creative accounting, fraud and international accounting scandals · 2018. 11. 8. · overview...
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Creative Accounting, Fraud and International Accounting
Standards
Michael Jones
University of Bristol
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Overview • Based on Book: Creative Accounting, Fraud and
International Accounting Scandals
• Investigates nature of creative accounting and fraud
• Examines history of accounting scandals
• Looks at creative accounting, fraud and accounting scandals in 13 countries worldwide
• Focus on political aspects
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Creative Accounting
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Two Quotes “How do you explain to an intelligent public that it is possible
for two companies in the same industry to follow entirely different accounting principles and both get a true and fair audit report?”
M. Lafferty
“Every company in the country is fiddling its profits”. I. Griffiths
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Definitions
1. Fair Presentation
Using the flexibility within accounting to give a true and fair picture of the accounts so that they serve the interests of users
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Definitions
2. Creative Accounting
Using the flexibility within accounting to manage the measurement and presentation of the accounts so that they serve the interests of preparers
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Definitions
3. Impression Management
Using the flexibility of the accounts
(especially narrative and graphs) to convey a more favourable view than is warranted of a company’s results serving the interests of preparers
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Definitions
4. Fraud
Stepping outside the Regulatory Framework deliberately to give a false picture of the accounts
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Definitions
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No Flexibility
Flexibility to give a
fraudulent view
Flexibility to give a “true and fair“
view
Working within regulatory framework to serve preparer’s interests
Working within regulatory framework to ensure users’ interests
Regulatory framework eliminates accounting choice
Working outside regulatory framework
Flexibility to give a
creative view
Outside regulatory framework
Within regulatory framework
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Managerial Motivation 1. Personal incentives e.g. Increase salaries through profit-related pay,
bonus schemes, shares and share options, job security
2. Market Expectations e.g. Meet analysts’ expectations Profit smoothing 3. Special Circumstances e.g. Manage gearing New issues Mergers and acquisitions Decrease regulatory visibility New management team
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Main Methods A. Creative Accounting 1. Increase Income e.g. premature sales recognition
2. Decrease Expenses e.g. provision accounting capitalisation of interest
3. Increase Assets e.g. enhance goodwill revalue fixed assets
4. Decrease Liabilities e.g. off balance sheet financing reclassifying debt as equity
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Main Methods B. Fraud
1. Misappropriate assets
e.g. steal cash, inventory
2. Fictitious transactions
e.g. invent sales or even whole subsidiaries
However, creative accounting and fraud overlap
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Accounting Scandals – Across Time Table 7.1: A Selection of major scams and scandals across time
i. Ancient and medieval 1. Cruciform monument, Mesopotamia second millennium BC
2. Medieval merchants, Italy, fourteenth century
3. Cely Family, England , late fifteenth century
ii. Seventeenth and eighteenth centuries 4. Africa and India company of Scotland, Scotland, 1695
5. South Sea Bubble, England, 1720
iii. Nineteenth Century 6. Railway scandals 1840s-1860s , England
7. City of Glasgow bank, Scotland, 1878
iv. Twentieth century: Before Second World War 8. P&O , New Zealand, 1917-36
9. Royal Mail Steam Packet Company , UK, 1931 13
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Accounting Scandals – Across Time
iv. Twentieth century: Before Second World War (cont.d) 10. Kreuger & Toll, Inc., US, 1932
11. McKesson & Robbins, US, 1937
v. Twentieth century: 1945-1980s 12. Reid Murray, Australia, 1963
13. H.G. Palmer, Australia, 1965
14. Associated Electrical Industries takeover by General Electric Company, UK, 1967
15. Minisec, Australia, 1971
16. Equity Funding Corporation of America, US, 1973
17. Cambridge Credit, Australia, 1974
18. Renouf and Judge Corporations, New Zealand, 1980s
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Major Accounting Cases Covered
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AUSTRALIA GERMANY
Adelaide Steamship Bond Corporation Harris Scharfe One.Tel HIH Insurance
Co-op Balsam Bremer Comroad Flowtex Philip Holzmann Vulkan Verbund
CHINA GREECE
Shenzhen Yuanye Great Wall Fund Raising Hongguang Daqing Lianyi Kangsi Group Lantain Gufen Zhengzhou Baiwen
Bank of Crete Dynamic Life Esta Finance
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Major Accounting Cases Covered
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INDIA NETHERLANDS
Satyam Fokker Royal Ahold RSV
ITALY SPAIN
Parmalat Afinsa and Forum Filatelico Banesto Caja Rural de Jaen Gescatera Promotura Social De Viviendas
JAPAN SWEDEN
Fuji Sash Riccar Kanebo Sanyo Special Steel Livedoor Sawako Morimoto-gumi Yamaichi Securities Nikko Cordial Yaohan Japan
ABB Fermenta Prosolvia Skandia
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Major Accounting Cases Covered
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UK US
Mirror Group Polly Peck Bank of Credit and Commerce International
Adelphia Communications Bear Stearns Bre-X Minerals California Micro Devices Enron HealthSouth Lehman Brothers Madoff Securities International Tyco International WorldCom
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Countries and Authors Australia Garry Carnegie and Brendan O’Connell
China Catherine Chen, Yuanyuan Hu, Jason Xiao
Germany Hansrudi Lenz
Greece Maria Krambia-Kapardis, George Kontos, Nikolaos Milonas
India Bhabatosh Banerjee
Italy Andrea Melis
Japan Kazuyuki Suda
Netherlands Henk Langendijk
Spain Nieves Carrera
Sweden Gunnar Rimmel
UK David Gwilliam, Richard Jackson
US Charles Mulford and Eugene Comiskey
Bank Failures Simon Norton
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Six Scandals in Depth Australia HIH provisions
financial reinsurance goodwill
China Zhenzou/Baiwen fraudulent sales related party capitalised and deferred expenses bad debts inflated assets
Greece Bank of Crete manipulation of accounting records embezzlement
Italy Parmalat redeemable preference shares debtors false sales debts as equity related party overstated assets
UK AEI Stocks Contracts Debts
US Enron Loans as sales Off-balance sheet subsidiaries Swapping sales 19
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HIH • Australian second largest insurance company
• Collapsed in 2001
• Three accounting issues:
i. Underprovided for future expected claims
ii. Reinsurance which did not transfer risk (e.g., side letters)
iii. Losses transferred to goodwill account
• Executives prosecuted
• Anderson’s criticised for lack of independence, failure of audit committee and consultancy work
• Corporate Law Economic Reform Program Act 2004
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Zhenzhou Baiwen • Company dealing with household appliances
• Fifth largest company in China in 1997
• 2002 ran into serious problems
• Accounting Issues:
i. Fraudulent sales
ii. Misused raised capital
iii. Capitalised expenses
iv. Deferred expenses
v. Inflated assets
vi. Related party provisions
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Zhenzhou Baiwen • Zhengzhou auditing company fined
• Failures of governance
i. Board of directors
ii. Supervisory board
iii. Local government
• Consequences
i. Revised corporate governance guidelines
ii. Changes to Law
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Bank of Crete • Koskotas, a fraudster
• From ages 15-25 in US commits 64 forgery offences as well
as forging academic qualifications
• 1979 starts work Bank of Crete
• 1980 Head of Internal Audit
• Steals US $ 1,555,000 and deposits them with Westminster
Bank
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Bank of Crete • Overall embezzles US $32 million
• Forges letters and documents to cover tracks
• External audit failure
• Detected through a special audit
• Close connection with Andreas Papandreou, acquitted
• Corporate Governance code mandatory
Bank of Crete privatised
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Parmalat • European Enron
• 2003 Parmalat defaults on $150 million bond
• Accounting Issues
i. Fictitious sales
ii. Double billing
iii. Fabrication of operating subsidiaries’ sales
iv. Not recording debts
v. Recording debt as equity
vi. Overstating assets
vii. A forged € 3.95 billion Bank of America cheque
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Parmalat • Governance Issues
i. Tanzi family dominate Board
ii. Non-independent non-executive directors
iii. Audit committee lacks independence
iv. Board of stability auditors ineffective
• External auditors failed in monitoring role
• Aftermath
i. Changes to audit regulations
ii. Changes in 8th Directive
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AEI • UK Company taken over by GEC
• Contested bid
• AEI forecasts a £10 million profit
• GEC published results £4.5 million loss
• Political controversy
• UK Accounting Standards Steering Committee formed
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ENRON Highly Successful company
Off-balance sheet financing, fictitious income,
misreported cashflow
Seventh biggest company in US, Bankruptcy
Sarbanes Oxley Act
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Some Themes 1. Overstrong personalities
Charismatic persuaders and conmen
e.g. In UK, Robert Maxwell and Asil Nadir
In US, Bernie Ebbers at WorldCom
In Spain, Mario Conde at Banesto
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Some Themes 2. Managerial Motivations
Cover up bad performance 30
Personal benefits 35
Meet listing requirements 5
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Some Themes 3. Failure of Internal Control
Frequent Examples:
At Zhenzou Baiwen failure of supervisory, board, independent directors and state controlled shareholders
At Parmalat no independent directors, supervisory board and audit committee failed
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Some Themes 4. Failure of External Auditors
Frequent features: In all seven Chinese cases negligent or complicit auditors
At Parmalat auditors failed may have let company post a letter to Bank
Comroad surprising failure of auditor to spot a non-existent subsidiary
In Spain at Forum auditors did spot some irregularities, but failed to question sales and repurchase agreements
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Aftermath Short term, generally
Loss of share price
Company taken over or goes into liquidation
Directors jailed or fined
Auditors fined
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Aftermath Longer Term
Regulations especially: i. changes in law
ii. new Codes of Corporate Governance
Continual revisions
Gradual increase in laws, regulations and political interference
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Theoretical model to reduce creative accounting and fraud
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Enhanced by
Reduced by
Potential for creative accounting and fraud
Lax rules and regulations
Market Personal
Enforcement and ethics
Poor supervision
Enhanced supervision
Appropriate reward and incentive structures
Code of ethics
Harsher penalties
Better regulations and code of governance
Inappropriate reward and incentive structures
Motives Environmental opportunities Environmental constraints
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How can this be Stopped? Environmental Constraints
1. Appropriate reward and incentive structure
2. Better regulations and codes of Corporate Governance i. Enforcement and Ethics
ii. Better enforcement
iii. Code of ethics
iv. Enhanced supervision
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Conclusion
• Creative Accounting and Fraud perennial problems • Over 12 countries, we study at least 58 different
instances of accounting scams • Sensational collapses e.g., HIH in Australia , Zhenzhou
Baiwen in China, Parmalat in Italy and Enron in US • Arise from managerial motivation for personal gain • Often promulgated by charismatic persuaders • Facilitated by poor corporate governance and failure of
external audit • Lead to financial loss and increased legislation • Darwinian rule of the fittest
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