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Impact of creative accounting on the wealth of shareholders

Topic

The impact of creative accounting on the wealth of shareholders: A case study of selected auditors in Melbourne local government.

Statement of purpose

Earnings management and creative accounting are accounting euphemisms and practices that will always try to cleverly circumvent and manipulate the rules of standard accounting practices or spirit of the values mentioned. The creative accounting and earnings management is characterized by the usage of novel ways and dubious complications of presenting assets, liabilities and income as argued by Herve & Gaetan (2014). There are many reports on profit overstatement, price manipulations and falsification of accounts by dubious agents of the company including employees and top management. The financial reporting is rendered ineffective because of the dubious stewards. In the recent past, business failures have been attributed to the failure of the corporate governance that involves a number of stakeholders including some investors, auditors and management board of directors.

Organizations engaging in business activities have always been affected by the financial collapse due to their connection to fraud. The accounting fraud has affected several companies in the past such as World.com, Enron, Parmalat, and Tyco among others. The scandals have damaged the accounting profession ad led to a loss of billions to stakeholders of the company because of the misrepresentation. The erosion of the accounting standards set for the audit report has been rampant.

Research questions

In regard to the achievements of the above-mentioned research objectives for the research paper, the following research questions will provide a relevant guide:

What relationship exists between shareholders wealth and creative accounting?

Can the investment decisions of shareholders significantly affected by creative accounting practices?

What is the impact of creative accounting on the dividends of shareholders and organizations share price?

To what extent can a well-designed accounting regulation framework reduce the occurrence of creative accounting practices in corporate financial reporting?

Research hypothesis

Ho: Creative accounting does not have any impact on the investment decisions of shareholders.

Ho: There is no significant relationship between shareholders wealth and creative accounting.

Ho: There is no significant relationship between share prices and creative accounting of an organization.

Significance of the study

The study will be of great benefit to the management of various organizations, policymakers, student researchers, shareholders and auditors. The study will also allow managers to have a deeper understanding of the impact of creative accounting and costs related to the window dressing of financial statements (Naomi, 2007). Investors will benefit as the public and shareholders will gain confidence and resort to using of the audited financial state of companies to make investment decisions. The study will also be readily available for use by academicians and other academic consumptions.

Objectives of the study

The main purpose of the study is to evaluate the impact of creative accounting on the shareholder's wealth. Specific objectives include the following:

To examine the relationship between shareholders wealth and creative accounting

To establish whether practices being used in creative accounting significantly impact the investment decisions of the shareholders.

To determine the impact of creative accounting on the organizations share price and dividends earned by shareholders.

To establish whether the existence of a well-designed accounting regulation framework will reduce the instances of creative accounting practices in corporate financial reporting.

Background and literature review of the study

The current economic recession and business environment have until in recent periods pushed the top management of several companies and firms to focus on how they will make their organization's financial statements appear attractive so as to attract investors. The top management of these organizations is forced to manipulate the financial statements by either decreasing or increasing the figures based on their potential selfish gain. The manipulation of the financial statements will be done using either creative or aggressive accounting so as they can achieve what they want at the moment.

Most organizations are currently being affected by earnings management and other forms of accounting fraud undertaken by the top management posing a real threat to these organizations according to Jankowicz (2005). The fraud being done by these companies has the potential of causing a big risk that will lead to a lot more problems. Such problems include loss of confidence of the public and shareholders. This research proposal will focus on finding solutions to fraud being done on financial statements. The research will by extension undertake further research on the involvement of auditor in solving creative accounting problems. The research will also use the corporate governance tool in the prevention and detection of fraud.

The process of accounting and policy selection is a result of several types of judgments and which at the same time are capable of manipulation leading to creative accounting. The varied accounting policies observed in the financial reporting are prepared legitimately using a varied of accounting policies causing differences in reported figures for the same organization and over the same period of time. The difference has brought credibility challenges to accounting on reporting and statements.

A number of scholarly articles and papers have been written that address creative accounting in corporate industries. The widely known scholarly article is the Anglo-Saxons that was published in the year 1970s by Zimmerman and Watts. The literature elaborated the importance of creative accounting by employing guidelines on appropriate accounting practices. The report concluded that during a critical situation, creative accounting can be used but will depend on the ethical environment of the company involving how management will use the creative accounting weapon as a technique. Unethical conduct involving creative accounting practices represent the dark side of creative accounting practices that lead to the collapse of companies such as Worldcom and Enron. By indulging in creative accounting, the enterprise is exposed to risk since the benefits will only last for a short period of time. Later on, the enterprise will be involved in a lot of scandals. Therefore, financial reporting should be closely monitored and the top management should find the causes that may provoke the emergence of creative accounting. 

According to Kassem (2012), it is argued that ethical practices involving creative accounting exist to increase efficiency and accuracy from the external auditors in finding fraudulent activities. For most people, they find it difficult to differentiate fraud and creative accounting but auditors can quickly differentiate between the two. The auditors will establish whether it is a financial error or fraud that led to the loss. The external auditors will also try to understand the methodology used by the fraudulent individual to get guidance on how to best work on the firm in providing information that will fully support their work.  

According to Jack Dowds, John Blake and Orial Amat (2009), "Journal of economic literature classification", it states that creative accounting is important to management and auditors as it allows them to manipulate things in a manner that suits their current condition though it is morally unacceptable. Concerned authorities and government have taken appropriate steps to protect firms from such practices but it has proven futile. A lot of users of financial statements are conversant with earning management and creative accounting and hence the top management get the opportunity to manipulate the books the way they want. Therefore, we can conclude that no adequate solution exists for creative accounting. However, the practices can be curbed by reducing the number of choices that are practised by accounting staff. Specific methods can be used for each specific situation.

Gartan and Herve (2004) under the article "Accounting Manipulations: A Literature Review and proposal conceptual Framework". The paper defines accounting manipulations based on the objective of practising it. Such malpractices are difficult to be removed from the system but the changes can only be minimized by promoting an ethical mindset in the corporate world. Partnoy (2006) postulates that credit rating agencies will provide a better platform in which investors can make investment decisions. If the financial statements have been analyzed by a team of expert that is independent of each other, investors will find the information reliable. The company themselves pay fees to the credit agencies and better rating means higher fee leading to deteriorating of trust in most CRAs rating agencies. Most CRA needs to regain a better image and attract market confidence. The regulatory bodies and stakeholders have realized that preventing financial markets from manipulations is a difficult undertaking.

Creative accounting poses a threat to the accounting profession with a potential of causing extreme negativity on the standards and credibility of the accounting principles. It’s simply undesirable and deceitful practices. The ethical implications require close scrutiny of the potential abuse related to the choice of the accounting policy and manipulation of transactions according to Parviz (2012). The paper provides a relationship of fact on the ongoing financial crisis in a multidimensional nature with deep roots on financial reporting complicated by the use of creative accounting.

The study is expected to reveal the regulations and rules of accounting practices that need to be put in place within the organization to reduce the probability of manipulation from creative accounting. Those undertaking the accounting duties are required to adopt the IFRS standards. In general, the corporate world should encourage strict enforcement of ethics and corporate governance. By enforcing these codes of the regulatory framework, ethical standards and accounting regulations, the organizations will reduce incidences of creative accounting that gives rise to misleading reporting. 

Methodology

This section of the paper will provide detailed information on the design employed during the collection of primary data. The data will be subjected to technical and interpretation analysis so as to provide facts that will support this paper thesis. The research design used includes structured questionnaires and semi-structured questionnaire concurrently. The open-minded semi-structured technique will involve data being extracted from an individual interview, conversation, focus group and informant interview as argued by Balacium and Vladu (2010). The structured questionnaire will deal with structured face to face interview in combination with telephone and postal variants. The research team will further use the case study type as a technique to describe conditions from facts existing at a specific point of time.

For purposes of analysis, the research team will categorize the population under study into three groups that will form the corporate sector of Australia. The three groups will be the middle level, top management and low-level management. The sample will provide data that will represent the staff management from finance and department functions and thus will include auditors, financial managers, financial directors, cashiers, accountants among other workers related to finance department and working within the corporate industry of Australia.

The research team will also employ the non-probability sampling technique and adopt the purposive sampling technique by applying the key informant technique. This technique is preferred because they are useful in the research process when a researcher is seeking specialized knowledge of an issue in question. The key informant technique was used because the research person would require respondents that would provide in-depth financial information that is related to the manipulation of creative accounting in the corporate industry of Australia. 

The field instrument includes a questionnaire that will be carefully designed and divided into five sections to ensure an efficient data collection as stated by Luca Enriques (2010). The first section (SECTION A) will request the demographics characteristics of participants such as age, sex, employment status (temporary or permanent) and type of work they are involved in with where they are employed. The second section (SECTION B) will establish the reasons for being involved in creative accounting from the point of view of the respondents. The third section (SECTION C) will describe the impact of creative accounting on the reported financial statements of the agency they work with while section D will consist of questions regarding the key manipulators of the financial statements and why they do so and the last part which is section E will establish different methods of manipulation and their impact on the accounting policies. The area of study as the corporate sector of the Australian companies that operate as insurance companies, banks, fund management funds, fast moving product companies and revenue collection sectors. The sample population framework consisted of 100 (one hundred people) and we are glad, there were a total of 100% participation from the respondents in our field studies.

Limitations of the study

The research study was undertaken under a short period of time and under a tight schedule. The study was carried out within a very short time. The research study was carried out using private studies and intermittently with lectures and in a very short period of time. During the process of data collection, there was a little problem due to the reluctance of the respondents in providing the required information on time. Some internet sites were down during the period.

Reference

Amat, O., Blake, J., and Dowds, J. (2009), The ethics of creative accounting, available at econ-papers.

Michael G. Alles & Srikant M. Datar(2014), “How do you stop the books from being cooked”

Beneish, M. (2007). Detecting GAAP violation: Implications for assessing earnings management among firms with extreme financial performance. Journal of Accounting and Public Policy

Herve & Gaetan(2014), “Accounting Manipulations: A Literature Review and Proposed Conceptual Framework. International Journal of Disclosure and Governance, International Journal of Disclosure and Governance.

Luca Enriques (2010), “The Law on Company Directors’ self-dealing: A Comparative analysis”

Naomi S. Soderstrom(2007), “IFRS Adoption and Accounting Quality: A Review” The University of Colorado at Boulder, Accepted paper series extracted from Journal SSRN Parviz Saeidi (2012), “The relationship between income smoothing and income tax and profitability ratios in Iran stock” Asian Journal of Finance & Accounting

R.H Grey (2005), “Business Ethics and Organizational Change”, Managerial Auditing Journal

A.D. Jankowicz (2005), Business Research Project (2nd ed.) International Thomson Business Press Berkshire House UK, ISBN 1-86152-351-3 Balacium D. and Vladu A. B. (2010), Creative Accounting-players and their gains and losses. https: www.steconomiceuoradea.ro 

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