Creative Accounting, Fraud and International Accounting Scandals

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