Definition of Window Dressing in Accounting
Window Dressing in Accounting means the intentional manipulation of data and figures by the management of the company in the financials of the company just prior to 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 financials of the company does not seem favorable or acceptable, sometimes the management of the company tends to manipulate the facts and figures mentioned in the financials through some methods which are unethical and the practice is voluntarily & intentionally executed by the management. Such practices are termed as Window Dressing in Accounting. This helps the management in gaining the confidence of the investors, shareholders of the company, and users of the financial statement of the company. The financial position of the company pays a big role for the company to expand its business as well as earn the confidence of the investors and other interested parties. When financial data of the company seems appealing to them then it helps in increasing or expanding the business on new levels.
How does it work?
In case of companies having a large number of shareholders, window dressing becomes beneficial for the management of the company 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 come on the decision to use the window dressing method to up strong the financial of the period through some window dressing method.
For example, in case the company is running on negative cash then the company could decide some methods to overvalue the cash by showing some pending payments or to reduce the operating expenses company may capitalize on the revenue expenditure through unethical methods.
Such unethical practices could be identified through a thorough audit of the company. Manipulation of cash transactions, manipulation of revenue expenditure into capital expenditure are just some of the most used methods of window dressing in accounting.
Examples of Window Dressing in Accounting
For understanding the concept let’s take some examples.
Let’s suppose a company named PQR Inc. at the end of the financial year find out that the company is showing negative cash balance and the business has been run in the same mode for the whole year and decided 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 are to be done in the financial period and managing to show the positive cash balance at the end of the financial period and 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 cash balance of the company.
Methods of Window Dressing in Accounting
Following are some methods of window dressing in Accounting:
- Inventory: Management can manipulate inventory valuation by increasing the value of inventory to increase the profitability of the company.
- Depreciation: For increasing the profitability of the company 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 debit side of profit and loss will decrease and the profitability of the company will be increased.
- Cash/Bank: Company can manipulate cash and bank balance at the end of the year by holding payment of vendor at the end of the year. By doing this at the end of the year balance of cash and bank will be increased.
- Revenue: Revenue can be manipulated by increasing sales volume at the end of the year by selling products at 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 bank, by increasing the profitability of the company, and by showing good performance of the company, the financial institution will grant loan facility to 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 stakeholder of the company.
Following are the Advantages of window dressing for the company-
- The company can get fund from the financial institute by showing the better position of financials
- Window dressing attract stakeholders
- Window dressing help reducing tax liability
- By showing 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
Following are the disadvantages of Window Dressing in Accounting:
- By doing window dressing it shows a false picture of financials of the company
- It can cause major loss to stakeholders because when the actual conditions will be released in public they will start losing their money.
- Banks and the financial institutions will be insecure about getting repayment of their fund and interest on that fund.
- The market price of company will fall and shareholders will lose their money
- There is a loss of tax to the government if the company has shown less profit in financials
- The company can reach a stage of bankruptcy
Window dressing is a gateway for the management to show the strong financial position of the company through some unethical methods. As stronger financial position helps the company to earn many benefits like expanding the business, arranging funds, etc. whereas the practice is unethical as well as wrong which may lead 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 interest of the management which just show a 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 –