Definition of Cooking the Books

What does the term "cook the books" mean? What is meant by "cooking the books"?

The term "cooking the books" refers to when financial statements are falsified in order to make things seem better than they actually are.

There are accounting rules and principles that all companies must follow. If these rules are bent or broken, then the "cooking of books" can occur.

Why would a company "cook the books"? There are multiple reasons.

Cooking the Books - Definition and IllustrationPerhaps the CEO and CFO's earnings are attached to the financial performance of a company, so they hatch a scheme to "cook the books" in order to increase their own personal compensation.

Perhaps the company is engaging in outright fraud and wants to hide the fraud from the general public, so they hatch a scheme to "cook the books".

Perhaps one small indiscretion at a company has transformed itself into a full-blown "cooking of the books" as the company tries to hide something from its past.

Let's give you an example of when a company is "cooking the books".

Joe Smith owns a small company that teaches people how to perform CPR. His company is doing fairly well, but he decides to sell.

The company that buys Smith's business agrees to let Smith and his accountant continue to run the company (Smith will be the CEO and his accountant will be the CFO). The purchasing company will have 100% of the equity.

The purchasing company agrees that if Smith increases revenues by at least 25% over the next year, then he will be entitled to a $50,000 bonus.

Smith and his CFO hatch a scheme when they will inflate revenues by accelerating revenues. For instance, a company that uses Smith's services can pay on a month-by-month basis. However, Smith and his CFO decide to count the monthly fee as a full year of revenue (monthly fee X 12), despite the fact that a company can cancel the agreement at any time.

By counting a full year of revenues, Smith and his CFO are able to greatly inflate their revenues and receive (at least they think) their $50,000 bonus.

This is "cooking the books".

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