lexicon of earnings management-Big Bath and Cookie Jar Reserves

Explain the following two terms in the lexicon of earnings management. When you explain each term, give an example, including a clear description, of how it is done (what accounts might be used and what situation would provide an opportunity for management to use this method). Label each answer.

1. Big Bath
2. Cookie Jar Reserves

Answer

Earnings management entails the modification of financial reports to mislead the stakeholders regarding the underlying performance of an organization. The use of these approaches of recording financial information about an organization’s income that give false idea of the company’s success are not illegal but are considered dishonest.

Big Bath

Big Bath is considered as an unethical accounting method whereby the income in a bad year is made to look even worse than it actually is. Banks can engage in big bath typically when facing rising default rates on loans when the economy gets into recession and unemployment increases.

Cookie Jar Reserves

Cookie Jar Reserves are savings from earlier quarters that an organization records as earnings in the subsequent quarters to alter the earnings making them look as if they were higher than they are really are. Ideally, when an organization fails to attain its target, the accountant can decide to dive into cookie jar and inflate the numbers.

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