The spectacular breakdown of Polly Peck impressively demonstrated the role of creative accounting in the 1980s. Although many companies were not doing well, creative accountants could easily deceive shareholders by manipulating figures.
The Companies Act requires financial statements ′to give a true and fair′ (i.e., factual and unbiased) ′view′. This enables user groups to properly assess a company′s financial position. If, however, accountants are free to arbitrarily manipulate figures, this becomes impossible. Therefore efforts had to be made to confine the extent of creative accounting.
By defining creative accounting (section 2), a critical evaluation of measures (section 3) and the conclusion (section 4), this essay will show that the measures introduced by the ASB are powerful to contain present creative accounting. However, they will not prevent future creative accounting.
Table of Contents
1. Introduction
2. Definitions
3. Critical Evaluation
3.1. Off-balance sheet finance
3.1.1 Quasi-subsidiaries and ‘lease and saleback’ schemes
3.1.2 FRS 5
3.2. Reserve Accounting
3.2.1 Exceptional Items
3.2.2 FRS 3
3.3. Goodwill
3.3.1 What is goodwill?
3.3.2 FRS 10
4. Conclusion
Research Objective and Topics
The primary objective of this work is to evaluate whether the measures introduced by the Accounting Standards Board (ASB) effectively mitigate creative accounting practices in the UK. The essay examines whether these standards succeed in curbing existing manipulative schemes or merely force accountants to find new loopholes in the system.
- Analysis of creative accounting definitions and the tension between the "letter" and "spirit" of the law.
- Critical evaluation of off-balance sheet financing, including quasi-subsidiaries and lease-back schemes.
- Examination of reserve accounting and the regulatory impact of FRS 3 on exceptional items.
- Assessment of FRS 10 and the challenges associated with accounting for goodwill and intangible assets.
- Critical review of the ASB's regulatory effectiveness and the role of the Financial Reporting Review Panel (FRRP).
Excerpt from the Book
3.1 Off-balance sheet finance
The ICAEW defines this as ‘the funding or refinancing of a company’s operations in such a way that (…) some or all of the finance may not be shown on the balance sheet’. Off-balance sheet finance aims to reduce the gearing ratio, defined as Net borrowings / Shareholder’s equity.
The higher a company’s net borrowings, the higher the gearing ratio. Gearing therefore assesses the company’s indebtedness. Due to the risk a high gearing implies, banks will not approve additional funding for high-geared companies. Therefore, off-balance sheet finance schemes try to pretend a lower gearing.
The Companies Act and SSAP 21 contained loopholes in its definitions of a subsidiary. Companies therefore created quasi-subsidiaries, i.e. ‘conducted business through another entity while keeping out of the formal definition of the Companies Act’: the mother company places assets into the quasi-subsidiary, thereby legally, but not commercially disposing of them.
‘Lease and saleback’ transactions use the same loophole. Companies either lease assets or sell them together with a repurchase option. Again the assets are legally disposed of. Finally, removing assets and their liabilities from the balance sheet pretends a lower gearing. FRRP Press Notice 44 provides an illustrative example.
Summary of Chapters
1. Introduction: This chapter highlights the historical significance of creative accounting, specifically referencing the Polly Peck collapse, and introduces the ASB's efforts to regulate financial statements.
2. Definitions: This section establishes a working definition of creative accounting, distinguishing it as the manipulation of figures that complies with the letter of the law while violating its spirit.
3. Critical Evaluation: This main body chapter examines specific ASB standards—FRS 5, FRS 3, and FRS 10—and analyzes their effectiveness in combating schemes related to off-balance sheet finance, reserve accounting, and goodwill.
4. Conclusion: The concluding chapter synthesizes the findings, arguing that while ASB standards have improved financial reliability, they remain limited in preventing future creative accounting due to the inherent subjectivity of accountancy.
Keywords
Creative accounting, Financial reporting, Accounting Standards Board (ASB), Off-balance sheet finance, Gearing ratio, Quasi-subsidiaries, FRS 5, FRS 3, FRS 10, Goodwill, Reserve accounting, Exceptional items, Compliance, Financial transparency.
Frequently Asked Questions
What is the central focus of this assignment?
The work investigates the effectiveness of the Accounting Standards Board (ASB) in the UK at reducing creative accounting practices through the implementation of new financial standards.
What are the primary themes discussed?
Key themes include off-balance sheet financing, the treatment of exceptional items in profit and loss accounts, and the complex valuation and amortization of goodwill.
What is the main research question of this study?
The research question asks whether the ASB can truly reduce creative accounting or if the introduction of new standards simply shifts the problem into new areas of ambiguity.
Which scientific method is applied here?
The author employs a critical evaluation and normative analysis, comparing existing accounting loopholes against the specific prescriptive measures introduced by various Financial Reporting Standards (FRSs).
What topics are covered in the main part of the paper?
The main part analyzes three specific areas of regulatory intervention: off-balance sheet finance (FRS 5), reserve accounting for exceptional items (FRS 3), and goodwill accounting (FRS 10).
How would you characterize this work using keywords?
The work is defined by terms such as creative accounting, financial transparency, FRS standards, off-balance sheet finance, and the "substance over form" principle.
What is the "substance over form" principle mentioned regarding FRS 5?
It is a regulatory requirement that companies report the economic reality of a transaction rather than just its legal form, specifically to prevent companies from hiding liabilities through vehicles or quasi-subsidiaries.
How does the author evaluate the success of the ASB?
The author concludes that while the ASB has succeeded in increasing the reliability of financial reporting compared to the 1980s, the subjective nature of accounting means that creative accounting will likely never be fully eliminated.
What does the "Hinton Dissent" refer to?
It refers to a critical stance against the accounting of goodwill, proposing that instead of capitalization and amortization, goodwill should be deducted directly from shareholder's equity.
- Arbeit zitieren
- Marcus Matthias Keupp (Autor:in), 2001, Can the ASB really reduce creative accounting?, München, GRIN Verlag, https://www.grin.com/document/7763
