Cookie Jar Accounting

What is 'Cookie Jar Accounting'

A disingenuous accounting practice in which periods of good financial results are used to create reserves that shore up profits in lean years. “Cookie jar accounting” is used by a company to smooth out volatility in its financial results, thus giving investors the misleading impression that it is consistently meeting earnings targets. This reliable earnings performance is generally rewarded by investors, who assign the company a premium valuation. Regulators frown on the practice since it misrepresents a company’s performance, which may be very different in reality from what it purports to be.

The term may be derived from the fact that a company which employs this practice dips into the “cookie jar” of reserves whenever it feels like it. But the company may have to pay a steep price if it is caught with its hand in the proverbial cookie jar.

BREAKING DOWN 'Cookie Jar Accounting'

One-time charges and special items are a couple of areas where a company can manipulate numbers to create cookie jar reserves. Potential investors should therefore scrutinize these numbers carefully before committing investment capital to the stock.

One of the best-known cases of cookie jar accounting in recent years was that of computer giant Dell, which in July 2010 agreed to pay a $100 million penalty to the Securities and Exchange Commission (SEC) to settle SEC allegations that it used cookie jar reserves. The SEC maintained that Dell would have missed analysts’ earnings estimates in every quarter between 2002 and 2006 had it not dipped into these reserves to cover shortfalls in its operating results. The cookie jar reserves were created through undisclosed payments that Dell received from chip giant Intel in return for agreeing to use Intel’s CPU chips exclusively in its computers. (Intel made these payments to Dell to lock out rival chipmaker Advanced Micro Devices from Dell computers.)

The SEC also said that Dell did not disclose to investors that it was drawing on these reserves. The Intel payments made up a huge chunk of Dell’s profits, accounting for as much as 72% of its quarterly operating income at the peak. Dell’s quarterly profits fell significantly in 2007 after it ended the arrangement with Intel. The SEC alleged that while Dell said the decline in profitability was due to an aggressive product-pricing strategy and higher component prices, the real reason was that it was no longer receiving the payments from Intel.

RELATED TERMS
  1. Michael S. Dell

    A long-time CEO and chairman of Texas-based computer company, ...
  2. Tech Street

    A term used in the financial markets and the press to refer to ...
  3. Controlling Interest

    When one shareholder or a group acting in kind holds a high enough ...
  4. Absorbed

    1. In a general business sense, when a cost is treated as an ...
  5. Voodoo Accounting

    Creative rather than conservative accounting practices. Voodoo ...
  6. Reserve Ratio

    The portion (expressed as a percent) of depositors' balances ...
Related Articles
  1. Managing Wealth

    Dell Stock Doesn’t Exist. Here is Why

    Learn why Michael Dell took his namesake company private after being publicly traded for 25 years. Discover why going private is helpful for the company.
  2. Markets

    What is an Original Equipment Manufacturer (OEM)?

    An OEM is a company whose products are used as components in another company's product.
  3. Investing

    Does the Dell/EMC Deal Make Financial Sense?

    Last week, Dell announced it would be buying IT provider EMC in a $67 billion deal, making it the largest technology deal ever.
  4. Insights

    Dell Agrees to IT Division Sale for $3 Billion

    NTT Data Corp, a subsidiary of Japan’s conglomerate Nippon Telegraph & Telephone Corp, agreed on Monday to purchase Dell Systems (formerly known as Perot Services), an IT consulting division ...
  5. Markets

    Intel Doesn't Need New Management

    Intel's purported manufacturing technology prowess has been completely squandered in the mobile arena, and the stock has been a disappointment.
  6. Trading

    Looking at Intel's Future Value (INTC)

    Reducing its dependency on slumping personal computer sales has been and continues to be Intel's top priority.
  7. Markets

    Is This Intel's Breakthrough Quarter? (INTC)

    Combined with various product cycle refreshes in both the datacenter and the PC client segments, Intel could be setting up for an upside surprise.
  8. Managing Wealth

    Dell Nears Purchase of EMC For $67B (EMC, VMW)

    What’s in it for Dell and also for EMC shareholders as the deal gets support from advisory firms?
  9. Investing

    The Biggest Risks of Investing in EMC Stock

    Read about some of the risks of investing in EMC now that its acquisition by Dell has been announced. There are issues with VMware and the firm itself.
  10. 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.
RELATED FAQS
  1. Who are Dell's main competitors?

    Learn about Dell's chief competitors in both the business and consumer computing sectors, and how the company has recently ... Read Answer >>
  2. What is earnings management?

    Before diving into what earnings management is, it is important to have a solid understanding of what we mean when we refer ... Read Answer >>
  3. Who are Intel's (INTC) main competitors?

    Explore Intel's many competitors in its six operating segments. Explore different niche companies and companies that compete ... Read Answer >>
  4. Who determines the reserve ratio?

    Understand what the Federal Reserve is and what it regulates in the U.S. economy. Learn about the reserve ratio and how the ... Read Answer >>
  5. How are bank reserve requirements determined and how does this affect shareholders?

    Learn how bank reserve requirements are determined and how bank reserves affect shareholders through improved bank stability ... Read Answer >>
  6. How do central banks acquire currency reserves and how much are they required to ...

    A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign ... 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