WINDOW DRESSING

Chairman of the board: How much profit did we make last year? ....Finance Director: How Much Profit do you want us to have made? You can take a pick from the following profit figures 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. It is also defined as: A form of accounting, which while complying with all the regulations, nevertheless, gives a biased impression of the companys performance. Though it is not illegal, it is considered by many financial pundits as unethical. Manipulation of financial numbers Within the scope of law and accounting standards Against the spirit Not providing true and fair value of the company Generally done to inflate the profits Hidden in the notes to accounts IS NOT ILLEGAL!!! Also called: Creative or Innovative Accounting Earnings Management or Aggressive Accounting

What is window dressing? Window-dressing involves emphasizing positive facts above and beyond their actual importance, while selectively soft pedaling or even omitting other information that is less positive. Thus, the presented information contains real information that can be verified. However, the presentation is not properly balanced in the way the particulars are portrayed. Purpose of Window Dressing At the end of the financial year every company is accountable for its performance to its shareholders. Window dressing is a tool which helps the company to create a rosy appearance regarding the financial position and performance of the company, hence satisfying the shareholders expectations. Thus it helps in influencing the share prices positively. Companies are liable to pay tax on its profits; window dressing can be useful in reducing such tax liability. Management gets its remuneration on the basis of its performance. Poor management decisions, inability to meet targets and other forms of inefficiency are concealed by using window dressing. It is also used to reflect a good image of the company in respect of liquidity and credibility to its prospective investors and creditors. Take over bids are often a threat to an underperforming company, therefore company might take help of window dressing to avoid such situation. Many of the companies use window dressing to some extent, depending upon its performance and its objectives. Some use it for creating a favorable impact to its stakeholders while some use it for fraudulent purposes. The following types companies are likely to use window dressing: Companies with a weak control environment No independent members Lack of competent/independent auditor Inadequate internal audit function

Management facing extreme competitive pressure or known or suspected of having questionable character. Small fast-growth companies requires funds more often to expand Newly-public companies aiming to influence the share prices Privately held companies often do not disclose its information to its stakeholders
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Reasons for Window Dressing: Enhance Liquidity position of the Co. hiding a deteriorating liquidity position, and Showcase stable Profitability of a company massaging profit figures with methods such as income smoothing or profit smoothing Reduce Liability for Taxation Ward-off takeover bids Encourage Investors Re-assure Lenders of Finance To influence share price Hide poor management decisions Satisfy the demand of major investors concerning the desired level of return Achieve the sales or profit target, thereby ensuring that management bonuses are paid

Window Dressing- Law & Ethics Some methods of window dressing are contrary to the law or contrary to the accounting standards and would not be employed by reputable firms. But accounting standards permits some flexibility of interpretations. When coupled with managerial interest in presenting figures in the most favorable light the result is window dressing. Some forms of window dressing a permitted within the law and accounting standards but if the intension is to deceive stakeholders then they are unethical. Window Dressing Methods There are certain procedures which are commonly used for the purpose of window dressing. Such methods have been discussed below. Income Smoothing: It redistributes income statement credits and charges among different time periods. The prime objective is to moderate income variability over the years by shifting income from good years to bad years. An example is reducing a Discretionary Cost (e.g., advertising expense, research and development expense) in the current year to improve current period earnings. In the next year, the discretionary cost will be increased.

 Ambiguity in Capitalizing and Revenue expenditure E.g. Computer software with useful life of 3 years. As revenue expenditure it is treated as negative item on P&L account. As capitalizing expenditure, it is treated as an asset in balance sheet, with yearly depreciation in the P&L. Changing depreciation policy - Increasing expected life of asset reduces depreciation provision in P&L account, hence, increasing net profits. Also, net book value in balance sheet will be higher for a longer period, thereby, increasing firms asset value. Changing stock valuation policy - Change in method of stock valuation policy (LIFO, FIFO) can lead to increase in value of closing stock, boosting up the profits. For example, in a rising price scenario, usage of FIFO method helps in increasing closing stock inventory valuation, thereby reducing the COGS, and hence inflating the earnings. Similarly, in a falling price scenario, LIFO valuation method for inventory is more favorable. Sale and Lease Back This involves selling fixed assets to a third party and then paying a sum of money per year to lease it back. Thus, the business retains the use of the asset but no longer owns it. Not Disclosing all Liabilities- Reporting revenue upon receipt of cash before rendering services. Failing to accrue expected or contingent liabilities. Applying means to keep debt off the books. Off-Balance Sheet Financing Conversion of capital lease to operating lease so that the asset no longer features in the assets or liabilities of the balance sheet which automatically improves ratios such as Total Asset Turnover Ratio (TATO), Return on Assets, Equity Multiplier, etc. The costs saved are the interest expense on debt availed to finance the capital lease and depreciation. Also, the debt-raising capacity of the company increases as the liabilities component tones down. Naturally, earnings are inflated under this method. In the later years of use of asset, the company may revert back to capital lease financing since the with net block having reduced considerably, the deprecation by WDV method will also
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be very less, thereby providing an opportunity to inflate earnings. Also, it provides the addition benefit of saving on tax. Including intangible assets - If intangible assets like goodwill are not depreciated the firm can maintain value of its assets giving a misleading view. Bringing sales forward Sales show up in the P&L account when the order is received and not at the point of transfer of ownership rights as mentioned in the notes to accounts of the Co. under the heading of Revenue Realization. Encouraging customers to place orders earlier than planned increases the sales revenue figure in P&L account. This brings sales forward from next year to this year. Extraordinary Items- Extraordinary items are revenues or costs that occur, but not as a result of normal business activity. These events are unusual and unlikely to be repeated they should be highlighted in accounts, and inserted after the calculation of Profit before Interest and Taxation. To include these in normal revenues will again exaggerate business profits.

The Enron Scandal Enron Corporation was an American energy company based in Houston, Texas, and the dissolution of Arthur Andersen, which was one of the five largest audit and accountancy partnerships in the world. In addition to being the largest bankruptcy reorganization in American history at that time, Enron undoubtedly is the biggest audit failure. Initial Success Kenneth Lay founded Enron in 1985 through the merger of Houston Natural Gas and Inter North, two natural gas pipeline companies. By 1992, Enron was the largest merchant of natural gas in North America, and the gas trading business became the second largest contributor to Enron's net income, with earnings before interest and taxes of $122 million. Enron pursued a diversification strategy. By 2001, Enron had become a conglomerate that both owned and operated gas pipelines, pulp and paper plants, broadband assets, electricity plants, and water plants internationally. The corporation also traded in financial markets for the same types of
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products and services. The prices of Enrons stocks were increasing by leaps and bounds. By December 31, 2000, Enrons stock was priced at $83.13 and its market capitalization exceeded $60 billion, 70 times earnings and six times book value, an indication of the stock markets high expectations about its future prospects. In addition, Enron was rated the most innovative large company in America in Fortune's Most Admired Companies survey. Some of the Major Accounting Discrepancies by Enron Enron's nontransparent financial statements did not clearly detail its operations and finances with shareholders and analysts. From late 1997 until its collapse, the primary motivations for Enrons accounting and financial transactions seem to have been to keep reported income and reported cash flow up, asset values inflated, and liabilities off the books. The combination of these issues later led to the bankruptcy of the company. Revenue Recognition: Enron and other energy merchants earned profits by providing services such as wholesale trading and risk management in addition to developing electric power plants, natural gas pipelines, storage, and processing facilities. When taking on the risk of buying and selling products, merchants are allowed to report the selling price as revenues and the products' costs as cost of goods sold. In contrast, an "agent" provides a service to the customer, but does not take on the same risks as merchants for buying and selling. Enron reported the entire value of each of its trades as revenue. This "merchant model" approach was considered much more aggressive in the accounting interpretation than the agent model. Enrons use of distorted, "hyper-inflated" revenues was more important to it in creating the impression of innovation, high growth, and spectacular business performance than the masking of debt. Mark to Market Accounting: Enron was the first non-financial company to use Mark to Market Accounting. Mark-to-market accounting requires that once a long-term contract was signed, income was estimated as the present value of net future cash flows. Often, the viability of these contracts and their related costs were difficult to judge. Due to the large discrepancies of attempting to match profits and cash, investors were typically given false or misleading reports. While using the method, income from projects could be recorded, this increased financial earnings. However, in future years, the profits could not be included, so new and additional
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income had to be included from more projects to develop additional growth to appease investors. For one contract, in July 2000, Enron and Blockbuster Video signed a 20-year agreement to introduce on-demand entertainment to various U.S. cities by year-end. After several pilot projects, Enron recognized estimated profits of more than $110 million from the deal. But the network failed to work and Blockbuster pulled out of the contract. Enron continued to recognize future profits, even though the deal resulted in a loss. Special Purpose Entities: Enron used special purpose entitieslimited partnerships or companies created to fulfill a temporary or specific purposeto fund or manage risks associated with specific assets. The company elected to disclose minimal details on its use of special purpose entities. These shell firms were created by a sponsor, but funded by independent equity investors and debt financing. For financial reporting purposes, a series of rules dictates whether a special purpose entity is a separate entity from the sponsor. In total, by 2001, Enron had used hundreds of special purpose entities to hide its debt. Other Accounting Issues: Enron made a habit of booking costs of cancelled projects as assets, with the rationale that no official letter had stated that the project was cancelled. This method was known as "the snowball". On November 28, 2001 Enron was fully bankrupt. The Enron scandal is one of the most infamous incidents in the history of accounting. It resulted in the creation of Sarbanes-Oxley Act due to its corporate governance failure. Various provisions were created to prevent occurrence of incident in the future. Favorite Areas Even if current year profits are presented as high, the next year would have to absorb the deferred expenses and hence there will be a dip. Revenue recognition Off-balance sheet financing Impairment of assets
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 Deferred revenue expenditure Inappropriate accruals and estimation of liabilities Amortization Major Scandals It encourages the attitude for committing more serious misrepresentations. Enron Tyco International Adelphia Peregrine Systems WorldCom Satyam

METHODS USED FOR WINDOW DRESSING

Income Smoothing: It redistributes income statement credits and charges among different time periods. The prime objective is to moderate income variability over the years by shifting income from good years to bad years. An example is reducing a Discretionary Cost (e.g., advertising expense, research and development expense) in the current year to improve current period earnings. In the next year, the discretionary cost will be increased. Ambiguity in Capitalizing and Revenue expenditure E.g. Computer software with useful life of 3 years. As revenue expenditure it is treated as negative item on P&L account. As capitalizing expenditure, it is treated as an asset in balance sheet, with yearly depreciation in the P&L. Changing depreciation policy - Increasing expected life of asset reduces depreciation provision in P&L account, hence, increasing net profits. Also, net book value in balance sheet will be higher for a longer period, thereby, increasing firms asset value. Changing stock valuation policy - Change in method of stock valuation policy (LIFO, FIFO or AVCO) can lead to increase in value of closing stock, boosting up the profits. For example, in a rising price scenario, usage of FIFO method helps in increasing closing stock inventory valuation, thereby reducing the COGS, and hence inflating the earnings. Similarly, in a falling price scenario, LIFO valuation method for inventory is more favourable. Sale and Lease Back This involves selling fixed assets to a third party and then paying a sum of money per year to lease it back. Thus, the business retains the use of the asset but no longer owns it. Off-Balance Sheet Financing Conversion of capital lease to operating lease so that the asset no longer features in the assets or liabilities of the balance sheet which automatically improves ratios such as Total Asset Turnover Ratio (TATO), Return on Assets, Equity Multiplier, etc. The costs saved are the interest expense on debt availed to finance the capital lease and depreciation. Also, the debt-raising capacity of the company increases as the liabilities component tones down. Naturally, earnings are inflated under this method.

In the later years of use of asset, the company may revert back to capital lease financing since the with net block having reduced considerably, the deprecation by WDV method will also be very less, thereby providing an opportunity to inflate earnings. Also, it provides the addition benefit of saving on tax. Including intangible assets - If intangible assets like goodwill are not depreciated the firm can maintain value of its assets giving a misleading view. Bringing sales forward Sales show up in the P&L account when the order is received and not at the point of transfer of ownership rights as mentioned in the notes to accounts of the Co. under the heading of Revenue Realisation.Encouraging customers to place orders earlier than planned increases the sales revenue figure in P&L account. This brings sales forward from next year to this year. Extraordinary Items- Extraordinary items are revenues or costs that occur, but not as a result of normal business activity. These events are unusual and unlikely to be repeated They should be highlighted in accounts, and inserted after the calculation of Profit before Interest and Taxation. To include these in normal revenues will again exaggerate business profits.

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THE SATYAM SCANDAL

Satyam Systems, a global IT company based in India, has just been added to a notorious list of companies involved in fraudulent financial activities, one that includes such names as Enron, WorldCom, Societe General, Parmalat, Ahold, Allied Irish, Bearings and Kidder Peabody. Satyams CEO, Ramalingam Raju, took responsibility for broad accounting improprieties that overstated the companys revenues and profits and reported a cash holding of approximately $1.04 billion that simply did not exist. This leads one to ask a simple question: How does this keep happening? At the Columbia Business School, we teach a course called Performance Measurement in which we study some of the dynamics that lead to this type of accounting scandal. In our course, we study the fraud committed at WorldCom and Kidder Peabody in detail. In our studies, a distinct pattern emerges. It starts small. Typically, executives do not wake up one morning and say, I feel like adding 5 billion rupees to our revenue today. They usually start by fudging the number a littleand then it grows. It is usually a response to competitive pressures. Companies have targets that they need to reach every month, quarter and year. These targets can come from their internal budgets or from the expectations of their shareholders and stock market analysts. The fiddle is easy to rationalize at first. Managers typically have confidence in their skills and believe that their company is fundamentally sound. Given that, its easy to rationalize that while were just a little short on the numbersnow, we will make it up in the future, and nobody will know. It gets out of control. When the company is unable to make up the gap, a larger distortion is needed to cover it up. This in turn creates pressure to deliver even better results which leads to bigger cover-ups, and so on. In his letter to his board, Satyams Raju shows the markers of this pathology. He states that, What started as a marginal gap between actual operating profits and ones reflected in the books
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of accounts continued to grow over the years. It has attained unmanageable proportions. Later, he describes the process as like riding a tiger, not knowing how to get off without being eaten. Can anything be done? Unfortunately, it appears that several of the mechanisms we rely upon today have not gone far enough. When management has the wrong incentives, we need other mechanisms to hold those incentives in check. Typically, we rely on corporate governance, audit and legal consequences. Historically, several characteristics have been considered important ingredients of excellent corporate governance. These include outsider representation on the board, boards that arent too large, boards that meet often, etc. Unfortunately, these characteristics dont seem sufficient. Satyam, for example, had a reputation of excellent corporate governance. In fact, the World Council for Corporate Governance awarded Satyam its Golden Peacock Award for Corporate Governance in 2008. This suggests that we need to fundamentally rethink the criteria that we require in order for boards to provide effective governance. When an accounting fraud involves reporting cash that is not there, it is typically the result of adding fraudulent transactions, such as cash sales, to customers that never happened. These types of transactions should have been audited to assure their legitimacy. In the case of Satyam, the auditors signed off on the financial reports, raising concerns that even the increased auditing standards imposed by Sarbanes-Oxley may not be sufficient. Finally, we also need stiffer penalties. Simply put, white collar crime cannot be viewed as less of an evil than any other form of crime. The fact that white collar crime continues to occur, and seemingly at an increasing rate, suggests that the expected costs do not outweigh the expected benefits from cheating. Stronger penalties are needed. Despite my calls for improvements in governance, audit and legal penalties, Im left with the nagging concern that whatever we do may be insufficient. At the end of the day, the actions at
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Satyam were perpetrated by one or two individuals who simply may not have realized that the small distortions they created in the past would lead to massive problems today. Hopefully, creating an awareness of the large consequences of small lies may help some to avoid this trap. Actions such as those of Satyam are being observed all over the world, and their effects are not simply localized to their executives, employees or even their countries. Whether it is accounting fraud, excessive trading risks, a Ponzi scheme or making loans to those who cant pay, many are hurt by corporate improprieties. These types of actions affect the global economy. In other words, they affect us all. If there isnt sufficient belief in the notion that business will act in good faith, then the capitalist system is itself at risk. Professor Sudhakar (Sid) V. Balachandran teaches accounting at the Columbia Business School, where he is the faculty director of the executive programs Finance & Accounting for NonFinancial Executives and Essentials of Financial Management.

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SATYAM SCANDAL SHOCKS INDIA

The Satyam scandal has shocked India.

It is being called India's Enron. Many in the financial circles are dismayed that the biggest-ever corporate fraud in the country could have escaped unnoticed for so many years. It has brought into question the levels of corporate governance in the country, and has cast an ugly shadow on the once shining image of Indian industry overseas. Investors stunned For the last couple of days outside the Bombay Stock Exchange, all anyone can talk about at the chai stalls and sandwich stores is how Ramalinga Raju, the former boss of Satyam Computers, managed to rack up a billion-dollar fraud right under their noses. Investors in Indian shares were stunned by Mr Raju's revelation, in a letter to the stock exchange this Wednesday, when he confessed his wrongdoing and admitted that he had effectively cooked the books of his firm for the last several years.

Satyam's shares plummeted on the news by 75%, dragging down India's stock main market by 7%. "I can't believe it," says investor Rajiv Gupta outside the stock market.
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"It's very worrying, and it's happened at the worst possible time. Markets here were just started to look like they were recovering. But this news - it is very very bad." Ashok Bakliwal, another investor, agrees: "This will put the spotlight on Indian companies, and overseas investors will be wary of putting their money here without taking a good, hard look at the company's books." "As if India wasn't going through enough of a bad time - now this? I really don't know what will happen next. How could a fraud of this magnitude take place and go unnoticed? "

What went wrong? It's a question that everyone is asking. The controversy has got many in corporate circles here wondering whether it was India's new found love affair with capitalism that led to Satyam's downfall. In the letter to his shareholders, Mr Raju says that he was trying to cover up the losses at Satyam, and in doing so got caught up in a vicious cycle of lies and debts. He says this attempt to hide the losses from investors and shareholders was like "riding a tiger, not knowing how to get off without being eaten". According to Mr Raju's statement, about $1bn (0.65bn), or 94% of the cash on the company's books, was made up - and analysts say it was the manipulation of the cash flow which could have been one reason why the deceit was undetected. Many analysts also say that the chase for huge profits, and the desire to keep up with the breakneck speed of India's $50bn outsourcing industry's growth rates that may have been behind Mr Raju's motivation in fudging the accounts at his firm.

Disappeared But trying to get any answers from Mr Raju since his confession letter is proving to be impossible - he has disappeared.

A company spokesperson has been quoted as saying that his whereabouts remain unclear for now.

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At a company press conference on Thursday, the acting chief executive Ram Mynampati told journalists that he and other board members had no knowledge of the financial fraud and were hoping to get back to business as soon as possible. "Our only aim at this time is to ensure that the business continues," Mr Mynampati says. But it will be some time before it is business as usual for the troubled tech firm. Indian media is reporting that financial regulators have despatched investigators to Hyderabad to launch a formal investigation into the case. India's main stock exchanges have announced they are removing Satyam Computers from their indices as of January 12 because of the stunning revelations Leading members of Indian industry have also expressed their shock and disappointment that such an audacious act of deception could take place. Chanda Kochar, the joint managing director of ICICI Bank, one of India's biggest lenders, says she is shocked by the news. "It's a wake-up call - but I would like to say that it's important to remember this is an isolated event and shouldn't be seen as a barometer for the general level of corporate governance in India," she says. "But it is also important for us to monitor the auditors and the other players in this scandal, and for us to become a lot more careful."

Investor flight? But caution alone may not be enough to convince international investors that Indian companies are serious about cleaning up their governance Many of Satyam's customers were persuaded to get into business with the company because of Mr Raju's suave, professional image.

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WHY DO FIRMS 'WINDOW DRESS'?

To protect from take-overs revaluing assets especially Brands To improve share valuations - managers must be seen to perform. To encourage shareholder approval - less likelihood of difficult AGM's. To increase revenue from take-overs - this can be fraudulent. To win or retain institutional investor support - careful use of creative accounting can disguise poor performance trends. To retain or gain lines of credit - business creditors are encouraged by strong liquidity. Window Dressing is a wide-spread practice, it can vary from a presentation

Of statistics so that a company highlights what it sees as best about its performance and avoids stressing the worst aspects of the previous years trading, to the disguising of liquidity problems or even fraudulent representation of liabilities. This gross misrepresentation of debts has been seen with Enron in the US, where $billions of long term liabilities were hidden off balance sheet. British, American and European banks still

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seem in many cases unable or unwilling to adjust their accounts to show true value of assets for which they massively overpaid. The reasons behind Window Dressing are often understandable, but greed, selfinterest, or fraud all can influence how accounts are presented. Worldcom, a huge telecoms and communications company, again in the US, inflated profits by disguising expenses expenditure as investment in assets what seemed like a hugely successful and profitable company, had it seems never actually made a profit! So take accounts as published with a large pinch of salt, even leading fund managers have been, and will continue to be, misled by accounting practices of some large businesses.

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CONCLUSION
Thus, it can be concluded that a company can use window dressing to create a favorable situation for it self in the short run but in the long run it is detrimental to the companys interest and extensive practice of window dressing can lead the company to termination as it was seen in case of Enron. In the aftermath of Satyam, India's markets recovered and Satyam now lives on. India's stock market is currently trading near record highs, as it appears that a global economic recovery is taking place. Civil litigation and criminal charges continue against Satyam. Tech Mahindra purchased 51 percent of Satyam on April 16, 2009, successfully saving the firm from a complete collapse. With the right changes, India can minimize the rate and size of accounting fraud in the Indian capital markets.

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BIBLIOGRAPHY
www.satyamcompany.com www.google.com www.wikipedia.org Tabrez Ahmad & Tabrez Malawat & Yashowardhan Kochar & Ayan Roy, (2009). Satyam scam in the contemporary corporate world: a case study in Indian perspective. SSRN, Retrieved from [link] Vikas Bajaj & Keith Bradsher, (2009). Developing market investors ride wave of optimism. The New York Times, Retrieved from [link] Ronojoy Banerjee, (2009). Listed firms to get new conduct code. Financial Chronicle, Retrieved from [link]

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