, Okoye & Alao
2008).

1. Flexibility in regulation. Generally the regulation, particularly the accounting regulation

permits flexibility in choosing a policy to follow; the International Accounting Standards let the
financial management to choose between valuation of the non-current assets at depreciated
historical value or at revaluated value. The management may decide the change of the policies,
and these shifts are difficult to be identified a few years later (Schipper,1989).
2. Lack of regulation is meeting in some areas in every domain. In most countries accounting
regulation is limited in some areas, for example in Nigeria there is standards yet for recognition
and measurement of financial instruments.
3. Management can use their discretionary position in order to obtain the financial position and
stability they assumed; for example, the managers decide to increase or reduce provisions for bad
debts (McNichols & Wilson 1988).
4. The timing of some transactions offers to the management the opportunity to increase the
revenues when the operating profit is not satisfactory and to create the desired impression in the
accounts. The existing stocks in company‟s patrimony that have a significant higher value
compared to the historical value may be sold only when the operating profit is not satisfactory.
5. The artificial transactions are often used in order to manipulate the balance sheet amounts or
to move the profits between accounting periods. These transactions are realized by entering in a
controlled transaction with two or three parties, one of them, most of the times, a bank. Such
arrangements consists in selling of an asset at a higher/lower rate than in an uncontrolled
transaction, and then leasing it back for the rest of it useful period, compensating through the
rentals the price difference.
6. Reclassification and presentations of financials are relatively less analyzed in accounting
literature. However, the study by Gramlich et al. (2001) suggests that firms may engage in
balance sheet manipulation to reclassify liabilities in order to smooth reported liquidity and
leverage ratios. A special type of creative accounting relates to the presentation of financial
numbers, based on cognitive reference points. As explained by Niskanen and Keloharju (2000):
„the idea behind this behavior is that humans may perceive a profit of, say, 301 million as
abnormally larger than a profit of 298 million‟. Their study and others (e.g. van Caneghem,
2002) have indicated that some minor massaging of figures does take place in order to reach
significant reference points.

A census (not exhaustive) of the techniques used in creating accounting

1. TANGIBLE ASSETS
(a) The practice of "subjective depreciation" of assets creates proper field of creativity in
accounting. In the exercise of professional reasoning, IAS 36 requires that at each balance sheet
date to determine whether there are indications that the asset depreciation suffered analyzed. If
management estimates that the recoverable value is lower than the net accounting assets are
considered impaired for the difference. In this case the result will be affected by recording a
depreciation expenses. On the opposite side, if the management company seeks an attitude
"optimistic" about the outcome, will appreciate that there are no indications that the asset has
suffered depreciation, thus avoiding diminishing results.
(b) The lease-back as they highlight the impact of a value that will be established in the year of
sale, results. Charges will be recorded during the leasing contract.

2. GOODWILL
Underestimation assets purchased leads to increase goodwill. Capitalization and depreciation of
goodwill during its useful life have influence on the outcome of further years. Cost of goodwill
amortization resulting from the reduction outcome, with the exchange rate and competitiveness
of the shares bids competitive. Charging goodwill to equity to reduce their lead, the result of
years of future costs are not influenced by goodwill amortization.

3. DEPRECIATION
Option for a particular method of depreciation or otherwise in connection with the accounting
policy of the undertaking, the assignment in a systematic way the depreciation of an asset during
its useful economic life has an impact on the profit and loss. Thus, a different method of
depreciation has a different impact on the outcome. Depending on the method chosen is amended
in time allocation of expenditure. Options on different useful life lead to different expenditure.
Review of useful life lead to adjustment costs with current depreciation period and future
periods. Deducting the residual value has the effect of reducing depreciation and therefore
increases the outcome of exercise.

4. INVENTORIES
The inventories provide sufficient opportunities for creative accounting and subjectivism. An
error detected on a voluntary basis in determining the size of existing stock in assets at the end of
exercise can lead to a practice of "polishing" of the result, meaning that the underestimation or
overestimation of stock finally has an impact not only on the financial statements of the current
year but also on the following year. The inclusion of financial costs in the cost of production of
stocks has the effect of the increase in the outcome in which the inclusion of expenses. On the
opposite side, where the management has a pessimistic vision of the outcome, the result will
apply the method, treating interest expense as an element of the power exercised.

5. PROVISIONS FOR LIABILITIES AND CHARGES

Practice provisions (increase and reduction thereof) are an effective tool for bringing possible
outcome. Establishment of provisions in those years, where the profit result leads to the decrease,
while the resumption of the provisions in the income year in which the registers deficit increase
leads to the better result.

6. CONSTRUCTION CONTRACTS
Mechanisms that have an impact on the balance sheet will be listed in the following table:
Table 2: Creative Accounting that Impact on the Balance Sheet
Elements Mechanisms Impact on balance sheet
Tangible assets Lease-back: the sale of - Improvement revolving fund;
fixed assets, followed by - Improve cash.
taking them in the
Immediate location.
Tangible assets Revaluation of tangible - Increased asset value (increase in
and equity assets depreciation expenses)
- Increased equity
Minority Interests Inserting in equity, debt, - Change indebtedness and equity.
or between the two
alternatives.
Loans In substance defeasance - Reduced rate indebtedness;
arrangement by which - Increase rate financial
the transferred assets to autonomy;
a trust, which - Increase financial profitability.
incorporates the same
time and management of
debt.
Customer Claims Discounting of ticket Reducing the need for working
Orders capital;
- Increased Treasury
Assignment of claims Slight decrease of working capital
from a pool (from the difference between price and
value of transaction);
- Decreased need for working capital
- Increased Treasury
Source: Cosmin, L. I. (2010). “A census of creative accounting techniques”, Romanian economic
business review, 5( 4-1) ,104-108.
Possible solution for above techniques
It seems clear that in general creative accounting is seen as a deceitful and undesirable practice.
In this section we analyze some measures which can help to reduce the scope for creative
accounting practices, identifying, where applicable, recent developments in International
Accounting Standards (IASs). IASs will become the standard for all European listed companies
from 2005.
Accounting regulators who wish to curb creative accounting have to tackle each of these
approaches in a different way:

1. Scope for choice of accounting methods can be reduced by reducing the number of permitted
accounting methods or by specifying circumstances in which each method should be used.
Requiring consistency of use of methods also helps here, since a company choosing a method
which produces the desired picture in one year will then be forced to use the same method in
future circumstances where the result may be less favorable. The latest developments in
International Accounting Standards are pursuing the objective of reduction in accounting choice.
(IASB, 2003).

2. Abuse of judgment can be curbed in two ways. One is to draft rules that minimize the use of
judgment. At one time, for example, company accountants tended to use the 'extraordinary item'
part of the profit and loss account for items they wished to avoid including in operating profit.
Again, the present rules of the International Accounting Standards have nearly abolished the
category of 'extraordinary item'. Auditors also have a part to play in identifying dishonest
estimates. The other is to prescribe 'consistency' so that if a company chooses an accounting
policy that suits it in one year it must continue to apply it in subsequent years when it may not
suit so well.

3. Artificial transactions can be tackled by invoking the concept of 'substance over form',
whereby the economic substance rather than the legal form of transactions determines their
accounting substance. Thus linked transactions would be accounted for as one whole.
4. The timing of genuine transactions is clearly a matter for the discretion of management.
However, the scope to use this can be limited by requiring regular revaluations of items in the
accounts so that gains or losses on value changes are identified in the accounts each year as they
occur, rather than only appearing in total in the year that a disposal occurs. It is interesting to
observe that the International Accounting Standards Board is tending to move towards valuation
at fair value rather than based upon historical cost in several recent accounting standards and
discussion papers.
But apart from changes in accounting regulation, ethical standards and governance codes must be
properly enforced in the corporate world. Regulation without thorough enforcement techniques is
likely to be ineffective in preventing individuals from employing misleading reporting practices.
Presence of Creative Accounting in India
According to Nobel Research Report – 50 Good market cap size companies are indulged in
creative accounting practices and investors have to carefully examine the books of accounts, its
profits and cash flows. After the news of Satyam, question is raised on all the giant firms which
were directly or indirectly related with company. India is developing economy where corporate
sector is contributing a major part in national income, and it is spreading its wings all over world
where they get lots of opportunities to go for creative accounting as all countries have different
accounting system which creates ambiguity in investor‟s mind. And thus number of accounting
scandals is increasing in India. Creative accounting is prevailing in almost all the companies in
India, the reason might be the increasing level of competition and dearth of sustain in the market.
Loopholes or weaknesses in Indian accounting standards are facilitating the corporate sector to
indulge in creative accounting practices. They find that where the relevant accounting standards
are permissive managers will exploit the potential use of creative accounting. Such behaviors are
curtailed once the provisions of accounting standards are tightened. But the loopholes are so
common and prevailing in accounting standards in such a manner that even if certain loopholes
are eliminated, the practice of creative accounting is likely to exist. Nobel research report
highlighted the common manipulations in accounting records in India:
1. Revenue manipulation: a) Recording revenues ahead of time; b) Booking fictitious sales:
2. Expense manipulation
3 Cash manipulation
4. Invisible restatement of prior period accounts
Most of the companies in India are taking undue advantage of weaknesses of accounting
principles. Like as mentioned by Nobel Research report companies tend to show revenue which
is not earned. This is also considered as aggressive accounting technique whereby revenue is
shown in the books of accounts before the project is completed in effect of which revenue
increases. Cash manipulation is one of the common practices followed by most of the companies.
INTRODUCTION ON CORPORATE GOVERNANCE

Definitions on corporate governance

Corporate Governance is the mechanism in which companies are governed in a transparent
manner by rule of law in which participation of shareholders prevail in a responsive, efficient &
effective way so as to ensure sustainability & accountability. The concept of corporate
governance is getting prominence with each passing day why this so because each & every
country in recent past has seen a disastrous trail of many big corporate failures that shook their
entire economy. And with the advent of globalization, there is greater deterritorialization and less
of governmental control, which results is a greater need for accountability (Crane and Matten,
2007). Hence, corporate governance has become a vital issue in managing organizations in the
current global and complex environment. So it becomes very important to develop
comprehensive policies in regard of corporate governance.

Larcker & Tayan “corporate governance is the collection of control mechanisms that an
organization adopts to prevent or dissuade potentially self-interested managers from engaging in
activities detrimental to the welfare of shareholders & stakeholders”.

Sir Adrian Cadbury who is also considered as the father of modern corporate governance
also defines Corporate Governance as The system by which companies are directed and
controlled.

Sherdan and Kendall, suggest that,”……..different countries have different ideas as to what
good corporate governance […..] nowhere does anyone appear to have defined corporate
governance per se”.

Adam Smith(1776) to Berle and Means(1932), were concerned with the separation of
ownership and control that is with the agency relationship between a „principal‟ and a „agent‟.
According to Cochran and Wartick, corporate governance is an umbrella term that covers
many aspects related to concepts, theories and practices of board of directors and their executive
and nonexecutive directors .It is a field that concentrates on the relationship between boards,
stockholders, top management regulators, auditors and other stakeholders.

“Corporate governance is the relationship between corporate managers, directors and the
providers of equity, people and institutions who save and invest their capital to earn a return. It
ensures that the board of directors is accountable for the pursuit of corporate objectives and that
the corporation itself conforms to the law and regulators.”(International Chamber of
Commerce).

Corporate governance refers to the private and public institutions, including laws, regulations
and accepted business practices, which together govern the relationship, in a market economy,
between corporate managers and entrepreneurs (corporate insiders) on one hand, and those who
invest resources in corporations, on the other (OECD, 2001, p. 13).

La Porta et al., (2000) view corporate governance as a set of mechanisms through which outside
investors protect themselves against expropriation by insiders, i.e. the managers and controlling
shareholders. The insiders may simply steal the profits; sell the output, the assets or securities in
the forum they control to another firm they own at below market prices; divert corporate
opportunities for firms; put unqualified family members in managerial positions; or overpay
managers.

It has been contended that corporate governance practices is not a standard mode (not a “one size
fits all”) and thus cannot operate in any standard form but rather vary across nations and firms
(OECD, 2000). This variety reflects distinct societal values, different ownership structures,
business circumstances, and competitive conditions strength and enforceability of contracts.
The political standing of the shareholders and debt holders, and the development as well as the
enforcement capacity of the legal system is all crucial to effective corporate governance
(Gregory & Simms, 1999).

Based on the above definitions and arguments, it is clearly that corporate governance is
concerned with the social political and legal environment in which the corporation operates
systems practices and procedures-the formal and informal rules that governed the corporation. In
not shell corporate governance is very vital in every organization, because good corporate
governance contribute to better firm performance, it is expected for every other organization to
enforce corporate governance policy, in order to achieve a stated goal.

THEORIES OF CORPORATE GOVERNANCE

6.1 Agency Theory

Agency Theory is based upon the agency relationship. Agency relationship often results into
agency problems that arise because managers not solely act in the best interest of the
shareholders rather they start protecting their own interest. Managerial discretion allows
managers to serve their own interests over shareholders‟ objectives. Following agency theory,
managers will not act to maximize the returns to shareholders unless appropriate governance
structures are implemented to safeguard the interest of shareholders, especially in large
corporations. The role of accounting in reducing the agency cost in an organization, effectively
through written contracts tied to the accounting systems as a crucial component of corporate
governance structures, because if a manager is rewarded for their performance such as
accounting profits, they will attempt to increase profits which will lead to an increase in bonus or
remuneration through the selection of a particular accounting method that will increase profits.

6.2 Stewardship Theory

Stewardship Theory believes that mangers if left alone at their own will in fact act as the
responsible stewards of the organization & of the assets they control. This theory provides an
alternative of agency theory. As per this theory managers achieve organizational rather than self-
serving objectives because steward perceives greater utility in cooperative than in individualistic
behavior, and behaves accordingly. A steward is motivated to maximize organizational
performance, thereby satisfying the interests of shareholders.

6.3 Stakeholders Theory

This theory center on the issues concerning to the stakeholders in an institution. It stipulates that
a corporate entity invariably seeks to provide a balance between the interests of its diverse
stakeholders in order to ensure that each interest constituency receives some degree of
satisfaction (Abrams, 1951).The theory studies the relationship of a company not only with the
shareholder but with all others associated with it like employees, customers, suppliers;
bondholder‟s etc. empowerment of these stakeholders other than the shareholders‟ is the key
premise of stakeholder‟s theory.

6.4 Resource Dependency Theory

The basic proposal of resource dependence theory is the need for environmental linkages
between the firm and outside resources. In this view, directors serve to connect the firm with
external factors by co-opting the resources needed to survive (Pfeffer and Salancik, 1978). Thus,
boards of directors are an important mechanism for fascinating critical elements of
environmental uncertainty into the firm. The organization‟s need to require resources and these
leads to the development of exchange relationships or network governance between
organizations. Further, the uneven distribution of needed resources results in interdependence in
organizational relationships.

6.5 Social Contract Theory

Among other theories reviewed in corporate governance literature social contract theory, sees
society as a series of social contracts between members of society and society itself (Gray, Owen
& Adams 1996). An integrated social contract theory was developed by Donaldson and Dunfee
(1999) as a way for managers make ethical decision making, which refers to macrosocial and
microsocial contracts. The former refers to the communities and the expectation from the
business to provide support to the local community, and the latter refers to a specific form of
involvement.

6.6 Legitimacy Theory

Another theory reviewed in the corporate governance literature is legitimacy theory. Legitimacy
theory is defined as “a generalized perception or assumption that the actions of an entity are
desirable, proper, or appropriate with some socially constructed systems of norms, values, beliefs
and definitions” (Suchman 1995). Similar to social contract theory, legitimacy theory is based
upon the notion that there is a social contract between the society and an organization. A firm
receives permission to operate from the society and is ultimately accountable to the society for
how it operates and what it does, because society provides corporations the authority to own and
use natural resources and to hire employees.

RELATIONSHIP BETWEEN CREATIVE ACCOUNTING AND

CORPORATE GOVERNANCE
The connection between corporate governance and creative accounting take place because of
conflict between ownership and control i.e. AGENCY THEORY. Managerial discretion in the
application of accounting methods used to report firm performance is not considered to be
manipulative until the particular discretion is used with the intent to manipulate reported results.
This is related also to the fact that managers may focus on short-term personal incentives such as
maximizing salaries, bonuses, and other short-term compensations, instead of focus on the long
term economic success of the firm. All the doubts appear where a separation of the ownership
from the control of a corporation exists and in this respect the conflict that arises is described by
the Agency theory. The conflicts are related to sharing the economic resources and the lack of
confidence, these conflicts between the shareholders and managers being considered in the
literature to be the root of creative accounting.
The importance of corporate governance studies in the area of creative accounting presented
under all its arrangements of manifestation is related to the general trend that poor governance
persuade or sustain a manipulative behavior. A weak corporate governance structure is more
likely associated with misleading accounting information (Giroux,2006) whereas strong
corporate governance structure is less prone to fraud, earnings manipulation and other creative
accounting practices (Dechow et al,1996, Beasley,1996). Basically, a qualified, committed,
independent, tough-minded audit committee represents true guardian of public interest. It
monitors management actions and oversees the accounting and financial reporting as well as
audit of the company thereby helping to stop earnings management. Also discussions are
regarded the fact that poor governance results in inflated compensation packages that induce
managers to act in a manipulative manner.
Information asymmetry is regarded as also as a creation point for manipulative behavior. The
general trend when it comes to explain information asymmetry is that one side of the market has
better information that the other. In the context of corporate governance the CFO and the board
of the company knows more than the shareholders and other users of accounting information
about the profitability of the company. Dye (1988) and Trueman and Titman (1988) asserted that
the existence of information asymmetry is the necessary condition for earnings management.
When information asymmetry is high the shareholders and stakeholders do not have sufficient
information, resources, incentives or access in order to monitor manager‟s actions then this give
rise to creative accounting practices.
There are two different patterns of financing the companies. This related to the corporate
governance model that conquers in a particular country. If a certain country belongs to the
Anglo-American accounting model the determinant corporate governance model is the
shareholder model. In this context the capital market has a great role in financing companies and
as a result of that great importance will be put in information presented to shareholders.
Companies in this context are dominated by equity and there is a great separation between
managers and owners and as a consequence of this the information asymmetry that exists in the
complex may have the power to give rise to corporate deprived structures as management. In this
perspective the incentives to manipulate accounting information are considered to be stronger.
In a country belonging to Euro-Continental accounting model, the corporate governance
model that is reflected in this context is the stakeholder model. In this context, great importance
is placed on the information presented to the creditors (e.g. banks) since the finance pattern of
the companies is related to them. Accounting rules are conservative as they aid mainly for the
creditor‟s needs of information.
In both corporate governance models, information asymmetry is seen as a creation point for
creative accounting occurrence or earnings management behavior. In a context of information
asymmetries, the managers can unscrupulously manage the accounting number in order to
present the results that are expected by the market. The main purpose appears as a consequence
of the desire to avoid the negative consequences that of the news that raised the alarm would
represent in terms of stock price performance. The role of corporate governance complex
mechanism is to minimize information asymmetry and to ensure compliance with mandated
reporting requirements while maintaining the credibility of a firm`s financial statements and
safeguard against manipulative behavior.

Legitimacy Theory has also been used in explaining corporate reporting disclosure practices.
According to this theory the main scope of disclosure is to alter perceptions regarding the
legitimacy of the organization since disclosure are not regarded as voluntary channels of
information but as responses to public pressure since firms are considered to have a social
contract with the society they activate since their survival depends of societal norms. In this
respect sometimes firms may focus more on the need for information on customers‟ needs rather
than investor‟s needs when preparing the annual reports (Ogden and Clarke, 2005).

The Institutional Theory asserted that firms respond to institutional expectations but adopting
norms and procedures in order to reduce inspection by internal and external constituents. In this
respect managers are assumed to respond to institutional pressures when disclose their financial
statements The Stakeholder Theory is similar to Legitimacy Theory, the differences exist in the
fact that firms prepare the financial statements as a response and demand of various groups of
stakeholders (e.g. employees, customers, government agencies, etc. ).

Signaling Theory is focused on the behavior of managers in well performing firms who tend to
disclose the performance with greater transparency in their presentation of financial statements.
Out of all five theories, Agency theory and signaling theory are preoccupied by the investor`s
informational data regarding financial performance and the channels related to this, the other
three theories consider the society as a whole and the stakeholders particular needs of
information, is comprised in the audience of firms‟ disclosures that in those cases offers a
different view since in those disclosures social and environmental performances are approached
proving the fact that manipulation is not related only to financial performance (Valdu et al,
2010).

Most of the factors(independent board of directors, independent audit committees, size of board
etc.) are considered corporate governance tools designed to restrict creative accounting but still
some of them inspire it (e.g. management remuneration packages).

How Corporate Governance code of conduct helps in reducing

Creative Accounting Practices
Codes and Standards on Corporate Governance
In the eyes of law, shareholders are considered supreme and Directors being their agents. But in
reality, the position is completely different. It is not the shareholders but the directors who are in
fact supreme because of:
 Boards-family managed with unchallenged control.
 Shareholders- generally scattered, ill organized and have little say
 Employees-financially poor to act.

SINCE the high profile collapses of large number of corporations and most of which involved
accounting fraud, there is need for better codes and standards on corporate governance to
overcome the practices of Creative Accounting.
There are various committee reports on corporate governance all over world; some of these are
discussing here;
 Sir Adrian Cadbury Committee(UK), 1992
The committee addressed the financial aspects of corporate governance and produces a Code of
Best Practice, the provision of which, in their belief, that all listed companies should incorporate
a statement of compliance, or non-compliance, with the provisions, in their annual report and
accounts. In respect of areas of non-compliance an explanation of the reason was sought. This
code of Best Practices designed by the committee had 19 recommendations.
 Greenbury Committee(UK),1995
The committee followed the tradition of the Cadbury Report and addressed a growing concern
about the level of director remuneration. Their Code of best practices was endorsed by the
listing rules aiming for establishment of remuneration committee.
 Bosch Report(Australia),1995
The committee dealt with 800 hundred items of constructive comments from the community on
the standards. The Standards include recommendations on composition of board and term of
directorship.
 Vienot Report(France),1995
 Calpers Global Corporate Governance Principles(USA),1995
California Pension Employee‟s Retirement System (Calpers) is the largest Pension Fund in the
US. Calpers insist on independent directors and specify standards of behavior for them.
 Hampel Committee on Corporate Governance(UK),1998
The report aimed to combine, harmonize and clarify the Cadbury and Greenbury
recommendations.
 Combined code of Best Practices (London Stock Exchange),1998
It derives from a review of the role and effectiveness of non-executive directors by Derek Higgs
and a review of audit committees by a group led by Sir Robert Smith.
 Blue Ribbon Committee(USA),1999
The origins of the Blue Ribbon Committee lie in an initiative of the SEC in 1998.Its objective
was to develop recommendations for audit committees enabling them more effectively to fulfill
their function as defenders of the interests of investors. In 1999 the recommendations of the Blue
Ribbon Committee were adopted and declared to be mandatory by the NYSE, Amex, NASDAQ
and AICPA.
 OECD Principles of Corporate Governance (focus on disclosures),1999 and then
revised in 2004
 The corporate governance framework should protect and facilitate the exercise of basic
rights of shareholders.
 Equitable treatment of shareholders
 Recognize the rights of stakeholders and encourage active co-operation between
corporations and stakeholders
 Disclosure and Transparency
 Audit
 The role of board

 Euroshareholders Corporate Governance Guidelines,2000

To represent the interests of individual shareholders in the European Union
 Joint Committee on Corporate Governance (Canada),2001
 King ll Report on Corporate Governance for South Africa(2002)

It was aimed at promoting highest standards of Corporate Governance in South Africa because of
the new Companies Act of 2008 and changes in international governance trends.

 Sarbanes-Oxley (SOX) Act, 2002(USA)

Public Accounting Reform and Investor Protection Act of 2002 known as SOX Act was enacted
in 2002. The main objective of this Act is to response investors‟ confidence by preventing
corporate frauds and ensuring transparency and disclosures. The SOX Act is arranged into 11
titles. The following are the eleven Sarbanes-Oxley Titles:
1. Public Company Accounting Oversight Board (PCAOB)
2. Auditor Independence
3. Corporate Responsibility
4. Enhanced Financial Disclosures
5. Analyst Conflicts of Interest
 6. Commission Resources and Authority
7. Studies and Reports
8. Corporate and Criminal Fraud Accountability
9. White Collar Crime Penalty Enhancement
10. Corporate Tax Returns
11. Corporate Fraud Accountability

While the SOX Act lays down detailed requirements for the governance of organizations, the
three highest profile and most critical sections are 302,404,409.
Table: Sarbanes-Oxley Act Sections 302,404,409
Section 302 Section 404 Section 409
Required  Quarterly  Management  Monitor
certification of annually certify operational risks
financial internal controls  Material event
reports  Independent reporting
 Disclosure of accountant must  Real-time
all known attest report implications 4
control  Quarterly change business days for
deficiencies reviews report to be filled
 Disclosure
acts of fraud
Responsible  CEO  Management  Management
 CFO  Independent  Independent
auditor auditor

 Smith Report(UK) on Audit Committee(2003)

 Higgs Report, UK(2003)
 ‘UNCTAD Guidance on Good Practices in Corporate Governance Disclosure,
UK(2008)
The high profile cases of corporate governance failure around the world led to vigorous reforms.
The corporate governance and reporting requirements applicable to all companies significantly
changed with the enactment of the SOX Act 2002 after major corporate collapses. SOX Act is
obviously a great achievement in response to the scandals for restoring investors’ faith in
corporation. It represents a shift toward government regulation of corporate standards relating
to auditing, accounting, quality control, ethics, and independence, through the Public Company
Accounting Oversight Board (PCAOB).The recent move, by SEC, to mandate full disclosure for
managerial compensation and perks, is also a great step to curb creative accounting practices
through these stringent rules and regulations.

Role and Responsibilities of Board of Directors

The key objective of a company‟s board purpose is to ensure its prosperity by collectively
directing the company's affairs, whilst meeting the appropriate interests of its shareholders and
stakeholders. The law imposes a number of duties, burdens and responsibilities upon directors, to
prevent abuse. Much of company law can be seen as a balance between allowing directors to
manage the company's business so as to make a profit, and preventing them from abusing this
freedom. Directors are responsible for ensuring that proper books of account are kept. The
important characteristics of independent board are:
 The inclusion of independent board directors.
 Separation of the role the chair and chief executive officer.
 Presence of an independent nomination committee.
 The board member should be competent.

Role of Internal Auditors

The objective of internal auditing according to the Institute of Internal Auditors (1999) is an
independent, objective assurance and consulting activity designed to add value and improve an
organization‟s operations. It helps an organization accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and improve the effectiveness of risk management,
control and governance processes. Organizations with an internal audit function are more likely
than those which outsource such a function to detect fraud within their organizations.

The Role of the Independent Auditor

By law, limited liability companies‟ annual financial statements are audited each year by
independent auditor‟s accountants who examine the data for conformity with Generally
Accepted Accounting Principles (Corams et al, 2006). The auditor‟s conduct a systematic
examination of a company‟s accounting books, transaction records and other relevant documents
to consider whether the financial statements are fairly presented and free from material
misstatements. The auditor prepares a written report containing an opinion on the financial
statements (Rezaee, 2002).

The audit committee’s duties and responsibilities

The audit committee members should be independent board members with financial expertise.
Creative accounting practices are less likely to occur whose board includes both independent
outside auditors and directors of corporate experience. Audit committee has important role in
discouraging creative accounting practices.
The minimum responsibilities should include the following:
 Overseeing the financial reporting and disclosure process.
 Monitoring choice of accounting policies and principles.
 Overseeing hiring, performance and independence of the external auditors.
 Oversight of regulatory compliance, ethics, and whistleblower hotlines.
 Monitoring the internal control process.
 Overseeing the performance of the internal audit function.
 Discussing risk management policies and practices with management

Thus it is important to carry out legislative changes, to harmonize accounting practices with the
policies of the international specialized committees, and to cultivate a fair and transparent spirit
in order to mitigate the discrepancies within companies and, of course, to eliminate the pressures
which, most of the times, lead to a reckless behavior of the managers with long-term drastic
consequences or in other words to curb the practices of creative accounting.
REVIEW OF LITERATURE
Gherai and Balaciu (2011) explain Creative Accounting Practices and Enron Phenomena to the
current financial crisis using deductive approach and also taking comparison method of various
scandals in large corporations. It brings into attention the creative accounting phenomena. The
paper concluded that Creative Accounting Practices will not disappear unless the causes which
have given rise to them will disappear. Sox Act is one of the reforms that have repercussion
throughout the world.

Okaro and Okafor (2012) using a case study of Cadbury Company in Nigeria explains how
corporate watchdog institutions and system in the company were affected by creative accounting
practices. Author concluded that Cadbury case in Nigeria is due to the failure of audit
committees. It also shows the relationship between corporate governance and fraudulent
reporting. And there is need of one global uniform standard of reporting-IFRS to curb these
practices.

Melis and Carta (2009) taking evidence from the disclosure of Share-based Remuneration to
show does Accounting Regulation Enhance Corporate Governance. The study was conducted on
research design by taking sample. The findings of the paper show that Financial Reporting and
Corporate Governance are inter-related; it reduces the information asymmetry between corporate
outsiders and insiders. IFRS 2 is likely to increase the level of disclosure further and all share
based plans will have to expense.

Berinde Sorin et al. (2012) explored qualitative study regarding the relationship between
Corporate Governance and Creative Accounting. The result of the study shows that Corporate
Governance and Creative Accounting are closely related. Audit committee has important role in
discouraging creative accounting. SOX Act came to strength the audit independence, increased
proportion of independent directors lead to better performance. Thus creative accounting
practices will reduced by modification of corporate governance system in terms of legislative
changes, to harmonize accounting practices with IFRS.
Odia J.O. and Ogiedu K.O.(2013) investigated Corporate Governance, Regulatory Agencies
and Creative Accounting practices in Nigeria. The paper aimed as whether corporate governance
structure affect creative accounting practices. Study concluded that Corporate Governance is
more related to Creative Accounting practices then Nigeria‟s standard (NASB). Corporate
governance should strengthen and the NASB should devise appropriate means and
enlightenment; in addition to the sentences and fines for the elimination of creative accounting
practices.

Vladu and Matris(2010) tried to explored as Corporate Governance and Creative Accounting
the two concepts strongly connected? It is fundamental research of Inductive type. Result
concluded that Corporate Governance and Creative accounting is two edged sword. The
connection between corporate governance and creative accounting take place because of conflict
between ownership and control i.e. Agency Theory. Independent directors limit creative
accounting while remuneration packages will inspire it.

Shah and Butt (2011) tried to explore whether the creative accounting is good for the companies
or it brings companies in crises situation. It is an observatory study. The paper revealed that the
complex and diverse nature of the business transaction and the latitude available in the
accounting standards and policies make it difficult to handle the issue of creative accounting. It is
not the creative accounting solutions are always wrong .It is the intent and the magnitude of the
disclosure which determines it‟s true and nature and justification.

Laura and Ileana (2014) investigated the difference between the means of executing creative
accounting and that of executing fraud. Study tried to explore the relation between creative
accounting and fraud. The study concluded that According to American definition, creative
accounting includes fraud i.e. it is illegal while in UK it is not seen as illegal action. Creative
accounting perceived in a negative light while the researcher says that all respondent had the
tendency to mistake two activities as same, while hypotheses believe that creative accounting is
legal and meant to benefit the company in certain situation.

Xie et al.(2002) investigated the relation between Earning management and corporate
governance; the role of the board and the audit committee. It takes the sample of 282 firms from
the S&P 500 index. The study revealed that earning management is less likely to occur or occurs
less often in companies whose board includes both independent outside directors and directors
with corporate experience. This study also shows an association between lower levels of earning
management and the meeting frequency of boards and the audit committees.

Rajput (2014) provide literature review on creative accounting, motivators for its uses,
techniques of creative accounting and reviewing ethical issues by suggesting some solution in
India. According to this paper creative accounting is seen as a deceitful and undesirable practice.
Indian economy is in line with other developed countries in accounting fraud. Study was found
that companies are forced and under pressure of performing well because of the motivators of
creative accounting. It also found that this problem may exist due to lack of awareness and
information level of investors and creative accounting practices are detected and prevented by
various agencies like SFIO, Indian forensic in India.

Salome et al.(2012) shows the effect of creative accounting on the job performance of
Accountants (Auditors) in reporting financial statement Nigeria. The study takes empirical
survey of 227 out of 500 respondents using simple random sampling technique. The paper aimed
to identify the strategies used by the accountants to avoid creative accounting in any of their
financial dealings. Result of the study shows that the Accountants/Auditors indulge in creative
accounting through profit eroding mechanisms to attract stakeholders but deceptive or fraudulent
accounting practices often conduct to drastic consequences. Implication of the findings is that the
managers of NPO may have incentive to manipulate the accounts because donors use these
accounts for contribution margin.

Kaman (2012) investigated whether tax avoidance and evasion influence creative accounting
practices among companies in Kenya using random sample of 36 accountants working for
various companies in Kenya. The result of the study established that tax avoidance and evasion is
indeed one of the major strong factors contributing to practice of creative accounting among
companies in private sector in Kenya. This therefore calls for accounting regulatory bodies like
IFRS to curb the creative accounting practices.

Marnet (2005) tried to explain why History repeats itself or the failure of rational choice
models in corporate governance. Whether reforms based on the standard monitoring model of
corporate governance are sufficient to prevent corporate scandals. Result shows that an over-
reliance of legal and economic theory on the rational model of choice behavior leads to over-
confidence with regard to the feasibility of independence of directors and external auditors.
Author said that that strictly numerical measure is not a reliable guide to the quality of corporate
governance. A better understanding of what derives managerial and monitor conduct in the real
world would be improved by placing it on psychologically more realistic foundations like
GAAP.

Chandra Shil (2008) explains concept of corporate governance, its legal framework, its current
status and how accounting may be practiced to protect corporate corruption. It is a observatory
study. The finding of the paper shows that Good corporate governance is very essential for
today‟s complex and dynamic business environment to ensure long-term sustainability. So, it
should be cultivated and practiced regularly within the current structure of the business.
Corporations that genuinely recognize and embrace the principles of „good governance‟ will
derive enormous benefits while „bad governance‟ lead to financial dissatisfaction and over
excercing power which leads to drastic consequences.
Sushus and Demirhan (2013) provide literature review on creative accounting and present a
conceptual and historical framework about this. It is an Empirical Analysis, and referring
secondary source. Study reviewed that it would be impossible to eliminate creative accounting or
earning management practices. But it is possible to minimize the negative effects of creative
accounting practices by adopting accounting standards, giving more importance to ethical
considerations and decreasing the flexibility in the accounting methods.

Shah (1998) explore the environment of creative accounting in the UK, focusing on the
motivations and constraints on such practices, by examining the accounting practices of two UK
companies which issued creative financing instruments. It was found that creative accounting in
the United Kingdom is influenced by two key motivators: stakeholder contracts and performance
indicators (focus on EPS and Gearing). Analysis showed that management took advantage of
gaps in accounting standards to present a biased picture of financial performance and corporate
governance play a potential role in restricting creative accounting.

Balaciu (2005) investigated Creative Accounting are a form of manipulation. The scope of this
paper is to relate the causes, the main motivations behind their application, the objectives, the
methods and the consequences of manipulation in financial reporting. Study found that
Manipulation is known by different terms like Aggressive accounting, creative accounting,
earning management, income smoothing .The main cause of creative accounting is the flexibility
of the regulation. Conflict among different interest groups is the main reason for this practice. It
also shows that manipulation is not fraud it is matter of interpretation.

Baralexis (2004) has investigated why, how, to what extent, and in what direction creative
accounting was practiced in Greece. Paper was based on sample selection method and
questionnaire to professional Accountant and to Auditors. The results of the study indicated that
creative accounting was practiced in Greece frequently (25%), and to a considerable extent
despite detailed accounting regulation. The findings also suggested that large firms augmented
profits for external financing, while small firms understated profits to reduce income taxes.

Omurgonulsen and Omurgonulsen (2009) have examined the creative accounting practices in
Imarbank, one of the banking scandals in Turkey, using case study methodology. They have
concluded that significant reasons of creative accounting practices in the case were dearth in the
legal frameworks for banking and accounting, inadequacies in the autonomy of governmental
regulation and supervision bodies, practical difficulties in enforcing legal and ethical rules due to
the slow functioning of the judicial system. In addition, personal greed of both owners and top
management of Imarbank and its customers were accepted as stimulating factors of creative
accounting.

Breton and Taffler (1995) used a case study based experimental approach to investigate the
impact of window dressing on stockbroker analyst evaluation of a company‟s annual accounting
numbers. They developed a case study from the financial statements of two companies. One set
of accounts was left unchanged, to serve as a control, and the other was manipulated to contain
different combinations of the window dressing practices. The case studies were administered to
63 experienced stockbroking analysts under controlled conditions filled in a short personal
questionnaire. It was found that window dressing correction rates in the study were very low.
Thus, they concluded that stockbroking analysts did not adjust their financial analysis directly to
take into account creative accounting in financial statements.

Heiko (2009) tried to explore patterns of integrating corporate responsibility issues into
corporate governance mechanisms and their development over time. Data from the Business in
the Community Corporate Responsibility Index was taken to reveal dominant governance
patterns of corporate responsibility issues for the 51 organizations continuously participating in
the index. The major findings were First, there was increasing CEO leadership for the corporate
responsibility agenda of the firm. Second, governance structures developed over time are now
increasingly making use of corporate responsibility committees. In 2002 about 15 percent of the
firms were using a CR committee; the number had increased by 2008 to more than 60 percent.
Third, firms with a CR committee in place outperform others in the Corporate Responsibility
Index.

Amat et al. (1999) explored surveys of auditors' perceptions of creative accounting in the UK,
Spain and New Zealand to investigate the ethical issues raised by creative accounting. When
they compared the findings of two studies conducted in UK and Spain surveying auditors' views
on creative accounting, they found that substantial minority of auditors in each country taking a
tolerant view of creative accounting. In Spain there seemed to be more optimism on prospects for
resolving the problem. The study also found that creative accounting was not now a significant
problem in New Zealand, there had been a reduction in its practice.

Kwaku and Mawutor (2012) investigated the complicity of Public Company Auditors in
financial statement fraud, and the responsibilities and obligation of the Auditor to detect and
report financial statement fraud. It was empirical data analysis, of SEC‟s report by AADR on
enforcement action by taking sample of 1240 fraud schemes in 344 financial statements fraud
before their perpetration. The study found that, apart from the numerous financial statement
fraud cases committed by other stakeholders in corporate governance, 23 percent of Auditors
were involved in financial fraud cases implying that, some auditors are complicit in financial
statement fraud. As a result, there is the need for International Reporting Agencies such as IASB
to develop more creative measures in identifying and reporting fraud.

Yusoff and Alhaji (2012) provide literature review on the variety of theories in corporate
governance. It was a deeply review of Insight of Corporate Governance theories .They talked
about agency theory, stewardship theory, and stakeholder theory and evolved to resource
dependency theory, political theory, legitimacy theory and social contract theory. The cause and
consequence of variables, such as board structure, audit committee, independent non-executive
directors, social responsibilities. It was proposed that a combination of various theories is best to
describe an effective and efficient good governance practice.

Mary Low et al. (2006) explored the issue of corporate values and behavior and to provide some
insights as to why we continue to have corporate and accounting scandals using descriptive
method and with two surveys, conducted with accounting major students. The first was a small
survey conducted with some senior students and other collected information on students‟
perception of ethics business. Study found that Corporate transparency, corporate values and
behavior, money culture, vices of a capitalist society (process of blame shifting), legalistic
culture prevails in the society leads to in some extent to have continued these corporate and
accounting scandals. The findings of the survey, suggests that it is still possible to influence the
„thinking‟ of accounting graduates before they entered the complex world of business.
RECOMMENDATIONS
To prevent or curb creative accounting practices corporate governance code of conduct play
important role. There are various recommendations than can help in detecting and preventing
these fraudulent practices:-

 An audit committee, comprising of at least three non-executive directors, should be

established and it should have authority to investigate.
 The board should include a balance of executive and non-executive directors (in
particular independent non-executive directors).
 The majority of non-executive should be independent of management and free from any
business or other relationship.
 The board should establish formal and transparent arrangements for considering how they
should apply the financial reporting and internal control principles.
 The external auditors to be accountable to the Board of Directors and to the Audit
committee.
 Level of remuneration should be sufficient to attract, retain and motivate directors of the
quality required to run the company successfully, but a company should avoid paying
more than is necessary for this purpose.
 The corporate governance framework should ensure that timely and accurate disclosure is
made on all material matters regarding the corporation, including the financial situation,
performance ownership, and governance of the company.
 There should be certification of financial statements by the company‟s chief executive
officer and chief financial officer.
 Require certain disclosure in financial reports including information about off balance
sheet transactions and orders the SEC to develop rules regarding pro-forma disclosures.
 There should be criminal penalties for corporate fraud and document shredding.
 SEC should recognize standards established by a private-sector accounting standard setter
provided that the standard setter is deemed acceptable by the SEC and consider
International convergence in developing standards.
 Adoption of one set of global financial reporting standards known as IFRS embrace by all
operators of Accounts or those performing an accounting duty.
 Auditor can play an important role in prevention and detection of creative accounting
practices. If company‟s auditor is well establish entity and has good track record then its
auditing process may be trusted. But that auditor should not be the only auditor of the
company, there should be more than one auditor and that also should be rotated
periodically. So that familiarity between company and auditor does not lead to decrease
in objectivity.
 Proper system should be introduce to educate investors about the financial terms and its
probable impact on financial position through providing booklet of methods adopted by
the proposed company for various items in different situations and expected changes in
special circumstances.
 Reducing the alternative choices of accounting treatment in accounting standards.
CONCLUSION
The relation between Corporate Governance and Creative accounting is two edged sword. These
two terms are two sides of a coin, since the occurrence of creative accounting is related to the
weakness of corporate governance. The connection between corporate governance and creative
accounting take place because of conflict between ownership and control i.e. Agency Theory and
due to Information Asymmetrical. Creative Accounting is the process of manipulating
accounting figures by taking advantage of the loopholes in accounting rules within the
framework of law, it is not illegal. The complex and diverse nature of the business transaction
and the latitude available in the accounting standards and policies make it difficult to handle the
issue of creative accounting and it would be impossible to eliminate creative accounting or
earning management practices. But it is possible to minimize the negative effects of creative
accounting practices by adopting accounting standards, giving more importance to ethical
considerations and decreasing the flexibility in the accounting methods because flexibility in the
accounting method is the major cause of creative accounting. Audit committees play important
role in discouraging creative accounting practices. There is need of modification of corporate
system to curb creative accounting practices in terms of various code of conducts, it is also
important to carry out legislative changes, to harmonize accounting practices with the policies of
the international specialized committees, and to cultivate a fair and transparent spirit in order to
mitigate the discrepancies within companies and to eliminate the pressures on the managers so
that the disastrous trail of big corporate failures(like Enron, WorldCom, Tyco, Satyam etc.) can
be stopped. These scandals set in motion the corporate governance reforms process and result in
passing of the Sarbanes-Oxley Act to prevent corporate frauds and ensuring transparency and
disclosures. Similar kinds of reforms are needed in India too. Even though corporate governance
mechanisms cannot prevent unethical activity in top management completely, but they can at
least act as a means of detecting such activity before it is too late. As according to Sir David
Tweedie “We’re like a cross eyed javelin thrower competing at the Olympic game; we may not
win but we’ll keep the crowd on the edge of its seats”.
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