Creative Accounting Case Study

1. Explain the meaning of “creative accounting” and “earnings management”.

Creative accounting is the exploitation of loopholes in the financial legislation to create a better image of the company and to create the appearance of the strong financial condition. Due to the least conscientious of the accounting profession in the accounting process it will provides opportunities for companies to manipulation, deceit and distorts the value of the information that their financials provide in order to gain advantage and presenting favourable report. Companies utilize the creative accounting to overstate their asset and understate their liabilities.
Earnings management is the strategy taken by the management that involve a choice by a manager of accounting

The first main motivation is fraud triangle which issued by Auditing Standard Board, indicates that the occupational fraud triangle comprises three conditions that are generally present when a fraud occurs. At an individual level, these conditions include an incentive or pressure, an opportunity, and a rationalization. On the other side, Enron’s case highlights fraud on organizational level which is leadership, management control system and organizational culture that form the three points of the organizational fraud triangle. The first point of organizational fraud triangle which motivates the practice of earnings mismanagement is Jeffrey Skilling’s leadership style. Under Skilling’s power as President and CEO, a very different management control style introduced and elements of Enron’s culture and operations underwent a radical transformation. In order to meet analysts’ expectations, Skilling exercised control over almost all facets of the organization, particularly regarding its accounting procedures. Earnings mismanagement was accomplished largely using special purpose entities (SPEs) and mark-to-market accounting, which recorded profits from long-term deals immediately even though there were still doubts about the project. Therefore, this emphasized Enron is extensively larger than it really is. The second point of organizational fraud triangle is management control systems which refer to the tools that seek to elicit behavior that achieves the strategic objectives of an organization. Example of Enron’s management controls which motivated the practice of earning mismanagements is Enron’s Performance Review System (PRC). Skilling introduced PRC which became known as the harshest employee ranking systems in the country. In order to have a high performance, everyone in the organization became instantly motivated to do post earning which considered as earning