Creative accounting describes a set of technically legal accounting activities and practices that are not traditionally accepted or practiced. The main objective of such practices is to make the company appear to be financially stronger than it actually is.
Various methods can be used to place emphasis on a company’s strong points and mask any risks or losses. Since the main intention is to present a false image of the company, such actions are considered unethical, even though they can be justified within the bounds of the law.
One of the common reasons for resorting to creative accounting is to increase the company’s stock value. This can be done by issuing additional stock or by reporting increased sales, even though no real profit was made. This misleads prospective investors into thinking that the company is experiencing growth and is financially strong. The increased demand brings up the value of the stock. Companies may also decide to resort to creative accounting in order to ensure the inflow of capital and investments while it works its way towards actually generating profit.
Although many companies are able to get away with engaging in creative accounting activities, some have been exposed and found guilty of misleading investors. As such, there is now a greater demand for companies to be transparent in the presentation of their financial reports. Some countries have also introduced and are enforcing more regulations to ensure that misrepresentation of financial data is avoided.
Creative accounting may also be referred to as cooking the books or earnings management.