What is Cookie Jar Accounting
Cookie jar accounting is 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 answer tough questions 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.
Example of Cookie Jar Accounting
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, but the real reason was that it was no longer receiving the payments from Intel.