Voodoo Accounting
Strategy companies use to inflate their profits in financial records
Voodoo accounting is a term used to describe unethical and “creative” ways of accounting. These methods are often used to manipulate numbers artificially, generally employed to inflate a company's financial statement.
These companies will use multiple tactics to find loopholes around their statements. They strive to make their profits appear larger while downplaying or concealing liabilities and losses. By using these inflated numbers, a company can make itself seem more valuable, attracting more investors.
These tactics are mainly used by smaller companies that are under minimal levels of scrutiny and analysis. Due to the limited attention they receive, these companies can manipulate figures without being caught.
Additionally, smaller companies benefit more by inflating their revenue. By seeming more appealing to investors, they have a higher chance of finding funding to expand and, in turn, increase actual revenue.
Fortunately, larger companies and blue-chip stock companies rarely use these tactics. Large companies are required to fill out financial statements truthfully. Nonetheless, these companies are also under large scrutiny.
If a large company was found lying about its profits, its reputation would be ruined, and it would most likely fail in the coming weeks. When investing in a company, look over publicly available financial statements.
If you can catch one instance of lying on a financial statement, it is a strong sign of internal problems within the company and its employees. Only good investments come from large companies that are truthful and ones that follow the law.
Key Takeaways
- Voodoo accounting is a strategy companies employ to inflate their profits in financial records.
- Accountants use multiple tactics to minimize losses, store savings, or materialize profits.
- The primary objective of this type of accounting is to gain investors' trust and confidence.
- Several laws and regulations have been implemented to combat these deceptive accounting practices.
How Voodoo Accounting Works
Companies engaging in voodoo accounting seem to conjure profits out of thin air while making losses mysteriously vanish.
However, this process is magical, highly unethical, and illegal. Companies use these tactics to falsify financial statements to lie to the government and deceive investors.
Some voodoo accounting practices may exploit legal loopholes but remain highly unethical and unjust to investors and competitors.
Although the risks of participating in practices like these are so high, most companies, even Wall Street companies, will to a certain degree, practice these accounting tactics. Pressure from quarterly reports and investors wanting to see high returns force these companies to use these tactics.
The most common way to perform Voodoo accounting is to employ a team of accountants. These accountants will collectively look at all financial reports, company profits, and liabilities to find the best possible profit report for the quarter or year.
These accountants will try to minimize any liabilities or cost the company could have incurred during that quarter or year. These include lawsuit expenses, supply expenses, wages, and executive bonuses.
By removing all these expenses, the profit can be increased. If there is less cost, the gross revenue used to cover these costs can be turned into profit for the quarter or year. A higher profit for a company is much more appealing to possible investors.
NOTE
Accountants assisting in such practices employ various tricks and exploit loopholes to eliminate or downplay less desirable expenses from the company's financial records.
This can trigger more people to start investing in the company, potentially expanding investors. But with more investors comes more scrutiny. Large companies that employ these tactics face significant risks if their practices are exposed.
Executive compensation, jobs, brand reputation, and other important parts of a company are all at risk when they are proven to falsify financial statements. Not only will they suffer social punishment, but they will most likely be in large legal battles against the company.
Examples Of Voodoo Accounting Tactics
Some multiple examples and tactics can be used in Voodoo accounting. These tactics involve enlarging profit numbers and minimizing or erasing losses and liabilities.
Below are some of the tactics that accountants can use:
1. Big Bath Charges
Big bass charges include manipulating the current year's financial statements to make the company's health seem worse than it is. This can be in the form of decreasing actual profits or inflating current liabilities or expenses.
While it may seem counterintuitive to make a company look worse, it is a deceptive tactic aimed at making future financial statements appear stronger by making the previous year's figures appear worse.
2. Cookie Jar Reserves
Cookie jar reserves are types of savings or financial write-offs that a company can store without placing on a financial statement and use as profit during the current financial year.
Whenever a company is experiencing a bad year and is losing profit, it can take savings out of this cookie jar reserve and write it down as profit. These reserves are used whenever a company needs to boost profits for a year.
NOTE
There are multiple ways to fill a cookie jar. There can be unreported profits that can be used in the future. For example, a company could write a liability such as a large purchase, and when the time comes, cancel the order and write it down as profit for the company.
These tactics act as a safeguard for most companies. By continuing a steady flow of profit and, in some instances, increasing the profit for one year, the company seems much more stable and desirable to investors.
3. Mergers
Mergers are often used to help grow a company. However, mergers in themselves are a prospective option and often attract investors because of the potential for an expansion of an already existing company.
When companies merge, there are often high costs for acquisitions or hostile takeovers. There can be fees to settle legal disputes and debts of the merging company. If these costs build up to become a large denomination, it could hinder the company.
NOTE
Mergers already attract a lot of attention and bring a lot of investments, more tactics can be used to maximize the benefit a merger can do for a company.
Not only will it hinder the company's savings, but it also will put it at risk. This high risk comes from the amount of capital spent securing the merger. This, in turn, will scare investors.
To remove this factor from mergers, accountants for a company will often write off most or all acquisition prices as research and development (R&D).
These tactics have one golden thing in common, to instill confidence within investors. All these practices either minimize liabilities or skyrocket profits. When a company's Financial reports show an increase in profit, investors are more likely to trust and invest in the company.
Enforcement of Voodoo Accounting
While unethical practices may sometimes go undetected, there are laws and regulations in place to limit the extent of such actions. These regulations aim to increase oversight of companies and require them to disclose their financial statements.
Although these laws attempt to do their best to limit the amount of fraud that occurs, it's impossible to eliminate all of it. Laws like these are only created when fraudulent financial statements are uncovered and brought to light.
These discoveries tend to happen years after statements were published. Because of this large time gap, it's often extremely hard for authorities and even governing figures to clamp down on these instances.
But there is some hope; laws like the Sarbanes-Oxley Act of 2002, also known as the SOX Act of 2002, mandated reforms for security regulations and added new penalties for accounting fraud.
NOTE
Read more about the full Sarbanes-Oxley Act of 2002 on the U.S. Congress Website.
The law was enacted after multiple scandals involving high-profile companies came to light. These companies included Enron Corporation, Tyco International, and WorldCom.These companies are found to have exited the financial statements and multiple other records.
Due to the high criticism from the companies, the SEC or the Securities Exchange Commission passed the law to regulate the companies in the future and stop future accounting fraud.
The law put into place restrictions and limitations on financial records. These include:
1. Senior Certification
Under Section 302 of the SOX Act, senior corporate officers certify in writing or signature that the financial statement complies with the requirements and regulations of the SOX.
Suppose any financial records are found to be fraudulent. In that case, all senior corporate officers certified on the financial statement will be liable and subject to criminal penalties, including fines and prison time.
2. Internal Control
The SOX Act of 2002 mandated that all companies establish internal controls and messages to report the accuracy and legitimacy of all financial records.
NOTE
Preventative and detective controls alongside the robust system of audit trails would help ensure that the company actively prevented financial fraud and, in the case of an investigation, actively sought out sources and possible sites of fraud.
3. Recordkeeping
To prevent future instances of fraud, companies must maintain comprehensive records of all financial statements, their sources, their recipients, and the individuals involved in their preparation.
This extensive library of knowledge ensures that no piece of a financial statement is unknown. This helps investigators track down any sources of fraud and allows companies to relinquish any unethical employees.
Summary
Accounting tactics like these are unethical and illegal practices that some companies still practice. These practices, although unethical, have been proven to boost a ompany's investors and stability.
Accountants that work on these projects work together to try and minimize losses and maximize profits. They use several tricks, including write-offs, rewriting purchases and losses, and using savings as profits.
Although some companies have specialized in these types of practices, there are efforts to minimize and stop them. Efforts have been made to curb such practices through regulations like the Sarbanes-Oxley Act of 2002.
These laws have made it simpler for investigators and investors to examine a company's financial statements. This allows them to decide whether a company is truthful or fraudulent.
NOTE
If governments do not take action, a well-prepared investor should always have a team of accountants or should personally look into the financial statements of any company they're thinking of investing in.
There are multiple ways an investor can look into financial statements. They can look at previous financial statements and audit trails and cross-reference them. They can also talk to other investors and see their thoughts.
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