Voodoo Accounting

What Is Voodoo Accounting?

The term voodoo accounting alludes to a creative and unethical method of accounting that falsely inflates figures found on a company's financial statements. Voodoo accounting utilizes various accounting contrivances to help the bottom line by swelling revenue, covering expenses, or both.

The individual accounting moves utilized in voodoo accounting might be minor, and one-time accounting tricks might be disregarded by investors. Notwithstanding, repeat offenses frequently influence the company's market value and reputation for the more terrible.

How Voodoo Accounting Works

As verified above, voodoo accounting portrays the stunts a company might use to conceal its losses and inflate its profits. The explanation for the name is basic — profits and losses appear to show up and vanish utilizing accounting contrivances magically.

This interaction isn't just amateurish, but at the same time it's unethical. That is on the grounds that companies that utilization this technique purposely misdirect investors and analysts into accepting that they're substantially more profitable than they actually are. Accounting stunts are difficult to pull off for companies exposed to higher levels of analysis. It is among more modest, less followed public companies that voodoo accounting can be more common.

Creative accounting techniques are not new. In fact, they've existed for a really long time. A portion of the voodoo accounting practices distinguished by former Securities and Exchange Commission (SEC) Chair Arthur Levitt at the level of the dotcom bubble in the late 1990s included:

• Huge bath charges: This technique includes the inappropriate reporting of one-time losses. Companies do this by taking an enormous charge to veil lower-than-anticipated earnings.
• Cookie jar reserves: This contrivance is involved by companies for income smoothing.
• Perceiving revenue before it is actually collected.
• Consolidation magic: When a company utilizes this stunt, it discounts all or the greater part of a acquisition price as in-process research and development (R&D).

Most companies participate in practices like voodoo accounting so investors don't lose confidence in them. All things considered, a profit is obviously superior to losses — especially when they're reliable. What's more, the pressure of meeting quarterly earnings expectations on Wall Street is likewise one more primary motivation for utilizing voodoo accounting. Be that as it may, when found, these stunts could have serious ramifications. Executive compensation and occupations are regularly in question, alongside a company's reputation and value in the market.

Special Considerations

As the accounting calling developed and regulators turned out to be more serious in upholding laws, voodoo accounting went under greater examination. This was especially true following the Enron scandal. The faltering energy and utility company utilized off-the-book accounting practices to fool shareholders and regulators into accepting it was profitable.

Enron utilized special purpose vehicles (SPVs) to conceal losses, toxic assets, and volumes of debt, consequently misdirecting the two its creditors and shareholders. The company petitioned for Chapter 11 and the scandal brought about fines and charges for a number of company executives.

The Enron scandal shook the financial world in light of the stunts that the company used to conceal bounteous measures of debt and toxic assets it was dealing with for quite a long time. Regulators considered Enron's actions alongside different instances of financial unfortunate behavior from any semblance of Tyco and WorldCom by passing the Sarbanes-Oxley Act of 2002. The law required reforms to regulations and furthermore set in stricter punishments for the people who committed financial fraud.

The Sarbanes-Oxley Act of 2002 was passed to guarantee companies are honest and transparent in their financial reporting.

Illustration of Voodoo Accounting

Here is a speculative illustration of how voodoo accounting functions. A company might utilize voodoo accounting to rashly perceive $5 billion of revenue while covering $1 billion in surprising expenses during a quarter.

These tactics empower it to report net income that is $6 million higher than the true figure for the quarter. This might have critical ramifications on the stock endless supply of the quarterly earnings report. Nonetheless, the discovery that these extra profits for the period were not real would rapidly delete a positive share price reaction and call into question management credibility.

Features

• The Sarbanes-Oxley Act of 2002 was passed in response to these scandals to reform regulations and implement stricter punishments on those responsible for fraudulent acts.
• Voodoo accounting is a shoptalk term for unlawful or unethical accounting practices that appear to magically work on a company's financial figures, swelling revenues and covering expenses — or both.
• Voodoo accounting practices went under examination after a series of accounting scandals became known including the falls of Enron, Tyco, and WorldCom.