Final answer:
Cookie-jar reserves are used to stabilize earnings by setting aside excess profits in good years to boost profits in poor years, thereby smoothing income over time. This can either reduce earnings and tax liabilities in high-income years or increase them in low-income years. The practice can be used to manipulate earnings, which can mislead investors when not transparently disclosed.
Step-by-step explanation:
The use of cookie-jar reserves in accounting refers to the practice of companies setting aside reserves from good financial periods to use in future periods that may not perform as well.
This practice can affect earnings in different ways depending on when the reserves are utilized. If a company dips into these reserves during periods of lower income, it can increase reported earnings and consequently, tax liabilities during those years. Conversely, when a company adds to the cookie-jar reserves in high-income years, it may report lower earnings for that period, reducing its tax liabilities. The underlying goal is often to smooth out earnings over time, making results appear more stable to investors.
However, this practice can also be used to manipulate earnings, potentially misleading investors about the company's true financial performance. When not used transparently and in accordance with accounting principles, the manipulation of earnings through cookie-jar reserves can be unethical or even illegal.
It's important to recognize that while it can help stabilize earnings and manage tax burdens, the use of cookie-jar reserves can be controversial when it comes to fair financial reporting.