Creative Accounting

Financial Accounting Management

Report on Creative Accounting

Name: - Aniket Dharmadhikari

Section: - D, Roll no. 2010183

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Creative Accounting refers to accounting practices that seem to follow the letter of the applicable accounting
standards but deviate from the spirit of those standards. The motivation to indulge in these practices is
anticipation of rewards which may include higher share prices, improved credit rating resulting in lower
borrowing costs, higher incentive compensation for executive management, increased profits, inflated asset
values, understated liabilities etc. The motivation of management and accountants typically include bonuses,
promotion, salary rises, etc.
There are other reasons for creative accounting.
To keep the companys financial results within agreed limits set by creditors
To fulfill public listing requirements
To help negotiations with regulators
To pay less tax
To push the company towards insolvency

Creative accounting always starts with human intervention. Rarely can a system, even the most advanced
accounting system, create profits and assets out of thin air. Creative accounting can be caused by human errors,
but statistically, some of these errors would have a positive effect on profits, others would have negative effects.
Therefore, a typical creative accounting incident involves both human effort and a bias towards some objective.

Creative Accounting Scope: -

Different types of creative accounting practices are used by companies to window dress their financial
performance. The most prevalent are

1) Booking revenues before they are materialized

2) Booking fictitious sales
3) Expense manipulation
4) Cash manipulation
5) Invisible restatements of previous records
6) Faulty accounting in connection with business combinations,
7) Wrongful use of off- balance-sheet arrangements.

Takeovers and acquisitions also create opportunities for creative accounting. In the year of the takeover, the new
management and accountant have a bias to show a dismal picture - low profits, deflated asset values, inflated
provisions, and perhaps an impacted stock value. Then in the years after the takeover, the assets can be re-
inflated, provisions released, all contributing to increased profits and a perception that the new management is
doing a great job.
The above technique may also be used before a management buy-out. This helps the new buyers negotiate a
lower purchase price, and increases their return after the buy-out. These fraudulent schemes can be devastating
to users like shareholders, lenders, employees, board of directors and other stakeholders.
Creative accounting tends to shoot up when the economy starts slowing down. Indian companies, whose shares
witnessed a spectacular ascend recently, are now under pressure to justify those valuations. This has raised
concerns that many companies may resort to creative accounting in a bid to check further slide in their stock
prices.

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Creative Accounting Case

Company Involved: - DSQ Software

Year of Scam Expose: - 2003

Amount Involved: - Rs.595 Crore

Type of Fraud: DSQ Software accused of dubious acquisitions and biased allotments in 2000-01

Impact: - MD Mr Dinesh Dalmia was arrested in 2006 and is currently serving jail sentence

Introduction

The main business of the company includes activities related to development of software programmes and
packages. Mr Dinesh Dalmia became its Managing Director in March 1992. As per the Serious Fraud
Investigation Office (SFIO) report, Mr Dinesh Dalmia along with group entities of DSL are guilty of cheating
investors by manipulating share prices, fraudulently creating the shares to take advantage of the manipulated
share price and lastly by selling 1.3 crore shares in the market at an exorbitant price.

The SFIO report said the accounts of the company for the period1998-99 to 2001-02 were inaccurate. Funds
amounting to Rs 242 crore were diverted in the form of investment in group / associate company shares at a
very high value and subsequently over a two-year period the same were diminished to nil.

SFIO recommended prosecution against DSQ Software Ltd (DSL) for manipulation of share price, falsification
of accounts, diversion of funds and violations under the Companies Act.

Inaccurate accounts

The SFIO report indicated that DSQ Holdings / DSQ Software transferred funds worth Rs 85.67 crore to two
Ketan Parekh Group companies - Classic Credit Ltd and Panther Fincap and Management Services Ltd. This
helped Mr. Ketan Parekh to manipulate the share price of the company through brokers of various exchanges.

Violations of Acts

The investigation brought out several violations of provisions of the Companies Act such as failure to bring
amount reduction in share capital despite submitting an affidavit in this regard before the Company Law Board,
submission of documents to Registrar of Companies containing misleading and false information, non-transfer
of unpaid dividend to special dividend account, failure to distribute dividend within 30 days of its declaration,
and investments and loans given by the company were in excess of the limits prescribed.

Faulty Accounting in Business Combinations

Besides DSQ Software Limited, three companies were cited as accused in a charge sheet filed by the Central
Bureau of Investigation in a stocks scam, involving Rs.595 crore. The companies are DSQ Holdings Ltd., Hulda
Properties and Trades Ltd. and Powerflow Holding and Trading Pvt Ltd., all under the control of Dinesh
Dalmia.

According to the charge sheet, Mr. Dalmia obtained wrongful gain through partly paid shares of DSQ Software
Ltd., in the name of New Vision Investment Ltd, U.K., and unallotted shares in the name of Dinesh Dalmia
Technology Trust and Dr.Suryanil Ghosh-Trustee Softec Corporation. DSQ Holdings Ltd, Hulda Properties and
Trades Ltd and Powerflow Holding and Trading Pvt. Ltd. indulged in cheating.

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Fictitious Share Allotment

The CBI investigations revealed that 1.30 crore shares of DSQ Software Ltd had not been listed on any stock
exchange. Also, except the 30 lakh shares allotted to New Vision Investment Ltd., none of the shares was
actually allotted by DSQ Software. Even in the transaction relating to the allotment of 30 lakh shares, the partly
paid equity shares were forfeited / cancelled in March 2001. But Mr. Dalmia had fraudulently got these shares
dematerialised as fully paid in May 2000.

Mr. Dinesh Dalmia is alleged to have made false representation to the National Securities Depositories Ltd and
fraudulently got the 1.30 crore shares dematerialised, showing them as fully paid and allotted by the company.

Later, he sold the shares to the trading system and cheated the shareholders of the software company and also
the purchasers of these shares. The shares were sold by brokers for Rs.594,88,37,999.

A total of Rs.572,61,51,225 was paid by brokers to Hulda Properties and Trades Ltd, DSQ Holdings Ltd and
Powerflow Holding and Trading Pvt. Ltd. None of the sale proceeds of the shares was received by DSQ
Software Ltd, the charge sheet said.

Accounting Policies (Auditor Report -2004)

Significant Accounting Policies

1. Basis for Preparation of Financial Statements:

As required by the Companies (Auditor's Report) Order 2003 issued by Central Government in terms of section
227(4A) of the Companies Act, 1956 and on the basis of examination of the books and records of the company.

2. Subsidies

Based on the representations given by the Management in respect of transactions, the validity, completeness and
the values thereof, entered into between the Company and its overseas subsidiary /business associate companies
and by its overseas branch, relating to sale of services / products, purchase of products/ services and
reimbursement of expenses amongst these entities and in the view of the Management such transactions are not
prejudicial to the interests of the Company.
3. Investments

Unable to comment upon the adequacy of the provision for diminution in the carrying out value of the
investments since the realisability /marketability of such unquoted shares is uncertain. Relied on the
representations given by the management that the investments made are not prejudicial to the interests of the
Company.

4. Sales and Service Income

The revenue recognition / adjustment of receivables by credit notes is based on management representation as to
the arms length price of the transactions

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5. Warranty Claims

The company has been saddled with legal proceeding from various Government agencies, the financial
institutions and creditors. SEBI vide its order dated 9.09.04, has prohibited the company from accessing the
capital market for a period of 10 years, making it difficult for the company to raise financial resources from
public. Under these conditions there is a significant uncertainty whether company will be able to continue its
operations as a going concern and therefore may be unable to realize its assets and discharge its liability in the
normal course of its business.

6. Fixed Assets and Depreciation

The company has maintained proper records showing full particulars including quantitative details and situation
of fixed assets. The fixed assets have been physically verified by the management during reasonable interval.

References: -

http://www.thehindubusinessline.com/2006/04/26/stories/2006042603700900.htm

http://economictimes.indiatimes.com/quickiearticleshow/3959714.cms

http://en.wikipedia.org/wiki/Creative_accounting

http://www.indiainfoline.com/Markets/Company/Fundamentals/Auditors-Report/DSQ-Software-
Ltd/523864

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