Cookie jar accounting is a term that refers to the practice of storing back excess financial reserves during periods of high production for use in later periods when income is not sufficient to meet expenses. While this general principle can be used in both a household and corporate environment, the actual term tends to be utilized in business circles. By creating reserves against losses that may take place in the future, the company is able to fortify itself in a way that will allow continued operation without borrowing resources, or selling off property in order to generate cash to cover normal operating expenses.
The basic approach to cookie jar accounting is relatively simple. If at the end of an accounting period the company is found to have realized net profits above and beyond the amount projected in the operating budget, this creates what is known as surplus. The company is then able to place the surplus profits into some sort of interest bearing account. When and as there are budget deficits in later accounting periods, the surplus can be utilized to cover operating expenses without disrupting or having to cut back on production.
Cookie jar accounting is understood to hearken back to a common practice that was used in residential settings in years past. When the cash intended for the monthly budget was not completely utilized to cover the various bills and regular expenses of the household, the extra cash was housed in a cookie jar that resided in the kitchen. If the following month was beset with an unexpected expense, the unused cash in the cookie jar could be used to handle the situation without throwing the current month’s budget into turmoil.
Private companies today continue to make use of the basic cookie jar approach. However, public companies are not always free to make use of this type of corporate accounting practice. In several countries around the world, publicly traded companies are not allowed to engage in cookie jar accounting. This is because corporate trading practices of this type can be employed to create the impression that a public company is in better financial condition that is actually the case. Because this false impression could possibly create the wrong impression for a prospective investor, government regulations normally limit the use of cookie jar accounting to privately held businesses.