Creative accounting is a
euphemism
A euphemism () is an innocuous word or expression used in place of one that is deemed offensive or suggests something unpleasant. Some euphemisms are intended to amuse, while others use bland, inoffensive terms for concepts that the user wishes ...
referring to
accounting
Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "languag ...
practices that may follow the letter of the rules of
standard accounting practice
Publicly traded companies typically are subject to rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on th ...
s, but deviate from the spirit of those rules with questionable
accounting ethics
Accounting ethics is primarily a field of applied ethics and is part of business ethics and human ethics, the study of moral values and judgments as they apply to accountancy. It is an example of professional ethics. Accounting was introduced by ...
—specifically distorting results in favor of the "preparers", or the firm that hired the accountant.
They are characterized by excessive complication and the use of novel ways of characterizing income, assets, or
liabilities, and the intent to influence readers towards the interpretations desired by the authors. The terms "innovative" or "aggressive" are also sometimes used. Another common synonym is "cooking the books". Creative accounting is oftentimes used in tandem with outright financial
fraud
In law, fraud is intentional deception to secure unfair or unlawful gain, or to deprive a victim of a legal right. Fraud can violate civil law (e.g., a fraud victim may sue the fraud perpetrator to avoid the fraud or recover monetary compens ...
(including
securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a deceptive practice in the stock or commodities markets that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in los ...
), and lines between the two are blurred. Creative accounting practices are known since ancient times and appear world-wide in various forms.
The term as generally understood refers to systematic misrepresentation of the true
income
Income is the consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms. Income is difficult to define conceptually and the definition may be different across fields. For ...
and
asset
In financial accountancy, financial accounting, an asset is any resource owned or controlled by a business or an economic entity. It is anything (tangible or intangible) that can be used to produce positive economic value. Assets represent value ...
s of corporations or other organizations. "Creative accounting" has been at the root of a number of
accounting scandals
Accounting, also known as accountancy, is the measurement, processing, and communication of financial and non financial information about economic entities such as businesses and corporations. Accounting, which has been called the "language ...
, and many proposals for
accounting reform
Accounting reform is an expansion of accounting rules that goes beyond financial measures for both individual economic entities and national economies. It is advocated by those who consider the focus of the current standards and practices wholly ...
—usually centering on an updated analysis of
capital
Capital may refer to:
Common uses
* Capital city, a municipality of primary status
** List of national capital cities
* Capital letter, an upper-case letter Economics and social sciences
* Capital (economics), the durable produced goods used f ...
and
factors of production
In economics, factors of production, resources, or inputs are what is used in the production process to produce output—that is, goods and services. The utilized amounts of the various inputs determine the quantity of output according to the rel ...
that would correctly reflect how value is added.
Newspaper and television journalists have hypothesized that the
stock market downturn of 2002
In 2001, stock prices took a sharp downturn (some say "stock market crash" or " the Internet bubble bursting") in stock markets across the United States, Canada, Asia, and Europe. After recovering from lows reached following the September 11 attac ...
was precipitated by reports of "accounting irregularities" at
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. It was founded by Kenneth Lay in 1985 as a merger between Lay's Houston Natural Gas and InterNorth, both relatively small regional companies. ...
,
Worldcom
MCI, Inc. (subsequently Worldcom and MCI WorldCom) was a telecommunications company. For a time, it was the second largest long-distance telephone company in the United States, after AT&T. Worldcom grew largely by acquiring other telecommunic ...
, and other firms in the
United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...
.
According to critic
David Ehrenstein
David Ehrenstein (born February 18, 1947) is an American critic who focuses primarily on gay issues in cinema.
Life and career
Ehrenstein was born in New York City. His father was a Jew with Polish ancestors, and his mother was half-black and ha ...
, the term "creative accounting" was first used in 1968 in the film
''The Producers'' by
Mel Brooks
Mel Brooks (born Melvin James Kaminsky; June 28, 1926) is an American actor, comedian and filmmaker. With a career spanning over seven decades, he is known as a writer and director of a variety of successful broad farces and parodies. He began h ...
, where it is also known as
Hollywood accounting
Hollywood accounting (also known as Hollywood bookkeeping) is the opaque or creative accounting methods used by the film, video, television and music industry to budget and record profits for creative projects. Expenditures can be inflated to re ...
.
Motivations behind creative accounting
The underlining purpose for creative accounting is to “present
business in the best possible light” typically by manipulating recorded profits or costs. Company managers who participate in creative accounting can have a variety of situational motivations for doing so, including:
*Market and stockholder expectations of profits
*Personal incentives
*Bonus-related pay
*Benefits from shares and share options
*Job security
*Personal satisfaction
*Cover-up fraud
*Tax management
*Management buyouts
*Debt covenant
*Manager's self-interest
*Mergers and acquisitions
Types/examples of creative accounting schemes
Earnings management
Creative accounting can be used to manage earnings. Earnings management occurs when
managers
Management (or managing) is the administration of an organization, whether it is a business, a nonprofit organization, or a government body. It is the art and science of managing resources of the business.
Management includes the activities o ...
use judgment in
financial reporting
Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity.
Relevant financial information is presented in a structured manner and in a form which is easy to un ...
and in structuring transactions to alter financial reports to either mislead some
stakeholders about the underlying economic performance of a company or influence contractual outcomes that depend on reported accounting numbers.
Hollywood accounting
Practiced by some Hollywood film studios, creative accounting can be used to conceal earnings of a film to distort the profit participation promised to certain participants of the film's earnings. Essentially, participants in the gross revenue of the film stay unaffected but profit participants are presented with a deflated or negative number on profitability, leading to less or no payments to them following a film's success. Famous examples of deceiving
good faith profit participants involve
Darth Vader
Darth Vader is a fictional character in the ''Star Wars'' franchise. The character is the central antagonist of the original trilogy and, as Anakin Skywalker, is one of the main protagonists in the prequel trilogy. ''Star Wars'' creator George ...
actor
David Prowse
David Charles Prowse (1 July 1935 – 28 November 2020) was an English actor, bodybuilder and weightlifter. He portrayed Darth Vader (voiced by American actor James Earl Jones) in the original ''Star Wars'' trilogy and a manservant in Stanle ...
(with $729M adjusted gross earnings on ''
Return of the Jedi
''Return of the Jedi'' (also known as ''Star Wars: Episode VI – Return of the Jedi'' is a 1983 American epic space opera film directed by Richard Marquand. The screenplay is by Lawrence Kasdan and George Lucas from a story by Lucas, who ...
'') and ''
Forrest Gump
''Forrest Gump'' is a 1994 American comedy-drama film directed by Robert Zemeckis and written by Eric Roth. It is based on the 1986 novel of the same name by Winston Groom and stars Tom Hanks, Robin Wright, Gary Sinise, Mykelti Williamson and ...
'' novel writer
Winston Groom
Winston Francis Groom Jr. (March 23, 1943 – September 17, 2020) was an American novelist and non-fiction writer. He is best known for his novel '' Forrest Gump'' (1986), which became a cultural phenomenon after being adapted as a 1994 film of ...
(with $661M gross theatrical revenue)
—both of which have been paid $0 on their profit participation due to the films "being in the red".
Tobashi schemes
This form of creative accounting—now considered a criminal offense in Japan, where it originated—involves the sale, swap or other form of temporary trade of a liability of one company with another company within the holding's portfolio, often solely created to conceal losses of the first firm. These schemes were popular in the 1980s in Japan before the government instituted harsher civil laws and eventually criminalized the practice. The
Enron scandal
The Enron scandal was an accounting scandal involving Enron Corporation, an American energy company based in Houston, Texas. Upon being publicized in October 2001, the company declared bankruptcy and its accounting firm, Arthur Andersen then on ...
revealed that
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. It was founded by Kenneth Lay in 1985 as a merger between Lay's Houston Natural Gas and InterNorth, both relatively small regional companies. ...
had extensively made use of sub-corporations to offload debts and hide its true losses in a Tobashi fashion.
Lehman Brothers' Repo 105 scheme
Lehman Brothers
Lehman Brothers Holdings Inc. ( ) was an American global financial services firm founded in 1847. Before filing for bankruptcy in 2008, Lehman was the fourth-largest investment bank in the United States (behind Goldman Sachs, Morgan Stanley, a ...
utilized
repurchase agreements
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
to bolster profitability reports with their
Repo 105
Repo 105 is Lehman Brothers' name for an accounting maneuver that it used where a short-term repurchase agreement is classified as a sale. The cash obtained through this "sale" is then used to pay down debt, allowing the company to appear to reduc ...
scheme under the watch of the accounting firm
Ernst & Young
Ernst & Young Global Limited, trade name EY, is a multinational professional services partnership headquartered in London, England. EY is one of the largest professional services networks in the world. Along with Deloitte, KPMG and Pricewaterh ...
. The scheme consisted of mis-reporting a
Repo
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
(a promise to re-buy a liability or asset after selling it) as a sale, and timing it exactly in a way that half of the transaction was completed before a profitability reporting deadline, half after—hence bolstering profitability numbers on paper. Public prosecutors in New York filed suit against EY for allowing the "accounting fraud involving the surreptitious removal of tens of billions of dollars of fixed income securities from Lehman's balance sheet in order to deceive the public about Lehman's true liquidity condition".
Enron
Enron Corporation was an American energy, commodities, and services company based in Houston, Texas. It was founded by Kenneth Lay in 1985 as a merger between Lay's Houston Natural Gas and InterNorth, both relatively small regional companies. ...
had done exactly the same about 10 years earlier; in their case,
Merrill Lynch
Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment bank ...
aided Enron in bolstering profitability close to earnings periods by willfully entering
repurchase agreements
A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in government securities. The dealer sells the underlying security to investors and, by agreement between the two par ...
to
buy Nigerian barges from Enron, only for Enron to buy them back a few months later. The
U.S. Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market ...
(SEC) filed charges and convicted multiple Merrill Lynch executives of aiding the fraud.
Currency swap concealment of Greek debt by Goldman Sachs
In 2001–2002,
Goldman Sachs
Goldman Sachs () is an American multinational investment bank and financial services company. Founded in 1869, Goldman Sachs is headquartered at 200 West Street in Lower Manhattan, with regional headquarters in London, Warsaw, Bangalore, H ...
aided the government of
Greece
Greece,, or , romanized: ', officially the Hellenic Republic, is a country in Southeast Europe. It is situated on the southern tip of the Balkans, and is located at the crossroads of Europe, Asia, and Africa. Greece shares land borders with ...
after its admission to the Eurozone to better its deficit numbers by conducting large
currency swaps. These transactions, totaling more than 2.3 billion Euros, were technically
loans
In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations, etc. The recipient (i.e., the borrower) incurs a debt and is usually liable to pay interest on that de ...
but concealed as currency swaps in order to circumvent
Maastricht Treaty
The Treaty on European Union, commonly known as the Maastricht Treaty, is the foundation treaty of the European Union (EU). Concluded in 1992 between the then-twelve member states of the European Communities, it announced "a new stage in the ...
rules on member nations deficit limits and allowed Greece to "hide" an effective 1 billion euro loan. After Goldman Sachs had engineered the financial instrument and sold it to the Greeks—simply shifting the liabilities in the future and defrauding investors and the
European Union
The European Union (EU) is a supranational political and economic union of member states that are located primarily in Europe. The union has a total area of and an estimated total population of about 447million. The EU has often been des ...
, the investment bank's president
Gary Cohn pitched Athens another deal. After Greece refused the second deal, the firm sold its Greek swaps to the Greek national bank and made sure its
Short
Short may refer to:
Places
* Short (crater), a lunar impact crater on the near side of the Moon
* Short, Mississippi, an unincorporated community
* Short, Oklahoma, a census-designated place
People
* Short (surname)
* List of people known as ...
and
Long
Long may refer to:
Measurement
* Long, characteristic of something of great duration
* Long, characteristic of something of great length
* Longitude (abbreviation: long.), a geographic coordinate
* Longa (music), note value in early music mens ...
positions towards Greece were in balance—so that a potential Greek default would not affect Goldman Sachs.
Parmalat's mis-accounted credit-linked notes
Italian dairy giant
Parmalat
Parmalat S.p.A. is a dairy and food corporation which is a subsidiary of French multinational company Lactalis. It was founded by Calisto Tanzi in 1961.
Having become the leading global company in the production of long-life milk using ultra-h ...
employed a number of creative accounting and wire fraud schemes before 2003 that lead to the largest bankruptcy in European history. It sold itself
Credit-linked notes with the help of
Merrill Lynch
Merrill (officially Merrill Lynch, Pierce, Fenner & Smith Incorporated), previously branded Merrill Lynch, is an American investment management and wealth management division of Bank of America. Along with BofA Securities, the investment bank ...
through a
Cayman Islands
The Cayman Islands () is a self-governing British Overseas Territory—the largest by population in the western Caribbean Sea. The territory comprises the three islands of Grand Cayman, Cayman Brac and Little Cayman, which are located to the ...
special-purpose entity
A special-purpose entity (SPE; or, in Europe and India, special-purpose vehicle/SPV; or, in some cases in each EU jurisdiction, FVC, financial vehicle corporation) is a legal entity (usually a limited company of some type or, sometimes, a limited ...
and over-accounted for their value on the balance sheet. It also forged a $3.9Bn check from
Bank of America
The Bank of America Corporation (often abbreviated BofA or BoA) is an American multinational investment bank and financial services holding company headquartered at the Bank of America Corporate Center in Charlotte, North Carolina. The bank w ...
. The publicly listed company stated to investors that it had about $2Bn in liabilities (this figure was accepted by its auditors
Deloitte
Deloitte Touche Tohmatsu Limited (), commonly referred to as Deloitte, is an international professional services network headquartered in London, England. Deloitte is the largest professional services network by revenue and number of profession ...
and
Grant Thornton International
Grant Thornton is the world's seventh-largest by revenue and sixth-largest by number of employees professional services networks, professional services network of independent accounting and Management consulting, consulting member firms which ...
), but once audited more vigorously during the bankruptcy proceedings, it was discovered that the company's debt turned out to actually be $14.5Bn.
This massive debt was largely caused by failed operations in Latin America and increasingly complex financial instruments used to mask debt—such as Parmalat "billing itself" through a subsidiary called Epicurum. It was also discovered that its CEO
Calisto Tanzi
Calisto Tanzi (17 November 1938 – 1 January 2022) was an Italian businessman and convicted fraudster. He founded Parmalat in 1961, after dropping out of college. Parmalat collapsed in 2003 with a €14bn ($20bn; £13bn) hole in its accounts ...
had ordered the creation of shell accounts and diverted 900M Euros worth into his private travel company.
Offshoring and tax avoidance
In order to avoid taxes on profits, multinational corporations often make use of
offshore subsidiaries
A subsidiary, subsidiary company or daughter company is a company owned or controlled by another company, which is called the parent company or holding company. Two or more subsidiaries that either belong to the same parent company or having a sa ...
in order to employ a creative accounting technique known as "Minimum-Profit Accounting". The subsidiary is created in a
tax haven
A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual or legal entity) by a governmental organization in order to fund government spending and various public expenditures (regional, local, or n ...
—often just as a shell company—then charges large fees to the primary corporation, effectively minimizing or wholly wiping out the profit of the main corporation. Within most parts of the
European Union
The European Union (EU) is a supranational political and economic union of member states that are located primarily in Europe. The union has a total area of and an estimated total population of about 447million. The EU has often been des ...
and the
United States
The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territorie ...
, this practice is perfectly legal and often executed in plain sight or with explicit approval of tax regulators.
Nike, Inc.
Nike, Inc. ( or ) is an American multinational corporation that is engaged in the design, development, manufacturing, and worldwide marketing and sales of footwear, apparel, equipment, accessories, and services. The company is headquartered ne ...
famously employed offshoring by selling its
Swoosh
The Swoosh is the logo of American sportswear designer and retailer Nike. Today, it has become one of the most recognizable brand logos in the world, and the most valuable, having a worth of $26 billion alone.
Bill Bowerman and Phil Knight fou ...
logo to a
Bermuda
)
, anthem = "God Save the King"
, song_type = National song
, song = " Hail to Bermuda"
, image_map =
, map_caption =
, image_map2 =
, mapsize2 =
, map_caption2 =
, subdivision_type = Sovereign state
, subdivision_name =
, e ...
-based
special-purpose entity
A special-purpose entity (SPE; or, in Europe and India, special-purpose vehicle/SPV; or, in some cases in each EU jurisdiction, FVC, financial vehicle corporation) is a legal entity (usually a limited company of some type or, sometimes, a limited ...
subsidiary for a nominal amount, and then went on to "charge itself" licensing fees that Nike Inc. had to pay to the subsidiary in order to use its own brand in Europe. The Dutch tax authorities were aware of and approved of this siphoning structure, but did not publish the private agreement they had with Nike. The licensing fees totaled $3.86Bn over the course of 3 years and were discovered due to an unrelated U.S.-based lawsuit as well as the
Paradise Papers
The Paradise Papers are a set of over 13.4 million confidential electronic documents relating to offshore investments that were leaked to the German reporters Frederik Obermaier and Bastian Obermayer, from the newspaper'' Süddeutsch ...
. In 2014, the Bermuda deal with Dutch authorities expired, and Nike shifted the profits to another offshore subsidiary, a
Netherlands
)
, anthem = ( en, "William of Nassau")
, image_map =
, map_caption =
, subdivision_type = Sovereign state
, subdivision_name = Kingdom of the Netherlands
, established_title = Before independence
, established_date = Spanish Netherl ...
-based Limited Liability Partnership (CV, short for
Commanditaire Vennootschaap, generally known as a
Kommanditgesellschaft
A (abbreviated "KG", ; from + ) is the German name for a limited partnership business entity and is used in German, Belgian, Dutch, Austrian, and some other European legal systems. In Japan, it is called a '' gōshi gaisha''. Its name derive ...
). Through a Dutch tax loophole, CV's owned by individuals that are residing in the Netherlands are tax-free. Exploiting this structure saved Nike more than $1Bn in taxes annually and reduced its global tax rate to 13.1%; the company is currently being pursued for billions of dollars worth of
back taxes
Back taxes is a term for taxes that were not completely paid when due. Typically, these are taxes that are owed from a previous year. Causes for back taxes include failure to pay taxes by the deadline, failure to correctly report one's income, or ...
in litigation by multiple governments for this multinational
tax avoidance
Tax avoidance is the legal usage of the tax regime in a single territory to one's own advantage to reduce the amount of tax that is payable by means that are within the law. A tax shelter is one type of tax avoidance, and tax havens are jurisdict ...
.
In popular media
A number of center around financial scandals and
securities fraud
Securities fraud, also known as stock fraud and investment fraud, is a deceptive practice in the stock or commodities markets that induces investors to make purchase or sale decisions on the basis of false information, frequently resulting in los ...
that involved creative accounting practices:
* ''
Enron: The Smartest Guys in the Room''
*
''Inside Job'' (2010 film)
*
PBS
The Public Broadcasting Service (PBS) is an American public broadcasting, public broadcaster and Non-commercial activity, non-commercial, Terrestrial television, free-to-air television network based in Arlington, Virginia. PBS is a publicly fu ...
documentary film based on ''
The Ascent of Money
''The Ascent of Money: A Financial History of the World'' is a 2008 book by then- Harvard professor Niall Ferguson, and an adapted television documentary for Channel 4 (UK) and PBS (US), which in 2009 won an International Emmy Award. It examines t ...
''
* Documentary based on ''
The Commanding Heights
''The Commanding Heights: The Battle for the World Economy'' is a book by Daniel Yergin and Joseph Stanislaw first published as ''The Commanding Heights: The Battle Between Government and the Marketplace That Is Remaking the Modern World'' in ...
''
* ''
Betting on Zero
''Betting on Zero'' is a 2016 American documentary directed by Ted Braun. It investigates the allegation that Herbalife is a pyramid scheme, and follows Bill Ackman's short investment in Herbalife, which is ostensibly a billion-dollar bet that ...
''
* ''
The China Hustle
''The China Hustle'' is a 2017 finance documentary produced by Magnolia Pictures and directed by Jed Rothstein. The documentary reveals systematic and formulaic decades-long securities fraud by Chinese companies listed on the US stock market.
...
''
*
''Dirty Money''
* ''
'', about
Nick Leeson
Nicholas William Leeson (born 25 February 1967) is an English former derivatives trader whose fraudulent, unauthorized and speculative trades resulted in the 1995 collapse of Barings Bank, the United Kingdom's oldest merchant bank. Leeson w ...
and
Barings Bank
Barings Bank was a British merchant bank based in London, and one of England's List of oldest banks in continuous operation, oldest merchant banks after Berenberg Bank, Barings' close collaborator and German representative. It was founded in 1762 ...
* ''
The Inventor: Out for Blood in Silicon Valley''
* ''
Chasing Madoff'', about the
Madoff investment scandal
The Madoff investment scandal was a major case of stock and securities fraud discovered in late 2008. In December of that year, Bernie Madoff, the former NASDAQ chairman and founder of the Wall Street firm Bernard L. Madoff Investment Securities ...
* ''
The Price We Pay''
* ''
Fyre'' and ''
Fyre Fraud'', two competing documentaries about the
Fyre Festival
Fyre Festival was a fraudulent luxury music festival founded by con artist Billy McFarland and rapper Ja Rule. It was created with the intent of promoting the company's Fyre app for booking music talent. The festival was scheduled to take pla ...
See also
*
Corporate abuse
*
Reverse takeover
A reverse takeover (RTO), reverse merger, or reverse IPO is the acquisition of a public company by a private company so that the private company can bypass the lengthy and complex process of going public. Sometimes, conversely, the public compan ...
References
Further reading
* Amat, O., & Gowthorpe, C. (2004)
Creative accounting: Nature, incidence and ethical issues Economics Working Papers 749, Department of Economics and Business, Universitat Pompeu Fabra.
*
*
* Oliveras, E., & Amat, O. (2003)
Ethics and creative accounting: Some empirical evidence on accounting for intangibles in Spain ''UPF Economics and Business Working Paper'', (732).
{{Authority control
Accounting systems
Euphemisms
Ethically disputed business practices
Financial controversies