Creative Accounting, Fraud and International Accounting Scandals

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.

• List of Contributors xviiPreface xxiiiAcknowledgements xxvPart A 11 Introduction – Setting the Scene 3Michael Jones1.1 Introduction 31.2 Exploring the Terms 41.2.1 Creative Accounting 41.2.2 Fraud 71.2.3 Other Terms 91.3 Structure of the Book 111.3.1 Increase Income 121.3.2 Decrease Expenses 121.3.3 Increase Assets 121.3.4 Decrease Liabilities 121.4 Conclusion 182 The Creative Accounting and Fraud Environment 21Michael Jones2.1 Introduction 212.2 The Main Actors 222.2.1 Managers 222.2.2 Investment Analysts 242.2.3 Regulators 242.2.4 Auditors 252.2.5 Shareholders 262.2.6 Merchant Banks 262.2.7 Other Users 272.2.8 Legal Authorities 272.3 Effective Corporate Governance 282.3.1 Effective Internal Controls 282.3.2 Division of the Responsibility between Chief Executive and Chairman 282.3.3 Audit Committee 282.3.4 Independent Board of Directors 282.4 Economic Environment 282.5 Conclusion 293 Motivations to Indulge in Creative Accounting and Fraud 31Michael Jones3.1 Introduction 313.1.1 Personal Incentives 333.1.2 Market Expectations 343.1.3 Special Circumstances 363.1.4 Cover-up Fraud 393.2 Conclusion 394 Methods of Creative Accounting and Fraud 43Michael Jones4.1 Introduction 434.2 Basic Principles 444.3 Nature of Accounting 454.4 Methods of Creative Accounting 454.4.1 Strategy 1: Increase Income 464.4.2 Strategy 2: Decrease Expenses 484.4.3 Strategy 3: Increase Assets 564.4.4 Strategy 4: Decrease Liabilities 584.4.5 Strategy 5: Increase Operating Cash Flow 604.5 Simple Numerical Example 614.6 Fraud 624.6.1 Misappropriation of Assets 644.6.2 Fictitious Transactions 654.7 Conclusion 675 Evidence for Creative Accounting and Fraud 69Michael Jones5.1 Introduction 695.2 The Descriptive Studies 695.2.1 Ian Grif ths, Creative Accounting (1986) 715.2.2 County Natwest WoodMac, Company Pathology (1991) 725.2.3 UBS Phillips & Drew, Accounting for Growth (1991) 735.2.4 Trevor Pijper, Creative Accounting (1993) 765.2.5 Frank Clarke, Graeme Dean and Kyle Oliver, Corporate Collapse: Accounting, Regulatory and Ethical Failure (2003, rst issued 1997) 775.2.6 Frank Clarke and Graeme Dean, Indecent Disclosure: Gilding the Corporate Lily (2007) 785.2.7 McBarnet and Whelan, Creative Accounting and the Cross-eyed Javelin Thrower (1999) 785.2.8 Charles Mulford and Eugene Comiskey, The Financial Numbers Game (2002) 795.2.9 Beasley, Carcello and Hermanson, Fraudulent Financial Reporting 1987–1997: An Analysis of U.S. Public Companies (1999) 815.2.10 Joseph Wells, Principles of Fraud Examination (2005) 825.3 The Statistical Studies 845.3.1 Earnings Management Studies 845.4 Conclusion 936 Impression Management 97Michael Jones6.1 Introduction 976.1.1 Accounting Narratives 976.1.2 Graphs 1026.2 Conclusion 1117 Taking the Long View: Accounting Scandals over Time 115Michael Jones7.1 Introduction 1157.1.1 Ancient and Medieval 1177.1.2 Seventeenth and Eighteenth Centuries 1187.1.3 Nineteenth Century 1197.1.4 Twentieth Century: Before Second World War 1227.1.5 Twentieth Century: 1945–1980s 1277.2 Conclusion 132Part B 1358 Accounting Scandals in Australia since the Late 1980s 137Garry D. Carnegie and Brendan T. O’Connell8.1 Introduction 1378.2 Overview of Accounting Scandals during and since the 1890s 1388.3 Case Studies of Accounting Scandals since the Late 1980s 1418.3.1 Adelaide Steamship 1428.3.2 Bond Corporation 1438.3.3 Harris Scarfe 1458.3.4 One.Tel 1468.4 HIH Insurance 1478.4.1 Background 1488.4.2 Why did HIH Collapse? 1498.4.3 Accounting Issues 1508.4.4 Legal Outcomes Arising from the HIH Collapse 1528.5 Corporate Governance Reforms Following the Accounting Scandals of the Early 2000s 1558.6 Conclusion 1569 Corporate Accounting Scandals in China 163Catherine Huirong Chen, Yuanyuan Hu and Jason Zezhong Xiao9.1 Introduction 1639.2 Summary of Corporate Scandals 1649.2.1 Shenzhen Yuanye 1649.2.2 Great Wall Fund Raising 1669.2.3 Hongguang 1679.2.4 Daqing Lianyi 1689.2.5 Kangsai Group 1699.2.6 Lantian Gufen 1709.3 A Case in Depth – Zhengzhou Baiwen 1729.3.1 Background 1729.3.2 Themes of the Scandal 1749.3.3 Who is to Blame? 1769.3.4 Consequences of the Baiwen Scandal 1789.3.5 Aftermath 1799.4 Conclusion 18010 Accounting Scandals in Germany 185Hansrudi Lenz10.1 Introduction 18510.2 Accounting Scandals Between 1985 and 2006 18610.2.1 Co op AG (1988) 18610.2.2 Balsam AG (1994) 18710.2.3 Bremer Vulkan Verbund AG (1995) 18910.2.4 Philipp Holzmann AG (1999) 19110.3 Most Important Cases: Flowtex and Comroad 19310.3.1 Flowtex Gmbh & Co. KG (2000) 19310.3.2 ComRoad AG (2001) 19510.4 Accounting Scandals and Regulatory Responses 20010.5 Examinations of the German Financial Reporting Enforcement Panel 2005–2006 20210.6 Conclusion 20811 Creative Accounting and Fraud in Greece 211George Kontos, Maria Krambia-Kapardis and Nikolaos Milonas11.1 Introduction 21111.2 Two Accounting Scandals 21311.2.1 ETBA Finance 21311.2.2 Dynamic Life 21711.3 The Bank of Crete Scandal 22011.3.1 Koskotas’s Employment with the Bank of Crete 22111.3.2 The Accounting Information Systems of the Time 22311.3.3 The Economic Environment at that Time 22511.4 The Aftermath 22911.5 Conclusions 23112 Corporate Creative Accounting in India: Extent and Consequences 233Bhabatosh Banerjee12.1 Introduction 23312.2 Some Examples of Creative Accounting in India 23412.3 Some Important Corporate Cases in India 23912.4 The Satyam Computer Services Ltd Scandal (2009) 24012.4.1 Background 24012.4.2 Satyam: A Global Organisation 24012.4.3 Alleged Possible Processes and their Impact 24112.4.4 Good Guy, Bad Choices 24312.4.5 Role of the Auditors 24312.4.6 Institution of Legal Proceedings 24512.4.7 Salvaging Satyam 24512.4.8 Rebuilding the Corporate Image 24612.4.9 Some Antidotes 24712.5 Aftermath 24712.5.1 Changes in the Companies Act 24712.5.2 Measures Taken by the SEBI 24812.5.3 Prudential Norms of the RBI 24912.6 Conclusion 25012.7 Acknowledgements 25113 Creative Accounting and Accounting Scandals in Italy 253Andrea Melis13.1 Introduction 25313.2 Creative Accounting Practices in Italy: A Case Study Analysis 25513.2.1 The Choice of Consolidation Technique 25513.2.2 The Accounting of Stock Options 25613.2.3 The Accounting of ‘Creative Gains’ in Football Club Companies 25713.3 The Most Important Accounting Fraud in Italy: The Parmalat Case 25913.3.1 Parmalat: Was it a Case of Creative Accounting or of False Accounting? 26013.3.2 Key Accounting Issues at Parmalat: Some Examples of the Accounting Fraud 26113.3.3 The Role of Corporate Governance Actors 26513.3.4 The Role of Information Demand-side Actors: Institutional Investors, Financial Analysts and Banks 27113.4 The Aftermath of the Parmalat Scandal and its Impact on Business and Society 27213.5 Conclusion 27414 Creative Accounting and Accounting Scandals in Japan 279Kazuyuki Suda14.1 Introduction 27914.2 Accounting Regulations and Standards in Japan 28014.2.1 Accounting Regulations 28014.2.2 Accounting Standards 28014.3 Short History of Accounting Scandals Before the 1980s 28114.4 Three Types of Accounting Scandal Post-1980s 28314.4.1 Accounting Scandal to Maintain High Share Prices 28514.4.2 Accounting Scandal Related to Contracts 28914.4.3 Accounting Scandal to Avoid Bankruptcy 29214.5 Consequences of the Accounting Scandals 29614.5.1 Revision of Accounting Standards for Consolidated Financial Statements 29614.5.2 Reorganization of Audit Firms 29614.5.3 Establishing Internal Control Systems 29714.6 Conclusion 29815 Financial Accounting Scandals in the Netherlands 305Henk Langendijk15.1 Introduction 30515.2 Some Minor Accounting Scandals 30715.2.1 Creative Accounting at Rijn-Schelde-Verolme (RSV) 30715.2.2 Creative Accounting at Fokker 30915.3 Royal Ahold 31015.3.1 Consolidation of Joint Ventures at Royal Ahold 31015.3.2 Consolidation Accounting in the Netherlands 31115.3.3 Consolidation Accounting under US GAAP 31115.3.4 The Control and Side Letters 31215.3.5 Accounting for Vendor Allowances at US Foodservice (USF) 31515.3.6 Proper Accounting Treatment Vendor Allowances 31515.3.7 Measures Taken by Royal Ahold after Discovering the Fraud 31815.3.8 Acquisition Accounting 31915.3.9 Reserves, Allowances and Provisions 32015.3.10 Lease Accounting 32015.4 Conclusion 32016 Creative Accounting and Financial Scandals in Spain 325Nieves Carrera16.1 Introduction 32516.2 Accounting Scandals in Spain Since the 1980s 32616.2.1 The Banking Sector 32716.2.2 Investment Service Firms 33016.2.3 The Real Estate Sector: The Case of PSV and IGS 33216.3 Investments in Stamps: The Latest Series of Financial Scandals in the Country. Afinsa and Fórum Filatélico 33316.3.1 Background of the Cases of Afinsa and Fórum Filatélico 33416.3.2 The Nature of the Businesses and the Accounting for Investment Contracts 33516.3.3 The Suppliers 33716.3.4 Valuation of Stamps 33916.3.5 Reflections on the Scandal 34016.3.6 Where were the Auditors? 34116.3.7 Was it a Surprise? 34116.3.8 Consequences of the Scandal 34316.4 The Aftermath of the Scandals 34416.5 Conclusion 34617 Accounting Scandals in Sweden – A Long Tradition 359Gunnar Rimmel and Kristina Jonäll17.1 Introduction 35917.2 Fermenta and Prosolvia: Swedish Stock Market Darlings 36017.2.1 Fermenta – 1980s Biotech Company’s Accounting Errors 36017.2.2 Prosolvia – 1990s Experts in Simulating Virtual Reality? 36317.2.3 Reconstruction of Ownership 36417.2.4 Fictitious Invoices, Invented Agreements and Premature Income Recognition 36417.2.5 Insider Trading 36517.3 Two Scandals in Multinationals that Dominated the Swedish Media 36517.3.1 ABB – Shaken and Stirred 36517.3.2 Skandia – A Shooting Star Turns into a White Dwarf 36817.4 Conclusions 37318 Creative Accounting – The UK Experience 379David Gwilliam and Richard H.G. Jackson18.1 Introduction 37918.2 Historical Background 38118.3 Some Recent Accounting Scandals 38218.3.1 Bank of Credit and Commerce International (BCCI) 38318.3.2 The Mirror Group 38518.4 Polly Peck 38618.4.1 Meyna 38918.4.2 Vestel 39018.4.3 Unipac 39018.4.4 Accounting Policies at Polly Peck 39118.5 The Immediate Aftermath 39818.5.1 Accounting Regulatory Change 39818.5.2 Governance and Enforcement 40018.6 Subsequent Developments 40018.7 Conclusions 40218.8 Acknowledgements 40419 Creative Accounting and Accounting Scandals in the USA 407Charles W. Mulford and Eugene E. Comiskey19.1 Introduction 40719.2 Scandals since the 1990s 41019.2.1 Premature or Fictitious Revenue Recognition 41019.2.2 Capitalized Costs and/or Extended Amortization Periods 41219.2.3 Overstated Assets and/or Understated Liabilities 41619.2.4 Other Creative Accounting Practices 41619.3 Enron and Worldcom 41919.3.1 Enron Corp. 41919.3.2 WorldCom, Inc. 42119.4 Aftermath of the Scandals 42320 Bank Failures and Accounting During the Financial Crisis of 2008–2009 425Simon D. Norton20.1 Introduction 42520.2 42820.2.1 Kaupthing Bank 42820.2.2 Northern Rock 42920.3 Origins of the ‘Credit Crunch’ 43020.3.1 Sub-prime Lending 43020.3.2 Types of Mortgage 43220.3.3 Economic Downturn and Rising Unemployment 43220.4 Financial Instruments Associated with the Credit Crunch 43220.4.1 Collateralised Debt Obligations (CDOs) 43320.4.2 Credit Default Swaps (CDS) 43320.4.3 Collateralised Mortgage Obligations (CMOs) 43420.4.4 Securitisation and Off-balance Sheet Financing 43420.4.5 Repurchase agreements or ‘repos’ 43620.5 Creative Accounting in the Banking Sector 43720.5.1 Loan-loss Allowances 43720.5.2 Adjustment of Reporting Dates 43720.5.3 Enhancing Pro ts through Disposals of Assets 43820.5.4 Lawful Adjustments to Composition of ‘Level 3’ Assets in Banks’ Balance Sheets 43820.5.5 Decline in Value of Outstanding Debt 43920.6 Lehman’s, Madoff and Bear Stearns; Failures and Consequences 44020.6.1 Lehman Brothers 44020.6.2 Bernard Madoff 44520.6.3 Bear Stearns 44820.7 Conclusion 450Part C 45321 Identifying Some Themes 455Michael Jones21.1 Introduction 45521.2 Some Themes 45521.2.1 Background 45521.2.2 Creative Accounting or Fraud 45921.3 The Major Methods Used 46021.3.1 Strategy 1: Increasing Income 46121.3.2 Strategy 2: Decreasing Expenses 46221.3.3 Strategy 3: Increasing Assets 46421.3.4 Strategy 4: Decreasing Liabilities 46521.3.5 Other Methods of Creative Accounting 46621.4 Methods of Fraud 46721.5 Incentives for Creative Accounting and Fraud 47121.6 Overstrong Personalities 47321.7 Failure of Internal Controls 47421.8 Failure of External Auditors 47521.9 Conclusion 47722 The Impact of Accounting Scandals and Creative Accounting 479Michael Jones22.1 Introduction 47922.2 Short-term Immediate Effects 47922.2.1 Insiders 48022.2.2 Outsiders 48122.3 Long-term Effects 48422.3.1 One-off Regulatory Responses 48422.4 Cumulative Effects 48722.5 Conclusion 49023 Conclusion – Looking Backwards and Forwards 493Michael Jones23.1 Overview 49323.2 Thematic Analysis 49623.3 Lessons for the Future 49923.3.1 Factors Increasing the Possibilities of Creative Accounting and Fraud 49923.3.2 Factors Reducing the Potential for Creative Accounting and Fraud 50123.4 Prognosis 50523.5 Conclusion 506Appendix 1 Chronological List of Major Instances of Accounting Issues Across 12 Countries and Beyond 509Appendix 2 Alphabetical List of Most Important Accounting Scandals Across 12 Countries and Beyond since about 1980 519Index 535

"AS A JOURNALIST I must confess I don't usually read the accounting books that drop onto my desk on a weekly basis but Michael Jones' hefty tome - Creative Accounting, Fraud and International Accounting Scandals - is different. Indeed, it is a rare thing in this sector, a real page turner." (Accountancy Age, November 2010)