Creative accounting refers to any accounting practice that is technically correct but deviates from how accounting policies were intended to be used. In general, creative accounting capitalizes on loopholes in generally accepted accounting principles in order to disguise financial performance, such as by keeping debt off a balance sheet.
The sorts of accounting irregularities that are often seen as creative accounting may be technically permitted but in general are frowned upon and often indicate fraud. Creative accounting is also referred to by the slang phrase “cooking the books,” implying that these practices require falsification and omission in the presentation of company financial records. While unfortunately common and occasionally harmless, professional accountants are cautioned against resorting to these sorts of practices.
The Enron scandal is one of the most prominent examples of creative accounting. In 2001, the U.S. corporation Enron filed for bankruptcy as a result of fraudulent, deceptive accounting practices that were ongoing throughout the 1990s. The company masked debt, under-reported losses, and manipulated their financial reports in order to create an illusion of profitability. Arthur Anderson, the now-defunct public accounting firm in charge of the company’s annual audit, played into the deception, allowing Enron to continue on with their illegitimate accounting practices.
Another significant example is the WorldCom scandal, in which the company improperly categorized telecommunications expenses as capital expenses, rather than ordinary expenses, and inflated revenue using bogus accounts in order to disguise losses and maintain its position in the market.