What’s (Financial) Window Dressing?

Financial managers can do certain things to increase or decrease net income recorded in the year. This is called profit smoothing, income smoothing, or just plain old window dressing. This isn’t the same as fraud or cooking the books.

Most profit smoothing involves pushing some revenue and expenses into other years than they would typically be recorded. A common technique for profit smoothing is to delay routine maintenance and repairs. This is referred to as deferred maintenance. Many routine and recurring maintenance costs required for autos, trucks, machines, equipment, and buildings can be delayed or deferred until later.

A business that spends a significant amount of money on employee training and development may delay these programs until the following year. Hence, the expense in the current year is lower.

A company can cut back on its current year’s outlays for market research and product development.

A business can ease up on its rules regarding when slow-paying customers are written off to expense as bad debts or uncollectible accounts receivable. The business can record some of its bad debts expense until the next reporting year.

A fixed asset that is not being actively used may have minimal current or future value to a business. Instead of writing off the un-depreciated cost of the impaired asset as a loss in the current year, the business might delay the write-off until the following year.

You can see how manipulating the timing of certain expenses can impact net income. Although companies can go too far in massaging the numbers to make their financial statements misleading, this isn’t illegal. For the most part, though, profit smoothing isn’t much more than robbing Peter to pay Paul. Accountants refer to these as compensatory effects. The effects next year offset and cancel out the effects in the current year. Less expense this year is balanced by more expense the following year.