Window Dressing

The old jokes are the best jokes

• Chairman of the board: How much profit

did we make last year?
• Finance director :What profit do you want
us to have made? You can take your pick
from the following profit figures
What is window dressing?
• Window dressing is presenting company
accounts in a manner which enhances the
financial position of the company
• It is a form of creative accounting
involving the manipulation of figures to
flatter the financial position of the
business
• The focus of window dressing
– Liquidity – hiding a deteriorating liquidity
position
Definition of creative accounting
• “A form of accounting which, while complying
with all the regulations, nevertheless gives a
biased impression (generally favourable) of the
company’s performance” (CIMA)
• Creative accounting involves using the flexibility
within accounting to manage the measurement
and presentation of the accounts so that they
serve the interests of people who prepare the
accounts rather than those for whom accounts
are prepared
The law and ethics
• Some methods of window dressing are contrary to the
law or contrary accounting standards and would not be
employed by reputable firms
• But accounting standards permit some flexibility of
interpretation
• When coupled with managerial interest in presenting
figures in the most favourable light the result is window
dressing
• Some forms of window dressing are permitted within the
law and accounting standards but if the intention is to
deceive stakeholders then they are unethical
• In the continuum that follows there is no scope for
creative accounting in 1, 4 represents fraud whereas 2
and 3 are the “grey” areas
Continuum of creative accounting
1. No flexibility permitted.
No scope for creative
accounting
2.Flexibility to give a true and
fair view
3.Flexibility used to give a
creative view
4.Flexibility used to give a
fraudulent view
Accounting standards eliminate
choice in accounting policies
Work within regulatory framework
to ensure the interests of
stakeholders
Working within the regulatory
framework but this time to serve
the interests of managers
preparing the accounts
Outside the regulatory framework.
Therefore this is illegal
Reasons for window dressing
• To show a stronger market position than is warranted
• To influence share price
• To reduce liability for taxation
• To hide liquidity problems
• To ward off takeover bids
• To encourage investors
• To re-assure lenders of finance
• To hide poor management decisions
• To satisfy the demands of major investors concerning
the level of return
• To achieve sales or profit target thereby ensuring that
management bonuses are paid
Method used to window dress

• Sale and leaseback

• Short term borrowing
• Chasing debtors
• Bringing sales forward
• Changing depreciation policy
• Including intangible assets
• Changing stock valuation policy
Changing accounting policies
• The easiest way to do a snow job on investors is
to change one factor in the accounting each
month. Then you can say, ”It’s not comparable
with last month or last year. And we can’t really
draw any conclusion s from the figures”
(Robert Townsend, Up the Organisation)
• This points to the importance of maintaining
consistency in accounting policies. By changing
accounting policies it is possible to mislead
stakeholders
Sale and leaseback
• This involves selling fixed assets to a third party
and then paying a sum of money per year to
lease it back
• The business retains the use of the asset but no
longer owns it
• The liquidity or cash position of the improves
but:
– the asset no longer features on the balance sheet
– there is a continuing commitment to pay rental to use
the asset
– the business is not tackling the cause of the liquidity
problem
Short term borrowing

• Short term borrowing just before the date

on which the balance sheet is drawn up
• This enhances the apparent ability to pay
its short term debts
• But creates an additional liability
Chasing debtors

• Special effort to chase debtors before the

balance sheet is drawn up
• This might involve discounts for prompt
payment
• Conversion of debtors into cash will
improve the balance sheet and cash
position of the organisation
• Liquidity does improve but at the expense
of sales revenue
Bringing forward sales
• Sales show up in the P&L account when the
order is received - not when the cash is received
• Encouraging customers to place orders earlier
than planned will increase the sales revenue
figure in the P&L account
• This can bring sales forward from next year to
this year
• The drawback is that the sales cannot be
included in next year’s figure
• It fails to tackle the underlying problem
Changing depreciation policy
• Increasing the expected life of the asset will
reduce the depreciation provision in the P&L
account
• This will increase the net profit shown in the
account
• Lengthening expected life boosts profits -
shortening it reduces profits.
• It will also mean that net book value in the
balance sheet will be higher for a longer period
thereby increasing the firm’s asset value on the
balance sheet
Including intangible assets

• Intangible assets: brand names, goodwill

• Normally only included if purchased
• They are subject to depreciation (known
as amortisation) like other fixed assets
• But if they are not depreciated the firm
can maintain the value of its assets thus
giving a misleading view of the asset value
of the firm
Capitalising expenditure
• The distinction between revenue expenditure
and capital expenditure is not clear cut
• Example: computer software with a useful life of
3 years
• If treated as revenue expenditure it is treated as
a negative item on the P&L account
• If treated as capital expenditure it is treated as
an asset on the balance sheet (with yearly
depreciation as a negative item on the P&L)
Stock valuation
• There are various methods of stock
valuation: LIFO,FIFO,AVCO
• A change in method will lead to different
figure for
– issue price used in costing
– closing stock which then impacts on profits
– stock in the balance sheet which then impacts
on the value of the firm’s assets
• Anything which increases the value of
closing stock will increase profits
A final thought

• “Every company in the country is fiddling

its profits. Every set of published accounts
is based on books which have been gently
cooked or completely roasted. The figures
which are fed twice a year to the investing
public have been changed to protect the
guilty. It is the biggest con trick since the
Trojan Horse”
(Ian Griffiths, Creative Accounting, 1989)