CFA Practice Question

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CFA Practice Question

When a company sells a product with a warranty, it must recognize the estimated expense of honoring that warranty at the same time that it books the revenue. A company might conclude that it incurs warranty costs of $10,000 for every $1 million in sales. If it's having a particularly profitable year, it might decide to recognize a $30,000 warranty expense per $1 million in sales, just to be safe. This practice is commonly referred to as ______.

A. conservative accounting
B. cookie jar reserve accounting
C. big-bath accounting
Correct Answer: B

This practice builds up a big warranty reserve now so that the company doesn't have to record warranty expenses in the future, thus shifting profits from one period to the other. This tactic goes by the name "cookie jar accounting" because it essentially stashes excess profits away to be used when needed.

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