What is Voodoo Accounting
Voodoo accounting is creative rather than conservative and proper 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” lies in the fact that profits can be made to appear like magic with certain accounting tricks. 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
Creative accounting techniques have existed for decades. As the accounting profession evolved and regulators became more serious in enforcing laws, voodoo accounting came under greater scrutiny. Some of the voodoo accounting practices identified by former Securities and Exchange Commission (SEC) Chairman Arthur Levitt at the height of the dot-com bubble in the late 1990s included:
- “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 price as “in-process” research and development.
Example of Voodoo Accounting
For example, a company may employ voodoo accounting to prematurely recognize $5 billion of revenue and conceal $1 billion of an unexpected expense in a quarter. These tactics enable it to report net income that is $6 million higher than the true figure for the quarter. This may have significant implications on the stock price upon release of the quarterly earnings report. However, the discovery that these additional profits for the period were not real would quickly erase a positive share price reaction and call into question management credibility.
The pressure of meeting quarterly earnings expectations on Wall Street is the usually the primary motivator of voodoo accounting. Executive jobs and compensation are at stake. For companies that are subjected to higher levels of analysis, accounting tricks are hard to pull off. It is among smaller, less followed publicly-traded companies that voodoo accounting can be more prevalent.