Creative Accounting In Bangladesh And Global Perspectives

CREATIVE ACCOUNTING IN BANGLADESH AND GLOBAL PERSPECTIVES Professor Dilip Kumar Sen School of Business Independent University, Bangladesh (IUB) MBA Building, House No.15, Road No.14, Baridhara, Dhaka – 1212, Bangladesh E-mail: [email protected] 1

Professor Eno L. Inanga (Emeritus) Maastricht School of Management Endepolsdomein150 6229 EP Maastricht The Netherlands Abstract: This paper is an outcome of a study of Creative Accounting in Bangladesh and global perspectives. Global scenario is included in the study to illustrate the extent of creative accounting practice. Creative accounting could be a blessing or a curse. It is a blessing where something new is introduced to refine the accounting system and therefore becomes an addition to the existing stock of accounting knowledge. It becomes a curse when unethical elements make intrusion. But real world situations tend to show that creative accounting practice is, in most cases, a curse rather than a blessing, and therefore undesirable. The main purpose of the practice is usually to attract unsuspecting investors, or obtain undeserved accounting-based rewards, by presenting an exaggerated, sometimes misleading or deceptive, state of a company’s financial affairs. Creative accounting practice has been increasing in recent years not only in Bangladesh but also in many developed countries. However, it is evident that the extent of window-dressing of company financial statements in some developing countries has greatly violated all known ethical standards. This study stresses the need for preventing, rather than stopping, the practice in corporate enterprises wherever it exists. The paper recommends that forensic accounting be introduced and recognized internationally. National accounting bodies, law courts, and Governments need to adopt strict measures to stop the practice. Fraudulent financial reporting, by misrepresenting facts and falsifying company financial statement should be considered serious and punishable offences. Accountants need to uphold high ethical standards and maintain integrity in all their professional activities. They need to ensure that the accounting profession rests on ethical principles and values, commanding national and international respect and confidence, by stopping the evil practice of creative accounting and misleading financial reports. Keywords:

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Creative accounting, Published accounts, Accounting policies, Forensic accounting, Ethical principles, Bangladesh.

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CREATIVE ACCOUNTING IN BANGLADESH AND GLOBAL PERSPECTIVES I.

Introduction

In 1992, Terry Smith’s book caused a stir in the United Kingdom (U.K) professional accounting circles. Titled Accounting for Growth, with a sub-title Stripping The Camouflage from Company Accounts, Smith described the book on its cover as “The book they tried to ban”, but did not say who “tried to ban” the book. He subsequently described the title of the book as “a deliberate pun” because, in his view, much of the apparent growth in company profits “in the 1980s was the result of accounting sleight of hand rather than genuine economic growth” (Smith, 1992:4). He gave an example of a private company, Brentford Nylon, which collapsed in 1976, shortly after reporting a profit of £130,000 sterling, but was later taken over by another company, Lonrho. A more dramatic example was Polly Peck, a UK textile company. On 3 September 1990, the company had “announced record interim results for the six months to 30 June 1990 and made enthusiastic comments on prospects for the year and beyond…Polly Peck was placed in administration on 25 October 1990” (Smith, 1992: 221). These were a few of the several similar examples cited in the book. The above examples raised a fundamental question, “How can a company that reports substantial profit during a particular period collapse shortly afterwards?” Part of the possible answer to this question can be found in the first two words of the title of this paper, “Creative Accounting”, which this paper examines with reference to Bangladesh as well as from global viewpoint. The rest of the paper is structured in five sections. Section 2 discusses conceptual aspects of creative accounting, while section 3 analyses its causes and effects. Section 4 gives an overview of the prevailing creative accounting scenario in Bangladesh using information obtained from various sources. Section 5 sheds some light on creative accounting practice in global perspective. Section 6 concludes the study and provides some recommendations. 2. Conceptual Aspects of Creative Accounting Creative accounting, as a matter of approach, is not objectionable per se. However, when unethical elements make intrusion, the resultant accounting details become anything but true and fair. Creativity in such context is like referring to a half glass of water as half-full instead of describing it as halfempty. While both statements are factually correct, they paint different pictures and thus convey different images. Creativity in company accounting may arise under at least three different financial market conditions. The first is when a company floats its shares to attract investors to subscribe to such shares either at par or at a premium, depending on the financial market evaluation of the company’s future prospects. The second is when the company whose shares are already listed in a stock exchange, wants to paint an attractive picture of its financial conditions so that the shares may be quoted at a premium. Finally, a company having its shares listed in the stock exchange may declare and pay high dividends based on inflated profits through overvaluation of assets, undervaluation of liabilities and change in systems of stock valuation that may boost the image of the company at least in the short run. Unethical considerations in creative accounts have developed to 2 such depths that terms like fraud audit and forensic accounting have gained currency and are becoming new professions. Accounting practitioners and auditors are increasingly required to appear in courts for deposition.

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The term creative accounting is widely used to describe accepted accounting techniques which permit corporations to report financial results that may not accurately portray the substance of their business activities ... creative accounting is recognized as a synonym for deceptive accounting. Creative accounting methods are noteworthy because they remain in use as generally accepted accounting principles, even though they have been shown to be deceptive in many cases (Metcalf, 1977: 188). Every company in the country [UK] is fiddling its profits. Every set of published accounts is based on books which have been gently cooked or completely roasted ... this deception is all in perfectly good taste. It is legitimate. It is creative accounting (Griffiths, 1992: 1). H. Bosch refers to a situation with regard to creative accounting in the following way (1990:122-23): It was common [in the mid 1980s in Australia] for the so-called entrepreneurial companies to include capital profits from the sale of properties or shares ... as operating profits ... on the ground that speculation was a major element in their business ... Some companies ... booked unrealized capital gains as operating profit ... some of the transactions which gave rise to these “profits” were done with business associates or even within the same group of associated companies. The values put on the assets “sold” often looked very suspicious, with secret put and call option arrangements sometimes allowing the “buying' ” company to transfer the asset back to the seller at a later date – in some cases just after balance sheet date … It was common for companies to include their “share” of the net profits of associated companies in their own results…There was an extensive use of 49 per cent owned companies that were not consolidated into group accounts to keep debt off a group’s balance sheet and thus to give a misleading appearance of its capital structure. Associated companies and interposed trusts were also used to conceal other favorable information from the eyes of investors. From a positive viewpoint, it may seem that creative accounting connotes invention of accounting principles and techniques to recognize changes in economic, social, political and business environments. But in reality, the term is not normally used in the positive, but negative, sense, although it might be both a blessing and a curse. It is a blessing when something new is created to refine the accounting system and becomes an addition to the existing stock of accounting knowledge. Creative accounting becomes a curse, and therefore undesirable, when unethical elements enter the system. But real world experience reveals that it is in most cases practised in an undesirable way to attract investors by presenting an exaggerated, sometimes misleading and deceptive state of an organization’s financial affairs. This is why this system of accounting is sometimes referred to as “deceptive accounting” Thus, two perspectives of this term may be identified. The first one recognizes genuine changes in the business accounting practices while the second one reflects undesirable window-dressing that tends to distort financial information. And this second perspective is normally referred to as creative accounting. Habibulla (as cited by Alam, 1988: 5) associates creative accounting with any, or a combination, of the following actions: (a) Creation of data, (b) dressing up of documents and (c) cooking up of accounts... the accountant is perceived to be a pottery artist. If [the accountant] is given clay as basic raw material, he can make either ‘Shiva’ (the God of Hindus) or ‘monkey’ as desired by the client, manipulating the items on either side of the profit and loss account. This is why the accountant’s strict adherence to professional ethics is most important. As James Poon Teng Fatt (1995: 997) has rightly argued, “Accountants have an obligation to the organizations they serve, their profession, the public, and themselves to maintain the highest standards of ethical behavior. They have a responsibility to be competent and to maintain confidentiality, integrity and objectivity.” “The auditor should be straight-forward, honest and sincere in his approaches to his professional work” (IFAC, 1992: 60). This statement of the International Federation of Accountants (IFAC) is applicable not only to auditors but also to all other professionals in the course of their professional duties. But this advice has greater significance to a person who is a member of a profession, because s/he represents not only herself/himself but also the entire profession. The name and the reputation of a profession depend on the personal qualities of those who constitute the profession. An accountant should not allow personal prejudice or bias to override objectivity. When conveying

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information in financial statements, the accountant must maintain impartiality. However, whether or not an accountant is objective in the course of his professional duties may be a matter of opinion. The criterion to be applied in judging fairness and objectivity is whether an accountant has acted in a manner that a reasonable person would have acted in a given situation. Here again the dictum of reasonableness is an illusion. However, an accountant has to be seen to be free from prejudice/bias. While it is not possible to inquire into the working of one’s mind, an accountant should satisfy herself/himself that none of her/his acts is influenced by personal bias. This principle needs to be understood in its proper perspective and observed by dictates or conscience. We may therefore conclude that creative accounting in the context of this paper refers to accounting techniques in which financial information is distorted by window-dressing and various manipulations in order to present, theoretically, a better financial picture by either increasing or reducing profit as the case may be, by giving a misleading appearance of capital size or structure and by concealing relevant information from existing or potential investors. 3. Causes and Effects of Creative Accounting The real causes of creative accounting lie in the conflicts of interest among different interest groups. Managing shareholders’ interest is to pay less tax and dividends. Investor-shareholders are interested to get more dividends and capital gains. Country’s tax authorities would like to collect more and more taxes. Employees are interested to get better salary and higher profit share. But creative accounting puts one group or two to advantageous position at the expense of others. One day the present authors had an opportunity to have a discussion with the Chief Accountant of an enterprise in this regard. The Chief Accountant told, in the course of conversation, that he was determined to retain profit for the expansion of his existing unit and establishment of new ones. Quite naturally, his interest was to pay less tax and less dividend and, accordingly, to ‘create’ financial statements. This type of creative accounting has led David Schiff (1993: 94) to warn investors; in general that taking a company’s financial statements at face value can be ‘a recipe for disaster.’ Earnings per share (EPS), the only number to which investors often go wrong by paying too much attention, can be ‘boosted by the stroke of an accountant’s creative pen.’ Schiff (1993: 94-95) has mentioned six of the many ways companies can goose their earnings: (1) hidden pension liabilities, (ii) capitalizing expenses instead of writing them off, (iii) receivables or inventories growing faster than sales, (iv) negative cash flow, (v) consolidating owned subsidiary’s income and net worth, with the impossibility of receiving the same, and (vi) following seemingly conservative practice in a situation of reverse direction [e.g., if layers of lower priced LIFO (last-in, first-out)-costed inventory are “inflated” and sold at current prices, current earnings power is overstated]. Jim Kennan, the Attorney General of Victoria, in a speech before members of the Australian Society of Accountants, stressed that financial statements, which inflate the performances of companies by manipulating figures (i.e., through creative accounting) should be stamped out as it puts the investor to great difficulties to distinguish between the paper entrepreneur and the truly successful entrepreneur. The message from his statement may now be stated to focus on the obvious effects of creative accounting: (1) (2) (3) (4)

There are companies listed on the stock exchange, which show inflated profit and better financial position in their creative accounting statements to attract investors; this creation of accounts just misguides and creates confusion. Some company prospectuses may not always depict the reality of the financial positions of the listed companies. Processes adopted for created accounting statements may hold out untrue hopes to investors for a shorter period but cannot continue to succeed for a longer period. Ultimately, the concerned companies listed in the stock exchange collapse and the investors lose confidence in them and stock market.

4. Creative Accounting: Bangladesh Scenario

The study presented in this paper is an exploratory one, based on both primary and secondary sources of information. The secondary sources include published books, journals, periodicals, reports and newspaper. The study’s population was limited to: (1) the list of chartered accountants (as of July 1, 2004) available in the Institute of Chartered Accountants of Bangladesh (ICAB), (2) the list of cost and management accountants (as of July 1, 2004) available in the Institute of Cost and Management Accountants of Bangladesh (ICMAB), and (3) the list of university teachers of accounting (as of July 1, 2004) available in the University Grants Commission of Bangladesh (UGCB). For the purpose of analysis, the collected data have been tabulated in four tables using percentages to show the results of analysis of experts’ views. The analysis based on expert opinion survey was aimed at examining whether the experts’ views agreed with, or differed from, the information based on literature survey. Another purpose has been to study their perception about creative accounting, which appears to be a day-to-day problem in the accounting systems of both developing and developed countries. Table 1 below shows the breakdown of the population and corresponding study sample size. Table 1: Breakup of Population and Samples for the Study Respondent Groups

Population

Chartered Accountants Cost & Management Accountants University Teachers of Accounting Total

695 621

Sample Size (% of Population) 70 (approximately 10%) 60 (approximately 10%)

285

30 (approximately 11%)

1,601

160 (approximately 10%)

The study adopted simple random sampling (with replacement) technique to draw the samples from the three groups of respondents (population) as shown in the above table. The overall study sample size is approximately 10 percent of the population. Primary information was collected by administering a brief questionnaire consisting of only five questions related to a few relevant issues of creative accounting. Almost all the questions were in structured form, i.e., in closed form. The questionnaire (presented in the Appendix) was administered to (i) seventy chartered accountants, (ii) sixty cost and management accountants and (iii) thirty university accounting teachers, all of Bangladesh. Each of the respondents filled in the questionnaire as it was administered. 4.1 Analysis Based on Published Materials The authors assume that creative accounting has long been practised in Bangladesh. But the questions are: (1) Which organizations practise this? (2) To what extent is it practised? These questions should interest investors. Many of the company prospectuses published in Bangladesh are based on creative accounting. An instance of created reporting of prospectus relates to M. M. Dyeing and Finishing Mills Ltd. According to section 135 of the Bangladesh Companies Act 1994, the detailed ‘matters to be specified in [company] prospectus and reports to be set out therein’ are contained in Schedule-III of the Companies Act. This Schedule requires the auditors to report on: (i) the profits of the company showing clearly the trading results and all charges and expenses incidental thereto excluding income or profits having no relation to the trading for the period covered and excluding also items of profit or income of a non-recurring nature but including amounts appropriated for taxation and reserve [clause 24(2) of Schedule-III] and (ii) rates of dividend paid, sources from which such dividends were paid, and classes of shares on which such dividends were paid, and in case dividends were not paid at all, or on any class of shares, a statement of that fact [clause 24(1)(b) of Schedule-III]. The report shall cover a period of five financial years immediately preceding the issue of the prospectus. However, in the cited case, the auditors of the company did not audit the financial statements for the st four months ended 31 October 1999, but surprisingly included the unaudited figures in their reports on profits, and also covered unaudited period in their report on dividends. The association of auditors’

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name/report without audit could mislead prospective investors. However, issuing such report (which could not be thought over before six months) has become a rule in Bangladesh rather than exception, being issued also by the auditors of Pharma Aids Ltd. and Rahim Textile Mills Ltd. The authors also found the existence of creative accounting in Pharma Aids Ltd., previously referred to. The company had capitalized borrowing costs on long-term loans from 1 July 1994 to 30 June 1997, although it commenced commercial operations on 1 July 1984, thereby violating paragraph 25 of IAS 23 (International Accounting Standard 23: Borrowing Costs) which had been adopted by the Institute of Chartered Accountants of Bangladesh (ICAB) as Bangladesh Accounting Standard (BAS). Clearly, the intention was to convert the accumulated loss of Taka 37.90 lakh on 30 June 1996 into a retained earning of Taka* 0.736 million (US$ 11682.539) on 30 June 1987. Besides this, the company charged “depreciation on fixed assets as per production proportionate ratio”, a method of depreciation never heard of in the manufacturing sectors. This apparently does not conform to IAS 4 (International * 1 US$ = Bangladeshi Taka 63.00. Accounting Standard 4: Depreciation) adopted by the ICAB. The results of all these dubious practices were that the company purported to have earned profits during the period July 1,1996 through September 1997 whereas, in reality, it had incurred losses. This apparent profit entitles the company to declare interim dividend at 10 percent. Such dividend declared, not backed by actual profit, is illegal since it is paid out of capital. The creative accounting here made “paper entrepreneurs” appear like “successful entrepreneurs”. We found another instance of creative accounting in the financial statements of Rahim Textile Mills Ltd. for the six months ended 31 December 1997. The company charged depreciation under declining balance method but limited the depreciation to the capacity utilized proportion – an unheard of depreciation method in the manufacturing sector of Bangladesh. This again does not agree with the IAS 4. Moreover, the company treated the “loss during trial operation” as deferred revenue expenditure to be written off over a period of 5 years although such treatment is not allowed by Generally Accepted Accounting Practices [paragraph 4 of Statement of Standard Accounting Practice (SSAP) 11 issued by the New Zealand Society of Accountants. Sequel to this practice of creative accounting, the company’s loss for a period at Taka 2.566 million (US$ 40730.158) were transformed into a net profit of Taka 0.440 million (US$ 6984.1269), and a deficit of Taka 3.762 million (US$ 59714.285) shown as retained earning of Taka 0.440 million (US$ 6984.1269). A traditional case of creative accounting, which is largely practised in Bangladesh, involves Cenco Incorporated (Medical/Health Division). The company inflated the value of inventory to increase profit by falsifying records. The inflation of profit originally took place for one year and once only. However, it could not be covered in the next year, so larger inflation of profit had to be effected the next year. The time came when much larger inflation could no longer take care of the problem. The company then arranged for a fire outbreak and listed both the missing and obsolete inventory as having been destroyed by the fire. Initially, shareholders benefited from the creative accounting practice; but ultimately suffered when their share prices fell after the fraudulent accounting picture came to light and the company was embroiled in litigation (Alam, 1988: 7). It is unfortunate that in recent days, issued company prospectuses in Bangladesh have tended to ignore the “notes to financial statements” as well as the information required by BAS/IAS, especially as regards disclosures and accounting policies. However, the Securities and Exchange Commission (SEC), regulatory authority for public limited companies listed with the stock exchanges in Bangladesh, is recently working as a constant watchdog in this regard. SEC lodged a criminal case in the second quarter of 2000 with the court of the Chief Metropolitan Magistrate (CMM) against Mark Bangladesh Shilpa and Engineering Ltd. and its directors under section 25 of the Securities and Exchange Ordinance 1969 for the company’s involvement in overvaluation of its assets and misappropriation or improper utilization of initial public offering (IPO) funds. SEC detected the overvaluation of assets by employing technical experts in this regard. In another case, SEC detected professional misconduct of an auditor (M. A. Fazal & Co.), which, while auditing, ignored false figures and statements given in the annual accounts of Rupam Oil for the year 1996-97. ICAB suspended the membership of members of the Chartered Accountant firm involved for a year with effect from 31 May 2000 (SEC Quarterly Review, April-June 2000: 4-5). SEC has also

cancelled through an order dated 10 July 2000 the IPO of Modern Food Products Limited for concealing information relating to the company’s financial health (SEC Quarterly Review, JulySeptember 2000: 5). In another move, SEC has found fraudulent audit reports prepared by 12 audit firms through creative accounting. According to the findings, audit firms involved have prepared audit reports on the basis of motivated information created by them in collaboration with the Client Company and brokers/dealers. As a result, the investors and the government were deprived of dividends and income taxes respectively, owing to showing of over-reporting of expenses and underreporting of income. SEC reported the matter to ICAB authority for appropriate action against these audit firms (The Daily Jugantor, a vernacular newspaper published from Dhaka, 24.05.2001). In order to detect possible creative accounting in recording some fraudulent transactions to influence share-prices, SEC has ordered special audit of account of three listed companies – Shinepukur Holdings Ltd., Olympic Industries Ltd. and Mark Bangladesh Ltd. – at the cost borne by the companies (The Prothom Alo, a vernacular newspaper published from Dhaka, 29.08.2001). 4.2 Analysis based on Expert Opinion Survey In this sub-section, we examine the problem of this study (related to a few issues only), by a surveying and analysis of experts’ views. These experts are (i) chartered accountants of Bangladesh, (ii) cost and management accountants of Bangladesh, and (iii) university teachers of accounting of Bangladesh. The issues addressed are: (1) whether creative accounting has long been in practice in limited liability companies in Bangladesh, (2) whether the prospectuses issued by these companies ignore “notes to financial statements” as well as the information required by BAS/IAS, especially with reference to disclosures and accounting policies, (3) whether creative accounting is a blessing or curse for the companies, (4) what the reasons are for regarding creative accounting as a blessing or curse, (5) what possible measures could be adopted to stop the practice of creative accounting, and (6) if, and what, important code of ethics should be included in accounting education. The issues and respondents’ opinions are analyzed in table 2. Table 2: Responses as to whether creative accounting has long been in practice in the organizations of Bangladesh Respondents Chartered Cost & Management University Accountants Accountants Teachers of Accounting Total Responses f (percent) f (percent) f (percent) 131 (81.9%) Yes 60 (85.7%) 52 (86.7%) 19 (63.3%) 24 (15.0%) No 10 (14.3%) 08 (13.3%) 06 (20.0%) 05 (03.1%) Don’t know -- --- -05 (16.7%) Total 70 (100%) 60 (100%) 30 (100%) 160 (100%) Note: f stands for frequency. Table 2 shows that a substantial majority of chartered accountants (85.7 percent), cost and management accountants (86.7 percent) and university teachers of accounting (63.3 percent), that is, overall 82 percent of all the respondents taken together are of the view that creative accounting has long been in practice by companies in Bangladesh, while only 16.7 percent of university teachers of accounting seem to have no idea about how long creative accounting has been in practice by companies in Bangladesh. It is, therefore, clear that creative accounting has been in practice in Bangladesh, although it is not clear for how long.

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Table 3: Responses as to whether the prospectuses issued by the organizations in Bangladesh ignore “notes to financial statements” as well as the information required by the BAS/IAS especially with regard to disclosures and accounting policies Respondents

Chartered Accountants

Responses Yes No Don’t know Total

f (percent) 66 (94.3%) 04 (05.7%) -- -70 (100%)

Cost & Management Accountants f (percent) 58 (96.7%) 02 (03.3%) -- -60 (100%)

University Teachers of Accounting f (percent) 25 (83.3%) 03 (10.0%) 02 (06.7%) 30 (100%)

Total 149 (93.1%) 09 (05.6%) 02 (01.3%) 160 (100%)

It is evident from table 3 that an overwhelming majority of chartered accountants (94.3 percent), cost and management accountants (96.7 percent) and university teachers of accounting (83.3 percent), an overall 93 percent of all the respondents taken together agree that prospectuses issued by companies in Bangladesh tend to ignore “notes to financial statements” as well as information required by BAS/IAS, especially as regards disclosures and accounting policies. In this respect, only a small proportion of university teachers of accounting (6.7 percent) have regretted their inability to respond to whether prospectuses issued by companies in Bangladesh ignore all those information or not. Table 4: Responses as to whether creative accounting is a curse or blessing for the organizations in Bangladesh Respondents

Chartered Accountants

Responses Curse Blessing Total

f (percent) 65 (92.9%) 05 (07.1%) 70 (100%)

Cost & Management Accountants f (percent) 54 (90%) 06 (10%) 60 (100%)

University Teachers of Accounting f (percent) 25 (83.3%) 05 (16.7%) 30 (100%)

Total 144 (90%) 16 (10%) 160 (100%)

Table 4 shows that quite majority of chartered accountants (92.9 percent), cost and management accountants (90.0 percent) and university teachers of accounting (83.3 percent), an overall 90 percent of all the respondents, regarded creative accounting as a curse, while a small proportion of all the three groups of respondents considered creative accounting a blessing for companies in Bangladesh. Those few who consider creative a blessing have given one vital reason for their answer. This is that some companies in Bangladesh have been found to be interested in refining their accounting system. For example, Bangladesh Lamps Ltd. and Bangladesh Electrical Industries (Pvt.) Ltd. have adopted inflation accounting, under the guidance of N. V. Philips Gloeilampenfabrieken, Holland. These companies maintain two sets of accounts – one set under Historical Cost Accounting system that ignores the effects of inflation and another set under Replacement Cost Accounting system that incorporates the effects of inflation. Some companies listed with the stock exchanges are also found not to follow the requirements of IASs in the accounting system, although they are required to observe it according to rule 12 of the Securities and Exchange Rules 1987 (effective from October 1997). On the other hand, those who have regarded creative accounting as a curse have argued that in many organizations of Bangladesh, unethical elements are found to have created accounts in order to attract investors. They present an exaggerated and misleading or deceptive state of company financial affairs so that more and more people are attracted to invest in the companies. This way of presentation is undesirable and for that reason a curse. With respect to providing suggestions to stop the unethical practice of creative accounting, 100 percent respondents of all groups under study (chartered accountants, cost and management accountants and university teachers of accounting) suggested the following five measures (enumerated in the questionnaires): (1) (2)

Introduction of forensic accounting; Punitive measures by national accounting bodies, courts and government;

(3) (4) (5)

A very soundly constituted stock market and Securities and Exchange Commission; Giving much importance to ethical codes by the accounting profession; and Prevention of fraudulent financial reporting by all means.

Finally, the responses to question 5 (in the questionnaire in the Appendix) reveal that 100 percent respondents of all the study groups (chartered accountants, cost and management accountants and university teachers of accounting) have recommended that the moral virtues of honesty, integrity and incorruptibility should not only be included in the accounting curriculum and taught in tertiary institutions but should also be instilled into the very fiber of students’ character. 5. Creative Accounting in Global Perspective Creative accounting seems to be widespread globally. The difference is possibly in the degree and technique. Several years back (1986) in the United Kingdom (UK), Westminster and Midland Banks were in controversy regarding treatment of write-offs as extraordinary or exceptional items. The Midland Bank wrote off its substantial LDC less developed countries’ (LDC’s) lending as “below-theline extraordinary item”, thereby ensuring that its operating results and earning per share remain unaffected. On the other hand, the Westminster bank’s treatment of its equivalent item was to disclose it separately as “above-the-line exceptional item” to arrive at its operating results. However, both treatments did not conform to the criteria of revised UK accounting standards – SSAP 6, requiring their audits, ironically the same Ernst & Whinny, to face a barrage of pointed questions, as well as a tribunal of the professional standards committee (Griffiths, 1992; Alam, 1988: 7). This is a historical fact presented as a matter of reference only. Creative accounting resulting in fraud may sometimes be so masked as to escape detection even by auditors applying the strictest rules of professional practice. A good example that illustrates this was the experience of Ferranti International Signal and its USA subsidiary, International Signal Control (ISC) Technologies (Inanga 1991). Ferranti International had acquired ISC Technologies in September 1987 for £420 million sterling, based on accounts that have been audited by KPMG Peat Marwick McLintock, who were unaware of an alleged fraud of £215 million sterling in the company. The fraud involved three non-existent arms deals in Pakistan, China and Nigeria, through payments made to a network of companies in Panama and Switzerland who, purportedly, were sub-contractors to the deals. Some of the money was recycled to the company’s United Stares subsidiary as if the contracts were real. The effect of this was to inflate the assets and profits of the subsidiary, which, as a result, showed a net worth of US $320 million, whereas the company had absolutely no net worth. Ferranti International suffered because it paid £420 million sterling to acquire a company that was worthless at the time of acquisition. In other words, Ferranti International paid £420 million sterling to acquire net assets that did not exist (Financial Times, November 17, 1989). A very small number of publicly held companies in the USA continued to face enforcement actions by the Securities and Exchange Commission for creative accounting. In the case of Information Displays, Inc., revenue was overstated by recognizing “purported sales that were ordered on a ‘noobligation’ trial basis.” In Automatix Incorporated, revenue was. overstated “by counting as sales shipments on trial or conditional basis.” In Oak Industries, Inc., net income for 1982 was decreased by $44 million to show a loss for the year at $40 million from the previously declared profit of $4 million. The cause of this restatement was that the company created unnecessary secret reserves in prior years aiming to release them in the future if income failed to reach the desired level; and such unnecessary reserves were released by the company to bolster income for 1982 (Alam, 1988: 7). But probably the most widely known case of creative accounting in the USA is possibly the case of the Enron. Established in July 1985 as an interstate natural gas pipeline company, Enron rose to number seven on the Fortune 500 in 2000. On November 8, 2002, Enron disclosed that it overstated earnings by US$586 million since 1997 and on December 2, 2001, Enron filed for bankruptcy protection, when its US$85-worth share (in 2000) fell below US$1 and was later suspended. The company hid its losses using a complicated web of subsidiaries, partnerships and special-purpose-entities. Other ways include: issuance of stock options to employees instead of incurring remuneration expenses, boosting

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profits by booking income immediately on long-term contracts, and using aggressive tax avoidance strategy. Arthur Andersen, the auditor of Enron, was paid US$52 million in fees in 2000, US$27 million of which was for consultancy work. In the mid-1990s, Arthur Andersen even handled some of Enron’s internal auditing work. Enron’s in-house financial team was also dominated by former Andersen partners. On January 9, 2002, when criminal investigation into Enron was announced, Arthur Andersen admitted to destroying some Enron documents. The most-cited criticisms against Arthur Andersen include: not highlighting, or possibly being party to, the fact of Enron’s overstatement of profit by some US$586 million since 1997 and hiding debt via off-balance-sheet partnership; shredding of documents and e-mail messages related to its audit of Enron; and possible clouding of auditing judgment arising from its multimillion-dollar consulting contract with Enron (Sze, 2002: 30-31). When accounting problems at American International Group surfaced last winter, it looked like a small matter next to the corporationbusting scandals of the Enron era. Even after AIG issued a statement March 30 detailing the issues, it said only $1.77 billion in shareholder value was threatened -- not so much for a multinational company then valued at more than $81 billion. Enron collapse is a gloomy example of creative accounting showing the failure of the accounting profession, which caused the most negative effect on the confidence of the public in audited published company financial statements. Another recent case in the USA similar to Enron is that of American International Group (AIG) which surfaced in the winter of 2004 (“Accounting for the abuses at AIG”, http://knowledge.wharton.upenn.edu/article/1180.cfm - We thank Professor Bruce Schneider of California State University in Los Angeles for drawing our attention to this article). On March 30, 2005, AIG issued a statement indicating, “only $1.77 billion in shareholder value was threatened…not so much the multinational company then valued at more than $81 billion”. According to the article, “AIG directors acted as if the company' s very survival was at stake, removing Maurice Greenberg as CEO and later forcing him to step down as chairman. According to press reports, the tipping point came when directors and regulators learned that documents might have been removed from an AIG building or destroyed. New York Attorney General Eliot Spitzer then threatened criminal charges against AIG itself. No major financial firm had survived such a blow”. . Among other problems was the plummeting of stock prices. Investors’ confidence had been shaken and they were “worried about what else would be uncovered, how the management purges would affect the future, and whether a tainted AIG would lose customers”. The directors of the company later discovered several cases of questionable accounting. The most serious of these abuses, “involved reinsurance contracts AIG had taken with a Barbados re-insurer, Union Excess, allowing AIG' s risk to pass to the other company and off AIG' s books. AIG found that Union did business exclusively with AIG subsidiaries, and that Union was partially owned by Starr International Company Inc. (SICO), a large AIG shareholder controlled by a board made up of current and former AIG managers. Hence, the AIG statement said, SICO could be viewed as an AIG unit, or "consolidated entity," and SICO' s risks were therefore actually AIG' s. As a result, AIG had to reduce its shareholders'equity by $1.1 billion”. Now to Australia, where the National Companies and Securities Commission (NCSC) gave a media exposure in 1997 to the fact that they were monitoring the financial statements of 12 publicly listed companies for departing from Australian Accounting Standards (AASs) in their 1986 annual accounts. In the Coles Myer’s case, the company’s write-off of $98 million as goodwill from the acquisition of business immediately after purchase instead of over a period not exceeding 20 years as required by AAS 18 was questioned by the NCSC. The NCSC, in fact, discovered several cosmetic accounting practices which included: (i) showing capital gains as operating profit, (ii) selective process in identifying transactions as abnormal or extraordinary items, (iii) unrealized gains being included in revenues, (iv) the dubious treatment of goodwill, (v) unorthodox misleading recording of unrealized foreign currency losses as assets, and (vi) differing equity accounting, consolidation and depreciation interpretations. Puscas (2002) has mentioned a number of possible lessons to be lesrnt, and possible actions with respect to the Enron collapse: (1) a structural overhaul of the system, including new rules prohibiting firms that audit the accounts of a company from serving as a consultant for the same

company; (2) punishment for corporate irresponsibility; (3) more participation and power of the workers in management decisions; (4) struggle against trade agreements; and (5) questioning the free market system (Puscas, 2002). As a consequence of the Enron’s collapse, the SarbanesOxley Act of 2002 was passed in the USA. According to section 201 of the Sarbanes-Oxley Act of 2002, it shall be unlawful for a registered public accounting firm and any associated person of that firm that performs for any issuer any audit required, to provide to that issuer, contemporaneously with the audit, any non-audit service, including (1) bookkeeping or other services related to the accounting records or financial statements of the audit client; (2) financial information systems design and implementation; (3) appraisal or valuation services, fairness opinions, or contribution-inkind reports; (4) actuarial services; (5) internal audit outsourcing services; (6) management functions or human resources; (7) broker or dealer, investment adviser, or investment banking services; (8) legal services and expert services unrelated to the audit; and (9) any other service that the Public Company Accounting Oversight Board determines, by regulation, is impermissible (The US SEC 2002). 6. Conclusions and Recommendations It is clear from the foregoing discussion that creative accounting practice is found not only in Bangladesh but also in developed countries like the UK, the USA and Australia. In the USA, to check creative accounting, the practice of forensic accounting is on the increase. In a country like Bangladesh where the unethical aspects of creative accounting are rampant, the practice of forensic accounting (i.e., investigative accounting done by forensic accounting consultants to solve problems in courts) needs to be introduced and recognized. In this regard, Loren Kellogg, a US CPA (Certified Public Accountant) whose “Financial Statement Alert” scrutinizes public companies’ questionable accounting practices, advises investors to examine carefully shareholder letters and management’s discussion and analysis of financials, and to try to read between the lines by looking at four basic areas: (i) extent of a company’s earnings from operations, as opposed to onetime occurrences, warning signs in the financial statements (e.g., shrinking profit margins, or fast growing inventories or receivables, or insufficient cash generation, etc.), (iii) changing accounting methods to more favorable one, or using accounting methods different from the ones the competitors use, and (iv) assets or liabilities on (or off) the balance sheet that might affect future earnings (vide Schiff, 1993: 94). The result that emerges from the analysis of expert views is that creative accounting has long been in practice in Bangladesh. Most of the companies in Bangladesh create accounts in an undesirable way to attract investors, while some of the companies practise it with a good motive of refining the accounting system. It is a good sign. Another healthy sign is that experts have started feeling that the unethical practice of creative accounting should be stopped by all means. They also recommend that while imparting accounting education, it is the indispensable duty of the instructors to instill the moral virtues of honesty, integrity and incorruptibility into the very fiber of students’ character. To detect and prevent the pitfalls of creative accounting, punitive measures have to be taken by national accounting bodies, courts and Government. The country needs to have a sound, strong stock market as the foundations of free and fair enterprise system. Ethical codes need to be given much importance by the Accounting Profession. Accountants need to understand ethical codes in proper perspective and follow them accordingly. Students of accounting also need to learn all these by heart. Fraudulent financial reporting has to be prevented by all means. Misrepresentation of facts and falsification of accounts have to be treated as great offences and dealt with strictly. Every accountant should keep in mind that ethical conduct and accounting education are critical to modern society, the business world and the accounting profession. Lapses in ethical behavior of accountants endanger the accounting profession’s credibility. The liability of an accountant for his/her acts and faults is not restricted to his/her immediate client alone but extends also to third parties who rely upon his/her professional advice. An accountant should, therefore, need to take all care to ensure that his/her advice is not incorrect or misleading, as third parties who rely upon his/her instructions or financial statements may hold him/her liable for consequent financial losses incurred. To ensure that the accounting profession commands the respect and confidence it deserves from the public and, simultaneously, to check unethical aspects of creative accounting, the need for accountants to adhere strictly to the code of professional ethics can hardly be overemphasized.

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A Select Bibliography Alam, A.K.M. Sahabub (1988), “Creative Accounting – Is It Leading Us Towards a Stock Market Crash?” The Cost and Management, The Institute of Cost and Management Accountants of Bangladesh, Dhaka, Vol. 16, No. 5 (September-October): 5-7. Bosch, H. (1990), The Working of a Watchdog (Melbourne: Heinemann). Dhar, Nirmalendu (2000), The Laws on Securities and Exchange (Dhaka: Chandpur Law Book House). Domash, Harry (2002), “How to Detect Creative Accounting: Detecting accounting shenanigans (see ww.winninginvesting.com). Financial Times, November 17, 1987, London Fatt, James Poon Teng (1995), “Ethics and the Accountant,” Journal of Business Ethics, Kluwer Academic Publishers, The Netherlands, Vol. 14: 997-1004. Ghosh, S. N. (1986), “Professional Ethics for Accountants in South Asia,” The Management Accountant, The Institute of Cost and Works Accountants of India, Calcutta. Griffiths, Ian (1992), Creative Accounting: How to make your profits what you want them to be (London: Routledge, First published in 1986). IFAC (International Federation of Accountants) (1992), IFAC Handbook 1992: Technical Pronouncements (New York: IFAC). Inanga, Eno L. (1991), Accounting and Accountability, Inaugural Lecture, Ibadan University Press. Jameson, Michael (1988), A Practical Guide to Creative Accounting (London: Kogan Page). Metcalf, L. (1977), The Accounting Establishment, Staff study as the Chairman of the US Senate Subcommittee (Washington, D.C.: The United States Government Printing Office). Puscas, Darren (2002), “A Guide to the Enron Collapse: A Few Points for a Clearer Understanding” (Ottawa, Ontario, Canada: Polaris Institute); see www.polarisinstitute.org. Schiff, David (1993), “The Dangers of Creative Accounting,” Worth (March): 92-94. Reprinted in Aileen Ormiston (ed.) (1998), Accounting 98/99 (Guilford, Connecticut, USA: Dushkin/McGraw-Hill): 94-96. Schmalenbach, E. (1959), Dynamic Accounting. Translated by G. W. Murphy and K. S. Most (London: Gee). SEC Quarterly Review, The Securities and Exchange Commission, Dhaka, various issues of 1999 and 2000. Smith, Terry (1992), Accounting for Growth, Century Business, London, UK. Sze, Joanna (2002), “Enron: Learning the Lessons,” Malaysian Business (March 1): 28-33. The Internet: http://knowledge.wharton.upenn.edu/article/1180’cfm The US SEC (2002), The Sarbanes-Oxley Act of 2002; see www.sarbanes-oxley.com/

APPENDIX Questionnaire For Chartered Accountants, Cost and Management Accountants And University Teachers of Accounting Q. 1:

Do you think that organizations in Bangladesh have long been practising creative accounting? Yes

Q. 2:

No

Don’t know

Do the prospectuses issued by the organizations of Bangladesh ignore “notes to financial statements” as well as the information required by BAS/IAS, especially in regard to disclosures and accounting policies? Yes No Don’t know

Q. 3 (a): Is creative accounting a blessing or curse for the organizations of Bangladesh? Blessing Curse Q.3 (b): Please give reasons for your answer.

Q. 4:

If creative accounting is a curse in general, please state what measures you should suggest to stop its evil practice. Possible measures:

Q. 5:

(a)

The practice of forensic accounting (i.e., investigative accounting done by forensic accounting consultants to solve problems of frauds in courts) has to be introduced

(b)

Punitive measures have to be taken by national accounting bodies, courts and Government

(c)

Bangladesh needs to have very sound stock market and Securities and Exchange Commission

(d)

Accounting profession needs to give much importance to ethical codes

(e)

Fraudulent financial reporting has to be prevented by all means

(f)

All of the above measures

(g)

Any other (Please specify)..................

While imparting accounting education, the moral virtues of honesty, integrity and incorruptibility should not only be taught, but should also be instilled into the very fiber of the students’ character. Do you recommend it? Yes No

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-: THANK YOU VERY MUCH FOR YOUR SINCERE CO-OPERATION : -

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