What is Window Dressing in Accounting?
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. It can be used by companies and mutual funds.
- Window dressing 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 looks appealing to them.
- It is done as the financial position of a company is one of the important parameters, and it plays a key 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 window dressing is not made 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 to invest 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 avoidance can be done by showing poor financial results.
- To cover up the poor management decisions taken.
- It improves the liquidity position of the business
- 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 insolvency.
Top Methods of Window Dressing in Accounting
Below are some of the methods used for window dressing in accounting.
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- Cash/Bank: Postponing the payment to suppliers, so that at the end of the reporting period 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 depreciation.
- 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 depreciation to the straight line depreciation method so the profits will be improved.
- Creation of provisions: As per the concept of prudence, 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 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 leasing it back for a longer term for the business operations.
- Expenses: Presenting the capital expenditure as revenue expenditure 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. The concept of window dressing 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 reviewed properly 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 balances and the effect of the same in financials
- Change in accounting policy during the year like change in the inventory valuation, change in depreciation method, etc.
- Improvement in sales due to enormous discounts and increase in trade payables.
Conclusion
Window dressing in accounting is a short term approach to make financial statements and portfolios to look better and more appealing than they truly are. Window dressing 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.
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