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.

RELATED TERMS
  1. Development To Policyholder Surplus

    The ratio of an insurer’s loss reserve development to its policyholders’ ...
  2. Income Smoothing

    The use of accounting techniques to level out net income fluctuations ...
  3. Inventory Accounting

    The body of accounting that deals with valuing and accounting ...
  4. Provision For Credit Losses - PCL

    In accounting, an estimation of potential losses that a company ...
  5. Cushion Bond

    A type of callable bond that sells at a premium because it carries ...
  6. Net Income - NI

    1. A company's total earnings (or profit). Net income is calculated ...
Related Articles
  1. Investing

    Spotting Creative Accounting On The Balance Sheet

    Companies have ways of manipulating their balance sheets that investors should be aware of.
  2. Markets

    What's a Run Rate?

    Run rate is a term used to denote annualized earnings extrapolated from a shorter time frame. Management uses the run rate to estimate future revenues.
  3. Investing

    Look For These Red Flags In The Income Statement

    Companies can overstate their revenues and understate their losses to boost investor confidence. Learn how to spot the these red flags in income statements.
  4. Investing

    Understanding the Income Statement

    The best way to analyze a company—and figure out if it's worth investing in—is to know how to dissect its income statement. Here's how to do it.
  5. Investing

    Understanding Deferred Income Tax

    Deferred income tax is a liability on a balance sheet that reflects income tax that is allocable to the current period, but has not yet been paid.
  6. Markets

    What You Should Know About Inflation

    Find out how this figure relates to your investment portfolio.
  7. Retirement

    Common Clues Of Financial Statement Manipulation

    Search for the "bloody" fingerprints in accounting crimes.
  8. Markets

    How Does National Income Accounting Work?

    National income accounting is an economic term describing the system used by a country to gather data and determine aggregate economic activity.
  9. Retirement

    3 Ways Retirees Can Generate Income From Investments

    Retirement can last a long time, which means people not only have to save for retirement but see it generate income. Thankfully there’s lots of ways to do that.
  10. Managing Wealth

    Top 8 Ways Companies Cook the Books

    Find out more about the fraudulent accounting methods some companies use to fool investors.
RELATED FAQS
  1. What is accounting fraud?

    Learn what accounting fraud is, why a company commits account fraud and some types of accounting fraud that misrepresent ... Read Answer >>
  2. What are some of the limitations of run rates?

    Understand what a run rate is and why a company would look to calculate it. Learn about the various limitations of relying ... Read Answer >>
  3. How do you find the break-even point using a payback period?

    Understand what a company's breakeven point is and what its payback period is. Learn why a company would want to track both ... Read Answer >>
  4. What is being adjusted in "adjusted net income"?

    Understand the difference between net income and adjusted net income, including which items factor into the adjustment and ... Read Answer >>
  5. When does Q2 start for most companies?

    Learn about the fiscal year of different companies and when the second quarter begins. Explore why analysts often prefer ... Read Answer >>
  6. What is the difference between gross income and earned income?

    Being able to distinguish between earned income and gross income is an important tool in preparing for and filing your individual ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center