SARDAR HAMZA NIAZ

220/FMS/BSAF/S18
Assignment# 3
Forensic Accounting
Submitted to: Sir Zaheer Akbar

What is the difference between creative accounting and window

dressing?
Creative accounting
It is a method adapted to manipulate the financial numbers, usually, within the
letters of the law and accounting standards, but very much against their spirit and
certainly not providing the true and fair view of an enterprise that accounts are
supposed to project. Also It is the application of Accounting policies, to structure a
particular transaction in such a way that the financial statements will portray a
picture of financial health that is in line with what the directors would like users to
see, rather than the true financial performance and position of the business. E.g.

 overstating Assets
 capitalization of recurrent expenditure etc.

Explanation
 By adopting these tricks, profit figures are inflated or deflated (depending on
the type of need). That is if operating efficiency should be boosted, then
profits are inflated. If secret reserves are to be created, then profits are
deflated. Sometimes, the enterprises may also reduce reported profits in
good years to smoothen the results.

 Assets and liabilities may also be manipulated, either to remain within limits
such as debt covenants or to hide problems. For example,
working capital efficiency is managed by valuing the stock at market value
which is higher than the cost (not recording the deviation at the main place)
knowing fully well stock should be valued at cost or market price whichever
is lower. The reporting of deviation (if done) is done most often in the notes
to take shelter under the loose ends of law (freedom of interpretation).

How Creative Accounting Works

 A primary benefit of public accounting statements is that they allow
investors to compare the financial health of competing companies. However,
 when firms indulge in creative accounting, they often distort the value of the
information that their financials provide.
 Creative accountants will always find bizarre and novel ways to tweak
figures to a company’s advantage. Their goal is to make a firm look as
successful and profitable as possible and sometimes they will go about doing
this by twisting the truth. If a gray area in accounting is found, it may be
exploited, even if it results in misleading investors.
 Getting caught can ruin a company's reputation overnight. However, some
management teams are willing to run that risk, condoning the use of creative
accounting because failure to meet short-term expectations of Wall Street or
year-end financial targets can have a hugely adverse impact on share prices.
 It is also worth remembering that more attractive figures may lead to higher
bonuses for directors, help convince a lender to give a firm a loan and inflate
the company’s valuation in the event of a sale.

Effect of Changes in Accounting Standards

 One of the major observations relating to creative accounting is that creative
accounting techniques change the main numbers shown in the financial
statements, but make themselves evident elsewhere, most often in the notes
to the accounts. Unless, the user of information thoroughly examines the
financial statements along with notes to the accounts and other additional
details, the hidden information cannot be detected.
 In fact, accounting standards are meant to block particular ways of
manipulating accounting through creative accounting. As accounting
standards change over time, the techniques of creative accounting also
change overtime. In the sense, when the accounting standards change, the
techniques that will work also change.

 The paradox is that the well-intentioned changes in accounting standards

open up new opportunities for creative accounting. One of the best examples
for this is the fair value concept. It should be noted that every rule has an
exception or contains a loophole that is used by the intellectuals of the
accounting profession to their advantage by practicing the method of
creative accounting.

Real World Examples of Creative Accounting

 Laribee Wire Manufacturing Co. offers a good example of inventory
manipulation. The copper-wire maker was in trouble in the late 1980s as
 sales to the troubled construction industry faltered and a big acquisition left
it with massive debt. Laribee recorded phantom inventory and carried other
inventory at bloated values to convince banks to lend it $130 million. The
company reported $3 million in net income for the period, when it really lost
$6.5 million.

Window Dressing
It is the strategy used to create a superficial or misleading presentation of financial
statements in an illegal and unethical manner. E.g.

 Deliberate overstatement of income

 Non recognition of irrecoverable debts.

Window dressing is actions taken to improve the appearance of a company's

financial statements. Window dressing is particularly common when a business
has a large number of shareholders, so that management can give the
appearance of a well-run company to investors who probably do not have much
day-to-day contact with the business. It may also be used when a company
wants to impress a lender in order to qualify for a loan. If a business is closely
held, the owners are usually better informed about company results, so there is
no reason for anyone to apply window dressing to the financial statements.

Ethics of Window Dressing: The entire concept of window dressing is

clearly unethical, since it is misleading. Also, it merely robs results from a future
period in order to make the current period look better, so it is extremely short-
term in nature.

Examples of Window Dressing

 Cash. Postpone paying suppliers, so that the period-end cash balance

appears higher than it should be.
 Accounts receivable. Record an unusually low bad debt expense, so that
the accounts receivable (and therefore the current ratio) figure looks
better than is really the case.
 Capitalization. Capitalize smaller expenditures that would normally be
charged to expense, to increase reported profits.
  Fixed assets. Sell off those fixed assets with large amounts of
accumulated depreciation associated with them, so the net book value of
the remaining assets appears to indicate a relatively new cluster of assets.
 Revenue. Offer customers an early shipment discount, thereby
accelerating revenues from a future period into the current period.
 Depreciation. Switch from accelerated depreciation to straight-line
depreciation in order to reduce the amount of depreciation charged to
expense in the current period. The mid-month convention can also be
used to further delay expense recognition.
 Expenses. Withhold supplier invoices, so that they are recorded in a later
period. 
Significance of Window Dressing
 For a company, window dressing is important because every business
wants its financial information to look as appealing as possible. It is what
attracts new business opportunities, investors, and even consumers.
 The downside to window dressing is that, on the whole, it’s looked at
with skepticism. Window dressing comes with at least a slightly negative
connotation. This is because it can – and sometimes does – involve
making unethical or even illegal changes to numbers, charts, timelines,
orders, etc., to make the financial picture of a company look the most
appealing to outsiders.

Common Reasons for Creative Accounting and Window Dressing

 To incur lower tax liability.
 To achieve competitive advantage
 To improve the market value or worth of the company's share so as to attract
investors.

Difference between Creative Accounting and Window Dressing

 Many a times, window dressing and creative accounting are used as
synonyms. But it is not so. When applied to accounts, window dressing is a
broader term that can be applied to other areas. In the US, window dressing
is often used to describe the manipulation of investment portfolio
performance numbers. In the context of accounts, window dressing is more
likely than creative accounting to imply illegal and fraudulent practices.
  Despite this explanation, one can see a thin layer of difference between the
two. Hence, it may not be incorrect to conclude that creative accounting is
often a means where window dressing is an end.
 In the nutshell, the objective of window dressing and creative accounting are
the same. But ways of achieving their results differs in the sense
that creative accounting involves taking the advantage of the loopholes in
the accounting laws and standards within limit, while Window dressing
doesn't necessarily take advantage of loopholes but intentionally go
against the provisions of the accounting laws and standards.
Preventive measures for creative accounting and window dressing
 Ensuring companies follow or comply with financial regulations in the
preparation of financial statements.
 complying with corporate governance codes and ethics.
 Monitoring, enforcement and penalties.

As we know that accounting data are the languages of business. This refers that the
performance of an organization is being reflected in the accounting data or
financial statements. This information is being used by various interested parties
like investors, bankers, government, creditors, debtors, researchers and so on. The
reliability and authenticity of these financial statements are important. However,
unfortunately most of the times the accounting information provided by these
corporate are not true. Here, the role of creative accounting through window
dressing comes in to the picture. The best example is Satyam Scam in India. In a
nutshell some of the major window dressing done by Satyam are enlisted below:
Sales were inflated with fake orders and order book position. The debtors were
also inflated due to this. To prevent the analysts from figuring this out from
Cash Flow Statements and show better cash position added the received yet
uncleaned cheques through Bank Reconciliation statements to Current Account
Balances. That showed huge balances with Current Account in Banks.
Understated liabilities of unsecured loans and created false figures on Interest
accrued on fixed deposits whereas there was no interest accrued.
Conclusion
 Manipulating financial numbers, within the letter of law but against the spirit
is considered as creative accounting. 
 The tricks used are: Off balance sheet financing, over-optimistic revenue
recognition and use of exaggerated non-recurring items.
 Moro often, as accounting standards change over time, creative accounting
techniques also change.
 If creative accounting is used to manipulate financial numbers, window
dressing can be applied to other areas also as it is a wider term.
 In the context of accounting, window dressing is more likely than creative
accounting. 
 Creative accounting may be a means, whereas window dressing may be an
end.