What is Cookie Jar Accounting?

Cookie jar accounting occurs when a business sets up excessive reserves in profitable periods and draws down these reserves during lower-profit periods. The intent is to give the impression that the organization generates more consistent results than is really the case. When investors believe that a firm is able to consistently meet its earnings targets, they tend to place a higher value on its stock, which may be substantially higher than it is actually worth. Conversely, a business with variable results that does not use cookie jar accounting will report periods of large gains and large losses, which tends to drive away investors. Thus, a business that uses cookie jar accounting may be considered more valuable than a business that does not.

There is a greater temptation to use cookie jar accounting among publicly held businesses, since doing so can mislead analysts into issuing more favorable reports about them to the investment community. This approach to reporting earnings does not reflect actual results, and so can be considered fraudulent reporting.

Cookie jar reserves can be created either by over-estimating the more common reserves (such as for bad debts) or by taking large one-time charges for expected losses from one-time events, such as acquisitions or downsizings.

Example of Cookie Jar Accounting

Milagro Corporation has just gone public, and its CFO wants to report a consistent, gradual increase in profits to the investment community. In its first quarter of public reporting, a large sale generates $10 million of profits. Rather than reporting the full amount at once, the CFO greatly increases the company’s reserves for bad debts and obsolete inventory, and then draws them down over the next few quarters in order to report a modest quarterly profit increase in each successive quarter.

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FAQs

Where Did the Cookie Jar Accounting Concept Come From?

The cookie jar accounting concept originates from a metaphorical comparison to a cookie jar that a company dips into when needed. It refers to the practice of deliberately overstating reserves or liabilities during good financial periods, such as for bad debts, warranty expenses, or restructuring charges, creating a financial cushion that can later be reversed to boost earnings in weaker periods. This practice makes financial performance appear more stable or consistent than it truly is. The term became widely known during the late 1990s and early 2000s due to high-profile corporate accounting scandals, including those involving companies like WorldCom and Lucent Technologies, where regulators and auditors identified abuses of this tactic to manipulate earnings.