“Ovidius” University Annals, Economic Sciences Series

Volume XVII, Issue 2 /2017

Motivations in Choosing Creative Accounting Techniques:

A Managerial Perspective

Ciocan Claudia Cătălina

„Alexandru Ioan Cuza” University of Iasi,
Faculty of Economics and Business Administration
ciocan_claudia_catalina@yahoo.com

Abstract

The business world is a competitive one. Thus, managers tend to present their activity and of the
company they represent in the best terms possible, so the stakeholders, present and potential, to
have the best impression regarding that activity. Because numbers represent the main language of
businesses, changing the accounting figures tends to be the easiest way by which managers present
the most favorable situation of the company they represent, through the hands of the accountants.
The temptation to resort to creative accounting techniques increases, managers being attracted by
solutions to protect them in less favorable times. The desire to have better results and bigger
bonuses outlines a starting point from which all other problem begins. Through this paper we aim
to establish the boundaries of creative accounting and the reasons invoked by professionals.

Key words: creative accounting, stakeholders, creative techniques, motivations.

J.E.L. classification: M21, M4, M42

1. Introduction

In the life of a business, as in a man's life, there are good days and bad days, periods of
abundance and others of recession, conditions in which it is difficult to maintain investors'
confidence in the business performance. The temptation to engage in creative accounting
techniques increases, managers being attracted by solutions to protect themselves in less favorable
times. The desire to have the best results and the highest bonuses outlines one point from which all
the other problems begin.
Usually this term is associated with a good, positive thing, a feature that differentiates people
and gives them an unique character. We are glad to see a shadow of creativity in our children and
we`ll do anything to develop it into something great. This doesn’t apply for the accounting field
where creativity is usually seen as an undesirable habit, as a negative technique. „Why we do not
see creativity in accounting as something positive?”, “Why do we do anything to stop it?” are just
few of the questions we are seeking to answer through this paper.

2. Creative Accounting, from motivations to objectives and strategies: a literature review

The expression „creative accounting” was introduced for the first time in Anglo-Saxon
environment, being used by those who supervised and commented the activities of capital markets
(journalists and financial analysts). Subsequently, it was taken over in the vocabulary of other
countries, which led to the multitude of terms that describe it today (Ionașcu 2003, p.161). We
could say that the debates on this topic have intensified alongside the scandals that shook the
business world and will continue to do so, given that the removal of the premises allowing the use
of creative techniques is far from disappearing from the economic world.
Creativity is a red line in the evolution of accounting, and that can be seen from two different
perspectives. One, the positive side, is the source of evolution in accounting and accounting
profession. The complexity of the business world has always been a challenge for the professionals,

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and only their creativity has allowed accounting to evolve to its present form. Second, the same
business world has created competition, charts and wealth. These are sources of the grey side of the
creative accounting. Later, these motives have evolved into objectives and strategies, which have
led to different techniques, presented below.
Amat and Blake (1995, p.3) present creative accounting as a process by which accountants use
knowledge about accounting rules to manipulate a company's accounts, and introduce in their paper
four books, published on the subject, each from a different perspective:
• from the perspective of a business journalist: Ian Griffiths, in Creative Accounting, notes that
all businesses in a country hide their benefits. The annual accounts are based on registers that
were “finely cooked” or “completely fried” and the reports have been completely changed to
protect the supposing guilty persons. The author claims that creative accounting is the biggest
hoax since the Trojan horse and that, really, it is a completely legitimate fraud.
• from the perspective of a professional accountant: Michael Jameson argues, in A practical
guide to creative accounting, that the accounting process involves working with different types
of opinions and solving conflicts between different approaches to present financial results and
transactions. The author believes that this flexibility facilitates manipulation and deception.
These activities performed by unscrupulous members lead to what we call creative accounting.
• based on his experience in the field, Terry Smith, an investment analyst, states, in Accounting
for growth, that much of the apparent growth in the 1980s was more of a “hands-on game” than
real economic growth.
• from the point of view of an academician, Kamal Naser defines creative accounting, in
Creative financial accounting: its nature and use, as a transformation of financial accounting
information from what it really is, in what it wants to represent, taking advantage of existing
rules or ignoring some of them.
There are four different interpretations, from four different perspectives. Yet, closely analyzed,
there are two common elements: describing the incidence of creative accounting as common and
seeing it as a lying and unwanted practice (Amat et al. 1995, pp.4–5)
Regarding creative accounting techniques, Amat and Gowthorpe (2004, pp.7–8) show that the
potential to use creative accounting techniques lies in six areas: the flexibility of regulations, the
lack of regulations, the existence of management opportunities for future prospects, the timing of
certain transactions, the use of artificial transactions, and the reclassification and disclosure of
financial information. Stolowy (Feleagă 1996, p.148) divides the creative accounting techniques,
according to the pursued objectives, into three types: techniques with impact on the income
measurement, techniques with impact on cash-flows, and techniques with impact on the balance
sheet. Jones (2011a, pp.44–45) also proposes five strategies around which creative techniques
revolve: revenue growth, expenditure reduction, asset value increase, debt reduction, and cash flow
increase.
Whether we are talking about manipulating earnings (in the form of growth or minimizing
them), smoothing them to eliminate fluctuations, or balancing financial statements, there is always
a reason why managers choose this path (Ciocan 2017, p.453). Jones (2011, p.31) states that, in a
perfect world, there is no reason to call for creative accounting or fraud: the results would be
excellent, the bonuses and the price of the shares would be high, and the financial operations would
be in line with both the managerial and users’ expectations. But we are not perfect, the world we
live in is far from perfection and accounting is not an exception to this rule.
The appeal to creative techniques must be justified and among the most often cited reasons
found in the literature, we find: the possibility of obtaining certain tax benefits, the access to loans
or other similar facilities, meeting the expectations of the stakeholders, maintaining the price of
shares, thus reassuring investors of the well being of the entity, positioning the entity favorably in
less favorable times, etc. (Ciocan 2017, p.453). As a rule, those who engage in these practices are
expecting certain benefits, rewards from them. Mulford and Cominskey (2002, p.4) present a series
of rewards that fall into four major categories:
• share price effects (higher share prices, reduced share price volatility, increased corporate
valuation, lower cost of capital, increased value of stock options);

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• borrowing cost effects (improved credit quality, higher debt rating, lower borrowing costs, less
stringent financial covenants);
• bonus plan effects (increased profit-based bonuses);
• political cost effects (decreased regulations, avoidance of higher taxes).
Jones identifies three broad categories of reasons for managers to justify recourse to these
techniques and detail them as presented in Table 1

Table no. 1 Reasons that justify manager’s recourse to creative accounting

Category Motive Explanation
In some cases, managers' salaries are conditioned by the achievement
Increased salaries of certain goals or results, which causes them to resort to these
techniques.
Usually bonuses are conditioned on certain results, in which case
Bonuses
managers are drawn to modify them for their own interest.
This reason is cited most often in countries with strong capital markets,
like the United Kingdom or the United States. There is a directly
Personal Reasons

proportional relationship between profit and the price of shares, which

Shares and Share
makes a high profit company to also have a good price for its shares
Options
and one with weak profits to be disadvantaged from this point of view.
In this case, managers are attracted to use creative accounting to
achieve a high profit and thus a good price for the shares.
Managers also look for job security. The question which arises is:
Job security „Why should I be at risk of losing my job if there is a possibility of
arranging the results according to the investors’ expectations?”
In order to explain this reason, Jones brings into question human
nature. It is in our nature to expect gratitude, honor, and appreciation.
Personal
Managers are also people, and self-esteem often prevents them from
satisfaction
reporting the real situation of a company and exposing them to
criticism, thus resorting to creative accounting techniques.
In addition to annual reports, there are quarterly reports and in some
cases some additional information on future results. Based on past
Compliance with results, current information and some factors, financial analysts predict
the expectations of a certain level for future earnings, and if for some reason these
Market Expectations

financial analysts projections do not occur, stock prices may be affected. For managers
who are paid according to the share price it is a disadvantage that can
be prevented by using creative accounting.
Long-term strategy to maintain consistent earnings is also a reason for
applying creative accounting techniques. A company with fluctuating
Profit Smoothing results will be considered more risky and will give the impression that
is poorly managed, while one with consistent results will provide
certainty to investors.
Starting from the premise „if everybody does it so can I”, some
Trends managers use these techniques to be in trend with other managers who
use them.
Companies often borrow money, for which loan contacts are
concluded. Most of the times in these contracts there are clauses that
imply the stability of some economic and financial indicators or results
that, once violated, bring the company into the situation of paying
Special Circumstances

Manage Gearing penalties or even immediately reimbursing the credit. By maintaining

and Borrowing contractual parameters within the limits, using creative accounting
when it is not otherwise possible, managers keep the company away
from possible penalties or even more severe cases of economic
destabilization caused by reimbursement of a loan before the deadline
set by contract.
There are mainly two moments considered in this context: when a
company is listed for the first time on the Stock Exchange and when a
New situations company wants to raise more money through a share issue. In both
cases, creative accounting is used to make the company's results look
better than they really are.

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Category Motive Explanation

In this case there are two points of view: the one of the bidder and the
one of the target. From the perspective of the bidder, a good set of
Mergers and
results will allow the bid to be made from a position of strength with a
acquisitions
high price of shares. Referring to the target company, the bidder will
have to pay more, if the reported income reaches a certain level.
When the leadership of a new company changes, management tends to
blame old managers for all the poor results. A so-called "big bath"
New management
technique is adopted, whereby poor performance will be made even
team
worse by allowing managers to start from a low performance and
increase future results.
There are situations when a company is very weak, but has
Waiting for the
expectations for future periods. Through certain creative accounting
good times
techniques, these companies avoid delisting from the stock market.
A fairly rare case is when the managers want to give a true and fair
Believing that
view, but believe that current regulations prevent this from happening.
current regulations
Thus, they believe that, by adopting a more liberal, more creative way
are incorrect
of keeping the books, they will be able to deliver the fair view.
Some companies such as those dealing with oil processing, water
distribution, telecommunications, and other activities that could be
Decrease regulatory
subject to government intervention should not stand out with huge
visibility
profits; the creative accounting techniques are used in this case to
decrease the reported results.
A final reason is that creative accounting is not illegal. This reason is
more of an incentive than a purpose. Therefore, as managers are not
It is not illegal so
doing anything wrong, why shouldn’t they use creative accounting?
why shouldn’t we
This is a perfectly legitimate argument, even though it is not
use creative
necessarily following the spirit of the regulations. The fact that they
accounting?
may believe others are also adopting creative accounting reinforces this
argument.
Source: Own processing after Incentives for creative accounting and sometimes fraud, (M. Jones 2011b,
p.33)

Analyzing the Table 1, we can observe that the reasons can be splitted in two: personal and the
ones related to promoting the company. In the eyes of the accountants, creative accounting based
on explicit motives of self-interest can attract more disapproval than where the motivation was to
promote the company.
Following Jones's reasons, we can observe that these can be invoked especially in countries with
a predominantly Anglo-Saxon culture, where the financing of companies' activities is mostly made
through capital markets and are is „disconnected” from taxation. Because the accounting field is
subject to normalization, there are differences when it comes to continental countries. The strong
connection between accounting and taxation is one of the major differences that can be observed in
this context. Taxation is, therefore, a factor contributing to the use of creative accounting
techniques, given that taxable profit is calculated on the basis of accounting reports (Amat et al.
1999, p.120). If we determine the reasons why creative accounting can be used, we must also take
into account its impact on the actors involved in the life of an economic entity. For this purpose we
present in table no. 2 the potential gains and losses for all those involved in business life.

Table no. 2 Potential losses and gains for actors involved in the life of an economic entity
Gains Losses
Managers
Keeping their job; Reducing the cost of capital; Their job
Managing their remuneration; Minimizing the income Their reputation
tax; Improving the relationship with creditors,
investors and employees; Declaring and paying steady
dividends; Presenting constant results (income) from
one period to another; Well passing of the official
examination; Respecting debts covenants

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Gains Losses
Existing shareholders
Increasing their wealth; Increasing the market Confidence in the market
value of their shares; Reducing the cost of capital;
Controlling employees’ claims
Existing bondholders
Increase the market value of their shares Wealth transfer to the actual shareholders
Controlling employees claims
Employees
Keeping their jobs; Increasing their remuneration, Their jobs due to bankruptcies
especially in the case of profit share payable to
employees
Suppliers
Keeping their clients Money owned due to bankruptcies
Clients
Providing continuous services; Services interrupted;
Respecting warranties Warranty not honored
State
Tax to collect; No more tax to collect
Jobs for the people Expenses with the unemployed
Financial creditors
Repayment of the loans Money due to bankruptcies
Society
Jobs; Wealth for the economic environment Jobs lost as a result of bankruptcies
Source: Own processing after (Stolowy & Breton 2004, pp.41–42)

As we can see in table no.2, we cannot talk only about benefits for those involved, especially
those accountable with the entity’s management. However, the list of benefits is visibly longer and
more attractive, which is why managers are tempted to use these techniques in order to build the
desired image of the company's results.

3. Conclusions

Even if it involves risks such as losing their job or even worse, losing their reputation, creative
accounting practices remain attractive for managers. Starting from the premise „I'm too good to be
caught”, managers choose to position themselves favorably most of the time. Often the choice is a
simple one (the smallest evil): either they lose their jobs, being penalized by stakeholders for poor
management, or they lose their jobs if they are found to use creative accounting techniques.
Detection of such techniques involves advanced specialized knowledge from those who examine
the financial statements, but there is a small risk of being observed by investors, who often do not
possess such knowledge. Making understandability an enhancing characteristic of the accounting
information helped this process, because information can be presented, even if it is not understood
by all the users.
Another conclusion which can be drawn is related to the ethics of creative accounting: it is
possible that, if the reasons or motivations in applying the creative techniques are related to
promoting the company and not to self-interest, the thin line between ethical and unethical behavior
to be blurred? This is a question to be answered in future research.
Regardless of the reasons given by the entity's management, the use of these techniques should
not be used under the auspices of „purpose excuse the means” as they reduce the reliability of
accounting information.

4. References

• Amat, O., Blake, J. & Dowds, J., 1999. The ethics of creative accounting,
• Amat, O., Blake, J. & Gutierrez, S.M., 1995. La contabilidad creativa en España y en El Reino
Unido: un estudio comparativo, Available at: https://core.ac.uk/download/pdf/6475150.pdf [Accessed
May 15, 2017].

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• Amat, O. & Gowthorpe, C., 2004. Creative accounting: Nature, incidence and ethical issues,
• Ciocan, C.-C., 2017. True and Fair View: Incentive or Inhibitor for Creative Accounting? “Ovidius”
University Annals, Economic Sciences Series, Volume XVI(I), pp.451–455. Available at:
http://stec.univ-ovidius.ro/html/anale/RO/2017/Section-V/11.pdf [Accessed November 10, 2017].
• Feleagă, N., 1996. Controverse contabile, București: Editura Economica.
• Ionașcu, I., 2003. Dinamica doctrinelor contabilității contemporane, București: Economica.
• Jones, M., 2011a. Methods of Creative Accounting and Fraud. In Creative accounting, fraud and
international scandals. John Wiley & Sons, pp. 43–69.
• Jones, M., 2011b. Motivations to indulge in creative accounting and fraud. In Creative accounting,
fraud and international scandals. John Wiley & Sons, pp. 31–43.
• Jones, M.J., 2011. Creative accounting, fraud and international accounting scandals, John Wiley &
Sons.
• Mulford, C. & Cominskey, E., 2002. The Financial Numbers Game Detecting Creative Accounting
Practices, John Wiley & Sons.
• Stolowy, H. & Breton, G., 2004. Accounts Manipulation: A Literature Review and Proposed
Conceptual Framework. Review of Accounting and Finance, 3(1), pp.5–92. Available at:
http://www.emeraldinsight.com/doi/10.1108/eb043395.

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