Aggressive Accounting

Aggressive accounting refers to accounting practices that are designed to overstate a company's financial performance, either by delaying or covering up losses, or artificially inflating its value by overstating earnings. This is in contrast to conservative accounting, which is more likely to understate performance, and thus the firm's value.

Aggressive accounting, or creative accounting, may follow the letter of the law while deviating from the spirit of accounting rules. But during the late 1990s, many firms moved beyond technically legal expressions of management optimism to fraudulent falsification of financial statements, or cooking the books. Accounting scandals at Enron, Worldcom and other firms, led to the Sarbanes-Oxley Act, which improved disclosures and increased the penalties for executives who knowingly sign-off on inappropriate financial statements.

Aggressive accounting methods include inflating net income by recording expenses as capital purchases, as Worldcom did in 2001 and 2002, or understating depreciation expenses. Other techniques involve inflating the recorded value of assets and the premature recognition of revenues. Krispy Kreme, a poster child for aggressive accounting, booked revenue from doughnut equipment it sold to franchisees, long before they had to pay for it.

In order to inflate revenue, energy companies like Enron reported the value of energy contracts as gross revenue, instead of the commission they received as traders. Using this trick, the top five energy trading firms in the US increased their total revenue sevenfold between 1995 and 2000. Enron also used off-balance sheet corporations called special purpose entities to hide underperforming assets and book phantom profits.

Creative off-balance sheet accounting can also be used to hide capital expenditures and corporate debt. In 2002, Krispy Kreme donuts appeared to be increasing sales without any increase in capital. As it turned out, it had used synthetic leases to move $30 million it spent on a new mixing plant and warehouse off its balance sheet. This was legal, but it was also a subterfuge. Because the new assets were reported as an expense on the income statement, rather than a liability on the balance sheet, Krispy Kreme appeared to have a better return on capital employed than was really the case.