Updated July 20, 2023
Definition of Window Dressing in Accounting
Window Dressing in Accounting means the intentional manipulation of data and figures by the company’s management in the company’s financials just before the release of the same in public for presenting the more favorable and acceptable business performance and financial position of the company for the relevant financial period.
In case the company’s financials do not seem favorable or acceptable, sometimes the management tends to manipulate the facts and figures mentioned in the financials through unethical methods, and the practice is voluntarily & intentionally executed by the management. Such practices are termed Window Dressing in Accounting. This helps the management gain the confidence of the investors, shareholders of the company, and users of the company’s financial statement. The company’s financial position plays a big role in expanding its business and earning the confidence of investors and other interested parties. When the company’s financial data seems appealing to them, it helps increase or expand the business on new levels.
How Does it Work?
In companies with a large number of shareholders, window dressing becomes beneficial for the company’s management as the shareholders are not knowledgeable about the operational level of the company. During the period of the closing of the financial year, management may decide to use the window dressing method to up strong the financial of the period through some window dressing method.
For example, if the company is running on negative cash, then the company could decide on some methods to overvalue the money by showing some pending payments or reducing the operating expenses. The company may capitalize on the revenue expenditure through unethical practices.
Such unethical practices could identify through a thorough audit of the company. Manipulating cash transactions and manipulating revenue expenditure into capital expenditure are just some of the most used methods of window dressing in accounting.
Examples of Window Dressing in Accounting
To understand the concept, let’s take some examples.
Let’s suppose a company named PQR Inc. at the end of the financial year finds out that the company is showing a negative cash balance and the business has been run in the same mode for the whole year and decides to correct the same so that it won’t look bad in the financial statement and the interested personnel has their confidence in the company.
For the same reason, the management of the company decided to withhold some payments that were to be done in the financial period and manage to show a positive cash balance at the end of the financial period. On the next day or week, they pay out the withhold payments. This is one of the methods of window dressing in accounting to overstate the company’s cash balance.
Methods of Window Dressing in Accounting
Following are some methods of window dressing in Accounting:
- Inventory: Management can manipulate inventory valuation by increasing inventory value to increase the company’s profitability.
- Depreciation: To increase the company’s profitability by changing the depreciation method. From the WDV to the straight-line method.
- Capital Expenditure: Management can manipulate Accounts by capitalizing on revenue expenditures. By doing this, the debit side of profit and loss will decrease, and the company’s profitability will be increased.
- Cash/Bank: The company can manipulate cash and bank balance at the end of the year by holding vendor payments at the end of the year. By doing this at the end of the year, cash and bank balances will be increased.
- Revenue: Revenue can be manipulated by increasing sales volume at the end of the year by selling products at a discount. It will show better performance of the company.
Importance of Window Dressing in Accounting
Management plans window dressing in financial statements of the company to show a better financial position of the company. Sometimes they try to revive the company by taking a loan from a bank, increasing the company’s profitability, and by showing the company’s good performance, the financial institution will grant a loan facility to the company. They don’t disclose this to their stakeholders because they will lose the investment coming into the company. The share price of the company will fall, and shareholders of the company will start selling the shares of the company. Sometimes they create a secret reserve in a company for a specific purpose which they don’t disclose to every company stakeholder.
The following are the Advantages of window dressing for the company-
- The company can get funds from the financial institute by showing a better position of financials
- Window dressing attracts stakeholders
- Window dressing help reduce tax liability
- By offering good performance, it shows the stability of the company
- It influences the market price of the company.
- It shows a good liquidity position of the company
The following are the disadvantages of Window Dressing in Accounting:
- Doing window dressing shows a false picture of the financials of the company
- It can cause major losses to stakeholders because they will start losing their money when the actual conditions are released in public.
- Banks and financial institutions will be insecure about getting repayment of their fund and interest on that fund.
- The company’s market price will fall, and shareholders will lose their money.
- There is a tax loss to the government if the company has shown less financial profit.
- The company can reach a stage of bankruptcy
Window dressing is a gateway for the management to show the company’s strong financial position through some unethical methods. A stronger financial position helps the company to earn many benefits like expanding the business, arranging funds, etc. In contrast, the practice is unethical and wrong, which may put the hard-earned funds of the investors and shareholders at risk. Because it may help in the short run, but in the long run, it could become detrimental. Such practice is only adapted due to the management’s interest, which shows strong financials in the short term but could prove bad for the investors.
This is a guide to Window Dressing in Accounting. Here we discuss an introduction to Window Dressing in Accounting, explanation, examples, importance, advantages, and disadvantages. You can also go through our other related articles to learn more –