I explore the aspect of creative accounting; one of the practices which if consistently abused results in frauds like the latest Stayam saga.

Creative accounting has long been used as a means of manipulating the true incomes and loses of companies. These inappropriate practices if continually used often tend to throw things out of control from the management perspective and eventually result in frauds of unaccountable magnitude.

So what exactly is creative accounting and why do company managers resort to these accounting techniques in spite of being aware of the risks that are involved? Nothing can really justify these unlawful practices and outright manipulation of financial records year after year. For even though they play around with money that doesn’t exist they put a lot of the market capital at risk.

Companies are bound by the law to be transparent about their accounting statements. The more hidden these imperative facts are or the more complicated manner they are represented in is a sure shot indication of flouting of basic accounting principles. The accounting system however is a rather complicated and thus framing vacuum tight rules to govern poses a problem.

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Satyam Fraud: Australian Perspective »

Annual reports mean a lot and provide meaningful perspective about where a company stands and where it is headed. Thus managers try their level best to portray these figures in way to send out a positive message to their investors. The directors too, have their hefty bonuses at stake which are proportional to the kind of profits they report. An excellent annual report often influences the decision of the investors and the capital markets. Thus the managements mostly try to convey the kind of message they wish to convey via these will tailored reports using tricks of creative accounting.

These accounting techniques are resorted to in order to inflate the values of assets to avoid any sort of hostile take-overs which is also one of the reasons why Satyam CEO Ramalinga Raju had been manipulating the financial records since the year 2000; tailor results to send out a message of stability and consistent progress; incorrectly portray a commendable annual performance and raise the performance bar thus upping the pressure to always excel; to make up for a poor performance phase.

Manipulation of accounts done in one year often requires the same kind of tailoring to be made the next year too and thus the process is constant. More like a vicious circle you find difficult to get out of. That’s exactly what happened with the Enron Fiasco and now again with Satyam Computers. The corporate world has had its fare share of experiences with such kind of incidents where creative accounting and manipulation have lead to downfalls of huge companies. In spite of this they have found it difficult to refrain from these practices.

Likewise Ramalinga Raju too didn’t take the available cues from these incidents. In his resignation letter he admitted that what started off as a small manipulation soon grew into a gap that he was unable to bridge. This disaster is soon taking shape into one of the biggest frauds India Inc. has ever witnessed. It’s really a pity to see hoe respectable executives like Ramalinga get so involved to a perfect picture about their companies that they lose sight of where the limits of the law lie.