Creative accounting: an empirical examination

"Australian firms, already strong practitioners of creative accounting, are jumping on the bandwagon [of a change to an IASB standard allowing firms flexibility to amortise assets]" - Paul Kerin (The Australian, 13 April 2009). A search of articles in the Australian news media specifically using the words "creative accounting" reveals widespread use of this term. The world economic crisis of 2008 and 2009 has again placed a spotlight on financial reports of public companies and the accounting standards from which the reports are derived. -- Despite some studies having suggested that investors are not fooled by creative accounting practices (that investors somehow see through accounting techniques and adjust for differences (Dharan and Lev 1993 p493), it seems clear that the market has been fooled by financial reports which did not reflect the real-world phenomena, at least anecdotally (Sterling and Harrison 1974 p147). -- The accounting profession has a special franchise granted to it by the community, to appraise the value and legitimacy of end-of-year financial reports (Briloff 2002 p1). Some suggest creative accounting conjures perceptions of financial permissiveness, and the continued presence of creative accounting practices evidenced through autopsies of corporate failures is associated with a crisis of confidence in the Australian accounting profession (Clarke et al. 2003 pp29-30). -- There has been limited empirical work identifying creative accounting in Australia (Healy and Wahlen 1999). A central thesis of this dissertation is to ascertain empirically the extent creative accounting may be present in financial statements of Australian companies from 1998 to 2004. -- Three tests were utilised to obtain evidence which may be consistent with the potential presence of creative accounting: a histogram analysis (Holland and Ramsey 2003), a regression analysis based on the Jones (1991) model and a gamma regression model (developed within) with supporting company case studies. An initial sample comprised 71 firms (497 firm years) who were listed as top 200 Australia companies continuously in each of the seven years of the sample period. The financial sector has been included within this dissertation, in contrast to other Australian studies where this sector has been specifically excluded. -- The findings of this dissertation provide evidence that certain Australian ASX 200 companies' financial reports are likely to contain creative accounting. The histogram analysis of the reported profits provides the strongest evidence that creative accounting is within the financial reports of certain sample companies, whilst the Jones (1991) regression analysis proves to be a weak indicator of creative accounting within the sample companies. An explorative model was developed and identified the financial reports of three companies which exhibited likely signals of creative accounting.