What Are Cookie Jar Reserves?
Cookie jar reserves are savings from previous quarters that a company records as earnings in subsequent quarters to make it appear that its earnings were higher than they really were. When a company fails to meet its earnings target, a company accountant can dip into the cookie jar to inflate the numbers.
Needless to say, the practice of cookie jar accounting is frowned on by government regulators as it misleads investors on the company's performance.
Understanding Cookie Jar Reserves
Wall Street values companies that consistently meet or beat their earnings targets quarter after quarter. Analysts rate them highly and investors pay a premium for their stock shares.
- Cookie jar reserves are chunks of income that a company keeps hidden in order to report them in a future quarter when its performance fails to meet expectations.
- A company may even create a liability in one quarter in order to erase it from a later quarter in order to disguise poor results.
- Cookie jar accounting deliberately misleads investors and violates accepted public company reporting practices.
They tend to be valued more highly than companies that have the potential to earn spectacular amounts of money in some quarters but fail in others.
Cookie jar accounting can be used to smooth out volatility in financial results and give a false impression of stability.
One line item in company reports, special items, is a particularly good place to hide a cookie jar accounting move. Special items may include any large payment or other income that the company expects to be a one-time event. Or, it may be a chunk of money from a previous highly lucrative quarter that the company has hidden in the cookie jar and is now using to inflate a poor earnings number.
Stuffing the Cookie Jar
An even more egregious variety of cookie jar accounting creates a liability in one quarter and then erases it from a subsequent quarter.
For example, in a genuinely great quarter, a company might add a vague and probably mythical liability to its earnings report. It could, say, record a $1 million liability for equipment it intends to buy. That $1 million liability goes into the cookie jar. The next time the company has a terrible quarter, it cancels its non-existent plan to buy equipment and lists the liability as income.
Example of Cookie Jar Accounting
One famous case of cookie jar accounting ended with the computer giant Dell paying a $100 million penalty to the Securities and Exchange Commission (SEC) in July 2010.
The line item "special items" is a good place to hide a transfer from the cookie jar.
The SEC argued that Dell would have missed analysts’ earnings estimates in every quarter between 2002 and 2006 had it not dipped into its reserves to cover the shortfalls in its operating results.
In this case, the cookie jar reserves reportedly consisted of undisclosed payments that Dell received from chip giant Intel in return for agreeing to use Intel’s CPU chips exclusively in its computers.
The SEC also alleged that Dell did not disclose to investors that it was drawing on these reserves.
In fact, the Intel payments made up a huge chunk of Dell’s profits, accounting for as much as 72% of its quarterly operating income at their peak. Dell’s quarterly profits fell significantly in 2007 after the arrangement with Intel ended.
The SEC also alleged that Dell claimed that the decline in profitability was due to an aggressive product pricing strategy and higher component prices, but the real reason was that it was no longer receiving payments from Intel.