What is 'Voodoo Accounting'
Creative rather than conservative accounting practices. Voodoo accounting employs numerous accounting gimmicks to artificially boost the bottom line by inflating revenue or concealing expenses or both. The origin of the term “voodoo accounting” probably lies in the fact that once the accounting gimmicks come to light, the purported profits disappear like magic. Investor reaction to news that a company has been engaged in voodoo accounting depends on the magnitude of the offense. While minor, one-time accounting gimmicks may be ignored by investors, substantial repeat offenses would affect the company’s market value and reputation.
BREAKING DOWN 'Voodoo Accounting'
Some of the voodoo accounting practices identified by former SEC chairman Arthur Levitt at the height of the dot-com bubble in September 1998 include:
- “Big bath charges,” in which a company improperly reports a one-time loss by taking a huge charge to mask lower-than-expected earnings.
- “Cookie jar reserves” used by a company for income smoothing.
- Recognizing revenue before it is actually collected.
- “Merger magic,” whereby a company writes off all or most of an acquisition's price as “in process” research and development.
For example, a company may employ voodoo accounting to prematurely recognize $5 million of revenue and conceal $1 million of an unexpected expense. These tactics enable it to report net income of $2.5 million for the quarter. But a diligent auditor discovers these items in a year-end audit, and the company is forced to restate its results to show a net loss of $500,000, rather than the net income of $2.5 million reported earlier through voodoo accounting.