Recent study

In a more recent study, Solowy (2000) see creative accounting as ‘an assembly of procedures in order to change the profit, by increasing or to misrepresent the financial statements, or both of them’. Companies generally prefer to report a steady trend of growth in profit rather than to show volatile profits with a series of dramatic rises and falls. This is achieved by making unnecessarily high provision for liabilities as against assets values in good years so that these provisions can be reduced, thereby improving reported profits, in bad years (Amat and Gorthworpe 1999). Advocates of this approach that it is a measure against the ‘short- termism’ of judging an investment on basis of the yields achieved in the immediate following years. It also avoids raising expectations so high in good years that the company is unable to deliver what is required subsequently. Against this is argued that if the trading conditions of a business are in fact volatile then investors have a right to know this and that income smoothing may conceal long term changes in the profit trend.

The literature on the ethics of bias in accounting policy choice is reviewed at the ‘macro’ level of the accounting regulator. This literature can similarly be applied to the bias in accounting policy choice at the ‘macro’ level of the management of individual companies that is implicit in creative accounting. Ruland (19n84) distinguishes between the deontological view where by moral rules apply actual actions and the teleological view that an action should be judged on the bases of the moral worth of the outcome. Unlike Ruland’s study, Revisine appears to take a teleological view of accounting in the private sector, allowing managers to choose between the alternatives permitted in ‘loose’ standards to achieve there desired end, but to take a deontological view of accounting in the public sector where he calls for tighter standards to prevent such manipulation. One might ask whether the presence or absence of market discipline justifies such ethical inconsistency. Ruland also discusses the distinction between a ‘positive’ responsibility; that it should be the duty to present unbiased accounts and a ‘negative’ responsibility were managers would be responsible for states of affairs they fail to prevent. Thus it is explicit that Ruland gives priority to the ‘positive’ responsibility concept. Within Revisine’s framework, where all outcomes are deemed to be impounded in the process of contracting and price-setting, the distinction is not acknowledged. To Ruland ‘duty to refrain’ would imply avoiding the bias inherent in creative accounting while the ‘duty to act’ would involve pursuing the consequences to be achieved by creative accounting. Ruland sees the ‘duty to refrain’ the more important. Revisine seems to see compliance with Generally Accepted Accounting Practice (GAAP) as the prime responsibility of the management, with no constrains on choice within GAAP. This may be a legitimate approach in countries where there is flexibility in a jurisdiction that prescribes an overriding qualitative objective for accounts with true and fair view. To the professional accountant creative accounting generally seems to be regarded as ethically dubious. In USA, the then senior partner of Price Waterhouse observed: When fraudulent reporting occurs, it is frequently perpetrated at levels of management above those for which internal control systems are designed to be effective. It often involves using the financial statements to create an illusion that the entity is healthier and more prosperous than it actually is. This illusion sometimes is accomplished by masking economic realities through intentional misapplication of accounting principles (Conner, 1986). Moizer, (1997) identified two types of ethical reasoning; Consequentialism and Deontology. In Consequentialism, actions are judged based on the consequences that it results, whereas in deontology some acts are morally obligatory in spite of their consequences. According to Lei (2009) the ethical position that an auditor has will influence his/her decision in terms of auditor independence and honest reporting. Thus an auditor could adopt the deontological stance because it is wrong to be dishonest. This type of person therefore would not give an audit opinion that he/she knows to be wrong due to creative accounting practices, even though the consequences of issuing an honest opinion are expected to be terrible for a number of other stakeholders of the firm. In view of the above arguments, this study seeks to examine the effect of the ethical perception of creative accounting by the auditors who have the responsibility of giving an independent opinion on the financial statements audited by them. Fox (1997) reports on how accounting policies in some companies are designed within the normal accounting rules, to match reported earnings to profit forecasts. When these companies sell products a large part of the profit is differed to future years to cover potential upgrade and customer support costs. This perfectly respectable and highly conservative accounting policy means that future earnings are easy to predict. Company directors may keep an income-boosting accounting policy change in hand to distract attention from unwelcome news.