What is window dressing in accounting?

May 17, 2011

Explanation of window dressing and examples in companies and mutual funds.

1. Definition of window dressing

Window dressing is a set of actions or manipulations with financial or other information in financial documents (financial statements, reports, etc.) to make this information look more attractive to its users. Even though window dressing can occur at any time, it is commonly used at the end of a period.

Window dressing can be used by companies and mutual funds.

A company can use window dressing when preparing financial statements to improve the appearance of its performance or liquidity.  In this case, window dressing may consist of changing asset depreciation or valuation policies, making short-term borrowings, or engaging in sales and leaseback transactions at the end of a period. By doing so, management embellishes the company’s results or liquidity and obtains some benefits.

Other examples of window dressing by companies may include advertising, selling, and marketing.  In these cases, window dressing occurs when positive characteristics of products or services are a little exaggerated to increase demand for them while negative characteristics are not mentioned or kept hidden.

Mutual funds use window dressing when preparing periodic (quarterly, yearly) reports.  Window dressing by mutual funds consists of selling underperforming stocks and buying well-performing stocks near the reporting period end. This practice makes a fund portfolio look more profitable and thus more attractive to its (prospective) clients.

2. Reasons and beneficiaries of window dressing

In most cases, beneficiaries of window dressing are those who use this practice, i.e., companies and mutual fund managers. In many cases, managers’ remuneration (i.e., salaries and bonuses) depend on how well their companies or mutual funds performed; so there is a direct interest in making financial results or liquidity look better than they really are.

Refer to the table below to see specific reasons for window dressing:

Illustration 1: Reasons for window dressing

Beneficiary

Reason

Window dressing Action

Who is misled

Company

To obtain funding (to borrow money)

Increase profits and liquidity ratios

Borrowers (banks, other financial institutions)

To reduce tax payments

Decrease profits by increasing expenses

Government

To smooth financial data (sales, expenses, accounts receivable, etc.)

Record sales or purchases in an inappropriate period;

give large discounts to debtors for payments received before period end

Owners

To hide some problems (liquidity, profitability, poor management decisions)

Increase cash account balance at the period end; increase useful life of fixed assets

Owners

Mutual Fund

To improve fund portfolio structure

Buy more well-performing stocks and selling nonperforming ones

Investors

To increase portfolio value

Buy additional well-performing stocks at a higher price

Investors

Not a member?
See why people join our
online accounting course:
Lecture Contents:
Free Study Notes
Download free accounting study notes by signing up for our free newsletter (example):
First Name:
E-mail:
We never share or sell your e-mail to third parties.