Cook the Books Meaning
Cooks the book is used to describe that the fraudulent activities performed by the corporations for falsifying their financial statements and therefore, as a means to distort financial accounts of the firm deliberately for avoiding the tax payments or 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 very every company to balance the budget and to ensure continuation funding to the company from investors. However, when these manipulations exceed a certain level where the executives of the company cross the line, then it turns into corporate fraud. If some people cook the books, then he might have to face serious consequences.
Top Examples of Cook the Books
#1 – Lump Sum Payments Booking
The company can manipulate 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 four 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 to increase 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 three years each.
#2 – Off the Balance Sheet Items
The company can manipulate financial statementsFinancial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels. with the help of the off the balance sheet items. For example company, XYZ Ltd created separate subsidiaries to incur 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 companySubsidiary CompanyA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company. so formed. If the subsidiaries created are separate legal entities that are not owned wholly by the parent company, then those are not required to be recorded by the parent companyParent CompanyA holding company is a company that owns the majority voting shares of another company (subsidiary company). This company also generally controls the management of that company, as well as directs the subsidiary's directions and policies. in its financial statements; the same can hide from the investors of the company.
Real-Life Examples of Cook the Books
Some of the examples where there were companies who 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 didn’t exist in reality.
Why do Companies Cook the Books?
These 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.
- 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 investors and the other stakeholder’s perspective, this type of manipulation is problematic as it will give wrong information about the financial health of the company.
Important Points of Cook the Books
- Many of the interesting numbers present in the financial statements of the company can motivate the investors for a quick decision about the financial health of the company and 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 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 a slang term used for the accounting tricks used to make the financial result of the company look better than actuals. Generally, cooking the books involve 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 lineBottom LineThe bottom line refers to the net earnings or profit a company generates from its business operations in a particular accounting period that appears at the end of the income statement. A company adopts strategies to reduce costs or raise income to improve its bottom line. . Despite many reform legislation from authorities in the past, 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 itemsOff-balance Sheet ItemsOff-balance sheet items are those assets that are not directly owned by the business and therefore do not appear in the basic format of the balance sheet. However, they tend to impact the financials of the company indirectly., 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 –