Voodoo accounting definition
/What is Voodoo Accounting?
Voodoo accounting involves the use of aggressive accounting techniques to artificially inflate reported profits. This is done through a combination of revenue inflation and avoiding the recognition of expenses. The term is derived from how accountants use these techniques to make profits magically appear. When engaged in on a small scale, investors are unlikely to notice these practices. However, when they are used repeatedly to enhance reported earnings, investors may notify the regulators, whose investigations may lead to fraud charges.
Types of Voodoo Accounting Practices
There are a number of voodoo accounting practices, including the following:
Recognizing revenue before it is earned. This bolsters revenue in the short term, but at the expense of the revenue reported in subsequent periods.
Creating excessively large reserves and using them to smooth out reported earnings. This increases expenses in the short term, and reduces them over the long-term.
Deferring the recognition of expenses until a later period. This reduces expenses in the short-term and increases them over the long term.
Capitalizing expenses and charging them to expense through depreciation over a long period of time. This can defer the recognition of expenses for a long period of time, depending on the useful lives over which depreciation occurs.
Reporting large one-time charges that are supposedly associated with one-time events, in order to hide ongoing operating losses. This creates a massive short-term expense, and higher profits in subsequent periods.
Over-valuing ending inventory, to reduce the cost of goods sold. This reduces the cost of goods sold for just the current reporting period, and increases this expense in the next reporting period.
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Businesses are more likely to engage in voodoo accounting when they are trying to maintain a high stock price, achieve targeted earnings in order to pay out bonuses to management, or keep from having a loan called by the bank.
Example of Voodoo Accounting
The president of ABC International is granted 100,000 stock options by the board of directors, and so has an incentive to jack up the company’s stock price. To do so, he plans to artificially inflate the firm’s reported net income by $10 million. To achieve this, he commands the controller to lower the company’s capitalization level from $10,000 to $1,000, so that more expenditures are recorded as assets. He also mandates that the company’s allowance for doubtful accounts be reduced in size, so that bad debt charge-offs are pushed into later periods. He changes the organization’s rules for when to recognize revenue for its long-term servicing contracts, thereby shifting more revenue into the current year. The result is higher profits and happier investors who bid up the stock price. The president can now cash in his stock options for a substantial profit.