Meaning of Window Dressing In Accounting

Basic terminology, audit is an independent examination of financial information with an objective to give an opinion on its true and fare view.. So Auditors work is to give an opinion on the financial statements which is in fact prepared by the management.
                        
Why Audit is important?
Audit is important because financial information on which auditor expresses his opinion is used and relied by many stakeholders like shareholder's, creditors, investors, government etc. And any wrong opinion on the financial statements by auditor will fail the real purpose and impact the users of the financial statements.

Let's discuss about window dressing
Many a times management of the company (which prepares the financial statements) tries to hide the real financial position of the company by stating incorrect and unrealistic information in the financial statements with an objective to mislead the users or to get an undue advantage. Window dressing gives you fraudulent views about the Financial Statement as it creates wrong impressions about the company on investors and misguides the stakeholders about the true and fair view of financial statement.

Let's take few examples
  1. When the statement of account is showing that the company has incurred profit in a financial year when actually the company has incurred a loss in reality.
  2. When the statement of account is showing heavy losses to get government grants but in reality the company might have got profits.
  3. Understatement of creditors
  4. Overstatement of inventories
  5. Overstatement of Debtors
A company window dresses its financial statements to prevent the occurrence of certain negative events such as, but not limited to, the following: 
  1. defaulting on a loan (and making the loan immediately due and demandable) if debt covenants are not met
  2. bank’s refusal to grant the company a loan if certain ratios (e.g., liquidity and solvency and activity ratios) are too low or are not met
  3. failure to raise targeted capital (due to investors’ pullout) if operating performance is below forecasted levels or industry benchmark
  4. low or zero increase in employees’ salaries for the next fiscal year
  5. no bonus payout to employees during the year
  6. overall decline in the company’s market value due to continual losses in recent years
 Top Methods of Window Dressing in Accounting
  1. Cash/Bank: When an accountant Postpones  the payment to suppliers, so that the cash/bank will have a high balance at the end of the reporting period. Selling off the old assets, so that the cash balance will improve and show a better liquidity position, at the same time, there won't be much difference in fixed assets balance since it is an old asset with more accumulated depreciation.
  2. Inventories: Changing the valuation of inventories/stocks so that there will be an increase or decrease in profits.
  3. Revenue: Companies sell products at a discounted price or gives special offers to improve sales at the end of the year so that the financial performance of the company appears good.
  4. Depreciation: Changing from accelerated to the straight-line method of depreciation so the profits will be improved.
  5. Creation of Provisions: According to concept of prudence, it requires recording expenses and liabilities as soon as they are incurred but revenue only when it is realized. Creating excess provision can reduce the profits of the business and also reduce corresponding tax payment.
  6. Short Term Borrowing: A company can obtain short term loans to maintain its liquidity position.
  7. Sale and Leaseback: Selling off the assets of the business before the end of the financial year and uses the money to fund the business, and maintain the liquidity position and leasing it back from the buyer for a longer term for the business operations.
  8. Expenses: Showing the capital expenditure as revenue expenditure to under-report the profits of the business.
The above listed methods are just a few ways of window dressing in accounting, there are many other ways where the financials of a business can be manipulated and presented according to the needs of management.

How to Identify Window Dressing in Accounting

Window dressing in accounting can be identified by proper analysis and review of the financial statements. Financial parameters should be properly reviewed to understand the position of the business.

Some of the ways to identify window dressing in accounting are;
  1. Improvement in cash balance as a result of short term loans or cash flow from non-operating activities. The review should be done on the statement of cash flows to check which activity has resulted in cash inflow.
  2. Unusual increase or decrease in any of the account balances and its effect in financials
  3. Change in accounting policy before the end of the year. Examples are changing the inventory valuation method, change in method of depreciation, etc.
  4. Increase in sales due to massive discounts and also increase in trade payables.
Window dressing is like dolling up the Beast and making him appear as Beauty! So basically it's the job of Auditors to ensure no such window dressing is done by the management while preparing the financial statements and this is ensured by auditor by performing his audit procedures and once he gets reasonable assurance on financial statements the Auditor gives his opinion on the financial statements that they are free from material misstatements and they reflect true and fair view.