What is window dressing? Explanation of fraudulent techniques, how to detect it, and how to investigate.

When window dressing is discovered, not only can the parties involved be held criminally liable, but it can also cause significant damage to the company. This article also explains the basics of window dressing, the main techniques, measures to prevent it, and how to detect it. It also introduces appropriate investigation methods in the event that it actually occurs.

What is window dressing?

Window dressing is the overstatement of a company's profits. It is an act of disguising income and expenses through fraudulent accounting procedures with the aim of gaining the trust of stakeholders by falsely claiming that the company is performing well.

What is reverse window dressing?

Reverse window dressing is the opposite of window dressing. The purpose is to reduce the amount of taxes to be paid, which is also illegal.

Reasons and Risks of Window Dressing and Reverse Window Dressing

Why do companies engage in illegal window dressing and reverse window dressing? We will explain the main reasons, background, and risks to which companies are exposed.

Main reasons for window dressing and reverse window dressing

-To obtain loans from banks
The most common reason, especially among small and medium-sized enterprises, is to obtain a loan from a bank. In many cases, they depend on banks for funding, and if their business condition is poor, they will face difficulties due to stricter borrowing conditions or suspension of new borrowing. Therefore, they try to make their business performance look good even if it means paying more taxes.

-To maintain listing or to take stock price action
This is a common reason for publicly listed companies to maintain their listing or to take stock price action. They do not want to be held accountable by shareholders, so they window dress their accounts to make it look like they are in good business condition.

-To reduce taxes
Reverse window dressing is often used to reduce taxes. The effective tax rate of corporate tax is approximately 30%, and companies are tempted to engage in the illegal act of reverse window dressing because they do not want to lose the profits they have earned and cannot run their business if they lose the profits.

Major Risks Posed by Window Dressing

-Imprisonment - subject to penalties
Criminal charges applicable to window dressing include illegal dividends, misstatement of securities reports, special breach of trust, and fraud. Imprisonment or fines, or both, may be imposed.

-Possibility of claims for damages.
A company can be sued for damages if its window dressing caused harm to a third party, such as a bank that was forced to provide a loan on terms that were far from normal or a shareholder whose stock price plummeted.

-Payment of additional taxes
If a company declares less tax than it owes due to a mistake or misunderstanding, it will be subject to an additional tax for underreporting. However, if the company maliciously cheats on taxes, as in window dressing, it will be subject to a heavy additional tax. The maximum tax rate for underpayment of additional tax is 15%, but the rate for heavy additional tax is extremely high at 35%.

Major methods of window dressing and reverse window dressing and measures to prevent them

The following is an explanation of the techniques used for window dressing and reverse window dressing, and the measures to prevent them.

Main methods used for window dressing and reverse window dressing

-Overstatement or fictitious recording of sales and inventories
Fictitious inventory that is not actually on hand is made to appear to be present, and inventories on the balance sheet are increased by reporting a lower cost of goods sold. Another tactic is to record sales by creating fictitious contracts with suppliers.

-Manipulation of costs and expenses
Another technique of reverse window dressing is to report company housing or company cars used for personal purposes as expenses, or to intentionally post sales that should have been reported in the current period to the following period or later.

-Creating multiple financial statements
In order to obtain favorable loans from financial institutions, some companies prepare multiple financial statements, not by manipulating figures, but by preparing multiple financial statements themselves. In one case, a company prepared separate financial statements for all of its correspondent banks.

Measures to prevent window dressing

-Strengthen the internal checking system
First of all, thoroughly inform employees of the fact that window dressing is a criminal act through compliance training and in-house education. It is also effective to set up an internal reporting desk. Then, it is important to strengthen the internal check system, for example, by ensuring that authority is not concentrated in a specific person or department so that the criminal act cannot be physically carried out.

-Availability of an accountant or tax accountant for consultation.
In addition to the company's internal checking system, utilize outside help, such as by voluntarily introducing accounting audits, which are mandatory for listed companies, etc., and having a professional certified public accountant look at the accounts. By using a tax accountant, you can also strengthen your external monitoring system. Having a tax specialist available for consultation at any time will make it more difficult for employees who are tempted to window dress their accounts to take action.

How to detect window dressing

Even with a check system in place, window dressing may still occur. This section explains how to detect window dressing, including points to look for in financial statements and effective investigations.

View Accounts Receivable, Accounts Payable, and Accounts Payable

In accounts receivable, estimate how many months of monthly sales is appropriate, and be careful if the amount is abnormally large. Conversely, if accounts payable and accrued liabilities are lower than usual, be wary.

View Inventory

Inventory adjustments are also common in window dressing. Increasing inventory can affect the cost to sales ratio and gross profit ratio. Be careful if gross profit margins suddenly improve.

See Suspense Payments and Loans

Pay attention to the contents and amounts of these accounts to ensure that expenses actually paid are not forcibly capitalized to reduce expenses and make profits appear higher.

Conduct a forensic investigation.

Once you find something suspicious, a thorough investigation is necessary. A "forensic investigation," which collects and analyzes not only financial statements but also data related to money and transactions, is effective.

Use "forensic investigation" when window dressing occurs.

If window dressing is suspected, a forensic investigation by a professional investigation company is effective. This section explains what kind of investigation it is and how to select an investigation company.

What is a forensic investigation?

A forensic investigation is a field of forensic science that collects and analyzes information stored on digital devices to reveal evidence of criminal or fraudulent activity.

Choose a forensic investigation company that specializes in forensic investigations with a proven track record.

It is recommended that forensic investigations not be conducted in-house, but rather by an investigation company. By utilizing the specialized software and know-how of an investigation company, an investigation can be conducted reliably, efficiently, and at a cost appropriate to the scale of the investigation.

AI-based survey companies can conduct surveys with high accuracy and speed.

The use of AI (Artificial Intelligence) has become indispensable in today's forensic investigations, which deal with enormous amounts of data. By having a small number of experts look through a small number of sample files and having AI learn decision criteria, a large amount of data can be sorted into potentially relevant and irrelevant categories. The simple data sorting work that must be done at the beginning of a survey can be done in a short time by a small number of people, which not only improves the efficiency of the survey, but also increases its accuracy by concentrating the resources of the experts.

For window dressing investigations, contact "FRONTEO," which has an established track record and technology for forensic investigations.

FRONTEO has been a pioneer in forensic investigations in Japan since its establishment in 2003, and has worked to solve a wide range of corporate problems.

By combining our experience in handling cases with our in-house AI engine, we have achieved a high level of accuracy and efficiency that no other company can match, including significant labor and cost reductions in document reviews through the use of our self-developed AI engine, KIBIT.

We have data centers in Japan and South Korea, and we have full security measures in place. We seamlessly provide services to our clients' headquarters, local subsidiaries, and law firms. We provide prompt support through our global operations.