Accounting Cushion


DEFINITION of 'Accounting Cushion'

The overstatement of a company's expense provision, in order to create a cushion for future results. A company can use this to artificially understate income in the current period by overstating liability or allowance accounts. This will give the company the ability to overstate income in a later period. An accounting cushion can be achieved by increasing allowances for bad debts in the current period, without any indication that bad debts will actually rise. This would understate accounts receivable in the current period, and the company could make up for it in the next period by overstating accounts receivable. This is a method of income smoothing, and if discovered an auditor or analyst should adjust these back to their proper levels.

BREAKING DOWN 'Accounting Cushion'

You may be wondering why any company would want to understate income in any period. The reason is that some company's are expected to be very stable, and investors buy their stocks for that reason. Investors may expect company ABC to grow at 4% every period. If the company instead grows 6% in the first period, and declines 1% in the second, it would be bad for the perception of the stock. Investors may require a higher risk premium, therefore driving down the value of the stock. Management would rather understate the 6% growth and overstate income in the second period to smooth out the income. This may seem less harmful then some other, but misleads the investing public about the true stability of a company's income stream.

  1. Income Smoothing

    The use of accounting techniques to level out net income fluctuations ...
  2. Debt

    An amount of money borrowed by one party from another. Many corporations/individuals ...
  3. Risk Premium

    The return in excess of the risk-free rate of return that an ...
  4. Cash Discount

    An incentive that a seller offers to a buyer in return for paying ...
  5. Accounts Receivable - AR

    Money owed by customers (individuals or corporations) to another ...
  6. Liability

    A company's legal debts or obligations that arise during the ...
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