What is Window Dressing in Accounting?
Window Dressing in Accounting refers to the manipulation done by the management of the company intentionally in the financial statements in order to present a more favorable picture of the company in front of the users of the financial statement before the same is released in the public.
Window dressing in accounting means an effort made by the management to improve the appearance of a company’s financial statements before it is publicly released. It is a manipulation of financial statements to show more favorable results of the business. It is done to mislead the investors. Companies and mutual funds can use it.
- It is done when a company/business has a large number of shareholders, and the management wants to project to the investors/ shareholders that the business is doing well, and wants their financial information to look appealing to them.
- It is done as the financial position of a company is one of the critical parameters, and it plays a crucial role in bringing in new business opportunities, investors, and shareholders.
- Window dressing can mislead the investors and other stakeholders who do not have the proper operational knowledge of the business.
- In closely-held business, it is not done as the owners are aware of the company’s performance.
Example of Window Dressing (WorldCom)
Worldcom case is one of the most infamous examples of window dressing, which was done by inflating earnings through improper capitalization of expenses. WorldCom declared bankruptcy in July 2002. Chief Accounting and finance executives charged with securities fraud.
Purpose of Window Dressing in Accounting
- Shareholders and Potential shareholders will be interested in investing in the company if the financial look is good.
- It is useful to seek funds from investors or to obtain any loan.
- The stock price of the company will shoot up if the financial performance is good.
- Tax avoidanceTax AvoidanceTax avoidance is the process of reducing the income tax liability of an individual or firm by adopting the lawful methods. The taxpayers can claim exemptions and deductions as allowed under the nation's tax provisions. Such as investments in municipal bonds and deductions for business loss. can be done by showing poor financial results.
- To cover up the poor management decisions taken.
- It improves the liquidity position of the businessLiquidity Position Of The BusinessLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.;
- To show a stable profit and results for the company.
- It is done to reassure the financial stability of the company to money lenders.
- It is done to achieve targeted financial results.
- It is done to showcase a good return on investment.
- To increase the performance bonus to the management team based on the overstated profits.
- To cover up the actual state of business in case the business is nearing insolvencyThe Business Is Nearing InsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow..
Top Methods of Window Dressing in Accounting
- Cash/Bank: Postponing the payment to suppliers so that at the end of the reporting periodReporting PeriodA reporting period is a month, quarter, or year during which an organization's financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements., the cash/bank balance will be high. Selling off the old assets, so that the cash balance will improve and show a better liquidity position, at the same time fixed assets balance will not differ much since it is an old asset with more accumulated depreciationAccumulated DepreciationThe accumulated depreciation of an asset is the amount of cumulative depreciation charged on the asset from its purchase date until the reporting date. It is a contra-account, the difference between the asset's purchase price and its carrying value on the balance sheet..
- Inventories: Changing the valuation of inventories to increase or decrease profits.
- Revenue: Companies sell products at a discounted price or gives special offers to boost up the sales at the year-end so that the financial performance of the company looks better.
- Depreciation: Changing the depreciation method from accelerated depreciationAccelerated DepreciationAccelerated depreciation is a way of depreciating assets at a faster rate than the straight-line method, resulting in higher depreciation expenses in the early years of the asset's useful life than in the later years. The assumption that assets are more productive in the early years than in later years is the main motivation for using this method. to the straight-line depreciation methodStraight-line Depreciation MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. so the profits will be improved.
- Creation of Provisions: As per the concept of prudence in accounting, it requires recording expenses and liabilities as soon as possible but revenue only when it is realized or assured. If an excess provision is created, it can reduce the profits and reduce the corresponding tax payment.
- Short Term Borrowing: Short term borrowing is obtained to maintain the liquidity position of the organization
- Sale and Leaseback: Selling off the assets before the end of the financial year and uses the money to fund the business and maintain the liquidity position and leasingLeasingLeasing is an arrangement in which the asset's right is transferred to another person without transferring the ownership. In simple terms, it means giving the asset on hire or rent. The person who gives the asset is “Lessor,” the person who takes the asset on rent is “Lessee.” it back for a longer term for the business operations.
- Expenses: Presenting the capital expenditureCapital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year. as revenue expenditureRevenue ExpenditureRevenue expenditure refers to those costs incurred during regular business operations by the organization while availing its benefits in the same period. Such operating expenses include rent, utility expenses, salary, insurance expenses, etc. to understate the profits;
The above mentioned are a few ideas for window dressing in accounting; there are many other ways where the financials can be manipulated and presented according to management needs.
Window dressing is predominantly done to boost up the stock price and to make potential investors get interested in the business. This concept is unethical as it is misleading, and it is only a short term advantage as it merely takes the benefit from the future period.
How to Identify Window Dressing in Accounting?
Window dressing in accounting can be spotted by proper analysis and comparison of the financial statements. Financial parameters and other components should be appropriately reviewed to understand the state of the business.
The following can be looked into the financials of the company to identify window dressing.
- Improvement in cash balance because of short term borrowings or cash flow from non-operating activities. The proper review should be done on the statement of cash flows to check which activity has resulted in cash inflow.
- Unusual increase or decrease in any of the account balancesAccount BalancesAccount Balance is the amount of money in a person's financial account, such as a savings or checking account, at any given time. Furthermore, it can refer to the total amount of money owed to a third party, such as a utility company, credit card company, mortgage banker, or other similar lender or creditor. and the effect of the same in financials
- Change in accounting policyAccounting PolicyAccounting policies refer to the framework or procedure followed by the management for bookkeeping and preparation of the financial statements. It involves accounting methods and practices determined at the corporate level. during the year like change in the inventory valuationInventory Valuation Inventory Valuation Methods refers to the methodology (LIFO, FIFO, or a weighted average) used to value the company's inventories, which has an impact on the cost of goods sold as well as ending inventory, and thus has a financial impact on the company's bottom-line numbers and cash flow situation., change in depreciation method, etc.
- Improvement in sales due to enormous discounts and an increase in trade payables;
Window dressing in accounting is a short term approach to make financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. and portfolios to look better and more appealing than they genuinely are. It is done to mislead investors from the real performance. It is an unethical practice as it involves deception, and it is done in the interest of the management.
This has been a Guide to Window Dressing in Accounting and its meaning. Here we discuss top methods used in window dressing along with examples and ways to identify them. You can learn more about financing from the following articles –