Forensic Accounting and Creative Accounting - Essay Example

Forensic Accounting & Creative Accounting Table of Contents Table of Contents 2 Introduction 2 Forensic Accounting 3History of Forensic Accounting 4 Application of Forensic Accounting 4 The Future of the Forensic Accounting Profession 6 Creative Accounting 7 History of Creative Accounting 8 Forms of Creative Accounting 9 Legal and Ethical Aspects of Creative Accounting 11 Conclusion 12 Introduction Forensic accounting and creative account are some of the common accounting contempt ray issues that influence how accounting is done. These practices are employed by various practitioners and organizations for specific purposes and intentions. This treatise traces the historical development of forensic accounting and creative accounting. It also explores how these practices link with independent audits, their application in real word scenarios and the future of these two practices. Part 1 Forensic Accounting Forensic accounting is a practice that continues to finds its way in various business and organization operations. Crumbley et al. (2005) defines forensic accounting as a specific type of engagement that involves carrying out of forensic based investigations, coming up with a report based on the findings and at times acting as a witness in the legal proceedings that may result from such investigations. The forensic investigations that are carried out in forensic accounting involves gathering of the required evidence so as to ensure that the report or forensic witness statement, which is prepared is appropriate for the purpose it is intended for. Gray (2008) on the other hand defines forensic accounting as the practice of using various auditing, investigative and accounting skills to be able to carry out an investigation into the financial statements of a company or organization. This is done is to allow for analysis of the financial aspects of the company. Those who carry out the forensic accounting are therefore trained to focus beyond the numbers as well as the deals which appear in the financial statements of the company in question. Another widely accepted definition of forensic accounting is that it is the practice or act of investigating and documenting white color financial malpractices in an organization or firm (Kwok, 2008). This investigation and documentation is carried out so that the attorneys and law enforcement officers involved in a financial malpractice case are given the needed litigation support. Organizations and businesses consult or hire forensic accountants so that fraud allegations in a business can be investigated. Cicchella (2005) says that the forensic accountants work as financial investigators when any kind of fraud has been alleged in a company. Forensic accounting allows them to look for deceptive transactions that they document in their reports. Such reports are used for various purposes which may include in trials. History of Forensic Accounting Nigrini (2011) indicates that many people think and believe that forensic accounting is a new practice. This is due to the fact that the practice has continued to receive publicity with its application in the investigation of financial frauds and malpractices growing. However, forensic accounting is not a recent practice. According to Kwok (2008), archaeological findings show that forensic accounting existed even in the 3500 BC in Egypt. During this time, accountants were involved in practices and investigations that were intended to help prevent fraud. For a long time, forensic accounting was taken to be part of the larger accounting profession. In the 19th Century the accounting profession took the bigger role while forensic accounting was taking the back seat role. This however started to change when accounting investigations were incorporated into the legal fraternity. Forensic accounting has slowly found its way into both family law and commercial law issues. Application of Forensic Accounting Forensic accounting is widely used in various aspects of an organization. The forensic investigations do take long time than the other financial instigations that are carried out. This is because it involves investigating, interpreting and analyzing complex information that relate to the finances of the company in question. One of the major areas where forensic accounting is applied is in the investigation of frauds (Cicchella, 2005). When a company comes across financial fraud allegations that involves the various stakeholders in the company, a forensic accountant may be employed or contracted to help in unraveling the issue. The forensic accountant will be tasked with looking into the financial accounts of the company and the transactions of the company so that they can be able to determine if the fraud claims and the white collar crime claims are true or not. From the findings they will make reports that are then handed to the company or the involved prosecuting authorities. When the investigations reveal that the claims are true, the prepared reports are used in the litigation process. The forensic accountants themselves may also act as witnesses in the litigations with their view and stand being backed by the findings of these reports (Crumbley et al., 2005). The other area where forensic accounting is applied is in the investigation of insurance claims, insolvency as well as in the investigations to support liquidation. Before claims are given to parties by insurance firms, there is usually the need for the right information about the claims. The forensic accountants come handy in this aspect. Matrimonial disputes may also benefit from forensic accounting. This is in cases where financial benefits and properties are involved. The forensic accountants carry out their investigations on the matrimonial property and businesses so that they can help in solving the matrimonial dispute and in sharing of wealth and income from matrimonial property. Contract matters may also require the services of forensic accounting. Forensic accounting can be used in instigating matters that are associated with the breach of contracts, warranty breach and acquisition of a company (Kwok, 2008). This investigation is done so as to help in understanding any accounting or financial irregularity that may have taken place. The other areas where forensic accounting is used and applied include tracing of the funds of a company, regulatory enquiries, confidential investigations and in surveys that are related to risk and fraud management. Partnership dispute as well as company ownership issues may also require the practice of forensic accounting. Due to the fact that carrying out of forensic accounting is very engaging and may take longer times, it is normally vital for the forensic accountants to ensure that they do their work in a way that is concise, accurate and detailed. The Future of the Forensic Accounting Profession Forensic accounting continues to grow and it has been integrated into various disciplines such as legal matters. Due to the importance of this practice and its applicability in various fields, the number of forensic accountants continues to grow. The forensic accountants are normally hired to work as watchdogs over the accounting and financial practices of an institution. (Crumbley et al., 2005) says that forensic accounting has huge growth potential. Over the next ten years, it appears that there may be more training on forensic resources. The application of forensic accounting is also expected to grow more speedily. The demand for the forensic accounting skills has been growing after the various stakeholders understood the importance of the discipline. Currently, there are several private investigators and FBI agents who are studying CPA in order for them to be able to carry out investigations into accounting practices across different sections of the world (Kwok, 2008). This is a clear indication that forensic accounting is not only required in the private sector but also in the public sector. One aspect of forensic accounting that is expected to expand and grow and thus widening the practice is in electronic detection. This is due to the fact that technology is ever changing. Technology is being used in several aspects of a business to carry out financial and accounting operations. This therefore means that electronic detection will be an important aspect of forensic accounting. Expansion of the electronic detection is expected to widen the mechanisms for searching for and locating evidence that may be used to detect fraud and white collar malpractices. In the current world, most of the accounting documents and transaction documents that are used in both the private and public sector are electronically created. This therefore means that with the incorporation of the best available technology into the forensic accounting practices, detection of these documents will be more easy and accurate. When this is done, the credibility of the results of the forensic accounting investigations will be boosted. This will in the long run make the practice to be widely applied in various aspects of the society where accounting issues and principles are concerned. The organizational techniques of forensic accounting may also be boosted in the near future. When the forensic accountants are able to chronological follow and track documentary evidence, the outcome of the investigations will be very much acceptable (Kwok, 2008). This in turn will lead to the efficiency of the forensic accounting practices. It can be supposed that the future of forensic accounting looks bright. The practice will continue being incorporated into various disciples for various purposes. With the inclusion of technology into the practice, the validity findings from these investigations will also be boosted. Part 2 Creative Accounting Oriol, Blake & Dowds (2009) defines creative accounting as a practice that is employed by various companies and organizations so that their accounting looks may appear better than they actually are. In most of the instances, creative accounting uses several aggressive as well as questionable techniques so that the desired result or financial outlook of a company can be attained. This entails disposing of the assets of a company at lower cost than expected and not writing down the company inventories after value had declined. Other companies are involved in creative accounting by shipping out a very large volume of the assets of a given company towards the end of the year so that these assets counter a given financial stand that is preempted in the financial statement of the company. Gaetan & Taffler (2005) defines creative accounting as an act of incoming smoothening. Creative accounting in this aspect is taken to be a form of financial engineering that is intended to intentionally put the accounting practices and books of a firm in order. In the USA, many companies prefer describing this practice as management of the earnings. In Europe, the companies call it creative accounting. Creative accounting can also be defined as the correction of the accounting books of a company in order to achieve the financial objectives and goals of a business and to boost investor confidence (Blake et al. 2000). It is accomplished by giving the business a strong financial position. Creative accounting may entail repeated selection of the measurement and reporting rules that are used by the company. History of Creative Accounting Creative accounting is a practice that became very common and popular in the last two decades. This is demonstrated through the mounting number of business entities and firms which are involved in this practice. Despite this being the case, creative accounting is not a new practice. The urge to manipulate financial figures is something that is over 400 years old. This practice has a very long history. Oriol & Gowthorpe (2004) says that Venetian traders were known to make double entry into their book keeping records using different pens. In cases when inconsistencies were noticed, they would then change the figures so that the entries became eligible. This is a case of manipulative behavior and practice from which curative accounting came from. The term creative accounting however came into use in the year 1968 after a movie that was produced by Mel Brooks became viral (Merchant & Rocknes, 2004). Among the financial and economic practitioners and accountants, creative accounting first became popular in the United Kingdom. Several books and articles were written to document the flexibility that managers were using in the management of the accounts of businesses and organizations. Forms of Creative Accounting Creative accounting takes different forms in accounting profession. These forms are better understood when one considers the different techniques that the accounting managers use in order to manipulate the financial standing of the company. One of the forms that creative accounting appears is the premature recognition of revenue. Fong (2006) says that various accounting practitioners may be involved in coming up with fictitious revenue that may have a direct impact on the earnings of the company or firm. Accountant may be forced to be involved in recognizing the revenue of a company prematurely since this practice is viewed as an accepted accounting principle. Fictitious creation of revenue is done to make up of the revenue that the company needs so that the accounting books appear the way the company wants it to be. In most cases, the directors of a company or other stakeholders may want the financial statement of a company to appear in a given form (Emre, 2011). In such instances the accountants will record revenue that does not exist so that they are able to attain the desired outlook. The other form of creative accounting is the big bath. This is a form of managerial tactic which is intended to help get away with all the bad news at once. In this practice, the accountants go ahead to write off any kind of cost that exist in the current accounting books. This ensures that the performance of the company looks better and that the future performance is not affected by the current bad state. One of the factors that drive accountants into this form of creative accounting is the need to rectify the accounting books to facilitate acquisitions and take over. The use of cookie jar resources is another form of creative accounting. This practice is normally involved when the management requires keeping the profits of a company to a level that will be possible to maintain in the future. In such cases the expenses of the company or business are brought up in order to lower the profits. This practice may also be used when there is the need to show that the profits of the company are high (Naser, 2003). In such instances, the accountants neglect some of the expenses of the company and the result of this is that the profits will appear to be higher than the true value. Accountants are also involved in is the manipulation of the inventory of the business to change the accounting books o the company. Manipulation of the inventory of the company can be done by changing the quantity or the value of the inventory. In the cases where the accountants are instructed that the profits of a company are to be increased, inventory quantity is normally moved up by carrying out very rigorous stock taking (Ruland, 2011). Other ways that accountants and firms may use in order to change the value of inventory is by providing the absolute and slow moving stock. This is also done by changing the actual method that is employed in valuing the inventory to fit the desires of the commerce or the accountants. Other common forms of creative accounting may include being generous on the company’s bad debts, use of creative income statements and manipulation of the financial statements. These forms of creative accounting all ensure that a desired financial or accounting position is achieved by the company or those people who are involved in the practice. Ruland (2011) says that there are several motivations towards these forms of creative accounting. Some of the common motivations that have been identified include income based tax levies, need to report stable earnings and profits and psychological expectations on the income and returns of the company. Ref says that tax which is determined by the existing policies in a county is the single most important motivator of creative accounting. Legal and Ethical Aspects of Creative Accounting Despite the widespread use of the creative accounting practice, there are several legal as well as ethical concerns of this practice. Leung & Cooper (2005) say that the primary role of accounting is to provide a true and clear picture of the actual financial standing a particular company. This is only possible when the accounting is done on the basis of the best legal accounting techniques. The accountants who are involved in creative accounting normally do so in order to achieve their own desired goals. Some of the creative accounting techniques and forms, especially those that are motivated by the tax polices appear to be illegal. These techniques are at times meant to lower the reported income of a company to a certain level so that the company can pay lower taxes. This is illegal in most countries and in the long run, it may have some legal implications such as litigations which may affect the company. Ghosh (2010) says that creative accounting is a form of fraudulent reporting. This practice appears to be done at all the levels of management. The practice allows the firm to use the financial statements of a company to make an illusion that a company is healthy financially yet this may not be the actual case. Such practices at times entail covering up of the financial realities by misuse of accounting techniques and principles. This is an issue that goes against the goals and objectives of the accounting practice. The use of creative accounting impacts both on the investors and the accounting profession. When these forms of creative accounting are used, validity and reliability of accounting practice is affected and thus compromising the profession. On the side of the investors, creative accounting may prevent them from getting the true picture of the financial position of the company. This may lead to the investors making the erroneous decisions on the place to invest. Conclusion Creative accounting has been widely used and it is a challenge that is facing the entire accounting profession. Some of the benefits of the practice that have been put forward include the fact that it allows for creation of investor confidence, it stabilizes profits and prevents the fluctuation of the earnings of the company. All these are said to result in creation of a positive outlook of that particular company (Ruland, 2011). Despite these said advantages, creative accounting remains a challenge that has several drawback and risks. This practice hides vital information from various stakeholders through the misapplication of accounting principles. The effect of this is that it brings about the risk of the accounting principles being misused for specific selfish gains. This results into several legal and ethical concerns. Due to this, I believe that this is a practice that needs to be banned as it compromises the validity of the accounting practices. This will ensure that the stakeholders are not shielded way from the actual information on the financial standings of a company. 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