Creative accounting

Although the subject of creative accounting is little known in Chile, countries like Spain and England have been debating for years between the fine line of "creativity" and "fraud" that these practices create, as well as ethical discussions or legal that its application may entail.

Creative accounting consists of taking advantage of the possibilities that accounting standards provide for the presentation of information.

The users of the information and their information needs are varied and therefore the forms of presentation of the financial statements may also be.

Depending on the interests of a company, this information can be manipulated in a way that reflects an image according to what users want to see, not always necessarily being the real or the best.

Thinking that creative accounting is a mere fraud, takes away the ingenuity of those who know how to take advantage of the possibilities that the same accounting standards and generally accepted criteria offer.

As for its relationship with tax planning, it is only the application of the legal norms that govern the matter in order to achieve a lower tax burden for both companies and their owners, without compromising the presentation of the situation. financial and economic for the same interested parties.

The objective of this work is to demonstrate how through the use of creative accounting as an element of tax planning, it is possible to reduce the tax burden through tax deductions and deductions.

In addition, the position that creative accounting is far from being an unethical, illegal or fraudulent practice will be defended, but quite the opposite, a planning tool that allows displaying different information depending on the users of it, taking advantage of the facilities that the The game's own rules provide. To support our position, we will carry out several numerical exercises that reflect the advantages that good use of creative accounting can provide.

Opinions about creative accounting:

There are diverse and mixed opinions about creative accounting, the main ones are:

Griffiths: «All companies in this country (United Kingdom) manipulate their profits. All accounts published are based on books that have been more or less delicately retouched. The figures provided to the investing public have been modified to protect the culprit.

It is the most important ploy since the Trojan horse (…). Actually, these are tricks that do not violate the rules of the game. They are totally legitimate. It is simply creative accounting. "

Jameson: “Creative accounting is essentially a process of using standards, where flexibility and omissions within them can make financial statements appear somewhat different than what was established by those standards. It consists of going over the rules to find a way out.

Naser: "Creative accounting is the transformation of accounting data from what it really is to what its creators want it to be, taking advantage of the facilities provided by existing rules and / or ignoring some or all of them."

Amat and Blake: "Creative accounting is the process by which accountants use their knowledge of accounting standards to manipulate the figures included in a company's accounts."

Blasco: «The term 'creative accounting' has been introduced in Spanish literature to describe the process by which knowledge of accounting standards is used to manipulate the figures in the annual accounts (…). It could be said that it is a euphemism, used to avoid referring to these practices by their real names: accounting devices, accounting manipulations, frauds ».

Birth of creative accounting.

The birth of creative accounting arises from the asymmetry of interests that exist around an organization and the use of these differences by those responsible for displaying relevant information to satisfy these interests, showing the closest economic and financial image to desired by these.

On the other hand, it is known that accounting is not considered a science, but a technique that is far from being exact and neutral, and the principles that govern the subject can be applied on many occasions with discretion.

In addition to that not all areas are adequately regulated neither legally nor legally, and the application of the norms in many occasions depends more on a choice between different accounting alternatives or on the subjectivity of the one who applies them.

It is generally associated with the use of creative accounting as a strategy to face the financial difficulties of companies, understanding that through these practices the aim is to present a more optimal economic and financial image, although this is not always the case, on the contrary sometimes it is preferable to show inferior results or a poorer position than you really have.

This last case could be the one that, combined with good tax planning, effectively reduces the tax incidence in an institution.

Finally, another cause that can lead to the birth of creative accounting is to maintain or stabilize a certain image of the company through the years.

The reasons for the use of the CC are many and will depend on the idiosyncrasy of each company and the more or less conservative policies of those who must finally show this information, however by way of example the following can be cited:

Pressure from the investment community on companies to present positive results, profitability, wealth and financial situation, Existence of remuneration systems linked to benefits, share prices, company evolution, etc. Interest of the campaign in obtaining Loans Tax incentives Possibilities to attribute successes in subsequent years

CC: Companies live off the pressure to obtain high profits.

Creative practices and creative accounting.

A company presents itself to society through the information provided by its financial statements. For this reason, their elaboration and their content depend on the presentation and image of this company.

It is necessary to distinguish between those practices that are related to the elaboration of the information with those that are related to the presentation of the same.

Someone who manipulates the preparation of the financial statements does so as a mechanism for projecting the true image of the company to approach a desired or desired image.

It is in these cases where one could speak of unethical or fraudulent practices, because by applying CC, the company could “believe” that image appropriate to its needs and make erroneous decisions that could lead to problems of various kinds.

Instead, the CC used as a practice to present the information, is the one that uses the rules themselves in their weakest aspects to distort the image that is presented to a certain user, although always knowing what things are being changed (hiding or presenting in a confused way) to make up the real situation.

Ways to apply creative accounting combined with tax planning

Among the accounting practices regarding the use of creative accounting, the most common to apply are the following:

Sales record very early, that is, to account for income before it is completed or when there is still uncertainty about the same or the delivery of the good or service has not been completed, Record of false sales: record them when only an exchange was made or register a money returned by a vendor as sales Recognize non-recurring gains such as the sale of a fixed asset Defer current expenses, for example: amortizing expenses too slowly or not eliminating assets that are completely undervalued Keeping debts out of accounting.

However, the accounting standards for the valuation and presentation of the financial statements do not always coincide with the tax standards, which must be different to avoid tax avoidance.

Therefore, when these results are not the same, which happens in most companies, it is necessary to determine the differences that exist and the causes that are due to them. These differences are normally classified into three types:

Permanent: These are expenses and income only recognized in economic terms, but from a tax point of view they are not recognized at any time.

(Ex: remuneration paid to the taxpayer's spouse or unmarried children under 18 years of age, disbursements or expenses that are attributable to non-income or exempt income, expenses or disbursements granted to the beneficiaries of Art. 33, letter f, n ° 1 LIR, tax-rejected expenses such as automobile expenses, excess remuneration paid, dividends, among others.

Temporary: These are expenses and income that are recognized both financially and tax, but in different periods, these are the ones that originate the "Deferred Taxes" from the accounting point of view.

This can be exemplified by the estimation of bad loans, accelerated depreciations, leased assets, provision for compensation for years of service, leasing operations, etc.

However, for purposes of the objective of the work, the following concepts will be used, a) Income

b) Costs and expenses

c) Tax credits through the use of franchises and benefits granted by law

d) Investment Decisions.

On these, tax planning tools and creative accounting will be applied to achieve financial and economic improvement through positive net savings translated into lower tax payments.

Application of tax planning and creative accounting for the Lake of Revenue.

The LIR indicates at what times they should recognize income from a tax point of view. For this, the date on which the income will be generated can be controlled, in order to minimize the tax burden of the year that suits the taxpayer's interests, thus financial planning determines the tax.

At the creative accounting level to reduce the tax impact on the results of a company, it is important to highlight that tax revenues may be deferred to other subsequent years, depending on the financial capacity of the company to bear more or less tax burden, through some of the ways presented below:

Partialization of operations. When the taxpayer is taxed under a perceived income regime, he can use the term as a modality of his legal businesses, or he can also use suspensive conditions for these businesses. Celebrate a promise of sale or contracts that only serve as a domain title., so that the way of acquiring is suspended, for those cases in which the law requires the title of ownership and the way of acquiring for the sale of assets to operate. Accept the optional regime of Art. 14 bis, LIR

We will analyze this topic in the explanation of a specific case that is the real estate business and taking into account the current taxes.

Practical case

Article 5 of Law 18,630 establishes that construction companies have a special credit equivalent to 65% of the amount of VAT charged on the invoices they issue for the sale of real estate for rooms or for general construction contracts for real estate for rooms. other than by administration. This credit is for buyers or contractors a reduction in VAT or the final price.

In turn, the construction companies will apply this special credit, to the fulfillment of obligatory monthly provisional payments, and if there is a remainder this will be charged to any other withholding tax or surcharge, and if there is a remainder after these imputations, they can ask for return.

The best way to take advantage of this type of credit is to create a partner company that has the title of a real estate company, which receive in transfer the properties built by the mother company, in these cases the special credit is used by the real estate company.

This allows the construction company to better manage its sales margins and use a large part of its tax credits.

In addition, real estate companies are not VAT taxpayers and the transfer of acquired and finished properties is not a taxable event. These situations make this type of companies, in addition to the special credit of 0.65 seen additionally enjoy the following benefits:

If the real estate company decides to exploit assets with facilities, it will be able to use as a tax credit the VAT charged on the transfer from the construction company, with neutral effects at the consolidated balance sheet level.

As they are assets of your fixed assets, you can take advantage of Article 17, first paragraph, which allows you to reduce the amount of the rent corresponding to 11% per year of the tax assessment of the real estate or proportionally to the periods corresponding to the operation.

The real estate company can be legally organized as a people society, which being related companies, the construction company can make withdrawals to compensate for eventual losses generated by the application of low sales margins and improve profitability.

In addition, the first category credit of the income tax paid by the real estate is used.

Both companies can sign real estate sales promise contracts with their clients, thus achieving low-cost financing and thus deferring the payment of income tax for said income.

It is important to be able to represent all these benefits at the level of numerical calculations to see the final effect on taxes to pay and the reasons that show the economic and financial situation of this type of business.

Application of tax planning and creative accounting by the Lake of Costs and Expenses.

Following the same criteria as that used for Income, there are ways that can anticipate expenses or defer them, according to the taxpayer's interest, in subsequent years. The ways to anticipate expenses are as follows:

Provision of expenses in exceptional cases where they are allowed, such as the IAS to all events. Application of accelerated depreciation. Conclusion of financial leasing contracts or leaseback. Apply amortizations to expenses of Art. 31 n ° 9, 10 and 11. Make penalties. Make sales with losses, to carry out operations with contrary balances later. Hold contracts or subcontracts with related companies that are organized and covered by Article 14 bis so that the entry is made in the company deferring the payment of the Tax 1st category.

Application of tax planning and creative accounting by the lake of tax benefits and franchises.

The law grants certain privileged treatments with respect to certain taxpayers whose purpose is to promote certain activities or geographical areas, stimulate savings and investment, etc.

The main tax benefits and incentives that the LIR gives are the following:

Taxation based on withdrawals: Art. 14, letter A, n ° 1, letter C. Reinvestment of profits: the income that is withdrawn to reinvest it in other companies obliged to determine effective income by means of complete accounting, will not be taxed with the IGC until they are withdrawn from the company that made the investment. Optional taxation of Art. 14 bis. This type of companies can choose to pay taxes on all withdrawals, whether in money or kind or the amounts they distribute to any title, without consider whether it is taxed income or not, its source or origin. Income not constituting income: Art. 17 of the LIR mentions that events give rise to this type of income or are subject to a single tax of the 1st Category tax. Presumed income regime: It is simplified taxation for certain taxpayers of agricultural activity,mining and transportation, with requirements.Donations: Whether they are accepted as an expense or credit to the tax to be paid.Compensations for tax loss carryover.

The use of some of these items causes the taxpayer to generate a credit, which represents personal right, which are relevant for tax planning purposes because they are a factor in choosing the best option or action plan.

Application of tax planning and creative accounting by the lake of Investment Decisions.

When the decision is made, within a company, to make a disbursement and invest it, the question always arises from which of all the financing sources to choose.

Financial leverage is decisive in answering this question, because it will indicate which of all the available sources is the one that allows me to increase my benefits (in this case, after taxes) due to the use of external resources instead of my own. Using external resources is not always the most appropriate decision, it should only be made when the money obtained from a loan pays more than it costs, that is, the company's rate of return is higher than the interest rate of the loans.

Practical case

The clearest way to see this topic is to analyze how a leasing operation can serve to leverage the company both tax and financially.

Financial leasing is the contract by which a company with this line of business acquires a good at the request of the lessee, to deliver it to the lessee with the option to purchase, who is obliged to pay a monthly rent during the term of the contract, being able to exercise the option purchase, at the end of the contract, for a residual value.

Tax, you are in the presence of a leased asset, which will generate an accepted expense for the LIR in each installment paid or accrued due to the contract.

This is, in some cases, an advantage even over accelerated depreciation, provided that the term of the leasing contract is less than the useful life of the asset.

We will call this “Leverage through leasing”.

On the other hand, taxpayers are still entitled to use the credit of 4% of the value of the assets of the immobilized physical asset, calculated on the total amount of the contract.

It will be taxed or not with VAT depending on the type of property in question (furniture or real estate) and the imputation or refund of VAT may be used for the acquisition of goods destined to fixed assets, when credit remnants have been accumulated for six or more periods consecutive tributaries.

On these, tax planning tools and creative accounting will be applied to achieve financial and economic improvement through positive net savings translated into lower tax payments.