UNIT – I - INTRODUCTION OF AUDITING

Auditing – Meaning, Definition, Objectives of an audit – Primary & Secondary

objective, Case Laws on Audit Objectives, Types of Audit – Statutory & Independent Audit,
Meaning of errors, Classification of errors, Its detection by an auditor, Frauds – meaning,
intention, classification & detection by auditor and prevention of frauds by an auditor,
Window dressing of financial statements,
INTRODUCTION -AN OVERVIEW OF AUDITING:
Economic decisions in every society must be based upon the information available at
the time the decision is made. For example, the decision of a bank to make a loan to a
business is based upon previous financial relationships with that business, the financial
condition of the company as reflected by its financial statements and other factors. If
decisions are to be consistent with the intention of the decision makers, the information used
in the decision process must be reliable. Unreliable information can cause inefficient use of
resources to the detriment of the society and to the decision makers themselves.

In the lending decision example, assume that the barfly makes the loan on the basis
of misleading financial statements and the borrower Company is ultimately unable to repay.
As a result the bank has lost both the principal and the interest. In addition, another company
that could have used the funds effectively was deprived of the money.

As society become more complex, there is an increased likelihood that unreliable

information will be provided to decision makers. There are several reasons for this:
remoteness of information, voluminous data and the existence of complex exchange
transactions

ORIGIN AND EVOLUTION

The term audit is derived from the Latin term ‘audire,’ which means to hear. In early
days an auditor used to listen to the accounts read over by an accountant in order to check
them Auditing is as old as accounting. It was in use in all ancient countries such as
Mesopotamia, Greece, Egypt. Rome, U.K. and India.

The Vedas contain reference to accounts and auditing. Arthasashthra by Kautilya

detailed rules for accounting and auditing of public finances. The original objective of
auditing was to detect and prevent errors and frauds Auditing evolved and grew rapidly after
the industrial revolution in the 18th century With the growth of the joint stock companies the
ownership and management became separate.

The shareholders who were the owners needed a report from an independent expert on
the accounts of the company managed by the board of directors who were the employees. The
objective of audit shifted and audit was expected to ascertain whether the accounts were true
and fair rather than detection of errors and frauds.

With the increase in the size of the companies and the volume of transactions the
main objective of audit shifted to ascertaining whether the accounts were true and fair rather
than true and correct. Hence the emphasis was not on arithmetical accuracy but on a fair
representation of the financial efforts The companies Act.1913 also prescribed for the first
time the qualification of auditors

The International Accounting Standards Committee and the Accounting Standard

board of the Institute of Chartered Accountants of India have developed standard accounting
and auditing practices to guide the. accountants and auditors in the day to day work The later
developments in auditing pertain to the use of computers in accounting and auditing. In
conclusion it can be said that auditing has come a long way from hearing of accounts to
taking the help of computers to examine computerised accounts

DEFINITION

Spicer and Pegler: "Auditing is such an examination of books of accounts and

vouchers of business, as will enable the auditors to satisfy himself that the balance sheet is
properly drawn up, so as to give a true and fair view of the state of affairs of the business and
that the profit and loss account gives true and fair view of the profit/loss for the financial
period, according to the best of information and explanation given to him and as shown by
the books; and if not, in what respect he is not satisfied."

Prof. L.R.Dicksee. "auditing is an examination of accounting records undertaken with

a view to establish whether they correctly and completely reflect the transactions to which
they relate

MEANING OF AUDITING

Once we complete preparing the final statements and accounts for the year the accounting
process is over. However, we still cannot be completely certain of the accuracy of these
accounts. This is when the concept of auditing comes in. Let us see the audit meaning and
features of an audit.

AUDIT MEANING

The word “audit” is a very generic word, it essentially means to examine something
thoroughly. But we will be learning about auditing as it relates to accounting and the finance
world. So audit meaning is the thorough inspection of the books of accounts of the organization.

This involves the examination of vouchers and the verification of various assets of the
organization. And the person who carries out such an audit is known as the auditor.

OBJECTIVES OF AUDITING

A ) PRIMARY OBJECTIVES

THE PRIMARY OBJECTIVES OF AUDITING ARE AS BELOW;-

FAIRNESS OF STATEMENTS:

The purpose of auditing is to determine the fairness of statements. The financial

statements can show true and fair view after auditing. Due to limitations of financial
statements it is not possible to provide cent percent accuracy, So an attempt is made to
show the fair view of financial statements.
PRESCRIBED LAWS
The purpose of the audit is to check that prescribed laws have been followed
in the preparation of financial statements. There are various laws that govern the
working of many businesses. The auditor can indicate whether the prescribed laws
were followed in the preparation of final accounts.
ACCOUNTING POLICIES
The purpose of auditing is to examine the accounting policies. There is need to
follow the accounting policies for preparing accounting records. The effective
accounting system can provide better results. The auditor can express an opinion on
the accounting policies in the best interest of business.
 INDEPENDENT OPINIO
The purpose of the audit is to express an independent opinion. The auditor
must be honest in his work. Management and other persons must not influence him
There must be high ethical standard for independent reporting.

B) SECONDARY OBJECTIVES
The Secondary objectives of auditing are as below;-

DETECTION OF ERRORS
The purpose of auditing is to detect the errors. The auditor can use ways and
means to find out errors in the accounting records. It is the duty of management to
avoid errors. The independent audit work is helpful for discovery and correction of
errors.
DETECTION OF FRAUDS:
The purpose of auditing is to detect frauds. The management is responsible
for the detection of frauds. The various types of fraud may be detected by an audit.
The management can take steps to correct the wrong effects of frauds for the benefit
of owners.
PREVENTION OF ERRORS
The purpose of auditing to errors. The errors can be prevented through
effective internal check- The mistake can occur due to heavy load work or
carelessness on the part of employees. There should be no extra burden of work on
each employee. The senior person should check the work of a junior person.
PREVENTION OF FRAUDS
The purpose of auditing is to Prevent frauds. In accounting, it includes
manipulation or alteration of records and misappropriation of assets, an omission of
the effects of the transaction from records or documents, recording of the transaction
without substance and misapplication of accounting policies. The effective internal
check is a useful tool to prevent frauds.
TYPES OF AUDIT
DIFFERENT TYPES OF AUDIT
As a brief recap, an audit examines your financial records and transactions to verify they are
accurate. Typically, audits look at your financial statements and accounting books to compare
information.
You or your employees may conduct audits. Or, you might have a third party audit your
information (e.g., IRS audits).
Many business owners have routine audits, such as once per year. If you are not organized or
don’t keep thorough records, your audits might take more time to complete.
Types of audits can vary from business to business. For example, a construction business
might conduct an audit to analyze how much they spent on a specific project (e.g., costs for
contractors or supplies).
Overall, audits help ensure your business is operating smoothly. So, what are the various
types of audit?

TYPES OF AUDIT (types on the basis of performance)

STATUTORY AUDIT

The auditing that is required by law for local authority about particular financial
statements for a specific type of entities is called statutory audit. The common examples of
statutory auditing are the that all banks’ financial statements are required to be audited
my proper audit firms which are approved by Central Bank. Statutory audit is conducted
only after approval by higher authorities and for the submission to official authorities.
PARTIAL AUDIT
This audit is done only for a specific purpose; for example, to check the receipt side of
the payment side of the cash book, to check cash sale, to check purchases or expenses
only. A partial audit is concerned with the part of accounting books and records or part of the
year.

CASH AUDIT
Full or partial audit of cash transactions over a specific period, to determine if (1)
all cash received is properly recorded, (2) all disbursements are properly authorized and
documented, (3) recorded cash balance matches cash on hand and/or on deposit.
INTERIM AUDIT
An audit which conducted in between the two annual audits with a view to find out
interim profits to enable the company to declare an interim dividend is known as Interim
Audit. It is a kind of audit which is conducted between the two periodical or balance sheet
audits.
BALANCE SHEET AUDIT
They compare the information in the financial statement with third-party
documentation. For example, auditors will determine if the assets and liabilities found in
the balance sheet exist. They confirm that the assets legally belong to the company and the
liabilities properly attach to the firm
COST AUDIT
cost audit comprises the following; Verification of the cost accounting records such as
the accuracy of the cost accounts, cost reports, cost statements, cost data and costing
technique. Examination of these records to ensure that they adhere to the cost accounting
principles, plans, procedures and objective.
OCCASIONAL AUDIT
Audit means checking the accounts prepared by others with a view of express an
opinion. The occasional audit is conducted when there is need of it.
TYPES (on the basis of organization)
1. Private audit
2. Audit under statue
3. Government audit
4. Internal audit

PRIVATE AUDIT
1. AUDIT FOR SOLE TRADING ORGANIZATION
For individual organizations auditing is not compulsory, some large or
medium scale organization if the proprietor or promoter they want to very his or her
company accounts individually they can appoint and auditor for the company they
can verify all the account statements
AUDIT FOR PARTNERSHIP
 Like audit for sole trading organization auditing is not compulsory for
partnership. if the partners they want to know the fairness of the accounts yes they can
verify all the accounts with the help of auditor
AUDIT FOR OTHER PRIVATE INSTITUTIONS
Auditing is not compulsory other private institutions because they are
professionals like Doctor, lawyer, consultant etc. for tax purpose they need to conduct
audit
2. AUDIT UNDER STATUE
Statutory Audit as the name suggests is a compulsory audit for all companies.
Every entity which is registered under the Companies Act, as a Private Limited or
a Public Limited company has to get its books of accounts audited every year. This type
of audit is not conditional, it depends upon the entity type.
1. Audit of a public corporation
2. Audit of join stock companies
3. Audit of trust
4. Audit of banks
5. Audit of co-operative society
Audit of a public corporation
These types of institutions were instituted by passed a special resolution in the house
of parliament. Eg reserve bank of india, LIC, this type of institutions or organization we
may call it as a autonomous corporation . how to audit and what are all the procedure are
their everything was gave by Indian government according to that they have to submit the
auditing reports to the government
Audit of join stock companies
audit is a statutory requirement for joint stock company. ... Audit is done to ensure
whether the balance sheet and profit & loss are drawn as per the Companies Act and it
represents true and fair view of the financial position of the company.
Audit of trust
It is mandatory for a trust to file return of income electronically with or without
digital signature. ... However, a trust liable to get its accounts audited under section 44AB
shall furnish the return electronically under digital signature.
Audit of banks
Auditing is not compulsory for banking institutions because banks are comes under
banking act not company audit but the bank individually appoint auditor and they can verify
all the accounting statements.

Audit of co-operative society

Auditing is not compulsory if they want they can verify suppose the total turenover is
more than 1 crore the auditing is compulsory otherwise not required
ERRORS
What is An Error?
An error refers to unintentional mistakes in financial information, such as (a)
mathematical or clerical mistakes in the underlying records and accounting data (b) oversight
or misinterpretation of facts or (c) misapplication accounting policies. The accounting staff
may make mistake without knowing it.
The responsibility of errors lies on the head of management. An attempt is made to
write up error-free accounts. There are various ways to eliminate errors from the books of
accounts. The independent audit is one of these ways, The auditor must use skill and care to
locate errors. The books must be rectified. so that financial statements may show true and fair
view about business matters.
DEFINITION
An error represents an unintentional misstatement of the financial statement. it may be
material or immaterial. Fraud represents an intentional misstatement of the financial
statement which can be material or immaterial. Fraud takes place when you find evidence of
intent to mislead.
UNDERSTANDING ACCOUNTING ERRORS
Accounting errors are unintentional book-keeping errors and are sometimes easy to
identify and fix. For example, if the debits and credits don't add up to the same amount in
the trial balance, an accountant can easily see what account is inaccurate. The trial balance is
a type of worksheet that accountants use to record the debit and credit entries. The totals from
the trial balance are later carried over onto the financial statements at the end of the reporting
period. However, there are instances where accounting errors exist, but the trial balance is not
out of balance, which can be more difficult to identify and fix the errors.
 CLASSIFICATION OF ERRORS

CLERICAL MISTAKES | ERROR

ERRORS OF OMISSION
There is an error of omission when an entry is omitted as a whole. This
error cannot affect the trial balance. The debit and credit aspects are altogether
neglected. In partial omission, one account may be complete but other accounts may
be omitted In this case the trial balance will not agree.
ERRORS OF COMMISSION
There is an error of commission when wrong accounts are entered either in
the journal or in the ledger or when the totals are wrongly made, or when the posting
is done to wrong accounts. There is no effect on trial balance.
COMPENSATING ERRORS
There are compensating errors when one account is wrongly debited for a
certain amount and another account is wrongly credited for. the same amount. In fact,
there are two mistakes Of the same amount. One error is compensating the other error.
ORIGINAL ENTRY ERRORS
There is an error of original entry when correct amount is not recorded. The
wrong figures are used in recording the transaction. The amount of vouchers does not
tally with the amount of journal entries.
REVERSAL ERRORS
There is reversal error when a debit account is credited and credit account is
debited. There is a wrong analysis of transaction by accounting staff. There is no
effect of this entry on trial balance.
ERRORS OF DUPLICATION
There is an error of duplication when entry is passed twice. One employee
may record one entry and another employee may record another entry for the same
voucher. In this way, the accounting clerk commits the error of duplication.
ERRORS OF POSTING
There is an error of posting when a transaction has been journalized or
recorded in a subsidiary book but has been posted wrongly in the ledger account.
Goods sold to R on credit for Rs.500 have been posted in R account as Rs.50. Goods
purchased from Rashid for 20 have been posted to Rasheed account.
 ERRORS OF CASTING
Casting errors occur due to short casting or excess casting. if any subsidiary
book or in any account in the ledger. These errors are reflected in the trial balance
unless it is compensated by other errors.
TRIAL BALANCE ERRORS
There is trial balance error when a debit balance is placed on credit side or
vice versa. There may be an omission of one account from the trial balance. Another
account may be written twice in the trial balance.
ERRORS OF PRINCIPLE
WRONG ALLOCATION
The errors of principle consist of wrong allocation of expenses Between
capital and revenue items. The capital items can be treated as revenue and vice
versa. The carriage paid on machinery account may be charged to the carriage
account. The errors cannot affect the trial balance,
OMITTING OUTSTANDING ASSETS
The error of omission relates to an omission of outstanding assets. These
assets include prepaid insurance, prepaid taxes, prepaid rent, prepaid interest;
salaries paid in advance, accrued income, rent receivable, interest receivable and so
on.
OMITTING OUTSTANDING LIABILITIES
The outstanding liabilities include wages unpaid, carriage outstanding, rent
due, tax payable, commission payable, interest payable and unearned income.
WRONG VALUATION
There may be the wrong valuation of floating and fixed assets. The current
assets may not be valued at cost or market rule. The fixed assets may not be valued at
cost less depreciation. Such valuation does not affect the trial balance.
RECORDING EXPENSE AS INCOME
There is a recording of expense as income or vice versa. The commission
expenses can be recorded as income. The interest expense can be stated as income.
The true and fair view of business matters cannot be stated
CONCEALING EXPENDITURE HEADING
There may be concealing title of expenditure account. The repair to
machinery may be charged to depreciation account. The advertising expenses may be
 recorded as assets. The actual head of expense is not disclosed.
POSTING TO WRONG ACCOUNT
There may be posting of a transaction to the wrong account. The purchase of
machinery may be purchased account. The repair of a building can be posted to It
does not affect the trial balance. The truth cannot be stated in accounts.
LOCATION OF ERRORS
1. The auditor must recheck the total of trial balance. The debit column total and credit
column total may not tally.

2. . The auditor can see that all entries appearing in the books of original entry have
been posted.
3. The auditor can collect the list of debtors from management. He can compare it with
the total stated in the trial balance,
4. He auditor can receive the schedule of creditors from the management. He can tally
it with the balance stated in the trial balance.
5. The auditor must check the’ totals of accounts appearing in the accounting books
and records.
6. The trial balance can be examined in order to note that no account is appearing twice
in it,
7. The account appears in the ledger may not be transferred to trial balance. The auditor
can see that no account is missing.
8. The auditor can check the total of cashbook, He can compare this total with the
balance appearing in the trial balance.
9. .The auditor should check the total of purchase journal. He can compare such total
with the amount appearing in the trial balance. 10.The total of sales books can be
examined. The total of sales journal can be matched with the amount appearing in the
trial balance.
10. The auditor can check the posting made to the ledger. The difference in posting can
be noted.
11. The portal entries can be examined to test the truth in the journal. The wrong entries
should be traced to find the true position.
12. The auditor can find the exact difference appearing in the trial balance. The account
of the same amount may be traced.
13. The difference may be doubled. The account of such amount may be traced,
 14. The auditor can find out the difference. It should be divided by 9. In this case, there
may be a transposition of figures.
15. The auditor should note the opening balance appearing the ledger account. The last
year account can be checked for tracing correct balance.
16. The auditor can check casting, posting and taking out balances in the books of
accounts. Thorough checking can help the auditor.

FRAUDS – MEANING, INTENTION, CLASSIFICATION & DETECTION BY

AUDITOR AND PREVENTION OF FRAUDS BY AN AUDITOR
Theft of cash receipts and petty cash and showing fictitious payment to workers,
creditors, purchases, etc. Showing false payments or excess payments in cash book. ... Cash
sale can be shown as credit sale.
What is Fraud?
Fraud is defined as the intentional false representation or concealment of a material
fact for the purpose of inducing another to act upon it to his or her injury (as defined by the
American Institute of Certified Public Accountants).

The main objective of auditing is to ensure the financial reliability of any

organization; detection of fraud is just an incidental object.

Independent opinion and judgement form the objectives of auditing. The job of an
Auditor is to ensure that the books of accounts are kept according to the rules stipulated in
the Companies Act; an Auditor also needs to ensure whether the books of accounts show a
true and fair view of the state of affairs of the company or not.

The following are the three distinct types of fraud −

 Misappropriation of Cash

 Misappropriation of Goods

 Manipulation of Accounts

MISAPPROPRIATION OF CASH

Misappropriation of cash is the easiest way of fraud especially in large business houses
where there is limited or no communication between the owner of an organization and the
cashier. Following are some of the ways through which embezzlement or misappropriation
can be done −
  Theft of cash receipts and petty cash and showing fictitious payment to workers,
creditors, purchases, etc.

 Showing false payments or excess payments in cash book.

 By using the Teeming and Lading method, the money received from any customer
can be pocketed and the money received from another customer can be shown as
money received from the former.

 Cash sale can be shown as credit sale.

Strict internal control system should be followed in receipts and payments of cash so that the
work done by one person should be automatically checked by another person.

MISAPPROPRIATION OF GOODS

Misappropriation of goods can be done in the following ways −

 Goods may be stolen by employees or with the help of employees.

 By issuing false credit notes to customer on account of goods return.

Detection of misappropriation of goods is more difficult rather than detecting

misappropriation of money, especially where management is not much vigilant and sound
system of book-keeping, internal control and adequate system of securities are not available.
To keep control on the physical verification of goods, reconciliation of physical stock with
books and careful checking of sale and purchase is must.
MANIPULATION OF ACCOUNTS

Two types of manipulation of accounts are mainly done by top management to mislead
some parties for some specific purpose.

 Showing higher profits − Following are the reasons behind showing higher profit
than actual −

o To obtain credit or to enhance existing credit from financial institutions and

also to show credit worthies to suppliers of the company.

o To maintain confidence of shareholders.

o To hike the market price of shares of the company and enable the sale of those
at higher price, it may be done by declaring higher dividends on shares.
 o To get more commission where commission is calculated on the basis of
profit earned.

o To declare dividend at higher rate.

 Showing low profits − Following are the reasons behind showing lower profit than
actual −

o To avoid or to reduce Direct Taxes of the company (Income Tax, Wealth

Tax).

o To purchase shares at lower price.

o To give wrong impression to the other competitors of the business.

MANNER OF MANIPULATION OF ACCOUNTS

Manipulation of accounts may be done in the following ways −

 Window dressing is a manipulation or miss-representation of financial data in such a

way that it seems better than what it actually is. Some of the method of window
dressing is given as hereunder.

o ver valuation of closing stock

o Under valuation of Liabilities or Over-valuation of assets

o Purchases and expenses of current year may be deferred to next financial year

o Charging revenue expenses as capital expenditure

o Sale and other incomes of preceding year may be shown as income or sale of
the current year.

 Secret reserves of previous years may be used in the current financial year to inflate
the profit or secret reserves may be created to suppress the profit of the current
financial year.

 Stock may be under or overvalued. Income and sales may be suppressed or inflated.
Expenses and purchases may be suppressed or inflated.
DETECTION OF FRAUD AND ERROR : DUTY OF AN AUDITOR

AAS-4, “Auditors Responsibility to Consider Fraud and Error in an Audit of Financial

Statements”, deals at length with the auditor’s responsibilities for the detection of material
misstatements resulting from fraud and error when carrying out an audit of financial
information and to provide guidance as to the procedures that the auditor should perform
when he encounters circumstances that cause him to suspect, or when he determines, that
fraud or error has occurred. Broadly, the general principles laid down in the AAS may be
noted as under:

1) In planning and performing his examination, the auditor should take into
consideration the risk of material misstatement of the financial information caused
by fraud or error. He should inquire of management as to any fraud or significant
error which has occurred in the reporting period and modify his audit procedures, if
necessary.
2) If circumstances indicate the possible existence of fraud or error, the auditor should
consider the potential effect of the suspected fraud or error on the financial
information. If the auditor believes the suspected fraud or error could have a material
effect on the financial information, he should perform such modified or additional
procedures as he determines to be appropriate.
3) The auditor should satisfy himself that the effect of fraud is properly reflected in the
financial information or the error is corrected in case the modified procedures
performed by the auditor confirm the existence of the fraud. In case auditor is unable
to obtain evidence to confirm or dispel a suspicion of fraud, the auditor should
consider relevant laws and regulations and may wish to obtain legal advice before
rendering any report on the financial information or before withdrawing from the
engagement.
4) The reporting responsibilities would also include communicating with management.
When those persons ultimately responsible for the overall direction of the entity are
doubted, the auditor may seek legal advice to assist him in the determination of
procedures to follow. The auditor should also consider the implications of the
circumstances on the true and fair view which the financial statements ought to
convey and frame his report appropriately.
5) Where a significant fraud has occurred the auditor should consider the necessity for a
disclosure of the fraud in the financial statements and if adequate disclosure is not
 made, the necessity for a suitable disclosure in his report. AAS 4, “Auditor’s
Responsibility to Consider Fraud and Error in an Audit of Financial Statements”, by
way of example lists certain risk factors and circumstances relating to possibility of
fraud which may be considered by the auditor are dealt in the following paragraphs.
Examples of Risk Factors Relating to Misstatements Resulting from Fraud: The
fraud risk factors identified below are examples of such factors typically faced by
auditors in a broad range of situations. However, the fraud risk factors listed below
are only examples; not all of these factors are likely to be present in all audits, nor is
the list necessarily complete. Furthermore, the auditor exercises professional
judgment when considering fraud risk factors individually or in combination and
whether there are specific controls that mitigate the risk

Fraud Risk Factors Relating to Misstatements Resulting from Fraudulent Financial

Reporting: Fraud risk factors that relate to misstatements resulting from fraudulent financial
reporting may be grouped in the following three categories:

1. Management's Characteristics and Influence over the Control Environment.

2. Industry Conditions.
3. Operating Characteristics and Financial Stability.

For each of these three categories, examples of fraud risk factors relating to
misstatements arising from fraudulent financial reporting are set out below:

1. Fraud Risk Factors Relating to Management's Characteristics and

Influence over the Control Environment:

A. These fraud risk factors pertain to management's abilities, pressures, style,

and attitude relating to internal control and the financial reporting process.

There is motivation for management to engage in fraudulent financial

reporting. Specific indicators might include the following:

A significant portion of management's compensation is represented by

bonuses, stock options or other incentives, the value of which is contingent upon the
entity achieving unduly aggressive targets for operating results, financial position or
cash flow.

There is excessive interest by management in maintaining or increasing the

entity's stock price or earnings trend through the use of unusually aggressive
 accounting practices. Management commits to analysts, creditors and other third
parties to achieving what appear to be unduly aggressive or clearly unrealistic
forecasts. Management has an interest in pursuing inappropriate means to minimize
reported earnings for tax-motivated reasons.

B. There is a failure by management to display and communicate an

appropriate attitude regarding internal control and the financial reporting process.
Specific indicators might include the following: ♦

 Management does not effectively communicate and support the

entity's values or ethics, or management communicates inappropriate
values or ethics.
 Management is dominated by a single person or a small group without
compensating controls such as effective oversight by those charged
with governance.
 Management does not monitor significant controls adequately.
 Management fails to correct known material weaknesses in internal
control on a timely basis.
 Management sets unduly aggressive financial targets and expectations
for operating personne

WINDOW DRESSING OF FINANCIAL STATEMENTS

Window dressing in accounting means an effort made by the management to improve
the appearance of a company's financial statements before it is publicly released. It is a
manipulation of financial statements to show more favorable results of the business. It is done
to mislead the investors.
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. Examples of window dressing are:
  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

These actions are taken shortly before the end of an accounting period.
The window dressing concept is also used by fund managers, who replace poorly-
performing securities with higher-performing ones just before the end of a reporting
period, to give the appearance of having a robust set of investments.

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.