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.

RELATED TERMS
  1. Michael S. Dell

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

    Absorbed as a business term generally refers to taking in, acquiring ...
  3. Original Equipment Manufacturer ...

    An OEM provides the components in another company's product, ...
  4. Voodoo Accounting

    Voodoo accounting is creative rather than conservative and proper ...
  5. Free Reserves

    Free reserves are the reserves a bank holds in excess of required ...
  6. Working Reserves

    Reserves held by banks above the required minimum level - or ...
Related Articles
  1. Personal Finance

    The Cookie Jar Method of Budgeting

    The cookie jar method of budgeting can get you on the path to saving and reaching financial goals.
  2. Investing

    Dell CEO Reports Q3 Results After EMC Acquisition

    After completing the largest tech merger to date, Dell's CFO says the firm is on track.
  3. Insights

    HP CEO Slams Dell on Excessive Debt (HPE)

    As HPE and Dell employ drastically different strategies to slim down versus beef up, Whitman points to the Dell balance sheet to ignite uncertainty.
  4. 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.
  5. 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.
  6. Investing

    Inside Intel: A Look At The Mega Chipmaker

    There's a very good chance that you've utilized an Intel chip today. Here's how the chipmaker became so ubiquitous.
  7. Investing

    VMware in $500M Stock Repurchase Plan With Dell

    VMware agreed to buy Class A common stock held by EMC Corp., which Dell bought for $67 billion.
  8. Tech

    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. Personal Finance

    Adam Dell Launches Clarity Money

    Adam Dell, entrepreneur and venture capitalist, talks about his new venture, Clarity Money, and why he helped bring it to market.
  10. Investing

    Why Do Investors Want Intel to Get Bigger? (INTC)

    For decades, Intel (NASDAQ: INTC) has been a colossus in the semiconductor world, with a dominant position in the chips that have made personal computers run nearly since their invention. Yet ...
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?

    Earnings management is a strategy to deliberately manipulate a company's earnings so that the figures match a pre-determined ... 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 are Apple's main competitors in tech?

    Explore Apple's competitive position in the many industries in which it operates. Learn about the different products and ... Read Answer >>
  5. What are the key barriers to entry for companies in the electronics sector?

    Learn how the entry barriers of economies of scale and scope, research and development, capital and brand loyalty affect ... Read Answer >>
  6. How are asset management firms regulated?

    Find out how the asset management industry is regulated and how those regulations fit within the broader scope of financial ... Read Answer >>
Hot Definitions
  1. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  2. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  3. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  4. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  5. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  6. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
Trading Center