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Creative Accounting - Have you seen the red flag?

Forensic Focus - September 2009

Accounting suffered a series of major reputational blows in the 1980’s and 90’s. The “creative accounting” practices used made some businesses appear to be more profitable (or less profitable for tax reasons) and financially stronger than they really were. Lenders and investors lost millions as a direct result of these practices. 

However, it would be wrong to simply conclude that those were the ‘bad old days’ and financial reports are no longer manipulated for gain. Unfortunately, ‘creative accounting’ is not a dying art and is still used by some for financial gain.  

Insurers, lenders and government departments rely on accounting information in order to make assessments regarding insurance claims, ability to service loans and the need for financial support. Financial reports that have been manipulated can lead to overpaying insurance claims, lenders and creditors suffering higher levels of bad debts and government providing financial support to organisations that don’t require it.

What to look out for?

In our experience, you should pay particular attention if one of the following are identified in an organisation's  annual financial statements as the figures for these are easily manipulated:

  • Management fees
  • Transactions with related parties
  • Wages to family members
  • Shareholder salaries

Also be weary of significant and unexplained changes in the level of sales, gross profit percentages, expenses, stock, accounts receivable and accounts payable. 

If one of these red flags is flying, we suggest you carefully question the organisation. Often this will unlock whether there are valid commercial reasons for these items. If not, it may be necessary to investigate further before you can reach an accurate conclusion as to an organisation’s real profitability and/or financial strength. 

Please contact Jason Weir if you would like further information on this.

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