Cook the Books Meaning
The term cooks the book is used to describe that the fraudulent activities have been performed by the corporations for falsifying their financial statements. It means the distorting of the financial accounts of the firm deliberately for avoiding the tax payments, hiding of the facts so that the situation of the company seems better than the actual situation prevailing. Manipulation to some extent is done by every company in the practical world to make sure that there is budgets balance and there is a continuation of the funding to the company by the investors.
However, when these manipulations are done beyond the certain level where the executives of the company cross the line then it turns into the corporate fraud. Cook the books if found to be done some person then he might have to face the serious consequences of the same.
Top Examples of Cook the Books
Let’s see some examples of cookbooks.
#1 – Lump Sum Payments Booking
The company can cook the books by recording the lump sum payments received by it in the financial year in which it is received, the service of which is to be provided in upcoming financial years as well. For example, Company XYZ ltd is into the business of providing different services to its clients. In the current financial year, it received $ 100,000 as of the lump-sum payment from the company ABC Ltd for providing the services for the period of the next 4 years including the current year.
Now the company XYZ ltd included the whole $ 100,000 received from the ABC ltd as the revenue for the current financial year only for the purpose of increasing the current profits instead of amortizing it over the life of service contract i.e., $ 25,000 ($ 100,000 / 4) in the current year and $ 25,00 in next 3 years each. This is the example of the cook the books.
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#2 – Off the Balance Sheet Items
The company can do cook the books of the financial statements with the help of the off the balance sheet items. For example company, XYZ Ltd created the separate subsidiaries for the purpose of incurring those expenses that parent company is reluctant to disclose in its financial statements and it can show it in the books of accounts of the subsidiary company so formed. If these subsidiaries created are being set up as the separate legal entities which are not owned wholly by the parent company than those are not required to be recorded by the parent company in its financial statements and same can be hidden from the investors of the company.
Real-Life Examples of Cook the Books
Some of the examples where there were companies who actually cooked the books include the famous companies Adelphia, Enron, and Worldcom where they claimed the existence of billions in assets in their financial records which actually didn’t exist in the reality.
Why do Companies Cook the Books?
Cook the books are the manipulation in the financial records of the company which is not allowed and is an illegal act. It is done by the company to present its better picture in front of the stakeholders or hide the facts from the stakeholders which it doesn’t want them to know. It is wrongdoing, so no advantages are present in this; instead, if someone is found guilty for doing the manipulation in the books of accounts of the company it will be treated as the fraud and the person responsible can be punished for such wrongful act.
Disadvantages of Cook the Books
There are different limitations and drawbacks of the cook the books which include the following:
- If the company uses the cook the books and if it comes into the notice then it will be treated as the fraud and the person responsible will be liable for the legal actions for such wrongful act.
- From the perspective of the investors and the other stakeholders of the company, cook the books are problematic as it will give wrong information to them about the financial health of the company.
Important Points of Cook the Books
- There are many of the interesting numbers which are present in the financial statements of the company that motives the investors take quick decision about the financial health of the company and to make the investment, but this should not be done as just by seeing the number the exact idea about the company cannot be gathered. One should look into the financial records of the company with the due diligence in order to understand the correct picture of the company and to get satisfied that no cook the books have been done.
- Investors should read the footnotes which are given at the financial statements of the company to get the clue for tracking down the truth of the company.
Thus, Cook, the books is the slang term which is used for the accounting tricks which are used make the financial result of the company to look better than what they really are. Generally the cooking the books involve the financial data manipulation with the motive of inflating the earnings of the company or deflating the expenses of the company for the betterment of the bottom line. Many of the reform legislation came from time to time in the past by the authorities but despite these regulations, still, the corporate misdeeds occur. There are various ways through which cook the books can be done by the company like accelerating revenues, delaying expenses, accelerating the pre-merger expenses, manipulating off-balance sheet items, manipulation in the pension plans, etc.
Looking at these items and finding the hidden items from the financial statements of the company can be used as the warning sign by the investors for the manipulation of the earnings. However, this does not necessarily mean there is cooking the books by the company, investors should look at all the things with due diligence before making any investment in the company he decides to invest in.
This has been a guide to what is Cook the Books and it’s meaning. Here we discuss why do companies Cook the books along with examples, disadvantages and its limitations. You can learn more about accounting from following articles –