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More About This Title Creative Accounting, Fraud and InternationalAccounting Scandals
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Michael Jones, MA Oxon, is Professor of Financial Reporting at Bristol University. He has taught accounting for 33 years at all levels from GCSE to final-year degree course, and has published over 140 articles in professional and academic journals, covering a wide range of topics including financial accounting, the history of accounting and international accounting.
He is joint editor of the British Accounting Review and serves on two more editorial boards. He is Director of the Financial Reporting and Business Communication Unit and he chairs the British Accounting Association Financial and Reporting Special Interest Group. He has served on the British Accounting Association Committee and on the Committee for Professors of Accounting and Finance. He is also the author of three textbooks: Accounting, Financial Accounting and Management Accounting.
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List of Contributors xvii
Preface xxiii
Acknowledgements xxv
Part A 1
1 Introduction – Setting the Scene 3
Michael Jones
1.1 Introduction 3
1.2 Exploring the Terms 4
1.2.1 Creative Accounting 4
1.2.2 Fraud 7
1.2.3 Other Terms 9
1.3 Structure of the Book 11
1.3.1 Increase Income 12
1.3.2 Decrease Expenses 12
1.3.3 Increase Assets 12
1.3.4 Decrease Liabilities 12
1.4 Conclusion 18
2 The Creative Accounting and Fraud Environment 21
Michael Jones
2.1 Introduction 21
2.2 The Main Actors 22
2.2.1 Managers 22
2.2.2 Investment Analysts 24
2.2.3 Regulators 24
2.2.4 Auditors 25
2.2.5 Shareholders 26
2.2.6 Merchant Banks 26
2.2.7 Other Users 27
2.2.8 Legal Authorities 27
2.3 Effective Corporate Governance 28
2.3.1 Effective Internal Controls 28
2.3.2 Division of the Responsibility between Chief Executive and Chairman 28
2.3.3 Audit Committee 28
2.3.4 Independent Board of Directors 28
2.4 Economic Environment 28
2.5 Conclusion 29
3 Motivations to Indulge in Creative Accounting and Fraud 31
Michael Jones
3.1 Introduction 31
3.1.1 Personal Incentives 33
3.1.2 Market Expectations 34
3.1.3 Special Circumstances 36
3.1.4 Cover-up Fraud 39
3.2 Conclusion 39
4 Methods of Creative Accounting and Fraud 43
Michael Jones
4.1 Introduction 43
4.2 Basic Principles 44
4.3 Nature of Accounting 45
4.4 Methods of Creative Accounting 45
4.4.1 Strategy 1: Increase Income 46
4.4.2 Strategy 2: Decrease Expenses 48
4.4.3 Strategy 3: Increase Assets 56
4.4.4 Strategy 4: Decrease Liabilities 58
4.4.5 Strategy 5: Increase Operating Cash Flow 60
4.5 Simple Numerical Example 61
4.6 Fraud 62
4.6.1 Misappropriation of Assets 64
4.6.2 Fictitious Transactions 65
4.7 Conclusion 67
5 Evidence for Creative Accounting and Fraud 69
Michael Jones
5.1 Introduction 69
5.2 The Descriptive Studies 69
5.2.1 Ian Grif ths, Creative Accounting (1986) 71
5.2.2 County Natwest WoodMac, Company Pathology (1991) 72
5.2.3 UBS Phillips & Drew, Accounting for Growth (1991) 73
5.2.4 Trevor Pijper, Creative Accounting (1993) 76
5.2.5 Frank Clarke, Graeme Dean and Kyle Oliver, Corporate Collapse: Accounting, Regulatory and Ethical Failure (2003, rst issued 1997) 77
5.2.6 Frank Clarke and Graeme Dean, Indecent Disclosure: Gilding the Corporate Lily (2007) 78
5.2.7 McBarnet and Whelan, Creative Accounting and the Cross-eyed Javelin Thrower (1999) 78
5.2.8 Charles Mulford and Eugene Comiskey, The Financial Numbers Game (2002) 79
5.2.9 Beasley, Carcello and Hermanson, Fraudulent Financial Reporting 1987–1997: An Analysis of U.S. Public Companies (1999) 81
5.2.10 Joseph Wells, Principles of Fraud Examination (2005) 82
5.3 The Statistical Studies 84
5.3.1 Earnings Management Studies 84
5.4 Conclusion 93
6 Impression Management 97
Michael Jones
6.1 Introduction 97
6.1.1 Accounting Narratives 97
6.1.2 Graphs 102
6.2 Conclusion 111
7 Taking the Long View: Accounting Scandals over Time 115
Michael Jones
7.1 Introduction 115
7.1.1 Ancient and Medieval 117
7.1.2 Seventeenth and Eighteenth Centuries 118
7.1.3 Nineteenth Century 119
7.1.4 Twentieth Century: Before Second World War 122
7.1.5 Twentieth Century: 1945–1980s 127
7.2 Conclusion 132
Part B 135
8 Accounting Scandals in Australia since the Late 1980s 137
Garry D. Carnegie and Brendan T. O’Connell
8.1 Introduction 137
8.2 Overview of Accounting Scandals during and since the 1890s 138
8.3 Case Studies of Accounting Scandals since the Late 1980s 141
8.3.1 Adelaide Steamship 142
8.3.2 Bond Corporation 143
8.3.3 Harris Scarfe 145
8.3.4 One.Tel 146
8.4 HIH Insurance 147
8.4.1 Background 148
8.4.2 Why did HIH Collapse? 149
8.4.3 Accounting Issues 150
8.4.4 Legal Outcomes Arising from the HIH Collapse 152
8.5 Corporate Governance Reforms Following the Accounting Scandals of the Early 2000s 155
8.6 Conclusion 156
9 Corporate Accounting Scandals in China 163
Catherine Huirong Chen, Yuanyuan Hu and Jason Zezhong Xiao
9.1 Introduction 163
9.2 Summary of Corporate Scandals 164
9.2.1 Shenzhen Yuanye 164
9.2.2 Great Wall Fund Raising 166
9.2.3 Hongguang 167
9.2.4 Daqing Lianyi 168
9.2.5 Kangsai Group 169
9.2.6 Lantian Gufen 170
9.3 A Case in Depth – Zhengzhou Baiwen 172
9.3.1 Background 172
9.3.2 Themes of the Scandal 174
9.3.3 Who is to Blame? 176
9.3.4 Consequences of the Baiwen Scandal 178
9.3.5 Aftermath 179
9.4 Conclusion 180
10 Accounting Scandals in Germany 185
Hansrudi Lenz
10.1 Introduction 185
10.2 Accounting Scandals Between 1985 and 2006 186
10.2.1 Co op AG (1988) 186
10.2.2 Balsam AG (1994) 187
10.2.3 Bremer Vulkan Verbund AG (1995) 189
10.2.4 Philipp Holzmann AG (1999) 191
10.3 Most Important Cases: Flowtex and Comroad 193
10.3.1 Flowtex Gmbh & Co. KG (2000) 193
10.3.2 ComRoad AG (2001) 195
10.4 Accounting Scandals and Regulatory Responses 200
10.5 Examinations of the German Financial Reporting Enforcement Panel 2005–2006 202
10.6 Conclusion 208
11 Creative Accounting and Fraud in Greece 211
George Kontos, Maria Krambia-Kapardis and Nikolaos Milonas
11.1 Introduction 211
11.2 Two Accounting Scandals 213
11.2.1 ETBA Finance 213
11.2.2 Dynamic Life 217
11.3 The Bank of Crete Scandal 220
11.3.1 Koskotas’s Employment with the Bank of Crete 221
11.3.2 The Accounting Information Systems of the Time 223
11.3.3 The Economic Environment at that Time 225
11.4 The Aftermath 229
11.5 Conclusions 231
12 Corporate Creative Accounting in India: Extent and Consequences 233
Bhabatosh Banerjee
12.1 Introduction 233
12.2 Some Examples of Creative Accounting in India 234
12.3 Some Important Corporate Cases in India 239
12.4 The Satyam Computer Services Ltd Scandal (2009) 240
12.4.1 Background 240
12.4.2 Satyam: A Global Organisation 240
12.4.3 Alleged Possible Processes and their Impact 241
12.4.4 Good Guy, Bad Choices 243
12.4.5 Role of the Auditors 243
12.4.6 Institution of Legal Proceedings 245
12.4.7 Salvaging Satyam 245
12.4.8 Rebuilding the Corporate Image 246
12.4.9 Some Antidotes 247
12.5 Aftermath 247
12.5.1 Changes in the Companies Act 247
12.5.2 Measures Taken by the SEBI 248
12.5.3 Prudential Norms of the RBI 249
12.6 Conclusion 250
12.7 Acknowledgements 251
13 Creative Accounting and Accounting Scandals in Italy 253
Andrea Melis
13.1 Introduction 253
13.2 Creative Accounting Practices in Italy: A Case Study Analysis 255
13.2.1 The Choice of Consolidation Technique 255
13.2.2 The Accounting of Stock Options 256
13.2.3 The Accounting of ‘Creative Gains’ in Football Club Companies 257
13.3 The Most Important Accounting Fraud in Italy: The Parmalat Case 259
13.3.1 Parmalat: Was it a Case of Creative Accounting or of False Accounting? 260
13.3.2 Key Accounting Issues at Parmalat: Some Examples of the Accounting Fraud 261
13.3.3 The Role of Corporate Governance Actors 265
13.3.4 The Role of Information Demand-side Actors: Institutional Investors, Financial Analysts and Banks 271
13.4 The Aftermath of the Parmalat Scandal and its Impact on Business and Society 272
13.5 Conclusion 274
14 Creative Accounting and Accounting Scandals in Japan 279
Kazuyuki Suda
14.1 Introduction 279
14.2 Accounting Regulations and Standards in Japan 280
14.2.1 Accounting Regulations 280
14.2.2 Accounting Standards 280
14.3 Short History of Accounting Scandals Before the 1980s 281
14.4 Three Types of Accounting Scandal Post-1980s 283
14.4.1 Accounting Scandal to Maintain High Share Prices 285
14.4.2 Accounting Scandal Related to Contracts 289
14.4.3 Accounting Scandal to Avoid Bankruptcy 292
14.5 Consequences of the Accounting Scandals 296
14.5.1 Revision of Accounting Standards for Consolidated Financial Statements 296
14.5.2 Reorganization of Audit Firms 296
14.5.3 Establishing Internal Control Systems 297
14.6 Conclusion 298
15 Financial Accounting Scandals in the Netherlands 305
Henk Langendijk
15.1 Introduction 305
15.2 Some Minor Accounting Scandals 307
15.2.1 Creative Accounting at Rijn-Schelde-Verolme (RSV) 307
15.2.2 Creative Accounting at Fokker 309
15.3 Royal Ahold 310
15.3.1 Consolidation of Joint Ventures at Royal Ahold 310
15.3.2 Consolidation Accounting in the Netherlands 311
15.3.3 Consolidation Accounting under US GAAP 311
15.3.4 The Control and Side Letters 312
15.3.5 Accounting for Vendor Allowances at US Foodservice (USF) 315
15.3.6 Proper Accounting Treatment Vendor Allowances 315
15.3.7 Measures Taken by Royal Ahold after Discovering the Fraud 318
15.3.8 Acquisition Accounting 319
15.3.9 Reserves, Allowances and Provisions 320
15.3.10 Lease Accounting 320
15.4 Conclusion 320
16 Creative Accounting and Financial Scandals in Spain 325
Nieves Carrera
16.1 Introduction 325
16.2 Accounting Scandals in Spain Since the 1980s 326
16.2.1 The Banking Sector 327
16.2.2 Investment Service Firms 330
16.2.3 The Real Estate Sector: The Case of PSV and IGS 332
16.3 Investments in Stamps: The Latest Series of Financial Scandals in the Country. Afinsa and Fórum Filatélico 333
16.3.1 Background of the Cases of Afinsa and Fórum Filatélico 334
16.3.2 The Nature of the Businesses and the Accounting for Investment Contracts 335
16.3.3 The Suppliers 337
16.3.4 Valuation of Stamps 339
16.3.5 Reflections on the Scandal 340
16.3.6 Where were the Auditors? 341
16.3.7 Was it a Surprise? 341
16.3.8 Consequences of the Scandal 343
16.4 The Aftermath of the Scandals 344
16.5 Conclusion 346
17 Accounting Scandals in Sweden – A Long Tradition 359
Gunnar Rimmel and Kristina Jonäll
17.1 Introduction 359
17.2 Fermenta and Prosolvia: Swedish Stock Market Darlings 360
17.2.1 Fermenta – 1980s Biotech Company’s Accounting Errors 360
17.2.2 Prosolvia – 1990s Experts in Simulating Virtual Reality? 363
17.2.3 Reconstruction of Ownership 364
17.2.4 Fictitious Invoices, Invented Agreements and Premature Income Recognition 364
17.2.5 Insider Trading 365
17.3 Two Scandals in Multinationals that Dominated the Swedish Media 365
17.3.1 ABB – Shaken and Stirred 365
17.3.2 Skandia – A Shooting Star Turns into a White Dwarf 368
17.4 Conclusions 373
18 Creative Accounting – The UK Experience 379
David Gwilliam and Richard H.G. Jackson
18.1 Introduction 379
18.2 Historical Background 381
18.3 Some Recent Accounting Scandals 382
18.3.1 Bank of Credit and Commerce International (BCCI) 383
18.3.2 The Mirror Group 385
18.4 Polly Peck 386
18.4.1 Meyna 389
18.4.2 Vestel 390
18.4.3 Unipac 390
18.4.4 Accounting Policies at Polly Peck 391
18.5 The Immediate Aftermath 398
18.5.1 Accounting Regulatory Change 398
18.5.2 Governance and Enforcement 400
18.6 Subsequent Developments 400
18.7 Conclusions 402
18.8 Acknowledgements 404
19 Creative Accounting and Accounting Scandals in the USA 407
Charles W. Mulford and Eugene E. Comiskey
19.1 Introduction 407
19.2 Scandals since the 1990s 410
19.2.1 Premature or Fictitious Revenue Recognition 410
19.2.2 Capitalized Costs and/or Extended Amortization Periods 412
19.2.3 Overstated Assets and/or Understated Liabilities 416
19.2.4 Other Creative Accounting Practices 416
19.3 Enron and Worldcom 419
19.3.1 Enron Corp. 419
19.3.2 WorldCom, Inc. 421
19.4 Aftermath of the Scandals 423
20 Bank Failures and Accounting During the Financial Crisis of 2008–2009 425
Simon D. Norton
20.1 Introduction 425
20.2 428
20.2.1 Kaupthing Bank 428
20.2.2 Northern Rock 429
20.3 Origins of the ‘Credit Crunch’ 430
20.3.1 Sub-prime Lending 430
20.3.2 Types of Mortgage 432
20.3.3 Economic Downturn and Rising Unemployment 432
20.4 Financial Instruments Associated with the Credit Crunch 432
20.4.1 Collateralised Debt Obligations (CDOs) 433
20.4.2 Credit Default Swaps (CDS) 433
20.4.3 Collateralised Mortgage Obligations (CMOs) 434
20.4.4 Securitisation and Off-balance Sheet Financing 434
20.4.5 Repurchase agreements or ‘repos’ 436
20.5 Creative Accounting in the Banking Sector 437
20.5.1 Loan-loss Allowances 437
20.5.2 Adjustment of Reporting Dates 437
20.5.3 Enhancing Pro ts through Disposals of Assets 438
20.5.4 Lawful Adjustments to Composition of ‘Level 3’ Assets in Banks’ Balance Sheets 438
20.5.5 Decline in Value of Outstanding Debt 439
20.6 Lehman’s, Madoff and Bear Stearns; Failures and Consequences 440
20.6.1 Lehman Brothers 440
20.6.2 Bernard Madoff 445
20.6.3 Bear Stearns 448
20.7 Conclusion 450
Part C 453
21 Identifying Some Themes 455
Michael Jones
21.1 Introduction 455
21.2 Some Themes 455
21.2.1 Background 455
21.2.2 Creative Accounting or Fraud 459
21.3 The Major Methods Used 460
21.3.1 Strategy 1: Increasing Income 461
21.3.2 Strategy 2: Decreasing Expenses 462
21.3.3 Strategy 3: Increasing Assets 464
21.3.4 Strategy 4: Decreasing Liabilities 465
21.3.5 Other Methods of Creative Accounting 466
21.4 Methods of Fraud 467
21.5 Incentives for Creative Accounting and Fraud 471
21.6 Overstrong Personalities 473
21.7 Failure of Internal Controls 474
21.8 Failure of External Auditors 475
21.9 Conclusion 477
22 The Impact of Accounting Scandals and Creative Accounting 479
Michael Jones
22.1 Introduction 479
22.2 Short-term Immediate Effects 479
22.2.1 Insiders 480
22.2.2 Outsiders 481
22.3 Long-term Effects 484
22.3.1 One-off Regulatory Responses 484
22.4 Cumulative Effects 487
22.5 Conclusion 490
23 Conclusion – Looking Backwards and Forwards 493
Michael Jones
23.1 Overview 493
23.2 Thematic Analysis 496
23.3 Lessons for the Future 499
23.3.1 Factors Increasing the Possibilities of Creative Accounting and Fraud 499
23.3.2 Factors Reducing the Potential for Creative Accounting and Fraud 501
23.4 Prognosis 505
23.5 Conclusion 506
Appendix 1 Chronological List of Major Instances of Accounting Issues Across 12 Countries and Beyond 509
Appendix 2 Alphabetical List of Most Important Accounting Scandals Across 12 Countries and Beyond since about 1980 519
Index 535
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