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New Research On The Control Of Creative Accounting

Creative accounting was one of the key themes in corporate finance and corporate governance in the 1980s. Controlling it is a key issue today. New research published this week explores how successful attempts to regulate creative accounting have been and how companies can still resist the regulation.

Dr Chris WhelanThe research, published as a book, Creative Accounting and the Cross-Eyed Javelin Thrower, by Dr Christopher Whelan of the University of Warwick, and Dr Doreen McBarnet of Oxford takes its title from Sir David Tweedie, Chairman of the Accounting Standards Board. When Sir David was asked whether the new regime spearheaded by his Board would win the battle against creative accounting he responded, characteristically, with a joke:

"We’re like a cross-eyed javelin thrower competing at the Olympic Games; we may not win but we’ll keep the crowd on the edge of its seats!"

Creative accounting is very attractive to companies. It can:

  • manipulate key ratios used in market analysis
  • boost reported profits/minimise reported losses
  • gain access to finance that couldn’t otherwise be raised
  • enhance management performance (and performance-related pay)
  • circumvent borrowing restrictions
  • conceal financial risk
  • escape shareholder control

What’s more, creative accounting can also claim to be ‘perfectly legal’ which is why it has proved so difficult to control in the past. But, creative accounting has a downside. It often has a major adverse impact on investors, creditors, employees and others, amply demonstrated in the 1980s with the demise of companies - Maxwell Communications Corporation for example was enmeshed in various forms of creative accounting.

So a new policing agency, the Financial Reporting Review Panel, has been created to police accounting and it has been armed with new weapons. It can investigate cases of alleged creative accounting and require directors to revise the accounts. If they refuse, the Panel can take the directors to court and the court can order revision and make directors personally liable for all the costs involved.

Every company so far which has faced a Panel demand to issue new accounts has agreed to do so without going to court. No one so far has wished to bear the costs and adverse PR of challenging the Panel. The powerful weapons of the Panel - as yet unchallenged in court - are seen by so many as overly draconian.

The research concludes that the new regime has kept it promise to "keep the crowd on the edge of its seats" and has had major victories in pushing companies beyond "creative compliance" with the letter of accounting standards to a compliance more in keeping with the spirit of the law. However, the researchers also point out some concerns about the new regulatory system.

The system is heavily reliant on whistleblowers to uncover accounting. The burden of enforcement of good practice appears to be falling disproportionately on small and medium-sized companies. Companies can employ legal arguments - and technical advisers - to resist Panel demands. Taking directors to court might mean winning the battle but losing the war.

The book sets the battle to control creative accounting in a wider political and regulatory context. Creative accounting may be controlled by means other than the Panel and the courts. It argues that law is a double-edged sword - an instrument of control but also a basis for arguing escape routes from it. As creative accounting - and the bid to control it - continues, the focus of the research on the process of enforcement, and on strategies of control and resistance should, as Chris Swinson, President of the Institute of Chartered Accountants in England and Wales says in a foreword to this research, "prove valuable to finance directors and practitioners as well as standard-setters and policy-makers".

For further details contact:
Dr Christopher Whelan 01203-523290
Peter Dunn Press Officer  01203 523708

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CWN / Education / University of Warwick / Press Release / 13 May 99

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