What is Cook the Books?

Cook the book is a term indicating using accounting tricks to make a company’s financial results look better than they really are. Typically, cooking the books involves manipulating financial data to inflate a company’s revenue and deflate its expenses in order to pump up its earnings or profit.

Companies can manipulate their financial records to improve their financial results using a multitude of tactics. Some companies don’t record all of their expenses that incurred in a period until the next period. By recording a portion of Q1’s expenses in Q2, for example, a company’s Q1 earnings or profit will look more favorable.

Many companies who sell their product, extend terms to their customers, which allows them to pay the company at a later date. These sales are recorded as accounts receivables (AR) since they represent product that’s been sold and shipped, but the customers have yet to pay. The terms can be 30, 60, 90 days, or more. Companies can falsify their AR by claiming that they made a sale and record the accounts receivable on the balance sheet. If the fake receivable is due in 90 days, the company can create another fake receivable 90 days from now to show that current assets remain stable. Only when a company falls behind collecting its receivables will it show that there’s a problem. Unfortunately, banks often lend, in part, based on the value of a company’s accounts receivables and can fall victim to lending off false receivables. During a detailed audit, the bank auditors would match the AR invoices to customer payments into the company’s bank accounts, which would show any amounts not being collected.

During the first years of the new millennium, several large Fortune 500 companies, such as Enron and WorldCom, were found to have used sophisticated accounting tricks to overstate their profitability. In other words, they cooked the books. Once these massive frauds came to light, the ensuing scandals gave investors and regulators a stark lesson in how clever some companies had become at hiding the truth between the lines of their financial statements.

Investopedia