Creative accounting definition
/What is Creative Accounting?
Creative accounting involves the use of unorthodox techniques to adjust the reported profit level or financial position of a business. Managers may engage in creative accounting to increase their bonuses, convince a lender to give the firm a loan, or increase its valuation in the event of a sale. Creative accounting can also be used to reduce reported profit levels, typically to avoid paying taxes. Creative accounting techniques are generally acceptable under the relevant accounting framework, but operate in a gray area where reported results are definitely being skewed away from actual results.
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Types of Creative Accounting
There are many creative accounting techniques. For example, a business could extend the useful life assumption for an asset in order to reduce the related periodic depreciation charge. Doing so extends the depreciation expense associated with an asset over a longer period of time. Another possibility is to increase the assumed salvage value of an asset in order to reduce the related periodic depreciation charge. Doing so may result in a larger loss when the asset is eventually sold, but this is likely to be in a later reporting period. A third creative accounting technique is to reduce the periodic accrual charge for the bad debt reserve. Doing will result in an underfunded reserve that will eventually need to be replenished, but it will increase profits over the short term. A fourth possibility is to defer the recognition of contingent liabilities that may or may not occur. By assuming that these liabilities will not occur, management is delaying their recognition until they actually do occur, probably in a later reporting period.