Before we get into the details, let us first understand ”what is window dressing?”. Window dressing in accounting refers to the deliberate distortion of facts and statistics in the firm's profit reports by the administration. A company uses window dressing to show the firm's business achievements and economic condition more favourably and appropriately for the upcoming fiscal period.
Did you know? An accountant can prepare an appealing financial statement of an ineffective commercial firm to cover management errors using window dressing.
What is Window Dressing in Accounting?
In accountancy, "window dressing" is an attempt that management makes to enhance the visual appeal of a company’s financial accounts before they’re open to the market. A company manipulates the income reports to reflect more advantageous outcomes for the company. The intention is to deceive shareholders. Businesses and mutual funds usually use it.
Sometimes in a business with many investors, the administration will use window dressing to give the investors/stakeholders the impression that the firm is doing well. It makes the business interesting to them for investments. It is used because a company’s economic standing is vital for attracting new business opportunities, investors, and stakeholders.
A company can easily mislead all the investors and other shareholders who lack the necessary operational expertise of the company by using window dressing. Management does not perform this in privately held companies because the proprietors know how the company is doing.
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Methods of Window Dressing in Accounting
By altering various elements in financial statements, the companies perform window dressing.
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Cash Window Dressing
Postponing payments to lenders is one way a business can show a good cash position. The cash holdings will rise when they pay the debtors after the deadline.
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Inventory Management
Adjusting stock values in either direction raises or lowers the worth of current assets and, consequently, raises or lowers the firm's profits.
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Capitalisation
Trying to capitalise on a few everyday expenses is yet another strategy for window dressing income. For instance, if a company uses research spending to artificially raise net profit (even though many authorities forbid it with just a few exclusions). If a company capitalises on the costs, the overall cost will go down, and the profits will go up by that much. However, a part is reduced from profits and losses as depreciation. That, though, is a small issue. As a result, the company has the option to influence profitability by changing its capitalisation rules.
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Depreciation
Dealing with a way of depreciation and switching it from an accelerated to a straight-line approach to boost the present year's revenues is among the most popular window dressing techniques.
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Current Liabilities
Companies use short-term financing to enhance their cash flow, but this raises their outstanding debts and is riskier than other methods.
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Revenue
The turnover indicates a company's capability and needs. By giving consumers a discount for early shipments, you companies move revenue from a future period into the current one.
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Why Window Dressing?
Companies adjust to window dressing tactics for a variety of reasons. Let's talk about a couple of them:
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Positive Image
It is a simple response, and the company wants to appear trustworthy to stakeholders, creditors, and investors. To raise share prices by reporting greater earnings (e.g., profits arising from revaluation being treated as revenue). The management portray a positive performance to the public, even when this may not be the situation. Consequently, one of the factors for businesses to "window dress" their accounting is to increase money by projecting a favourable picture of success and performance.
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Higher Stock Price
The stock value of the firm greatly influences a public firm's market capitalisation. People regard a corporation with a large market capitalisation as reliable, profitable and trustworthy. Therefore, faking revenues will encourage more investors to purchase the company's shares. Consequently, a rise in purchases will raise the company's stock value. And the sponsors of the enterprise will become richer as a result.
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Financial Strength
One of the reasons businesses alter their revenues is to avoid paying taxes. The businesses which are running in losses do not require to pay taxes, as is well known. Businesses will begin to indicate higher spending, but perhaps not in money. Rather than capitalising or writing off one-time expenditures, they will take larger loans. All of this will result in lower income. Therefore, the firm can miss the tax payment.
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Future Potential
A company’s future is predictable via its forecasts. Depending on its performance, a company can predict its probable development, profits, and cash position. Businesses can post inflated predictions to draw investors.
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Examples of Window Dressing
Take a glance at the sample below to get a good idea of what window dressing might entail:
Company XYZ is preparing accounting statements for the conclusion of the accounting period. It aims to entice new stakeholders and investors to make the firm seem as appealing as possible. In order to achieve this, XYZ Company unexpectedly "acquires" and holds a large amount of cash in order to make their firm appear more liquidity and readily capable of making mortgage repayments, paying dividends, or employing their significant cash flow for investment in growing the company.
Additionally, the corporation modifies its sales forecasts, reporting them as far more significant than they will be. The overall purpose is to alter everything to raise the share price and pique the attention of potential shareholders. Window dressing does not frequently entail making blatantly misleading claims that are against the law, and generally, it's more a case of twisting the truth without distorting it.
Company XYZ, for instance, can look to have plenty of working capital by disposing of a sizable asset right before the financial year-end. They might not be telling shareholders that they would be purchasing the asset return back in the following financial period since they truly require it to function. The firm's future revenue projections merely represent choosing the most hopeful forecast from a range of estimations derived from a variety of projection measures.
Advantages Of Window Dressing
The benefits of window dressing for the business are as follows:
- By demonstrating a stronger financial situation, the firm can obtain funding from the financial institution.
- Window dressing draws interested parties.
- Window dressing assists in lowering tax obligations.
- The great performance demonstrates the firm's durability.
- It affects the firm's market rate.
- It displays the firm's strong liquidity situation.
Disadvantages Of Window Dressing
The drawbacks of window dressing in accounting are as follows:
- Window dressing creates a false impression of the firm’s financial position.
- Shareholders may suffer significant losses as a result of the fact that they will begin to lose money once they release the real terms to the public.
- Banks and other financial firms will be concerned regarding the repayment of their money and the income they earned on it.
- The firm's stock price will decline, and stockholders will experience a financial loss.
- If the firm's financials indicate lesser profit, the government loses tax revenue.
- The business could eventually declare bankruptcy.
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Conclusion:
Window dressing is a strategy for the administration to demonstrate the firm's solid financial situation using some questionable practices. The approach is immoral and wrong since it puts the hard-earned money of investors and stakeholders in danger. A better economic state enables the firm to profit in various ways, such as global expansion, securing funding, etc. Since window dressing is misleading, the practise as a whole is unethical. Additionally, it is particularly short-term in nature because it just steals outcomes from a future time to make the current period look better. Such a technique is only adopted because the administration shows more interest in maintaining short-term economic clout at the expense of investors.
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