MIDLANDS STATE UNIVERSITY

FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTING

NAME: SAVIOUS BUSHE

REG NO: R104117B

LEVEL: 4.2

MODE OF ENTRY: PDP

PROGRAMME: HACC

CELL NUMBER: 0777 351 729

THE IMPACT OF CREATIVE ACCOUNTING ON THE QUALITY OF FINANCIAL

STATEMENTS CASE OF REGENCY FAIRMILE MOTEL
INTRODUCTION
This chapter highlights the statement of the problem and the background information for
better comprehension of the problem. The chapter also outlines research questions, aims,
objectives and justifications of the research. It also indicates the assumptions, study
limitations and delimitations and definition of terms in the research.

BACKGROUND OF THE STUDY

Regency Hotel Fairmile operates in the Tourism and Leisure industry. Its core business is
tourism, hospitality management and conferencing. Financial statements are one of the most
important ways for most business to reveal their performance and status to investors,
regulators and employees alike (Elliott, B. et al. 2005) As a vital means of representing the
internal information to the public, the preparation of Financial Statements is also desired to
fulfil all the principles, regulations, standards and practices. Ideally Financial Statements
should reflect a company’s wealth and activity performance through a transparent accounting
system and therefor the right tool to fair and true company evaluations.

Regency Hotel Fairmile uses estimates in the preparation of Financial Statements and
estimating amounts to be included in the entity’s Financial Statements is an allowed practice
in accounting. It is under certain circumstances allowed by accounting principles to estimate
the specific amount if exact amount are not available. Estimates are based on judgements and
discretion. Since the making of accounting estimates is based on judgement and discretion
there is a possibility that they may have an earnings management or creative accounting
effect. This will become a problem because these estimates will affect the quality of financial
statement as they can be manipulated. An example is the estimation of the useful life of an
asset for the purpose of depreciation. (Blake, Bond, Amat and Oliver 2000:136-137)

Due to creative accounting it is now difficulty for users of financial information to discern
fact or fiction. Naser (1993:59) defines “creative accounting “as the manipulation of
accounting figures to change what they should be to a required accounting result. The
manipulation of Financial Statements is also referred to as “earnings management”. The
manipulation of financial statements affects the entity’s true financial position and
performance and hides relevant information to the users of Financial Statements (Elias,
2004:84). As a result creative accounting deteriorates the quality of financial statements and
it will not represent faithfully what it purports to represent.

Table 1.1 Extract of Turnover, Gross Profit, Estimates and Loss

2013 $ 2012 $ 2011 $

Turnover 2 212 056 1 304 066 958 814
Cost of sales (598 765) (340 819) (208 898)
Gross profit 1 733 291 1 253 254 743 846
Estimates 1 980 000 1 479 038 901 200
Loss before tax (247 356) (225 784) (157 354)
(Source-Extract of Statement of Comprehensive Income for Regency Hotel Fairmile
2011-2013)

According to table 1.1, the estimates of Regency Hotel Fairmile were as high as they rose
from $901 200 in 2011 to $1 479 038 in 2012 and $1 980 000 in 2013. The estimates were
escalating and the gross profit reduced drastically for the past 3 years to in 2011, in 2012 and
2012. The figures for the estimates were calculated based on judgement and discretion. The
figures may be manipulated as management may try to conceal errors. As a result, this impact
the objective of the Federation of Accounting Standard Board (FASB) Conceptual
Framework of ensuring financial statements is prepared with quality to its users. This will
also give wrong information to users of financial statements who will be willing to make
informed decision.

As it is appearing from the above that because accounting estimates are based on judgement
and discretion, it can lead to the manipulation of financial statements that is creative
accounting. The financial statements are influenced by estimates and the only risk of using
estimates is that the financial statements are manipulated. Consequently, the financial
statements which have been manipulated do not fairly represent the effects of transactions
and events. As a result the quality of the financial statements will be compromised. The
probable risk that is involved in using accounting estimates in the preparation of financial
statements forms the basis of the problem of this study which is called creative accounting.

STATEMENT OF THE PROBLEM

Accounting estimates are allowed by Financial Reporting Standards (IFRSs) in the

preparation of financial statements. The problem is that how reliable and valuable such
financial statements are to users since they include estimates which are based on judgement
and discretion. There is risk that the financial statements may be manipulated by the use of
estimates leading to creative accounting or earnings management. The users of financial
statement must make well informed economic decisions from such financial statements. The
question also comes whether quality decisions can be made where creative accounting has
been practiced.

RESEARCH OBJECTIVES

 To investigate the impact brought by creative accounting on the quality of financial

statements.
 Is there a risk that the use of accounting estimates may lead to creative accounting?
 To explore several reasons or motives behind creative accounting.
 Are there any responsibility placed to prevent and detect creative accounting and how
the quality of financial statements can be improved.
 To identify and explain the techniques of creative accounting and the role of auditors
and their responsibility in the deduction of creative accounting.

MAIN RESEARCH QUESTION

What is the impact of creative accounting on the quality of financial statements?

SUB RESEARCH QUESTION

 How does creative accounting affect the quality of financial information?

 What are the risks associated with the use of estimates and what qualitative
characteristic do true and fairly presented financial statements possess?
 What are the motives behind creative accounting?
 What methods can be there to combat creative accounting?
 What are the techniques used to induce creative accounting?

SIGNIFICANCE OF THE STUDY

To The Researcher

 The research was in partial fulfilment of the requirements of the bachelor of

Accounting Honours Degree the researcher is currently pursuing at Midlands State
University. Its successful completion enhanced the academic and professional
standards of the researcher.
To The University

 The researcher believes that the research will add information into the body of
literature for further studies by other scholars. The study also provided a basis for
future researches on the same subject.

To Regency Hotel Fairmile

 The research findings were aimed at assisting the organisation to mitigate the impact
of creative accounting on the quality of financial performance through the
implementation of the research recommendations suggested at the end of the research.

DELIMITATIONS OF THE STUDY

 The research mainly focused on Regency Hotel Fairmile and excluded other units
The research covered periods January 2011-2013.
 The study focused on the impact of creative accounting on the quality of financial
statements of the organisation. It excluded factors such as errors or unintentional
misstatements which also might have an impact on the quality of financial statements
of the organisation.

ASSUMPTION OF THE STUDY

 Secondary data appropriate to the research was accessed

 Responses from questionnaires were free from bias and accurate which facilitated for
reasonable conclusion and deductions
 Sample selected was a true representation of the population (members in the
organisation)

LIMITATIONS OF THE STUDY

 Limited access to confidential information which was vital for the purpose of the
research.

The researcher solved the above limitation by creating an environment of between

them and l explained the nature and purpose of study. I gave respondents assurance that
gathered data was mainly for academic purposes and I would not disclose it to other parties

 Inability to draw inferential or descriptive conclusion from the selected data

In order to solve the above limitation, the researcher conducted a pilot study where
questionnaires were distributed to a sample population. These questionnaires were assessed to
determine whether they covered the appropriate areas and were not perceived as too long or
ambiguous.

 Some participants did not respond well to questionnaires

To solve the above problem the researcher gave participants assurance that actual names were
not being used and there was no need to fear as the names were not going to be disclosed.

DATA COLLECTION METHODS

For the purpose of this study, various methods were used to gather primary and secondary
data. The pros and cons to each of these methods were highlighted and analysed of. The
methods used were the following,

 Questionnaires – These were distributed to managers and various employees of

Regency Hotel Fairmile.
 Interviews – quite a number were conducted with different representative of users
of financial statements of Regency Hotel Fairmile.
 Periodicals – newspapers, financial reports and business journals were also used
both from either hard copies and from the internet.

DEFINITION OF TERMS AND ACRONYMS

The researcher defined all terms to make it easier for the reader to understand the sense
conveyed within the context of the research.

Creative accounting – All steps including the aggressive choice and application of
accounting principles, fraudulent financial reporting and any steps taken towards earnings
management or income smoothing (Mulford and Comiskey 2002:3).

Earning management – The manipulation of earnings toward a predetermined target

(Mulford and Comiskey 2002:3)

Estimates – An approximation of the amount of an item in the absence of a precise means of

measurement (IAAS/PAAB 2006 ISA 540: par.3).
Profits - according to Turney (2007), profit is the difference between revenue and costs to
that revenue.

IAASB – International Accounting Standard Assurance Board.

PAAB – Public Accountants and Auditors Board

SUMMARY

This chapter was an introduction of the research study and provided an overview of the
overall study. It covered the areas which included the background of the study, the statement
of the problem, research objectives, research questions, significance of the study, problem
likely to be faced by the researcher and definition of terms to be used in the research. The
next chapter dealt with literature review and it scrutinized what prior researches had
researched on the relevant area.