Unmasking Voodoo Accounting: Deceptive Practices and the Impact of the Sarbanes-Oxley Act

Voodoo Accounting: Unraveling the Deceptive Practices


Voodoo accounting refers to an unethical and creative method of accounting employed by companies to artificially inflate their financial figures, such as revenue and profit, by concealing expenses or using accounting gimmicks. These practices came to light following high-profile accounting scandals involving companies like Enron, Tyco, and WorldCom. In response to these scandals, the Sarbanes-Oxley Act of 2002 was enacted to reform regulations and impose stricter penalties on fraudulent acts.

Understanding Voodoo Accounting

Voodoo accounting involves various maneuvers used by companies to hide losses and inflate profits, deceiving investors and analysts into believing that the company is more profitable than it actually is. While larger companies subjected to greater scrutiny find it challenging to execute these tricks, voodoo accounting is more prevalent among smaller, less closely monitored public companies. The motivation behind these practices often stems from the pressure to meet quarterly earnings expectations on Wall Street.

Examples of Voodoo Accounting Practices

  1. Big bath charges: This technique entails reporting one-time losses improperly, where companies take a significant charge to mask lower-than-expected earnings.
  2. Cookie jar reserves: Companies use this gimmick for income smoothing, manipulating financial figures by setting aside reserves during periods of higher profits to offset future losses.
  3. Recognizing revenue before collection: This practice involves recording revenue before it is actually received, artificially inflating current financial figures.
  4. Merger magic: Some companies write off most or all of an acquisition price as in-process research and development (R&D), manipulating financial statements to boost the bottom line.

Implications and Special Considerations

Companies often resort to voodoo accounting to maintain investor confidence and meet expectations. However, the discovery of these deceptive practices can have severe consequences. The repercussions may include compromised executive compensation and job security, tarnished company reputation, and diminished market value.

The Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 was enacted in response to high-profile accounting scandals, primarily the Enron scandal, where the company employed off-the-book accounting practices to deceive shareholders and regulators. The act aimed to enhance financial reporting integrity and transparency by implementing reforms and imposing stricter penalties for financial fraud. It plays a crucial role in preventing and combating voodoo accounting practices.

Example Illustrating Voodoo Accounting

To better understand voodoo accounting, let’s consider a hypothetical scenario. A company employs voodoo accounting to prematurely recognize $5 billion of revenue while concealing $1 billion in unexpected expenses during a quarter. By doing so, the company reports a net income that is $6 million higher than the actual figure for the quarter. However, once the discovery of these fictitious profits is made, the positive share price reaction is quickly reversed, raising concerns about management credibility.


Voodoo accounting represents an unethical and deceptive approach to financial reporting that artificially inflates a company’s figures. It involves various accounting gimmicks to manipulate revenue and conceal expenses. The Sarbanes-Oxley Act of 2002 serves as a regulatory framework to prevent and penalize such fraudulent practices, ensuring companies uphold truthfulness and transparency in their financial reporting.

Comprehensive Resources on Voodoo Accounting and Sarbanes-Oxley Act

Websites and Online Resources:

  1. Investopedia – Voodoo Accounting Definition and Examples Link: https://www.investopedia.com/terms/v/voodoo-accounting.asp
    • Provides a clear definition and detailed examples of voodoo accounting, helping readers understand the deceptive practices used by companies.
  2. U.S. Securities and Exchange Commission (SEC) – Sarbanes-Oxley Act Information Link: https://www.sec.gov/fast-answers/answersarbohtm.html
    • Offers official information from the SEC about the Sarbanes-Oxley Act, its key provisions, and its role in combating accounting fraud and voodoo accounting.


  1. “The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron” by Bethany McLean and Peter Elkind Link: https://www.amazon.com/Smartest-Guys-Room-Amazing-Scandalous/dp/1591846609
    • This book delves into the Enron scandal, revealing how voodoo accounting led to the downfall of the energy giant and provides valuable insights into fraudulent accounting practices.
  2. “Sarbanes-Oxley For Dummies” by Jill Gilbert Welytok Link: https://www.amazon.com/Sarbanes-Oxley-Dummies-Jill-Gilbert-Welytok/dp/0471754889
    • A beginner-friendly guide that explains the Sarbanes-Oxley Act’s intricacies, its impact on financial reporting, and its significance in curbing voodoo accounting.

Academic Journals and Research Papers:

  1. “The Impact of the Sarbanes-Oxley Act on Corporate Structure” by Robert Charles Clark Link: https://hls.harvard.edu/faculty/directory/10825/Clark
    • A scholarly article discussing the effects of the Sarbanes-Oxley Act on corporate governance and structure, shedding light on its role in mitigating voodoo accounting practices.
  2. “Detecting Earnings Management: A Simple Test of Voodoo Accounting” by Simon Gervais and Terrance Odean Link: https://faculty.haas.berkeley.edu/odean/papers/voodoo.pdf
    • This research paper outlines a test for detecting earnings management, including voodoo accounting techniques, providing valuable insights for investors and analysts.

Reports and Studies:

  1. “Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Reports” by Howard Schilit Link: https://www.amazon.com/Financial-Shenanigans-Detect-Accounting-Gimmicks/dp/126011726X
    • An informative report highlighting various accounting gimmicks, including voodoo accounting, and offering tools to detect fraudulent practices.
  2. “Sarbanes-Oxley Section 404 Compliance Costs and Earnings Quality” by Joseph V. Carcello and Terry L. Neal Link: https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1475-679X.2003.00092.x
    • A research study examining the relationship between the costs of Sarbanes-Oxley Act compliance and the quality of earnings, providing insights into its impact on financial reporting accuracy.

Professional Organizations and Associations:

  1. American Institute of Certified Public Accountants (AICPA) Link: https://www.aicpa.org
    • The AICPA offers resources and guidance on accounting ethics, fraud prevention, and professional standards, providing valuable insights into detecting and preventing voodoo accounting practices.
  2. Financial Accounting Standards Board (FASB) Link: https://www.fasb.org
    • FASB sets accounting standards in the United States and provides educational resources and updates on financial reporting practices, including measures to address voodoo accounting.

The Andersen Effect and the Sarbanes-Oxley Act: Preventing Accounting Scandals and Safeguarding Financial Integrity

The Andersen Effect: Meaning and History in the Enron Scandal

What is the Andersen Effect?

The Andersen Effect refers to auditors taking extra precautions and performing more extensive due diligence to prevent financial accounting errors and mishaps similar to those that led to the collapse of Enron in 2001.

The term “Andersen Effect” is derived from Arthur Andersen LLP, a prominent accounting firm based in Chicago. By 2001, Arthur Andersen had become one of the Big 5 accounting firms, alongside PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young, and KPMG. At its peak, Arthur Andersen employed nearly 28,000 people in the U.S. and 85,000 worldwide. The firm was renowned globally for its ability to deploy experts internationally, providing auditing, tax, and consulting services to multinational businesses.

History: From a “Big 5” to Collapse

Arthur Andersen’s reputation and success were shattered in 2002. The firm faced severe consequences as more flawed audits were uncovered during the Enron investigation and subsequent indictment. In June of that year, Andersen was convicted of obstruction of justice for destroying documents related to its audit of Enron, which became infamous as the Enron scandal. The Securities and Exchange Commission (SEC) also faced criticism for its perceived failure in overseeing the situation. However, Arthur Andersen, previously highly reputable and respected, suffered the most significant damage.

Arthur Andersen’s involvement in faulty audits extended beyond Enron. Other high-profile accounting scandals associated with the firm included Waste Management, Sunbeam, and WorldCom.

The Sarbanes-Oxley Act of 2002

In response to the series of accounting scandals, Congress passed the Sarbanes-Oxley Act of 2002 (SOX). This federal law established new or enhanced requirements for all U.S. public companies, management, and public accounting firms, aiming to prevent another Enron scandal and the Andersen Effect. Key points regarding SOX and its impact include:

  1. Requirements: SOX mandated new or expanded obligations for public company boards, management, and public accounting firms.
  2. Strong Corporate Governance: The accounting and corporate scandals triggered by Arthur Andersen led to a push for stronger corporate governance and heightened accounting controls to prevent similar incidents.
  3. Positive Outcomes: An unexpected positive outcome of SOX is that it introduced a higher level of scrutiny, resulting in companies voluntarily restating their earnings even if there was no intentional misrepresentation of accounting information.

The Bottom Line

The collapse of even the largest and most reputable accounting firms can occur due to mismanagement or mistakes made on behalf of a client. The Sarbanes-Oxley Act was enacted to protect clients and investors. However, the increased scrutiny mandated by the act also safeguards companies and public accounting firms, preventing errors that could potentially lead to their downfall.

Further Resources on the Andersen Effect and the Sarbanes-Oxley Act

Websites and Online Resources:

  1. Securities and Exchange Commission (SEC) – Official website providing comprehensive information on regulations, enforcement actions, and corporate governance related to the Sarbanes-Oxley Act and other financial matters. Link
  2. Public Company Accounting Oversight Board (PCAOB) – The official resource for audit standards and oversight, offering insights into auditing practices and measures taken to prevent accounting scandals. Link


  1. “The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron” by Bethany McLean and Peter Elkind – An in-depth exploration of the Enron scandal and its connection to Arthur Andersen, shedding light on the events that led to the Andersen Effect. Link
  2. “Sarbanes-Oxley For Dummies” by Jill Gilbert Welytok – A comprehensive guide to understanding the Sarbanes-Oxley Act, its implications, and the measures it introduced to prevent corporate fraud and enhance transparency. Link

Academic Journals and Research Papers:

  1. “The Sarbanes-Oxley Act and Corporate Governance” by Reinier Kraakman, George Triantis, and Howell Jackson – A research paper discussing the impact of the Sarbanes-Oxley Act on corporate governance and financial reporting. Link
  2. “Arthur Andersen and the Enron Case: A Critical Analysis of the Law and Ethics of Corporate Governance” by James M. Olson – An academic examination of the ethical and legal issues surrounding the Enron scandal and the role of Arthur Andersen. Link

Reports and Studies:

  1. “The Impact of the Sarbanes-Oxley Act on American Businesses” – A report by the U.S. Chamber of Commerce assessing the effects of the Sarbanes-Oxley Act on American businesses and financial markets. Link
  2. “Lessons from the Enron Scandal On Corporate Governance, Executive Compensation, And Auditor Independence” – A study by the U.S. Senate Committee on Governmental Affairs analyzing lessons learned from the Enron scandal and implications for corporate governance. Link

Professional Organizations and Associations:

  1. American Institute of Certified Public Accountants (AICPA) – The leading professional organization for CPAs, offering resources and guidelines related to auditing and accounting practices, including those influenced by the Sarbanes-Oxley Act. Link
  2. The Institute of Internal Auditors (IIA) – A global organization providing guidance and standards for internal auditing, relevant to corporate governance and internal controls required by the Sarbanes-Oxley Act. Link