Voodoo AccountingDefined with Examples & More

Written By:
Lisa Borga

What is Voodoo Accounting?

Voodoo accounting is a term that refers to a system of accounting through which a company’s profits can be inflated on its financial statements.

These methods are an unethical and, in some cases, illegal way to make the company appear to be performing better than it is.

In some cases, these accounting techniques may be a relatively minor misrepresentation that could be overlooked by analysts and investors.

However, in other cases, it can be used to significantly misrepresent a company’s losses or revenue and cause enormous damage to its reputation if discovered.

These tactics are often most associated with their notorious use by companies, including Enron, which caused an enormous scandal in the early 2000s.

How Voodoo Accounting Works

Voodoo accounting employs a wide variety of techniques that inflate revenues and disguise expenses.

When employed correctly, these techniques appear to make revenue appear, and expenses disappear like magic which is why these tactics are referred to as “voodoo.”

Some of these tactics include:

• Recognizing revenue before it is actually earned.
• Deferring recognition of certain expenses until a future accounting period.
• Creating large capital reserves that are sometimes referred to as a “cookie jar reserve” to create smoother reported earnings.
• Capitalizing expenses in order to expense them through depreciation over multiple accounting periods.
• Fabricating huge one-time charges to hide ongoing losses or less than anticipated earnings.
• Exaggerating the value of ending inventory in order to reduce the cost of goods sold.

A company may employ any of these techniques in order to cover expenses or inflate profits to deceive analysts and investors.

Why Would a Company Use Voodoo Accounting?

Voodoo accounting is not only unethical but often illegal, so why would a company use it?

The answer is to manipulate analysts and investors into thinking the company is performing much better than it is.

These practices have existed for many decades and are used in order to prevent a loss of public confidence in the company.

Through voodoo accounting, a company could appear to have smooth, consistent earnings even while losing money.

However, a company cannot make this last forever, and the use of these techniques by several companies, which resulted in an enormous collapse and associated scandal in the early 2000s, has resulted in much more scrutiny of companies’ financial reporting.

As a result, large companies typically face too high a degree of scrutiny to easily perform voodoo accounting practices, and it is thought to be performed more commonly by smaller, less scrutinized companies.

Enforcement of Voodoo Accounting

Accounting techniques have continued to evolve and become more accurate and effective at communicating a company’s actual financial standing.

Correspondingly government authorities have grown more committed to enforcing laws regarding the accuracy of companies’ accounting practices.

This became particularly true in the wake of the Enron scandal in the earlier part of the 2000s.

In the Enron scandal, the energy company employed unscrupulous accounting techniques, particularly special purpose vehicles, to hide its losses and failed investments while correspondingly raising enormous sums of money from investors using its fraudulently inflated stock prices.

However, this did not last, and Enron went from one of the largest and most highly valued companies in the U.S. to bankruptcy in only a few years.

The company filed for Chapter 11 bankruptcy, and the ensuing investigations revealed enormous numbers of tricks used to disguise its humongous amount of debt and toxic assets that it had held for years before its collapse.

This discovery shocked many in the financial industry, and several other similar incidents of unethical reporting practices during the same timeframe resulted in the government passing the Sarbanes-Oxley Act of 2002 in order to enforce stricter requirements on financial reporting practices.

Voodoo Accounting Example

As an example of voodoo accounting, consider the ABC Company.

This company has a team of accountants who are attempting to report the highest possible profits for the first quarter.

In order to do this, they choose to recognize one million in revenue that would only be realized in the following quarter now while deferring recognition of $500,000 in expenses.

By doing this, ABC Company can report $1,500,000 higher profits during the first quarter.

By reporting so much higher in profits than it actually made, ABC Company can likely inflate its stock prices.

However, if the deception is discovered, the company will likely face a great deal of negative attention that will more than offset any gains it made from the inflated earnings.

Further, the company, as well as its management, may face legal consequences for the fraudulent reporting practices.

Key Takeaways

• Voodoo accounting is a term referring to the unethical misuse and potentially illegal misuse of accounting techniques to inflate a company’s bottom line.
• These accounting techniques may affect investors’ view of a company, making them believe that they will receive better returns on investments, in turn leading more investors to buy into the company.
• In response to scandals caused by several companies, including most famously Enron using these tactics, the U.S. government passed the Sarbanes-Oxley Act of 2002 to create stricter requirements regarding the transparency of a company’s accounting practices.