Creative accounting is not so much a new phenomenon, but rather a taking to
new extremes of what has long been part of the accountant's art. The objectives are
generally either to improve reported earnings or to enhance the company's debt/equity
ratio. While unadjusted profits often fluctuate from year to year, the market looks for
steadily rising earnings, which impact upon both the share price and the market. The
debt/equity ratio provides an indication of risk, and is often used by lenders to restrict
further borrowing.
Profit enhancement can be achieved by spreading expenses over
several years, by changing depreciation, by manipulation of foreign currency loans and by
timing of revenues on long-term contracts. Complex capital instruments blur distinctions
between debt and equity and provide many opportunities to improve ratios. This can also be
done with off-balance-sheet financing.
Mergers and acquisitions bring their own problems - and accounting
opportunities. Merger accounting avoids the goodwill problem, but fair value adjustments
in acquisition accounting provide ways of influencing future profits and the balance
sheet. If all else fails, the company can write off all its bad news in one year, as well
as provide against future losses to help cushion future profits.
Peter Walton