Accounting Cushion
Barron's Accounting Dictionary:
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Accounting Cushion
Overstating an expense provision. This provides a larger balance in the estimated liability or allowance account so as to minimize the amount of an expense provision for a later period. It understates the current period's profit and in effect overstates the earnings in the period when the anticipated event occurs. For example, a company's allowance for bad debts from accounts receivable may substantially increase even though the company's bad debt write-off experience has become much better. In this case, the overstatement of bad debt expense unjustifiably understates the present year's net income.
Because less of a bad debt expense provision will be needed next year due to the overstated allowance account, net income will be higher next period. The auditor should upwardly adjust net income for the charges creating the accounting cushion. It should be noted, however, that for tax purposes companies must use the direct write-off method for bad debts.
See also income smoothing.
Because less of a bad debt expense provision will be needed next year due to the overstated allowance account, net income will be higher next period. The auditor should upwardly adjust net income for the charges creating the accounting cushion. It should be noted, however, that for tax purposes companies must use the direct write-off method for bad debts.
See also income smoothing.
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Investopedia Financial Dictionary:
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Accounting Cushion
The overstatement of a company’s expense provision, in order to create a cushion for future results. A company can use this to artificially understate income in the current period by overstating liability or allowance accounts. This will give the company the ability to overstate income in a later period. An accounting cushion can be achieved by increasing allowances for bad debts in the current period, without any indication that bad debts will actually rise. This would understate accounts receivable in the current period, and the company could make up for it in the next period by overstating accounts receivable. This is a method of income smoothing, and if discovered an auditor or analyst should adjust these back to their proper levels.
Investopedia Says:
You may be wondering why any company would want to understate income in any period. The reason is that some company’s are expected to be very stable, and investors buy their stocks for that reason. Investors may expect company ABC to grow at 4% every period. If the company instead grows 6% in the first period, and declines 1% in the second, it would be bad for the perception of the stock. Investors may require a higher risk premium, therefore driving down the value of the stock. Management would rather understate the 6% growth and overstate income in the second period to smooth out the income. This may seem less harmful then some other, but misleads the investing public about the true stability of a company’s income stream.
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Barron's Accounting Dictionary
Dictionary of Accounting Terms. Copyright © 2010 by Barron's Educational Series, Inc. All rights reserved.
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