Chapter 3

Motivations to Indulge in Creative Accounting and Fraud

Michael Jones


In a perfect world there would be no incentives for managers to indulge in creative accounting or fraud. This is because the business operations of the company would be in line with managerial and city expectations. Results would be excellent and bonuses and share prices would be high. Unfortunately, however, in the real world the company does not always live up to expectations. This is where the problems start and the temptations for creative accounting arise. It may be very tempting to book more sales than would actually be recorded by following the spirit of the accounting rules and regulations. Alternatively, it might be that profits are disappointing so it might seem like a good idea to use the flexibility in the accounting regulatory system to boost them. Finally, debt might seem a bit high and therefore massaging it downwards might seem a good idea.

Generally the incentives will be to maximize reported sales, maximize reported profits, increase net assets and decrease liabilities. However, this is not universally true. For example, income smoothing will involve reducing profits in bumper years. Similarly, in some cases, such as regulated industries subject to governmental price controls, it might be prudent to reduce profits in years in which the firms could be accused of making excessive profits. If this is not done then there is a risk that the government may intervene to ...

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