A cookie jar is a revenue-based scheme of financial statement fraud, focused on manipulating

revenue that exploits the timing of the revenue - it shifts revenue from accounting period to
another. More specifically, it involves pushing current revenue to future period, for example when
the involved company believes that it has been successful beyond expectations in the current
period, and there exists an uncertainty as to the future earning prospects, or its inability to match
or improve upon current periods success in the future. The management in that situation begins
accumulating reserves for the rainy day, and that the reserve can be dipped into and would bail
them out when a future periods revenue falls short of expectations, that is, when it gets wet. It is
like pulling a cookie from a jar when needed. Accordingly, it is used to smooth out the earnings
and make the companys operating performance seem more consistent than it factually is. If a
company is looking stable in it profit generating ability, it is favored as an investment vehicle in
the eyes of potential investors. Thus it stock prices in the market improve drastically - and so does
the managers chances of getting their annual bonuses.
Cookie jar reserve scheme involves understatement of earnings, especially when the management
believes it has already met the earning expectations of the current period, so that it can afford a
cushion in the subsequent periods. It can be achieved with help of contra-assets reserve accounts
or liability accounts. A company can use its liability reserves as cookie jar when its executives
inappropriately record decreases in an overstated liability account in order to smooth out the
earnings. For example, Symbol Technologies, Inc. establishes a liability account for a valid
reason - a special retirement plan for senior executives. Later, retirement benefits were exchanged
with another alternative policy of split life insurance. The normal procedure would then be to
take that liability off the books at the time of the exchange. However, it kept the liability on its
books waiting for an opportunity when it could be utilized in the future periods. Usually, these
liability reserves (especially the generic ones) are often grouped in a soft liability account
sometimes called other current liabilities or accrued expenses.
Contra-assets accounts could be used in the provision for Allowance for Doubtful accounts and
sales returns. The management use irrational assumptions to arrive at these estimated charges and
inflate these accounts, and later, cut back these charges or use provisions in accounting standards
such as IFRS to reverse previous charge (such as asset impairment). It could further utilize this
opportunity in the period of weak operating performance, thus providing funds in the sluggish
periods. As far as the estimates are within acceptable ranges, they are unlikely to be caught by
external auditors. Companies also use restructuring charges to lessen their reported growth, and in
so doing, both lowered the bar to meet future period market expectations and create reserves that
could be released when needed. The cookie jar scheme actually provides such companies with
more discretion over its future earnings.
Another example is of Freddie Mac. Freddie Mac, the big mortgage financier, used a variety of
cookie jar reserves to artificially smooth earnings by utilizing techniques to make its underlying
business of insuring and buying mortgages seem less profitable and to create a reserve of earnings
for later years.
The ethical implications of cookie jar reserves and its economic consequences can be drastic. In
such scenarios, the management fails to perform its professional duties with the required sense of
integrity. Their actions lack the interest of the stakeholders. If a cookie jar reserve involves
estimates, there is an issue of lack of rational and moral judgment. As a consequence, investors
are misled regarding companys performance and make wrong investment decisions. It negatively
affects the quality of earnings as it distorts the information in a way that hinders the shareholders

and investors ability for predicting future earnings and cash flows. Markets rely on trust. If the
shareholders and the investors lose faith in the numbers reported in the financial statements, it
will result in damaging capital markets. Investors should monitor soft liability accounts closely
and flag any sharp declines relative to revenue. Often, companies discuss these soft liabilities in a
footnote. Additionally, they need to intensify scrutiny of income measurement and reporting to
ensure the quality of earnings and investors confidence in the income statement.
Another revenue recognition scheme involving timing is premature recognition of revenue. It is
the opposite of cookie jar in the sense that it involves recognizing revenue too soon - it shifts
future revenue to current period. The reasoning behind this scheme is straightforward. A company
brings its future revenues backwards to the current period with an expectation of making up for
this difference in the subsequent period. Managers get involved in such a practice when the
companies begin to lag behind forecasted revenue expectations for some reason or the other. Of
course, the hope and assumption behind such a measure is that they feel they will always carve a
way to make subsequent period successful.
Any sales transaction consist of records such contracts, sales orders, journal entries, shipping
documents etc. One way is to alter one of such critical information - for example, keep the
accounting records open past the end of the accounting period. This scheme allows sale of the
subsequent period to be recorded as though it occurred in the preceding period. It was
straightforward when computers were not employed in the workplace when it was simply
accomplished by altering the date of transaction in the sales journal - for example, entering an
earlier date for the transaction. In a computerized environment, especially when enterprises are
automated with extensive resource planning systems like SAP and Oracle, it has become difficult,
if not impossible. However, overriding a computer-generated date or altering the computer
program itself can accomplish it.
For example, Computer Associates International, Inc. (CA) was involved in keeping the
accounting books open beyond the end of the quarter, and thus allowing sales contracts executed
after the quarter to be recognized as though they happened within the quarter just ended. CA
usually concealed these by having wrong dates on licensing contracts - usually the last date of the
quarter that has just ended. In effect, it regularly stretched out its month to 35 days on the books!
Of course, this practice allowed CA to meet analysts earnings expectations, and its stock profited.
Another technique utilized by CA to record premature revenue was to pull forward license sales
that would be earned for many years in the future. In this way, the management recorded a far
greater amount than was warranted. CA would also record long-term license contract, and
recognize the present value of that revenue of the entire contract lasting 5-7 years immediately.
Hence there was a huge difference between the net income and operating cash flow of the firm,
because of the large amounts of long-term receivables.
Economic reality of such transactions required revenue to be deferred until the billing period for
each installment sale, but CA was way off-track from this economic reality. Had the investors
known about the aggressive revenue recognition approach, and that license revenue was not that
attractive, they probably would have considered selling their stock immediately. That
misrepresentation of information dampened investors confidence in the market.

References:
1. Gerald M. Zack, Financial Statements Fraud
2. Howard Schilit, Financial Shenanigans

3. Revsine, Collins, Johnson, Financial Reporting and Analysis