Creative accounting practices, and tax compliance among small and medium entreprises in Nairobi city county, Kenya

Abstract

Many economies around the world continue to experience low tax compliance levels among Small and Medium Enterprises (SMEs), resulting in revenue authorities failing to meet their annual collection targets. This challenge significantly affects government operations, limiting its ability to provide essential services and implement development projects. Clearly, there is a need for governments and tax authorities to reassess their strategies in promoting compliance among taxpayers, especially SMEs, which form the backbone of many economies. The current study sought to establish the effect of creative accounting practices on tax compliance among SMEs in Nairobi City County, Kenya. The variables of interest were: income smoothing, accelerated depreciation, and off-balance sheet financing as the independent variables, while tax compliance was the dependent variable. The study was anchored on Agency Theory, Positive Accounting Theory, and the Theory of Planned Behavior. The study adopted a descriptive research design and the target population was 1,364 registered SMEs operating within Nairobi City County, from which a sample of 309 firms was selected using stratified sampling technique. Primary data was collected using a structured questionnaire. Data collected were coded and then analyzed using descriptive statistics, Pearson correlation analysis and multiple regression analysis. The results revealed that income smoothing had a positive and significant beta coefficient (β₁ = 0.319, p = 0.000 < 0.05). Similarly, accelerated depreciation had a positive and significant beta coefficient (β₂ = 0.426, p = 0.000 < 0.05). However, off-balance sheet financing had a negative but statistically insignificant beta coefficient (β₃ = -0.031, p = 0.579 > 0.05). Based on these findings, the study concluded that income smoothing and accelerated depreciation significantly enhance tax compliance among SMEs. Conversely, off-balance sheet financing does not significantly affect compliance. Among the three practices studied, accelerated depreciation had the greatest positive effect on tax compliance. The study recommends that the Kenya Revenue Authority (KRA) strengthen its engagement with SMEs by offering clearer guidelines and training on acceptable accounting practices—especially on income recognition and depreciation methods—to enhance voluntary compliance and boost tax revenue collection.