While in the kitchen you might like to have your cookies stored away in a special container, in the world of finance, cookie jar accounting is forbidden. This practice involves companies making use of reserves from good years as hedges against losses that occur during bad years. The United States Securities and Exchange Commission prohibits this financial practice because it misrepresents the company’s financial status to investors.
Here is a way to better understand the concept. Let’s say that company A has a large expense during the 1st quarter, a period in which profits were marginal. Rather than report that expense in the proper quarter they wait and report it in the 2nd quarter when profits were high. This looks better because the company can still show a profit even with this loss of income in that period.
For the potential investor the company looks as if it is consistently making a profit – the overall picture has been “smoothed” out, especially if it takes place over several years. An investor is much less likely to invest in a company that shows dramatic profits and losses in rapid succession. The reserve held by such companies during good years is often called their “cookie jar reserve.”
The term itself hearkens back to an era when people functioned on a cash basis and any money left over from the monthly expenses would be stored in anticipation of additional expenses later on. Often the money would be kept in an empty coffee can or a cookie jar, thus the name.
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