Accounting Cushion

AAA

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.

INVESTOPEDIA EXPLAINS '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. Income Smoothing

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

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

    An incentive that a seller offers to a buyer in return for paying ...
  4. Debt

    An amount of money borrowed by one party from another. Many corporations/individuals ...
  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 ...
RELATED FAQS
  1. How does transfer pricing help business?

    Transfer pricing involves the trade of goods or services between two related companies, and both can come out the winner. ... Read Full Answer >>
  2. How do I calculate my effective tax rate using Excel?

    Your effective tax rate can be calculated using Microsoft Excel through a few standard functions and an accurate breakdown ... Read Full Answer >>
  3. How important are contingent liabilities in an audit?

    Contingent liabilities, when present, are very important audit items because they normally represent risks that are easily ... Read Full Answer >>
  4. How does quantifying fixed overhead volume variance show whether a company is profitable ...

    Fixed overhead volume cannot definitively prove a company is profitable, but it can be used to provide an excellent indication ... Read Full Answer >>
  5. What does inventory turnover tell an investor about a company?

    The inventory turnover ratio determines the number of times a company's inventory is sold and replaced over a certain period. ... Read Full Answer >>
  6. What is a deferred tax liability?

    A deferred tax liability is an account that is listed on a company's balance sheet and occurs when its taxable income is ... Read Full Answer >>
Related Articles
  1. Markets

    Material Adverse Effect A Warning Sign For Stocks

    Learn what this phrase means and how to spot it in a company's financial statements.
  2. Investing Basics

    The Importance Of Corporate Transparency

    Clear and honest financial statements not only reflect value, they also help ensure it.
  3. Fundamental Analysis

    Financial Footnotes: Start Reading The Fine Print

    Find out what could be hidden in this often-overlooked part of the financial statements.
  4. Active Trading Fundamentals

    Evaluating A Company's Management

    Financial statements don't tell you everything about a company's health. Investigate the management behind the numbers!
  5. Options & Futures

    An Investor's Checklist To Financial Footnotes

    Footnotes to the financial statements contain very important information, but reading them takes skill.
  6. Economics

    What are Noncurrent Assets?

    Noncurrent assets are property that a company owns that will last for more than one year.
  7. Investing Basics

    How Much Do CPAs Make?

    If you're considering becoming a CPA, here's what you might expect to earn.
  8. Economics

    Explaining Activity-Based Costing

    Activity-based costing (ABC) is a managerial accounting method that assigns certain indirect costs to the products incurring the bulk of those costs.
  9. Economics

    What is a Contra Account?

    A contra account is an offset that reduces the value of a related account.
  10. Fundamental Analysis

    What is Quantitative Analysis?

    Quantitative analysis refers to the use of mathematical computations to analyze markets and investments.

You May Also Like

Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Productivity

    An economic measure of output per unit of input. Inputs include labor and capital, while output is typically measured in ...
  3. Variance

    The spread between numbers in a data set, measuring Variance is calculated by taking the differences between each number ...
  4. Terminal Value - TV

    The value of a bond at maturity, or of an asset at a specified, future valuation date, taking into account factors such as ...
  5. Rule Of 70

    A way to estimate the number of years it takes for a certain variable to double. The rule of 70 states that in order to estimate ...
  6. Risk Premium

    The return in excess of the risk-free rate of return that an investment is expected to yield. An asset's risk premium is ...
Trading Center