What is Voodoo Accounting?
“Voodoo accounting” is a slang term that describes a system through which profits for a company can be inflated. Unscrupulous and/or flat-out illegal methods of financial record-keeping are used to bolster a company’s bottom line, in large part, to make current investors happy and to attract new investors.
Voodoo accounting may be used to hide a company’s losses or, in some other way, provide a misrepresentation of a company’s actual financial status. The term is a reference to the magical practice of voodoo. With voodoo accounting, money and/or money issues are magically made to appear or disappear.
Voodoo accounting first garnered true, critical attention and focus when the nefarious accounting tactics of companies such as Enron came to light in the early 2000s.
- Voodoo accounting is the use of inaccurate accounting techniques to bolster a company’s bottom line.
- Voodoo accounting manipulates how investors view a company, potentially leading them to believe they will reap better returns on their investment; such a false perception of a company may also lead new investors to dump substantial funds into a company.
- The Sarbanes-Oxley Act of 2002 required companies to be more transparent with their accounting tactics.
How It Works
To get a better sense of how voodoo accounting works, let us look at an example.
Let’s say that Company X employs a team of accountants collectively looking to submit the best possible profit report for the current quarter. They realize that they can report a profit of $2 million for the quarter, but only if they cover up a $750,000 expense to settle a lawsuit and $250,000 for supplies expenses. If they don’t make the expenses disappear, the company can only report $1 million in earnings for the quarter.
Clearly, investors are going to be happier with $2 million in profits, and new investors would be more likely to invest in a company that brings in $2 million per quarter. An accountant can utilize various unethical or illegal tricks to make unwanted expenses disappear from the quarter’s accounting figures.
Auditors will likely inevitably look through Company X’s report. Companies with significantly high profit margins and/or high profits per quarter tend to be scrutinized extremely closely. Once auditors discover the discrepancies, the fact that all the proper expenses for the quarter are still unreported, then the $2 million profit vanishes. The individuals responsible for the fraudulent accounting practice suffer the consequences.
Significance of Voodoo Accounting
While it may seem obvious, it’s important to grasp fully the significance of voodoo accounting. Unethically or illegally manipulating a company’s financial figures significantly affects a number of different elements. Primarily, false profit numbers make a company look substantially better than it is. It tricks investors into thinking they are or can be getting a much better payoff for their investments.
If reported profits are high enough, an investor may skew his investment portfolio to show weighty favor to a company that isn’t as financially successful as it appears. It leaves the investor open to significant financial losses.
The company reporting inaccurate profits is hurt as well. When its lies are discovered, it is subjected to close scrutiny by regulators, which may only be aware of one instance of voodoo accounting tactics. All of the company’s records will be scrutinized. All parties who participated will be held accountable. The company, as a whole, will be held accountable, especially in terms of public opinion.
The Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 was passed not long after voodoo accounting fell into the spotlight when Enron took center stage. The act was passed so that accounting practices were required to be more transparent. It also led to the creation of the Public Accounting Oversight Board, which regulates accounting firms that offer auditing services.
Companies – regardless of their size – serve the public and the individuals who invest in them. The use of unethical and unfair accounting tactics to report inaccurate financial figures can cause a huge impact on investors and on the company itself.
CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: