WINDOW DRESSING AND ITS ETHICAL CONCERNS

'Window dressing' is the act of manipulating the financial statements of an entity so as to show a better financial position and performance than their actual existence. It is a form of creative accounting and while the financial statements may have been prepared in accordance with proper accounting standards, there is bias in the way the figures are presented.


It can be used to hide liquidity problems or to make the financial statements look better to present to lenders of finance or to encourage investors. Some of the common methods of achieving 'window dressing' include the following:

1. Sale and leaseback - sell an asset before the year-end and lease it back after the year-end. This increases cash but does involve a commitment to pay rentals.
2. Short-term borrowings - borrowing just before the year-end shows a better ability to repay debts although it does increase liabilities.
3. Receipt of receivables - asking customers to pay their debt early so that cash is received before the year-end. Discounts are usually offered to customers so that they will agree to this. This improves the cash position and thus liquidity, but reduces profits.
4. Bringing sales forward - asking customers to take sales early so that they can be recognised before the year-end. This increases revenue and profits but not cash, and the sales could not be recognised again in the following year.
5. Changing depreciation policies - extending the useful lives of non-current assets so that the depreciation charge is reduced. This increases profits and the carrying value of non-current assets.
6. Changing valuation policies - a change in valuation methods will affect profits, especially for inventory.
7. Recognising intangible assets - if this can be done, it will improve asset values although if amortised, the expense will reduce profits. If the intangible asset is not amortised, then it will give even higher asset values that may not be true.

It is often argued that cash flows and cash balances cannot be manipulated because it is a matter of fact. It is not subject to estimates and can only be treated in one way. However, there is still some scope for the manipulation of cash flows.

Cash balances are measured at a point in time. This means that receipts and payments of cash can be arranged so that the cash balance is some particular amount. For example, a business may make special efforts to collect debts just before the year-end, or delay paying creditors until just after the year-end.

A business may also structure transactions so that the cash balance is favourably affected. For example, if assets are acquired under leasing agreements, cash outflows are spread over several accounting periods rather than one accounting period.

'Window dressing' is not an ethical way of preparing financial statements. In preparing financial statements, the preparer must ensure that the information is prepared honestly and fairly and that it can be relied upon by the users of those financial statements. If the financial statements are altered so that they do not present fairly the performance and position of the entity, then they may be misleading to users.