- 10 Marks
Question
Manipulation of reporting entities’ books and records has been termed in many quarters as “Creative Accounting” and “Window Dressing.” The Management of Wastage Plc requires clarification of these two concepts.
You are required to write a report to the management of Wastage Plc. Your report should include:
a. Definitions of the TWO concepts. (2 Marks)
b. FIVE examples of each. (5 Marks)
c. THREE possible reasons for Creative Accounting and Window Dressing. (3 Marks)
d. Advise to management on FIVE possible preventive measures of Creative Accounting. (5 Marks)
Answer
To: The Management of Wastage Plc
From: Consultant
Date: November 15, 2016
Subject: Report on Creative Accounting and Window Dressing
a. Definitions of Creative Accounting and Window Dressing
- Creative Accounting: This involves presenting financial information in a way that diverges from underlying facts, often exploiting accounting policies to structure transactions that portray a desired financial health. The primary objective is often to inflate profits or adjust assets and liabilities to meet strategic goals.
- Window Dressing: This strategy presents a misleading financial performance, often illegally or unethically. Unlike Creative Accounting, Window Dressing typically involves more direct manipulation, sometimes intentionally breaching accounting regulations.
b. Examples of Creative Accounting and Window Dressing
Creative Accounting Examples:
- Smoothing income over periods through discretionary accruals.
- Off-balance-sheet financing to omit debt.
- Recognizing revenue prematurely (e.g., “channel stuffing”).
- Overstating assets by failing to record impairments.
- Capitalizing expenses (e.g., research costs) instead of expensing them.
Window Dressing Examples:
- Non-recognition of irrecoverable debts.
- Understating provisions for doubtful debts.
- Overstating closing inventory.
- Premature recognition of income.
- Using special purpose entities to mask financial realities.
c. Reasons for Creative Accounting and Window Dressing
- Reducing tax liabilities by managing reported profits.
- Enhancing management remuneration tied to profit targets.
- Attracting investors by presenting an improved financial image.
d. Preventive Measures Against Creative Accounting
- Financial Regulation Compliance: Ensure adherence to relevant statutory requirements.
- Independent Audits: Conduct external audits to confirm true and fair representation.
- Corporate Governance: Apply a governance code, including non-executive directors on the board.
- Promote Ethics: Emphasize ethical training for management and staff.
- Whistle-blower Support: Foster a culture where irregularities can be reported without fear.
Yours faithfully,
Financial Controller
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