Creative Accounting

Version	Summary	Created by	Modification	Content Size	Created at	Operation
1		Mostafa Abdulkareem Ali	--	1715	2022-04-26 16:32:39	\|
2	format correct	Catherine Yang	-11 word(s)	1704	2022-04-27 03:07:51	\|

This entry is adapted from the peer-reviewed paper 10.3390/risks10040077

The main function behind the conceptualization of creative accounting is maintaining the quality of financial reporting practice. Basically, creative accounting is the practice of influencing financial indicators through accounting knowledge without explicitly violating accounting policies, rules, and laws. Creative accounting is practiced to demonstrate the financial status desired by the company management wherein the stakeholders are informed what the management wants them to perceive. It facilitates the manipulation of financial information in its proper and accurate form in which the preparer uses the existing rules or in many cases ignores one or more rules.

ethical issues disclosure quality internal control

1. Creative Accounting Determinants and Financial Reporting Quality

It is generally seen that top management pressurize the accounting personnel in their banks to overestimate the financial state of their companies (Salome et al. 2012). As a result, accounting managers often manipulate the financial and accounting information to maximize the earnings of banks. These dishonest and manipulative practices benefit the shareholders since an increase is noted in the share prices of these listed banks. However, creative accounting practices can often lead to self-destruction, as a false disclosure of financial reports regarding the company’s debt can mislead the public (Kardan et al. 2016). The different accounting engineering techniques which are implemented by the bank can help them present a desirable public image and portray a financial performance based on their specified preferences. This is done by exploiting legislative ambiguities. All these practices decrease financial data reporting quality. Hence, the banks that implement a higher level of creative accounting practices tend to possess a low or poor quality of financial reporting (Tri Wahyuni et al. 2020). The accounting managers of these banks, who carry out creative accounting practices, project a higher financial performance, better earnings, stock, and share prices (Goel 2014). In this study, the researchers have attempted to define some determinants which can affect financial reporting quality. This study can also explain the various manipulative practices which are implemented during the presentation of financial reports and their effect on the banking industry.

Ethical issues refer to right or wrong practices, based on an ethical viewpoint. The ethical issues implemented in an organization are important for the rejection or adoption of creative accounting practices. It has been argued that the tendency of some managers to focus on short-term gains is mainly responsible for an unethical environment in the bank, which further encourages poor financial reporting (Tassadaq and Malik 2015). However, when managers adopt ethical behaviour, accounting transparency in the bank can increase (Butala and Khan 2011). The acceptability and implementation of ethical behaviour had been examined amongst accountants, treasurers, and institutional investors (Cernusca et al. 2016). They observed that the treasurers significantly implemented creative accounting practices, whereas regulators and public accountants rarely carried out creative accounting practices (Ezeagba and Chidoziem Abiahu 2018). Charles et al. proposed a direct approach that suggested that managerial and corporate ethics affect the quality of financial reporting (Akenbor and Tennyson 2014). Thus, it can be concluded that an ethical environment and ethical management affect the quality of financial reporting.

The agency theory suggested that managers, who represent shareholders often indulge in creative accounting practices to maximize shareholder wealth. This theory stated that control mechanisms need to be carried out for protection of the shareholders against any conflict that affects their profit (Tommasetti et al. 2019). Hence, an information asymmetry is noted due to the profit conflicts occurring between the shareholders and managers. The people who follow the capital market seek reliable financial reports and data to decrease the information asymmetry occurring between the external investors and company management. Various researchers who investigated accounting practices stated that information asymmetry can be decreased by obtaining high disclosure quality (Song et al. 2013). Thus, disclosure quality was regarded as a major concept which helped in significantly decreasing profit and information asymmetry conflicts, thereby leading to an increase in the bank value (Yasser et al. 2016). A negative relationship is noted between information asymmetry and disclosure quality. Studies indicated that many banks do carry out creative accounting practices (Abed et al. 2020b).

Despite this, it is observed that a defined and an established internal control can decrease the auditing fees and improve the integrity and reliability of the financial reporting presented by the organization (Rozidi et al. 2015). These results showed that a weak, or lack of, internal control decreases the objectivity and quality of the financial reporting presented by the management. A positive correlation is seen between financial reporting quality and strong internal control (Ayagre et al. 2014). Furthermore, (Brauweiler et al. 2019) stated that the adoption of internal control is vital for improvement of the quality of financial reporting. The primary correlation occurs between the need for effective internal control and financial reporting quality (D’Mello et al. 2017). They explained the statements made by the former Chairman of the US Securities and Exchange Commission (SEC), who stated that the quality of financial reporting was determined by internal control. Thus, it could be concluded that an inefficient internal control causes a misstatement in financial reporting.

However, (Nagata and Nguyen 2017) noted that a better ownership structure can improve the external control on management, thereby improving the quality of the financial reporting. An ownership structure decreases the creative accounting practices; however, this effect is dependent on the size of the bank (Sahasranamam et al. 2019). According to (Alzoubi 2016), the ownership structure affects the quality of financial reporting in banks which use creative accounting indicators. In these banks, the agents use novel creative accounting techniques, which further decreases the quality of financial reporting. Furthermore, they stated that the ownership structure improves the financial reporting quality in organizations which use an accrual creative accounting indicator. Many earlier researchers have observed that the ownership structure of the banks showed a low efficiency when monitoring their agents (Kao et al. 2019). Other researchers also observed a positive effect of the ownership structure on bank performance (Bao and Lewellyn 2017). Additionally, the ownership structure positively affected the financial reporting quality (Han et al. 2019).

2. The Moderating Impacts of the Audit Committee

The impacts played by the audit committee have encouraged researchers to concentrate on financial reporting quality (Qian et al. 2015). Manipulation of the accounts causes an alteration in the share prices, and thereby the market capital of the company, which increases the risk of losing investors. In the past few years, the audit committee has played a vital role in the corporate governance mechanism (Saleem 2019). Some researchers have investigated the electiveness and competencies of the audit committee. However, many others believed that the existence of the audit committee was essential, as it can improve financial reporting quality (Buallay 2018; Al-Shaer et al. 2020). The audit committee had an impact on the determination of creative accounting (Inaam and Khamoussi 2016). It was significantly related to the quality of abnormal returns, accruals, financial restatements, and fraud.

Thus, ethics play a significant role in financial reporting as they are based on accounting standards. The ethical behavior of the employees in the organizations help to ensure that the organizations can gain the trust of the users with regard to the bank’s services. Ethics allow organizations to determine right and wrong values. Following the right ethics ensures that organizations are not in crisis (Cernusca et al. 2016). It further indicates that organizations need to consider professional and societal ethics, and investigate how much the auditor can ethically detect creative accounting practices. Ethical issues related to creative accounting practices allow the audit committee to enhance their accuracy and efficiency in detecting fraudulent practices (Al Momamani and Obeidat 2013; de Jesus et al. 2020). Hence, the audit committee discourages any manipulation occurring in financial accounts. Thus, it was concluded that ethical issues regarding creative accounting practices were essential for financial reporting. Therefore, a fair and just attitude was essential while carrying out financial reporting (Voinea and Dimitriu 2014).

The organizations which are vulnerable owing to their industry and size are more likely to disclose information voluntarily to manage legitimacy, as audit committees vary due to the company size and sector, and can significantly affect the disclosure quality content (Mutuc et al. 2019). The effect of individual aspects of the audit committee characteristics can be seen in financial reporting quality (Saleem 2019). The audit committee promoted financial disclosure and its expert abilities promoted efficient financial reporting quality (Yekini and Jallow 2012; Mudel 2016). An independent audit committee was generally selected since this type of committee improved financial reporting quality (Qian et al. 2015). Hence, it is essential to investigate the effect of an audit committee on the correlation between the disclosure quality and the quality of the financial reporting presented by the organization.

An audit committee needs to regularly review the conclusions presented by the internal control department and ensure that the management of the company is acting on the recommendations of the internal control department in a diligent manner (Inaam and Khamoussi 2016). The internal control department is responsible for developing annual plans, and also submitting annual reports to the audit committee or company board (Brauweiler et al. 2019). Hence, the audit committee and internal control department are motivated to release high-quality financial reporting. Moreover, it is believed that the audit committee and internal control department executed high-quality audit reports to prevent legal liabilities and maintain reputation. The primary function of an audit committee is to supervise the financial reporting quality and monitor the inclination of the company’s management to implement creative accounting practices (Buallay 2018). Thus, organizations need to establish an internal control department using skills and resources which are vital and applicable to their size, complexity, and nature (Richman and Richman 2012).

Audit committees played a vital role in limiting creative accounting practices even though the ownership structure was controlled by a few people (Bajra and Čadež 2018). However, it was stated that the efficiency of these audit committees decreased if the ownership structure members belonged to or dominated the corporate boards. The influence of auditing committee characteristics on financial reporting quality has been examined (Saleem 2019). It was noted that the independence of the audit committee was related to a strong ownership structure function. An audit committee restricted aggressive creative accounting practices (Buallay 2018). An active audit committee provided effective monitoring, which improved the quality of the bank’s financial reports (Deng et al. 2018). Banks with a concentrated ownership structure acquire good-quality financial reporting from an effective audit committee (Mutuc et al. 2019).

References

Salome, Ezeani Nneka, Martin Ifeanyi Ogbonna, Ezemoyih Chuks Marcel, and Okonye Ekendu Echezonachi. 2012. The effect of creative accounting on the job performance of accountants (auditors) in reporting financial statementin Nigeria. Kuwait Chapter of the Arabian Journal of Business and Management Review 33: 1–30.
Kardan, Behzad, Mahdi Salehi, and Rahimeh Abdollahi. 2016. The relationship between the outside financing and the quality of financial reporting: Evidence from Iran. Journal of Asia Business Studies 10: 20–40.
Tri Wahyuni, Ersa, Gina Puspitasari, and Evita Puspitasari. 2020. Has IFRS improved Accounting Quality in Indonesia? A Systematic Literature Review of 2010–2016. Journal of Accounting and Investment 21: 19–44.
Goel, Sandeep. 2014. The quality of reported numbers by the management: A case testing of earnings management of corporate India. Journal of Financial Crime 21: 355–76.
Tassadaq, Fizza, and Qaisar Ali Malik. 2015. Creative accounting and financial reporting: Model development and empirical testing. International Journal of Economics and Financial Issues 5: 544–51.
Butala, Amy, and Zafar U. Khan. 2011. Accounting Fraud at Xerox Corporation. SSRN Electronic Journal 16: 81–89.
Cernusca, Lucian, David Delia, Cristina Nicolaescu, and Bogdan Cosmin Gomoi. 2016. Empirical Study on the Creative Accounting Phenomenon. Studia Universitatis Vasile Goldiș Arad—Economics Series 26: 63–87.
Ezeagba, Charles Emenike, and Mary-Fidelis Chidoziem Abiahu. 2018. Ezeagba, Charles Emenike, and Mary-Fidelis Chidoziem Abiahu. Influence of Professional Ethics and Standards in Less Developed Countries: An Assessment of Professional Accountants in Nigeria. Asian Journal of Economics, Business and Accounting 6: 2–6.
Akenbor, Cletus O., and Oghoghomeh Tennyson. 2014. Ethics of Accounting Profession in Nigeria. Journal of Business and Economics 5: 1374–82.
Tommasetti, Roberto, Marcelo Á. da Silva Macedo, Frederico A. Azevedo de Carvalho, and Sergio Barile. 2019. Better with age: Financial reporting quality in family firms. Journal of Family Business Management 10: 40–57.
Song, Dan-Bee, Ho-Young Lee, and Eun-Jung Cho. 2013. The association between earnings management and asset misappropriation. Managerial Auditing Journal 28: 542–67.
Yasser, Qaiser Rafique, Abdullah Al Mamun, and Irfan Ahmed. 2016. Quality of financial reporting in the Asia-Pacific region: The influence of ownership composition. Review of International Business and Strategy 26: 543–60.
Abed, Ibtihal A., Nazimah Hussin, Mostafa A. Ali, Nada Salman Nikkeh, and Mohammed A. Mohammed. 2020b. Creative Accounting Phenomenon in the Financial Reporting: A Systematic Review Classification, Challenges. Technology Reports of Kansai University 62: 1–10.
Rozidi, Muhammad Syafiq Razelin Anis, Nor Aime Mohd Nor, Nuraini Abdul Aziz, Nur Amalina Rosli, and Norlaila Mazura Hj Mohaiyadin. 2015. Relationship between Auditors’ Ethical Judgments, Quality of Financial Reporting and Auditors’ Attitude towards Creative Accounting: Malaysia Empirical Evidence. International Journal of Business, Humanities and Technology 5: 81–87.
Ayagre, Philip, Ishmael Appiah-Gyamerah, and Joseph Nartey. 2014. The effectiveness of Internal Control Systems of banks. The case of Ghanaian banks. International Journal of Accounting and Financial Reporting 4: 377.
Brauweiler, Hans-Christian, Aida Yerimpasheva, and Zerma Bagalbayeva. 2019. Avoiding creative accounting: Corporate governance and leadership skills. Zeszyty Teoretyczne Rachunkowości 12: 9–19.
D’Mello, Sheetal R., Celia N. Cruz, Mei-Ling Chen, Mamta Kapoor, Sau L. Lee, and Katherine M. Tyner. 2017. The evolving landscape of drug products containing nanomaterials in the United States. Nature Nanotechnology 12: 523–29.
Nagata, Kyoko, and Pascal Nguyen. 2017. Ownership structure and disclosure quality: Evidence from management forecasts revisions in Japan. Journal of Accounting and Public Policy 36: 451–67.
Sahasranamam, Sreevas, Bindu Arya, and Mukesh Sud. 2019. Ownership structure and corporate social responsibility in an emerging market. Asia Pacific Journal of Management 37: 1165–92.
Alzoubi, Ebraheem Saleem Salem. 2016. Ownership structure and earnings management: Evidence from Portugal. International Journal of Accounting & Information Management 24: 135–61.
Kao, Mao-Feng, Lynn Hodgkinson, and Aziz Jaafar. 2019. Ownership structure, board of directors and firm performance: Evidence from Taiwan. Corporate Governance: The International Journal of Business in Society 19: 189–216.
Bao, Shuji Rosey, and Krista B. Lewellyn. 2017. Ownership structure and earnings management in emerging markets—An institutionalized agency perspective. International Business Review 26: 828–38.
Qawqzeh, Hamza Kamel, Wan Anisah Endut, Norfadzilah Rashid, and Mohammad Mustafa. 2019. Ownership structure and financial reporting quality: Influence of audit quality evidence from Jordan. International Journal of Recent Technology and Engineering (IJRTE) 8: 2212–20.
Qian, Wei, Jacob Hörisch, Stefan Schaltegger, Fatma Baalouch, Salma Damak Ayadi, Khaled Hussainey, and Ben Kwame Agyei-Mensah. 2015. A study of the determinants of environmental disclosure quality: Evidence from French listed companies. Journal of Management and Governance 22: 1608–19.
Saleem, Khalil Suleiman Abu. 2019. The Impact of Audit Committee Characteristics on the Creative Accounting Practices Reduction in Jordanian Commercial Banks. Modern Applied Science 13: 113–23.
Buallay, Amina. 2018. Audit committee characteristics: An empirical investigation of the contribution to intellectual capital efficiency. Measuring Business Excellence 22: 183–200.
Al-Shaer, Habiba, Aly Salama, and Steven Toms. 2020. Audit committees and financial reporting quality: Evidence from UK environmental accounting disclosures. Managerial Auditing Journal 35: 1639–62.
Inaam, Zgarni, and Halioui Khamoussi. 2016. Audit committee effectiveness, audit quality and earnings management: A meta-analysis. International Journal of Law and Management 58: 179–96.
Al Momani, Mohammed Abdullah, and Mohammed Ibrahim Obeidat. 2013. The Effect of Auditors’ Ethics on Their Detection of Creative Accounting Practices: A Field Study. International Journal of Business and Management 8: 118–36.
de Jesus, Tânia Alves, Pedro Miguel Pinheiro, Catarina Kaizeler, and Manuela M. Sarmento. 2020. Creative Accounting or Fraud? Ethical Perceptions Among Accountants. International Review of Management and Business Research 9: 58–78.
Voinea, Maria-Mădălina, and Otilia Dimitriu. 2014. Manipulating User Behavior through Accounting Information. Procedia Economics and Finance 15: 886–93.
Mutuc, Eugene Burgos, Jen-Sin Lee, and Fu-Sheng Tsai. 2019. Doing Good with Creative Accounting? Linking Corporate Social Responsibility to Earnings Management in Market Economy, Country and Business Sector Contexts. Sustainability 8: 4568.
Yekini, Kemi, and Kumba Jallow. 2012. Corporate community involvement disclosures in annual report: A measure of corporate community development or a signal of CSR observance? Sustainability Accounting, Management and Policy Journal 3: 7–32.
Mudel, Sonia. 2016. A Study to Show the Relation between Creative Accounting and Corporate Governance. SSRN Electronic Journal 2: 193–99.
Richman, Vincent, and Alex Richman. 2012. A Tale of Two Perspectives: Regulation Versus Self-Regulation. A Financial Reporting Approach (from Sarbanes-Oxley) for Research Ethics. Science and Engineering Ethics 18: 241–46.
Bajra, Ujkan, and Simon Čadež. 2018. Audit committees and financial reporting quality: The 8th EU Company Law Directive perspective. Economic Systems 42: 151–63.
Deng, Xin, Yen Teik Lee, and Zhengting Zhong. 2018. Decrypting coin winners: Disclosure quality, governance mechanism and team networks. Governance Mechanism and Team Networks.

© Text is available under the terms and conditions of the Creative Commons Attribution (CC BY) license; additional terms may apply. By using this site, you agree to the Terms and Conditions and Privacy Policy.

Upload a video for this entry

Information

Subjects: Management

Contributors MDPI registered users' name will be linked to their SciProfiles pages. To register with us, please refer to https://encyclopedia.pub/register :

Mostafa Ali

NAZIMAH HUSSIN

View Times: 1.3K

Update Date: 27 Apr 2022

Table of Contents

Video Upload Options

Confirm

1. Creative Accounting Determinants and Financial Reporting Quality

2. The Moderating Impacts of the Audit Committee

References