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SEC comment on use of 'cookie jar reserves'

The Securities and Exchange Commission (SEC) has cracked down on what the SEC fondly refers to as "cookie jar reserves." In the eyes of the SEC, 'cookie jar reserves' are estimated liabilities that are too high and unrealistic. Then these unrealistic accruals can be dipped into during the bad times; put a cookie away in the good times and take one out in the bad. This is a way to manage, or smooth earnings.

On the surface, earnings management via overaccruals sounds bad. However, is earning management such a bad phenomenon for investors?

Solution Preview

Managing earnings via over-accruals is an effective technique from the viewpoint of an investor. Market price changes in volatile equity markets can be minimized by smoothing out earnings. This plan can then provide a steady and solid view of a company. Wide swings in gross sales and net income can make investors or potential investors fearful.

Remember that the other side of an over-accrual entry will most likely affect the income statement, i.e. over-accruing accounts receivable will increase sales; over-accruing accounts payable will increase costs.

When investors sell a company's stock, or don't buy it, then ...

Solution Summary

In a 338 word, cited solution, the response provides a background in the use of the 'cookie jar reserves' including the effect to investors of smoothing out earnings with the method. The GAAP issue is discussed as well as a method to comply with GAAP to smooth out earnings while not using the 'cookie jar reserves' method.

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