Why it’s bad for business
The formal definition of accounting that can be found in most text books is that “accounting is the process of identifying, measuring and communicating information to permit informed judgment and decision by users of the information” (Weetman, 2011, p19). The users’ element of the definition suggests to us that there is a demand for accounting information by these users (stakeholders). As a result, we can assume that there is a corresponding supply of information i.e. where there is demand there is supply. This allows us to view accounting information as a public commodity as it affects various stakeholder groups. For example, employees may be interested in accounting information for job security purposes and creditors may need evidence for the repayment of loans. Accounting information, as a public commodity, therefore has to be regulated in terms of its production and distribution in order to obtain the optimum allocation of resources in the economy (David et al, 1982).
Creative accounting can be defined as the exploitation of loopholes in financial regulation in order to gain advantage or present figures in misleadingly favourable light. We can therefore ascertain from the definition that creative accounting reduces the value of financial information. We have seen the effects on creative accounting in the past with companies such as Enron. As a business owner, it is often tempting to utilise creative accounting in order to get away with paying less tax. However, the implication of creative accounting can have long lasting effects. For example, your business may require investment in the future which requires that the financial health of the company to be analysed and evaluated. If the financial reports you are presenting do not purport the true nature of the company then you are setting yourself up to fail. Since accounting is a public commodity, the failure would not be limited to your business but to the wider community that relied on your financial information to make decisions. It is also important to understand that creative accounting can be a habit that becomes extremely costly (if your accounts are audited).
The true value of accounting comes from the ability to produce financial information that allows management (including other key stakeholders) to make key strategic decisions (personal or business related) regarding the health of the business. Creative accounting can be seen as lying to yourself, about your business, for short term gain. Changing a few digits here and there may seem harmless but once you start a lie, in accounting, it becomes very difficult to stop. Recording accurate financial information is a habit that is good for the long term sustainability of the business partly because management can trust the information. It is also important to draw a distinction between management accounting and financial accounting. Management accounting specifically relates to accounting for the internal members of the business whereas financial accounting is for all other stakeholders including the business. As a result, this article has a specific focus on financial accounting.
There are two opposing views of accounting: the traditional view, represented by David Solomon, and the radical view, represented by Tony Tinker. Traditionalists believe that accounting should reflect economic reality. This means that they believe that there is a pre-existing reality out there that needs to be faithfully represented. An accountant’s job, similar to that of a journalist, is to report the truth about the organization through the use of accounting symbols (Solomon, 1991). One could then ask, what is the truth? We have established in the introduction above that there is more than one user of accounting information. Does this imply that there is one truth for all the users of the information i.e. they all have the same view of what accounting information should represent. The radical proponents of accounting believe that there is no pre-existing economic reality. They believe that we as human beings construct reality. “Accounting theory, like any social belief, is not merely a passive representation of reality, it is an agent in changing (or perpetuating) a reality” (Solomon, 1991, p288). Therefore, with this view, objectivity and neutrality are complete misnomers in accounting.