Window dressing in accounting is described as an intentional way of manipulating the financial statements of a company in order to make them appear more appealing than they actually are. Companies apply window dressing when there are a large number of shareholders and investors who have little day-to-day interaction with the business but are needed in the business. Window dressing presents a fraudulent view of the data and figures of a company’s finances and creates wrong impressions on stakeholders in a bid to make the financial information of the company look attractive to them.
The primary objective of window dressing in accounting is to mislead the users, stakeholders, shareholders, and investors by showing favorable results for the organization prior to the release of the same financial report. It can also be used to impress a lender so as to qualify for a loan.
One of the most common non-accounting approaches to window dressing is the presentation of statistical information in a way that boosts the appearance of a company’s performance. It can be represented on a graph with the high base figure in place of the vertical axis so as to exaggerate the increase and give the impression of a significant improvement.
Why Do Companies Use Window Dressing?
The reasons companies and organizations employ the use of window dressing vary by what they intend to achieve. Below are some of the reasons:
- To dissuade a prospective buyer from bidding. When the managers of an enterprise raise the values on the financial statements of the company, it boosts the company’s assets.
- To show off an impressive return on investment
- Obtaining new shareholders, investors, and business opportunities.
- To increase the revenue generated by takeovers
- Convince shareholders and investors that the company is doing well.
- To raise the company’s stock price.
- To encourage shareholders to approve accounts during the Annual General Meeting without delay or interrogation.
- To conceal the company’s original state in the event that it is in decline.
- To improve share valuations by presenting higher profits.
- Seeking funding from investors and obtaining loans
- To present a consistent profit and loss statement for the organization.
- To shield poor decisions taken by the management.
- To achieve the desired financial outcomes
- To make it trustworthy for money lenders.
The Benefits Of Window Dressing In Accounting
- Obtaining funds from banks and other financial institutions
- influencing the enterprise’s market price
- Obtaining shareholder approval
- To demonstrate a strong liquidity position
- To provide the company with a consistent font
- To increase the value of the company’s stock.
- To attract and retain stakeholders
- To save money on taxes
Disadvantages Of Window Dressing In Accounting
- It creates a false financial picture for the company.
- The company’s market price will fall, and shareholders will lose their money.
- Businesses are prone to going bankrupt.
- Potential tax loss to the government if the organization shows lower profits.
- When the true report is made public, investors may suffer significant losses.
- Financial institutions and banks will lose trust in the company.
Identifying Window Dressing In Accounting
The manipulations (window dressing) in the financial statements of a company can be singled out through adequate analysis by the auditor. Financial parameters should be properly checked to ascertain the level of the business.
Window dressing can, however, be identified in the financial statements of a company through the methods below;
- A change in accounting policy before the end of the fiscal year, such as a change in depreciation.
- An increase in sales as a result of significant discounts and an increase in trade payables
- An unusual increase or decrease in any of the account balances, as well as the impact on finance
- An increase in cash balance as a result of short-term borrowings or cash flow from non-operating activities There should be a solid review of the cash flow statement to identify the activity that brought about the flow.
Examples Of Window Dressing In Accounting
Below are examples of when window dressing has occurred in a business:
- When there is a creditor understatement
- When inventories have been overstated
- When the number of debtors is exaggerated
- When the account statement shows huge losses in order to obtain government grants, despite the fact that the business actually made profits.
- When the company’s account statement shows that it made a profit, when it shows that it lost money.
Methods Of Window Dressing In Accounting
There are different types of window dressing in accounting. Some of the common ones are
- Revenue: For the purpose of increasing sales, especially at the end of the year, companies sell products at a discounted price or give special offers that are appealing enough to customers in order to boost the revenue of the company and make the company’s financial report appear better and more encouraging.
- Short-Term Borrowing: To maintain its liquidity position, an organization or company can apply for a short-term loan.
- Fixed Assets: Companies typically sell off some fixed assets with significant accumulated depreciation in order to represent a relatively new list of assets in their net book value.
- Expenses: This method of window dressing shows capital expenditure as revenue to dilute the company’s profits.
- Cash/Bank: Companies can choose to postpone paying suppliers or vendors until the end of the year in order to have a higher cash balance during the annual financial report.Also, when old assets of the company are sold, the cash balance will increase and show a better liquidity position without having a significant effect on the fixed asset balance since the asset sold is an old asset.
- Account Receivable: Companies may record an extremely low bad debt expense in order to make the current ratio appear better than it is.
- Provision Making: According to the concept of prudence, expenses and liabilities must be recorded as soon as they are incurred, but revenue is only recorded when it is realized. When an excess provision is created, the profits of the business and the corresponding tax payment can be reduced.
- Capital Expenditure: A company can have its accounts manipulated by capitalizing on revenue expenditure, which leads to a decrease in the debit side of profit and loss, and an increase in the company’s profitability.
- Depreciation: In order to increase profits, companies often switch from accelerated depreciation to straight-line depreciation.
- Sales and Leaseback: In this case, companies tend to sell off the assets of the business before the end of the fiscal year, then use the money to fund the business to maintain liquidity position, after which the company leases it back from the buyer for a longer term for the business’s operation.
- Inventory: Companies can manipulate inventory valuation by increasing the value to achieve a higher profit or loss, depending on the purpose of the report.
Note that window dressing is a short-term method of making the financial report and portfolio of a company look better, and it is an unethical method aimed at deceiving the users all for the benefit of the organization. The method may be of help for a while, but it ends up being detrimental in the long run.