Creative Accounting
International Journal of Trade, Economics and Finance, Vol. 2, No. 6, December 2011
Use or Abuse of Creative Accounting Techniques
Syed Zulfiqar Ali Shah, Safdar Butt, and Yasir Bin Tariq
India who are always short of this product. It takes three years for a cement plant to start production. By the time the new plants came into production in late nineties, the country’s economic scenario had changed. The government had no money for development, the economy was generally in recession, and construction had virtually come to a halt.
With tremendous overcapacity, the cement prices started falling precariously. The companies got together and slashed production. Plants started operating at an average of around 22% production capacity to ensure that prices do not fall. The prices drop stopped but still it did not help much.
Now cement is one industry where the largest slice of costs is fixed and time related, rather than operations related. As much as 72% of annual costs of a new cement plant may comprise of only two items namely depreciation and interest.
Both of these are fixed and computed on the basis of time.
As a result, a low capacity utilization meant higher cost per ton of cement produced in any period, leading to huge losses. One creative way found around this situation was to convert the depreciation cost from a fixed time related cost to a variable charge. To achieve this end, the method of computing annual depreciation by dividing the total plant cost over the number of plant’s useful life was abandoned.
Instead, the total cost of plant was divided over the total cement production to be expected from the plant over its entire life – thereby computing depreciation cost per ton of cement produced. This drastically curtailed the periodic charge to the Income Statement and improved the profitability figures. This had no implication for corporation taxes as depreciation is not a tax allowable expense virtually anywhere in the
Use or Abuse of Creative Accounting Techniques
Syed Zulfiqar Ali Shah, Safdar Butt, and Yasir Bin Tariq
India who are always short of this product. It takes three years for a cement plant to start production. By the time the new plants came into production in late nineties, the country’s economic scenario had changed. The government had no money for development, the economy was generally in recession, and construction had virtually come to a halt.
With tremendous overcapacity, the cement prices started falling precariously. The companies got together and slashed production. Plants started operating at an average of around 22% production capacity to ensure that prices do not fall. The prices drop stopped but still it did not help much.
Now cement is one industry where the largest slice of costs is fixed and time related, rather than operations related. As much as 72% of annual costs of a new cement plant may comprise of only two items namely depreciation and interest.
Both of these are fixed and computed on the basis of time.
As a result, a low capacity utilization meant higher cost per ton of cement produced in any period, leading to huge losses. One creative way found around this situation was to convert the depreciation cost from a fixed time related cost to a variable charge. To achieve this end, the method of computing annual depreciation by dividing the total plant cost over the number of plant’s useful life was abandoned.
Instead, the total cost of plant was divided over the total cement production to be expected from the plant over its entire life – thereby computing depreciation cost per ton of cement produced. This drastically curtailed the periodic charge to the Income Statement and improved the profitability figures. This had no implication for corporation taxes as depreciation is not a tax allowable expense virtually anywhere in the