Creative Accounting, Internal Auditing and Shareholders Interest in Saudi Arabia - Case Study Example

Creative Accounting, Internal Auditing & Shareholders’ Interest: case of Saudi Arabia Abstract There are a lot of definitions that are capable of being used to convey the term creative accounting. In more broad terms, the term can be applied to relate to the knowledge of the accountants on the rules of their field which enables them to stage-manage the statistics that are accounted for in a trade account. This paper will explore some of the common definitions of this field and the various modes in which creative accounts is done. It will also seek to elaborate the reasons that creative accounts is done in a certain business with respect to the interests of the shareholders. In the later parts of the paper, there will be an insight into the perceptions of the auditors of the concept of creative accounting basing the argument in Saudi Arabia. in trying to get the state of affairs as it is in Saudi Arabia, a number of people were served with questionnaires which helped to gather some data. The respondents were mainly company directors. Aim The aim of this paper is to discuss the concept of creative accounting in a company. There will be an introduction into the concept and the definition of creative accounting, the role of internal auditing in creative accounting and the points which should be considered whilst focusing on creative accounting for the protection of the interests of the shareholders. The paper will be based on organizations in Saudi Arabia in general. Objectives 1. To critically discuss the concept of “creative accounting” 2. To review literature on creative accounting and the role of internal auditing 3. To review literature on creative accounting and the interests of the shareholders 4. To review the implications of creative accounting on the interests of the shareholders 5. To relate the concepts to real time cases in Saudi Arabia. Introduction Many authors have tried to define the term creative accounting in a bid to get the main underlying meaning of this concept. According to Griffith (1986, 1), companies are always involved in dubious manipulation of their profits and all the accounting books are ever increasingly being manipulated in order to protect the interests of some individuals. This happens to be a legitimate way of making sure that the interests of the bigger public are respected. This is the creative accounting concept. The process of accounting is complex and involves many judgment matters and conflict resolutions on approaches which compete to presenting the financial transactions which gives room for the manipulation of the fiscal account, misrepresenting the information and deceit. The people involved in this kind of transactions are in the profession of accounting this coming up with creative accounting (Jameson, 1988, 7). Smith (1993, 2) says that “We felt that much of the apparent growth in profits which had occurred in the 1980s was the result of accounting sleight of band rather than genuine economic growth, and we set out to expose the main techniques involved, and to give live examples of companies using those techniques”. According to Naser (1993, 2), creative accounting entails transforming figures of fiscal accounting from what they really are supposed to be to the desired figures by the people preparing them. This involves following the existent rules and ignoring some of the rules as well. According to this other the system of accounting has been exposed to manipulation due to the permissible freedom that it has. Annotated bibliography Blake, J., et al (1995) 'The continuing problem of international accounting diversity', Company Accountant, April: 23-5. This source is an insight into the problems that affect the field of accounting with more pressure to the decisions that are affected by major regulations that are politically motivated. Such regulations tend to force some professionals to engage in creative accounting, it is thus a source of the factors that contribute to engagement or refusal of creative accounting. Griffiths, 1(1986). Creative Accounting, London: Sidgwick & Jackson. This book has a different perspective on the regulations that are involved in accounting. There is an insight into the effects of the state on the normal markets and the political dimensions that seek to affect the markets. It looks into the standards of accounting and how they are set thus assisting the reader to have a better understanding of the requirements of creative accounting. Naser, K. (1993). Creative Financial Accounting: Its Nature And Use, Hemel Hempstead: Prentice Hall. This book comprehensively looks into the concept of creative accounting by looking into the basis behind it, how it is done and some of the effects that come with it. Grover, R. (1991a). 'Curtains For Tinsel Town Accounting?', Business Week, 14 January: 35. This is an in depth analysis of the ethical implications of accounting behaviors into the profession in general and also to the practitioners as well. There is a clear discussion of the significant ethical dimensions. Hamilton, J. (1991). 'Blowing The Whistle Without Paying The Piper', Business Week, 3 June: 138. This source brings out the reality in the calamities tat are bound to face most organizations in the line of most duties. It tells of the responsibility of the people involved in serious decisions that have impacts on the organizations how they should be involved in serious decision making. Such issues happen to be creative accounting. Fox, J. (1997). 'Learn to play the Earnings Game', Fortune, 31 July This source contributes to the practice of accounting and covers a variety of issues that prompt some crucial changes in behaviors in accounting practice. There is a close examination of the concerns with facts from different areas. Categories of creative accounting The rules in a certain company about the procedures and methods of accounting allow the company to be able to choose between various accounting modes. In most countries, the companies are allowed to write off expenditure on development during its occurrence and consequently paying it off over the life of the project at hand. Some accounting entries require some amount of judgment, prediction and estimation. Some of these cases are approximating the functional existence of an asset so as to compute the decline that the asset has. Such kinds of estimates are done within the business. In this mode the creative accountant has the opportunity to make some cautious or opportunistic mistakes in calculation of the estimates. Grover (1991), he articulated a report on the estimation of the production cost of a film. In relation to this discussion he asserted “Some studies are certainly more positive than the rest and in this case Orion was at all times amongst the mainly optimistic. . . Orion would holdup, occasionally for years, winning write downs on the films that did not appear to measure up” (Grover, 1991b, 56). In some other cases a specialist from outside is brought into the organization so as to be able make the necessary estimates for that organization. A good example of this situation is when someone is employed to assess the accountability of the projected pension. In such a circumstance the creative accountant can have the ability of maneuvering the valuation by picking an external valuer who is well known to him and one who will succumb to his conditions. Such a deal can be used to influence the influence the balance sheets or at times to shift the profits. put up for sale the venture and so augment the earnings in the financial records. There are differing ways in which the regulators of the accounting procedures can try to inhibit creative accounting procedures. This happens when they decide to tackle the approaches that are used in creative accounting in a variety of ways and means. Range for selection of office techniques are able to be compacted by dipping the amount of allowable bookkeeping techniques or by spelling out conditions where every one means is supposed to be dealt with. The requirement for uniformity of use of techniques also aids here, given that a corporation chooses a system which creates the preferred representation in a given time will then be compelled to make use the identical technique in prospective conditions wherever the consequence possibly will be a little favorable. Exploitation of judgment can possibly be restricted in two methods. One of the methods is to sketch rules that minimize the utilization of judgments. In Saudi Arabia company accountants tend to use the unexpected item' fraction of the actual earnings and loss financial credit for articles that they desired to keep away from counting in the operational profit. Auditors as well contain a component to participate in recognizing deceitful approximations. The additional supplementary method is to lay down steadiness so that when a corporation decides an bookkeeping strategy that ensembles it in a single year it is obliged to carry on applying it in succeeding years when it might not fit in very well. It is possible to tackle artificial transactions by invocation of concept over form transactions. In this circumstance, the accounting substance is determined through the use of the economic substance in preference to the legal substance. This ensures that there is a possibility of an account of transactions which are linked together. Reasons for creative accounting There are many reasons as to why company directors decide to have creative accounting procedures undertaken in their companies. Some of the reasons as to why they decide to effect the manipulations involve; Smoothing of the income: Companies have a preference of reporting a stable trend of profits instead of demonstrating unstable profits which succeeded by dramatic changes. This is mainly realized by making gratuitously elevated conditions for accountability and aligned with asset standards in fine days so that the stipulations are able to be condensed, thereby civilizing accounted profits, in terrible days. Supporters of this advance claim that it’s a gauge alongside the “short-termism:' of moderating an outlay on a foundation of the gains attained in the following years. It also keeps away from raising anticipations so high in excellent years that the corporation is not capable to convey what is requisite consequently. Due to this, it is stated the shareholders have a right to know the volatility of a business as and when it happens, and that the income smoothing process can deter changes in the profit trends. In countries like Saudi Arabia, where the accounting systems are largely conservative, accounting smoothing can be pronounced due to the accumulative high level of provisions that come along with it. Sometimes companies exaggerate their losses such that they may seem to have a better accounting year on the following years (Blake et al. 1995). In addition to the smoothing of the incomes, companies tend to manipulate their profits such that they stay in line with the forecasts. According to Fox (1997), Microsoft designs its procedures in such a way that their earnings are reported in line with the forecasts. In this manner, when the company sells more software than it is anticipated, a big part of the profits is ignored and transferred to the future years when the business will be down. With this method put in place, it hence becomes easy to predict the future profits and the general company earnings. Company managers may maintain an earnings boosting financial strategy alteration in hand so as to sidetrack concentration from undesirable information. Collingwood (1991) articulates on how an adjustment in accounting methods boosted K-Mart's magazine income by $160 million, by content twist of fate off-putting concentration from the business slipping reverse from becoming the chief vendor in the country. “Creative accounting” might aid to uphold or increase the shares’ value by lowering the obvious heights of loans, so creating an image to the corporation to appear liable to less danger, and though generating the outward show of a good earnings trend. This facilitates the corporation to elevate resources from innovative share concerns, offer their personal shares in offer, and oppose takeover by some other corporations. When the company administrators decide to have some internal deals while dealing with the shares in the company, creative accounting is necessary or delay of the information release to the market which assists them by giving them a chance to gain from the internal knowledge. In the real market situation, income boosting changes may be viewed as weaknesses by analysts. Shareholders at times gain from the reality that directors can influence stated earnings to 'smooth' profits in view of the fact that this might reduce the perceptible unpredictability of income and so augment the worth of their shares. Other organization action, like avoidance of evasion on loan accords, can also be beneficial to the shareholders. According to Resvine (1991), the major accounting role is the putting up of a mechanism which identifies the prospect of manipulation in accounts and appropriately reflects this in the pricing strategies. At the same time operation of the marketing mechanisms will be in such a way that it will be reflected in decisions on pricing and also in contracting. Solution Some survey of the views of the auditors has been conducted in Saudi Arabia. According to the table below, there are few auditors in Saudi Arabia who take a broadminded view of creative accounting. In this country, it seems more stakeholders are optimistic in tackling this menace. Proposition Agreement UK Percentage Saudi Arabia (%) Creative accounting is legitimate 36 31 Creative accounting is u problem without a solution 91 38 In Saudi Arabia, there is a general practice which has to be followed where companies have to comply with some standards which govern the accounting procedures and also use some policies which are appropriate and supported by the profession. Further analysis sought to infer whether relative accounting was problematic in Saudi Arabia, and whether the problem was actually proliferating or decreasing in the land. There was also an explanation of the reasons which would be used to reduce creative accounting policies. Conclusion Creative accounting has an offer of a redoubtable test to the bookkeeping vocation. The trouble is global, with bookkeeping strategy option being a fastidious setback in an “Anglo-American” practice and contract management a fastidious dilemma in the whole practice as well as in Saudi Arabia. There is an ample variety of inspirations for bosses to employ themselves in creative accounting. The explanation for “creative accounting” put ahead in the “positive accounting theory” practice is: Conflicting interests in the conventional ethical thoughts In Saudi Arabia, the development of the stock market is of major importance and the consequent focus on the accounting regulations which have been put into details instead of the broad principles which are less as compared to the former Relevance in various other states Accountants who are found to recognize the ethical confront that “creative accounting” elevates requirement to be conscious of the extent for mistreatment of bookkeeping strategy choice and exploitation of the relevant dealings. Saudi Arabia presents an instance of a state where an elegant structure of bookkeeping guideline has restricted “creative accounting”. On the other hand, our discussion raised some concern as to whether this state of affairs will last. References Blake, J., et al (1995) 'The continuing problem of international accounting diversity', Company Accountant, April: 23-5. Collingwocd, H. (1991) 'Why K-Mart's good news isn't', Business Week, March 18:40. Fox, J. (1997). 'Learn to play the Earnings Game', Fortune, 31 July. Griffiths, 1(1986). Creative Accounting, London: Sidgwick & Jackson. Grover, R. (1991a). 'Curtains For Tinsel Town Accounting?', Business Week, 14 January: 35. Hamilton, J. (1991). 'Blowing The Whistle Without Paying The Piper', Business Week, 3 June:138. Naser, K. (1993). Creative Financial Accounting: Its Nature And Use, Hemel Hempstead: Prentice Hall. Smith, T. (1992). Accounting for Growth, London: Century Business. Read More