What Is Creative Accounting and When Does It Cross the Line?

Creative accounting means using accounting choices, estimates or timing to present a more favourable picture of a company’s finances. 

It often begins with a legitimate judgement that is pushed too far. Revenue is recorded early, expenses are postponed or assets are kept at values that are difficult to justify.

Financial statements are complex and sometimes liberties must be taken. The best way to describe creative accounting is photography. Proper accounting brings the picture into focus while creative accounting reaches for the beauty filter.

Quite literally, painting a rosier picture.

But is it legal and where is the line? Today, our accounting service firm will talk about it.

Where Does Creative Accounting Come From?

“Creative accounting” is not an official term found in accounting standards. It describes the creative use, or misuse, of the flexibility built into financial reporting.

Accountants regularly need to estimate:

• If customers will pay
• What old inventory is worth
• How long machinery will remain useful
• Whether an asset has lost value
• When revenue has been earned

Different reasonable estimates can produce different results. The problem begins when management chooses an estimate mainly because it creates the profit figure they want, or the KPI they have to hit.

There are many reasons why companies may do this. Sometimes it’s to secure financing, meet profit targets, attract investors, declare dividends or hide weak performance.

Is Creative Accounting Always Wrong?

No. Making reasonable estimates is a normal part of accounting.

The difference lies in if the treatment reflects the actual condition of the business.

Treatment	Meaning
Reasonable judgement	Supported by evidence and applied consistently
Aggressive accounting	Uses the most optimistic available assumptions
Misleading accounting	Distorts or omits information that readers need
Fraudulent accounting	Intentionally falsifies or conceals information

Creative accounting crosses the line when the accounts no longer provide a true and fair view or deliberately mislead people who rely on them.

A Recent Malaysian example:

The declassified Tabung Haji RCI report brought the term “creative accounting” into public discussion and is the reason why we’re making this article.

According to the RCI findings, Tabung Haji reported a RM3.4 billion profit in 2017. However, the report concluded that full application of the Malaysian Financial Reporting Standards would have produced a RM1.4 billion loss, creating a difference of approximately RM4.8 billion.

The case illustrates why accounting treatments matter: the same organisation can appear profitable or loss-making depending on how its assets, income and losses are recognised.

What Are Common Examples of Creative Accounting?

1. Recording Revenue Too Early

A company receives a RM100,000 order in December, but the goods will only be delivered in January. Recording the sale in December could make the current year’s revenue and profit appear higher.

2. Delaying Expenses

A business receives services in December but records the expense in January.

This is akin to sweeping rubbish under the sofa before guests arrive. The room looks cleaner, but the rubbish is still there.

3. Ignoring a Fall in Asset Value

An asset is recorded at RM500,000, although the business expects to recover only RM300,000. Failing to recognise the RM200,000 impairment could overstate both assets and profit.

This can affect old inventory, uncollectible debts, damaged equipment and underperforming investments.

4. Treating Expenses as Assets

Recording routine repairs as a long-term asset spreads the cost over several years instead of recognising it immediately. This can make the current year’s profit look stronger.

5. Using Unrealistic Estimates

A company may assume that almost every customer will pay, even though several invoices are seriously overdue.

When Does It Cross the Line?

Under Malaysia’s financial reporting framework, companies generally apply either the MFRS or the MPERS, depending on their eligibility.

Both frameworks allow professional judgement, but that judgement must be supported by evidence and produce financial statements that provide a true and fair view of the business.

Accountants would ask these four questions:

1. Is the accounting treatment supported by evidence?
   Estimates should be backed by invoices, contracts, payment records, stock counts, valuations or other reliable documents.
   
   
2. Has it been applied consistently?
   Accounting policies should not change whenever the existing treatment produces an inconvenient result. Any genuine change should have a valid reason and follow the applicable reporting standard.
   
   
3. Have important changes and uncertainties been disclosed?
   Material policy changes, related-party transactions, doubtful debts, asset impairments and significant uncertainties should not be hidden from people reading the accounts.
   
   
4. Would the full facts change someone’s decision?
   In accounting, information is considered material if omitting or misstating it could reasonably influence a lender’s, investor’s or shareholder’s decision.

The line is crossed when professional judgement is used to conceal the true financial position. At that point, it may amount to non-compliance with accounting standards, improper record-keeping or deliberate financial misrepresentation.

Can Creative Accounting Lead to Legal Action?

Creative accounting is not a specific offence by itself. The legal consequences depend on what was done and whether there was an intention to mislead.

One relevant provision is Section 245 of Malaysia’s Companies Act 2016. It requires companies, directors and managers to maintain records that sufficiently explain the company’s transactions and financial position and allow true and fair financial statements to be prepared.

A contravention may result in:

• A fine of up to RM500,000
• Imprisonment for up to three years
• Or both

Not every accounting mistake is a criminal offence. The available evidence, seriousness of the misstatement and intention of the people involved all matter.

Who Is Responsible for the Accounts?

Directors and management are responsible for maintaining complete records and ensuring the financial statements fairly reflect the company’s position.

An accountant may prepare the accounts, while an auditor may examine them. However, directors should still understand the main figures before approving the statements, especially revenue and unusual year-end adjustments.

Under the Companies Act 2016, directors must make sure that applicable accounting standards are followed and proper records are maintained. 

Directors do not need to perform the calculations themselves, but they should ask questions and understand what they are approving. A “I don’t know mah” would not save you in court.

How Can Businesses Avoid Creative Accounting?

• Prepare monthly accounts: Review income, expenses and cash flow regularly instead of discovering problems at year-end.
• Review overdue customer balances: Identify invoices that may not be collected and discuss if a bad-debt provision is needed.
• Count and assess inventory: Conduct periodic stock counts and flag items that are damaged, expired, missing or difficult to sell.
• Document important estimates: Keep short notes and supporting documents for asset values, provisions, depreciation and other significant judgements.
• Compare profit with cash flow: If profit is rising but cash is falling, check whether customers are paying and whether expenses have been fully recorded.
• Provide complete information: Share invoices, contracts, bank statements, loan documents and related-party transactions with the accountant promptly.

Most importantly, always ask the accountant for the correct result, not the preferred result. Sometimes, an accountant may want to satisfy their clients by giving them the ideal situation, but don’t allow them to do that.

“Imagine a doctor saying you are perfectly healthy because that is what you want to hear. An honest diagnosis may be uncomfortable, but it helps you take the right steps before the problem becomes more serious.” – Mrs Lim

Creativity Is Great, Just Not in Your Accounts

Creativity belongs in your products, marketing and business strategy. Your financial statements should be far less imaginative and more by the books.

At Accounting.my, our work is grounded in proper records, supporting evidence and sound accounting judgement. We provide bookkeeping and outsourced accounting services, including bank reconciliation, accounts receivable and payable, and fixed-asset tracking.

Speak with our team for accounts that show where your business truly stands, so you can make better decisions about where it goes next.

Source:

• Companies Commission of Malaysia (SSM) — Companies Act 2016, Act 777
• Malaysian Accounting Standards Board — Malaysian Financial Reporting Standards
• Malaysian Accounting Standards Board — A Comparative Analysis of PERS, MPERS and MFRS Frameworks
• The Edge Malaysia — “‘Creative accounting’ propped up Tabung Haji’s high hibah payouts — RCI”
• Free Malaysia Today — “RCI uncovers ‘creative accounting’, political influence behind TH’s financial woes”